The 'Lemons Effect' in Corporate Freeze-Outs

21 Pages Posted: 29 Jun 2000 Last revised: 21 Apr 2008

See all articles by Lucian A. Bebchuk

Lucian A. Bebchuk

Harvard Law School; European Corporate Governance Institute (ECGI); National Bureau of Economic Research (NBER)

Marcel Kahan

New York University School of Law; European Corporate Governance Institute

Date Written: February 1999

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 private information. In particular, the analysis shows that the pre-freezeout market price of minority shares cannot be used an 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 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 affect a freeze-out. By showing how controllers are able to use their private information to affect freeze-outs at terms favorable to them, this paper demonstrates that freeze-outs can become a significant source for private benefits of control.

Suggested Citation

Bebchuk, Lucian A. and Kahan, Marcel, The 'Lemons Effect' in Corporate Freeze-Outs (February 1999). NBER Working Paper No. w6938. Available at SSRN: https://ssrn.com/abstract=226397

Lucian A. Bebchuk (Contact Author)

Harvard Law School ( email )

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Marcel Kahan

New York University School of Law ( email )

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European Corporate Governance Institute ( email )

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Belgium

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