TABLE OF CONTENTS INTRODUCTION I. UNDERSTANDING THE LEGAL INFRASTRUCTURE OF DEALS II. CASE STUDIES A. Google 1. The Timing of the Deal 2. The Appeal of the Auction Structure 3. Execution of the Deal 4. Evaluating the Deal: Efficiency 5. Evaluating the Deal: Branding Effects 6. The Branding Power of Auctions B. Ben & Jerry's Homemade, Inc 1. Vermonters-Only 2. Costs and Benefits of the Geographic Restriction 3. A Scoop of the Action: Epilogue C. Apple 1. One Dollar 2. The Executive-Compensation Image Problem 3. "One Dollar" D. Stanley Works 1. An All-American Company 2. The Inversion Deal 3. What Stopped the Deal? III. BRANDING THE DEAL: THE MECHANISMS OF MARKETING INEFFICIENCY A. Branding through Desirable Atmospherics B. Reaching Early Adopters CONCLUSION INTRODUCTION
Consider the unusual legal structures of the following four deals:
* When Google went public in 2004, it used an Internet auction to sell its stock to shareholders.
* When Ben & Jerry's went public in 1984, it sold its stock only to Vermont residents.
* Steve Jobs's contract with Apple entitles him to an annual cash salary of exactly one dollar.
* Stanley Works, a Connecticut toolmaker, considered reincorporating in Bermuda to reduce its tax liability. Under public pressure, it changed its mind and remains legally incorporated in Connecticut.
What do these deals have in common? In each case, the legal infrastructure of the deal had a branding effect: the design of the deal altered the brand image of the company.
The structure of each of the first three deals is difficult to understand using the traditional tools of corporate finance alone. The deals appear to be inefficient, at least if one thinks about efficiency in the usual way. (1) But if one also considers the impact of the deal on brand image, the Google, Ben & Jerry's, and Apple deals are success stories. The Stanley Works deal was a failure. But it did not fail because of some flaw in its financial design, such as a miscalculation of the tax savings or difficulty in communicating the tax benefits to its shareholders. The deal failed because its managers failed to predict the negative impact that its legal infrastructure would have on its brand image.
The concept of branding rarely appears in academic debates about corporate finance and corporate governance. Finance scholars focus their attention on the relationship between the firm; its investors and creditors, who supply financial capital; and its managers, who supply human capital. (2) Contracts are efficient when they properly align incentives; a good contract design is one that allows managers to raise capital cheaply and deploy it effectively. At best, consumers enter the discussion as the emotionless buyers who make up the product markets and serve as a potential indirect check against agency costs. (3)
The functionality-oriented consumer. The implicit assumption in these debates is that consumers have no rational reason to care about the internal corporate governance of a firm whose products they buy. Most consumers, after all, have only the haziest notion of how firms interact with the capital markets and labor markets. Finance scholars, then, act like the editors of Consumer Reports. They assume that consumers only value basic product attributes like price, durability, resale value, and quality. Contract design, after all, would seem to have little effect on the absorbency of a paper towel, the sound quality of an mp3 player, or the creaminess of a pint of frozen yogurt. From this perspective, the best managerial structure is whatever structure produces the best products while keeping production costs and transaction costs low. Corporate governance is a matter for shareholders and managers and creditors to work out amongst themselves. By focusing on the functionality of products, however, we mask any link between products and contract design.
The brand-oriented consumer. Focusing only on functionality is, of course, problematic. Consumers choose brands, not just product attributes. Buying a pint of Ben & Jerry's is not the same experience as buying a pint of Haagen-Dazs, even if the product is similar. Brand image reflects the values of the people who create the product. In certain circumstances, I argue here, contract design contributes to the atmospherics of the brand. An innovative deal structure may cost the company something in short-term efficiency, but it may pay dividends in the form of increased demand from consumers in the long run. Deal structure, then, is not just a method of managing transaction costs. It is also an advertising medium. Unlike direct marketing tactics, however, the process is more subtle. Whatever its content, the "message" of the deal structure reaches consumers indirectly through early adopters or other opinion leaders--knowledgeable, sophisticated consumers who experiment with new products and are particularly sensitive to the trustworthiness of the manufacturer. Just the sort of consumer, in other words, who might pay attention to deal structure.
This Article explores the branding effect of deal structures by looking at four case studies. First, I examine two initial public offerings (IPOs), the first by Google, the second by Ben & Jerry's. From a traditional corporate finance perspective, the goal of a properly structured IPO is to manage the information asymmetry between the issuer and potential buyers in order to raise the largest amount of money possible per share of stock sold. From this perspective, the success of the Google deal is questionable. Few would call this deal elegant or efficient. (4) But this is not really what the Google IPO structure was about, or at least it is not the full story. When Google structured its IPO as an auction, it reinforced Google's identity as an innovative, egalitarian, playful, trustworthy company. Talking about Google's IPO makes you want to use Google's products.
Similarly, the Ben & Jerry's deal structure may not have been terribly efficient. By selling its stock only to Vermont residents, the company saved a few thousand dollars in legal and accounting fees. On the other hand, the geographic restriction artificially limited demand for the stock, which may have pushed the price down. Was the tradeoff worth it? Without considering consumers, the cost-benefit analysis fails to capture the essence of the deal. The offering was not just about selling stock and raising capital. It was also about selling ice cream. Selling stock to Vermonters helped build the brand image of the company.
The next case study looks at Apple and its contract with its CEO, Steve Jobs. Jobs takes a salary of one dollar a year. He also owns a substantial amount of Apple stock. Executive-compensation contracts typically provide a mix of cash and equity designed to align the executive's incentives with those of the company's investors. (5) But I argue here that Jobs's salary isn't designed to provide an efficient mix of cash and equity. His contract is a symbolic statement indicating that he's not in it for the money. "One Dollar" feeds the cult of the Mac.
The last case study looks at Stanley Works, a Connecticut toolmaker. In 2002 Stanley Works considered reincorporating in the tax haven of Bermuda. Conventional wisdom holds that there is no patriotic duty to pay more in taxes than one is legally required to pay. (6) Stanley Works was within its rights, legally speaking, to reincorporate in Bermuda. One would expect a well-advised corporation managed by rational profit-maximizing agents to do so. But Stanley Works' reincorporation, or rather its failure to close the deal, was not ultimately about taxes. It was about selling hammers and screwdrivers in the heartland. Corporate expatriation won't play in Peoria. (7)
What can we learn from these case studies? Innovative deal structures allow us to peer through the gossamer corporate veil and spy the values of the company's founders and managers. Like the Emperor penguins stoically waddling in single file to their breeding ground, (8) unusual deal structures anthropomorphize the firm in the eyes of consumers. Innovative deal structures are striking, and they can marginally affect the set of mental associations that make up brand image. Google is not just a network of connected contracts; (9) it is playful and innovative. Ben & Jerry's isn't just a manufacturer of a dessert product; it's a loyal companion.
Deal structure, then, is a specialized kind of advertising medium, and it fits some firms better than others. Reputation and brand image are especially important for firms that produce expensive credence goods like medical treatment, financial advice, or an Ivy League education. (10) Consumers, skeptical of self-serving claims, turn to sources of information in addition to traditional advertising, such as newspaper articles, U.S. News Rankings, (11) word-of-mouth, product reviews on Amazon.com, or blogs. Deal structure provides these opinion leaders with another source of information. Deal structure, then, is more likely to prove effective as an advertising medium for companies that rely heavily on opinion leaders to drive demand, such as consumer-technology companies or manufacturers of trendy consumer goods and cult brands. These companies seek consumers who highly value attributes like innovation, creativity, coolness, or altruism, and not just functionality. For these companies, the legal infrastructure of deals provides early adopters with a window through which they can view, or imagine, the soul of the company.
Roadmap and clarification of terms. Following this introduction, I have organized this Article into three main sections. In Section II below, I briefly review the literature on the lawyer's role in structuring deals. Many would consider branding a "business issue" of little concern to lawyers; Section II explains why responsible lawyers should consider the institutional and social context in which deals...