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E-MailRyan Bubb is the Robert B. McKay Professor of Law at New York University School of Law, Emiliano Catan is the Catherine A. Rein Professor of Law at New York University School of Law, and Holger Spamann is the Lawrence R. Grove Professor at Harvard Law School. This post is based on their recent paper.
State corporate law grants shareholders two key sets of rights in mergers and acquisitions (M&A). First, shareholders have statutory rights, such as voting on the transaction and appraisal rights for dissenting shareholders. Second, shareholders are entitled to loyal conduct by corporate fiduciaries—managers and directors—through the enforcement of their fiduciary duties. However, legal reforms in recent years have reduced shareholders’ ability to sue for breaches of these duties, placing greater reliance on shareholders’ statutory rights to safeguard their interests. This raises an important question: how powerful is the first set of rights—voting and appraisal—and can it obviate the second set—fiduciary duties? More generally, how should we understand and protect shareholders’ interests in control transactions from a functional perspective?
We tackle these issues by developing a general framework that focuses on the different bargaining dynamics created by different legal regimes. Our analysis begins by examining a baseline scenario where the target company has dispersed public shareholders and only managers can initiate a sale. Shareholders in this scenario are limited to their statutory rights, creating a fundamental problem. These shareholders, being numerous and unable to coordinate or make counteroffers, are vulnerable to “take-it-or-leave-it” offers from their managers. Consequently, shareholders receive only the value of their claims in the status quo, regardless of the degree of competition among bidders.
Why is this a problem? According to most of the prior literature, it isn’t. That literature has focused excessively on the efficiency of the market for corporate control, i.e., whether all and only value-enhancing transactions go forward. As we show, voting or appraisal rights, alone or in combination, achieve this goal. However, an equally important dimension of the problem is which firms get financed in the first place. From this perspective, it is a problem if shareholders cannot be promised a part of the deal upside, since this limits the financing needs that can be met through equity financing. We prove that starting from the statutory regime, shifting some of the deal surplus to shareholders would improve overall efficiency, even at the cost of reducing the efficiency in the market for corporate control. Specifically, we show that the marginal deals deterred by allocating more surplus to shareholders lack social value, while the marginal firms that are financed due to this shift have positive social value.
Fiduciary duties, the second key set of shareholder rights, play a critical role in securing a greater share of the deal surplus for shareholders. We expand our baseline model to analyze fiduciary duty regimes, beginning with the “anti-self-dealing norm,” which limits managers to receiving deal consideration proportional to their share ownership, prohibiting the acquirer from making “side payments” to the Manager. If courts can enforce this norm effectively, it ensures that shareholders receive a significant portion of the deal surplus, although it may lead to entrenchment—managers refusing offers to buy the company at a premium. Indeed, we find that a relatively strict anti-self-dealing regime that results in some degree of entrenchment is socially optimal.
Further, we examine the “cleansing” effect of shareholder approval. We first show that treating shareholder approval as foreclosing fiduciary duty suits unravels the protection offered by fiduciary duties. In addition, we show that the seemingly shareholder-friendly doctrine requiring controlling shareholders to condition certain transactions on a majority of the minority vote ab initio to receive more judicial deference can undercut shareholder protections by helping the controller make credible “take-it-or-leave-it” offers.
Finally, we explore how bidder competition interacts with fiduciary duties, including Revlon duties. Competition generally benefits shareholders by driving up the total price paid by the acquirer—albeit only if the rules in place prevent managers from appropriating the higher price. A “no frustration” norm—where bidders can make offers directly to shareholders without the approval of target managers—does even better on limiting side payments but also forgoes the potential benefit of an empowered bargaining agent by cutting out the manager entirely. Which rule—the anti-self-dealing norm or the no frustration rule—is superior for shareholders depends on both the degree of bidder competition and the bargaining power of target managers.
Finally, we analyze “Revlon duties,” which obligate managers to sell the firm to the highest bidder once they initiate any sale. When competition among bidders is strong, Revlon duties can improve shareholder outcomes by limiting side payments, albeit at the cost of potential entrenchment. However, imposing Revlon duties also weakens target managers’ bargaining leverage by taking away their ability to threaten to sell to a lower-valuing bidder.
In conclusion, our analysis suggests reconsidering courts’ increasing reliance on the shareholder vote and appraisal rights to protect shareholders. Strictly enforcing fiduciary duties is indispensable for effective shareholder protection. More generally, the key to evaluating alternative bundles of shareholder rights in control transactions is in understanding their impact on the bargaining structure.
