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Lucian Arye Bebchuk

Working Paper 9078



1050 Massachusetts Avenue

Cambridge, MA 02138

July 2002

William J. Friedman and Alicia Townsend Friedman Professor of Law, Economics, and Finance, Harvard Law School; Research Associate, National Bureau of Economic Research and Center for Economic Policy Research. E-mail: bebchuk@law.harvard.edu; website: http://www.law.harvard.edu/faculty/bebchuk/. For helpful conversations and comments, I am grateful to Oren Bargil, Lisa Bernstein, Victor Brudney, John Coates, Alma Cohen, Allen Ferrell, Jesse Fried, Oliver Hart, Marcel Kahan, Louis Kaplow, Martin Lipton, Mark Roe, Steve Shavell, Leo Strine, Guhan Subramanian, and participants in a workshop at Harvard Law School and in The University of Chicago Law Review Symposium on Management and Control of the Modern Business Corporation. I also wish to thank the John M. Olin Center for Law, Economics, and Business at Harvard Law School for its financial support. The views expressed herein are those of the authors and not necessarily those of the National Bureau of Economic Research.

© 2002 by Lucian Arye Bebchuk. All rights reserved. Short sections of text, not to exceed two paragraphs, may be quoted without explicit permission provided that full credit, including © notice, is given to the source.

The Case Against Board Veto in Corporate Takeovers Lucian Arye Bebchuk NBER Working Paper No. 9078 July 2002 JEL No. G30, G34, K22


This paper argues that once undistorted shareholder choice is ensured -- which can be done by making it necessary for hostile bidders to win a vote of shareholder support -- boards should not have veto power over takeover bids. The paper considers all of the arguments that have been offered for board veto -- including ones based on analogies to other corporate decisions, directors' superior information, bargaining by management, pressures on managers to focus on the short-run, inferences from IPO charters, interests of long-term shareholders, aggregate shareholder wealth, and protection of stakeholders. Examining these arguments both at the level of theory and in light of all available empirical evidence, the paper concludes that none of them individually, nor all of them taken together, warrants a board veto. Finally, the paper discusses the implications that the analysis has for judicial review of defensive tactics.

Lucian Arye Bebchuk Harvard Law School 1545 Massachusetts Ave

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A. Ensuring Undistorted Choice via Voting

B. Can Preventing “Structurally Coercive” Bids Ensure Undistorted Choice?

C. Alternative Ways of Introducing Voting

D. Arrangements with Voting and No Board Veto


A. Alternative Normative Perspectives

B. The Target Shareholders’ Perspective: Costs of Board Veto..................18

1. Ex Post Agency Costs

2. Ex Ante Agency Costs

C. The Target Shareholders’ Perspective: Arguments for Board Veto......22

1. Analogies to other Corporate Decisions

2. Inefficient Capital Markets

3. Directors’ Superior Information

4. Bargaining by Management

5. Dangers of Short-Term Focus

6. Executive Compensation to the Rescue

7. Inferences from IPO Charters

D. The Perspective of Long-Term Shareholders

E. The Perspective of Aggregate Shareholder Wealth

F. The Perspective of Stakeholders

1. Expanding Discretion to Benefit Stakeholders

2. Are Boards Good Agents of Stakeholders?

3. The Tenuous Link between Stakeholder Protection

and Board Veto

4. Protecting Stakeholders or Protecting Managers?

G. Implementation within Existing Case Law



A. Did Willamette’s Incumbents Deliver Value for Shareholders?............58 B. Should Willamette-type Stalling Be Permitted?


In the last thirty years, takeover law has been the subject most hotly debated by corporate law scholars. During this period, takeover law has undergone many changes and much development, receiving the frequent attention of both legislators and courts. State legislators have been busy adopting a variety of antitakeover statutes. Courts have been busy developing a rich body of takeover doctrine. And an army of lawyers and investment bankers has been busy improving and practicing techniques of takeover defense and attack.

A central issue in the debate has been whether boards should have power to block unsolicited acquisition offers. To some scholars, such power is a serious impediment to efficient corporate governance.1 To others, a board veto is, on the contrary, necessary for effective corporate governance.2 Whereas opinions on the role of boards in corporate takeovers differ greatly, there is wide agreement about the importance of this subject for corporate governance and for the allocation of corporate assets.3 The aim of this paper is to present the case against board veto over takeover bids. Board veto could be justified in the absence of an undistorted choice by shareholders—that is, a choice reflecting their judgment on whether acceptance of the acquisition offer would serve their collective interest.4 However, such an undistorted choice can be secured by appropriate mechanisms, especially ones based on shareholder voting.

1 For an early work taking this view, see Frank H. Easterbrook and Daniel R. Fischel, The Proper Role of a Target’s Management in Responding to a Tender Offer, 94 Harv L Rev 1161 (1981). Whereas Easterbrook and Fischel argued that management should remain completely passive in the face of a takeover bid, other works that were opposed to board veto at the time took the view that management should be permitted to solicit competing offers but not to block any bids. See Lucian Arye Bebchuk, The Case for Facilitating Competing Tender Offers, 95 Harv L Rev 1028, 1054–56 (1982); Ronald J. Gilson, A Structural Approach to Corporations: The Case against Defensive Tactics in Tender Offers, 33 Stan L Rev 819 (1981).

2 For an early work taking this view, and starting the takeover debate of the 1980s, see Martin Lipton, Takeover Bids in the Target’s Boardroom, 35 Bus Law 101, 103 (1979).

3 See William T. Allen, Jack B. Jacobs, and Leo E. Strine, The Great Takeover Debate: A Meditation on Bridging the Conceptual Divide, 69 U Chi L Rev _ (2002) (suggesting that the “great takeover debate” reflects a fundamental struggle between competing models of the corporation and corporate governance). But see Marcel Kahan and Edward B. Rock, How I Learned to Stop Worrying and Love the Pill: Adaptive Responses to Takeover Law, 69 U Chi L Rev _ (2002) (arguing that the takeover debate has lost much of its practical significance due to developments in executive compensation schemes).

4 Thus, when shareholders exercise undistorted choice, an acquisition offer will succeed if and only if the shareholders view the offered acquisition price as higher than the In the presence of a mechanism ensuring shareholders’ undistorted choice, I argue, boards should not have a veto power over acquisitions beyond the period needed for the board to put together alternatives for shareholders’ consideration. In the course of my analysis, I examine the full array of arguments that supporters of board veto have made over the years. I also use and rely on the substantial body of empirical evidence that has accumulated since the debate on the subject started. Concluding that board veto is undesirable, at least in the absence of explicit shareholder authorization to the contrary, I also discuss how takeover law should best proceed given its established structure and principles.

Part I of this paper discusses arrangements needed to ensure undistorted shareholder choice. In the absence of any such arrangements, arguments for board veto could be based on collective-action problems that could lead shareholders to tender even if they view remaining independent (at least for the time being) as best. Such collective-action problems, however, can be effectively addressed without providing boards with a veto power. One approach that has received considerable support is to block “structurally coercive” bids,5 but such an approach, I show, is not an effective instrument for securing undistorted choice. A better approach for this purpose is “the shareholder voting approach” that makes it necessary for hostile bidders to win a vote of shareholder support. Such a vote would provide a genuine reflection of shareholders’ preferences regarding the acquisition offer.6 There are different ways, some better than others, to introduce winning a shareholder vote as a formal or practical condition for a takeover. Many existing arrangements, both in the United States and Europe, have introtarget’s independent value. The concept of undistorted choice in the face of an acquisition offer was introduced and analyzed in Lucian Arye Bebchuk, Toward Undistorted Choice and Equal Treatment in Corporate Takeovers, 98 Harv L Rev 1695 (1985) (hereinafter Bebchuk, Undistorted Choice), Lucian Arye Bebchuk, The Pressure to Tender: An Analysis and a Proposed Remedy, 12 Del J Corp L 911 (1987) (hereinafter Bebchuk, Pressure to Tender), and Lucian Arye Bebchuk, The Sole Owner Standard for Takeover Policy, 17 J Legal Stud 197 (1988) (hereinafter Bebchuk, Sole Owner Standard).

5 See Ronald J. Gilson and Reinier Kraakman, Delaware’s Intermediate Standard for Defensive Tactics: Is There Substance to Proportionality Review?, 44 Bus Law 247, 265 (1989).

6 For a formal model that demonstrates the advantages of shareholder voting over tender decisions, see Lucian Arye Bebchuk and Oliver Hart, Takeover Bids versus Proxy Fights in Contests for Corporate Control, Harvard Olin Discussion Paper No 336 (2001), available online at http://papers.ssrn.com/id=290584. I also argued for requiring bidders to win a vote or some other vote-like test as a condition for an acquisition in Bebchuk, Undistorted Choice, supra note 4, at 1695; Bebchuk, Pressure to Tender, supra note 4, at 911; and Bebchuk, Sole Owner Standard, supra note 4, at 197.

duced voting as such a condition. In the United States, most states have control share acquisition statutes that make it practically necessary for a bidder to win a vote in order to gain control.7 Furthermore, in most states, boards may install and maintain poison pills that prevent an acquisition. The power to maintain pills implies that a hostile bidder would be able to gain control over incumbents’ objections only if the bidder first won a ballot box victory to replace the incumbents with directors that would redeem the pill.

In my view, once a mechanism that ensures an undistorted choice by shareholders is in place, the board should not be able to veto an acquisition beyond the period necessary for preparing alternatives for shareholder consideration. The board should not use its powers either to deny shareholders access to a vote beyond such a period or to impede bids that have won a shareholder vote of support.

However, boards in most companies around the United States have some significant veto power that enables them to block for a substantial period of time an offer that could (or even did) win a vote of shareholder support. Some of this veto power comes from the interaction of the power to maintain pills with some antitakeover charter provisions (the large majority of which had been adopted before their antitakeover significance could have been recognized by shareholders). The combination of a poison pill and a staggered board, which exists in a majority of publicly traded firms, is especially powerful in providing boards with a veto power.8 Incumbents’ advisors keep coming up with new ideas for strengthening incumbents’ veto power.9 The push to expand and protect board veto over corporate acquisitions has been much helped by state legislators and courts.

Supporters of board veto have put forward a wide array of arguments in support of their position. They have used these arguments to suggest that boards should have the power to block acquisition offers at least for a subSee Grant Gartman, State Takeover Laws §§ A-2 to A-3 (Investor Responsibility Research Center 2000).

8 See Lucian Bebchuk, John Coates IV, and Guhan Subramanian, The Anti-Takeover Power of Classified Boards: Theory, Evidence and Policy, 54 Stan L Rev (forthcoming 2002). This work provides a theoretical account and an empirical confirmation of the powerful antitakeover force of staggered boards. It also reports that 58 percent of the firms in a sample of about 2,400 publicly traded firms had staggered boards. The discussion of staggered boards in this paper, and the proposal discussed below for not allowing directors with a staggered board to maintain a pill after losing one election over a bid, are largely based on this work.

9 See, for example, Quickturn Design Systems, Inc v Shapiro, 721 A2d 1281, 1287–88 (Del 1998) (describing how the board of Quickturn first adopted a “dead hand” pill and subsequently replaced it with a “deferred redemption” pill).

stantial period of time. Indeed, in the view of the most well-known and powerful defender of the board veto position, the best regime would have directors elected for five-year terms and granted largely absolute power over acquisition offers made in the five years between elections.10 Part II of this paper presents the case against board veto. Whereas scholars opposed to board veto have analyzed and relied on the agency problems involved in such veto, they have not attempted thus far to provide a full analysis of the array of arguments marshaled by supporters of board veto.

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