Asking the Right Question: The Statutory Right of Appraisal and Efficient Markets
In appraisal cases, shareholders have the right to have a judge determine the “fair value” of their shares. These cases bring economic analysis into sharp focus in judicial proceedings as shareholders and companies argue over the appropriate metrics to use in determining fair value as courts are instructed to look to accepted financial principles relevant to determining the value of corporations and their stock when engaged in the exercise of determining fair value
Our paper focuses on the role of stock prices and the Efficient Capital Markets Hypothesis (ECMH) in appraisal litigation in the important state of Delaware. We note the recent trend in Delaware cases to focus on the market prices of the company being valued, if the company’s shares trade in an efficient market, and defend this market-oriented methodology against those who maintain that recent discoveries in behavioral finance indicate that markets are inefficient and that share prices are unreliable due to various cognitive biases. We then show how the framework and methodology for utilizing market prices would be clarified and improved if courts used the pre-transaction market price of the securities of the target company whose shares are being valued, unadjusted for the news of the merger, rather than at the deal price that was reached by the parties in the transaction as the key benchmark in determining fair value.
Unadjusted market price is the best benchmark because the unadjusted market price automatically subtracts the target firm’s share of the synergy gains and agency cost reductions impounded in the deal price. This is appropriate to do because dissenting shareholders in appraisal proceedings are not entitled to these increments of value which are supplied by the bidder. Also, the unadjusted market price is unaffected by any potential flaws in the deal process that led to the ultimate merger agreement.
In our paper we note that no deal process is perfect, and ignoring market prices when a deal process is flawed succumbs to what economists call the Nirvana fallacy, which posits that an analytical approach (such as relying on market prices) should not be ignored or abandoned even if using that approach does not produce perfect results. Rather, an analytical approach should be used if it is better than the available alternatives and provides useful information to a tribunal or policymaker.
Finally, we extend our analysis of market efficiency to a new domain. We point out that market prices can be used even when shares of nonpublicly traded target companies are being evaluated to determine whether the acquirer paid a fair price in certain cases by examining the share price performance of the acquirer’s shares. In cases where a bidder has paid an unfairly low price for the target’s shares due to self-dealing or incompetence or inattention on the part of the seller, the acquirer’s stock should react positively to the announcement of the transaction if the transaction is significant. In the absence of such a positive share price reaction on the part of the acquirer, the price should be deemed presumptively fair. This analysis seems particularly apt in situations where there is a decline in the value of the bidder’s stock upon announcement of an acquisition.