Securities Law
Fixing Freezeouts
115 Yale L.J. 2 (2005) Freezeout transactions, in which a controlling shareholder buys out the minority shareholders, have occurred more frequently since the stock market downturn of 2000 and the Sarbanes-Oxley Act of 2002. While freezeouts were historically executed as statutory mergers, recent Delaware case law facilitates a new mechanism--freezeout via tender offer--by eliminating entire fairness review for these transactions. This Article identifies two social welfare costs of the current doctrinal regime. First, the tender-offer-freezeout mechanism facilitates some inefficient (value-destroying) transactions by allowing the controller to exploit asymmetric information against the minority. Second, the merger-freezeout mechanism deters some efficient (value-increasing) transactions because of the special committee's veto power against the deal. These negative wealth effects are unlikely to be resolved through private contracting between the controller and the minority in the corporate charter. Rather than advocating patchwork reforms to correct these problems, this Article proposes a return to first principles of corporate law in the freezeout context. The result of this re-grounding would be a convergence in judicial standards of review for freezeouts and the elimination of the efficiency loss that is inherent in the existing doctrine.
Bargaining in the Shadow of Takeover Defenses
113 Yale L.J. 621 (2003) For decades, practitioners and academic commentators who believe that target boards should have broad discretion to resist hostile takeover attempts have put forward the "bargaining power hypothesis" to support their view. This hypothesis states that a target with strong takeover defenses will extract more in a negotiated acquisition than a target with weaker defenses, because the acquirer's no-deal alternative, to make a hostile bid, is less attractive against a strong-defense target. The hypothesis helped usher in the modern era of takeover defenses: In endorsing the poison pill in Moran v. Household International, Inc., the Delaware Chancery Court framed the question as a balance between "the unrestricted right of shareholders to participate in nonmanagement sanctioned tender offers" and "the right of a Board of Directors to increase its bargaining powers." The bargaining power hypothesis has been voiced more frequently over the past few years as other shareholder-focused arguments in favor of takeover defenses, such as protection against "structural coercion" and protection against "substantive coercion," have been rendered less important through federal and state intervention or challenged by recent empirical evidence. Yet despite its venerable heritage and recent revitalization, the bargaining power hypothesis has generally been asserted by defense proponents and conceded by defense opponents, never subjected to a careful theoretical analysis or a comprehensive empirical test. This Essay attempts to fill this gap. I use negotiation-analytic tools to construct a model of bargaining in the "shadow" of takeover defenses. This model identifies the conditions that must exist in order for the bargaining power hypothesis to hold in a particular negotiated acquisition. I demonstrate that the bargaining power hypothesis only applies unambiguously to negotiations in which there is a bilateral monopoly between buyer and seller, no incremental costs to making a hostile bid, symmetric information, and loyal sell-side agents. These conditions suggest that the bargaining power hypothesis is only true in a subset of all deals, contrary to the claim of some defense proponents that the hypothesis applies to all negotiated acquisitions. I confirm the features of this model with evidence from practitioner interviews. It is interesting to note that while the bargaining power hypothesis lies squarely at the intersection of law and business--namely, legal rules on takeover defenses influencing the business issue of price--to my knowledge the businesspeople who actually negotiate price have been silent on this question. In order to better understand practitioner views, I interviewed the head or co-head of mergers and acquisitions at ten major New York City investment banks. Collectively these firms represented either the acquirer or the seller, or both, in seventy-two percent of negotiated acquisitions by number, and ninety-six percent by size, during the 1990s deal wave. The evidence compiled from these practitioner interviews is consistent with the theoretical model presented here. I then test the bargaining power hypothesis against a database of negotiated acquisitions of U.S. public company targets between 1990 and 2002 (n = 1692). If the hypothesis is correct, then premiums should be higher in states that authorize the most potent pills (Georgia, Maryland, Pennsylvania, and Virginia), and lower in the state that provides the least statutory validation for pills (California), relative to Delaware, which takes a middle ground on the pill question. Consistent with the predictions of my model, however, I find no evidence that premiums are statistically different across these states, either overall or in those subsamples in which bargaining power is most likely to manifest itself. I further test for intrastate differences using the Maryland Unsolicited Takeovers Act of 1999 as the basis for a natural experiment, and also find no empirical support for the bargaining power hypothesis. These findings have implications for the current antimanagerial, pro-takeover trajectory of Delaware's corporate law jurisprudence in the aftermath of Enron. Proponents of the status quo warn that such doctrinal movements will weaken targets' bargaining power in negotiated acquisitions, which will in turn reduce overall returns for target shareholders. But by unpacking the "black box" of negotiated acquisitions and examining the microlevel underpinnings of the bargaining process, this Essay suggests that a return to the original promise of intermediate scrutiny articulated in Unocal Corp. v. Mesa Petroleum Co. is unlikely to yield significant negative wealth consequences for target shareholders. Rather, as I and others have argued, a controlled revitalization of the hostile takeover marketplace can help to improve overall corporate governance, an objective that has become only more important in the post-Enron era. The remainder of this Essay proceeds as follows. Part II provides relevant background, including the origins of the bargaining power hypothesis and the evidence put forward to support it. Part III constructs a theoretical model of bargaining power in the negotiated acquisition context, beginning with a baseline case in which the bargaining power hypothesis clearly holds, and then adding real-world complexities that make it less plausible in many negotiated acquisitions. In addition, Part III uses evidence from practitioner interviews to illustrate the features of the model. Part IV provides new econometric evidence on the validity of the bargaining power hypothesis. Part V discusses implications of these findings. Part VI concludes.
How To Fix Wall Street: A Voucher Financing Proposal for Securities Intermediaries
113 Yale L.J. 269 (2003) Securities market intermediaries reduce the collective action problem facing investors in the capital markets. Analysts provide securities research. Proxy advisory firms assist investors in determining how to vote their shares. Even shareholders bringing proxy contests can be viewed as providing a collective benefit to the extent the contests are motivated by a desire to increase share value. Despite the services they provide to investors, many intermediaries face financing problems due to pervasive free riding on the part of dispersed shareholders. This can result in underfunding of valuable intermediary services or, alternatively, excessive or duplicative funding of wasteful services. One regulatory response is mandatory financing of intermediaries. Regulators are poorly suited, however, to determine optimal funding levels and to make appropriate allocation decisions. Alternatively issuers, through their managers, can subsidize intermediary services. Issuers may subsidize analysts, for example, through the investment banking fees they pay to brokerage firms. Manager control over allocation of issuer-based funding can, however, corrupt the intermediaries in favor of the managers. Understanding the problem of intermediary corruption as an outgrowth of the financing problem cautions against simply imposing regulatory prohibitions on voluntary issuer subsidies. Instead, this Article proposes a voucher financing mechanism to separate the source of subsidization from the allocation. Under the proposal, regulators determine a subsidy amount funded through levies on publicly traded firms, roughly equal to the present amount of subsidies that flow from issuers to intermediaries. Shareholders are then given the ability to direct the subsidy dollars to their preferred intermediaries, using vouchers in proportion to their shares. Voucher financing offers a market-based mechanism to finance intermediaries, resulting in greater flexibility and responsiveness in the provision of intermediary financing. Shareholders may aggregate vouchers from several companies in their portfolios and direct them across different intermediaries to their highest-value use. By providing a common funding mechanism for a range of intermediaries, voucher financing enables shareholders to address problems of both excessive and inadequate intermediary funding. Similarly, shareholder allocation reduces the potential for intermediary corruption. Although voucher financing is subject to problems, including information problems, coordination problems, and shareholder apathy, the Article identifies potential solutions to these problems and argues that voucher financing reflects a substantial improvement over the existing regulation and funding of intermediaries.
Insider Abstention
113 Yale L.J. 455 (2003) Scholars writing on insider trading have long believed that insiders can beat the market simply by using nonpublic information to decide when not to trade. Using a simple model, this Essay has shown that the conventional wisdom is wrong. Insiders prevented from trading while in possession of nonpublic information cannot outperform public shareholders, even if they can use such information to abstain from trading. In fact, insiders unable to trade or abstain while in possession of nonpublic information would systematically earn lower trading profits than public shareholders. The Essay has also offered a preliminary analysis of the effects of insider abstention on managers' incentives. It explained why insider abstention is unlikely to create the same types of potential distortions as insider trading. Indeed, insider abstention tends to align managers' interests with those of shareholders, and is therefore likely to improve managers' incentives. This Essay's analysis has important implications for current issues in insider trading regulation. First, the analysis contributes to the "possession versus use" debate by demonstrating that the "possession" standard for Rule 10b-5 liability achieves greater parity between insiders and outsiders than does the "use" standard. Second, the SEC's safe harbor permitting insiders to buy or sell shares pursuant to prearranged trading plans while in possession of material nonpublic information and to cancel the plans while aware of material nonpublic information enables insiders to profit from their access to such information. The SEC could easily eliminate insiders' advantages over public shareholders by not allowing insiders to cancel their plans after becoming aware of material nonpublic information. More fundamentally, the analysis calls for reconsideration of established positions in the larger debate over insider trading. This Essay has shown that the failure of Rule 10b-5 to prevent insiders from using nonpublic information to abstain from trading should be seen neither as an undesirable "loophole" that needs to be closed nor as an embarrassing gap that proves the futility of insider trading regulation. I hope this work removes the shadow cast by insider abstention over the insider trading debate and helps refocus attention on the most important policy issue: the optimal regulation of insider trading.
A Dilution Mechanism for Valuing Corporations in Bankruptcy
111 Yale L.J. 83 (2001) This Article proposes a new mechanism for valuing firms in bankruptcy. Under the "senior dilution" mechanism, a court would dilute the reorganized stock issued to senior claimants by issuing additional shares to junior claimants until there was no excess demand for the stock at a price that would implement absolute priority. A "junior diluation" mechanism could also be implemented to provide a market test for proposed reorganization plans of junior claimants by having a court issue additional debt to senior claimants until there was no excess supply of the debt at a price that would implement absolute priority. We show that these mechanisms harnass the private information of the claimants and of third parties to produce distributions consistent with absolute priority. Dilution mechanisms can be superior to other information-harnassing devices (such as an option or auction approach) because they (1) are less susceptible to the problem of junior illiquidity than an option approach proposed by Lucian Bebchuk, (2) are less susceptible to the problem of market manipulation and may better allocate control premia than a partial float proposal by Mark Roe; and (3) may produce fewer transaction costs than a full auction approach proposed by Douglas Baird. Moreover, as a response to the Supreme Court's recent admonition in LaSalle that bankruptcy courts employ market tests more often when creditors dissent to a reorganization plan, the junior dilution mechanism provides a uniquely workable solution within the current statutory framework.
The Rise of Dispersed Ownership The Roles of Law and the State in the Separation of Ownership and Control
111 Yale L.J. 1 (2001) Deep and liquid securities markets appear to be an exception to a worldwide pattern in which concentrated ownership dominates dispersed ownership. Recent commentary has argued that a dispersed shareholder base is unlikely to develop in civil-law countries and transitional economies for a variety of reasons, including (1) the absence of adequate legal protections for minority shareholders, (2) the inability of dispersed shareholders to hold control when the private benefits of control are high, and (3) the political vulnerability of dispersed shareholder ownership in left-leaning social democracies. Nonetheless, this Article finds that significant movement in the direction of dispersed ownership has occurred and is accelerating across Europe. What, then, are the legal and political precondiitons to the emergence of strong securities markets? Examining the origins of dispersed ownership in both the United States and the United Kingdom during the late nineteenth and early twentieth centuries and contrasting their experiences with the contemporaneous failure of securities markets to develop in Continental Europe, this Article finds little evidence that the existence of strong legal protections for minority shareholders is the explanatory variable that best accounts for the divergent evolution of common-law versus civil-law economies. During this era, particularly in the United States, the private benefits of control were high, controlling shareholders regularly exploited minority shareholders and manipulated markets, and political corruption undercut the effectiveness of those legal remedies that existed. Yet, ownership and control gradually separated in the largest U.S. corporations. The critical factors explaining early market development in the United States appear to have been the private efforts of investment bankers to develop credible bonding mechanisms plus enlightened self-regulation of the New York Stock Exchange. In this light, the decisive difference between the common-law countries, in which securities markets developed, and the civil-law countries, in which they did not, appears to have been less their divergent legal rules than the early emergence of a relatively autonomous and decentralized private sector in the former countries, in which competition could flourish and self-regulation was encouraged. In contrast, market development was impeded in Continental Europe by pervasive state intervention and a view of the securities market as an appendage of the state. Ultimately, the correlation between strong securities markets and strong legal standards seems real, but the causal sequence may be the reverse of that suggested by recent commentators. Rather than strong legal protections engendering strong markets, securities markets appear to develop first through private initiatives and then create political constituencies that demand stronger legal proetections. "Crash then law" is a recurring cycle. Hence, although law contributes to market growth and particularly market stability, it appears more to follow than precede economic development.