An Efficiency Analysis of Defensive Tactics
Ronald J. Gilson & Alan Schwartz
For thirty-five years, courts and scholars have been divided over the effects of defensive tactics in the market for corporate control. Strong defensive tactics locate authority to accept a hostile bid in the target’s board. The board can bargain for a higher takeover price than uncoordinated shareholders could realize, but high takeover prices may reduce shareholder returns by reducing the likelihood of receiving a bid. The Delaware Courts themselves disagree. The Delaware Chancery Court would locate ultimate decision authority in the tar- get’s shareholders, while the Supreme Court, by permitting strong defensive tac- tics, allocates extensive power to the target’s board. Though the Supreme Court’s view settles the legal issue in Delaware for now, the normative debate among scholars and decision makers regarding whether the shareholders or the board should decide remains unresolved.
The Delaware courts ask whether defensive tactics maximize target shareholder welfare: the shareholders’ expected return from acquisitions. But the more important question concerns social welfare: do defensive tactics reduce efficiency in the market for corporate control? Empirical difficulties so far have prevented analysts from answering either the private or social welfare question rigorously. Regarding private welfare, the analyst cannot observe bids that a target’s defensive tactics level deterred. Regarding public welfare, the analyst cannot observe how an otherwise identical market would behave under either weak or strong defensive tactics levels.
We address the two empirical questions by creating a structural model that predicts how the market for corporate control performs under varying defensive tactics levels and then testing the model by simulating market performance. A simulation permits us to isolate the effect of different defensive tactics levels. It also permits us to solve for a target’s optimal tradeoff between the increased share of an acquisition’s gain that strong defensive tactics permits a target to capture and the reduced probability of receiving bids in consequence of the acquirer’s reduced gain.
The simulated corporate control market performs poorly, making 15% fewer acquisitions under strong defensive tactics than under weak defensive tactics. Target boards, however, apparently have been faithful fiduciaries for their shareholders, choosing defensive tactics levels that optimize the tradeoff be- tween bid frequency and bid returns. On the one hand, we show that the privately optimal target defensive tactics level greatly exceeds the socially efficient level. On the other, we suggest that some firms’ recent efforts further to strengthen defensive tactics, such as by combining a staggered board with a poison pill, reduce both efficiency and target shareholder welfare.
Our results do not support a call for an immediate regulatory response. Initially, we do not rigorously analyze other possible justifications for defensive tactics, such as that they encourage potential targets to take long-term projects that the market may undervalue. Also, simulations raise an external validity question: do the researcher’s assumed simulation parameters capture real world patterns? We argue that our parameters do well on this measure, but a simulated market cannot perfectly capture real world behavior. As well, the magnitude of our results and their consistency with theoretical predictions strongly support our central claim: today’s market for corporate control is so unlikely to maximize the number of value-increasing acquisitions that scholars, regulators, and courts should revisit the defensive tactics debate.
Power and Statistical Significance in Securities Fraud Litigation
Jill E. Fisch & Jonah B. Gelbach
Event studies, a half-century-old approach to measuring the effect of events on stock prices, are now ubiquitous in securities fraud litigation. In determining whether the event study demonstrates a price effect, expert witnesses typically base their conclusion on whether the results are statistically significant at the 95% confidence level, a threshold that is drawn from the academic literature. As a positive matter, this represents a disconnect with legal standards of proof. As a normative matter, it may reduce enforcement of fraud claims because litigation event studies typically involve quite low statistical power even for large-scale frauds.
This Article, written for legal academics, judges, and policy makers, makes three contributions. First, it contributes to a nascent literature demonstrating that the standard event-study methodology can be problematic in securities litigation. In particular, the Article documents the tradeoff between power and confidence level and the ensuing impact on the likelihood that valid claims of fraud will erroneously be rejected. In so doing, the Article highlights that the choice of confidence level is a policy judgment about the appropriate balance between the costs of litigation and the costs of securities fraud. Second, the Article argues that the Securities and Exchange Commission (SEC) has both the legal power and the institutional competence to develop litigation standards that balance these costs.
Third, the Article provides a novel and feasible framework through which the SEC can implement such litigation standards. The framework relies on an assessment of the defendant firm’s market capitalization and abnormal returns distribution to determine the maximum confidence level (minimum significance level) that is consistent with the minimum required power of detecting a fraud of the benchmark magnitude. The SEC is uniquely positioned to make this determination based on the information it possesses about the level of fraud in the capital markets and the role of private litigation in deterring fraud.
The Future or Fancy? An Empirical Study of Public Benefit Corporations
Michael B. Dorff, James Hicks, & Steven Davidoff Solomon
The public benefit corporation (“PBC”) is one of the most hyped developments in corporate law, due to the PBC’s unique social purpose. Unlike the traditional corporation, directors of PBCs are required under their fiduciary duties to con- sider the impact of their decisions on a range of stakeholders and communities. This new form is hailed by many as a framework for a reformed capitalism. Critics, on the other hand, have assailed PBCs as unworkable, at best allowing corporations to “green wash,” or providing a thin disguise for ordinary corporate profit-seeking behavior.
What has been lacking in this debate is evidence about whether and how the new form is being adopted. We fill this gap with an empirical study of early-stage investment in PBCs. Early-stage investment, consisting of venture capital and similar funds, presents an interesting test case for PBC funding, because these investors have profit-maximizing incentives and fiduciary duties of their own. Using our novel dataset, we can discern whether for-profit investment is occur- ring in PBCs, and if so, whether it is different in kind from ordinary early stage investment.
We find that PBCs are receiving investment at significant rates, and that funding is coming from typical sources of venture capital—including traditional, profit- seeking VC firms. We also find that VC firms are investing more in consumer- facing industries, as well as investing smaller amounts than in traditional companies at the same stage, which raises concerns about greenwashing. While the ultimate arc of the PBC remains uncertain, our results show that it is gaining acceptance as an investment that can earn an acceptable rate of return— though, as we argue, the PBC status itself may be a secondary factor in VCs’ decisions.
We use these results to develop a theory of future PBC development, which asserts that in the medium term, investment in PBCs is likely to remain siloed in smaller, newly formed firms. We conclude that widespread adoption of the form will take time, as network effects build and experience with the form becomes embedded within the entrepreneurial and legal ecosystem. The PBC is not a failure. But it is in its infancy, and any full embrace will take a significant period of time.
Regulating Financial Guarantors
Steven L. Schwarcz
To improve financial regulation, scholars have engaged in extensive research over the past decade to try to understand why systemically important financial firms engage in excessive risk-taking. None of that research fully explains, how- ever, the unusually excessive risk-taking by financial guarantors such as bond insurers, protection sellers under credit-default-swap (CDS) derivatives, credit enhancers in securitization transactions, and even issuers of standby letters of credit. With tens of trillions of dollars of financial guarantees outstanding, the potential for failure is massive. This Article argues that financial guarantor risk- taking is influenced by a previously unrecognized cognitive bias, which it calls “abstraction bias.” Unlike banks and other financial firms that pay out capital—for example, by making a loan—at the outset of a project, financial guarantors do not actually transfer their property at the time they make a guarantee. As a result, they may view their risk-taking more abstractly, causing them to underestimate the risk (even after discounting for the fact that payment on a guarantee is a contingent obligation). The Article provides empirical evidence showing that abstraction bias is real and can influence even sophisticated financial guarantors. The Article also examines how understanding abstraction bias can improve the regulation of financial guarantor risk-taking.