The Michigan legislature recently amended the state’s control share acquisition statute to make it easier for the Taubman family to fend off the hostile bid for Taubman Centers from Simon Property Group and Westfield America Trust (I describe these statutes and the Michigan amendment in the Extended Post below). Several readers have written or used the comment feature to ask how I square these statutes with the race to the top hypothesis I have espoused in earlier posts. A fair question, indeed, but the two can be squared.
According to the standard race to the top account, investors will not purchase, or at least not pay as much for, securities of firms incorporated in states that cater too excessively to management. Lenders will not make loans to such firms without compensation for the risks posed by management's lack of accountability. As a result, those firms' cost of capital will rise, while their earnings will fall. Among other things, such firms thereby become more vulnerable to a hostile takeover and subsequent management purges. Corporate managers therefore have strong incentives to incorporate the business in a state offering rules preferred by investors. Competition for corporate charters thus should deter states from racing to the bottom. (The competing “race to the bottom” hypothesis argues that states compete in granting corporate charters. After all, the more charters the state grants, the more franchise and other taxes it collects. According to the race to the bottom theory, because it is corporate managers who decide on the state of incorporation, states compete by adopting statutes allowing corporate managers to exploit shareholders.)
The evidence on the race to the top versus race to the bottom dispute is not free from controversy, but I think the weight of the evidence clearly favors the race to the top. Roberta Romano’s event study of corporations changing their domicile by reincorporating in Delaware, for example, found that such firms experienced statistically significant positive cumulative abnormal returns. Roberta Romano, Law as a Product: Some Pieces of the Incorporation Puzzle, 1 J. L. ECON. & ORG. 225 (1985). In other words, reincorporating in Delaware increased shareholder wealth. This finding strongly supports the race to the top hypothesis. If shareholders thought that Delaware was winning a race to the bottom, shareholders should dump the stock of firms that reincorporate in Delaware, driving down the stock price of such firms. As Romano found, and all of the other major event studies confirm, there is a positive stock price effect upon reincorporation in Delaware. See generally ROBERTA ROMANO, THE ADVANTAGE OF COMPETITIVE FEDERALISM FOR SECURITIES REGULATION 64-73 (2002) (discussing the relevant studies and criticisms thereof).
The event study findings are buttressed by a well-known study by Robert Daines in which he compared the Tobin’s Q of Delaware and non-Delaware corporations. (Tobin’s Q is the ratio of a firm’s market value to its book value and is a widely accepted measure of firm value.) Daines found that Delaware corporations in the period 1981-1996 had a higher Tobin’s Q than those of non-Delaware corporations, suggesting that Delaware law increases shareholder wealth. Robert Daines, Does Delaware Law Improve Firm Value?, 62 J. FIN. ECON. 525 (2001). Although subsequent research suggests that this effect may not hold for all periods, Daines’ study remains an important confirmation of the event study data.
Additional support for the event study findings is provided by takeover regulation. Compared to most states, which have adopted multiple anti-takeover statutes of ever-increasing ferocity, Delaware’s single takeover statute is relatively friendly to hostile bidders. An empirical study of state corporation codes by John Coates confirms that the Delaware statute is the least restrictive and imposes the least delay on a hostile bidder. John C. Coates IV, An Index of the Contestability of Corporate Control: Studying Variation in Takeover Vulnerability (June 30, 1999). Given the clear evidence that hostile takeovers increase shareholder wealth, this finding is especially striking. See generally Stephen M. Bainbridge, Corporation Law and Economics 612-14 (2002). The supposed poster child of bad corporate governance, Delaware, turns out to be quite takeover-friendly and, by implication, equally shareholder-friendly. (Indeed, check out this headline: "Beware Delaware." The article goes on to argue that: "Since last summer, the Delaware Supreme Court has issued at least five decisions of great concern to the corporate bar. Each was remarkable not only because it found against directors and in favor of shareholders, but also because it reversed a lower court ruling that went the other way.")
This takes us to the Michigan anti-takeover statute. Given that state takeover regulation demonstrably reduces shareholder wealth but that most states have nevertheless adopted anti-takeover statutes, what are we to make of that data point? In my view, we must concede that state regulation of corporate takeovers appears to be an exception to the rule that efficient solutions tend to win out. But so what? Nobody claims that state competition is perfect. The question is only whether some competition is better than none. Delaware’s relatively hospitable environment for takeovers suggests an affirmative answer to that question.
In other words, the Michigan statute proves a central point of public choice theory. The incentives of legislators and regulators are driven by rent-seeking and interest group politics. In turn, the incentives of directors and managers who lobby state legislators vary by context. In most contexts, the financial incentives of directors and managers are aligned with those of shareholders for the reasons discussed above. In the hostile takeover context, however, the incentives of directors and managers deviate from those of the shareholders. Hostile takeovers are frequently followed by management purges, especially at the top management and board levels. Nobody likes to be fired, so it is hardly surprising that directors and managers try to use the legislative process to protect their jobs. Neither, however, does it disprove the race to the top hypothesis; it only shows that there is an exception to every rule.
Control share acquisition statutes rely on the states' traditional power to define corporate voting rights as a justification for regulating the bidder's right to vote shares acquired in a control transaction. A "control share acquisition" is typically defined as the acquisition of a sufficient number of target company shares to give the acquirer control over more than a specified percentage of the voting power of the target. The triggering level of share ownership is usually defined as an acquisition which would bring the bidder within one of three ranges of voting power: 20 to 33 1/3%, 33 1/3 to 50% and more than 50%. Most control share acquisition laws provide that shares acquired in a control share acquisition shall not have voting rights unless the shareholders approve a resolution granting voting rights to the acquirer's shares. See chapter 8 of my Mergers and Acqusitions text for more details.
Members of the Taubman family formed a group to pool their shares’ voting powers to oppose the Simon Property and Westfield hostile bid. Once aggregated, their combined shares exceeded the 33 1/3% threshold. Under the Michigan statute as then worded, the formation of the group constituted a control share acquisition as defined by statute (even though they did not acquire more shares in the usual sense of buying some), or so a federal court held back in May. Accordingly, the formation of the group required approval by Taubman Center’s other shareholders. The new bill amends the control share acquisition statute to permit shareholders to form such a group without triggering the voting requirement.
The stated purpose of control share statutes is providing shareholders with an opportunity to vote on a proposed acquisition of large share blocks which may result in or lead to a change in control of the target. These statutes are premised on the assumption that individual shareholders are often at a disadvantage when faced with a proposed change in control. If the target's shareholders believe that a successful tender offer will be followed by a purchase by the offeror of non tendered shares at a price lower than that offered in the initial bid, for example, individual shareholders may tender their shares to protect themselves from such an eventuality, even if they do not believe the offer to be in their best interests.
By requiring certain disclosures from the prospective purchaser and by allowing the target's shareholders to vote on the acquisition as a group, control share acquisition statutes supposedly provide the shareholders a collective opportunity to reject an inadequate or otherwise undesirable offer. For example, since control share acquisition statutes generally require the offeror to disclose plans for transactions involving the target that would be initiated after the control shares are acquired, shareholders presumably would be unlikely to approve a creeping tender offer or street sweep which would be followed by a squeezeout back end merger at a price less than or in a consideration different than that paid by the acquirer in purchasing the initial share block.
