The Single-Owner Standard and the Public-Private Choice.

• Author: Korsmo, Charles R.

1. INTRODUCTION 676 II. THE SINGLE-OWNER STANDARD IN DELAWARE LAW 680 A. The Corporation as Joint Property 681 B. Mergers and the Stockholders' Ownership Interest 684 1. Fair Value in Appraisal 686 2. Fiduciary Duty Actions 692 III. CRITICISMS AND DEFENSES OF THE SINGLE-OWNER STANDARD 696 A. The Rival "Market Standard" 696 B. Existing Defenses of the Single-Owner Standard 700 C. The Uncertain State of the Debate 702 IV. A DYNAMIC DEFENSE OF THE SINGLE-OWNER STANDARD 705 A. Market Standard Would Discourage Firms from Going Public 705 B. Public Equity Markets Generate Large Benefits 708 C. The Increasing Salience of the Public-Private Choice 710 V. CONCLUSION 712 I. INTRODUCTION

   What is the stockholder's interest in the corporation, and how should it be valued? These related questions sit at the heart of corporate law and have been enduringly confounding and controversial. They arise any time a court is called upon to evaluate the value that directors or others attribute to a company's shares, as in a control fight. And the questions are unavoidable whenever the court itself is required to assign a value to stock, as when calculating damages or performing a statutory appraisal.

   When a company's shares of stock trade in a liquid public market, the answer to this valuation question can seem tantalizingly easy. Shouldn't the measure of the share's value--no matter what rights the holder possesses--simply be what the stock trades for on the market? After all, the valuation generated by a deep and active financial market will almost certainly be more accurate than anything a judge might produce. Indeed, outside of the corporate law context, the value of a share of stock--or any other item for which an active market exists--is routinely assessed by reference to the market price. When a share of stock is stolen, for example, or transferred as a taxable gift, the market price supplies a ready value for calculating damages or tax liability.

   Delaware--the leading corporate law jurisdiction--has, however, famously refused to avail itself of this seemingly easy recourse to market prices when the question involves an internal corporate dispute. The merger context puts the issue in the sharpest relief. For a century, Delaware law has consistently drawn a distinction between the trading price of an individual share of stock and the "fair value" in a merger. In a corporate dispute at merger, whether in a statutory appraisal or a fiduciary case for damages, the court's focus is on "the corporation itself, as distinguished from a specific fraction of its shares." (1) The Supreme Court has explained that, in this basic inquiry, "the corporation is valued as an entity, not merely as a collection of assets or by the sum of the market price of each share of its stock." (2)

   Instead of valuing a share of stock as if it were no different from an ordinary chattel--like a lump of gold or a used car--Delaware courts have treated stock as a claim on a portion of the value of the underlying corporation itself. Thus, rather than valuing individual shares as the personal property of the individual stockholders, Delaware courts value the corporation as a whole--that is, what it would be worth to a hypothetical single owner--with each stockholder entitled to a proportionate share of that value. This value will generally be different from the value of their block of shares viewed in isolation. As a result, in deciding what a stockholder is entitled to receive as fair value in a merger, the trading price of the stock has historically had little or no bearing on a Delaware court's determination. As the Court of Chancery noted in the landmark 1934 case Chicago Corp. v. Munds, "no more than a moment's reflection is needed to refute" the idea that a stock's trading price is "an accurate, fair reflection of its intrinsic value . . . ." (3)

   The rejection of market prices as the measure of a stockholder's entitlement in corporate law disputes undergirds many landmark decisions, including Delaware's most important cases on fiduciary duties in the merger context. In the landmark Unocal case, for example, the Delaware Supreme Court endorsed a corporate board's conclusion that a pending $54 offer for the corporation was "wholly inadequate" (4)--even though the stock had never traded higher than $44 and had been priced as low as $29.87 during the prior eighteen months. (5) A board is not only empowered to reject a bid that exceeds the prevailing trading price, but it may be duty-bound to seek out even higher alternatives. Indeed, in Smith v. Van Gorkom, the court found gross negligence and an uninformed decision--exposing the directors to personal liability--where the board assessed the adequacy of an acquisition offer for the company by comparing it to the market price for the company's stock. (6)

   Despite its long pedigree and foundational status, what we call the "single-owner standard" (7) has remained stubbornly controversial. In the 1980s, an influential group of law and economics scholars--led by Frank Easterbrook, Daniel Fischel, and Alan Schwartz--put forward a rival "market standard," arguing that where stock is publicly traded, the market price is the only proper measure of the value of the stockholders' entitlements. (8) As a result, any takeover bid at a premium to the market price--no matter how small--would be fair to stockholders. This leaves boards with no justification for employing takeover defenses to fight off a hostile bid and no leverage to negotiate for a better deal. Advocates claim such a regime would: facilitate the market for corporate control; reduce agency costs; maximize economic efficiency by assuring the transfer of corporate assets to higher-value uses; and avoid capricious judicial valuations that are bound to be less accurate than the judgment of the market. (9) In practical terms, the primary distinction is that the single-owner standard permits (and may require) the board to negotiate with bidders to secure a portion of the gains from any merger, just as a single owner would, while the market standard would permit a bidder to capture the entirety of the gains from trade by paying only a whisker more than the market price.

   While the Delaware courts have thus far refused to embrace the market standard, they have struggled to refute it definitively. Courts have largely failed to articulate a straightforward, compelling set of functional justifications for the single-owner standard. Academics have only done slightly better, often falling back on ontological-style arguments over "director primacy" and "stockholder primacy" rather than engaging directly with the teleological questions more central to a practical field like corporate law. Lucian Bebchuk has probably been the most compelling academic defender of the single-owner standard on functional grounds. (10) Yet, even the justifications he provides largely turn on slippery empirical questions of market efficiency, or which standard offers fewer opportunities for managerial opportunism, or which is more likely to promote value-enhancing transactions while avoiding value-destroying transactions.

   In this Article, we present a novel and compelling functional justification for the single-owner standard. The justification is rooted in dynamic considerations and the desire to avoid disincentives for raising capital through the corporate form and issuing publicly-traded stock. The debate over the single-owner standard has taken the existing world of publicly traded companies for granted, tacitly presuming that it will continue to exist in more or less the same form, whichever standard may apply. But if the law were to disadvantage public stockholding as a form of ownership, entrepreneurs seeking to raise capital would pay a penalty for raising capital by operating in a corporate form and with dispersed ownership by public stockholders. Instead, they would face powerful incentives to remain private or otherwise maintain plenary control. To the extent that public markets and dispersed ownership are socially beneficial--for reducing the cost of capital; for generating information and allocating capital efficiently; for allowing small investors to share in the wealth creation of large enterprise; and so on--penalizing this form of ownership would be a bad thing.

   The key insight of our argument is that any alternative to the single-owner standard would disadvantage the public corporation as a form of ownership. It can be easy to forget that a corporation is nothing but a form of joint ownership of property. In most forms of property, the owner is entitled to refuse to sell an asset for any reason or for no reason, exercising what Blackstone called the "sole and despotic dominion" over the asset. (11) The owner has the exclusive authority to set the price at which they are willing to sell and can bargain for a portion of any higher value the buyer may place on the property. Although this approach is not without its social costs, (12) it is generally regarded as not only tolerable but affirmatively desirable because it gives owners the ex ante incentive to invest in the resources they own, secure in the knowledge that they may harvest the fruits of that investment through sale at some future date. This feature of property law is so basic that legal rules against the involuntary transfer of entitlements are conventionally known as "property rules." (13)

   Stock ownership is crucially different. In the conventional analytical framework for analyzing legal entitlements, (14) the stockholder's entitlement to their shares in a public corporation is protected by a form of liability rule rather than a property rule. In a merger, unless a stockholder maintains voting control over the company, their shares can be taken away whether they like it or not, at a price not of their choosing, so long as the transaction is approved by the board and a majority vote of the shares. Absent a...