Inefficient Results in the Market for Corporate Control: Highest Bidders, Highest-Value Users and Socially-Optimal Owners

Abstract

I. INTRODUCTION II. THE CONCERN FOR EFFICIENCY IN THE MARKET FOR CORPORATE CONTROL A. Hostile Tender Offers and Anti-takeover Devices B. Negotiated Acquisitions and Deal Protection Devices III. PRICE DISTORTIONS ARISING FROM NEGATIVE PECUNIARY EXTERNALITIES AND POSITIVE REAL EXTERNALITIES IN THE MARKET FOR CORPORATE CONTROL A. Highest Bidders, Highest-Value Users, and Socially Optimal Owners B. Negative Pecuniary Externalities Impounded into the Bids of Strategic Acquirers C. Positive Real Externalities Not Impounded into Bids of Strategic Acquirers D. Highest Bidders, Highest-Value Users, and Socially Optimal Owners Redux E. Frequency and Magnitude of the Price Distortions F. A Possible Real-World Example: The Acquisition of 3Par by Hewlett Packard G. How the Market for Corporate Control Differs from Most Other Markets IV. IMPLICATIONS OF THE PRICE DISTORTIONS IN THE MARKET FOR CORPORATE CONTROL A. New Explanation for the Winner's Curse B. The Inapplicability of Auction Theory to the Market for Corporate Control C. The Limited Relevance of Distortions Arising from Anti-takeover and Deal Protection Devices V. THE POSSIBILITY OF A POLICY RESPONSE A. Regulation Under the Federal Securities Laws B. Regulation Under Delaware Corporate Law C. The Possibility of Direct Regulation VI. CONCLUDING OBSERVATIONS I. INTRODUCTION For more than thirty years, the leading legal and economic scholarship concerning the market for corporate control has been guided by the principle that outcomes in that market should be efficient and thus that legal rules governing that market should facilitate efficient results. (1) In keeping with the standard assumption that allocating resources to their highest-value user will maximize social welfare and produce an efficient result, the virtually universal assumption in the legal and economic scholarship on the market for corporate control has been that whichever bidder is willing to pay the highest price to acquire the target company should be permitted to do so. When the highest bidder acquires the target, not only is wealth maximized for the target shareholders but, it has been assumed, ownership of the target is also transferred to its highest-value user, and this produces the efficient (that is, socially optimal) result. (2) This is a perfectly commonplace invisible-hand argument: by doing what is best for themselves by selling for the highest price available, the shareholders of the target also do what is best for society as a whole. This theme has dominated the literature on both hostile takeovers (3) and negotiated acquisitions. (4) With respect to hostile takeovers, the argument has generally been that, by allowing incumbent management to prevent willing shareholders from selling their shares to willing buyers, anti-takeover devices like poison pills and staggered boards reduce shareholder value, keep control of the target company from shifting to its highest-value user, and so reduce social welfare. (5) With respect to negotiated acquisitions, the scholarship has focused on the efficiency of deal protection devices like cash termination fees and voting agreements, with some scholars arguing that such devices promote shareholder value, the allocation of targets to their highest-value users, and the maximization of social welfare, and others arguing that they have just the opposite effects. (6) To be sure, some scholars have argued that mergers and acquisitions impose costs on third parties such as employees, creditors, suppliers, and the communities in which acquired companies operate and that these costs have to be taken into account in determining whether a corporate control transaction is efficient, but most scholars have concluded that these costs, no matter how important they may be in human terms, are relatively small compared to the gains captured by target shareholders and acquirers and so do not make otherwise efficient transactions inefficient. …