University of Pennsylvania Carey Law School Penn Law: Legal Scholarship Repository Faculty Scholarship at Penn Law 5-2008 Agency Costs, Charitable Trusts, and Corporate Control: Evidence from Hershey's Kiss-Off Jonathan Klick University of Pennsylvania Carey Law School Robert H. Sitkoff Follow this and additional works at: https://scholarship.law.upenn.edu/faculty_scholarship Part of the Business Law, Public Responsibility, and Ethics Commons, Business Organizations Law Commons, Economic Policy Commons, Economics Commons, Law and Economics Commons, Law and Society Commons, Nonprofit Administration and Management Commons, Securities Law Commons, and the Work, Economy and Organizations Commons Repository Citation Klick, Jonathan and Sitkoff, Robert H., "Agency Costs, Charitable Trusts, and Corporate Control: Evidence from Hershey's Kiss-Off" (2008). Faculty Scholarship at Penn Law. 1125. https://scholarship.law.upenn.edu/faculty_scholarship/1125 This Article is brought to you for free and open access by Penn Law: Legal Scholarship Repository. It has been accepted for inclusion in Faculty Scholarship at Penn Law by an authorized administrator of Penn Law: Legal Scholarship Repository. For more information, please contact [email protected]. \\server05\productn\C\COL\108-4\COL401.txt unknown Seq: 1 12-AUG-08 14:51 COLUMBIA LAW REVIEW VOL. 108 MAY 2008 NO. 4 ARTICLE AGENCY COSTS, CHARITABLE TRUSTS, AND CORPORATE CONTROL: EVIDENCE FROM HERSHEY’S KISS-OFF Jonathan Klick* Robert H. Sitkoff** In July 2002 the trustees of the Milton Hershey School Trust an- nounced a plan to diversify the Trust’s investment portfolio by selling the Trust’s controlling interest in the Hershey Company. The Company’s stock jumped from $62.50 to $78.30 on news of the proposed sale. But the Pennsylvania Attorney General, who was then running for governor, op- posed the sale on the ground that it would harm the local community. Shortly after the Attorney General obtained a preliminary injunction, the trustees abandoned the sale and the Company’s stock dropped to $65.00. Using standard event study methodology, we find that the sale announce- ment was associated with a positive abnormal return of over 25% and that canceling the sale was followed by a negative abnormal return of nearly 12%. Our findings imply that instead of improving the welfare of the needy children who are the Trust’s main beneficiaries, the Attorney General’s inter- vention preserved charitable trust agency costs of roughly $850 million and foreclosed salutary portfolio diversification. Furthermore, blocking the sale destroyed roughly $2.7 billion in shareholder wealth, reducing aggregate so- cial welfare by preserving a suboptimal ownership structure of the Company. Our analysis contributes to the literature of trust law by supplying the first empirical analysis of agency costs in the charitable trust form and by high- lighting shortcomings in supervision of charities by the state attorneys gen- * Professor of Law, University of Pennsylvania (effective Summer 2008); Jeffrey A. Stoops Professor of Law, Florida State University (through Summer 2008). ** John L. Gray Professor of Law, Harvard University. The authors thank William Bratton, Evelyn Brody, John Coates, John Columbo, Harvey Dale, Joel Dobris, Einer Elhauge, Allen Ferrell, Jonah Gelbach, Daniel Halperin, Eric Helland, Adam Hirsch, Edward Iacobucci, Marcel Kahan, Ehud Kamar, Louis Kaplow, Reinier Kraakman, John Langbein, Robert Lawless, James Lindgren, Yair Listokin, Geoffrey Manne, Henry Manne, John McGinnis, Richard Posner, Larry Ribstein, Edward Rock, Dan Rubinfeld, Max Schanzenbach, Kathryn Spier, Stewart Sterk, Mark Weinstein, Kathryn Zeiler, and workshop participants at FSU, Georgetown, Georgia, Harvard, Illinois, Northwestern, NYU, and the 2007 Annual Meeting of the American Law and Economics Association for helpful comments and suggestions; Teresa Gallego O’Rourke, Kelley Smith, Shira Tydings, Ethan White, Rachel Zeehandelaar, and Annmarie Zell for superb research assistance; and Harvard Law School and NYU School of Law for financial support. 749 Electronic copy available at: http://ssrn.com/abstract=1009353 \\server05\productn\C\COL\108-4\COL401.txt unknown Seq: 2 12-AUG-08 14:51 750 COLUMBIA LAW REVIEW [Vol. 108:749 eral. We also contribute to the literature of corporate governance by measur- ing the change in the Company’s market value when the Trust exposed the Company to the market for corporate control. INTRODUCTION .................................................. 750 R I. MILTON HERSHEY’S CHOCOLATE EMPIRE ................... 760 R II. AGENCY COSTS AND THE ABORTED 2002 SALE .............. 768 R A. The Aborted Sale .................................... 768 R B. Charitable Trusts .................................... 779 R C. Corporate Governance ............................... 787 R III. EMPIRICAL ANALYSIS ...................................... 790 R A. Data ................................................. 791 R B. Graphical Analysis ................................... 791 R C. Event Study Analysis ................................. 796 R 1. Introduction ..................................... 796 R 2. HSY Event Study ................................. 798 R 3. Competitor-Based Controls ....................... 806 R 4. The Problem of a Single-Firm Event Study ........ 810 R D. Summary of Empirical Findings ...................... 814 R IV. IMPLICATIONS FOR POLICY ANALYSIS ........................ 816 R A. Charitable Trusts .................................... 816 R 1. Alternative Modes of Supervision ................. 817 R 2. Cy Pres for Wastefulness ......................... 819 R 3. Propriety of Social Investing by Trustees and Other Fiduciaries ....................................... 822 R B. Corporate Governance ............................... 826 R 1. Controlling Shareholders in Corporate Governance ...................................... 826 R 2. The Market for Corporate Control ............... 828 R CONCLUSION .................................................... 829 R APPENDIX A: EXTENDED PRICE DYNAMIC GRAPHS .................. 832 R APPENDIX B: THE POSSIBILITY OF LEAKAGE ........................ 835 R APPENDIX C: HOW UNLIKELY ARE THE ABNORMAL RETURNS?....... 837 R INTRODUCTION Domestic tax-exempt charitable organizations hold roughly $2.4 tril- lion in assets and have roughly $1.2 trillion in annual revenues.1 These impressive figures speak to the American impulse toward philanthropy.2 But the ugly secret about charitable organizations is that their lack of 1. See Treasury Inspector Gen. for Tax Admin., Dep’t of the Treasury, Performance Measures and Improved Tracking Would Help the Exempt Organizations Function Better Allocate Resources 1 (2008), available at http://www.ustreas.gov/tigta/auditreports/2008 reports/200810057fr.pdf (on file with the Columbia Law Review). 2. Measured as a share of Gross Domestic Product, charitable giving in the United States is estimated to be “roughly three times larger than” in the second-place United Kingdom. Joel L. Fleishman, Public Trust in Not-for-Profit Organizations and the Need for Regulatory Reform, in Philanthropy and the Nonprofit Sector in a Changing America 172, Electronic copy available at: http://ssrn.com/abstract=1009353 \\server05\productn\C\COL\108-4\COL401.txt unknown Seq: 3 12-AUG-08 14:51 2008] HERSHEY’S KISS-OFF 751 clearly defined owners invites deadweight losses arising from agency costs. True, the state attorneys general have formal authority to ensure that the managers of such organizations efficiently pursue a bona fide charitable purpose.3 In reality, however, the typical state attorney general is an elected political official for whom the supervision of charitable orga- nizations offers little political payoff. Accordingly, scholars tend to as- sume the existence of significant agency costs in charitable trusts and other charitable organizations.4 A separate agency problem arises in the context of the public corpo- ration. The concern here is that the interests of the company’s managers will diverge from those of the shareholders. To align managers’ incen- tives with the interests of shareholders, the law gives shareholders various rights, including the right to sell their shares, which invites a takeover bid if the company’s current management yields inferior returns. An alterna- tive mechanism for minimizing corporate agency costs arises when the firm has a controlling shareholder or a large blockholder.5 A controlling shareholder or a large blockholder is more likely than an ordinary share- holder to have a concrete financial incentive to monitor actively and, if necessary, to impose value-maximizing operations on the company’s man- agers. Indeed, a host of scholars and policymakers have come to embrace the utility of monitoring by blockholders,6 and the incidence of such con- trol blocks is increasing among public U.S. firms and is quite common among public companies in Europe.7 175 (Charles T. Clotfelter & Thomas Ehrlich eds., 1999) [hereinafter Fleishman, Public Trust]. 3. See Restatement (Second) of Trusts § 391 cmt. a (1959) (“[A] suit to enforce a charitable trust can be maintained by the Attorney General of the State in which the charitable trust is to be administered.”); Marion R. Fremont-Smith, Governing Nonprofit Organizations: Federal and State Law and Regulation 305–24 (2004) (discussing power of state attorneys general to oversee charitable trusts). 4. See, e.g., Richard A. Posner, Economic Analysis of Law § 18.5, at 547 (7th