Do Mandatory Auctionss Increase the Gains of Target Shareholders in Mergers and Acquisitions? Evidence from the Effect of Time Warner

Abstract

Several years ago, in Revlon v. MacAndrews & Forbes Holdings, the Delaware Supreme Court held that when a “sale” or “break-up” of a company becomes “inevitable,” the duty of the directors is not to maintain the independence of the company or otherwise give priority to long-term considerations, but rather to obtain the highest price possible for the shareholders in the transaction (that is, to maximize short-term value). To satisfy this duty, the directors are generally supposed to conduct an auction for the shares of the company or, as clarified in subsequent decisions, “check” in the market that the shareholders are receiving the best price available. Even before Revlon, the literature was divided on whether takeover transactions should involve this kind of “auctioneering” duty. One strand of the literature generally supports auctions because they increase competition among bidders and thus lead to better prices for the target shareholders. For another strand, auctioneering duties do not necessarily increase prices because the directors of the target company will anyway seek to obtain the best deal available in the market in order to satisfy their ordinary duty of care to the shareholders. From that perspective, mandatory auctions are actually a friction in the takeover market that can have the unintended effect of deterring potential bidders. The effects of Revlon duties, however, have remained empirically untested. The purpose of this work is therefore to make a first step to fill that gap, particularly by examining the impact of Paramount Communications, Inc. v. Time, Inc. on target returns and deal incidence. The analysis focuses on this decision because prior literature has considered that it created an exemption from Revlon for a particular type of transactional form, and, as a result, target returns in those deals should experience a statistically significant decrease after the date of the decision if Revlon actually exerts an upward pressure on prices. Also, if Revlon duties deter prospective bidders, the incidence of the exempted transactions should increase after Time Warner relative to deals that generally trigger mandatory auctions. As further discussed in the text, Time Warner does not seem to have had any significant effect on target returns or deal incidence. These results, in turn, provide support for the trend toward greater flexibility in more recent case law.