The appropriate division of authority between a company’s board and its shareholders has been the central issue in the corporate governance debate for decades. This issue presents most vividly for defensive tactics: the extent to which the board of a potential acquisition target is allowed to prevent the shareholders from responding directly to a hostile bid. In the US today, the board’s power is extensive; formal control largely lies with the board. Normative evaluations of current law face two obstacles. First, defensive tactics raise the social welfare question to what extent the tactics deter ex ante efficient takeovers. Theory suggests a deterrent effect because defensive tactics shift expected acquisition surplus to targets and thus reduce acquirer search. The empirical importance of the theoretical effect cannot be measured using conventional empirical techniques, however, because the researcher cannot observe deterred bids. The private welfare issue also is difficult to assess for two reasons: (a) target expected returns from acquisitions under different defensive tactics levels are partly a function of the probability of receiving bids that various tactics induce. These probabilities, in turn, are a function of how defensive tactics affect acquirer search which, as said, is difficult to measure; (b) defensive tactics have a qualitative nature. Thus, is a poison pill more or less privately efficient than a staggered board? How are target expected returns affected when a target combines a pill with a staggered board or a supermajority voting requirement? In this paper, we address these largely empirical questions by simulating a model of the market for corporate control. In the simulations, potential acquirers search sequentially for good targets. Simulations permit us to specify the number of ex ante efficient acquisitions that could be made, so we can estimate acquisition market efficiency – the ratio of made matches to good matches – under legal regimes that are more or less friendly to defensive tactics. Regarding private welfare, we argue that the common metric among defensive tactics is time: the ability of various tactics to delay bid completion and thus reduce bidder, and thereby increase target, returns. Combining this view with the search intensities that the simulated legal regimes induce permits us to estimate target expected returns.
We have two important results: First, strong defensive tactics reduce market efficiency significantly. Our simulations suggest that approximately 25% more acquisitions would be made yearly in a legal regime that is less friendly to defensive tactics. This is an economically significant result in a trillion dollar a year acquisition market. Simulations are only suggestive and our simulated model likely overstates the welfare loss. Nevertheless, the result that defensive tactics cause economically significant welfare losses would stand even if our magnitude estimate is halved. Second, the defensive tactics level that maximizes target shareholder welfare is materially higher than the level that maximizes social welfare. Of institutional interest, the privately optimal level of defensive tactics is better realized under the view regarding those tactics that the Delaware Chancery Court holds than under the view of the Delaware Supreme Court.
Ronald J. Gilson & Alan Schwartz,
Defensive Tactics and Optimal Search: A Simulation Approach,
Stanford Law & Economics Olin Working Paper No. 505; Yale Law & Economics Research Paper No. 570
Available at: https://scholarship.law.columbia.edu/faculty_scholarship/2023