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E-MailAdam B. Badawi is Professor of law at Berkeley Law School; Matthew D. Cain is Senior Fellow at the Berkeley Center for Law and Business at Berkeley Law School; and Steven Davidoff Solomon is Professor of Law at Berkeley Law School. This post is based on their recent paper.
Louis D. Brandeis famously said that “sunlight is the best disinfectant” to promote vigorous and copious financial disclosure. While this principle seems like a common-sense aspiration, research has found that the social benefit of disclosure in the capital markets can be more complex and even negative. There is also a vigorous debate over the virtues of mandatory versus voluntary disclosure and the need for the former over the latter.
In Does Voluntary Financial Disclosure Matter? The Case of Fairness Opinions in M&A, recently posted to the SSRN, we use the shifting nature of Delaware disclosure requirements for fairness opinions in tender offers to assess the impact of voluntary versus mandatory disclosure in mergers and acquisitions (“M&A”) transactions. Unlike transactions structured as a merger—where the disclosure of fairness opinion details has long been required—the disclosure obligations for transactions structured as tender offers have shifted over recent decades. In this study, we scrape the details from over 900 disclosures by tender offer targets that span these changes in disclosure regimes. The sample, which encompasses 1995 to 2019, covers three distinct approaches taken by Delaware courts to tender offer disclosure. Prior to 2000, Delaware said little about the need to divulge the details of fairness opinions when a firm was the target of a tender offer. In this initial period, disclosure of these details was essentially voluntary. Around 2001, Delaware courts concluded that this information could be material to shareholders, but a series of cases in this period gave mixed messages about the level of detail required. Tender offer targets thus had to balance the costs of additional disclosure against a relatively low prospect of liability. By 2007, it became clear that a failure to disclose the relevant details of a fairness opinion would bring a significant risk of fiduciary liability. After this period, disclosure of fairness opinion details was essentially mandatory if a firm sought to avoid liability.
Across these time periods, we observe significant variation in whether firms disclose the details of fairness opinions in tender offers. Prior to 2000, when Delaware had said little about the practice, detail disclosure rates range from 6% to 16%. The era of uncertain guidance from 2000 to 2007 saw detail disclosure rates climb steadily from 27% to 62%. As Delaware became more insistent on the disclosure of these details, rates climbed to 87% in 2008 and stayed above 90% until reaching 100% disclosure in 2015.
These changing rules provide insight into the value of disclosure under both voluntary and mandatory regimes. The theoretical literature on disclosure emphasizes that, when disclosure is voluntary, a firm’s decision to disclose will turn on what the firm signals by choosing to disclose or not disclose. In the context of tender offers, a target is able to send signals both through the mere fact of disclosure and through the choice of details that it discloses. There are a number of potential audiences for this information, which include that target’s shareholders, other investors (including merger arbitrageurs), and other potential acquirors.
Disclosure of fairness opinion details is likely to be of most interest in low-premium deals. When the premium is high, the chances that shareholders will not tender or that a topping bid will emerge is lower. But these outcomes are more likely when the premium is low. We find evidence consistent with these expectations in the period before 2008, when disclosure of fairness opinion details was not mandatory. During this time, targets strategically utilized their discretion to disclose fairness opinion analyses. More specifically, we find that targets were more willing to provide detailed disclosure of fairness opinions when bidders made low-premium offers. We show that these disclosures were associated with subsequent price increases in transactions with low premiums. We also find that price increases are larger when the DCF range discloses a higher valuation of the target firm. Thus, we identify a channel through which disclosure plausibly communicates material information to market participants. We further analyze disclosure based on the investment bank and law firm. We find that fairness opinion disclosure is more likely to occur when a top-5 investment bank is retained.
We conduct this analysis in both the pre-2008 period when disclosure is voluntary and highly variant and in the latter years when the disclosure is more uniform and effectively mandatory (but still subject to some target discretion). We find that the disclosure effects we documented disappear once disclosure is more mandatory for targets. In other words, after 2007 when nearly all targets disclose the details of fairness opinions, the outcomes associated with voluntary disclosure disappear.
Our findings highlight the value of voluntary disclosure in M&A and capital markets generally. They also highlight the potential costs of mandatory disclosure. Targets utilize their disclosure option in order to provide a signal to the market concerning their valuation. This effect, however, disappears when disclosure is more uniform, indicating that investors are no longer able to pick up on any signal voluntary disclosure creates. Our results thus have policy implications for the usage of mandatory disclosure in M&A and highlight that such rules may have unintended effects.
