Download Selling Control for a Premium: Economics and Law

Selling Control for a Premium:
Economics and Law
Chapter 11
Evidence on Control Premiums & Voting Rights
• If you buy a minority share in a company with
a majority holder, will you pay the same price
per share as that paid for each share of a
controlling shareholder?
• If not, what would explain the difference?
• How are these price differences related to the
value of voting rights?
• What happens to the value of minority voting
rights when a firm’s controlling block of shares
changes hands?
Evidence on Control Premiums &
Voting Rights
• Premiums are paid for controlling block of
shares
• Stock price falls on the proxy voting date
(price cum-vote & ex-vote) in a corporate
control contest.
• Generally voting rights in firms without a
controlling shareholder have significant value
only in a corporate control contest
Example p. 338
•
Corp. has 1 MM shares
•
Control value = $5 MM
•
How much would you expect each
share value to increase if control
value were realized?
•
If control value were distributed
evenly among 1 MM shares, each
share would increase by $5
•
If a 50.1% group were created, and
that group got the entire control
premium, those shares would go up
apx. $10/share while the rest went
up by $0/share
•
The legal rules determine allocation
as much as financial incentives do.
$10
MM
$15 MM
($5 MM
bigger)
Perlman v. Feldman
Perlman v. Feldman
• The time was 1950 in the steel industry.
• The Korean War was escalating and so was demand for
steel
– (leading later to President Truman’s executive order seizing
the steel mills and the Supreme Court’s rebuff in the
Youngstown Steel case).
• But patriotic producers were refraining from advancing
prices with the predictable squeeze on supplies.
• The market‐clearing price would be at the intersection
of the two curves producing a price of P* and a
quantity of Q*.
Perlman v. Feldman
• But at the lower price (a “soft” price control) of P bar,
demand would be much higher as reflected by the
difference between Qs , the amount that suppliers would
supply at price P bar and QD and the amount users would
seek at price P bar.
• End users of steel, who could not obtain the steel they
needed (and presumably would be willing to pay for in the
current market) sought an alternative way to acquire steel.
• if these soft price controls prevent you from offering a
higher price to get the steel you want, they don’t prevent
you from buying a steel company and then being able to
direct the supply to your end users.
Price controls: price ceilings
P*= market price in
equilibrium
Q*= Equilib Q where S=D
S
Price
QD = D at controlled P
PD
QS = Supply at controlled
P
PD = market price at QS
P*
Price control
P + interest
subsidy
Price
Ceiling
P
bar
Shortage
D
QS
Q*
QD Quantity of
steel
Price Control Effects
P* = Market price (equilibrium)
Q* = Equilibrium quantity where supply =
Demand
P
P = Price control
S
QD = Demand at price control P
QS = Supply at price control P
PD = Market price at quantity QS
P
P
*
P
*
P = Price control plus interest subsidy
D
*
P
D
Q
Qs
*
Q
Excess Demand
QD
Perlman
• M&A is an alternative way to obtain steel.
• How much would an end user be willing to pay to acquire a steel company
and its supply of steel?
• See Figure 11‐1, if the quantity being produced is Qs the end users would
pay up to the market clearing rice at that quantity of PD.
• How much is this amount?
– We don’t know exactly, but it is likely to be a substantial part of the premium
by which the block sells above the existing market price.
• Are they other explanations for the gain?
• The Feldmann plan is an alternative way for existing steel users to recover
part of that price differential.
• By getting a cash advance with no interest, Newport and other sellers
would be receiving the time value of money of the use of that amount.
Perlman -- The parties
• not surprising that the purchasers are a group
of end‐users of steel who have not been able
to obtain the steel that they want.
• The transaction is not a corporate transaction
by Newport, but rather . . .
– a sale of stock by the controlling shareholder
group as individuals selling their shares to Wilport,
the group of end users.
Perlman v. Feldmann:
Economic Explanations
Wilport
Newport
$20/share
37% N
stock
Feldmann
How is the gain from the transaction to be
allocated?
• Since only members of the control group of
shareholders are parties to the deal, only they
will receive the consideration in the deal.
• How much of the gain from gaining the supply of
steel will the purchasers be willing to pay?
• Probably the entire amount that the additional
steel would be worth to them.
• They are indifferent as to whether the premium is
shared among all the shareholders or just 37% of
them, so long as the purchaser gets control of the
steel.
How is the gain from the transaction
to be allocated? (cont.)
• In Birnbaum v. Newport Steel, we read of
contemporaneous deal -- another end user of steel
(Follansbee) had sought to purchase Newport at $[ ]/
share.
• This time, however, the purchaser proposed a merger,
in which the premium would have been shared by all
shareholders on a pro rata basis.
• Feldmann, acting for the company, turns it down.
• Note substitutability of the two transactional forms –
(but it doesn’t tell us who ought to get the premium)
Perlman – legal issues
• What is the action for which Feldmann is
sued?
• There is no corporate action; rather taking
what can be seen as a corporate opportunity.
• What is the basis for plaintiff’s claim?
• Feldmann’s breach of his fiduciary duty.
• In what capacity is Feldmann sued?
Perlman – legal issues (cont.)
• The court begins with reference to Feldmann’s fiduciary relationship both
as a director and as dominant shareholder
• Later it says his violation is clearer because of his triple role
– although the court does not want “to be understood as saying that we should
accept a lesser obligation for any one of his roles alone.” (page 392).
• At what point does one become a dominant shareholder with fiduciary
duties?
• Here 37% was enough, although well short of a majority.
• Such holdings were less debatable in the 1950s when shareholders were
dispersed and passive so that if one group had 37% (or even less than
that) it practically had control since the chances of others organizing
against the 37% were unlikely.
• That assumption is much less likely to hold today
When can a shareholder sell shares for
a premium?
• This is the crucial question
• Is the answer is “Never”?
•
The court quotes from Cardozo’s punctilio standard in Meinhard v. Salmon
and talks about this personal gain as “reprehensible.”
• But the opinion also says explicitly (at page 392) “We do not mean to
suggest that a majority shareholder cannot dispose of his controlling block
of stock to outsiders without having to account to his corporation for
profits.”
• So when is it wrong?
• This case tells us that when there is a “sacrifice of an element of corporate
good will and consequent unusual profit.”
• Would any premium be a corporate opportunity or is it possible to
separate out the unusual ones?
Are non‐controlling shareholders
better or worse off?
• Can we look to the change in position of the non‐controlling shareholders
to tell us whether the controlling shareholders have breached a fiduciary
duty?
• Easterbrook & Fischel (note 4) assert that the minority Perlman
non‐controlling shareholders were in fact better off by the sale of control.
• They rely on an unpublished paper by Charles Cope that reports a rise in
the price of Newport over the remainder of 1950, a gain that remains
after accounting for the rising fortunes of the steel companies as a whole
during this period of the country’s effort to produce both guns and butter.
• Should the control premium rule be that the controlling shareholder can
take a premium so long as the minority is no worse off?
• Note that the trial court had put the burden of proof on the plaintiff but
the court of appeals disagrees noting that fiduciaries always have the
burden of proof in establishing the fairness of their dealings with trust
property.
Economic Impact on Minority Shareholders
• Are they worse off?
– Change in price for steel received by their company (same as before)
– Change from loss of income of the Feldman Plan: Wilport only pays the controlled
price for steel and no longer pays Feldmann premium to Newport.
• Minority own 63% of Newport shares, so they:
– lose 63% of Feldmann Plan interest subsidy’s value
– gain 63% of synergies & efficiency gains in control change
• How can we assess if minority shareholders have a net
gain or loss?
– Do expected benefits exceed expected loss of interest subsidy?
– Does Newport’s stock price rise or fall?
– Would that evidence sufficient to conclude there is no loss? What else would you
want to know?
Mendel v. Carroll & Sale of Control
• Chancellor Allen:
– “The law has acknowledged, albeit in a guarded and complex
way, the legitimacy of the acceptance by controlling
shareholders of a control premium.”
• Exceptions:
– Negligence/ sale to looter
– Sale of office
– Sale of Corporate Opportunity
• Where do Perlman & Mendel facts fit into that list?
Mendel: the deal
• two deals that intersect: The first parallels Cox
• The family that owns a controlling interest has proposed to acquire
all of the non‐family shares originally at a price of $22 when the
market price was $16.
• Paralleling the process in prior cases, a special committee was
appointed; Goldman Sachs was hired as well as a law firm for the
committee.
• The special committee rejects the $22, there was negotiation back
and forth over six months and the parties eventually agreed on a
merger at $25.75 leading to a proxy solicitation.
• Then eight days after mailing of the proxy solicitation, an outside
bidder (led by Pensler, who had worked for an investment banker
hired by the company two years before so he likely knew something
about the company’s potential) steps in with a $29 bid.
Mendel: the deal 2
• After three months of back and forth, the family withdraws its
merger, makes clear it is not going to sell to an outsider, but the
board and its special committee continue to consider the outside
deal, including a provision in the Merger Agreement proposed by
the outside bidder that would grant the bidder an irrevocable
option to purchase 1.8 million shares at a price equal to the merger
consideration.
• The board and the committee seek an opinion of counsel as to
whether issuing such an option would be a breach of duty.
• The special committee’s Delaware counsel issues a 32 page opinion
that concluded it was unclear whether granting the option would
be legal.
• In the face of the uncertainty, the board opts for a special dividend
of $14 per share.
Mendel: Comparing the Two Offers
• Who are the potential
acquirers?
– The Carroll family
• At what price?
– $22/$25.75
• Context?
– Cash out
• Legal Standard
– Weinberger
• Who are the potential
acquirers?
– Pensler
• At what price?
– $29/$27.80
• Context?
– Best price
• Legal Standard
– Revlon
Mendel v. Carroll
• How is the legal claim in this case different?
Against whom is it brought and on what
grounds?
– Requiring board to grant dilutive option
– Unprecedented; radical
– When might the court do it? “I suppose” “might
permissibly” “exploiting vulnerable minority”
Mendel v. Carroll: The resolution
• How does the court resolve it?
– “to be a protective guardian of the rightful interest of
the public shareholders,” but “does not authorize the
board to deploy corporate power against the majority
shareholders, in the absence of threatened serious
breach”
– “quite possible that the Carroll $25.75 price may have
been fair, even generous, while the $27.80 Pensler
price may be inadequate.”
– How can this be so? The value of control