Monday, May 15, 2006

Appraisal Rights and Rejecting the Current Bid

The stock of SMALL Co. is currently trading at $100 and BIG Co. comes in and offers $150/share in a 100/50 stock and cash, respectively, deal. Management rejects the offer saying it is out of line with the long-term plan, bad for shareholders and bad for other constituencies.

Without addressing the question of why management is all of a sudden allowed to take into consideration other constituencies we can first ask how the offer could be bad for shareholders? The market is currently viewing the Small Co. long-term plan as being worth $100. Another buyer believes they have a more productive use of the assets and are willing to buy them for $150. Shareholders would be left with $100 worth of stock and have $50 in cash.

How could this be bad for shareholders who get to make a 50% return instantly with little to no risk? Management claims this is bad for shareholders because the market is currently undervaluing their long-term plan. Once the market realizes the full value of their plan the stock will be worth more - significantly more - than $150.

Why significantly more - risk! The $150 is a sure thing (absent regulatory problems) while the company's long term plan has to be discounted for the uncertainty that it can be achieved. Management's argument is that if the market actually understood that long-term plan and the risk involved the current stock price would be discounted to some level above $150. If management only argues that it should be discounted to only $150 than the sure thing / takeover should always be the choice of a rational shareholder.

So how do we make management accountable? Courts will not enforce appraisal rights because they are not in the position to judge management's business decisions. We cannot set some arbitrary end date by which the stock must hit $150 or we will make management pay the difference because the stock would then trade immediately to $150 - not a penny above if the company is worth less, but also not a penny below.

So what are some sollutions - also, these only work if management and not the corporation pay the make the corporation pay would be to make shareholders pay themselves...

Offering a special dividend only to those people who own the stock at the time management rejects the offer. At some arbitrary end point the divident will be equal to $150 less the current stock price. The party can sell the stock or the divident right, but they are not attached to one another. This would work, but creates a strong possibility of market manipulation.

Another option is to force management to purchase shares for $150 from any shareholder that wants to sell them - force a MBO.

Thursday, May 04, 2006

The Profit Motive

The corporate scheme is traditionally viewed as having shareholders at the top, the corporation in the middle and other constituencies somewhere below the umbrella of the corporation.

We first must view all constituencies as customers of the corporation and the corporation as a customer of all constituencies. Capital providers purchase a return while the corporation purchases upfront capital. Employees purchase a salary while the corporation purchases labor. Customers purchase goods or services while the corporation purchases their dollars. These types of free trades are the cornerstone of capitalism and democracy.

The question is how this type of free trade leads us to find at law that a corporation should be focused only on profit. The argument is that a corporation can choose to focus on other things - charitable giving or reducing global warming for example - but every dollar spent on those things is a dollar taken away from another constituency. If the dollar is charged to capital providers their return will necessarily decrease and they may choose to provide capital elsewhere - thus forcing the corporation out of business. If the dollar is charged to consumers they may look to purchase the less expensive product from a competitor - thus forcing the corporation out of business. If the dollar is charged to employees they may look to provide labor to a higher paying competitor - thus forcing the corporation out of business.

The corporation that transfers resources to unrelated constituencies cannot survive unless it makes its charitable giving well-known and its related constituencies are willing to bear the cost. Why then, if people are so truly concerned about charitable giving, do they not more actively seek out this information in making purchasing decisions, in choosing where to invest, in choosing where to work? Should Dunkin Donuts charge an additional dollar for each cup of coffee and transfer that dollar to feeding the starving children in a third world country? Would that be an effective method of competing with Starbucks?

We have seen this type of campaign in the past - I remember a "Made in America" campaign. People would spend more money on a t-shirt if it was made in America. That was a campaign that was easy for people to get behind - at least it was easy for Americans to get behind. The inherent problem with a campaign like the hypotheticla Dunkin Donuts one listed above is that not every consumer - probably not the majority of consumers - is going to be willing to support that cause. A passerby might say - that is a great idea, but I'd rather save my dollar and donate it to the charity of my choice. An employee might say - I'd rather work for the company that pays a higher wage and then donate to the charity of my choice. Other related constituencies will tend to have the same attitude.

So is there a problem that profit seeking is a basis for decisions of corporate law? The problem is that this assumes that all shareholders, customers, employees and other related constituencies want the same thing. Then again, the evidence would tend to support this contention - how many people are willing to voluntarily sacrifice their dollar or let somebody else choose to sacrifice their dollar? Despite people saying they wish corporations were more charitable - more socially conscious - what they really mean is they wish some other constituency was willing to sacrifice so that the corporation could be more charitable. If the person protesting for social responsibility means it - let them donate the money they save or receive from the corporations lack of social responsibility.

This argument leads to the question of who is calling for social responsibility and where the assets are being distributed to. To use the example of there being only employees, customers and shareholders in a corporation. The corporation charges customers $10, pays $5 to employees and $5 to shareholders. If $10 is the maximum customers would be willing to pay for the good or service than their call for social responsibility would have to be paid for by another party - they are not willing to pay $11 for the good or service. If employees are willing to work for no less than $5 than their call for social responsibility will also have to be paid for elsewhere. The same is true with shareholders who will not accept a return of less than $5. So who pays? In this case no constituency is willing to pay - even if it is something they all want to see happen.

Maybe the more significant issue is when the three parties above all want social responsibility but there is the one party in management who does not. The party in management receives in salary - for example - $100; significantly more than any other constituency. Unfortunately, the management party would be willing and is most able to sacrafice $1 for charity - but will not because he or she does not support that cause and makes the decisions.

replacing management, collective action problem, too expensive to do, other way - mgt wants charity and nobody else does, mgt salary instead of ownership

This is a work in progress...we will see where it goes but it is not there - or anywhere - yet...comments welcome