The corporate governance arrangements of U.S. public companies have been transformed over the past four decades. Independent directors now dominate boards (at least numerically), activism by shareholders has become more prevalent and executive pay has become more lucrative and more performance-oriented. The changes have been accompanied by a new nomenclature—the term “corporate governance” only came into general usage in the 1970s. How and why did this transformation of corporate governance come about? Delaware and the Transformation of Corporate Governance, which is based on the 2014 Francis G. Pileggi lecture, addresses these questions by assessing Delaware’s impact on key corporate governance trends.
Posts Tagged ‘Delaware articles’
Financial reports should provide useful information to both shareholders and creditors, according to U.S. accounting principles. However, directors of corporations have fiduciary duties only toward equity holders, and those fiduciary duties normally do not extend to the interests of creditors. In our paper, Does Corporate Governance Make Financial Reports Better or Just Better for Equity Investors?, which was recently made publicly available on SSRN, we examine whether this slant in corporate governance biases financial reports in favor of equity investors. We show that the likelihood that firms will manipulate their reporting to circumvent debt covenants is higher when directors owe fiduciary duties only to equity holders, rather than when they owe fiduciary duties also to creditors. Covenants limit the amount of new debt that the firm issues, for example, and by that reduce bankruptcy risk, and allow creditors to avoid bankruptcy costs, and to recover more from the borrowing firm in case it approaches insolvency. When managers manipulate financial reports to circumvent these debt covenants, they transfer wealth from creditors to shareholders. Our results suggest that when corporate governance is designed to protect only equity holders, firms’ financial reports serve equity holders’ interests at the expense of other stakeholders. We find that when the legal regime requires directors to consider creditors’ interests, firms are less likely to use structured transactions designed to skirt debt covenant limits, particularly if the board of directors of the firm is independent.
In the US, every M&A deal of any significant size generates litigation. The vast majority of these lawsuits settle, and the vast majority of these settlements are for non-pecuniary relief, most commonly supplemental disclosures in the merger proxy.
The engine that drives this litigation is the concept of “corporate benefit.” Under judge-made law, litigation that produces a corporate benefit allows the court to order plaintiffs’ attorneys’ fees to be paid directly by the defendants provided that the outcome of the litigation is beneficial to the corporation and its shareholders. In a negotiated settlement, plaintiffs will characterize supplemental disclosures in the merger proxy as producing a corporate benefit, and defendants will typically not oppose the characterization, as they are happy to pay off the plaintiffs’ lawyers and get on with the deal. The supposed benefits of these settlements thus are rarely tested in adversarial proceedings. Knowing this creates a strong incentive for plaintiffs’ attorneys to file claims, put in limited effort, and negotiate a settlement consisting exclusively of corrective disclosures. But is there any real value to these settlements?
In November 2013 I delivered the 29th Annual Francis G. Pileggi Distinguished Lecture in Law in Wilmington, Delaware. My lecture, entitled “Delaware’s Choice,” presented four uncontested facts from my prior research: (1) in the 1980s, federal courts established the principle that Section 203 must give bidders a “meaningful opportunity for success” in order to withstand scrutiny under the Supremacy Clause of the U.S. Constitution; (2) federal courts upheld Section 203 at the time, based on empirical evidence from 1985-1988 purporting to show that Section 203 did in fact give bidders a meaningful opportunity for success; (3) between 1990 and 2010, not a single bidder was able to achieve the 85% threshold required by Section 203, thereby calling into question whether Section 203 has in fact given bidders a meaningful opportunity for success; and (4) perhaps most damning, the original evidence that the courts relied upon to conclude that Section 203 gave bidders a meaningful opportunity for success was seriously flawed—so flawed, in fact, that even this original evidence supports the opposite conclusion: that Section 203 did not give bidders a meaningful opportunity for success.
“Leximetrics,” which involves quantitative measurement of law, has become a prominent feature in empirical work done on comparative corporate governance, with particular emphasis being placed on the contribution that robust shareholder protection can make to a nation’s financial and economic development. Using this literature as our departure point, we are currently engaging in a leximetric analysis of the historical development of U.S. corporate law. Our paper, Law and History by Numbers: Use, But With Care, prepared for a University of Illinois College of Law symposium honoring Prof. Larry Ribstein, is part of this project. We identify in this paper various reasons for undertaking a quantitative, historically-oriented analysis of U.S. corporate law. The paper focuses primarily, however, on the logistical challenges associated with such an inquiry.
My article, Standing at the Singularity of the Effective Time: Reconfiguring Delaware’s Law of Standing Following Mergers and Acquisitions, examines the doctrine of standing as applied to mergers and acquisitions of Delaware corporations with pending derivative claims. The settled rules of direct and derivative standing break down at the “singularity of the effective time” of a merger, yielding to conflicting principles of standing, corporation law and policy, and basic equity. The path-dependent network of rules and exceptions that has developed is an outgrowth of case-by-case adjudication that now begs for a one-time, wholesale reconfiguration.
The article takes on that task, proposing three straightforward rules that need no exceptions:
Historically, buyouts by controlling shareholders (also known as “going-private transactions,” “squeeze-outs,” and hereinafter “freezeouts”) were subject to different standards of judicial scrutiny under Delaware corporate law based on the transactional form used by the controlling shareholder to execute the deal. In a line of cases dating back at least to the Delaware Supreme Court’s 1994 decision in Kahn v. Lynch Communications, a freezeout executed as a statutory merger was subject to stringent “entire fairness” review, due to the self-dealing nature of the transaction. In contrast, in a line of cases beginning with the Delaware Chancery Court’s 2001 opinion in In re Siliconix Inc. Shareholder Litigation, a freezeout executed as a tender offer was subject to deferential business judgment review.
Subramanian (2007) presents evidence that, after Siliconix, minority shareholders received less in tender offer freezeouts than in merger freezeouts. Restrepo (2013) finds that these differences in outcomes occurred only after Siliconix, and that the incidence of tender offer freezeouts increased after this opinion, also supporting the idea that controlling shareholders took advantage of the opportunity provided by Siliconix. Subramanian (2005) describes why these differences in outcomes for minority shareholders create a social welfare loss and not just a one-time wealth transfer from minority shareholders to the controlling shareholder.
The recent discovery that corporate law litigation very often takes place in courts outside of Delaware has rattled the academic consensus that Delaware won the corporate law “race” by providing a well-managed forum staffed with expert judges willing to decide complex deal cases quickly. In an apparent affront to this settled understanding, recent research shows that more cases are filed against Delaware corporations in other states than in Delaware itself.  As a forum for corporate litigation, in other words, Delaware no longer dominates.
Shaken from their settled understandings, commentators have sounded the alarm that fewer cases decided in Delaware could, over time, reduce the expertise of the Delaware judiciary in corporate law matters. Worse, the decisions reached by non-Delaware “dilettantes” threaten to adulterate and degrade the basic Delaware product. In sum, prior commentary on the out-of-Delaware trend has treated it as very bad for corporate defendants, very bad for shareholder plaintiffs, and very bad for Delaware.
In Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc.,  the Delaware Supreme Court explained that when a target board of directors enters Revlon-land, the board’s role changes from that of “defenders of the corporate bastion to auctioneers charged with getting the best price for the stockholders at a sale of the company.” 
Unfortunately, the Court’s colorful metaphor obfuscated some serious doctrinal problems. What standards of judicial review applied to director conduct outside the borders of Revlon-land? What standard applied to director conduct falling inside Revlon-land’s borders? And when did one enter that mysterious country?
By the mid-1990s, the Delaware Supreme Court had worked out a credible set of answers to those questions. As for the borders of Revlon-land, the Court had explained that:
Standstill agreements are ubiquitous in public company M&A deals. In fact, the execution of a standstill has been described as the “cost of entry” into negotiations and serves to indicate a bidder’s seriousness. Despite their ubiquity, there is surprisingly little Delaware case law on standstills and even less academic literature on the subject. In my paper, Promises Made to be Broken? Standstill Agreements in Change of Control Transactions, forthcoming in the Delaware Journal of Corporate Law, I attempt to begin to fill this gap in academic literature by examining and providing a blueprint for the resolution of various issues raised by the execution and enforcement of standstills in the context of sales resulting in a change of corporate control.
My paper concentrates on three issues the Delaware courts have yet to tackle: a target board’s ability to consider a third-party superior offer made in contravention of a standstill; a board’s promise not to waive a standstill; and a board’s ability to grant a “winning” bidder the right to enforce a previously executed standstill against a “losing” bidder. Each of these issues raises a conflict between two fundamental principles of Delaware M&A law: 1) a board’s Revlon duty to maximize stockholder value in a sale of corporate control; and 2) the sanctioning of certain deal protection provisions as permitted by the Delaware Supreme Court’s decision in Unocal Corp. v. Mesa Petroleum Co. and its progeny. As commonly argued, the availability of deal protection devices, including standstills and other promises made in relation to standstills, may assist a target board in extracting more value from bidders, thereby facilitating satisfaction of a board’s Revlon duties. Thus, at the pre-signing stage there may be good reason for a target board to agree to a standstill, and the provision may be permissible under Unocal but, pre-closing, the provision may inhibit the fulfillment of a board’s Revlon duties. Specifically, standstills may prevent a board from considering a third-party offer or deter a third party bound by a standstill from making an overbid in the first place.