Rationalizing Appraisal Standards in Compulsory Buyouts

Abstract:     
This Article makes several contributions to the literature on Delaware appraisal law. We first argue that the "going concern value" standard adopted by the Delaware courts as the measure of "fair value" in share valuation proceedings is superior to its two main competitors, market value and third-party sale value, on grounds of both fairness and efficiency. Application of the going concern value standard has two important consequences. First, it is critical that going concern value be measured in a way that includes not only the present value of the existing assets of the corporation, but also the present value of the reinvestment opportunities available to and anticipated by the firm at the time of merger. Second, going concern value should not include the value of corporate control in a case where the merger creates control through the aggregation of previously dispersed shares. In that case, the benefits created by the aggregation of shares belong to the party that created the increased value.

We address differently, however, the situation where a pre-existing controlling shareholder squeezes out the minority. Our concern here is the potential for a controlling shareholder to acquire the minority shares at a price that fails to reflect the firm's going concern value. Where a controller fails to present a valid discounted cash flow analysis and relies instead on a comparable company analysis that is based solely on historical data, the minority shareholders and the court are deprived of access to projections of future free cash flows of the firm. We therefore advocate that in this situation the courts adopt a penalty default in the form of a presumption that fair value includes the value of control as reflected in comparable company acquisitions. Such a presumption is consistent with common law doctrines of fiduciary duty and the entire fairness standard, as well as adverse evidentiary inferences drawn from failure to produce relevant evidence. The controller as faithful fiduciary can avoid the proposed presumption by preparing and submitting to judicial scrutiny a valid discounted cash flow analysis. The opportunistic controller, on the other hand, is subjected to a fair value determination that amounts to third-party sale value minus synergies.

Keywords: Corporations, takeovers, squeeze-out mergers, corporate valuation fair value, going concern value, synergies, implicit minority discount, control value, control premium, controlling shareholder, discounted value flow analysis, comparable company analysis, acquisition premium

JEL Classifications: D23, G34, K22

Working Paper Series