The powerful antitakeover force of staggered boards: further findings and a reply to symposium participants.

AuthorBebchuk, Lucian Arye
PositionDelaware

INTRODUCTION

Earlier this year in the Stanford Law Review, we presented a theoretical, empirical, and policy analysis of staggered boards. (1) We argued that "effective" staggered boards (ESBs) provide a powerful antitakeover defense, more powerful than is commonly recognized. We developed a theoretical account of how ESBs impede hostile takeover bids, and tested our theory using a new data set of hostile bids from 1996 to 2000.

Our empirical analysis provided three findings. First, targets with ESBs were substantially more likely to remain independent than targets without ESBs. Second, targets in our sample that remained independent did not, on average, achieve on their own the same returns as offered by the hostile bidder or white knight. Third, ESBs did not seem to provide countervailing benefits in the form of higher premiums in deals that were eventually completed. Putting these three findings together, we found that ESBs reduced shareholder returns for targets in our sample on the order of eight to ten percent in the nine months after a hostile bid was announced. Based on these findings and our analysis of Delaware takeover case law, we proposed that, at least absent explicit shareholder authorization to the contrary, incumbents protected by an ESB who lose one election over an outstanding bid should generally not be allowed by courts to further block the bid by maintaining a poison pill.

This issue of the Stanford Law Review includes five commentaries that present responses and reactions to our article. We are delighted by the range of views represented by the authors. Mark Gordon, our strongest critic, is a practicing lawyer and a palmer of Wachtell, Lipton, Rosen & Katz, the firm credited with inventing the poison pill. Steve Bainbridge and Lynn Stout are academics who have been writing on takeovers and corporate governance from perspectives quite different from our own. Patrick McGurn, as Special Counsel for Institutional Shareholder Services, is a direct participant in most takeover battles and has an excellent perspective on the views of institutional investors. Finally, Vice Chancellor Leo Strine of the Delaware Chancery Court represents an important audience for our work, as it is the Delaware judiciary whose future interpretation of takeover doctrine we seek to influence. We thank all of these commentators for their thoughtful and provocative responses.

While none of the commentators challenge either our theoretical account of how ESBs work as a takeover defense, or the three basic empirical findings that are summarized above, all of them, to varying degrees, raise important questions, objections, and areas of further inquiry regarding our analysis and conclusions. In this Reply, we respond to these points. In the course of our discussion, we extend our earlier work, and present new data that shed additional light on the issues raised. As there is some overlap among the commentaries, we structure our discussion by substantive issue rather than by commentator.

In Part I, we first note an important shift in the debate that this Symposium represents, with takeover proponents no longer claiming that defenses increase shareholder value for hostile bid targets from an ex post perspective. We believe that this acceptance of our basic findings, in itself, represents an important victory for our work. We then discuss claims concerning the outcomes of hostile bids, which has been the focus of our empirical inquiry. In particular, we provide new evidence to address the objection that, although the boards that remained independent in the face of hostile bids reduced shareholder value, on average, the cases studied were likely ones in which the board did not have independent directors or was dominated by the CEO. To examine this claim, we gather evidence on the composition of boards in our study and find that they do not stand out in the conjectured way. Rather, while many of the targets in our data set had a majority of independent directors, these targets did not perform considerably better in serving shareholder interests. This finding suggests that the absolute confidence that our critics would place in independent directors is unwarranted.

Part II discusses the claim that, even if ESBs hurt shareholders in hostile bid situations, they benefit shareholders in friendly transactions by increasing managers' ability to obtain a high premium. While we have documented the considerable adverse effect of ESBs on hostile bid outcomes, their effect on negotiated transactions remains very much an open question. Given that supporters of defenses have failed to produce any reliable evidence on the effects of ESBs (and defenses more generally) on negotiated premiums, we conduct some preliminary tests. Examining a sample of seventy-three negotiated transactions from 2000 to 2002, we find no systematic benefits in terms of higher premiums to boards that have ESBs. We conclude that, under current evidence, the speculated benefits of ESBs in friendly transactions do not justify the current role of ESBs in light of their other clear negative effects.

Part III discusses claims concerning the approach we propose courts should follow. Accepting the suggestions by Vice Chancellor Strine and others that standards better fit the general approach of the Delaware courts, we show how our approach could, and indeed should, be formulated as a standard. Under the proposed standard, if a board has lost an election conducted over an outstanding offer, maintaining the pill further should be presumed disproportionate or preclusive, but the target board should have an opportunity to persuade a court that its reasons for maintaining a pill were justified by unusual facts or circumstances. We also discuss how adoption of our approach by the Delaware courts would be consistent with a judicial approach that is cautious and evolutionary. We finally point out that the positions advocated by our critics are ones that are extreme both within their location on the continuum of choice and in terms of their departure from established principles. We conclude that, given the current body of theory and evidence, our approach is best both in terms of its substantive effects and in terms of its fit with notions of legitimacy and consent.

  1. THE EFFECT OF ESBS ON THE OUTCOMES OF HOSTILE BIDS

    In this Part, we address the criticisms of our core empirical result, involving the effect of ESBs on hostile bid outcomes. In Part I.A, we first note, as a rhetorical matter, an important shift in the debate, one that concedes a considerable amount of the ground that prior defenders of a board-centered approach refused to concede. In Part I.B, we move on to the first of two substantive criticisms of our study, put forward primarily by Gordon, that factors other than ESBs might be responsible for the results that we find. Though the possibility of omitted variables applies to any empirical study, and the effort to include all possible control variables is thus never-ending, we oblige Gordon and respond directly to each of the possibilities about which he speculates. In Part I.B, we address his primary concern that bad boards, not ESBs, are responsible for bad outcomes. In fact, we provide new evidence showing that bad outcomes are not exclusively caused by nonindependent boards or boards dominated by the CEO. Instead, the phenomenon we report in our original paper is far broader than pathological instances of unusually dysfunctional boards. In Parts I.C and I.D, we discuss some implications of these findings, first for the specific issues raised in this Symposium, and then for the recent corporate governance reforms in the Sarbanes-Oxley Act of 2002 and in the New York Stock Exchange revised listing guidelines. Finally, in Part I.E, we report the results on other factors that Gordon identifies, such as Delaware incorporation, bear hug bids, and our distinction between effective annual term (EAT) targets and ESB targets. Here again the evidence supports our core finding that ESBs are the primary driver of bad outcomes.

    1. The Welcome Concession of Defense Proponents

      We begin with the observation that none of the commentators who are critical of our study challenge our basic findings that ESBs allow hostile bid targets to remain independent and that, by enabling hostile bid targets to remain independent, ESBs are, on average, detrimental ex post to target shareholders. Instead of a direct attack, these commentators make collateral attacks in the form of alternative explanations for our results, or speculate about countervailing benefits of ESBs. Before moving on to these specific points, we wish to point out that these arguments already represent an important shift in the debate with respect to takeover defenses. By more or less accepting our conclusion that incumbents' ability to just say no hurts shareholders in hostile bid situations, our critics have conceded a great deal of the ground that takeover defense proponents in the past have refused to yield. This implicit concession is therefore important to highlight; in itself it represents an important victory for our work.

      For example, Lynn Stout kindly acknowledges that our empirical findings "do a nice job of undermining the argument that [takeover defenses] increase target shareholders' ex post returns." (2) Steve Bainbridge accepts this result but somewhat remarkably responds "so what?" (3) Even Gordon, a member of the firm that is most associated with the development of takeover defenses in general, and the poison pill in particular, does not question our finding that ESBs have overall hurt the shareholders of hostile bid targets, but only claims that this adverse effect is far outweighed by the benefits of ESBs in cases of friendly acquisitions. (4)

      We find these concessions interesting for at least two reasons. First, defenders of board veto and takeover defenses have long avoided making such a...

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