Adverse Selection and Gains to Controllers in Corporate Freezeouts

Concentrated Corporate Ownership (Randall K. Morck, ed., University of Chicago Press), pp. 247-259, 2000

New York University, Center for Law & Business, Working Paper No. 99-008

Harvard Law and Economics Discussion Paper No. 248, January 1999

15 Pages Posted: 1 Feb 1999 Last revised: 29 Apr 2009

Lucian A. Bebchuk

Harvard Law School; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR) and European Corporate Governance Institute (ECGI)

Marcel Kahan

New York University School of Law; European Corporate Governance Institute

Abstract

In a corporate freeze-out, the controller is required to compensate minority shareholders for the no-freezeout value of their shares that are taken from them. This paper seeks to highlight the difficulties involved in determining this no-freezeout value when, as is often the case, the controller has private information. In particular, the analysis shows that the pre-freezeout market price of minority shares cannot be used as a proxy for the no-freezeout value that these shares would have in the absence of a freeze-out. It is shown that, under a regime in which frozen out minority shareholders receive a compensation equal to the pre-freezeout market price, the pre-freezeout market price will be set at a level below the expected no-freezeout value of minority shares. The reason for this is a "lemons effect" that arises when a controller uses her private information in deciding whether to effect a freeze-out. By showing how controllers are able to use their private information to effect freeze-outs at terms favorable to them, this paper demonstrates that freeze-outs can become a significant source for private benefits of control.

Keywords: Corporate freezeouts, minority shareholders, private benefits of control, expropriation, agency costs, appraisal

JEL Classification: G30

Suggested Citation

Bebchuk, Lucian A. and Kahan, Marcel, Adverse Selection and Gains to Controllers in Corporate Freezeouts. Concentrated Corporate Ownership (Randall K. Morck, ed., University of Chicago Press), pp. 247-259, 2000; New York University, Center for Law & Business, Working Paper No. 99-008; Harvard Law and Economics Discussion Paper No. 248, January 1999. Available at SSRN: https://ssrn.com/abstract=147568 or http://dx.doi.org/10.2139/ssrn.147568

Lucian A. Bebchuk (Contact Author)

Harvard Law School ( email )

Cambridge, MA 02138
United States
617-495-3138 (Phone)
617-812-0554 (Fax)

HOME PAGE: http://www.law.harvard.edu/faculty/bebchuk/

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR) and European Corporate Governance Institute (ECGI)

Marcel Kahan

New York University School of Law ( email )

40 Washington Square South
New York, NY 10012-1099
United States
212-998-6268 (Phone)
212-995-4341 (Fax)

European Corporate Governance Institute ( email )

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

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