Reevaluating Shareholder Voting Rights in M&A Transactions

Afra Afsharipour is Professor of Law & Martin Luther King, Jr. Hall Research Scholar at the UC Davis School of Law. This post is based on a recent article by Professor Afsharipour, forthcoming in the Oklahoma Law Review. Related research from the Program on Corporate Governance includes Mergers, Acquisitions and Restructuring: Types, Regulation, and Patterns of Practice, by John C. Coates.

Shareholder voting plays a central role in corporate governance. Yet, for many public company acquisitions, only the target firm’s shareholders may be able to exercise voting rights. The lack of voting rights for bidder shareholders is problematic given evidence that many acquisitions involve negative returns for bidders. Bidder overpayment is particularly acute in the case of takeovers of publicly traded targets by publicly traded acquirers. Research shows that compulsory shareholder voting reduces the problem of bidder overpayment. In my article, Reevaluating Shareholder Voting Rights in M&A Transactions, which was recently published in Oklahoma Law Review, vol. 70, Fall 2017, I review the empirical and legal literature on the role of bidder shareholders in acquisitions and suggest ways that shareholder voting can be implemented in large public company acquisitions to reduce the overpayment problem.

The popular press is replete with stories of poorly performing acquisitions. The disastrous combination of firms such as America Online and Time Warner or the problem-laden acquisition of Countrywide by Bank of America are touted as examples of acquisitions that proved to be terrible deals for the acquirer. A company engrossed in an acquisition frenzy can end up overpaying for its target by significant amounts. For example, in September 2011, Hewlett Packard (“HP”) agreed to buy Autonomy for $10.3 billion—a decision that was controversial with HP shareholders who claimed that HP was overpaying. Only a year later, HP announced a write-down of $8.8 billion related to the Autonomy acquisition. The transaction also led to various lawsuits between HP and Autonomy management, and resulted in a large securities class action suit against HP.

Academic studies support popular perceptions of disastrous acquisitions. Empirical studies commonly find that acquisitions, particularly large deals involving publicly traded targets and buyers, result in losses for bidder firms and their shareholders. Not only do bidder shareholders lose, but losses from the worst-performing deals can be staggering.

Studies suggest two non-mutually exclusive explanations for bidder overpayment: agency problems and behavioral biases. Acquisitions tend to highlight conflicts of interest between managers and shareholders in large public corporations, and provide an opportunity for managers to obtain personal gain at the expense of shareholders. Management can benefit significantly from acquisitions through increased power, prestige, and additional compensation. The article provides a survey of several studies that point to CEO compensation as an important motive behind acquisitions. From a corporate governance perspective, studies indicate that acquisitions made by entrenched management destroy the most value for bidder shareholders. Behavioral biases also play an important role in acquisitions. Deals may be affected by management hubris or overconfidence about the value of the deal, management’s overestimation of and overoptimism regarding its ability to execute the deal successfully, and management’s desire to win or sunk cost biases. Despite these soft conflicts, the bidder’s board may not effectively stand in management’s way in large acquisitions. Management biases may also be amplified by advisors, including investment bankers, consultants who have been hired to undertake significant integration efforts, and lawyers. In cases where management stands to benefit from a deal, the often-close relationship between management and advisors can induce advisors to recommend transactions to avoid upsetting management’s plans. Once management and its advisors begin to feel committed to a deal and have expended significant resources to move forward on a transaction, abandoning plans can be quite difficult.

Neither the shareholders’ right to sell nor the right to sue effectively addresses the bidder overpayment problem and its underlying causes. Selling serves as a weak monitoring mechanism for bidder shareholders who often only sell their shares after the share price has fallen following announcement of an acquisition. The specter of a share drop following an acquisition announcement does little to deter bidder management given weaknesses in the market for corporate control. Suing is similarly unattractive for bidder shareholders. Unlike the vast number of fiduciary duty cases against target boards, cases against bidder boards are rarely brought and even more rarely successfully litigated. Not only do suits entail significant costs and delays, but for bidder shareholders the barriers to a successful suit are quite high given that such fiduciary duty cases likely will be subject to business judgment review.

What about the right to vote? Prominent legal scholars have previously suggested shareholder voting rights for bidder shareholders, but much of this debate has been muted over the past decade. Shareholder voting can reduce agency costs and incentivize greater director accountability. As the Delaware court famously noted in Blasius, “[t]he shareholder franchise is the ideological underpinning upon which the legitimacy of directorial power rests.” [1] In the U.S., however, management can easily avoid the vote for bidder shareholders in acquisitions. Two structures—a one-step triangular merger, or a two-step transaction involving a tender offer followed by a merger—are often used to acquire publicly traded firms. Transactions can be structured so that under state corporate law or stock exchange listing rules, bidder shareholders are excluded from any decision-making role in acquisitions.

Recent studies indicate that it may be time to reevaluate bidder shareholder voting. Shareholder voting rights could discourage opportunistic behavior by management. Studies indicate that powerful shareholders, such as institutional investors, value voting rights. A recent study by Becht et al addresses head on the value of voting on acquisitions, looking at the U.K. market where shareholder voting on large acquisitions is mandatory and binding under the U.K. listing rules. [2] The study shows that mandatory bidder shareholder voting increases firm value with results indicating that with mandatory voting U.K. shareholders gained $13.6 billion over 1992–2010 in aggregate (+$41 million on average), while without voting, U.K. shareholders lost $3 billion in aggregate. Moreover, the results of the study suggest that mandatory voting, which cannot be avoided by bidder CEOs in the U.K. as it can be in the U.S., changes management incentives and “imposes a constraint on the price that CEOs and boards can offer” in transactions subject to mandatory voting. [3]

Shareholder voting is now playing an increasingly important corporate governance role. Voting can serve a “monitoring role if the issue being decided affects the company’s stock price, or long-term value, and if the shareholder vote is likely to be superior, or complementary, to monitoring by the board or the market.” [4] The supplemental monitoring role of shareholders is particularly important when management suffers from soft conflicts, agency problems, and biases—the exact types of scenarios that research indicates are implicated in significant acquisition by public companies.

Voting may not be a panacea. Voting is costly and uncertain, and could potentially lead to additional deal risk. Voting rights do not guarantee that shareholders will make an informed decision, especially if shareholders are apathetic and/or suffer from collective action problems. Nevertheless, arguments against shareholder voting are tempered by the rise of institutional investors who have strong economic and political interests in monitoring management’s decisions via voting.

The article addresses several ways to achieve voting rights for bidder shareholders in significant acquisitions. One way to provide bidder shareholders with voting rights in large public company acquisitions is through amendment of stock exchange rules, akin to the listing rules adopted in the U.K. Such an amendment would necessarily require significant advocacy by organized institutional investors. Private ordering could be another avenue for providing voting rights to bidder shareholders. Shareholders could advocate for either advisory votes or binding votes (through a charter or bylaw amendment) on significant acquisitions. Such corporate governance proposals may take years to have an actual impact, and there may be political and economic reasons for stock exchanges and companies to resist greater shareholder voting rights. Nevertheless, given fundamental changes in the shareholder base of U.S. firms, voting in significant acquisitions may be more palatable now than ever.

The full article is available here.

Endnotes

1Blasius, Inc. v. Atlas Corp., 564 A.2d 651, 659 (Del. Ch. 1988).(go back)

2Marco Becht et al., Does Mandatory Shareholder Voting Prevent Bad Acquisitions?, 29 Rev. Fin. Stud. 3035, 3037 (2016).(go back)

3Id. at 3064.(go back)

4See Paul H. Edelman et al., Shareholder Voting in an Age of Intermediary Capitalism, 87 S. CAL. L. REV. 1359, 1363 (2014).(go back)

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