Proxy advisory firms, activist investors and some academics advocate that public corporations should unilaterally opt out of state anti-takeover statutes as not being in the shareholders’ best interest. They argue that such statutes can reduce management accountability by substantially limiting opportunities for corporate takeovers and thus prevent stockholders from receiving a buyout premium for their stock.
Section 203 of the Delaware General Corporation Law, which covers more than half of all publicly held U. S. corporations, and its counterparts in the corporate statutes of many other states, protect shareholders from coercive two-tiered tender offers. This gives the shareholders the freedom to vote against an offer which they deem inadequate without fear of being forced to accept an even less desirable price in the second-stage, freeze-out merger.
Moreover, as a practical matter, the board can negotiate to extract the very highest value from the buyer by refusing to agree to an exemption for a deal which it considers to be inadequate.
The control-share acquisition statutes provide similar protection for shareholders by preventing an acquirer from gaining control of the corporation through a series of open-market purchases without paying a control premium.
The current hostility toward anti-takeover statutes highlights the fundamental conflict between two fiduciary duties of the board of directors: to act in the best interests of the corporation; and to maximize long-term shareholder value — as contrasted with the investment community’s current, short-term focus on making a quick, easy profit.
The proxy advisory firms and activist investors believe shareholders should control all decisions about the sale of a company, regardless of whether their decisions are driven by short-term trading objectives rather than long-term value creation,and regardless of whether the offer represents the best value reasonably available for the shareholders.
Institutional investors on average own approximately 70% of the shares of major U.S. corporations. Therefore, this “shareholder democracy” governance model inevitably leads to greater emphasis on short-term financial results and greater risk-taking, rather than investing in long-term value creation and building a business.
Under the so-called Revlon Doctrine, the board of directors, when dealing with the potential sale of the company, must maximize the company’s value for the stockholders’ benefit. Put another way, the board’s legal duty in the sale context is to get the very best price reasonably available, not merely to get a price which will make the majority of investors happy. If the long-term, stand-alone value of the company exceeds the price resulting from the proposed transaction, the directors’ fiduciary duty requires that they reject the deal
Activist hedge funds, with approximately $100 billion in assets under management — almost triple the capital they held five years ago — are on the prowl all over the corporate landscape. Few public companies are safe. Activists have gone after Apple, perhaps the most innovative and successful company of the past 20 years, as well as Allergan, Sotheby’s, Microsoft, Yahoo, Dell, Dillard’s, McGraw-Hill, CSX and DuPont, to name a few.
The activists often target companies that conserve cash or make other decisions that management and boards believe position the businesses for long-term growth. Activists attempt to convince shareholders that they’ll increase profits quickly, providing a bump to the stock price and a quick payoff for everyone — but especially for the activists, as their proposals often rely on financial engineering and heavy leverage.
Wall Street’s enthusiasm for almost any deal, driven by insatiable hunger for quick trading profits, gives activist investors their firepower. This focus on making a fast buck is generally bad for a company, shareholders’ long-term prospects and the U. S. economy generally.
The inherent conflict between the board of directors’ fiduciary duty to maximize shareholder value upon a change of control and the investment community’s desire for quick, short-term profits was highlighted in In re Rural Metro Corporation Shareholders Litigation, No. 3650-VCL, 2014 WL 971718 (Del. Ch. March 7, 2014).
The chairman of Rural/Metro, who was the founder of an activist hedge fund owning 12% of the stock, orchestrated the sale of the company to a private-equity fund in a deal that produced a 39% premium for shareholders. The chairman was apparently motivated, in part, by the desire for his fund to post attractive returns in order to raise more money for his next fund. The Delaware Chancery Court found that the board breached its fiduciary duties under Revlon by conducting a flawed process which failed to maximize shareholder long-term value. The court found the price to be inadequate because the long-term stand-alone value of the enterprise substantially exceeded the price paid by the buyer.
State antitakeover laws provide valuable tools for the board to discharge its Revlon duties and pursue the best long-term value for the shareholders. Corporate boards should think long and hard about abandoning them and thereby exposing the company to even greater short-term performance pressure to satisfy the proxy advisory firms and activist investors, neither of whom share the board’s fiduciary duty to act in the best interests of the corporation and maximize long-term shareholder value.
Gardner Davis is a partner and corporate lawyer with Foley & Lardner LLP. He regularly counsels companies and their boards of directors in M&A transactions and corporate governance matters. Davis can be reached at firstname.lastname@example.org.