Judicial Deference, Procedural Protections, and Deal Outcomes in Freezeout Transactions: Evidence from the Effect of MFW

Abstract

Prior to 2013, merger freezeouts were invariably subject to entire fairness review, a demanding standard of judicial review that permits a judicial revision of the price paid to the target shareholders when the price is challenged. Even if a special committee of independent directors and the majority-of-the-minority shareholders approved the transaction, entire fairness would still be the applicable standard of judicial review. This changed in 2013. In an attempt to incentivize the simultaneous use of independent director approval and majority-of-the-minority conditions, the Delaware Chancery Court held in In re MFW Shareholders Litigation (2013) that when a merger freezeout is subject to those procedural protections, the transaction would be reviewed under the deferential business judgment rule and not under entire fairness. This work examines the impact of MFW on transactional practice and deal outcomes. The results indicate that controlling shareholders, in fact, responded significantly to this opinion. Majority-of-the minority conditions, which were implemented in less than 50% of the deals before MFW, have now become almost a uniform condition, with an incidence rate of more than 90%. Special committees were already the norm before 2013 and, as a result, their incidence did not change significantly. The increase in majority-of-the-minority conditions, however, was not followed by significant changes in deal premiums, target returns, changes from the controller's first offer to the final offer, and deal completion rates. The results therefore suggest that deferential judicial review is an effective way to incentivize procedural protections in freezeout transactions and that the increase in shareholder approval conditions did not come at the cost of higher frustration rates. In addition, the results suggest that entire fairness was an effective substitute for the concurrent use of independent director approval and majority-of-the-minority conditions prior to MFW. Taken together, these results present an assessment of MFW in particular and also shed light on the role of shareholder voting in freezeout transactions more generally.

JEL Classification: G38, K22, K42, L51, M41