Tag: Firm valuation

PECO v. Walnut: Firm Valuation

Steven J. Steinman is partner and co-head of the Private Equity Transactions Practice at Fried, Frank, Harris, Shriver & Jacobson LLP. This post is based on a Fried Frank memorandum by Mr. Steinman, Aviva F. Diamant, Christopher Ewan, and Gail Weinstein. This post is part of the Delaware law series; links to other posts in the series are available here.

In PECO v. Walnut (Dec. 30, 2015), the Delaware Court of Chancery refused to review a valuation firm’s determination of the value of an LLC’s preferred units when the LLC agreement provided that the value as determined by an independent valuation firm would be binding on the parties. While PECO related to the valuation of LLC units in connection with the exercise of a put right, the decision presumably would apply more broadly—including to post-closing adjustments and other valuations.


Equity Market Misvaluation, Financing, and Investment

Toni Whited is Professor of Finance at the University of Michigan. This post is based on an article authored by Professor Whited and Missaka Warusawitharana, Principal Economist at the Board of Governors of the Federal Reserve System.

Stock market volatility often dwarfs the volatility of real activity. Even in the 2008-2009 financial crisis, the sharp cutback in production and employment by many firms was tiny relative to the far steeper drops seen in most of their stock prices. The existence of such wide fluctuations in equity values relative to real activity raises the question of whether these swings reflect movements in intrinsic firm values. If not, then equity may be misvalued, and it is natural to wonder whether these non-fundamental movements in equity values affect managerial decisions. Put simply, does market timing occur, and how large are its effects?


The Long-term Effects of Hedge Fund Activism: A Reply to Cremers, Giambona, Sepe, and Wang

Lucian Bebchuk is Professor of Law, Economics, and Finance at Harvard Law School; Alon Brav is Professor of Finance at Duke University; Wei Jiang is Professor of Finance at Columbia Business School; and Thomas Keusch is Assistant Professor at the Erasmus University School of Economics. This post relates to a recent article, Hedge Find Activism and Long-Term Firm Value, by Cremers, Giambona, Sepe, and Wang, which was recently made publicly available on SSRN. This post is related to the study on The Long-Term Effects of Hedge Fund Activism by Lucian Bebchuk, Alon Brav, and Wei Jiang (discussed on the Forum here).

This post replies to a study by Cremers, Giambona, Sepe, and Wang (“the CGSW Study”), Hedge Find Activism and Long-Term Firm Value. The CGSW study, which has recently been publicly released on SSRN and simultaneously announced in a Wachtell Lipton memorandum, aims at contesting existing evidence on the long-term effects of hedge fund activism. As we explain below, the paper overlooks prior opposing evidence on the subject, offers a flawed empirical analysis, and makes claims that are contradicted by its own reported evidence. Furthermore, the paper’s conclusions are inconsistent not just with our work, but with a large body of empirical studies by numerous researchers. CGSW’s claims, we show, should be given no weight in the ongoing examination of hedge fund activism.

In a paper titled The Long-Term Effects of Hedge Fund Activism, (“the LT Effects Study”), three of us tested empirically the “myopic activism claim” that has long been invoked by opponents of shareholder activism. According to this claim, hedge fund activism produces short-term benefits at the expense of long-term value. The LT Effects Study shows that the myopic activist claim is not supported by the data on targets’ Tobin’s Q, ROA, or long-term stock returns during the five years following the activist intervention.

CGSW focus on one part of the results of the LT Effects Study—those concerning Q (financial economists’ standard metric of firm valuation). Accepting that industry-adjusted Tobin’s Q improves in the years following activist interventions, CGSW assert that what has been missing is a comparison of how activist targets perform relative to a matched sample of similarly underperforming firms. CGSW claim that their matched sample analysis shows that the Q of activist targets improves less in the years following the intervention than the Q of matched control firms and that activism therefore decreases, rather than increases long-term value. Although CGSW do not look at stock returns, their conclusions imply that the announcement of an activist intervention represents “bad news” for investors that should be expected to be accompanied immediately or ultimately by negative stock returns for the shareholders of target companies.

Below we in turn comment on:

(i) Our obtaining different results than those reported by CGSW when applying CGSW’s empirical methodology to the same data;

(ii) The inconsistency of CGSW’s claims with some of their own reported results;

(iii) CGSW’s puzzling “discovery” of a well-known selection effect;

(iv) CGSW’s failure to engage with prior work conducting matched sample analysis and reaching opposite conclusions;

(v) CGSW’s flawed empirical methodology;

(vi) The inconsistency of CGSW’s conclusions with the large body of evidence on stock returns accompanying activist interventions; and

(vii) CGSW’s implausible claim that activist interventions have destroyed over 50% of the value of “innovative” target firms.

Although CGSW direct their fire at the Long-Term Effects Study, the discussion below explains that their conclusions are inconsistent not just with this study but with a large number of empirical studies by numerous researchers, including the many studies cited below.

CGSW’s Data and Results

The CGSW paper is based on a dataset of activist interventions that two of us collected and that the LT Effects Study used. Although we are still working with the data to produce additional papers, we agreed to provide the authors with our data to facilitate research in this area. To our surprise, the authors did not provide us an opportunity to comment on their paper before making their paper public, and we first learnt about the paper from Wachtell Lipton’s memorandum announcing it.

Although we view the empirical procedure used by CGSW as flawed, we have attempted to replicate their results using our data (which CGSW used), following the procedure described in their paper and making standard choices for elements of the procedure that the paper does not fully specify. Doing so, we have obtained results that are very different from those of CGSW.

We asked the authors to provide us with the list of the matched sample companies used in their tests. Even though their paper is based on data we shared with them, CGSW declined to provide us with the requested list and stated that they would not do so prior to the publication of their paper in a journal (which might be many months away).

Claims Inconsistent with CGSW’s Own Results

CGSW claim that their matched sample analysis shows that “firms targeted by activist hedge funds improve less in value … than similarly poorly performing firms that are not subject to hedge fund activism.” However, the patterns displayed in the authors’ key Figure 1 do not support this central claim.

This Figure 1, which we reproduce below, reports industry-adjusted Tobin’s Q for firms targeted by hedge funds (blue graph) and industry-adjusted Tobin’s Q for the matched control firms (paired with the target firms by CGSW) during the years before and after the year at which target firms became a target.

Although the authors state that the Figure “confirms” their conclusions, it does not appear to do so. The Figure vividly shows that targets’ valuation increases more sharply than that of matched control firms that are not subject to hedge fund activism during the years following time t (denoting the end of the intervention year).

CGSW might argue that, although target valuation increases more sharply relative to matched control firms from time t (the end of the intervention year) forward, the activist intervention is responsible for the short-term decrease in value relative to control firms that targets experience from time t-1 (the beginning of the year of the intervention) to time t (the end of the year of the intervention). However, this short-term decrease is likely to at least partly precede the intervention and thus be a potential cause rather than a product of it. Furthermore, while opponents of hedge fund activism have been seeking to ground their opposition in claims regarding long-term effects, we are unaware of any claims by such opponents that such activism decreases value in the short term, and the well-documented stock market gains accompanying announcements of activist interventions would make such a claim implausible.

Indeed, CGSW themselves explain that the view that is empirically supported by their paper is that hedge fund interventions pressure management to produce short-term gains that come “at the potential expense of long-term performance.” This view implies a short-term increase in valuation followed by a decline in valuation during the years following the intervention year. The clear improvement in target valuation (relative to control firms) from time t forward displayed in Figure 1 thus contradicts CGSW’s claims and conclusions.

Tobin’s Q around the start of activist hedge fund campaigns (sample of all hedge funds campaigns)


Source: Cremers et al., November 2015, page 44.

Although the inconsistency of CGSW’s claims with their own Figure 1 is worth noting in assessing CGSW’s paper, we should stress that, due to the methodological problems noted below, we otherwise do not attach weight to the authors’ results, including those in Figure 1.


Employee Rights and Acquisitions

Anzhela Knyazeva is a Financial Economist at the U.S. Securities and Exchange Commission. This post is based on an article authored by Dr. Knyazeva, Diana Knyazeva, Financial Economist at the Securities and Exchange Commission; and Kose John, Professor in Banking and Finance at New York University. The views expressed in this post are those of Dr. Knyazeva and do not necessarily reflect those of the Securities and Exchange Commission or its Staff.


In our paper, Employee Rights and Acquisitions, which was recently featured in the Journal of Financial Economics, we consider incentive conflicts involving employees, and how they may affect firms in the context of acquisitions. More specifically, we look at the effects of variation in employee protections on shareholder value, the choice of targets, and deal characteristics.  We focus on acquisitions since they are major firm investment decisions with the potential to substantially affect firm value.


Merion Capital: Merger Price as a Factor in Appraisal Action

William P. Mills is a partner in the New York Office of Cadwalader, Wickersham & Taft LLP. This post is based on a Cadwalader publication by Mr. Mills, Martin L. Seidel,  Gregory A. MarkelJoshua Apfelroth, and Brittany Schulman. This post is part of the Delaware law series, which is cosponsored by the Forum and Corporation Service Company; links to other posts in the series are available here.

In a recent decision in an appraisal action, the Delaware Chancery Court reaffirmed the Court’s reluctance to substitute its own calculation of the “fair value” of a target company’s stock for the purchase price derived through arms-length negotiations, provided it resulted from a thorough, effective and disinterested sales process. The October 21, 2015 decision, Merion Capital LP and Merion Capital II LP v. BMC Software, Inc., not only provides a comprehensive review of the fundamentals of appraisal actions, but also serves as a cautionary tale for merger arbitrageurs and other stockholders looking to seek appraisal remedies.


Fair Price and Process in Delaware Appraisals

Jason M. Halper is partner in the Securities Litigation & Regulatory Enforcement Practice Group at Orrick, Herrington & Sutcliffe LLP. This post is based on an Orrick publication by Mr. Halper, Gregory Beaman, and Carrie H. Lebigre. This post is part of the Delaware law series, which is cosponsored by the Forum and Corporation Service Company; links to other posts in the series are available here.

On October 21, 2015, the Delaware Court of Chancery issued a post-trial opinion in an appraisal action in which it yet again found that the merger price was the most reliable indicator of fair value. Vice Chancellor Glasscock’s opinion in Merion Capital LP v. BMC Software, Inc., No. 8900-VCG (Del. Ch. Oct. 21, 2015), underscores, yet again, the critical importance of merger price and process in Delaware appraisal actions. In fact, as we have previously discussed, Merion is just the latest of several decisions by the Delaware Chancery Court over the past six months finding that merger price (following an arm’s length, thorough and informed sales process) represented the most reliable indicator of fair value in the context of an appraisal proceeding. See also LongPath Capital, LLC v. Ramtron Int’l Corp., No. 8094-VCP (Del. Ch. June 30, 2015); Merlin Partners LP v. AutoInfo, Inc., No. 8509-VCN (Del. Ch. Apr. 30, 2015).


Delaware Court Awards Damages to Option Holders

Jason M. Halper is a partner in the Securities Litigation & Regulatory Enforcement Practice Group at Orrick, Herrington & Sutcliffe LLP. This post is based on an Orrick publication by Mr. Halper and Peter J. Rooney. This post is part of the Delaware law series, which is cosponsored by the Forum and Corporation Service Company; links to other posts in the series are available here.

On July 28, 2015, the Delaware Court of Chancery issued a post-trial opinion in which it criticized in particularly strong terms the analysis performed by a financial firm that was retained to value companies that were being sold to a third party or spun off to stockholders (the “valuation firm”). See Fox v. CDX Holdings Inc., C.A. No. 8031-VCL (Del Ch. July 28, 2015)CDX is just the latest decision in which the Chancery Court has awarded damages and/or ordered injunctive relief based in part on a financial firm’s failure to discharge its role appropriately. Calling the valuation firm’s work “a new low,” Vice Chancellor Laster’s opinion is another chapter in this cautionary tale that lays bare how financial firms can be exposed not only to potential monetary liability but, as importantly, significant reputational harm from flawed sell side work on M&A transactions.


Appraisal Arbitrage—Is There a Delaware Advantage?

Gaurav Jetley is a Managing Principal and Xinyu Ji is a Vice President at Analysis Group, Inc. This post is based on a recent article authored by Mr. Jetley and Mr. Ji. The complete publication, including footnotes, is available here. This post is part of the Delaware law series, which is cosponsored by the Forum and Corporation Service Company; links to other posts in the series are available here.

Market observers have devoted a fair amount of attention to possible reasons underlying the recent increase in appraisal rights actions filed in the Delaware Chancery Court. A number of commentators have connected such an increase to recent rulings reaffirming appraisal rights of shares bought by appraisal arbitrageurs after the record date of the relevant transactions. Other reasons posited for the current increase in appraisal activity include the relatively high interest rate on the appraisal award and a belief that the Delaware Chancery Court may feel more comfortable finding fair values in excess of, rather than below, the transaction price.

In our paper Appraisal Arbitrage—Is There a Delaware Advantage?, we examine the extent to which economic incentives may have improved for appraisal arbitrageurs in recent years, which may help explain the increase in appraisal activity. We investigate three specific issues.


Angels and Venture Capitalists: A Match Made in Heaven?

Thomas Hellmann is Professor of Entrepreneurship and Innovation at Oxford University. This post is based on two recent articles authored by Mr. Hellmann, Veikko Thiel, Assistant Professor of Business Economics at Queen’s University; Paul Schure, Associate Professor of Economics at the University of Victoria; and Dan Vo, Research Fellow at the University of British Columbia. Related research from the Program on Corporate Governance includes Carrots & Sticks: How VCs Induce Entrepreneurial Teams to Sell Startups, by Jesse Fried and Brian Broughman (discussed on the Forum here) and Delaware Law as Lingua Franca: Evidence from VC-Backed Startups, by Jesse FriedBrian Broughman, and Darian Ibrahim (discussed on the Forum here).

Are angel investors and venture capitalists friends or foes? Are they synergistic partners in the process of funding entrepreneurial value creation? Or are they distinct funding mechanisms where entrepreneurs have to decide which camp they want to be part of? In a series of two recent papers (Friends or Foes? The Interrelationship between Angel and Venture Capital Markets; and Angels and Venture Capitalists: Substitutes or Complements?), we examine these questions both from a theoretical [1] and an empirical [2] perspective.


Delaware Court Relies Exclusively on Merger Price in Appraisal Action

Toby Myerson is a partner in the Corporate Department at Paul, Weiss, Rifkind, Wharton & Garrison LLP and co-head of the firm’s Global Mergers and Acquisitions Group. The following post is based on a Paul Weiss memorandum authored by Matthew W. Abbott, Angelo Bonvino, Justin G. Hamill, and Jeffrey D. Marell. This post is part of the Delaware law series, which is cosponsored by the Forum and Corporation Service Company; links to other posts in the series are available here.

In a recent appraisal proceeding, the Delaware Court of Chancery concluded that the company had engaged in a thorough sales process, and therefore found that it was appropriate to determine fair value of the company’s stock by relying exclusively on the merger price less net synergies. The court found that a discounted cash flow (or “DCF”) analysis was an inappropriate method to value the company’s stock in this instance, as the DCF analyses relied upon by the parties were derived from unreliable management projections.

In Longpath Capital, LLC v. Ramtron International Corporation, Cypress Semiconductor Corporation (“Cypress”) issued a bear hug letter to acquire all of the shares of Ramtron International Corporation (“Ramtron”), a semiconductor company, for $2.48 per share. After the Ramtron board rejected this offer as inadequate, Cypress initiated a tender offer for Ramtron’s shares at $2.68 per share (which it later raised to $2.88 per share). During the time that Cypress pursued its tender offer, Ramtron authorized its financial advisor to market the company. The advisor contacted twenty-four potential buyers and Ramtron executed nondisclosure agreements with six of those potential buyers. Ultimately, however, none of the potential buyers made a firm bid for Ramtron. Eventually, Ramtron and Cypress engaged in active negotiations, which resulted in Cypress raising its offer price twice before the parties settled on a final transaction price of $3.10 per share. Approximately two months following the signing of the merger agreement, the merger was approved by a vote of Ramtron’s stockholders. Longpath Capital, LLC (“Longpath”), a Ramtron stockholder, properly demanded appraisal of the fair value of its Ramtron stock under Section 262 of the General Corporation Law of the State of Delaware and filed an appraisal action in the Court of Chancery against Ramtron.