Corporate Defense Law for Dispersed Ownership
Nicholas L. Georgakopoulos
Indiana University - Robert H. McKinney School of Law
Hofstra Law Journal, Vol. 30, No. 1
The Delaware law regarding defensive tactics has a consistent and unnoticed undercurrent: it favors defenses against attacks that would concentrate corporate ownership. Similar trends seem to be developing in European merger and acquisition law, but they have a different flavor. Europe tries to foster dispersed ownership by discouraging defenses because it starts from an environment of concentrated ownership. Professor Georgakopoulos argues that pursuit of dispersed ownership is justified from an economic perspective and that defenses are intimately related with dispersed ownership. The "semi-entrenched" control that Delaware provides and that firms consistently choose in IPO's and prefer compared to golden parachutes is argued to be desirable despite having been consistently vilified in previous academic commentary.
Defenses prevent control from being ephemeral and, thus, allow entrepreneurs to relinquish majority control so as to make the transition to dispersed ownership. Defenses also facilitate venture capital. The dispersion in a successful IPO of the VC's controlling stake is more valuable for the entrepreneur who, thus, gets working control because that control is not ephemeral. Moreover, the good minority protection that is necessary for small minority discounts increases the credibility of the VC's commitment to break up the controlling stake.
The potential for temporarily low prices exposes skilled management to the risk of a takeover that is not justified by performance. In addition, a bias against hostile offers provides a delaying buffer in a world of changing technology. Publicly owned firms need not be ruthless in the updating of their methods of production. Allowing firms this slack mitigates the social problem of workforce retraining in a way superior to a centralized system of taxation and retraining expense. Dispersed ownership also enables investor diversification that allows investors to use the stock market as a vehicle for savings. Investor trading attracts speculator informed trading, which induces greater price accuracy, further reducing risk for investors and improving capital allocation by the market.
Finally, hostile takeovers are costly for investors, reducing their apparently large payoffs. The reduced likelihood of hostile takeovers due to defenses ensures that shareholders with short holding periods can invest in the stock market without fear of the negative implications of a buyout for taxes, repetitive transaction costs, and repeated undertaking of the investing gamble. In a world where price errors are conceivable, a bias against hostile offers ensures that the investing public will not suffer from systemic cherry-picking by private LBO funds. The resulting continued reliance on the equity markets for the raising of capital ensures that there is no bias in favor of firms that can raise capital internally.
The article concludes with a search for the optimal intensity of takeover defenses as a function of ownership dispersion, expected stock price accuracy, and speed of technological change. The US and EU defense schemes are reexamined in this light.
Keywords: M&A, mergers & acquisitions, defensive tactics
JEL Classification: K22
Date posted: November 9, 2001