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Regulating the Market for Corporate Control: a Critical Assessment of the Tender Offer's Role in Corporate Governance

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Regulating the Market for Corporate Control: a Critical Assessment of the Tender Offer's Role in Corporate Governance Columbia Law School Scholarship Archive Faculty Scholarship Faculty Publications 1984 Regulating the Market for Corporate Control: A Critical Assessment of the Tender Offer's Role in Corporate Governance John C. Coffee Jr. Columbia Law School, [email protected] Follow this and additional works at: https://scholarship.law.columbia.edu/faculty_scholarship Part of the Business Organizations Law Commons, and the Law and Economics Commons Recommended Citation John C. Coffee Jr., Regulating the Market for Corporate Control: A Critical Assessment of the Tender Offer's Role in Corporate Governance, 84 COLUM. L. REV. 1145 (1984). Available at: https://scholarship.law.columbia.edu/faculty_scholarship/25 This Article is brought to you for free and open access by the Faculty Publications at Scholarship Archive. It has been accepted for inclusion in Faculty Scholarship by an authorized administrator of Scholarship Archive. For more information, please contact [email protected]. COLUMBIA LAW REVIEW VOL. 84 JUNE 1984 NO. 5 REGULATING THE MARKET FOR CORPORATE CONTROL: A CRITICAL ASSESSMENT OF THE TENDER OFFER'S ROLE IN CORPORATE GOVERNANCE John C. Coffee, Jr.* Introduction ......................................... 1146 I. Shareholder Wealth Maximization: The First Frame of Reference 1161 A. Scorecard of the Players and Their Positions .............. 1162 1. The Disciplinary Hypothesis .......................... 1163 2. The Synergy Hypothesis ............................. 1166 3. The Empire Building Hypothesis ...................... 1167 4. The Exploitation Hypothesis ......................... 1169 5. An Overview ....................................... 1173 B. Does an Auction Market Increase Target Shareholder Wealth? 1175 C. The Uncertain Case for Shark Repellents ................. 1183 D. The General Deterrent Effect of the Hostile Takeover ..... 1192 E. Management's Response to a Rule of Passivity: The Leveraged Buy-Out as a Preemptive Strike ................ 1195 F. Summ ary ............................................. 1198 II. The Hostile Takeover as the Engine of Corporate Accountability: A Critical Analysis ........................................ 1199 A. The Limits of Market Discipline ......................... 1200 B. The Efficient Market and Inefficient Management: The Incon- sistent Evidence ....................................... 1206 1. The Stock Price Studies and the Contrary Evidence ..... 1207 2. The Bidder's Motivations: The Survey Evidence ........ 1211 3. A Behavioral Analysis: Organizational Dynamics and Bid- der M otivations ..................................... 1212 C. The Doctrinal Issue: Are Fiduciary Duties Owed to the Mar- ket? ........ 1216 III. The Diseconomies in Takeovers: A Look at the Cost Side of the Ledger .................................................. 1221 A. Empire Building: Defining the Diseconomy ............... 1224 1. Inefficient Transfers of Control ....................... 1225 * Professor of Law, Columbia Law School. B.A. 1966, Amherst College; LL.B. 1969, Yale University. The author acknowledges the helpful assistance of Bruce Ackerman, Melvin Eisen- berg, Louis Lowenstein, Susan Rose-Ackerman, and Joel Seligman. None bear responsibility for the views expressed herein. Preparation of this Article was assisted by a grant from Columbia's Center on Law and Economics. 1145 1146 COLUMBIA LA W REVIEW [Vol. 84:1145 2. The Relative Error Rate: A Comparison of Internal and External Monitoring Controls ........................ 1229 B. The Impact on the Managerial Labor Market .............. 1234 C. Excess Deterrence and the Problem of Demoralization ...... 1238 1. Post-Acquisition Assimilation Problems ................ 1238 2. Deterrence and Employer Motivation: Toward a Broader Theory ............................................ 1241 D. The Shift Toward Risk Preference ....................... 1243 1. The Target's Perspective ............................. 1243 2. The Bidder's Perspective ............................. 1244 3. Sum m ary .......................................... 1249 IV. Implementation: Steering a Middle Course ................... 1250 A. Stock Exchange Rules as a Vehicle for Balanced Regulation . 1255 1. An Overview and Evaluation ......................... 1255 2. Some Proposed Stock Exchange Rules ................. 1261 a. "Crown Jewel" Options .......................... 1261 b. Standstill Agreements ............................. 1261 c. Supermajority Provisions .......................... 1262 d. Disenfranchisement Provisions ..................... 1263 e. "Golden Parachutes" . ............................ 1263 3. The Scope of SEC Authority ......................... 1266 B. Penalizing the Empire Builder ........................... 1269 1. Bidder Ratification .................................. 1269 2. The Utility of Accounting Inducements ................ 1272 C. Stabilizing the Auction Market .......................... 1280 1. Regulation of the Bidder ............................. 1282 2. The Incentive Problem: Why Should a First Bidder Com- mence a Hostile Tender Offer? .. 1289 Conclusion ................................................... 1294 INTRODUCTION Better answers often await better questions. In the wake of a recent series of provocative articles dealing with contested tender offers,' several questions have been vigorously debated: 1. In large measure, this debate has pivoted around the thesis advanced by Professors Easterbrook and Fischel in a series of stimulating articles. See Easterbrook & Fischel, The Proper Role of a Target's Management in Responding to a Tender Offer, 94 Harv. L. Rev. 1161 (1981) [hereinafter cited as Easterbrook & Fisehel 1]; Easterbrook & Fischel, Corporate Control Transac- tions, 91 Yale L.J. 698 (1982) [hereinafter cited as Easterbrook & Fishel II]; Easterbrook & Fischel, Auctions and Sunk Costs in Tender Offers, 35 Stan. L. Rev. 1 (1982) [hereinafter cited as Easterbrook & Fischel I1]. These challenging articles have drawn a critical response from those who share the same fundamental economic premises as do Professors Easterbrook and Fischel and those who do not. For responses written from a basically similar economic perspective, see Bebchuk, The Case for Facilitating Competing Tender Offers, 95 Harv. L. Rev. 1028 (1982) 1984] CORPORATE CONTROL 1147 (1) Should management of the target company be allowed to resist a hostile tender offer in order to remain an independent company? 2 Which, if any, of the various "shark repellent" measures by which a potential target can make itself unattractive to a bidder are justified?; 3 [hereinafter cited as Bebchuk 1]; Bebchuk, The Case for Facilitating Competing Tender Offers: A Reply and Extension, 35 Stan. L. Rev. 23 (1982) [hereinafter cited as Bebchuk III; Carney, Shareholder Coordination Costs, Shark Repellents, and Takeout Mergers: The Case Against Fiduciary Duties, 1983 A.B.F. Research J. 341; Gilson, A Structural Approach to Corporations: The Case Against Defensive Tactics in Tender Offers, 33 Stan. L. Rev. 819 (1981) [hereinafter cited as Gilson I]; Gilson, The Case Against Shark Repellent Amendments: Structural Limitations on the Enabling Concept, 34 Stan. L. Rev. 775 (1982) [hereinafter cited as Gilson II]; Gilson, Seeking Competitive Bids Versus Pure Passivity in Tender Offer Defense, 35 Stan. L. Rev. 51 (1982) [hereinafter cited as Gilson I1]. For other writers that have criticized the position of Professors Easterbrook and Fischel from a vantage point that shares few of their premises, see Lipton, Takeover Bids in the Target's Boardroom, 35 Bus. Law. 101 (1979) [hereinafter cited as Lipton 1]; Lipton, Takeover Bids in the Target's Boardroom: An Update After One Year, 36 Bus. Law. 1017 (1980) [hereinafter cited as Lipton I]; Lipton, Takeover Bids in the Target's Board- room: A Response to Professors Easterbrook and Fischel, 55 N.Y.U. L. Rev. 1231 (1980) [hereinafter cited as Lipton III]; Lowenstein, Pruning Deadwood in Hostile Takeovers: A Pro- posal for Legislation, 83 Colum. L. Rev. 249 (1983). 2. Professors Easterbrook and Fischel have argued for a rule of managerial passivity under which management of the target company could take no action either to resist a bid, to buy back shares of the target offered to it by a potential hostile bidder or, to seek another friendly bidder (the proverbial "white knight") to make a counter bid. See Easterbrook & Fischel I, supra note 1, at 1164, 1194-1204. Essentially, Lucian Bebchuk and Professor Gilson concur as to the illegiti- macy of defensive tactics which seek to maintain the target corporation as an independent entity. However, both Bebchuk and Gilson believe that greater allocational efficiency results if target management is permitted to facilitate competing bids. See Bebchuk II, supra note 1, at 24-25 & n.8, 39-45; Gilson III, supra note 1, at 62-66. In contrast, Professor Lowenstein and Martin Lipton have argued it is desirable that manage- ment be able to resist the takeover, although in Professor Lowenstein's proposal the authorized scope of resistance would be limited and would be principally intended to give shareholders a more informed, or less pressured choice. Lowenstein, supra note 1, at 322-33. Of all these commentators, only Martin Lipton takes the view that the normal business judgment discretion accorded to the board of directors in other areas of corporate law should extend to the context of corporate control contests. See Lipton I, supra note 1, at 113-20. However, Professor Carney approaches this same result
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