Archives For takeovers

I’m just catching up with this Board Member article about Delaware’s new competitor, Nevada. It notes that Nevada’s share of the out-of-state incorporation market rose from 4.6% in 2000 to 6% in 2007.  Part of this may be due to lower fees than Delaware. But that can’t be the full explanation because all states are cheaper than Delaware.  More interestingly, the article suggests Nevada may be succeeding by offering a haven for shady operators with low fiduciary standards and high barriers to takeovers. 

The article features a discussion of Michal Barzuza’s article with David Smith, What Happens in Nevada? Self-Selecting into a Lax Law, which as the title indicates supports the competition-for-laxity position.  This paper, as the Board Member article notes, shows that “Nevada corporations posted accounting restatements twice as often as the national average from 2000-2008.”  Barzuza tells Board Member:  “It should be a cause for concern if the companies that need regulation most are allowed to choose a lax legal regime.”

I get a chance to respond in the Board Member article.  Here’s my quote:  “The data show that riskier firms are going to Nevada, but risky firms need capital, too. What Delaware has to offer is its legal infrastructure. But it’s reasonable to ask what that is worth to me as a business.” This is along the lines of my comment on Barzuza-Smith at last year’s Conference on Empirical Legal Studies. 

Barzuza also has a sole-authored paper that focuses on the normative aspects of the Barzuza-Smith empirical study.  That paper doesn’t yet have a public link, but I’ve read it and saw it presented at ALEA last week. 

Barzuza and I agree that Delaware and Nevada appeal to different segments of the incorporation market.  We disagree on whether this is a problem.  In a nutshell:

  • Barzuza thinks the relatively high level of accounting restatements by Nevada corporations indicates Nevada offers an escape from regulation for firms that most need to be regulated.  As Barzuza-Smith say in their abstract:  “Our findings indicate that firms may self-select a legal system that matches their desirable level of private-benefit consumption, and that Nevada competes to attract firms with higher agency costs.”
  • But I see an efficient contracting story, with Nevada offering smaller firms an opportunity to economize on monitoring and litigation costs. (Note: the more recent unposted Barzuza paper also discusses the efficient contracting story.)

The implications of this debate are important because it carries the threat of more federal regulation of corporate governance.

Here’s some support for my efficient contracting hypothesis:

  • Nevada isn’t, in fact, a haven for defrauders.  Its law provides for liability for fraud as well as intentional misconduct or a knowing violation of law. It couldn’t if it wanted to offer escape from federal securities law liability. Although B-S (Table 4) show a higher fraud percentage in Nevada restatements, the total percentage is tiny in Nevada as elsewhere.  More importantly, B-S found no evidence that increased restatements followed incorporation under Nevada’s lax (post-2000) provisions.  In other words, although Nevada may attract dishonest managers, there’s no indication these firms were reincorporating in Nevada in order to commit fraud.
  • The value of Nevada corporations doesn’t suffer from any evident “fraud discount” as measured by Tobin’s q (B-S Table 5) (although it’s not clear how these values might be affected by pre- or post-restatement accounting). 
  • There are benign explanations for the larger number of Nevada accounting restatements.  Nevada public firms are smaller than those in Delaware, increasing the per capitalization cost of setting up controls that could catch accounting errors.  Small size is one of the factors associated with weaker controls (see Doyle, Ge and McVay).  B-S show that Nevada has a relatively high percentage of mining firms, and Barzuza’s ALEA paper shows that Nevada has a relatively high percentage of family firms.  Both of these characteristics relate to the amount and type of monitoring required, and therefore to the efficient contracting story.

In short, the article’s data is consistent with the hypothesis that firms choose Nevada for its better balance of costs and benefits of monitoring than they could get in Delaware. Its strict default standards for suing managers may tolerate some managerial misconduct, but they also reduce firms’ exposure to opportunistic strike litigation.  Nevada removes from its statute the sources of legal indeterminacy that Delaware has been criticized for.  This enables Nevada to offer a legal package that is attractive to some firms without the costly legal infrastructure required to apply Delaware’s open-ended good-faith and loyalty standards.

In other words, in contrast to the B-S claim that Nevada “competes to attract firms with higher agency costs,” in fact Nevada may be attracting firms seeking lower agency costs defined by Jensen & Meckling to include monitoring and bonding costs as well as agent misconduct (Jensen & Meckling, Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure, 3 J. Fin. Econ. 305 (1976).  This recognizes that the costs of hiring an agent, and thereby separating ownership and control, are never zero.  Attempting to reduce agent misconduct to zero could actually increase total agency costs as compared with cheaper monitoring that tolerates a reasonable level of agent misconduct.

None of this is to say that Nevada law offers an optimal set of terms.  We could probably benefit from additional standard forms to match firms’ diverse governance needs.  (Watch for my forthcoming paper with Kobayashi on the production of private law.)   But Nevada law doesn’t have to be optimal to be welfare-increasing. The question is whether the Nevada package of terms offers a better match for some firms than a Nevada-less market for corporations in which only Delaware competes for out-of-state incorporations.

Aside from substantively evaluating Nevada law, it is worth asking whether the Nevada story suggests market failure in the corporate law market.  B-S show that Nevada is not pretending to be something it isn’t.  It clearly advertises its “laxity,” so both shareholders and managers know what they’re getting.  Moreover, the Board Member article indicates there’s inherent resistance to any state that departs from the Delaware standard.  Investors may over-discount Nevada corporate shares out of distrust or fear of the unknown so Nevada laxity is, if anything, over-reflected, in the price of Nevada IPOs.  If Nevada shareholders don’t get an adequate voice on Nevada reincorporations (as where an existing firm merges with a Nevada shell) this is a problem with the law of the non-Nevada states where the firms originate.

So more work needs to be done to flesh out the Nevada story.  This might include

  • More specific comparisons of the firms that are and aren’t choosing Nevada to get a clearer picture of the effect of Nevada incorporation. 
  • As somebody suggested at ALEA, perhaps California-based firms incorporating in Nevada may not really be choosing Nevada governance law because of California’s “quasi-foreign” provisions. 
  • Is there an “out of Nevada” effect analogous to the “out of Delaware” effect documented by Armour, Black and Cheffins, in which Nevada corporate cases, particularly those involving fraud, are being litigated in, say, California or federal court?  This would negate any effort by Nevada to attract managers seeking to escape fraud liability.
  • Is Nevada using a similar strategy to compete in the market for LLCs?  Kobayashi and my data on the market for LLCs suggest not, and that the overall market for LLCs differs from that for corporations.  So why don’t firms opt out of Delaware corporate law by opting into uncorporate law?  I show that this strategy could produce a Nevada-like reduction of indeterminacy.

In short, Barzuza & Smith are right and clever to focus on this evidence of segmentation in the incorporation market.  This contradicts those who contend that the so-called market for out-of-state incorporations is really a Delaware monopoly. 

But it’s a mistake without much more data to jump to the conclusion that this is a “cause for concern.” This sort of argument could feed building pressures to federalize corporate law.  So far the Nevada story shows that there’s a significant demand for rules that reduce governance costs even in the face of strong pressures toward Delaware standardization. This cuts against rather than for increasing federalization, particularly as we are learning that even federal law competes in a global market for corporate law.

The so-called “Dodd-Frank Wall Street Reform and Consumer Protection Act” was supposed to fix the problems that led to the financial bust.  Of course, that would require some understanding of what, exactly, those problems were, which Congress lacked.  The Act did little to fix the credit raters or the derivatives market that surely had something to do with the crash.  But it did include countless ill-considered provisions and rules lying in wait behind studies.  I’ve already commented (here and here) on the Act’s unwarranted federal intrusion into aspects of corporate governance that had little to do with the meltdown. And I’ve noted the Act’s contribution to hobbling initial public offerings.

Yale’s Jon Macey comments in today’s WSJ on the potential fallout from one of D-F’s most buried little gems:  Section 929R(a)’s authorization to the SEC to reduce the period for reporting 5% share acquisitions from ten days to “such shorter time as the Commission may establish by rule.”  Marty Lipton’s takeover defense firm, Wachtell, Lipton, Rosen & Katz, has seized on this provision to propose that the SEC reduce that period to one day. 

Alerting the market to a potential impending bid raises share prices and therefore the takeover’s overall cost. This would add to the effects of a long-term trend at both the state and federal level of allocating increasing shares of the potential gains from takeover-induced governance reforms to the incumbent shareholders and away from the bidder. This is fine for the shareholders, given the existence of a bid.  But if you increase the price of bids you’re likely to decrease the supply.  Fewer bids = more power to incumbent managers. 

As Macey notes:

Shareholders benefit from the reforms of corporate governance initiated by these activist investors. So does the economy generally, because the overall economy performs better when companies perform better. But managers are not so fond of this process because activist investors push incumbent senior managers hard to improve their performance. Occasionally they even fire them.

Since incumbent managers sometimes lose to activist investors in fair corporate elections, their preferred strategy for dealing with them is to hire legal talent and team up with friendly regulators to make new rules and to concoct anti-takeover devices like poison pills.

Macey observes that the success of these efforts explains “why the market for corporate control is relatively moribund, particularly when compared to the robust markets of the past.”

One would think that true financial reform would seek to have the opposite effect — to increase the pressure on incumbent managers, whose comfortable entrenchment helped them ignore huge risks that ended up destroying some big companies.

The roots of the W-L initiative lie in two other developments. First, as Macey notes, “changes in technology and other advances have made it possible for investors to buy shares and to file reports with the SEC in less time than before.”  Thus, incumbent managers fear losing some of the edge they’ve accumulated over bidders.  But this just returns to the question of how great that edge should be.

Second, and more important for present purposes, Steve Davidoff notes the role here of yet another formerly obscure Dodd-Frank provision, §766(e), which empowers the SEC to count cash-settled derivatives in their holdings for 13D purposes.  Davidoff suggests the real problem here isn’t reporting, but the fact that bank parties to these transactions hedge their positions by buying target shares. They can then vote those shares although they lacks a real economic interest in the company — i.e., the “empty voting” problem.  Davidoff suggests the solution is simply preventing the hedged parties from voting these shares.  Of course this would open for analysis the large can of “empty voting” worms.  As Kobayashi and I have written, this problem is much less obvious and more complex than meets the eye.  

Davidoff has discussed the interest group battle over the W-L proposal:

Corporate America is divided over the Wachtell petition. According to people close to the firm, an earlier draft of the petition was circulated among seven law firms, a working group of well-known corporate law firms commenting on Dodd-Frank initiatives. But the other law firms begged off signing the petition. * * * Wachtell portrays itself as a firm that favors management. It actively represents companies against hostile takeovers and activist shareholders but appears to have only one large hedge fund activist client* * *

Wachtell appears to have the ear of the S.E.C. Michele M. Anderson, the agency’s chief of mergers and acquisitions, said last month that the S.E.C. staff was planning to recommend that the reporting period be shortened.

The more basic issue here is the battle for control of corporate governance law between the states, who compete for business, and the federal legislators and regulators, who collect rents from powerful interest groups.  On the other side of the takeover argument from Wachtell are those who are pushing increased application of federal law to restrict state law regulation of takeovers.  I’ve argued that these moves are also ill-advised.

And then there is what Davidoff refers to as the “larger war against hedge funds.”  He sees the SEC as

desperately struggling for relevance. Hedge funds are rich but often unpopular. Wachtell, through its focus on protecting shareholders rather than corporate boards, is using the agency’s struggles to push through its agenda.

This might have something to do with a certain insider trading trial going on in NYC.

To make a long story short, rather than solve the problems that led to the financial crisis, Dodd-Frank included myriad buried treasures that are now serving as platforms on which interest groups and federal agencies can battle for control of large corporations.  In the case of 929R and 766(e), “financial reform” may well lead to more federalization of corporate governance law and more power for incumbent managers — exactly what the financial crisis demonstrated we do not need.

The Airgas decision

Larry Ribstein —  16 February 2011

So Chancellor Chandler, in deciding Airgas, preserved the board’s power to decide when to sell the company.  If a company’s shareholders don’t like it, they need to replace the board.  If shareholders generally don’t like it they need to change the Delaware statute.

In upholding the board’s power, and confirming what most astute observers knew the law likely was, despite very strong facts the other way (no “coercion” or other obvious reason why the pill was needed), the court preserved the stability of Delaware law. Hard facts don’t have to make bad law.  Although the Air Products bid was $70, the shares had been trading around $63.  They fell from $63.73 to $61 after the decision, suggesting clarification of a small residual amount of uncertainty.

The decision illustrates one reason why Subramanian, et al, were wrong to suggest the Delaware anti-takeover statute is preempted by the Williams Act.  If the statute, why not the pill — and other aspects of Delaware law that block takeovers?  Here’s my response along these lines to the Subramanian et al argument.

Of course Congress theoretically could pass a law that explicitly preempts poison pills.  Dodd-Frank’s intrusion into corporate governance makes this plausible.  But such additional federal interference would not be wise.

The WSJ reports on proposed rules forcing hedge funds to disclose confidential proprietary information:

Under current rules, many managers are required each quarter to publicly disclose their long equity positions in public securities. The proposed rules would require a much greater level of disclosure to regulators about trading positions, counterparties, liquidity, leverage and performance. * * *

“WikiLeaks has more or less proven that anything you give to the government you have to assume could one day be public,” said Nathan Greene, a lawyer with Shearman & Sterling LLP who represents hedge funds, referring to the leaks of thousands of diplomatic cables in recent months.

“It is impossible, after seeing State Department cables, to say to yourself, ‘I’m going to package my most sensitive business information and give it to the U.S. government,’ and do it without a pit in your stomach,” he said. * * *

Systemic-risk monitoring has long been under consideration for the hedge-fund industry.

Onerous disclosure regulation of hedge fund trading positions is costly and unnecessary, as I’ve discussed:

Hedge funds are not part of the systemic risk problem.  It’s more likely they’re part of the solution in the sense that they use proprietary and business methods to bet against the accepted wisdom, rather than following all the other lemmings off of financial cliffs.  For a good statement of this argument, see Jon Macey, Promises Kept, Promises Broken, 275-82 (2008). Increased disclosure may reduce the funds’ incentives to invest in developing these strategies, which could actually increase systemic risk.

More generally, as I’ve said, hedge funds, through short selling and takeovers, have been an important source of market discipline.

And then there are also the risks that (1) the SEC won’t effectively guard the information; and (2) won’t effectively use the data it gets.  Here’s more bearing on those issues.

Bebchuk, Cohen and Wang have posted Staggered Boards and the Wealth of Shareholders: Evidence from a Natural Experiment.  Here’s the abstract:

While staggered boards are known to be negatively correlated with firm valuation, such association might be due to staggered boards either bringing about lower firm value or merely being the product of the tendency of low-value firms to have staggered boards. In this paper, we use a natural experiment setting to identify how market participants view the effect of staggered boards on firm value. In particular, we focus on two recent rulings, separated by several weeks, that had opposite effects on the antitakeover force of the staggered boards of affected companies: (i) an October 2010 ruling by the Delaware Chancery Court approving the legality of shareholder-adopted bylaws that weaken the antitakeover force of a staggered board by moving the company’s annual meeting up from later parts of the calendar year to January, and (ii) the subsequent decision by the Delaware Supreme Court to overturn the Chancery Court ruling and invalidate such bylaws.

We find evidence consistent with the hypothesis that the Chancery Court ruling increased the value of companies significantly affected by the rulings –namely, companies with a staggered board and an annual meeting in later parts of the calendar year –and that the Supreme Court ruling produced a reduction in the value of these companies that was of similar magnitude (but opposite sign) to the value increase generated by the Chancery Court ruling. The identified positive and negative effects were most pronounced for firms for which control contests are especially relevant due to low industry-adjusted Tobin’s Q, low industry-adjusted return on assets, or relatively small firm size. Our findings are consistent with market participants’ viewing staggered boards as bringing about a reduction in firm value. The findings are thus consistent with institutional investors’ standard policies of voting in favor of proposals to repeal classified boards, and with the view that the ongoing process of board declassification in public firms will enhance shareholder value.

The paper reports on the Airgas/Air Products takeover battle.  Interestingly, it relies heavily on Steve Davidoff’s excellent reporting on this contest.

I have not studied the empirical test closely.  Taking the results at face value, I have a couple of observations.  First, although this evidence helps persuade Bebchuk et al that declassification “will enhance shareholder value,” proponents of strong boards who distrust markets driven by arbs and hedge funds would disagree.  I think the ultimate answer is best given by the corporate contract.  As interpreted by the Delaware courts in Airgas, that contract (reading the corporate charter in conjunction with the statute) favors strong board control.  See generally my venerable but still relevant article on interpreting the corporate contract in this context, Takeover Defenses and the Corporate Contract, 78 Georgetown Law Journal 71 (1989). This contract gives boards the power to, for example, maintain management continuity and long-run vision, at the possible cost of foregoing agency cost discipline. 

Second, there is, of course, another way — the uncorporation which, as I discuss in my Rise of the Uncorporation, may combine strong protection from takeovers with other mechanisms for disciplining managers.  For a recent article focusing on staggered boards in a particular type of uncorporation, see Corporate Governance and Performance in the Market for Corporate Control: The Case of REITs (no free online version available):  

We examine 132 mergers and acquisitions by Real Estate Investment Trusts (REITs) during 1997-2006 and explore the relationship between acquirer external and internal corporate governance mechanisms and announcement abnormal returns. We argue that in regulated industries with absent active takeover market, the importance of outside governance mechanisms is diminished and substituted by internal governance controls. We focus on the REIT industry. We find that bidder returns are higher for REITs with smaller boards, with more experienced CEOs, but with shorter tenure. Acquirers’ announcement returns are also significantly and positively related to higher ownership by their CEOs and board directors. We find no significant relationship between presence of staggered board and abnormal bidder returns, which supports our hypothesis that anti-takeover defense measured have reduced importance for REITs.

Abercrombie goes to Ohio

Larry Ribstein —  28 December 2010

Steve Davidoff has the story, and it’s an interesting exercise in corporate contracting complicated by jurisdictional choice.

Abercrombie’s proposed reincorporation is essentially a takeover defense.  Unlike Delaware, Abercrombie’s current state of incorporation, Ohio  

  • Has a business combination statute that’s triggered by a 10% acquisition rather than 15% as in Delaware.
  • Has a control share acquisition statute requiring shareholder approval of an acquisition of shares that would put the acquirer over the statutory level of control.
  • Would disenfranchise shareholders (i.e., arbs) who acquire a more than .5% block after an acquisition proposal.
  • Does not have a “Revlon rule” subjecting director decisions to sell the company to a higher scrutiny level.
  • Is Abercrombie’s home state, and therefore a friendly forum in a takeover battle.

This situation illustrates how jurisdictional choice makes contractual what would otherwise seem to be mandatory takeover rules.

Is it a problem that Abercrombie is changing the original statutory “bargain” based on Delaware incorporation its shareholders may have relied on?  Steve notes that Abercrombie proposed the reincorporation after the announcement of buyouts for competitors J. Crew and Jo-Ann Stores which may have put Abercrombie in play. 

It would be interesting to do an event study on Abercrombie shares. I wonder if they (1) took a hit from reducing the probability of a bid; (2) got a boost because any takeover will be after an auction and possibly at a higher price; (3) got a boost because the move communicates information about the likelihood of a bid; (4) didn’t move because a reincorporation was already priced in; or (5) didn’t move because the shareholders still  have to vote on the reincorporation, and proxy advisors may weigh in against it.

Finally, was there adequate disclosure to shareholders about the reason for and implications of the move?  Does it matter if there were enough sophisticated or well-advised institutional shareholders to help ensure an informed vote?

The bottom line is that the Law Market is a significant part of the transactional environment.

My Missouri colleague, Peter Klein, of Organizations and Markets fame (and, like Larry, a proud non-voter), has been asked to contribute a book chapter on the Austrian theory of the firm and the law. Peter, who has written extensively on the Austrian theory of the firm and maintains an online bibliography on the subject, is an expert on the economics. He asked me to give him some thoughts on the law — i.e., which business law doctrines cohere or conflict with Austrian insights on the nature of the firm.

I’m posting my initial thoughts on the matter in the hope that readers may enlighten us on additional business law doctrines that reflect or reject Austrian thinking. (And, of course, please let me know where I’m off base.) You can either respond to this post or email Peter or me directly.

Before I get into a discussion of specific business law doctrines, let me provide some (extremely cursory!) background on Austrian thought.


A hallmark of Austrian thinking, especially as articulated by F.A. Hayek, is the notion that the information required to allocate productive resources to their highest and best ends, and thereby to maximize wealth, is not readily available to any individual or central authority. Instead, it is widely dispersed among individuals throughout society. Accordingly, attempts to maximize value by allocating productive resources in a centralized fashion — i.e., according to the dictates of central planners — are destined to fail. Those planners lack access to important information (most notably, information about how individual consumers value competing uses of productive resources) and could not effectively process all that information, much of which is conflicting, even if it were accessible.

But, say the Austrians, there’s no need to despair. In a society with well-defined, freely transferable property rights, the impossibility of effective central planning presents little problem. As individuals engage in trades in an attempt to better themselves, prices for productive resources will emerge. Those prices incorporate all available information about the relative value of competing uses of a productive resource (i.e., the person willing to pay the highest price for something will create the most value from it and should possess it if the goal is to maximize wealth). They present that information in a simple, useful form (i.e., one need not worry about calculating the net effect of conflicting bits of information about a resource’s highest and best use; the price mechanism will do so). And they motivate economic actors to take precisely the steps that will maximize total wealth (i.e., relatively high prices for a resource induce producers to make more of it and consumers to substitute away from it; relatively low prices induce less production and more consumption of the resource). Thus, when property rights are well-defined and freely transferable, prices will create a spontaneous order that trumps anything achievable using central planning.

But wait a minute. Isn’t the business firm an instance of central planning?  Within a firm, productive resources are allocated according to the dictates of “central planners” — i.e., managers.  Indeed, Ronald Coase famously observed that the defining hallmark of the firm is “the supersession of the price mechanism.”  Does it even make sense, then, to talk about an Austrian theory of the firm? 

Well, yes, if one understands the business firm as an instance of spontaneous order.  In the so-called “socialist calculation debate,” in which the Austrians contended that economic welfare would be greater in a free economy than in a centrally planned one, the central planners were expected to have state power (legitimate power to coerce using force) and were not expected to face significant competition.  The “planners” within a firm, by contrast, cannot forcefully coerce their subjects (they must procure consent from resource providers), and they face significant competition from other business firms.  These two considerations constrain planning within a business firm so that it is used only when the benefits it generates — chiefly, a reduction in the costs of using the market (i.e., transaction costs) — exceed the losses it occasions in terms of allocative inefficiency (i.e., mistakes by planners attempting to allocate resources optimally) and agency costs (i.e., losses from planners’ opportunism and neglect).  Thus, in the sort of economic system advocated by the Austrians — one coupling well-defined, enforceable, and transferable property rights with broad freedom to contract — one would expect business firms to emerge spontaneously as entrepreneurs seek to minimize the sum of transaction costs, allocative inefficiencies, and agency costs.  One would also expect the boundaries of the firm to change (spontaneously) as technological and other developments alter the relative costs of bringing functions within the firm rather than procuring them on the market.  Such thinking coheres nicely with the Coasean understanding of the firm.

Before looking at specific business law doctrines that reflect or reject Austrian thinking, I should note one other Austrian (specifically, Hayekian) distinction, this one between types of legal rules.  Some legal rules are general in their application, are “purpose-independent” (meaning that the law-giver isn’t trying to achieve some specific social outcome but is instead trying to resolve a dispute in accordance with the parties’ settled expectations), and have the effect of setting clear expectations so that parties may confidently predict outcomes in structuring their affairs.  Hayek refers to these sorts of rules as nomos.  Other legal rules are more akin to specific orders from a central authority seeking to achieve some specific purpose.  Such “teleological” rules Hayek refers to as thesis

In light of their emphasis on the knowledge problem and the impossibility of effective central planning, the Austrians (most notably Hayek) contended that legitimate law is nomos.  Thesis is something other than genuine law.  The common law, for the most part, is nomos.  Most (but not all) legislation is thesis.  The characterization of any piece of legislation will depend on whether it amounts to specific orders aimed at achieving a set purpose (e.g., the new federal health care law), in which case it is thesis, or is instead simply seeking to codify purpose-independent rules that settle parties’ expectations and enable them to order their affairs in light of the information to which they alone are privy (e.g., the Uniform Commercial Code), in which case it is nomos.   

Below the fold, I discuss some business law doctrines that cohere with Austrian thinking and others that conflict.  Not surprisingly, the doctrines that are most consistent with the Austrian view of the firm are nomos-like; the inconsistent legal doctrines are thesis.
Continue Reading…

(Law Review Editors take note, my recent submission mentioned in the following post, titled: “Defending Against Shareholder Proxy Access: Delaware’s Future Reviewing Company Defenses in the Era of Dodd-Frank” is still in the process of negotiating for a permanent Law Review home, although the expedite process is getting very hot.)

After two years of steadily writing and commenting about corporate law as a junior academic trying to make my bones in this business (and, I hope, saying something interesting, as for example my recent 16 Defenses against the federal proxy access regime mandated by Dodd-Frank) I thought that I would take a month or two and edify myself in the field.  It seems like it could be a nice break just to let my brain absorb for a few weeks rather than focus on producing.  Maybe give the rat in my head some time off from the wheel.  To that end, I chose ten books that are required reading for the modern corporate governance thinker.  Well, let’s make it twelve.  Most I’ve read before, a few I am reading for the first time.  Here is my list of the top ten must reads, and I would be interested to hear what our readers or our blog neighbors suggest should be added to the list.

Roberta Romano, The Foundations of Corporate Law, Foundation Press (2010) 2nd Edition.  Professor Romano has updated her reader of the top articles in corporate law, and in these 500 pages you will find the classical debates of the last 50 years paired with the recent debates of the last 10.  A worthy update to the first edition, which was also a fun read.

Jonathan R. Macey, Corporate Governance: Promises Kept, Promises Broken, Princeton University Press (2008).  A summation of many years of great scholarship from Professor Macey.

Stephen Bainbridge, The New Corporate Governance in Theory and Practice, Oxford University Press (2008), A synthesis of Professor Bainbridge’s work, and unique commentary on many of the most pressing debates in the field.

R.H. Coase, The Firm, The Market, and The Law, University of Chicago Press (1990). A great collection from the source of our field.  Classics never die.

Frank Easterbrook & Daniel Fischel, The Economic Structure of Corporate Law, Harvard University Press (1996).  Again, classics never die.

William Allen, Renier Kraakman, and Guhan Subramanian, Commentary and Cases on the Law of Business Organizations, 3d, Aspen (2009).    I learned from Chancellor Allen’s book in law school when I studied under Prof. Coates (who, I am proud to say, I recently testified against before the Senate Banking Committee, and I won as TOTM readers are no doubt aware), I used it when I clerked in the Delaware Court of Chancery, and I teach from it now.  Every time I read it, I learn something new.  Bill Allen was the Chancellor of the Delaware Court of Chancery during the 1980s, when the takeover jurisprudence first developed, and Guhan Subramanian is one of the leading critics of Delaware’s approach to takeovers (particularly freeze-outs).  So you know that between them you get the most informed, but at the same time non-biased, view of the law.

Klein, Ramsayer and Bainbridge, Business Associations: Cases and Materials on Agency Partnerships and Corporations (2009). Another great book for Delaware corporate law, and for the advanced M&A course read Stephen Bainbridge, Mergers and Acquisitions, University Press (2008).

Larry E. Ribstein, The Rise of the Uncorporation, Oxford University Press (2009). Everything you wanted to know about the emerging dominance of alternative entities from a scholar who has been writing about these issues since the LLC and LLP entity forms first emerged.

Daniel F. Spulber, The Theory of the Firm: Microeconomics with Endogenous Entrepreneurs, Firms, Markets, and Organizations, Cambridge University Press (2009). A very detailed introduction to the theory of the firm literature that has interest both for the technically trained economist and for corporate legal scholars looking to apply the basic insights of the “theory of the firm” literature to their work.

Henry G. Manne, The Collected Works of Henry G. Manne, Liberty Fund (2009). Read this first.  Then, in a year, when you’ve finally finished reading the 1200 pages of groundbreaking insights from the mind of Henry Manne, reconsider everything you ever learned from reading Adolf Berle, Gardiner Means, or Louis Loss.

Louis Putterman and Randall Kroszner, Economic Nature of the Firm, A Reader, Cambridge University Press (1996).  A great reader on the theory of the firm literature that offers more depth on the classics than the Spulber reader listed above.  Randy Kroszner is a former Fed Governor and a leading economist, and does a great job choosing the must-read excerpts in the literature for the novice.

Update: Professor Bainbridge offers some additional suggestions.  A couple of commentors suggest I should include Berle and Means, but honestly I just didn’t think it was a very interesting book.

John Carney thinks a recent notable move of prominent banking partners from Latham to Milbank might signal that “debt financing for takeovers is about to take off,” just as it did when the same team moved from Skadden to Latham in 2004. This would also be consistent “with corporate cash piling up to record levels.”

It would be ironic if, after Latham took at 200-lawyer hit last year because of the end of the boom, it couldn’t capitalize on the upswing.

What interests me more than the transfer of business between firms is what this signals about the future of Big Law. As discussed in my Death of Big Law, takeover activity creates a demand for the sort of instant-access one-stop shopping that only big law provides. Beardslee, Nanda and Coates explain clients’ relationships with preferred-provider outside law firms as “legal capacity insurance.”

So would a big increase in m & a activity mean a rebirth of Big Law? It’s not clear.

I note in my paper that

[a]cquisition activity may be a threat as well as a boon to big law. Mergers and other restructuring, particularly in the financial services industry, can unsettle client relationships through management changes. Moreover, to the extent that restructuring involves disaggregation of firms, it can reduce the need for the sort of large, vertically integrated companies that need the services of the largest law firms.


I also wonder if the sort of outsourcing and technology I describe in my article has made one-stop-shopping less necessary even for takeover work. And billing is more constrained than it used to be. On the other hand, regulatory barriers have increased, so firms need more advice on takeovers than ever.

The bottom line is that the next wave of m & a activity, if it comes, may be an important test of my theory that Big Law really is dead rather than merely sleeping, waiting for the next big meal to come along.

Last fall Guhan Subramanian, Steve Herscovici and Brian Barbetta (“SHB”) posted a paper claiming that Delaware’s antitakeover statute (Delaware GCL Section 203) was preempted by the Williams Act because it did not leave hostile bidders the “meaningful opportunity for success” required by three 1988 federal district courts which had upheld the Delaware law back in 1988. Specifically, SHB concluded:

Using a new sample of all hostile takeover bids against Delaware targets that were announced between 1988 and 2008 that were subject to Section 203 (n=60), we find that no hostile bidder in the past nineteen years has been able to avoid the restrictions imposed by Section 203 by going from less than 15% to more than 85% in its tender offer. At the very least, this finding indicates that the empirical proposition that the federal courts relied upon to uphold Section 203’s constitutionality is no longer valid. While it remains possible that courts would nevertheless uphold Section 203’s constitutionality on different grounds, the evidence would seem to suggest that the constitutionality of Section 203 is up for grabs. This Article offers specific changes to the Delaware statute that would preempt the constitutional challenge. If instead Section 203 were to fall on constitutional grounds, as Delaware’s prior antitakeover statute did in 1986, it would also have implications for similar antitakeover statutes in thirty-two other U.S. states, which along with Delaware collectively cover 92% of all U.S. corporations.

SHB has now been published in The Business Lawyer with several responses, including mine, Preemption as Micromanagement. Here’s the abstract of my paper:

Guhan Subramanian, Steven Herscovici & Brian Barbetta, Is Delaware’s Antitakeover Statute Unconstitutional? Evidence from 1988–2008 , 65 BUS. LAW. 685 (2010) (“SHB”), argues that the constitutionality of the Delaware takeover statute is “up for grabs” because it denies bidders the “meaningful opportunity for success” three Delaware district court opinions require to avoid preemption by the Williams Act. However, this comment on SHB argues that, even assuming the applicable federal cases might be construed to support SHB’s conclusion, courts almost certainly would not follow this approach once they saw, with the aid of SHB’s analysis, the extent to which it requires courts to micromanage state corporate law. Moreover, from a policy standpoint, this micromanagement could have a significant negative effect on the development of state law. In short, rather than providing an argument for preempting the Delaware statute, SHB’s analysis demonstrates why it is important to avoid this result.

SHB respond to the comments, including mine (most footnotes omitted):

Professor Ribstein argues that “[i]t would be inconsistent with [the Delaware trilogy’s] reliance on the legislature’s judgment to invalidate the statute based on circumstances arising after the legislature had applied its judgment.” We know of no principle in constitutional law, nor does Ribstein offer one, suggesting that when the legislature makes a constitutional assessment, and a court later acknowledges that assessment, the constitutional question becomes untouchable. Ribstein states that courts “did not necessarily contemplate that plaintiffs could return to court more than a generation after the [Delaware trilogy],” but this is precisely what the Delaware trilogy envisioned.22 It should be remembered that Delaware passed its first antitakeover statute in 1976 and took it off the books in 1987 because it was likely unconstitutional. It is not obvious why Ribstein’s hypothesized statute of limitations on constitutional claims should run longer than eleven years but shorter than twenty-two.

 22 See SHB, supra note 1, at ___ (citing relevant cases). Professor Ribstein also states that “SHB suggest that the poison pill itself avoids preemption.” Ribstein, supra note 16, at ___. We do not suggest this in our Article; therefore the “attempted distinction” between Section 203 and the pill that Ribstein criticizes, id. at ___, is not a distinction that we try to make. Ribstein then criticizes our Section 203 analysis because (he argues) if it were correct it would call into question defenses of unquestioned constitutional validity, such as the staggered board. See id. at ___. In fact, there is a natural distinction between transactional defenses, such as Section 203 and the pill, and other corporate governance provisions, such as the staggered board. See, e.g., CTS Corp. v Dynamics Corp. of Am., 481 U.S. 69, 99 (1987) (White, J., dissenting) (describing the “fundamental distinction” between transactional defenses such as the Indiana antitakeover statute and other corporate governance provisions, such as cumulative voting and staggered boards).

I do not, in fact, argue for “a statute of limitations.” Rather, my point is that any approach to the Supremacy Clause that would imply a continuing and detailed federal judicial power to review the entire body of state corporate law from a single federal statute would amount to a quite significant federal intrusion into a traditionally state-dominated area. Indeed, SHB call attention to this effect by their attempts to distinguish the poison pill, staggered board provisions and Delaware Section 203.

The SHB analysis is particularly uncalled for given a far less intrusive alternative which the Supreme Court suggested more than 25 years ago – that is, a presumption against preemption of state regulation of internal corporate governance. This was the point I made in discussing SHB’s article when it first appeared last year:

I’m skeptical of the authors’ unconstitutionality claim. Notably, Section 203 is part of the Delaware’s corporate statute, and therefore an integral part of its regulation of internal corporate governance, like its jurisprudence on the poison pill. This is important because, as Erin O’Hara and I explain in The Law Market (p. 126, footnote omitted): “Although the U.S. Constitution probably does not forbid a state from regulating the internal governance of a firm that is incorporated elsewhere, it may confer some extra regulatory power on the incorporating state. In CTS Corp. v. Dynamics Corp. of America, the Court reasoned that “no principle of corporation law and practice is more firmly established than a State’s authority to regulate domestic corporations, including the authority to define the voting rights of shareholders.”  This “authority” in CTS allowed the incorporating state to regulate the governance of firms based in other states, consistent with the Commerce Clause, and to preserve a state corporate law provision notwithstanding a potentially preemptive federal law, under the Supremacy Clause.  

The dangers of superbroad implied preemption of state corporate law are particularly salient in light of the imminent adoption of federal financial reform, as I discussed a few weeks ago:

Although none of the [corporate governance provisions in the Dodd bill] is individually earth-shaking, they cumulatively touch many major aspects of corporate governance formerly left to contract and state law.  This bill thus clearly adds to the framework for federal takeover of internal governance that SOX established. The overall effect is that it will be increasingly difficult to demark an area left exclusively for state law. This leaves little “firebreak” to protect against judicial incursions in the spaces not yet covered by explicit federal provisions.  This could ultimately profoundly affect the relationship between federal and state law regarding business associations. 

A generation ago the Supreme Court could say that “no principle of corporation law and practice is more firmly established than a State’s authority to regulate domestic corporations, including the authority to define the voting rights of shareholders.” CTS Corp. v. Dynamics Corp. of America, 481 U.S. 69, 89 (1987). 

Erin O’Hara and I have argued that this separation between federal and state spheres does and should affect the scope of implied preemption of state law by federal statutes.  Thus, when the Court held that state securities actions were preempted by the Securities Litigation Uniform Standards Act, it emphasized “[t]he magnitude of the federal interest in protecting the integrity and efficient operation of the market for nationally traded securities.” Merrill Lynch, Pierce, Fenner & Smith, Inc. v. Dabit, 547 U.S. 71, 78 (2006). See also my article on Dabit.

However, we noted that “[m]any federal ‘securities’ laws reach deep into the kind of internal governance issues covered by the [internal affairs doctrine].” Thus, corporate internal affairs are only “relatively safe from federal preemption” and internal affairs is not “a constitutional boundary, as shown by the continuing forward march of federal corporation law.”

Under the Dodd bill, the forward march picks up the pace.  

The combination of increasing federal regulation of corporate governance, the cumulative preemption effects inherent in this regulation, and the extremely broad view of preemption that SHB endorse would effectively annihilate state corporate law. We can only hope that Congress eventually comes to its senses. We shouldn’t add to the political mess by inviting the courts to join in the destruction.

Questions on the Bailout

Josh Wright —  29 September 2008

From Peter Klein:

Over and over during the last week we’ve been told that unless Congress, the Treasury, and the Fed “take”bold action,” credit markets will freeze, equity values will plummet, small businesses and homeowners will be wiped out, and, ultimately, the entire economy will crash. Such pronouncements are issued boldly, with a sort of Gnostic certainty, a little sadness for dramatic effect, and only minor caveats and qualifications.

And yet, details are never provided. The analysis is conducted entirely at a superficial, almost literary, level. “If the government doesn’t act then banks will be afraid to lend, and people can’t get credit to buy a house or expand their business, and the economy will tank.” Unless we rescue these particular financial institution, in other words, a massive contagion effect will swamp the entire economy. But how do we know this? We don’t. First, we don’t even know if there is a “credit crunch.” Nobody has bothered to provide any empirical evidence. Second, even if credit markets are tight, how much does it matter? Any predictions about the long-term effects are, of course, purely speculative. Sure, borrowers like cheap and easy credit and tighter credit markets will leave some borrowers worse off. But what are the magnitudes? What are the likely aggregate effects? What are the possible scenarios, what is the likelihood of each, and how large are the expected effects? Where is the cost-benefit analysis? After all, the seizure of Fannie and Freddie, the takeovers of AIG and WaMu, the modified Paulson plan — the effective nationalization of the US financial sector, in other words — ain’t exactly costless. There are direct costs, of course, to be borne by taxpayers, but the possible long-term effects brought about by increased moral hazard, regime and policy uncertainty, and the like are enormous. Even on purely utilitarian grounds, the arguments offered so far are tissue-paper thin.

Microsoft has made a bid for Yahoo, and the Yahoo board of directors is anticipated to use the Nancy Reagan “Just Say No” defense.  I feel like I’m back in the 1980s merger boom.Â

Several thoughts:

1.  Rumor has it we are in a recession.  It is likely then that Yahoo stock is currently trading at a price that is not its highest.  Indeed, Microsoft’s bid for Yahoo is basically a big fat memo to Wall Street, in bolded all caps, indicating it (Microsoft) thinks Yahoo is a good buy.  How long before other bidders get the clue and come knocking on Yahoo’s door?

2.  Debt is cheap these days.  Super cheap.  Cheaper than it was in the 1980s when we saw a wave of debt-financed takeovers.  If Yahoo really is a bargain at its current price, other bidders will appear, using a good chunk of debt-financing, if necessary, to make their bids.

3.  If other bidders show up, can the Yahoo board members continue to “just say no” without violating their fiduciary duties?  At least for now, I am of the view that the Yahoo board can easily continue to keep the door to bidders closed.  Yahoo stock traded around $27-ish over the past year, and Microsoft is now offering $31 per share.  Given that, back in Jan. of ’06, when the S&P 500 and the DJIA were both weaker, Yahoo was trading in the vicinity of $40 per share, I have no problem thinking the Yahoo board can embrace their inner Nancy Reagan until a bidder steps forward with an offer well over $40 per share.

4.  Yahoo’s dance with Google is an interesting defensive move, making me think of the white knights, crown jewels, and lock-ups of the days of yore.

5.  Am I the only one who finds it *very* ironic that Microsoft is making a bid for Yahoo only days after AOL Time Warner has made clear it is going to try to undo its mega-merger from seven years ago between AOL and Time Warner?  Note to Microsoft:  It is important to have very specific business justifications – and related business plans – before indulging your urge to merge.

The M&A world seems to be flashing back to the 1980s.  Debt is cheap, private investors are bold, and some mega-mergers from the late 1990s might be perfectly situated for bust-ups.  It is just a matter of time before everyone is wearing parachute pants again.  You heard it here first.Â