It seems increasingly clear that Delaware courts are punting key corporate decisions to the shareholders. Ron Gilson made this point about hostile corporate takeovers 15 years ago, arguing that Delaware law on point had "developed into an unexplained and likely inexplicable preference that control contests be resolved through elections rather than through market transactions."
We see the same shift these days with respect to mergers and acquisitions generally, as well as a variety of shareholder transactions. In Corwin v. KKR Fin. Holdings LLC, 125 A.3d 304, 314 (Del. 2015), Delaware Chief Justice Leo Strine wrote that "where the stockholders have had the voluntary choice to accept or reject a transaction, the business judgment rule standard of review is the presumptively correct one and best facilitates wealth creation through the corporate form." Even where the transaction involves a controlling shareholder, approval by the disinterested and independent shareholders has become a critical factor in setting the standard of review courts will apply. See, e.g., Kahn v. M & F Worldwide Corp., 88 A.3d 635, 644 (Del. 2014) (holding that "where the controller irrevocably and publicly disables itself from using its control to dictate the outcome of the negotiations and the shareholder vote, the controlled merger then acquires the shareholder-protective characteristics of third-party, arm's-length mergers, which are reviewed under the business judgment standard").
The logic behind this trend seems to be an assumption that shareholders can protect their interests through the vote. As Corwin explained, "When the real parties in interest—the disinterested equity owners—can easily protect themselves at the ballot box by simply voting no, the utility of a litigation-intrusive standard of review promises more costs to stockholders in the form of litigation rents and inhibitions on risk-taking than it promises in terms of benefits to them." See also In re Lear Corp. S'holder Litig., 926 A.2d 94, 114–15 (Del. Ch. 2007) (“Delaware corporation law gives great weight to informed decisions made by an uncoerced electorate. When disinterested stockholders make a mature decision about their economic self-interest, judicial second-guessing is almost completely circumscribed by the doctrine of ratification.”).
A key difficulty I have with this line of cases is that it seems to assume homogeneity of interests on the part of shareholders. We know that voting--in any setting--is more likely to develop serious pathologies when the constituents have competing interests. The divergent interests of shareholders and stakeholders, for example, is one reason only one constituency gets to elect directors. See generally Stephen M. Bainbridge, The Case for Limited Shareholder Voting Rights, 53 UCLA L. Rev. 601, 612 (2006) ("The remaining question is why shareholders are the chosen constituency, rather than employees. ... One plausible answer rests on the divergence of interests within constituency groups."). Likewise, it is the heterogeneity of interests among shareholders that is a major reason corporate law is premised on director rather than shareholder primacy. See id. at 608 ("The divergence of interests ... looms large as a bar to the use of consensus in capitalist firms."). See also Michael C. Schouten, The Mechanisms of Voting Efficiency, 2010 Colum. Bus. L. Rev. 763, 773 (2010) ("When shareholders have heterogeneous preferences and some vote with a view to maximizing their private interests rather than their pro-rata share of the firm's future cash flows, the probability that a majority of the shares is voted for the correct option decreases dramatically."). See generally Kenneth A. Stahl, The Challenge of Inclusion, 89 Temp. L. Rev. 487, 506 (2017) (arguing with reference to voting within communities that "the more homogeneous the population, the more likely that voters will have a fairly uniform set of preferences that can be satisfied without interest group conflict and without creating a resentful class of 'losers'").
Now we get to the nub. It has long been clear that shareholders have heterogeneous interests. Lynn A. Stout, Are Stock Markets Costly Casinos? Disagreement, Market Failure, and Securities Regulation, 81 Va. L. Rev. 611, 616 (1995) (“[I]n a world of costly and imperfect information, rational investors are likely to form heterogeneous expectations--that is, to make different forecasts of stocks' likely future performance.”). My friend and UCLAW colleague Iman Anabtawi and the late Lynn Stout have further argued that "as shareholders are becoming more powerful, their interests are becoming more heterogeneous. Increasingly, the economic interests of one shareholder or shareholder group conflict with the economic interests of others. The result is that activist shareholders are using their growing influence not to improve overall firm performance, as has generally been assumed, but to profit at other shareholders' expense." Iman Anabtawi & Lynn Stout, Fiduciary Duties for Activist Shareholders, 60 Stan. L. Rev. 1255, 1258 (2008).
All of which leads me to the new paper that triggered this post, namely Bolton, Patrick and Li, Tao and Ravina, Enrichetta and Rosenthal, Howard, Investor Ideology (June 11, 2018). Columbia Business School Research Paper No. 18-21; European Corporate Governance Institute (ECGI) - Finance Working Paper No. 557/2018. Available at SSRN: https://ssrn.com/abstract=3119935:
This paper estimates a spatial model of proxy voting, the W-NOMINATE method for scaling legislatures, and maps institutional investors onto a left-right dimension based on their votes for fiscal year 2012. The far-left are socially responsible and the far-right are “money-conscious” investors. Significant ideological differences reflect an absence of shareholder unanimity. The proxy adviser ISS, similar to a political leader makes voting recommendations that place it center-left; to the left of most mutual funds. Public pension funds and other investors on the left support a more social and environment-friendly orientation of the firm and fewer executive compensation proposals. (Emphasis supplied.)
Instructively, there appears to be heterogeneity not only with respect to obviously political issues falling within the corporate social responsibility rubric but also as to financial and investment decisions.
All of this seems to call into question the logic of the trend in Delaware law towards treating the shareholder vote as dispositive. If it is the case, as seems to be true, that investors have differing interests and preferences, we cannot trust ratification votes to be free of pathologies, which call the validity of that vote into question.
Maybe Delaware needs to rethink the trend of its ratification doctrines. But. at least, the Delaware courts need to come up with a better justification for the direction they've taken.
Update: A friend sends along this comment:
I think Patrick's paper focuses on votes on Rule 14a-9 shareholder proposals, not on merger votes, the main focus of Delaware "ratification" stuff, where I think that shareholder unanimity would generally prevail (or at least would not have a "political" dimension).
It is true that the paper focuses on proposals. It's not obvious to me, however, that ideology would be irrelevant to other issues n which shareholders vote. A fairly obvious example, it seems to me, would be where shareholders vote to ratify executive compensation plans proposed by the board. Granted, however, mergers seem on first blush to be less overtly political.
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