Conflicted Voting by Shareholders in Hostile M&A Deals

Matteo Gatti is Associate Professor of Law at Rutgers Law School. This post is based on an article authored by Professor Gatti. This post is part of the Delaware law series; links to other posts in the series are available here. Related research from the Program on Corporate Governance includes The Case Against Board Veto in Corporate Takeovers by Lucian Bebchuk.

Takeovers have historically kept corporate scholars very busy. Yet, to date, a very relevant topic—conflicted voting by shareholders in connection with a hostile acquisition—has surprisingly received little attention. My paper, It’s My Stock and I’ll Vote If I Want to: Conflicted Voting by Shareholders in (Hostile) M&A Deals, represents a primer to organically analyze instances in which shareholder conflicts might lead to inefficient acquisition outcomes.

Delaware courts have granted significant discretion to directors on how to respond to a hostile takeover, but left a caveat known as the ballot box route: if shareholders do not like how directors are reacting to a given offer, they have the ability to vote the board out and get rid of the underlying defense (almost always a poison pill). Bar any staggered board structure, pure hostile deals are possible only through such a route, in the form of a joint tender offer and proxy fight. But while scholars and courts have engaged extensively in balancing the conflicting interests between an entrenched board and shareholders willing to tender their shares, what happens to such a conflict once it reaches the proxy fight stage is unclear. How does, and how should, the law address conflicts of interest by shareholders when shareholders vote in hostile deals? Are we comfortable from a policy perspective that the bidder freely votes its shares? What about the shares held by directors and management? In the tender offer structure, the bidder is the contractual counterpart to the target shareholders and is thus in potential conflict with them: put simply, buyers want to spend less, while sellers want to receive more. Additionally, because of the well-known desire to maintain their respective roles, the votes cast by directors and management of the target, together with persons affiliated with them, are potentially in conflict with the interests of the other shareholders. To be sure, my paper takes the view that the negative influence of shareholders’ conflicts of interest is circumstantial: the mere possibility of a conflict is not sufficient to taint the vote. The pathology, I argue, is pursuing a personal interest and casting a pivotal vote against the interests of the other shareholders. If the offer is value maximizing, directors and managers voting against it (that is, voting to maintain the board and leave the pill in place) will be in conflict, but the bidder voting in favor will not. Conversely, if the offer is not value maximizing, the bidder voting in favor (that is, voting to replace the board and redeem the pill) will be in conflict, while directors and managers voting against will not.

The underlying stakes are significant: pivotal conflicted votes could result in an inefficient acquisition or could fend off an efficient one. After surveying existing devices to police such conflicts under positive law in Delaware, my paper utilizes a rules-vs.-standards framework to understand the advantages and disadvantages of some policy solutions. I present three possible approaches to address conflicted voting in acquisitions: a rule-based approach, a standard-based approach, and an unengaged approach. I argue that none of these approaches can be expected to work better than the others under all circumstances—they each carry positives and negatives. A system of balanced bright-line rules (that is, applicable to both bidder and target incumbents) would contain conflicted voting in a series of circumstances, but its potential over-deterrence can put at risk a subset of deals in which the universe of disinterested shareholders might not get it right. Standards have the advantage that, if well adjudicated, only the prohibited, conflicted conduct will be detected and sanctioned, with no problems stemming from over- or under-deterrence. But the worrying aspect of a standard approach is judicial discretion and potential error: the policy would call for the judge to establish the long-term value of the target as an independent entity. While the advantage of the unengaged approach is preserving the status quo, its clear problem is not offering protection when a conflicted vote distorts the voting and acquisition outcomes.

I suggest a combination of a rule-based approach and a standard-based one: the bidder and the incumbents would vote, but their shares would be presumed conflicted and thus not counted for determining the outcome of the vote/acquisition (rule-based element); however, each group could rebut the presumption by proving that its votes are not conflicted because they are directed to an outcome that maximizes shareholder value (standard-based element). This would constitute a less harsh version of a pure disinterested shares regime, because a group initially labeled as interested could actually demonstrate the opposite: entrenchment-seeking directors and management will have to convince a judge they are casting their vote because rejecting the bid is the best course of action, while bidders will have to prove their offer is not a low baller. Not only would this type of reform draw a line and show the legal system is wary of potential conflicts and offers protection in conflicted voting situations, but the expected cost of litigation would generate pressure against unduly entrenchment (for target incumbents) and low balling (for bidders). Incumbents will have to be specific as to why the offer is not in the best interests of the shareholders. The bidder will have to offer what a majority of unaffiliated recipients would consider above their reservation price: low-balling might thus be discouraged. Second, such pressure would be bolstered by each group’s interest in avoiding the litigation route by being convincing with their fellow shareholders in the proxy campaign: because a landslide outcome would make either group’s vote not pivotal, there would no need to go to court to have their respective votes counted. All in all, this approach would utilize procedural tools, such as burden shifting and factoring in expected litigation costs, in order to shape the actions of takeover players in connection with the underlying M&A transaction and help achieve the substantive policy goal of curbing conflicted voting to avoid suboptimal deals and promote desirable ones.

The full paper is available for download here.

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