Sales and Elections as Methods for Transferring Corporate Control

Abstract

Under standard accounts of corporate governance, capital markets play a significant role in monitoring management performance and, where appropriate, replacing management whose performance does not measure up. While the concept of a market for corporate control was once controversial, now even the American Law Institute acknowledges that "transactions in control and tender offers are mechanisms through which market review of the effectiveness of management's delegated discretion can operate. Recent case law in Delaware, however, appears to have altered dramatically the mechanisms through which the market for corporate control must operate. In particular, the interaction of the poison pill and the Delaware Supreme Court's development of the legal standard governing defensive tactics in response to tender offers have resulted in a decided, but as yet unexplained, preference for control changes mediated by means of an election rather than by a market. In this paper, we begin the evaluation of the preference for elections over markets that the Delaware Supreme Court has not yet attempted. We apply to this effort both doctrinal and insights derived from an interesting but complex formal literature that has developed to understand how voting structures work in political contests and jury deliberations. Since these contexts differ substantially from transfers of corporate control, our analysis raises a question of fit: are voting models suitable for analyzing the question asked here? In our view, the models do illuminate the takeover institution, but if this view is ultimately rejected, then we will have eliminated what at least superficially appears to be a useful set of tools. Part 1 provides a very brief account of the doctrinal development that has given us the current bias for elections, focusing on the last step in the process: the Delaware Supreme Court's decision in Unitrin, Inc. v. American General Corp. Part 2 then argues that economic efficiency, to be made precise in this context below, is the appropriate normative criterion for directing the choice between markets and elections as mechanisms for effecting a change in control that is resisted by management. Parts 3 and 4 next develop two models which show that elections can perform badly in proxy contests in which the principal issue is whether the target company should be sold or not. The first model assumes that shareholder voters are well informed about the economic variables of interest and the second supposes uncertainty about these variables. Market sales apparently lack the defects that these models show can affect elections. Current regulation, which facilitates competing bids, and current takeover technologies, which permit making them, would eliminate much of the inefficiency in takeover bidding that prior models have identified if bidders could make proposals directly to target shareholders. Then the target would be an auction seller. A standard result in auction theory is that if the seller chooses a revenue maximizing auction form it is a dominant strategy for bidders -- here potential acquirers -- to big their true valuations. The dominant strategy for a maximizing seller then is to accept the winning bid. Therefore, target shareholders would not be in a strategic situation in an auction world. As a consequence, we focus on the possible inefficiencies arising from a judicial preference for elections (in which it is optimal for shareholders to act strategically) over markets as a takeover mechanism. In Part 5, we return to doctrine to show how Unitrin's preference for elections over markets may be eliminated without requiring the Delaware Supreme Court to confess error. We also suggest that, for jurisdictions with courts less influential than those in Delaware, a statutory change to permit more sales of control would be best.