What Do Stockholders Own? The Rise of the Trading Price Paradigm in Corporate Law.

• Author: Korsmo, Charles

1. INTRODUCTION 391 II. THE LONGSTANDING CONCEPTION OF THE STOCKHOLDER'S ENTITLEMENT 396 A. The Necessity of Defining Stockholder Entitlements at Merger 396 B. The Irrelevance of Trading Prices to Stockholder Entitlements 399 1. The Statutory Right to Dissent 400 2. The Fair Price Analysis When Evaluating the Conduct of 404 Fiduciaries 3. Measuring Damages in the Fiduciary Context 406 4. Justifying Defensive Tactics in M&A 407 C. The Empirical Reality of the Distinction Between Entity 410 Value and Trading Prices D. The Use of Trading Prices When Not Fixing Stockholder 412 Entitlements III. THE EMERGENCE OF A NEW PARADIGM 414 A. The First Signs of a Shift: DFC Global and Dell 414 B. The Elevation of Trading Prices: Aruba and Jarden 416 C. The Articulation of a New Paradigm 420 D. The Breadth of the New Paradigm 421 IV. THE REVOLUTIONARY IMPLICATIONS OF THE NEW PARADIGM 425 A. The Eclipse of Fiduciary Duties 425 B. The Fall of Airgas 428 C. The Undesirability of the Trading Price Paradigm 429 1. The Immediate Error: The New Paradigm in Appraisal Rights 430 2. The Folly of Separate Rules for Appraisal 431 3. The New Paradigm Disadvantages the Public Corporation 432 as a Form of Ownership V. CONCLUSION 434 I. INTRODUCTION

   In a spate of recent decisions involving stockholder appraisal rights, the Delaware Supreme Court has embraced a shift in its doctrine that augurs foundational change for corporate law. These decisions have birthed a new regime in appraisal rights--a development that has attracted considerable commentary. Their greatest impact, however, may lie beyond appraisal and may be still to come. With these decisions, the Delaware Supreme Court has set loose a new conception of how trading prices bear on the stockholder's entitlement, one that would alter basic ideas surrounding mergers, stockownership, and the very nature of the corporation as a vehicle for co-ownership. Delaware's corporate law appears to be on the verge of a paradigm shift. (2)

   At the heart of the shift is a question that has proved enduringly confounding: How should the stockholder's interest in the corporation be measured, in dollars and cents? Although a variety of doctrines allow a court to evade the question in many circumstances, sometimes the inquiry cannot be avoided. In particular, a court might be called to evaluate the value directors or others attribute to a corporation (as in a control fight), or it might be called itself to assign some value to the corporation (as when calculating damages or performing a statutory appraisal).

   Where a public market exists in a corporation's shares of stock, the answer to this valuation question can seem alluringly simple: the bundle of entitlements held by the stockholder ought to be valued at an amount equal to the trading price of a share of stock. Outside of the corporate domain, this easy answer is, in fact, the law. When tax authorities, for example, must determine the value of a share of stock received by gift, the market price supplies a ready answer.

   Delaware, however, has famously refused this easy answer when the question involves an internal corporate dispute. (3) In deciding what value a stockholder is entitled to receive, the trading price of the stock has had little or no bearing on the determination. At some level, this answer is unavoidable, since the trading price of a share of stock represents nothing more than the market's estimate of the value of the legal entitlements belonging to the owner of the share. In the tax context, the judicial inquiry is irrelevant to the stockholder's entitlements. But in the intracorporate context, the judicial inquiry determines the entitlements of the stockholder. To attempt to determine the content of the stockholder's legal entitlements by reference to a market price that itself depends entirely on the content of those legal entitlements would be an exercise in circularity.

   The merger context puts these issues in the sharpest relief. For a century, Delaware has largely disregarded trading prices in this context. Instead, Delaware doctrine attends to a conceptual distinction between, on the one hand, the trading price of a marginal share and, on the other hand, the hypothetical value of the entire corporation. (4) As the Court of Chancery noted in the landmark 1934 case of Chicago Corp. v. Munds, "no more than a moment's reflection is needed to refute" the idea that the trading price of a share of stock is "an accurate, fair reflection of its intrinsic value." (5) This conclusion was rooted not so much in a mistrust of market pricing, as such, but rather in the more fundamental insight that the market in question--for single shares of stock--was not the proper object of inquiry in a merger dispute. (6) The trading price of the stock represents the value of only the share of stock; the value of the corporation is something else, especially when the risk of opportunism is afoot. (7) As a result, in a corporate dispute at merger--whether a statutory appraisal or a fiduciary case for damages (8)--the court's focus is on "the corporation itself, as distinguished from a specific fraction of its shares." (9) In this 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." (10)

   This principle is at the heart of Delaware's most important merger doctrines. (11) In the landmark Unocal case, the supreme court endorsed a corporate board's conclusion that a pending $54 offer for the corporation was "wholly inadequate," (12) even though the stock had never traded higher than $44. (13) A board is not only empowered to reject a bid that exceeds the prevailing trading price, but it may also be compelled by its so-called Revlon duties to seek out better alternatives even where an above-market bid is in hand. (14) In Smith v. Van Gorkom, directors who assessed the adequacy of a bid by comparing it to the "current and historical stock price" were held to have committed such a basic error that they exposed themselves to personal liability. (15)

   Deep change is afoot in Delaware, however. Beginning in 2017, the Delaware Supreme Court has issued a series of decisions involving appraisal rights--DFC Global, Dell, Aruba, and Jarden--that announced a shift in appraisal doctrine and more broadly in the fundamental conception of the stockholder's entitlement. In all four cases, the Delaware Supreme Court expressed a newfound deference to trading prices as the measure of this entitlement. In each case, stockholders had dissented from a public company merger, seeking an amount above what the target board had negotiated. (16) In Dell, the supreme court claimed that it was difficult to conceive of a difference "between Dell's stock price and the Company's intrinsic value," for that would be "contrary to the efficient market hypothesis." (17) Pursuing this reasoning, the Court indicated that the stockholder's entitlement could best be measured by trading prices where shares trade on an efficient market. (18) In Aruba, the Supreme Court noted that a stock's trading price was "an important indicator of [the corporation's] economic value that should be given weight." (19)

   In Jarden, the supreme court reached the culmination of this line of reasoning. The trial court had concluded that stockholders were entitled only to the value of the pre-bid trading price. (20) On appeal, the dissenters contested this finding, pointing out that the lower court had "ignored... a 'long-recognized principle of Delaware law' that a corporation's stock price does not equal its fair value." (21) In affirming the lower court's decision, the supreme court proclaimed "[t]here is no 'long-recognized principle' that a corporation's unaffected stock price cannot equate to fair value." (22)

   In this Article, we argue that these appraisal cases represent the beginnings of a paradigm shift in Delaware's corporate law. Although we and others have explored and critiqued the appraisal cases for their appraisal law implications, this Article is the first to identify and examine the fundamental implications of these cases for corporate law generally. While we previously argued that the Delaware Supreme Court's mistakes had caused it to misapply Delaware law's conception of a stockholder's entitlement, we have now concluded that the Court has actually departed from it. In a real sense, the supreme court in the appraisal cases has simply altered its conception of the public corporation as a form of property.

   What a stockholder is entitled to receive in a merger depends on what claims the stockholder has as an owner of property in the first place. The longstanding paradigm in Delaware has been that the stockholder's entitlement is to a pro rata equitable claim on the value of the entire corporate estate. (23) The focus, as a result, was "on the determination of the intrinsic worth of the merged corporation, not on the distribution of shares among shareholders." (24)

   In the new paradigm, the stockholder's equitable claim to the corporate estate has been replaced with an interest in the share of stock as an ordinary chattel, like a gold nugget or a toaster, where the trading price is perfectly appropriate as the beginning and the end of any inquiry into value. There are thus no grounds for a stockholder to make a claim on the corporation that exceeds the value the market assigns to that chattel. Expressed in the conventional analytical framework, (25) Delaware now protects the stockholder's entitlement in a public corporation with a liability rule, where the stockholder's entitlement may be taken in a non-consensual exchange like a merger at any price exceeding the prevailing trading price.

   This paradigm shift augurs dramatic change not simply in appraisal, but in all of merger law. Most obviously, the shift will necessarily affect the basic measure of damages in other contexts. Indeed, the Court of Chancery...