Minority Discounts and Control Premiums in Appraisal Proceedings

Abstract:     
In a merger, a stockholder often has a statutory right of dissent and appraisal under which the stockholder may demand to be paid fair value exclusive of any gain or loss that may arise from the merger itself. Most courts and commentators agree that a dissenting stockholder should ordinarily receive a pro rata share of the fair value of the corporation without any discount simply because minority shares lack control. In several recent cases, the courts have indicated that a minority stockholder is thus entitled to a share of the control value of the corporation even though the merger does not constitute a sale of control (as in a going private transaction) and even though control of the subject corporation is not contestable (as where a single stockholder owns a outright majority of shares). In a similar vein, several courts have ruled that reliance on market prices for purposes of appraisal results in an inherent minority discount, thus requiring that a premium for control be added. In short, the emerging rule appears to be that fair value is the price at which a controlling stockholder could sell control, because failure to do so amounts to imposition of a minority discount.

It is the thesis here that the routine addition of a control premium - even though the transaction does not involve a cognizable transfer of control - is inconsistent with settled corporation law and good policy. First, it is based at least in part on the unwarranted assumption that the source of a control premium must be a minority discount. Second, it is inconsistent with the well settled rule that the circumstances of a transaction should be considered. Third, it is inconsistent with the idea that a controlling stockholder may sell control at a premium as long as the sale of control is not to the detriment of the minority. Fourth, it is contrary to public policy in that it encourages dissent by holding out the prospect of a control premium even in cases in which a majority of the minority has approved the deal. Fifth, and perhaps most important, the addition of a control premium (whether routine or not) may amount to double-counting. The Capital Asset Pricing Model (CAPM), which is the generally preferred method of valuation, implicitly adjusts for any minority discount by measuring the value of the subject company (based on its riskiness) relative to the market as a whole. Indeed, CAPM may actually add on an implicit premium in that it values a stock as if it is part of a well diversified portfolio, ignoring firm specific risk. Even if fair value is determined by reference to the prices of comparable companies, the routine addition of a premium presumes that market prices are inherently discounted. And if fair value is based on premiums in comparable transactions, the premium may arise from the fact that other target companies were trading at a discount prior to the comparable transaction.

To be sure, the courts should adjust for a minority discount if one is found. But the routine addition of a control premium as part of fair value creates a windfall for dissenting stockholders and infringes the legitimate rights of majority stockholders.

Keywords: appraisal, control premium, minority discount, fair value, merger, sale of control, CAPM, comparable, market price, valuation

JEL Classifications: G34, K22

Working Paper Series