Why Firms Adopt Antitakeover Arrangements

Firms going public have increasingly been incorporating antitakeover provisions in their IPO charters, while shareholders of existing companies have increasingly been voting in opposition to such charter provisions. This paper identifies possible explanations for this empirical pattern. Specifically, I analyze explanations based on (1) the role of antitakeover arrangements in encouraging founders to break up their initial control blocks, (2) efficient private benefits of control, (3) agency problems among pre-IPO shareholders, (4) agency problems between pre-IPO shareholders and their IPO lawyers, (5) asymmetric information between founders and public investors about the firm's future growth prospects, and (6) bounded attention and imperfect pricing at the IPO stage.

Using Options to Divide Value in Corporate Bankruptcy

This paper revisits the proposal to use options in corporate bankruptcy that was put forward in Bebchuk (1988). According to the proposed procedure, corporate bankruptcy should be implemented through the distribution to participants of appropriately designed options. The paper starts by discussing the goals that should guide the design of bankruptcy procedures. The paper then explains how the options procedure can improve both ex post efficiency and ex ante efficiency. The paper offers a refined version of the procedure, and it also responds to questions that have been raised regarding the execution and desirability of the procedure. The paper concludes by explaining the relationship between the options approach to corporate bankruptcy and the Black-Scholes characterization of all corporate securities as options.

A Rent-Protection Theory of Corporate Ownership and Control

This paper develops a rent-protection theory of corporate ownership structure - and in particular, of the choice between concentrated and dispersed ownership of corporate shares and votes. The paper analyzes the decision of a company's initial owner whether to maintain a lock on control when the company goes public. This decision is shown to be very much influenced by the size that private benefits of control are expected to have. Most importantly, when private benefits of control are large - and when control is thus valuable enough - leaving control up for grabs would attract attempts by rivals to grab control and thereby capture these private benefits; in such circumstances, to preclude a control grab, the initial owner might elect to maintain a lock on control. Furthermore, when private benefits of control are large, maintaining a lock on control would enable the company's initial shareholders to capture a larger fraction of the surplus from value-producing transfers of control. Both results suggest that, in countries in which private benefits of control are large, publicly traded companies will tend to have a controlling shareholder. It is also shown that separation of cash flow rights and voting rights will tend to be used in conjunction with a controlling shareholder structure but not with a dispersed ownership structure. Finally, the paper analyzes why companies might make control partially contestable, as many US companies currently do by adopting antitakeover arrangements. The results of the paper are consistent with the available evidence, can explain the observed patterns of corporate ownership, and yield testable predictions for future empirical work. The analysis also implies that a corporate law system that effectively limits private benefits of control can produce more efficient choices of ownership structure.

Optimal Defaults for Corporate Law Evolution

Public corporations live in a dynamic and ever-changing business environment. This paper examines how courts and legislators should choose default arrangements in the corporate area to address new circumstances. We show that the interests of the shareholders of existing companies would not be served by adopting those defaults arrangements that public officials view as most likely to be value-enhancing. Because any charter amendment requires the board's initiative, opting out of an inefficient default arrangement is much more likely to occur when management disfavors the arrangement than management supports it. We develop a 'reversible defaults' approach that takes into account this asymmetry. When public officials must choose between two or more default arrangements and face significant uncertainty as to which one would best serve shareholders, they should err in favor of the arrangement that is less favorable to managers. Such an approach, we show, would make it most likely that companies would be ultimately governed by the arrangement that would maximize shareholder value. Evaluating some of the main choices that state corporate law has made in the past two decades in light of our proposed approach, we endorse some but question others. The arrangements we examine include those developed with respect to director liability, state antitakeover statutes, and the range of permitted defensive tactics.

Information and the Scope of Liability for Breach of Contract: The Rule of Hadley V. Baxendale

According to the contract law principle established in the famous nineteenth century English case of Hadley v. Baxendale, and followed ever since in the common law world, liability for a breach of contract is limited to losses "arising ... according to the usual course of things," or that may be reasonably supposed "to have been in the contemplation of both parties, at the time they made the contract, ..." Using a formal model, we attempt in this paper to analyze systematically the effects and the efficiency of this limitation on contract damages. We study two alternative rules: the limited liability rule of Hadley, and an unlimited liability rule. Our analysis focuses on the effects of the alternative rules on two types of decisions: buyers' decisions about communicating their valuations of performance to sellers; and sellers' decisions about their level of precautions to reduce the likelihood of nonperformance. We identify the efficient behavior of buyers and sellers. We then compare this efficient behavior with the decisions that buyers and sellers in fact make under the limited and unlimited liability rules. This analysis enables us to provide a full characterization of the conditions under which each of the rules induces, or fails to induce, efficient behavior, as well as the conditions under which each of the rules is superior to the other.

A New Approach to Takeover Law and Regulatory Competition

The development of U.S. state takeover law in the past three decades has produced considerable and quite possibly excessive protection for incumbent managers from hostile takeovers. Although the shortcomings of state takeover law have been widely recognized, there has been little support for federal intervention because of the concern that such intervention might produce even worse takeover arrangements. This paper puts forward a novel form of federal intervention in the regulation of takeovers that would address these shortcomings without raising such a concern. Rather than mandating particular substantive takeover arrangements, this form of federal intervention would focus on increasing shareholder choice. Choice-enhancing' federal intervention would consist of two elements: (i) an optional body of substantive federal takeover law which shareholders would be able to opt into (or out of) and (ii) a mandatory process rule that would provide shareholders the right to initiate and adopt, regardless of managers' wishes, proposals for opting into (or out of) the federal takeover law. We argue that such a federal role in takeover law cannot harm and would likely improve the regulation of takeovers. Moreover, by showing how federal law can be used to improve regulatory competition in the provision of takeover law rather than preempt it, our analysis lays the groundwork for a more general reconsideration of regulatory competition in the corporate law area.

The Questionable Case for Using Auctions to Select Lead Counsel

This Article analyzes the shortcomings of using auctions for selecting lead counsel in class action cases. In contrast to what proponents of auctions suggest, the outcome of an auction is likely to diverge considerably from what an informed principal would have chosen. In particular, auctions push the percentage of recovery paid to counsel to the lowest level at which law firms would be willing to take the case. Because of the need to provide counsel with incentives to invest effort and resources, however, the class might well be better served by a higher percentage than this minimum level, and auctions might push fees to levels that are too low. The analyzed problems are ones that arise also in those types of cases for which the use of auctions should be considered according to the recent recommendations of a Task Force report

Federalism and Takeover Law: The Race to Protect Managers from Takeovers

This paper analyzes certain important shortcomings of state competition in corporate law. In particular, we show, with respect to takeovers, states have incentives to produce rules that excessively protect incumbent managers. The development of state takeover law, we argue, is consistent with our theory. States have adopted antitakeover statutes that have little policy basis, and, more importantly, they have provided managers with a wider and more open-ended latitude to engage in defensive tactics than endorsed even by the commentators most favorable to such tactics. Furthermore, states have elected, even though they could have done otherwise, to impose antitakeover protections on shareholders, who did not appear to favor them, in a way that left shareholders with little choice or say. Finally, we conclude by pointing out that proponents of state competition cannot reconcile their views with the evolution of state takeover law---and should therefore reconsider their unqualified support of state competition.