Control Premiums, Minority Discounts, and Optimal Judicial Valuation

Abstract:     
This article characterizes controlling and minority share prices and optimal appraisal-remedy valuation rules in a rational expectations equilibrium. The model identifies a set of optimal judicial valuation policies that would motivate shareholders to make optimal investment and freeze-out choices, and identifies consequences of judicial valuation error. In particular, the model suggests that the share appraisal rule, under which minority shares are assessed a minority discount in freeze-out appraisals, would be more optimal than Delaware's pro rata doctrine, which forbids discounting of minority shares. Indeed, in accordance with the share appraisal rule and in contradiction with their own pro rata doctrine, Delaware courts frequently allow implicit discounts to minority shares in freeze-out appraisals. In summary, the model articulates why courts should not equate minority share value with market price. Consistent with this implication, Delaware courts have always uniformly rejected the notion that market price should be the sole determinant of appraisal value.

Keywords: equity valuation, mergers and acquisitions, judicial valuation, judicial error

JEL Classification: G12, G32, G34, G38

Accepted Paper Series