Bundling and entrenchment

Harvard Law Review

Volumn 123, Issue 7, 2010, Pages 1549-1595

  Bebchuk, Lucian A ^a   Kamar, Ehud ^b,c  

^a HARVARD LAW SCHOOL   (United States)

^b UNIVERSITY OF SOUTHERN CALIFORNIA   (United States)

^c TEL AVIV UNIVERSITY   (Israel)

Author keywords

[No Author keywords available]

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EID: 77955542330     PISSN: 0017811X     EISSN: None     Source Type: Journal    
DOI: None     Document Type: Review

References (104)

1. See, e.g., R. DOUGLAS ARNOLD, THE LOGIC OF CONGRESSIONAL ACTION 102-03, 219, 255-56 (1990) (discussing, respectively, omnibus bills generally, the passage of the Tax Reform Act of 1986, and the passage of the Natural Energy Act of 1978).
2. see also MARTIN TOLCHIN, In the Face of Controversy, Packaging, N.Y. TIMES, Feb. 21, 1983, at B6 (providing examples of legislative package deals).
3. See Lucian Arye Bebchuk, The Case for Increasing Shareholder Power, 118 HARV. L. REV. 833, 864-65 (2005) (discussing charter amendments and reincorporations).
4. Lucian Arye Bebchuk, Federalism and the Corporation: The Desirable Limits on State Competition in Corporate Law, 105 HARV. L. REV. 1435, 1475 (1992) [hereinafter Bebchuk, Federalism and the Corporation] (discussing reincorporations).
5. Lucian Arye Bebchuk, Limiting Contractual Freedom in Corporate Law: The Desirable Constraints on Charter Amendments, 102 HARV. L. REV. 1820, 1839-40 (1989) [hereinafter Bebchuk, Limiting Contractual Freedom in Corporate Law] (discussing charter amendments).
6. Jeffrey N. Gordon, The Mandatory Structure of Corporate Law, 89 COLUM. L. REV. 1549, 1577-79 (1989) (discussing charter amendments).
7. See, e.g., Lucian Arye Bebchuk, Why Firms Adopt Antitakeover Arrangements, 152 U. PA. L. REV. 713, 723-28 (2003).
8. Michael Klausner, Institutional Shareholders, Private Equity, and Antitakeover Protection at the IPO Stage, 152 U. PA. L. REV 755, 759-61 (2003).
9. See, e.g., Mira Ganor, Why Do Managers Dismantle Staggered Boards?, 33 DEL. J. CORP. L. 149 (2008) (documenting management initiatives to destagger boards following shareholder pressure).
10. Bhattiprolu Murti, More Boards May End Staggered Terms, WALL ST. J., June 8, 2005 (LEXIS) (same).
11. See, e.g., Lynn A. Stout, The Mythical Benefits of Shareholder Control, 93 VA. L. REV. 789, 801-02 (2007).
12. One might argue that the motivation for staggering the board in some of these mergers was to prevent one party's representatives on the combined firm's board from unseating the other party's representatives, rather than to prevent ouster of the entire board by a hostile bidder. Once in place, however, a staggered board retards both types of control changes, and it is forced upon shareholders as part of the deal, rather than as a feature they may choose to leave out.
13. For example, shareholder approval is required for reincorporation, and commentators have inferred from this requirement that reincorporations take place only when favored by shareholders. See ROBERTA ROMANO, THE GENIUS OF AMERICAN CORPORATE LAW 18-19 (1993).
14. See, e.g., DEL. CODE ANN. tit. 8, § 101 (2001).
15. See, e.g., id. § 109 (providing that the charter stands above the bylaws); id. § 141(a) (providing that the charter stands above board decisions).
16. For an example of a charter provision read narrowly to avoid conflict with the language of the code, see Waltuch v. Conticommodity Services, Inc., 88 F.3d 87 (2d Cir. 1996), which applied Delaware law. Board actions, in contrast, are subject to fiduciary-duty review even when they violate no statute.
17. See, e.g., Schnell v. Chris-Craft Indus., Inc., 285 A.2d 437, 439 (Del. 1971) ("Management contends that it has complied strictly with the provisions of the new Delaware Corporation Law in changing the by-law date. The answer to that contention, of course, is that inequitable action does not become permissible simply because it is legally possible.").
18. See, e.g., Seibert v. Gulton Indus., Inc., 5 DEL. J. CORP. L. 514 (Del. Ch. June 21, 1979), aff'd, 414 A.2d 822 (Del. 1980) (dismissing a challenge to the validity of a charter-based antitakeover defense).
19. See ROBERT CHARLES CLARK, CORPORATE LAW 94 (1986) (describing the right to vote on charter amendments as one of the basic rights of shareholders).
20. See, e.g., DEL. CODE ANN. tit. 8, § 242(b).
21. See, e.g., FRANK H. EASTERBROOK & DANIEL R. FISCHEL, THE ECONOMIC STRUCTURE OF CORPORATE LAW 7, 17-22 (1991) (arguing that shareholders price charter provisions when the firm conducts an initial public offering).
22. Stephen M. Bainbridge, Director Primacy and Shareholder Disempowerment, 119 HARV. L. REV. 1735, 1736-44 (2006) (same).
23. Roberta Romano, Answering the Wrong Question: The Tenuous Case for Mandatory Corporate Laws, 89 COLUM. L. REV. 1599, 1601-02 (1989) (arguing that shareholders price charter provisions when the firm conducts an initial public offering and approve only value-increasing amendments thereafter); Stout, supra note 5 (arguing that the presence of staggered boards in the charters of firms conducting initial public offerings suggests that staggered boards are efficient).
24. But see Bebchuk, supra note 3 (discussing reasons to doubt the efficiency of charter provisions of firms conducting initial public offerings).
25. See Bebchuk, The Case for Increasing Shareholder Power, supra note 2, at 864-65 (discussing charter amendments and reincorporations).
26. Bebchuk, Federalism and the Corporation, supra note 2, at 1475 (discussing reincorporations).
27. Bebchuk, Limiting Contractual Freedom in Corporate Law, supra note 2, at 1839-40 (discussing charter amendments).
28. Gordon, supra note 2, at 1577-80 (discussing charter amendments).
29. *14 (LEXIS) (setting forth the procedures for proposing dissolutions).
30. The only fundamental change that shareholders can propose is to amend the bylaws. See, e.g., DEL. CODE ANN. tit. 8, § 109(a) (2001). Even this power, however, is limited because the bylaws must agree with the charter.
31. See, e.g., id. § 109(b). Thus, for example, shareholders cannot repeal a charter-based staggered-board structure through a bylaw amendment. Shareholders can also unanimously initiate a dissolution.
32. See, e.g., id. § 275(c). But this power is impractical in public firms with numerous shareholders.
33. See Romano, supra note 14, at 1612.
34. See ROMANO, supra note 7, at 2.
35. See Jeffrey N. Gordon, Ties that Bond: Dual Class Common Stock and the Problem of Shareholder Choice, 76 CAL. L. REV. 1, 48-49, 80-85 (1988).
36. Gregg A. Jarrell & Annette B. Poulsen, Dual-Class Recapitalizations as Antitakeover Mechanisms: The Recent Evidence, 20 J. FIN. ECON. 129 (1988).
37. See Jarrell & Poulsen, supra note 20, at 130.
38. Once the plan was approved, individual shareholders were typically given the choice whether to exchange their stock for the new class of low-voting stock. It was rational for all individual stockholders to do so because their choice would have no impact on the likelihood of a takeover.
39. See Richard S. Ruback, Coercive Dual-Class Exchange Offers, 20 J. FIN. ECON. 153, 164-65 (1988).
40. See Voting Rights Listing Standards; Disenfranchisement Rule, 53 Fed. Reg. 26,376 (July 12, 1988) (codified as amended at 17 C.F.R. § 240.19C-4 (2009)), invalidated by Bus. Roundtable v. SEC, 905 F.2d 406 (D.C. Cir. 1990).
41. See Bus. Roundtable, 905 F.2d 406.
42. See Order Granting Approval to Rule Changes Relating to the Exchanges' and Association's Rules Regarding Shareholder Voting Rights, Exchange Act Release No. 35,121, 59 Fed. Reg. 66,570, 66,570 (Dec. 27, 1994).
43. Some may think that bundling has been precluded by SEC Rule 14a-4(a)(3), which is known as the "unbundling rule." See 17 C.F.R. § 240.14a-4(a)(3) (2009). Despite its name, however, this rule does not prevent management from presenting proposals to shareholders for approval as a package. The unbundling rule permits management to condition the adoption of one proposal on the approval of another proposal. The rule requires only that shareholders be able to vote on the proposals separately - even if the approval of only one means that neither is implemented. Moreover, even this weak rule does not cover charter amendments effected through the merger of firms with different charters.
44. See DIV. OF CORP. FIN., U.S. SEC. & EXCH. COMM'N, MANUAL of Publicly Available Telephone Interpretations (5th Supp. 2004), http://www.sec.gov/ interps/telephone/phonesupplement5.htm.
45. Prior research has documented the emergence of charter-based antitakeover defenses in midstream, but not through bundling. Thus, it is now known that in corporate spinoffs (in which public firms take their subsidiaries public), staggered boards are more common among the spinoff firms than among their parents.
46. See Robert Daines & Michael Klausner, Agents Protecting Agents: An Empirical Study of Takeover Defenses in Spinoffs (Stanford Law Sch. John M. Olin Program in Law & Econ., Working Paper No. 299, 2004), available at http://ssrn.com/abstract=637001.
47. Spinoffs, however, do not involve bundling because they are effected either through a distribution of the subsidiary's shares to the parent's shareholders or through a sale of those shares in a public offering.
48. See id. at 9 (reporting that from a sample of 277 spinoffs from mid-1993 through 1997, 91 were share distributions and 186 were public offerings). In a share distribution, shareholders have no say. In a public offering, shareholders can price the offered shares and are not limited to accepting or rejecting the deal on management's terms.
49. See, e.g., DEL. CODE ANN. tit. 8, § 141(d) (Supp. 2008). Although this statute also permits company bylaws to stagger the board, this option is less commonly used than staggering the board in the charter because shareholders can amend the bylaws to eliminate the staggered structure.
50. See John C. Coates IV, Explaining Variation in Takeover Defenses: Blame the Lawyers, 89 CAL. L. REV. 1301, 1392-93 (2001).
51. Some states permit staggered boards with four classes. See, e.g., N.Y. BUS. CORP. Law § 704(a) (McKinney 2003).
52. A poison pill is a dividend of rights allowing all shareholders other than the hostile bidder to buy additional shares at a deep discount if the bidder crosses a threshold of share ownership, which dramatically raises the cost of the takeover.
53. See, WILLIAM T. ALLEN, REINIER KRAAKMAN & GUHAN SUBRAMANIAN, COMMENTARIES AND CASES ON THE LAW OF BUSINESS ORGANIZATION 522-25 (3d ed. 2009) (describing how poison pills work).
54. See Lucian Arye Bebchuk, John C. Coates IV & Guhan Subramanian, The Powerful Anti-takeover Force of Staggered Boards: Theory, Evidence, and Policy, 54 STAN. L. REV. 887, 940-43 (2002) (reporting that 6% of staggered boards were installed before 1974, when hostile takeovers became legitimate in the corporate marketplace, that another 17% were installed before 1985, when the Delaware courts validated the use of a poison pill by the board to resist takeovers, and that another 53% were installed before 1990, when the Delaware courts permitted the board to resist takeovers indefinitely).
55. see also Re-Jin Guo, Timothy A. Kruse & Tom Nohel, Undoing the Powerful Anti-Takeover Force of Staggered Boards, 14 J. CORE FIN. 274, 275 n.7 (2008) (reporting that most of the firms in a sample of firms with staggered boards staggered their boards before 1990 and that most of the firms that staggered their boards later did so before going public).
56. See Bebchuk, supra note 3, at 724-25; Klausner, supra note 3, at 758-59 (providing statistics).
57. Martijn Cremers & Allen Ferrell, Thirty Years of Shareholder Rights and Firm Valuation 35 fig.3A (Feb. 1, 2010) (unpublished manuscript), available at http://ssrn,com/abstract=1413133 (documenting a gradual increase in the incidence of staggered boards from 1978 until 1995, followed by a gradual decrease from 1996 until 2006).
58. See Ganor, supra note 4, at 155-58; Guo et al., supra note 30, at 275; Murti, supra note 4; sources cited supra note 31.
59. This statistic is based on the 1996 to 2007 editions of the Georgeson Annual Corporate Governance Review. See Georgeson, Annual Corporate Governance Review, http://www.georgesonshareholder.com/usa%20/acgro9.php (last visited March 27, 2010).
60. See GEORGESON, 2007 ANNUAL CORPORATE GOVERNANCE REVIEW 18 (2008), available at http://www.georgesonshareholder.com/usa/download/acgr/acgr2007.pdf.
61. GEORGESON SHAREHOLDER, 1996 ANNUAL MEETING SEASON WRAP-UP: CORPORATE GOVERNANCE 7 (1997), available at http://www.georgesonshareholder.com/usa/ download/acgr/acgr1996.pdf.
62. See Georgeson, supra note 33.
63. See GEORGESON, 2006 ANNUAL CORPORATE GOVERNANCE REVIEW 3 (2007), available at http://www.georgesonshareholder.com/usa/download/acgr/acgr2006.pdf.
64. See id. at 2-3.
65. See David Drake, Georgeson, Dispatches from the Proxy Front Shareholder Activism and the 2008 Proxy Season 13 (2007), http://www.georgesonshareholder. com/usa/download/articles/Shareholder-Activism-and-2008-Proxy-Season120407.pdf.
66. See Bebchuk et al., supra note 30, at 930 fig.3.
67. See id. at 934-35.
68. See Lucian A. Bebchuk & Alma Cohen, The Costs of Entrenched Boards, 78 J. FIN. ECON. 409, 409 (2005).
69. This association was subsequently confirmed by Olubunmi Faleye, Classified Boards, Firm Value, and Managerial Entrenchment, 83 J. FIN. ECON. 501, 509 (2007).
70. Michael D. Frakes, Classified Boards and Firm Value, 32 DEL. J. CORP. L. 113, 117 (2007).
71. See Bebchuk & Cohen, supra note 41, at 426-28.
72. See Guo et al., supra note 30, at 287.
73. See Faleye, supra note 41, at 503.
74. See Ronald W. Masulis, Cong Wang & Fei Xie, Corporate Governance and Acquirer Returns, 62 J. FIN. 1851, 1867-69 (2007).
75. See Thomas W. Bates, David A. Becher & Michael L. Lemmon, Board Classification and Managerial Entrenchment: Evidence from the Market for Corporate Control, 87 J. FIN. ECON. 656 (2008).
76. Id. at 658.
77. Id. at 675-76.
78. Even commentators who believe that a staggered board can negotiate better deals on behalf of shareholders agree that shareholders should be the judges of whether to have a staggered board, especially when the board structure is modified after the shareholders bought their shares.
79. See, e.g., Lynn A. Stout, Do Antitakeover Defenses Decrease Shareholder Wealth? The Ex Post/Ex Ante Valuation Problem, 55 STAN. L. REV. 845, 858-60 (2002).
80. See infra notes 52-53 and accompanying text.
81. A merger of A into B itself is often referred to as a "direct merger," and a merger of A with a subsidiary of B is often referred to as a "triangular merger." A triangular merger can be structured as a merger of B's subsidiary into A (a "reverse triangular merger") or as a merger of A into B's subsidiary (a "forward triangular merger").
82. See Theodore N. Mirvis, Takeover Law and Practice 2008, in WHAT ALL BUSINESS LAWYERS MUST KNOW ABOUT DELAWARE LAW DEVELOPMENTS 2009, at 201-02 (PLI Corp. Law & Practice, Course Handbook Series No. B-1740, 2009) (describing the various merger structures).
83. See DEL. CODE ANN. tit. 8, § 251 (2001 & Supp. 2008) (requiring that mergers be approved by the shareholders of the "constituent corporations"). Unlike the shareholders of A, the shareholders of B will vote on arms-length mergers only if B issues new stock that amounts to at least 20% of its outstanding common stock to pay the shareholders of A.
84. See id. § 251(g) (referring to mergers of A into B); NYSE Euronext, Inc., NYSE Listed Company Manual § 312.03(c) (2008) (referring to mergers of A with a subsidiary of B); NASDAQ, Inc., NASDAQ Stock Market Rules § 5635(a)(1) (2009) (referring to mergers of A with a subsidiary of B); NYSE Euronext, Inc., NYSE Amex Company Guide § 712(b) (2008) (referring to mergers of A with a subsidiary of B). For our purposes, however, the vote of interest is the vote by the shareholders of A because it is A's board structure that is changing. Their right to vote does not depend on how much common stock B will issue in the merger.
85. This deal structure is often referred to as a "double-dummy merger." See Mirvis, supra note 51, at 202.
86. Marie Leone, Two Mergers Are Better than One, CFO, Dec. 2005, at 35, 35.
87. Allan Sloan, The Double Dummy Can Be Very Smart, NEWSWEEK, Mar. 19, 2007, at 26, 26.
88. Marie Leone, Microsoft, Yahoo: Double Dummies?, CFO, Feb. 4, 2008, http://www.cfo.com/article.cfm/10636146.
89. While we assume for simplicity that the only possible merger is between A and B, the analysis remains similar when a third party, C, proposes an alternative merger that is not bundled with a staggering of the board. First, to win shareholder approval, C's alternative merger will have to produce synergies that exceed the net value of the merger between A and B. Second, to have its alternative merger even considered, C will need to overcome the array of defenses protecting the deal between A and B. In many cases, at least one of these conditions will not be met and the bundled merger between A and B will face no competition.
90. See, e.g., Yakov Amihud & Baruch Lev, Risk Reduction as a Managerial Motive for Conglomerate Mergers, 12 BELL J. ECON. 605, 615 (1981) (finding that managers engage in value-destroying conglomerate mergers to lower the risk of losing their job).
91. Jarrad Harford & Kai Li, Decoupling CEO Wealth and Firm Performance: The Case of Acquiring CEOs, 62 J. FIN. 917, 919 (2007) (finding that managers of acquiring firms are richly compensated even for poor acquisitions).
92. See sources cited supra note 31.
93. See infra Table 2, p. 1576, and accompanying text; cf. infra note 94.
94. See supra notes 52-53 and accompanying text.
95. See, e.g., Paul A. Gompers, Joy Ishii & Andrew Metrick, Extreme Governance: An Analysis of Dual-Class Firms in the United States, 23 REV. FIN. STUD. (forthcoming 2010) (on file with the Harvard Law School Library).
96. Deal planners may prefer to keep the party with dual-class capitalization public also to avoid the need for a separate vote on the merger by each class, which would invite holdups. Some states seem to require separate class votes in such mergers. See, e.g., N.Y. BUS. CORP. LAW § 903(a)(2) (McKinney 2003); MODEL BUS. CORP. ACT § 11.04(f)(1) (2008). As a precautionary measure, planners often assume that a separate class vote is needed in these states.
97. See 1 LOU R. Kling & Eileen T. Nugent, Negotiated Acquisitions of Companies, Subsidiaries and Divisions § 4.12 (2009).
98. See VIRGINIA K. ROSENBAUM, INSTITUTIONAL S'HOLDER SERVS. INC., CORPORATE TAKEOVER DEFENSES, at vi, xi (2006) (reporting staggered boards in 59.7% of 1925 firms comprising S&P 1500 firms plus additional firms "selected primarily on the basis of market capitalization and high institutional ownership levels" in 2004, and 56.4% of these firms in 2005). For similar figures, see Bebchuk et al., supra note 30, at 895 & fig.1.
99. See supra note 51.
100. See supra note 51.
101. The Wilcoxon signed-rank test is a nonparametric statistical hypothesis test for two related samples or repeated measurements on a single sample. It is an alternative to the paired Student's t-test when the population cannot be assumed to be normally distributed.
102. See Frank Wilcoxon, Individual Comparisons by Ranking Methods, 1 BIOMETRICS BULL. 80 (1945). We use it here because the mean of the parties' staggered board indicators can take only one of three values (-1, 0, or 1), and so the mean cannot be assumed to be normally distributed.
103. A t-test is a statistical hypothesis test in which the test statistic has a Student's t distribution if the null hypothesis is true. It is applied when the population is assumed to be normally distributed. See Student, The Probable Error of a Mean, 6 BIOMETRIKA 1 (1908).
104. See Jennifer Arlen & Eric Talley, Unregulable Defenses and the Perils of Shareholder Choice, 152 U. PA. L. REV. 577, 614-23 (2003) (describing provisions in company agreements with third parties that make the agreements terminable or impose penalties on the companies upon a change of control).