Putting Directors’ Money Where Their Mouths Are: A New Approach to Improving Corporate Takeover Dynamics
Peking University School of Transnational Law; Israel Securities Authority
August 24, 2016
Columbia Business Law Review, Forthcoming
Peking University School of Transnational Law Research Paper No. 16-6
This paper aims to improve shareholder protection from underpriced bids in takeover situations. Target boards, as stewards of the corporation who typically possess superior information about the desirability of unsolicited bids, can be expected to protect their shareholders from such bids. Unfortunately, because they have a conflict of interest with their shareholders in takeover situations, they tend to reject hostile bids to an excessive degree. Moreover, the current Delaware doctrine is ineffective in monitoring boards’ responses to takeovers, largely because boards might use selective inside information to which the courts lack access and because their judgments are backed by subjective, hard-to-attack legal and financial expert opinions which courts are ill-equipped to challenge.
To rectify the problems of courts’ and shareholders’ inferior information as well as boards’ skewed incentives, I propose an arrangement in which target boards wishing to veto nonstructurally coercive takeover bids would be encouraged to demonstrate their opposition by committing to buy, if the bid fails, and hold for a specified time a certain amount of target stock at the bid price. The directors would be incentivized to follow the arrangement because it would require courts, in a potential fiduciary duties lawsuit, to give directors’ commitments significant weight when evaluating their defense that they rejected the bid to protect their shareholders.
Adopting the proposed arrangement can significantly address important problems in corporate takeovers that have long claimed the attention of corporate law scholars and financial economists. In particular, inducing target boards to credibly transmit their genuine bottom-line understanding about the desirability of a bid would offset the courts’ inability to review the directors’ decision effectively. Imposing personal costs that the directors would uniquely incur if they wish to reject hostile bids would counteract the directors’ ex-post incentive to reject hostile bids excessively. Increasing the directors’ cost of a takeover attempt would improve market discipline and motivate the directors to increase firm value and reduce agency costs. Finally, favoring firms with high long-term value would protect them from myopic bidders and alleviate their unrelenting pressure to meet quarterly earnings expectations. For these reasons, the proposed arrangement could greatly improve corporate takeover dynamics.
Number of Pages in PDF File: 52
Keywords: corporate law, corporate governance, securities law, asymmetric information, signaling, director compensation, investors, shareholders, managers, directors, boards, agency costs, takeovers, Delaware, game theory, myopia, short-termism, corporate reform
JEL Classification: C70, G14, G34, J33, K22
Date posted: August 27, 2016 ; Last revised: October 2, 2016