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E-MailItai Fiegenbaum is a Visiting Assistant Professor at Willamette University College of Law. This post is based on his recent paper, forthcoming in the Lewis & Clark Law Review, and is part of the Delaware law series; links to other posts in the series are available here.
Friendly sales of control are a well-known breeding ground for corporate agency costs. Managers, for instance, might be tempted to push through a transaction with a favored bidder instead of exploring an overture organized by a party against whom they hold a grudge. Or they might offer the buyer a sweetheart deal with the anticipation (if not expectation) of lavish compensation from the newly-sold entity. Both situations leave shareholders shortchanged.
Delaware law is aware of incumbents’ predilection to stray from shareholders’ interests and accordingly subjects friendly sales to a heightened standard of review. The Revlon standard, so named for the iconic case in which it was unveiled, stands for the proposition that usual business judgement rule deference is no longer warranted in a sale scenario. The courts are instead instructed to evaluate the board’s decision making process in an attempt to uncover deviations from the proper goal of shareholder value maximization. The standard used to have actual bite, as evinced by high profile transactions that were invalidated by the courts. While the doctrinal directive has remained essentially constant for three decades, its application today is quite different. Judges are loathe to nix a firm offer to purchase a company. Egregious misdeeds will at most be remedied by additional disclosure and a slight delay before the deal is sent to the shareholders for their approval. And under the powerful Corwin doctrine, a positive shareholder vote restores business judgment rule review, thereby insulating the transaction from judicial oversight.
An accepted narrative for this tectonic shift in Delaware’s takeover jurisprudence has recently emerged. The large grant of authority given to corporate insiders introduces the risk of self-serving behavior. Shareholders’ voting and litigation rights are designed to keep them in check. Each measure comes with unique costs and benefits. Unfortunate trends diminished whatever goodwill was associated with representative shareholder litigation. At the same time, the growth of financial intermediation invigorated the potency of the previously dormant shareholder vote. Moving away from a meticulous examination of every sale eliminates the costs of frivolous litigation at no harm to shareholder value. Framed this way, everyone appears to be better off.
Or so it seems. Central to the Corwin line of reasoning is the notion that the shareholder vote provides an effective restraint against insider overreaching. Yet nearly every deal that includes a premium over the market price is assured of shareholder approval. Even the revelation of evidence that casts the sales process in a negative light barely leaves a dent in their enthusiasm for the deal. The doctrinal lynchpin’s real-life insignificance exposes a baffling inconsistency in the most important trend in contemporary takeover jurisprudence.
My paper, Taking Corwin Seriously, contends that the Corwin doctrine is founded on a misunderstanding of the channels and consequences of shareholder empowerment. To be sure, shareholders today are able to utilize their voting clout to as never before. Yet this new-found power does not manifest as an ability to vote down a concrete transaction they are asked to approve. Rather, it originates from the combined efforts of financial intermediaries and activist hedge funds. The latter seek out underperforming companies that exhibit traits of managerial indolence. A hedge fund’s modest ownership position does not pose a direct threat to insiders’ continued incumbency. In combination with the voting power wielded by financial intermediaries, however, a hedge fund’s demand is made loud and clear. Full blown proxy fights for corporate control remain rare; it is the threat of displacement that scares the corporate hierarchy into righting the ship.
Uncovering the method through which shareholders safeguard their interests paves the way for this paper’s proposal for reform. The shortcomings of the final shareholder vote necessitate some measure of court oversight to deter insider overreaching. Considerable stakes ride on the courts’ ability to identify the transactions that warrant a steeper review. An overly broad approach runs the risk of putting a damper on value-enhancing transactions and rekindling the harmful litigation dynamics that Delaware has endeavored to eradicate. Too little oversight, by contrast, will inevitably lead to cursory adherence to transactional best practices. This paper proposes that a target company’s recent history with hedge fund activism factor prominently in the court’s decision on whether to grant the standard-reducing effect of the Corwin vote. In any case, the transaction is assured of shareholder support. An activist presence, however, is indicative of improved operating performance prior to the sale, and ultimately, increased shareholder value. The proposal thus strikes a proper balance between multiple competing interests while staying true to Corwin’s ideological roots.
The complete paper is available for download here.
