Takeover Defense When Financial Markets Are (Only) Relatively Efficient
Michael L. Wachter
University of Pennsylvania Law School - Institute for Law and Economics
University of Pennsylvania Law Review, Forthcoming
This paper evaluates the impact of developments in the understanding of asset value pricing for alternative legal standards for takeover defenses: the management discretion and the shareholder rights positions. Both sides place considerable, albeit implicit, reliance on alternative views of the efficiency of financial markets. Developments in finance theory show that when financial markets are only "relatively efficient," stock prices can incorrectly value the corporation at any point in time, at the same time as investors cannot outperform the market on an ongoing basis. I focus on financial market anomalies arising from the failure of the capital asset pricing model to provide a reliable estimate of the market capitalization rate.
In a world of perfectly efficient capital markets, a shareholder choice standard is the dominant policy solution. In such a state, any noncoercive hostile tender offer at a premium to the market price moves assets to more valued uses while offering shareholders enhanced market value. Best of all, it sends a clear signal to all managers to be more faithful to shareholder interests or risk losing their jobs.
But in a world where capital markets are only relatively efficient, the calculus shifts. Successful hostile tender offers could move assets to less valued uses. Shareholders could be paid less than the intrinsic value of the corporation. Worst of all, managers might choose to manage to the financial market anomalies; that is, to adopt otherwise suboptimal business strategies intended to minimize the risks of under-pricing or maximize the probability of over-pricing.
I conclude that the legal standard prevailing in Delaware regarding takeover defenses can be understood as focusing on giving managers the discretion to maximize the value of the corporation. In light of modern finance theory, and the evidence that capital markets are only relatively efficient, this is a plausible way to strike the balance.
Number of Pages in PDF File: 41
Keywords: takeover defenses, hostile tender offers, intrinsic value of the corporation, shareholder choice, management discretion, anomalies in capital market efficiency
JEL Classification: G3, K2, L2
Date posted: September 18, 2002
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