Appraisal rights (or dissenter’s rights) entitle a shareholder to the judicially determined “fair value” of her shares upon the occurrence of a merger that she does not support. Once a quiet corner of corporate law, appraisal rights have recently given rise to significant litigation and a growing body of scholarship. Whereas existing scholarship commonly has focused on improvements to be implemented by the judiciary, I propose a legislative improvement.
In appraising “fair value,” courts have failed to give force to the legislative mandate to “exclude any element of value arising from the accomplishment or expectation of the merger,” which has prompted scholarly criticism of the courts. In failing to give force to that statutory exclusion, courts routinely have appraised “fair value” to be the merger price, which necessarily reflects elements of value arising from the merger. Courts have favored the merger price as representing “fair value” because courts lack training and experience in financial valuation; because the merger price is commonly the market-based result of arm’s length negotiations (so it is likely more reliable than the court’s own freewheeling valuation); and because the usage of the preannouncement market-based stock price—which some scholars favor and which necessarily excludes value arising from the merger, consistent with the appraisal statute—would enable exploitation of minority shareholders, whom the courts typically protect.
Given recent judicial developments that render breach-of-duty claims less effective in disciplining directors, appraisal litigation has assumed additional significance. The statutory exclusion, however, contributes to the courts’ common conclusion that “fair value” equals, or is less than, the merger price. Capping the appraised “fair value” at the merger price undermines the disciplinary effect on directors provided by appraisal litigation. Moreover, recent empirical studies reveal that enhanced appraisal rights redound to the benefit of shareholders, whether they support the merger or exercise appraisal rights. Consequently, this Article advocates for legislative deletion of the statutory exclusion, which would provide courts with greater freedom to determine that “fair value” exceeds the merger price. Such deletion would better reflect the courts’ existing analyses, better reflect apparent legislative intent, and better protect shareholders.
Introduction
Appraisal rights (or dissenter’s rights) entitle a shareholder to the judicially determined “fair value” of her shares upon the occurrence of a merger that she does not support.1 Given that any dissenting shareholder does not support the merger, legislatures sensibly exclude from the “fair value” determination any element of value arising from the expectation or accomplishment of the merger.2 Courts, however, have narrowly construed that statutory exclusion, prompting scholarly criticism.3 Courts routinely conclude that the value of the merger consideration constitutes “fair value,”4 even though the merger price necessarily reflects value attributable to the merger, which, by statute, must be excluded. Notwithstanding the statutory exclusion of value attributable to the merger, judges have favored appraising “fair value” as the merger price because their training is in law, not financial valuation; because the merger price commonly results from arm’s length negotiations and necessarily received the support of a majority of shares; and because the use of the market-tested preannouncement stock price, as favored by some scholars, would encourage exploitation of minority shareholders.5 Recently, however, courts have accorded the statutory exclusion some weight by subtracting the value of any synergies attributable to the merger from the merger price when appraising “fair value.”6 Such deference to the merger price as reflecting “fair value” contravenes the legislative text and judicial precedent.7 Moreover, such deference wrongly caps “fair value,” a problem exacerbated by a synergy deduction.
Shareholders’ breach-of-duty claims, as well as appraisal claims, serve as important checks on boards of directors in the context of mergers. Recent opinions, however, have lessened the check provided by breach-of-duty claims, elevating the importance of appraisal litigation.8 Empirical studies reveal that appraisal litigation is more likely to occur in conflict-of-interest transactions, where exploitation of minority shareholders is most likely, and in situations where the merger price falls short of expectations.9 Recent opinions that cap “fair value” at the merger price (or worse, subtract synergy value from the merger price) risk undermining the increasingly important check on corporate boards provided by appraisal litigation.10 Recent empirical studies also reveal that enhanced appraisal rights benefit shareholders, including those shareholders who support the merger, by prompting directors of the target corporation to extract more value during merger negotiations, and by prompting directors of the acquiring corporation to pay more value to avoid appraisal litigation.11
Whereas existing scholarship has focused on improvements to be implemented by the judiciary, this Article contributes to that body of scholarship by proposing a legislative improvement. This Article—which focuses on Delaware as the leading provider of corporate law12—proposes deletion of the statutory exclusion of any “value arising from the accomplishment or expectation of the merger” from the appraised “fair value.”13
Such deletion would bring the statute more in line with the valuation process currently undertaken by the courts. As mentioned, the Delaware courts’ prevailing analysis places great weight—even if not presumptive weight—on the merger price, which runs contrary to the statutory exclusion, as the merger price necessarily includes value attributable to the merger. So, deletion of that statutory exclusion would better reflect the Delaware courts’ current appraisal process. Deletion of the statutory exclusion would not prevent the Delaware courts, if so inclined, from employing the merger-price-minus-synergies analysis, given other language in the appraisal statute, including the legislative mandate that the courts take into account “all relevant factors” when determining “fair value.”14 Moreover, such deletion would seemingly better reflect legislative intent, as the Delaware courts have accorded little weight to the statutory exclusion, but the Delaware legislature—despite repeatedly amending the appraisal statute15—has not reacted legislatively to the courts according little weight to that statutory exclusion. Most importantly, deletion of the statutory exclusion would better free the courts—but not require those courts—to determine that “fair value” is greater than the merger price, which, given those recent empirical studies, would redound to the benefit of all of the shareholders of the target corporation, not just those dissenting shareholders.
In proposing that the Delaware legislature delete the statutory exclusion, this Article proceeds as follows. Part I offers a brief historical account of appraisal rights. Part II explains the ways in which courts have failed to abide by the legislative mandate to exclude from the “fair value” determination any value attributable to the accomplishment or expectation of the merger. Part III explains two critical reasons why courts have failed to abide by that legislative mandate. First, judges are trained in law, not financial valuation, prompting them to favor a market-based value—the merger price. Second, consistent with the legislative purpose of appraisal rights, courts protect minority shareholders from exploitation by the majority, where exploitation would be more likely if the courts favored a different market-based value—the unaffected, preannouncement stock price, which some scholars favor. Part IV formally proposes deletion of the statutory exclusion. A brief conclusion follows.
I. Appraisal Rights: Origin and Purposes
Appraisal rights entitle a shareholder to the judicially determined fair value of her shares if the corporation undergoes a fundamental change that she does not support.16 Individual states create and regulate corporations,17 and the states differ on the types of fundamental changes that entitle shareholders to appraisal rights. Some states grant appraisal rights to shareholders if the corporation engages in a merger or sells all of its assets, or if its shareholders amend the corporate charter.18 The market recognizes Delaware as the leading provider of corporate law,19 so this Article focuses on Delaware law, which limits appraisal rights to certain mergers.20 Moreover, as will be discussed, this Article focuses on publicly traded corporations that are acquired by merger.21
One cannot discern a completely coherent purpose of Delaware’s appraisal statute because it has been amended repeatedly over time to create numerous exceptions.22 While, in isolation, an exception may be easily explained by a coherent rationale,23 no single rationale accounts for all of the statute’s nooks and crannies. Historically, mergers could not be approved over the objection of a single shareholder.24 Perhaps, the unanimity requirement to approve a merger early in American history was sensible, when corporations were held by few shareholders. However, as corporations grew, as the shareholder base became large, and as connections between shareholders became more tenuous, the unanimity requirement lost any logical force that it may have once possessed. Consequently, by 1899, Delaware no longer required unanimous approval from shareholders to effect a merger.25 When the legislature removed the veto authority previously enjoyed by every shareholder with respect to any merger, the legislature created new rights—appraisal rights—to compensate shareholders for their lost veto rights.26 In 1899, appraisal rights permitted any shareholder, who previously would have vetoed the merger, to avoid becoming a shareholder of the acquiring corporation.27
Without appraisal rights, the dissenting shareholder could suffer a fundamental change to her investment to which she did not consent, regarding a transaction that she could no longer veto. An example may clarify the import of the veto right and, given its repeal, appraisal rights. Mr. Investor considers whether to acquire shares of Butter Co. or Gun Co. He loves butter and hates guns, so he invests in Butter Co. Subsequently, the boards of directors of those two corporations agree to merge, and, though Mr. Investor votes in opposition to the merger, the shareholders provide the statutorily required approval of the merger. The terms of the merger call for the shares of Butter Co. to be converted into shares of Gun Co. and for the assets of Butter Co., which previously were used to make tasty butter, to be deployed to make guns. Having lost veto authority, Mr. Investor would become a shareholder of Gun Co.—a fundamental change in his investment, and a change that he does not support. Appraisal rights protect an investor in several regards. First, as mentioned above, the legislature—having withdrawn the shareholder’s veto rights over a merger—provided a means to avoid becoming an unwilling shareholder in another corporation.28 Second, appraisal rights provide a liquidation right to the shareholder, even if the change in the nature of the investment is not as dramatic as butter-to-guns, but, instead, involves the merger of one butter company into another butter company.29 Third, appraisal rights protect the minority from exploitation by the majority.30 Fourth, and related to the other reasons, appraisal rights provide a shareholder with protective rights when a merger—approved by the board of directors and a majority of shares31—includes any terms opposed by that shareholder. This fourth reason looms large in modern appraisal cases, which are driven by shareholders who believe that the board and other shareholders approved the merger for a price that is too low.32 So, an eligible shareholder who exercises appraisal rights is entitled to receive “fair value,” but not any value “arising from the accomplishment or expectation of the merger.”33
II. Disregarding the Statutory Mandate to Exclude from Fair Value Any Element of Value Arising from the Accomplishment or Expectation of the Merger
Delaware’s corporate code provides that “[t]hrough [the appraisal] proceeding the Court shall determine the fair value of the shares exclusive of any element of value arising from the accomplishment or expectation of the merger . . . . In determining such fair value, the Court shall take into account all relevant factors.”34 The Delaware legislature sensibly excluded any value attributable to the merger from the amount payable to the dissenting shareholder, because the dissenting shareholder did not support the merger.35 Of course, if the shareholder wanted to receive any value attributable to the merger, then she simply could have collected the merger consideration and not exercised appraisal rights.36 Notwithstanding the legislative mandate to exclude from “fair value” any value attributable to the merger, the Delaware courts have, in many important respects, ignored that statutory exclusion. That is, the Delaware courts routinely conclude that the value of the consideration offered in the merger, which necessarily includes value attributable to the merger, constitutes “fair value” for purposes of the appraisal statute,37 rather than, for example, the per-share market price that preceded the announcement of the merger, which necessarily excluded any value attributable to the merger.38 And, in several recent decisions, when the Delaware courts did not conclude that the value of the consideration offered in the merger constituted “fair value,” the courts nonetheless used the value of the merger consideration, before deviating downward to ultimately determine “fair value.”39 Rather than giving force to the statutory exclusion, the Delaware courts have interpreted the statutory exclusion extremely narrowly and given excessive weight to the legislative instruction to “take into account all relevant factors,”40 thereby eviscerating the statutory exclusion.
Section II.A provides background information regarding mergers involving publicly traded corporations, including the concept of control and the consequent disparity between the preannouncement market price and the merger price. Section II.B discusses the value of “control,” which, arguably, should be excluded from an appraisal of “fair value” because it is value attributable to “the accomplishment or expectation of the merger.”41 Section II.C introduces factors that impact the acquirer’s payment of a “control” premium and examines their effect on “fair value.”
A. Disparity Between the Preannouncement Market Price and the Merger Price
In the appraisal context, the Delaware courts have rejected arguments based upon the positive impact of the announcement of the merger transaction on the corporation’s stock price,42 even though the Delaware courts acknowledge, and give great effect to, that impact in other contexts.43 For those unfamiliar with mergers, a timeline of events may be helpful. When two corporations—acquirer and target—contemplate a merger, they zealously guard the confidentiality, not only of any information that might be exchanged, but of the existence of the negotiations.44 The acquirer generally prefers to maintain the confidentiality of the negotiations to avoid attracting other bidders, which could generate a bidding war, and increase the acquirer’s costs.45 The target generally prefers to maintain the confidentiality of the negotiations, which commonly do not yield a successfully consummated transaction,46 because failed negotiations might attract unwanted bidders; because failed negotiations might cause the target to appear to be damaged goods; and because failed negotiations might jeopardize the target’s negotiating power against suppliers and customers, who might have doubts about the target’s future. With the confidentiality of the negotiations secure, the market has no information to which to respond, so the target’s market price generally will not be impacted. One generally focuses on appraisal rights exercised by shareholders of the target, not of the acquirer.47 When the acquirer and the target reach an agreement, the transaction will be announced to the public.48 Though the parties may have executed an agreement to merge, time will pass before the parties may consummate the merger because the approvals of shareholders and the government must be obtained49 and the parties must assemble and distribute information to secure the approvals of shareholders and the government.50 Even though the merger may not be consummated—because, for example, the necessary approval from the government cannot be obtained51—the market promptly responds to the announcement that the parties have entered into a merger agreement.52 Typically, the target’s stock price immediately rockets upward and nears the value of the offered merger consideration when news of the parties’ agreement becomes public.53 Typically, immediately after the announcement, the stock price stops short of the value of the offered merger consideration, discounted by the likelihood that the transaction will not be consummated.54 And, as time passes, and as the likelihood that the transaction will be consummated increases, the target’s stock price moves closer and closer to the offered merger consideration, as reflected in the diagram below.55
Diagram 1. Impact of Merger
Announcement on Target’s Stock Price56
Given that diagram, it may be too obvious to state that the dramatic increase in the stock’s value upon the announcement of the planned merger is “value arising from the . . . expectation of the merger,” and thus must be excluded from the “fair value” to be awarded to a dissenting shareholder.57 As we will see, however, the Delaware courts have not excluded such value.58
For those unfamiliar with merger transactions, one might expect that the per-share value of the offered merger consideration would equal the per-share market price at the time that the parties entered the merger agreement. Instead, the value of the offered merger consideration typically greatly exceeds the then-current market price.59 So, if one can acquire stock of the target at the market price, why would the acquirer offer consideration valued at more than the market price? The preannouncement market price represents the per-share price for a relatively small block of a corporation’s outstanding shares of stock; in a merger, the acquirer, loosely speaking, acquires all of the target’s outstanding shares of stock, and the preannouncement market price does not reflect the per-share price for all of a corporation’s stock.60 For example, an internet search will reveal that, on the New York Stock Exchange, shares of Exxon are trading at $X, and if you call your broker, then you will be able to acquire one hundred shares of Exxon around that price, keeping in mind that the price is constantly moving based upon other trades. However, your broker will inform you that you cannot buy all, or even most, of Exxon’s shares for $X per share. Given an offer to acquire all or most of Exxon’s outstanding shares, the supply of shares at $X will quickly dry up.61
Given their mission of appraising the value of the dissenter’s stock, the Delaware courts are quick to give credence to certain economic concepts.62 However, the Delaware courts just as quickly reject other economic concepts.63 Rejection of those economic concepts results in the Delaware courts failing to abide by the legislative mandate to exclude from fair value “any element of value arising from the accomplishment or expectation of the merger.”64
B. Control
While the Delaware courts, in nonappraisal contexts, have acknowledged the concept of control and its economic value, those courts have not applied the concept of control coherently in the appraisal context regarding publicly traded targets.
As discussed above, the typical merger structure involves the target surviving a merger with a wholly owned subsidiary (sub) of the acquirer.65 This structure denies appraisal rights to the shareholders of the acquirer,66 the exercise of which could impede the consummation of the transaction.67 Moreover, this structure permits the acquirer to shield its assets from the target’s creditors.68 Under this structure, the target’s shares would be cancelled, the sub would cease to exist, and the acquirer’s shares of the sub would be converted into shares of the target,69 leaving the target as a wholly owned subsidiary of the acquirer. So, before the transaction, the shareholders of the target, in the aggregate, controlled the target, but, after the merger is consummated, the acquirer, as the lone shareholder of the target, controls the target.70 To acquire the privilege of exercising control over a corporation, one must pay a premium over the preexisting stock price, because the preexisting stock price reflects the value of noncontrolling shares.71
Of course, given that the shares of the target are cancelled under the typical transaction structure, the shareholders of the target would never approve the transaction unless they received valuable consideration.72 The two most common forms of merger consideration are the common stock of the acquirer and cash.73 If the common stock of the acquirer is publicly traded, and if the acquirer issues its common stock as merger consideration to the shareholders of the target, then those target shareholders would not be entitled to appraisal rights.74 If the merger consideration is cash, then the shareholders of the target end up with no stock in any corporation.75 With cash as merger consideration, shareholders of the target would be entitled to appraisal rights.76 With cash as merger consideration, the shareholders of the target, in the aggregate, no longer control that corporation.77 It is the sale of control that yields the merger consideration that is valued in excess of the preannouncement market price;78 if the acquirer could not exercise control, then the acquirer would not pay a premium in excess of the preannouncement market price.79 Consequently, any value related to the sale of control is “value arising from the accomplishment or expectation of the merger,” and, under the Delaware appraisal statute, should be excluded from the “fair value” to be awarded to a dissenting shareholder.80
The Delaware courts, in appraisal settings, have rejected that control is a value “arising from the accomplishment or expectation of the merger,”81 notwithstanding their recognition of the value of control shares in other settings; notwithstanding their recognition that, for publicly traded shares, the preannouncement stock price is a “reliable assessment of fair value”;82 and notwithstanding their recognition that “[w]hat [a dissenting shareholder] is deprived of is what he should be paid for.”83
C. Sources of Premia
In acquiring the target, the acquirer may pay a premium above the target’s preexisting stock price for different reasons, many of which stem from the acquirer’s acquisition of control. Some of those reasons concern value that seemingly should be excluded from the appraised “fair value,” given the statutory exclusion of “value arising from the accomplishment or expectation of the merger.”84 Other reasons concern value that seemingly should be included in appraised “fair value.” Section II.C.1 addresses the acquirer’s acquisition and usage of the target’s confidential information. Sections II.C.2 and II.C.3 address mismanagement of the acquirer and of the target. Section II.C.4 addresses synergies between the acquirer and the target.
1. Target’s Confidential Information
As mentioned above, in a negotiated transaction, the target routinely grants the acquirer access to material nonpublic information, as the acquirer must be convinced: (a) to pay a premium above the per-share trading price, and (b) that it is not buying damaged goods.85 Material nonpublic information could be negative or favorable. The target may withhold negative information from the public for many reasons, including that the disclosure of any information—whether negative or favorable—is not costless.86 Perhaps counterintuitively, the target may withhold favorable information from the public. The target may do so because disclosure of the information could benefit the target’s competitors more than itself or its shareholders.87
Any such negative information regarding the target would be less likely to induce an acquirer to pay a premium above the market price. Nonetheless, access to such negative information comforts the acquirer that the target has nothing to hide. If the target’s material nonpublic information is favorable (and overwhelms any such negative information),88 then the acquirer may be more willing to pay a premium above the per-share trading price to acquire the target. The acquirer would possess information about which the market was unaware.
Because the acquirer’s offer reflects any such favorable nonpublic information, one may contend that the acquirer’s offer (or, at least, some component of its premium offer) represents the statutory “fair value” for purposes of appraisal, in a way that the market price that predated the offer did not.89 Though sound in theory, the contention falls flat in practice. First, given that acquirers routinely offer sizable premia, perhaps thirty to sixty percent over the market price,90 what is the secret information that justifies such premia and that explains how the market could misprice the stock by such a degree?91 Any such information should be easily identified and explained to the court in an appraisal proceeding.92 If such information cannot be identified and explained to the court, then the shareholder seeking appraisal should not be entitled to any value supposedly attributable to such information.
Second, if the basis for the acquirer’s above-market bid was material nonpublic information regarding the target, then the existence of the acquirer’s bid, when made public, should communicate the favorability of nonpublic information, even if the details of that information remain confidential.93 And, if the acquirer’s bid fails, then the target’s stock price should still reflect the existence of that favorable nonpublic information and remain elevated, to some extent, over the unaffected pre-offer stock price. However, empirical studies consistently find that, upon a failed acquisition, the target’s stock price—elevated due to the acquirer’s (now failed) offer—falls to the pre-offer stock price.94 Those empirical studies undermine the contention that favorable nonpublic information justifies the acquirer’s above-market offer.
Mismanagement of the acquirer may result in the acquirer offering a per-share price higher than both the preexisting market price and the target’s true “fair value.” Such mismanagement may manifest itself by an overvaluation of the target or by self-interested empire building by the acquirer’s managers. Neither manifestation of mismanagement of the acquirer provides a solid foundation for determining the target’s “fair value.”
Consider a bell curve of potential acquirers’ valuations of a target. Some potential acquirers value the target, on a per-share basis, at less than the existing per-share stock price, but no shareholder would be willing to sell her shares of the target for less than the existing per-share stock price. Some potential acquirers value the target, on a per-share basis, around the existing per-share stock price, but, as discussed above, the shareholders of the target expect to receive a premium above the per-share stock price in any acquisition of the target, so offers around the existing per-share stock price will not command the necessary support from the shareholders of the target. So, the focus eventually falls on one end of the bell curve. One can imagine a bidding war for the target, with the winning bidder falling near the extreme end of the bell curve.95 To oversimplify, two possibilities exist. First, it could be that the winning bidder properly valued the target—given potential synergies unavailable to other bidders—which possibility is addressed below in Section II.C.4.96 On the other hand, it could be that the winning bidder—falling at the extreme end of the bell curve—was an outlier that simply misjudged the value of the target. The latter possibility seems more likely, given the findings of empirical studies.97 Commentators have termed this possibility the “Winner’s Curse.”98 The acquirer may have “won” the bidding war, but, in so doing, the acquirer actually loses by overpaying for the target.99
Empirical studies seemingly confirm the validity of the Winner’s Curse—the bidder’s stock price falls at the time of the announcement of the transaction because the market recognizes that the bidder agreed to a price that is too high, or the bidder’s performance following the acquisition trails the performance of its peers.100 If the winning bidder secured value, even when paying a price above the target’s preexisting per-share stock price, then the bidder should increase in value, as reflected by an increase in its own stock price. If the winning bidder paid exactly the right price, even when paying a price above the target’s preexisting per-share stock price, then the bidder should neither increase nor decrease in value, as reflected by no change in its own stock price. However, empirical studies consistently reflect that bidders’ stock prices fall when transactions are announced.101 Moreover, empirical studies further indicate that, postacquisition, acquirers underperform their peers.102
Notwithstanding the consistency of those empirical studies, the Delaware courts have expressly rejected the Winner’s Curse when determining “fair value” in appraisal proceedings.103 “Fair value” should not be based upon the merger consideration offered by a winning bidder, especially when the winning bidder’s stock price falls on the announcement of the merger, as is typically the case, or as reflected by its own postacquisition underperformance and when the appraisal statute expressly excludes value attributable to the merger.104
For many people, and in many instances, bigger is better. Why run a smaller corporation, when you can acquire another corporation and then run the resulting bigger corporation? Commentators term this “empire building.”105 Salaries, perquisites, and prestige tend to be greater for larger corporations relative to smaller corporations.106 In those regards, any acquisition would be self-interested, in the sense that it furthered the interests of the acquirer’s managers,107 not necessarily the interests of the acquirer’s shareholders,108 but it would not be self-interested in the sense that those managers were on both sides of the transaction, and thus would not be subject to heightened judicial scrutiny.109 Moreover, if the acquirer is publicly traded, then the acquirer’s managers would be spending “other people’s money”110 in furthering their own interests. Self-interested behavior by the acquirer’s managers—perhaps even hubristic overconfidence111—and the consequent merger price form poor bases for the “fair value” of the dissenting shares.
Just as individuals could mismanage the acquirer, individuals could mismanage the target.112 Just as the acquirer’s managers might engage in self-interested conduct in pursuing the acquisition, so too might the target’s managers engage in self-interested conduct in pursuing the acquisition.113 Just as the acquirer’s managers might have implemented an ill-conceived plan—the acquisition—that does not maximize the value of the acquirer’s assets, the target’s managers may be pursuing an ill-conceived plan that does not maximize the value of the target’s assets, prompting its acquisition. For example, in Cede & Co. v. Technicolor, Inc., the target’s incumbent management focused on developing photos in one hour, and the acquirer intended to sell the target’s one-hour-photo business and enhance other products and services.114 An acquisition could displace the target’s managers who were pursuing an ill-conceived plan—as well as halt that ill-conceived plan—so that the target, under new management, maximizes the value of the target’s assets and, in so doing, maximizes the target’s value.115 One might contend that the appraised “fair value” of the target’s shares should be based upon the acquirer’s plan, which puts the target’s assets to their highest and best use. Of course, in most instances,116 the value attributable to the acquirer’s plan would constitute “value arising from the accomplishment or expectation of the merger.”117 Consequently, the Delaware courts have determined the appraised “fair value” must be determined just prior to the consummation of the merger,118 which would mean the lower-valued plan of the target’s incumbent managers, rather than the higher-valued plan of the acquirer that can be implemented only postacquisition, in most instances.119
Commentators include losses attributable to mismanagement within the generic term “agency costs.”120 A reduction in agency costs is more likely if the corporation is controlled by a single shareholder or a small, affiliated group of shareholders, rather than a large, diffuse group of shareholders. A single shareholder or a small, affiliated group of shareholders is better able to monitor managers, which lessens the occurrence and likelihood of mismanagement.121 In Aruba, the Delaware Supreme Court reversed the chancery court, when the chancery court contemplated subtracting value attributable to reduced agency costs from the merger price, because, according to the lower court, that value would have arisen from the “accomplishment . . . of the merger.”122 The Delaware Supreme Court explained its rejection of the chancery court’s position as follows: “[T]he merger at issue in this case would not replace Aruba’s public stockholders with a concentrated group of owners; rather, it would swap out one set of public stockholders for another: HP’s.”123 The Delaware Supreme Court’s explanation is problematic. First, although a reduction in agency costs may be more likely if the acquirer is controlled by one or a few shareholders, a well-managed, publicly traded acquiring corporation is perfectly capable of reducing agency costs in a poorly managed, publicly traded target corporation. Commentators routinely argue that any appraised “fair value” should exclude value attributable to a reduction in agency costs.124 Second, in one sense, the Delaware Supreme Court acknowledged the importance of control in reducing agency costs, which control could be wielded more effectively by one or a few shareholders compared to a large, diffuse group of shareholders. However, in another sense, the Aruba court failed to appreciate the importance of control. In Aruba, the merger agreement called for the shareholders of the target to receive cash as consideration,125 which presented the last opportunity for those shareholders to collect a control premium.126 Whether HP, the publicly traded acquirer, could effectively reduce agency costs in Aruba, the publicly traded target, is irrelevant, because the shareholders of the target would insist on compensation for what they were selling—the opportunity to control Aruba and reduce agency costs. In settings outside of appraisal, the Delaware Supreme Court has acknowledged the value of control,127 and it has recognized that one selling control will reasonably insist on compensation for ceding that control,128 whether or not the buyer can exercise that control. For example, in Cheff v. Mathes, the corporation repurchased shares from a shareholder who owned a significant block of stock.129 The corporation could not vote its own shares, so the corporation was not buying control of itself.130 Nonetheless, the Delaware Supreme Court recognized that the selling shareholder was sacrificing its ability to collect a control premium in the future, and in so doing, the selling shareholder required the payment of a control premium.131
Nonetheless, in the appraisal context, the Delaware Supreme Court has rejected the control‑based argument. In Cavalier, two controlling shareholders effected a merger, displacing the plaintiff, who exercised appraisal rights.132 The controlling shareholders argued that, in appraising the “fair value” of the plaintiff’s shares, the value of those shares should be reduced to reflect their lack of control, a so‑called “minority discount.”133 In rejecting that argument, the Delaware Supreme Court concluded that, in appraising “fair value,”
the company must be first valued as an operating entity by application of traditional value factors . . . . The dissenting shareholder’s proportionate interest is determined only after the company as an entity has been valued. In that determination the Court of Chancery is not required to apply further weighting factors at the shareholder level, such as discounts to minority shares . . . .134
The statute requires the valuation of “the shares,”135 which the court’s analysis accomplishes indirectly—by first determining the “fair value” of the corporation, and then awarding their pro rata share to the dissenting shareholders—rather than a direct valuation of the dissenting shares. A direct valuation of “the shares”136 would seemingly require a minority discount because the merger, which gives rise to appraisal rights, must be approved by a majority of shares, leaving only minority shares eligible for appraisal. Moreover, control flows from the right to vote, and the right to vote attaches to shares,137 not the corporation itself. So, courts should not include the value of control when appraising the “fair value” of minority shares. Nonetheless, a long string of cases, many of which cite Cavalier, have refused to accord a minority discount to appraised shares.138 In so doing, the Delaware courts have recognized their rejection of economic principles.139 Given that the Delaware courts routinely embrace economic principles when appraising “fair value,” their rejection of a minority discount—as reflected by the preannouncement stock price140—has invited criticism.141 Nonetheless, for reasons unrelated to the statutory exclusion, the Delaware courts’ conclusion in this regard may be correct.142
If an acquirer is willing to buy the target, especially at a premium over the preexisting per-share stock price, then the acquirer must expect to achieve a return above the cost of that investment. Synergies—reasons that the whole is worth more than the sum of the parts—may motivate the acquisition.143 Merger partners that seek approval from shareholders routinely cite synergies as justifying their combination.144 Certain synergies may enable the combined company to operate at a lower cost than the sum of the costs of each of the acquirer and the target operating as stand-alone entities.145 These cost synergies might include the closing of a redundant plant or product line,146 the termination of executives,147 the shift of work to whichever company provides labor at lower cost,148 and tax savings.149 Moreover, the combined companies may experience lower costs due to economies of scale, such as greater leverage when negotiating with third parties or greater risk-bearing regarding, for example, research and development. Other synergies may enable the combined company to generate revenue greater than the sum of the revenues of each of the acquirer and the target operating as stand-alone entities. Such revenue synergies might include the bundling of complementary products,150 entry into new markets,151 and the exercise of quasi-antitrust power.152
The merger facilitates any such cost or revenue synergies. Any appraised value attributable to synergies should be excluded as “value arising from the accomplishment . . . of the merger.”153 And, Delaware courts have, relatively recently, begun to exclude some value traceable to synergies from their appraisals of “fair value.”154 The Delaware courts acknowledge that the merger typically will generate some synergy value,155 that each of the acquirer and the target will command a portion of that value in agreeing to the merger price, and that some portion of the merger price should be excluded from the appraised “fair value” as “arising from the accomplishment . . . of the merger.”156 While the Delaware courts have been willing to exclude synergy value from their appraisals of “fair value,” doing so is difficult.157
III. Reasons that Courts Disregard the Statutory Exclusion
When appraising “fair value,” judges routinely disregard the statutory mandate to exclude value attributable to the merger—favoring the merger price—because they lack training in finance and the valuation of businesses and because of their desire to protect the minority from exploitation.
A. Legal, Not Financial, Training
Judges attend law school, not business school, and are educated in legal theories, not valuation theories.158 Delaware judicial officers repeatedly have acknowledged the limitations in their training and experience when appraising “fair value.”159 Given that, in other settings, “fair” commonly means a “range of possible prices that might have been paid in [a] negotiated arms-length” transaction,160 it is understandable that the Delaware courts might favor the merger price negotiated by the acquirer and the target, which necessarily was approved by a majority of the target’s shares, rather than undertaking a freewheeling valuation, for which the courts lack training and experience, and for which the courts must identify a specific point (the “fair value”) within an extremely wide range.161 Thus, the courts emphasize market principles in according great weight, commonly conclusive weight, to the negotiated merger price when determining “fair value.” In Aruba, the Delaware Supreme Court wrote:
[W]hen [the informationally efficient market] price is further informed by the efforts of arm’s length buyers of the entire company to learn more through due diligence, involving confidential non-public information, and with the keener incentives of someone considering taking the non-diversifiable risk of buying the entire entity, the price that results from that process is even more likely to be indicative of so-called fundamental value . . . .162
While understandable,163 a court’s undue emphasis on the value of the merger consideration, when determining “fair value,” to avoid a complicated valuation exercise amounts to judicial shirking of a legislative mandate to exclude “value arising from the accomplishment . . . of the merger.”164 More generally, courts commonly are asked to undertake complicated valuation exercises in other corporate law settings.165 Finally, deference to a market-based valuation does not necessitate emphasis on the parties’ negotiated merger price, as opposed to the market-based, preannouncement stock price.166
If courts give effect to the statutory mandate to exclude any value attributable to the merger and if courts favor emphasis on a market-based price, then courts should not emphasize the market-based merger price; instead they should emphasize the market-based preannouncement stock price. First, the statute itself requires exclusion of value attributable to the merger,167 so starting with the merger price flies in the face of the statutory mandate, whereas starting with the preannouncement stock price does no such thing. Second, the market for noncontrolling shares of the target is “thicker” than the market to acquire the target itself; that is, the number of buyers and sellers of noncontrolling shares of the target is high compared to the number of buyers and sellers of the target itself.168 Thick markets generate more reliable pricing.169 So, price reliability favors the preannouncement stock price over the merger price. Recall also the typical postannouncement negative impact suffered by the bidder—which market-based reaction suggests that the bidder agreed to a price too high—also counsels in favor of the reliability of the preannouncement price over the merger price.170
If a court begins its analysis of “fair value” with either market-based price—merger price or preannouncement stock price—then the court may be required to make adjustments thereto,171 but the adjustments to the latter may prove unnecessary or may be easier, which counsels in favor of the preannouncement stock price. Adjustments to the merger price typically require subtraction of merger synergies when determining “fair value.”172 Synergies, however, are difficult to quantify.173 Relatedly, synergy value will vary from acquirer to acquirer; there is no market-tested synergy value. Information quantifying the synergy value of the winning bidder would reside with that bidder,174 who could try to behave opportunistically by seeking to lower the amount payable to the dissenting shareholders. For instance, in Stillwater Mining Co., the acquirer argued that “fair value” was less than the merger price due to synergies, after the acquirer’s chief executive officer testified that there were no synergies, the acquirer’s valuation expert found no quantifiable synergies, and the acquirer informed shareholders that there were no synergies.175 In Columbia Pipeline Group, the court was prepared to deduct synergies from the merger consideration in determining “fair value,” except that the acquirer overplayed its hand, by arguing that the entire control premium was attributable to synergies.176
Moreover, now that the Delaware courts have emphasized that any synergy value should be excluded from the appraised “fair value,” one should expect acquirers, during their negotiations with targets, to craft documents that reflect more and more of the control premia being attributable to such synergies for which they need not compensate any dissenting shareholders, thereby lowering total acquisition costs.177 Although the Delaware courts have not embraced such adjustments when appraising dissenting shares, “fair value”—excluding “value arising from the accomplishment or expectation of the merger” and considering “all relevant factors”178—requires other adjustments, if courts implicitly—not presumptively—begin with the merger price. As mentioned above, control has a value, which attaches to majority shares—not minority shares—and which does not inhere to the target itself.179 Given that empirical studies support the Winner’s Curse and consistent bidder overpayment, courts should be inclined to adjust the merger price downward when appraising “fair value,” to account for such overvaluation, particularly when the acquirer’s stock price falls upon announcement of the merger.180 Self-interested conduct by the target’s management may necessitate an upward adjustment to the merger price when “fair value” is appraised.181
If, on the other hand, a court begins its “fair value” analysis with the market-based, preannouncement stock price, then the court may have to adjust that price to reflect any value attributable to the acquirer’s access to material nonpublic information.182 First, the target may not possess material nonpublic information, in which case no adjustment would be required.183 Second, recall that the target’s stock price, which rose upon announcement of the parties’ agreement, routinely falls to the preannouncement level, if the acquisition is never consummated.184 If the bidder possessed material nonpublic information that justified the elevated bid, then one would expect the target’s stock price to remain somewhat elevated if the planned merger failed, but empirical studies establish that the target’s stock price does not remain elevated after a failed acquisition.185 Those empirical findings undermine the suggestion that material nonpublic information composes an important part of the acquirer’s premium offer over the target’s preexisting stock price. If material nonpublic information composed an important part, then the target’s dissenting shareholders should be able to identify it, even if a court may not easily quantify its value.
Judges’ lack of training and experience regarding valuation helps explain their preference for a market-based valuation over their own free-wheeling valuation, especially when the litigating parties generate wildly divergent valuations. However, the courts’ preference for a market-based valuation, standing alone, does not explain the preference for the merger price over the preannouncement stock price.
B. Protection of the Minority
If the Delaware courts, due to a lack of applicable training, seek to avoid computing “fair value” by according great weight to a market-based valuation, then why don’t those courts accord great weight to the market-based preannouncement stock price, which seems more in line with the statutory exclusion of “value arising from the accomplishment or expectation of the merger,” rather than the market-based merger price, which seems less in line with the statutory exclusion? Strictly applying the statutory exclusion when appraising “fair value” risks affording too little protection to minority shareholders. The Delaware courts have long protected minority shareholders.186 Moreover, one of the legislative rationales that undergirds appraisal rights is the protection of the minority from exploitation by the majority.187 For example, in Cavalier, where the Delaware Supreme Court rejected the suggestion of a minority discount when appraising “fair value,” the court noted the risk of an “undesirable result,” whereby the majority shareholders could “unfairly enrich[] [themselves and] . . . reap a windfall from the appraisal process by cashing out a dissenting shareholder”188 Though the circumstances of Cavalier—where a two-person majority allegedly sought to exploit a one-person minority189—may not apply to many transactions that give rise to appraisal rights, many other transactions involve controlling shareholders.190 Further, a disaggregated majority of shares—the owners of which understandably are rationally ignorant—could approve a merger transaction at a price above the preexisting stock price, but at a price that is less than “fair value.”191 So, while the merger price may undervalue those shares, the preexisting stock price would undervalue those shares even further. Consequently, the Delaware courts commonly favor the former value and disregard the latter value. Nonetheless, given the statutory exclusion, the Delaware courts routinely award the dissenting shareholders with a “fair value” amount that is less than the value of the merger consideration due to the statutory exclusion.192 The prevailing “fair value” award equals merger-price-minus-synergies.193
IV. Proposal to Delete the Statutory Exclusion
Because of the statutory exclusion of “any element of value arising from the accomplishment or expectation of the merger” when appraising “fair value,” this Article presents many arguments against usage of the merger price, which necessarily reflects value components relating to the “accomplishment or expectation of the merger,” as well as many arguments in favor of usage of the preannouncement stock price, which necessarily excludes value components relating to the “accomplishment or expectation of the merger.” The purpose of that presentation was not to excoriate the Delaware courts’ seeming disregard of the statutory exclusion. Rather, this Article ultimately proposes deletion of that statutory exclusion.
As set forth in Parts I and II, the Delaware courts have interpreted the statutory exclusion extremely narrowly, rendering those legislative words meaningless in many regards. The Delaware legislature, which has been troubled by an increase in arguably misguided appraisal litigation,194 has repeatedly amended the appraisal statute to narrow the availability of appraisal rights.195 However, the legislature does not appear troubled by the courts’ narrow interpretation of the statutory exclusion nor by the courts’ analysis of “fair value,” as indicated by the absence of statutory amendments addressing “fair value” or exclusions therefrom. Given the regularity with which Delaware amends its corporate code and given the State’s intent to remain the leading provider of corporate law,196 Delaware’s legislative inaction proves more meaningful than legislative inaction in other jurisdictions. Legislative deletion of the statutory exclusion would more closely align the statutory language with the legislature’s apparent intent and the courts’ actual decision-making process.
Relatedly, legislative deletion of the statutory exclusion would end the Delaware courts’ ongoing addition of a “judicial gloss” to the clear statutory exclusion.197 Contrary to the interpretive canon that the specific trumps the general,198 the Delaware courts emphasize the general statutory mandate to consider “all relevant factors” in according little or no weight to the specific statutory mandate to exclude “any element of value arising from the accomplishment or expectation of the merger.”199 Historically, the Delaware courts have strived to give effect to all of the legislature’s words, eschewing interpretations that render the legislature’s words as surplusage.200
Akin to Delaware law, the Model Business Corporation Act requires that the court appraise “fair value” as of the date of the merger, which may follow the date of the parties’ entry into the merger agreement by months, but, unlike Delaware’s appraisal statute, the Model Act does not specifically exclude from “fair value” any value attributable to the transaction giving rise to appraisal rights.201 The Official Comments to the Model Act specifically reference concern regarding the majority’s exploitation of the minority in refusing to exclude value that may be attributable to the transaction.202 So, deletion of Delaware’s statutory exclusion would bring Delaware law in line with a majority of jurisdictions,203 where Delaware apparently has no interest in deviating from the norm, given judicial precedent in Delaware and the absence of a legislative response thereto.
One might argue that the deletion of the statutory exclusion would contradict the Delaware courts’ prevailing analysis that “fair value” equals merger-price-minus-synergies, because the exclusion of synergy value follows from the statutory exclusion of “value arising from the accomplishment . . . of the merger.”204 However, such an argument would be misguided because other statutory language would empower the court, if so inclined, to exclude synergy value from its appraised “fair value.” First, the statute requires that the court appraise the “fair value” of any dissenting shares, and one could easily conclude that, if a shareholder does not support the merger, then it is fair to exclude “value arising from the accomplishment . . . of the merger” when appraising the value of her shares.205 A reasonable definition of “fair” accounts for the existing statutory exclusion, such that the deletion of the statutory exclusion would not disrupt the prevailing analysis of “fair value.” In fact, when addressing breach-of-duty claims against directors, the Delaware courts undertake a “fairness” inquiry that the courts refer to as “quasi-appraisal.”206 When analyzing “fairness,” the courts focus not only on price, but also on the process that gave rise to that price, which includes the shareholder vote.207 Second, even if the legislature deleted the statutory exclusion, the statute would continue to empower the Delaware courts to consider “all relevant factors” when determining “fair value.”208 A “relevant factor” in determining the “fair value” of dissenters’ shares would be the fact of their dissent; why should those shareholders be entitled to “value arising from the accomplishment . . . of the merger,” whether or not that language appears in the statute, given their lack of support for the merger?209 Deletion of the statutory exclusion would not undermine the Delaware courts’ prevailing analysis of “fair value.”
Deletion of the statutory exclusion would preserve appraisal as an important check on the board of directors.210 A shareholder’s breach-of-duty claim also serves as an important check on the board of directors.211 However, appraisal has increased in importance as a check on directors due to legal developments that render breach-of-duty claims more difficult for shareholders to pursue.212 In a breach-of-duty claim, the shareholder seeks either an injunction or damages. For purposes of appraisal, an injunction to halt the merger is irrelevant, because there are no appraisal rights unless the merger has already occurred,213 and courts do not “undo” mergers that have already occurred.214 A shareholder’s breach-of-duty claim that seeks damages, though never easy,215 has become more difficult in recent years. In Corwin, a 2015 decision, the Delaware Supreme Court concluded that two prior landmark decisions—decisions that elevated judicial expectations of directors in merger transactions—were “primarily designed to give stockholders and the Court of Chancery the tool of injunctive relief . . . before closing. [Those earlier landmark decisions] were not tools designed with post-closing money damages claims in mind . . . .”216 Under Corwin, following an informed, uncoerced shareholder vote regarding a merger, a dissatisfied shareholder is precluded from pursuing a breach-of-duty claim.217 Litigants reacted to Corwin by pursuing claims in other jurisdictions,218 but director-amended bylaws that require such claims to be pursued in Delaware were embraced by the Delaware courts.219 Wide director discretion regarding mergers that result in unsuccessful challenges by shareholders may not seem problematic when shareholders seek to impose personal liability on directors. However, appraisal rights never entailed imposing personal liability on directors and were never intended to address wrongdoing.220 Moreover, a shareholder’s inability to succeed on a breach-of-duty claim against the directors does not mean that the resulting merger price equals (or should be used as a starting point to determine) “fair value.”221 In fact, mergers for which appraisal has been sought “tend to have substantially lower premia than a matched sample.”222
So, even in the absence of a fiduciary breach, appraisal actions lead the target’s directors to extract greater value in the merger and prompt the acquirer’s directors to pay greater value in the merger in hopes of avoiding appraisal litigation.223 This assumes that the Delaware courts faithfully fulfill their statutory obligation to determine “fair value.” If, however, the Delaware courts set “fair value” at the preannouncement stock price or they cap “fair value” at the merger price, then the discipline of appraisal will be lost.224 Discipline by appraisal would seem nonexistent if the inquiry shifts from a determination of “fair value” to a determination that, notwithstanding a “flawed” deal process, the dissenting shareholders were not “being exploited.”225 Deletion of the statutory exclusion would enhance the disciplinary effect provided by appraisal rights by giving courts greater freedom to conclude that “fair value” exceeds the merger price.226
In giving great weight to the merger consideration when determining “fair value,” the Delaware courts frequently emphasize the absence of a higher offer from bidder #2 between (a) the announcement of the merger agreement between bidder #1 and the target, and (b) the consummation of the merger between bidder #1 and the target.227 However, bidder #1 and the target typically include provisions in their merger agreement designed to deter a higher bid.228 Such provisions are enforceable so long as they do not preclude a higher bid, but they may reasonably deter higher bids.229 Thus, deal protection may “ward off subsequent bids in the first place” and “substantially impede an auction dynamic,” giving “reasons to doubt the efficiency” of the supposed market to acquire the target that gave rise to the merger price to which the Delaware courts accord undue weight.230
Conclusion
The Delaware legislature requires the exclusion of value attributable to a merger when a dissenting shareholder—a shareholder that did not support the merger—seeks the judicially appraised “fair value” of her shares. Though originally sensible, the statutory exclusion has lost logical force over time. Contrary to the statutory exclusion, the Delaware courts routinely include value attributable to the merger when appraising “fair value,” and the Delaware legislature—which annually updates the corporate code, and which recently and repeatedly has amended the appraisal statute—has acquiesced to the courts’ precedents that accord little weight to the statutory exclusion. Given such judicial precedent and legislative acquiescence, the statutory exclusion should be deleted to better reflect the courts’ current practices and the legislature’s intent. Moreover, given recent judicial decisions that render breach-of-duty claims less effective as a check on the board of directors, appraisal litigation has served as an increasingly important check on directors. The statutory exclusion, however, contributes to the courts’ common conclusion that “fair value” equals, or is less than, the merger price. Capping “fair value” at the merger price undermines the disciplinary effect on directors provided by appraisal rights. Deletion of the statutory exclusion would better free the courts, when appropriate, to conclude that “fair value” exceeds the merger price, which would benefit shareholders, not just dissenting shareholders, according to recent empirical studies.