Hedge Funds' Empty Voting in Mergers and Acquisitions: A Fiduciary Duties Perspective

Abstract

Hedge funds have become active lately in the market for corporate control. Their active involvement has been propelled by a tactic allowing them to decouple voting rights from economic ownership and labeled in the literature as “encumbered shares" or “empty voting."The aim of this article is twofold. On the one hand, I address the impact of hedge funds' activism on the financial markets and on the portfolio companies. In general terms, hedge funds' activism should be seen as a neutral element. After a cost-benefit analysis, I show that the costs implied by hedge funds' activism are at least offset by the relevant benefits. Data reported by recent empirical studies seem to back this conclusion. However, when empty voting is used, a potential risk of incentives distortion arises, particularly when empty voting is coupled with a conflicted position of the hedge fund which stands on both sides of the transaction, as illustrated by the famous King-Mylan case. In addition, I show with a numerical example that under certain circumstances empty voting likely causes and/or facilitates value-destroying (inefficient) mergers.On the other hand, the article pursues a policy approach. I do not present ad hoc policy measures based either on disclosure or voting abstention proposals, as already done in literature. Rather, I frame empty voting used in merger and acquisition transactions within the current Delaware corporate law standards of review. I indeed propose a functional approach based on the fiduciary duties doctrine which is applicable to empty voting regardless of the technical device employed. It endorses the direct involvement of the disinterested shareholders (i.e. the shareholders other than the empty voters) and posits that an approval of the transaction by the majority of disinterested shareholders should trigger a business judgment presumption.