Jonathan Macey, Joshua Mitts
Yale University and ECGI, Columbia University
Asking the Right Question : The Statutory Right of Appraisal and Efficient Markets
In this Article, we make several contributions to the literature on appraisal rights and similar cases in which courts assign values to a company’s shares in the litigation context.
First, we applaud the recent trend in Delaware cases to focus on the market prices of the company being valued, if the company’s shares trade in an efficient market, and defend this market-oriented methodology against those who maintain that recent discoveries in behavioral finance indicate that markets are inefficient and that share prices are unreliable due to various cognitive biases. Next, we maintain that the framework and methodology for utilizing market prices should be clarified. We contend that courts should look at the market price of the securities of a target company whose shares are being valued, unadjusted for the news of the merger, rather than at the deal price that was reached by the parties in the transaction. Unadjusted market price has two distinct advantages over deal price. First, the unadjusted market price automatically subtracts the target firm’s share of the synergy gains and agency cost reductions impounded in the deal price.
This is appropriate to do because dissenting shareholders in appraisal proceedings are not entitled to these increments of value which are supplied by the bidder. Second, the unadjusted market price is unaffected by any flaws in the deal process that led to the ultimate merger agreement. Recently, commentators have contended that deal prices in merger transactions should be ignored in appraisal cases where there are flaws in the process that led to the sale. However, flaws in the sales process are not reflected in the unadjusted market price, so such prices are valid indicators of value regardless of whether there were flaws in the deal process. Further, no deal process is perfect, and ignoring market prices when a deal process is flawed succumbs to what economists call the Nirvana fallacy, which posits that an analytical approach (such as relying on market prices) should not be ignored or abandoned even if using that approach does not produce perfect results. Rather, an analytical approach should be used if it is better than the available alternatives and provides useful information to a tribunal or policymaker. Finally, we extend our analysis of market efficiency to a new domain. We point out that market prices can be used even when shares of nonpublicly traded target companies are being evaluated to determine whether the acquirer paid a fair price in certain cases by examining the share price performance of the acquirer’s shares. In cases where a bidder has paid an unfairly low price for the target’s shares due to self-dealing or incompetence or inattention on the part of the seller, the acquirer’s stock should react positively to the announcement of the transaction if the transaction is significant. In the absence of such a positive share price reaction on the part of the acquirer, the price should be deemed presumptively fair.
This analysis seems particularly apt in situations where there is a decline in the value of the bidder’s stock upon announcement of an acquisition.
Keywords: merger, acquisitions, appraisal, arbitrage, law, finance, efficient, markets
Appraisal proceedings drag financial economics from the classroom into the courtroom. In Delaware, by statute, shareholders dissenting to a merger are “entitled to an appraisal by the Court of Chancery of the fair value” of their shares, “exclusive of any element of value arising from the accomplishment or expectation of the merger.” In that proceeding, courts are required to take into account “all relevant factors.” By law, courts will look at “accepted financial principles relevant to determining the value of corporations and their stock” when engaged in the exercise of determining fair value. Under this standard, sometimes a single market valuation metric such as the deal price or the pre-bid market price will provide the most reliable evidence of fair value. In such cases, “giving weight to another factor will do nothing but distort that best estimate. In other cases, ‘it may be necessary to consider two or more factors.’”