Gibson Dunn partner Eduardo Gallardo posts an interesting essay on Delaware law governing poison pills at the Harvard corporate law blog. He points out that:
Delaware law in this area, particularly as it relates to a board’s decision not to redeem a rights plan in the face of a financially attractive all-cash bid, has seen no major case law or statutory development in a number of years. With the recent levels of hostile M&A activity and the concurrent expansion of shareholder activism, the time may be ripe for the Delaware Chancery Court to resolve some of the perceived tensions in this important area.
He goes on to posit several questions Delaware law needs to answer, including:
... who ultimately controls a company? Is it the board, which manages the affairs of the company, or shareholders, who own the company? When faced with an all cash, structurally non-coercive tender offer, can the target board enact a plain-vanilla shareholder rights plan if it deems the offer price to be inadequate and essentially “just say no” to the offer? Or must the board give shareholders the opportunity to tender their shares? These questions remain to some extent unresolved under Delaware law.
He then reviews the relevant case law.
I addressed most of these questions in my article Unocal at 20: Director Primacy in Corporate Takeovers:
Who ultimately controls a company?
Deciding who decides thus requires an inquiry into first principles. What is the nature of the corporation? What is the nature of the shareholders’ relationship to the corporation? What is the proper role and function of the board of directors? And so on. ...
... neither shareholders, employees, nor any other constituency have the information or the incentives necessary to make sound decisions on either operational or policy questions. Overcoming the collective action problems that prevent meaningful involvement by the corporation’s various constituencies would be difficult and costly. Under these conditions, [Kenneth] Arrow predicts, it is “cheaper and more efficient to transmit all the pieces of information [at] once to a central place” and to have the central office “make the collective decision and transmit it rather than retransmit all the information on which the decision is based.” As we have seen, it is the board of directors that functions as that central office. ...
Must the board give shareholders the opportunity to tender their shares?
According to [proponents of such a rule], an individual shareholder’s decision to tender his shares to the bidder no more concerns the institutional responsibilities or prerogatives of the board than does the shareholder’s decision to sell his shares on the open market or, for that matter, to sell his house.182 Both stock and a home are treated as species of private property that are freely alienable by their owners.
The trouble is that none of the normative bases for the structural argument prove persuasive. The idea that shareholders have the right to make the final decision about an unsolicited tender offer does not necessarily follow, for example, from the mere fact that shareholders have voting rights. While notions of shareholder democracy permit powerful rhetoric, corporations are not New England town meetings. Put another way, we need not value corporate democracy simply because we value political democracy.
Indeed, we need not value shareholder democracy very much at all. As previously discussed, what is most striking about shareholder voting rights is the extensive set of limitations on those rights. These limitations reflect the presumption in favor of authority. They are designed to minimize the extent to which shareholders can interfere in the board of directors’ exercise of its discretionary powers. In fact, ... if authority were corporate law’s sole value, shareholders would have no voice at all in corporate decision making. Instead, all decisions would be made by the board of directors or those managers to whom the board has delegated authority. Shareholder voting rights are properly seen as simply one of many accountability tools available, not as part of the firm’s decision-making system.
Nor is shareholder choice a necessary corollary of the shareholders’ ownership of the corporation. As described in Part II.B, the nexus of contracts model visualizes the firm as a legal fiction representing a complex set of contractual relationships. Because shareholders are simply one of the inputs bound together by this web of voluntary agreements, ownership is not a meaningful concept under this model. A shareholder’s ability to dispose of his stock is merely defined by the terms of the corporate contract, which in turn is provided by the firm’s organic documents and the state of incorporation’s corporate statute and common law. As Vice Chancellor Walsh observed, “[S]hareholders do not possess a contractual right to receive takeover bids. The shareholders’ ability to gain premiums through takeover activity is subject to the good faith business judgment of the board of directors in structuring defensive tactics.” ...
Finally, and most importantly, the structural argument also ignores the risk that restricting the board’s authority in the tender offer context will undermine the board’s authority in other contexts. Even the most casual examination of corporate legal rules will find plenty of evidence that courts value preservation of the board’s decision-making authority.195 The structural argument, however, ignores the authority values reflected in these rules. To the contrary, if accepted, the structural argument would necessarily undermine the board’s unquestioned authority in a variety of areas. Consider, for example, the board’s authority to negotiate mergers. If the bidder can easily bypass the board by making a tender offer, hard bargaining by the target board becomes counter-productive. It will simply lead the bidder into making a low-ball tender offer to the shareholders. This offer, in turn, would probably be accepted due to the collective action problems that preclude meaningful shareholder resistance. Restricting the board’s authority to resist tender offers thus indirectly restricts its authority with respect to negotiated acquisitions.
