One of the more highly researched topics in the financial economics literature has been the analysis of the gains made by shareholders of companies that participate in a merger and acquisition transaction. This paper surveys the evidence for which acquirer characteristic or merger transaction type generates non-positive or positive abnormal returns for the acquirer’s shareholders. In doing so, I describe a comprehensive set of hypotheses that has been built on existing theory, which has been tested using proxies variables in a regression specification. The chapter then explains that a number of new hypotheses have yet to be examined. Finally, the paper describes outstanding empirical issues in much of the existing literature.
Edited by Claire A. Hill and Steven Davidoff Solomon
Claire A. Hill, Brian J.M. Quinn and Steven Davidoff Solomon
Mergers and acquisitions (M & A) have a rich history in the American economy. Over the course of the past century and a half, merger activity has proceeded in waves, each wave inevitably followed by a regulatory and legal response. Modern merger activity emerged during the late nineteenth century. The succeeding trust era, characterized by monopolies and frenetic acquisition activity, resulted in new regulations in the 1890s and early nineteenth century. Merger activity created vast conglomerates during the 1960s. During the 1970s and 1980s, the leveraged buyout boom led to the development of modern M & A legal doctrine. The late 1980s and 1990s saw the embracing of new participants such as private equity firms. Today, the Internet Age and globalization have led to the current M & A market, characterized by transactions that are global, very large (multi-billion dollar), and sometimes both. The rich history of M & A, with its alternating cycles of activity and quiescence, illustrates an important role for law. The law is both a response to M & A activity, implementing ex post facto regulation, and a guiding force, spurring waves of M & A activity throughout. There is no doubt that as M & A continues its cyclical life, the law, lawyers and those who study the law will continue to play an important part in this economic phenomenon. From its origins – when law mattered little – M & A has become a highly regulated business.
John C. Coates
M & A transactions are governed by contracts that exhibit constrained variation – they are negotiated, yet full of boilerplate, tailored, yet full of patterns and regularities. This chapter reviews the suite of contracts commonly needed in an M & A transaction, and offers two complementary descriptions of the core ‘deal contracts’ in M & A. The first tracks the customary organization of the contracts themselves, and the second re-analyzes their contents with a new, functional typology derived from the purposes of deal contracts: (1) specification (especially of deal structure, pricing terms, and, in partial acquisitions, the business to be acquired); (2) risk-sharing; (3) process management; (4) control and information sharing; and (5) dispute management. Each description is illustrated by examples from and links to recent, high-profile deals, augmented with cross-sectional data from a representative sample of M & A contracts involving U.S. targets. Ways that ownership and regulation shape M & A contracts for U.S. targets are summarized, and data consistent with that summary is presented. Finally, the rapidly growing body of empirical research on the contents and effects of M & A contracts is surveyed. The chapter concludes with a brief agenda for future research on M & A contracts.
D. Gordon Smith
For over 150 years, the business judgment rule performed a relatively straightforward task in the corporate governance system of the United States, namely, protecting corporate directors from liability for honest mistakes. Under the traditional version of the business judgment rule, when the board of directors is careful, loyal, and acting in good faith, courts refuse to second-guess the merits of the board’s decisions, even if the corporation and its shareholders are harmed by those decisions. While modern courts continue to insulate directors from liability for honest mistakes according to this traditional formula, in the 1980s Delaware courts began assigning the business judgment rule a more expansive role. The modern business judgment rule is applied not only in cases without procedural infirmities, but in cases where procedural infirmities at the board level have been mitigated by a special committee, stockholder approval, or partial substantive review by the court. In these new contexts, a court must satisfy itself that a board decision is worthy of respect, not because the decision was substantively correct, but because the effect of the procedural infirmities was sufficiently muted. After the court reaches that point, the business judgment rule ‘attaches’ to protect the substantive merits of the decision from (further) review. The modern business judgment rule is not a one-size-fits-all doctrine, but rather a movable boundary, marking the shifting line between judicial scrutiny and judicial deference. In describing the transformation of the business judgment rule, this chapter focuses on Delaware judicial opinions, with special attention to cases involving mergers and acquisitions, where the most important changes in the business judgment rule have been forged. The scripting of the business judgment rule’s new role by the Delaware courts is a work in progress, and the current law is inconsistent and confusing. Nevertheless, I trace the development of the modern business judgment rule and attempt to rationalize that development around the simple idea that the rule guides courts through the review of director conduct and marks the point at which judicial evaluation of a decision ends.
Charles K. Whitehead
To what extent should law and regulation treat business transactions – which differ in form, but are economically equivalent – in the same way? And what justifies the imposition of different costs across different transactional forms? This chapter considers equivalence by assessing the effect of different business acquisition forms on corporate stakeholders. It sets out factors that may be used to determine equivalence, as well as considering the extent to which different forms merit the same or different legal and regulatory treatment. There very well may be reasons to impose different requirements on different transactional forms – for example, based on differences in statutes, stakeholders, and judicial scrutiny, as well as the practical realities that make legal or regulatory equivalence difficult to achieve – but by starting with equivalence, we can begin to assess the relative merits of those differences. This chapter also begins to explore the limits of equivalence, suggesting that the computational skills needed to fully assess equivalence around business acquisitions have not yet caught up with the business lawyers’ ability to use different forms to achieve the same substantive results.
Robert P. Bartlett
This chapter investigates the widespread claim that the billion dollar valuations of ‘unicorn’ start-ups are unreliable because of the manner in which founders bargain for these valuations with their venture capital (VC) investors. In particular, unicorn skeptics posit that VC investors agree to use these valuations in exchange for receiving enhanced preferred stock preferences, particularly enhanced liquidation preferences that are payable on a sale of the company. By examining how liquidation preferences affect expected returns of founders and VC investors, this chapter argues that unicorn valuations are indeed unreliable measures of firm value but not for the reasons suggested by unicorn skeptics. While offering enhanced liquidation preferences to an investor can overcome the reduction in expected returns caused by financing a firm at a higher valuation, doing so will generally be more detrimental to a founder’s expected returns than if the financing were done at a lower valuation using a conventional liquidation preference. Rather, this chapter argues that unicorn valuations are unreliable measures of firm value for the same reason that all start-up valuations are unreliable measures of firm value – namely, the common practice among VC investors to price VC financings as if they are purchasing common stock when they are acquiring preferred stock with downside economic protections. As a result of this practice, the reported valuations of unicorns and non-unicorns alike can be significantly higher than the enterprise value an investor is implicitly placing on a firm when financing it. For founders and prior stockholders, this insight has important implications for understanding the effective enterprise value being used in a financing and avoiding unintended dilution.
Albert H. Choi
This chapter examines the role played by earnouts in mergers and acquisitions transactions. When one party is better informed of the true value of the deal than the other, the parties face the well-known ‘lemons’ problem, which could prevent them from consummating the transaction even when both are aware that the deal will produce a positive (but uncertain) surplus. By harnessing post-closing, verifiable information, earnouts allow the transacting parties to overcome this informational challenge. The essay also analyzes: (1) how the adoption and the size of an earnout will vary depending on the transactional characteristics; and (2) the earnout design issues when the parties face the problems of ex-post moral hazard, such as engaging in inefficient behavior to either maximize or minimize the earnout payment.
Jordan M. Barry
Scholars have spilled a remarkable amount of ink on the topic of takeover defenses. Despite – or perhaps because of – this, there remains remarkably little scholarly consensus on the topic. This chapter provides an overview of some of the ongoing scholarly debates surrounding corporate takeover defenses. It begins with background on the poison pill, widely considered to be the most important takeover defense for U.S. firms, before turning to studies of poison pills and other takeover defenses, in particular staggered boards. The chapter then considers the scholarly literature on why different firms adopt different levels of takeover defenses. The final two sections of this chapter discuss rapidly growing areas of scholarship that have implications for the literature on takeover defenses: the debate over whether U.S public corporations are myopic and the scholarship surrounding empty voting.
Simone M. Sepe
This chapter from the forthcoming Research Handbook on Mergers and Acquisitions provides an overview of the practice, economic theory, and evidence regarding staggered boards in U.S. public companies. In doing so, it pursues a twofold purpose. First, it aims at illustrating the extent to which empirical studies documenting a detrimental effect of staggered boards on firm value have influenced both academic discussions and the practice of staggered boards, in spite of inherent methodological limitations. Second, based on more recent empirical evidence asserting the opposite conclusion, it argues for a new direction in staggered board research.