Print
E-MailFernán Restrepo is an Assistant Professor of Law at the UCLA School of Law. This post is based on his recent paper. Related research from the Program on Corporate Governance includes Allocating Risk Through Contract: Evidence from M&A and Policy Implications (discussed on the Forum here) by John C. Coates, IV; The New Look of Deal Protection (discussed on the Forum here) by Fernán Restrepo and Guhan Subramanian; and Toward a Constitutional Review of the Poison Pill (discussed on the Forum here) by Lucian A. Bebchuk and Robert J. Jackson, Jr.
Approximately four decades ago, in Revlon v. MacAndrews and Forbes, 506 A.2d 173 (Del. 1986), the Delaware Supreme Court required the directors of the target company in change-of-control mergers and acquisitions (M&A) to maximize short-term value – that is, to expose the company to a market canvass and refrain from favoring one bidder over another for reasons unrelated to immediate value maximization. The basic motivation behind this doctrine was the court’s desire to mitigate the conflicts of interest that may emerge in change-of-control transactions and the fact that those deals pose a “last period” problem: because the directors might have personal interests in a particular transaction, and because the selling shareholders will no longer exert any power over the directors after the company is sold, there is a significant risk that the directors will favor the deal that maximizes their personal interests rather than those of the shareholders.
Revlon is certainly one of the best-known and most controversial cases in corporate law. As other commentators have noted, the decision has reached “almost mythical status,” with hundreds of citations in other cases and academic studies, and with a central role in framing the conduct of the board in M&A (Cain et al., 2020). Part of the reason Revlon is so controversial is that there is no consensus on the benefits of the doctrine. Notably, some argue that Revlon is simply an application of the board’s general duty to be informed, which in turn suggests that the doctrine should not have much effect on M&A outcomes (e.g., Giovannelli, 1996), while others argue that a policy that facilitates competing bids (like Revlon does) can actually result in lower prices for the target shareholders because first bidders might reserve some cash to match competing offers, but no competing bids might ultimately emerge (Easterbrook and Fischel, 1981; 1982).
Despite Revlon’s importance, however, there is little empirical evidence on the impact of the decision on the welfare of the target shareholders. Two prior studies moved the literature forward by comparing relatively recent deals that were subject to Revlon duties with deals that were not (Cain et al., 2020; Gubler, 2021), but because those studies examine only post-Revlon deals, they leave open the question of whether the gains of the target shareholders in fact changed after Revlon. In a recent paper, therefore, I evaluate Revlon’s impact by comparing the gains of the target shareholders in Revlon transactions before and after the decision, and by examining whether non-Revlon deals experienced similar changes.
I measure the gains of the target shareholders associated with a transaction as the cumulative abnormal returns (CARs) for the stock of the target around the announcement of the deal. The Revlon deals in my sample consist of the transactions in which the buyer bought the target’s shares for cash. The non-Revlon deals include the transactions in which the consideration took the form of stock because in those cases the target shareholders remain in the consolidated business and therefore those deals are less likely to involve “change-of-control” situations (Paramount Communications Inc. v. QVC Network Inc., 637 A.2d 34, 43 (Del. 1994)). Of course, this empirical strategy has limitations, but I perform various sensitivity analyses that seek to mitigate those limitations.
The results show that the target shareholders in fact received higher returns in Revlon transactions after the case was decided – both in absolute terms and in relation to deals that do not trigger Revlon. The results therefore lend additional support to the claim that Revlon explains at least to some extent the higher gains that shareholders receive in Revlon deals today – a result that implies that if courts continue to limit the scope of the decision (as they have in recent years), then that policy may ultimately harm the target shareholders.
The paper is available for download here: https://ssrn.com/abstract=4626391.
