Faculty Scholarship Digest
Steven M. Davidoff
Steven M. Davidoff, Rhetoric and Reality: A Historical Perspective on the Regulation of Foreign Private Issuers, 79 Cin. L. Rev. 619 (2010).
Over the past ten years, SEC regulation (and deregulation) has significantly eased the path for foreign private issuers to list (and, as importantly, delist) securities in United States markets. This article, part of a symposium on the globalization of securities regulation, looks closely at the process by which that regulatory shift occurred as well as at the consequences. Steve demonstrates how catch phrases like “mutual recognition” and “global competition” seemed to create a political whirlwind that swept away other regulatory concerns and shifted regulation of foreign issuers from a paradigm of treating foreign issuers the same as domestic issuers to treating foreign issuers the same as they are treated abroad. “The consequence is that regulation has been devalued beyond economic necessity, creating incentives for foreign issuers to list in the United States in order to extract regulatory advantages to the detriment of retail investors.”
The careful demonstration of the process by which the SEC adopted a one-size-fits-all approach to foreign issuers, and then how that one-size fits all approach was taken as a given and led to further easing of restrictions, is remarkable, but is not intended to argue about the merits of specific SEC actions; Steve illuminates numerous potential pitfalls from deregulation that can (and indeed have) befallen retail investors, but also acknowledges some potential advantages of the rules the SEC has adopted. Instead, the article contends that, in the context of very important and ambitious rule-making, the SEC “was not driven by any normative regulatory technique but by the political rhetoric of the time,” and suggests that this outcome is not only troubling with regard to a purportedly independent agency, but also subject to repetition in other important areas, such as hedge-fund regulation and proxy-access regulation.
Steven M. Davidoff, Uncomfortable Embrace: Federal Corporate Ownership in the Midst of the Financial Crisis, 95 Minn. L. Rev. 1733 (2011).
This article examines and assesses corporate ownership by the federal government spurred by the financial crisis of 2008. Steven has described the government’s approach in effectively acquiring AIG, Citigroup, GM, Chrysler, GMAC and in holding very significant interests in Bank of America and the TARP recipients as “regulation by deal,” and the case-by-case description of the acquisition and treatments in this case demonstrates the aptness of the phrase, “as each new rescue and deal brought different ownership terms and models.” The article’s description of each approach is instructive not only for understanding the individual events, but also for some broader generalizations. Although the government sometimes acted like a private equity firm in making its acquisitions, to a substantial degree negotiating commercial terms, it acted much more like an institutional investor after acquisition, relying on extrinsic market forces and norms for its post-acquisition control, as opposed to the very close management control that is often the very point of private equity acquisitions. At the same time, the article notes that, unlike an institutional investor, the government did not have the alternative of selling its stake on the public market and that in a private company (which the government’s acquisitions had become), the independent directors that institutional investors increasingly rely upon do not face the same market pressures that affect their behavior in the public company context. So, in some ways, the government was like a venture capitalist, except one that did not want to invest more money. In short, Steven concludes, no single-investor model or unifying theory can capture this experience.
The article emphasizes the government’s aversion (under both Presidents Bush and Obama) to obtaining post-acquisition formal corporate control, even by the basic mechanism of the right to replace a majority of the Board of Directors, as well as its consistent high priority on divestiture of ownership, even at the expense of profit-maximization. The article ascribes this approach to political cultural necessities, but also suggests that it may not be a bad thing, because the pressure for political (noneconomic) direction of government controlled entities was so strong. Moreover, Steven is careful to note that the government may have exercised soft power to control its acquisitions to a much greater degree than its arrangements formally authorized. In a concluding section, the article notes that while these government interventions certainly succeeded in aggregate (the government recovered most of its investments and avoided a much worse economic crisis), fuller “resort to commercial principles . . . is likely to provide the greatest benefit to the government and the nation.” Particularly post-investment, the article describes, departure from these principles tended to lead to private benefits that impose both economic and political costs.
Steven M. Davidoff & Claire A. Hill, Limits of Disclosure, 36 Seattle U. L. Rev. 599 (2013).
Steven Davidoff and his coauthor Claire Hill (Minnesota) challenge the idea that more disclosure is the answer to problems in the securities market and elsewhere. The authors use two main examples to support their thesis on the limits of disclosure: synthetic CDOs with mortgage-backed securities as reference collateral and executive compensation. The CDOs were overwhelmingly private transactions sold to large, sophisticated investors. These transactions and their substantial decline in value played a significant role in the financial crisis of 2008. Davidoff and Hill contend that these sophisticated investors failed to consider the disclosures and transactions that highlighted substantial risks. Instead, the authors describe how these new issuances were quickly bought up without regard to disclosures containing ample red flags and caveats. Executive compensation is another example of where disclosures did not work as expected. Disclosure of executive compensation was designed to empower shareholders to put an end to excessive executive compensation. In spite of extensive disclosure, it turns out that those who care the most are other executives who use them for leverage in negotiations to increase their pay. Despite the ineffectiveness of disclosures in these examples, the authors contend it is the regulators need to do something that is responsive and politically palatable. Davidoff and Hill “encourage wariness at too-ready use of expensive disclosure requirements.”
Steven M. Davidoff (w/Matthew D. Cain), Delaware’s Competitive Reach¸ 9 J. Empirical L. Studies 92 (2012).
Delaware dominates all states in the competition for chartering public companies, something like three-quarters of U.S. companies that go public incorporate in Delaware, and more than sixty percent of Fortune 500 companies are Delaware companies. Yet some have found threats to Delaware’s dominance in a pattern of both merger litigation and merger agreements moving to other jurisdictions. In this important contribution to that debate, Steven and his coauthor analyze over 1,000 merger agreements between public companies over a five-year period, focusing on their choice of law and choice of forum provisions and the variables that drive them. The article concludes that Delaware is actually growing in attractiveness to corporate actors in this particular context.
The article finds that Delaware is popular among merging companies both for the quality of its law and the quality of its judiciary. Predictability and timeliness of anticipated adjudicatory outcomes seem to drive these choices in merger agreements, to Delaware’s advantage, and Delaware law became more attractive over the period studied, in part in response to a second circuit decision that made New York less attractive, and more substantially in response to the 2008 financial crisis. The authors also identify the factors most likely to lead to Delaware as the forum of choice (and tease out the relationship between law and forum). Also important is the state of incorporation of the target company, and, since that is more likely to be Delaware than anywhere else, “Delaware benefits from offering complimentary product to its public chartering services.”
Steven M. Davidoff (w/Alan D. Morrison & William J. Wilhelm, Jr.), 37 J. CORP. LAW 529 (2012).
In this penetrating article, co-authored with outstanding professors from the business schools at Oxford and the University of Virginia, Steve takes a hard look at changes in the investment banking business and their implications for regulation through the lens of the ABACUS case, in which the SEC charged Goldman Sachs with securities fraud for their actions related to a 2007 collateralized mortgage-backed securities transaction. Goldman’s stock dropped 13% ($10 billion in market valuation) the day the SEC announced the complaint, and Goldman settled in July 2010, agreeing to pay more than $550 million. After describing the highly complex ABACUS transaction in some detail, the article studies it contextually, first in light of then current investment banking activities and customer expectations, and then in light of the historical evolution of the investment bank.
The investment bank business has changed substantially in recent decades, from a “trust-based business,” in which the bank’s reputation was a critical item and quality was difficult to measure, to one with a substantial (and growing) transactional business: “the center of mass for the modern investment bank is now in the dealing room.” In this latter environment, where “the roles of trust and reputation have been massively attenuated,” Steve and his co-authors demonstrate that the need for regulatory input through legal formalities is increased, particularly for bright-line legal rules. For the remaining trust-based portion of the business, particularly when investment banks are dealing with sophisticated partners rather than retail investors, the article argues that increased regulation, even with the softer approach of “fiduciary duty,” is likely to be counterproductive—further undermining trust and reputation forces without providing a useful substitute.
Steven M. Davidoff (w/Caroline M. Gentile & Paul L. Regan), Irreconcilable Differences: Director, Manager and Shareholder Conflicts in Takeover Transactions, 36 DEL. J. CORP. L. vii (2011).
This brief article is the introduction to a symposium issue of the Delaware Journal of Corporate Law that Steven organized. The symposium conference brought together scholars, judges, attorneys, investment bankers, and other industry participants for an in-depth discussion of Delaware law and takeover conflicts, and the introduction follows the usual course of providing an overview of the publications that followed. Delaware courts have grappled with principle-agent problems for more than a century, yet the issues these problems present remain unsettled, particularly in the takeover context. “As markets become more complex, old methods of reviewing and ameliorating conflicts may no longer be efficient,” the organizers note, but the substitutes for judicial monitoring raise potential problems of their own, and the authors collected for this discussion provide a variety of insights in this area.
Steven M. Davidoff (w/Matthew D. Cain), Form Over Substance: The Value of Corporate Process and Management Buy-Outs, 3 DEL. J. CORP. L. 849 (2011).
Management buy-outs of publicly traded companies (“MBOs”) have been controversial for decades. Opponents claimed that management’s privileged position allowed them to seize gains at shareholder expense, while proponents argued their efficiency as a result of decreased agency costs and the appropriate incentives created for management. As this debate has waxed and waned, however, the level of judicial review has remained relatively constant, with such transactions “reviewed under the ordinary state statutory conflict of interest transaction rules.” In this article, Steven and his co-author start with the premise that some regulation of MBOs is needed given management’s conflict-of-interest and attempt to answer empirically (by a study of MBOs announced between 2003 and 2009) whether the best means of protecting shareholders is judicial review or some combination of ex ante procedures (e.g., a special committee of the Board to evaluate bids), and, if the latter, which procedures.
The results of their study confirm the hypothesis that management can unduly influence the buy-out process to their personal benefit, but also that process mechanisms can serve as a significant offset to this problem. Competitive contracts and the use of special committees lead to larger offer premiums in MBOs, and competitive contracts are associated with low premium bid offers failing. They also demonstrate that while these pre-transaction procedural protections produce higher premiums (to be clear, a good thing) the availability of judicial review under the “entire fairness” doctrine (the Delaware judicial review standard for MBOs) was not related to offer premium. Hence the article’s title: procedural mechanisms such as special committees and competitive contracts (“form”) were actually better than judicial review of the merits (“substance”) in producing efficient transactions.
Steven M. Davidoff, A Case Study: Air Products v. Airgas and the Value of Strategic Judicial Decision-Making, 2012 COLUM. BUS. L. REV. 2:502 (2012).
This article was a part of a symposium on the Delaware Court of Chancery. As his title suggests, Steve uses his contribution to closely analyze the litigation surrounding Air Product’s hostile takeover effort targeting Airgas (perhaps the most prominent hostile takeover battle of 2010) with an eye towards assessing the judicial opinions in the case (there were three key decisions). Steven contrasts the elements of those decisions that might be considered “process oriented,” i.e., apolitical judgments based on positive law with gaps filled by reference to prior law, with those that might be considered “strategic,” i.e., judgments informed by “the institutions and forces that can affect their status and goals.” In the case of Delaware courts, strategic considerations can and certainly do include that judges “derive significant prestige [and post-retirement benefits] from their status as the leading corporate jurists of the land” and Delaware’s position as the preeminent jurisdiction for incorporation—“more than one-fourth of its state revenue is derived from public incorporations.”
In the Airgas matter, Steven finds both strategic and process-oriented decision-making. Two examples of the former receive the closest scrutiny. First, at a crucial stage of the battle, the Delaware Supreme Court overturned a decision of the Court of Chancery, with the Supreme Court’s decision favoring the target company, whereas the Court of Chancery had ruled for the putative acquirer. The article sets out how, on a positive law basis, the Supreme Court’s decision was surprising, but as a strategic matter less so, since a perception of protection from hostile takeovers may be an essential part of Delaware’s attractiveness for incorporation. Indeed, Steven notes that the target’s brief to the Supreme Court framed its argument to give prominence to this risk of corporate flight. Steven critiques the Court’s decision not for considering this strategic factor, but for misweighting it: the number of companies affected by a ruling for the acquirer would actually have been very small and the rule-of-law loss from ignoring certain precedents should have outweighed this consideration, even as a strategic matter. On the other hand, Steven has a kinder assessment of a Court of Chancery decision in the litigation in which the judge stated that precedent forced him in one direction but also explained why, in his view, the precedent was mistaken, thus “walk[ing] a line between . . . doctrinal development [and] the desire and need to cater to wider constituencies.”
Steven M. Davidoff (w/Anil K. Makhajia & Rajesh P. Narayanan), Fairness Opinions in M&A’s, in H. Kent Baker & Halil Kiymacz eds., The Art of Capital Restructuring, Creating Shareholder Value Through Mergers and Acquisitions (Wiley & Sons 2011).
This chapter, which results from a collaboration between scholars at law and business schools, reviews the curious case of “fairness opinions.” A fairness opinion is a report from a financial advisor to the board of a company involved in proposed corporate control transaction. The financial advisor is typically an investment bank already involved in the merger in question, and the fairness opinion states that the price being offered in a proposed corporate merger is within the range of prices that would be considered “financially fair.” These opinions are not appraisals, but they do typically contain underlying valuation analyses of the company being acquired, though there are no uniform standards or practices governing these valuations. Fairness opinions were originally introduced as an investment banking product, but a 1985 Delaware Supreme Court finding a board had breached its duty by approving the acquisition of the company it governed without making an “informed business judgment,” quickly resulted in fairness opinions, which can bring multimillion dollar fees to the investment banks that provide them, becoming “a de facto if not legal requirement . . . for targets of a corporate control transaction.”
The legal literature has been critical of fairness opinions for the subjectivity involved in choosing the type and technique of valuation analysis involved as well as for the conflicts of interest often involved for the investment banks preparing them. Some have concluded that they amount simply to a tax (paid to investment banks) on corporate control transactions that provide no real value. Others, including Steve, suggest that the underlying analyses (rather than the opinion) may help bargaining to an appropriate price in certain transactions where market mechanisms are absent. Dale Oesterle and others have also suggested approaches for improving the consistency of standards in these analyses. The finance literature focuses on the empirical question whether fairness opinions produce a better outcome for the side obtaining them. The evidence is somewhat limited and has produced ambiguous results, though there is some evidence “that boards and investment banks use fairness opinions to further their own interests at an expense to shareholders,” with shareholders being cognizant of such incentives. The chapter concludes that the persistence of expensive fairness opinions, and their use by acquirers as well as target companies in some cases, may suggest that they have some value in nonmarket situations and suggests further research to answer such questions.
Steven M. Davidoff, The Private Equity Contract, in THE OXFORD HANDBOOK OF PRIVATE EQUITY (Oxford 2012).
The distinguished contributors to this international and interdisciplinary volume bring a broad array of perspectives and expertise. Steve has authored ground-breaking research on private equity contracts and his chapter is the lead chapter in the book. Private equity contracts—the merger agreements by which private equity funds acquire companies—have been critically distinct from other merger agreements because of their “optionality,” which allows “private equity firms to . . . terminate the merger agreement for any reason” in return for a fee, typically about 3% of the transaction value. During the recent financial crisis, private equity firms used these provisions to great advantage by exercising them to get out of transactions that were suddenly unfavorable. Steve’s chapter explains that, while this was great for private equity in the short run, targets companies, newly conscious of the risk of such options, have become much less willing to grant them. This has hurt private equity because the option was a valuable protection not only against the catastrophic risk of a financial crisis, but also against more routine risks of difficulty in obtaining financing and the like. The chapter carefully examines this history and explores the challenges presented by the new realities surrounding private equity contracts.
Steven M. Davidoff, Takeover Theory and the Law and Economics Movement, in Claire A. Hill & Brett H. McDonnell eds., RESEARCH HANDBOOK ON THE ECONOMICS OF CORPORATE LAW (Edward Elgar 2012).
This remarkable chapter traces the theoretical and doctrinal interplay between the law and economics movement and corporate takeovers, a relationship now approaching its 50th year. The chapter provides an insightful guided tour through this thicket, with careful citation to major viewpoints and developments. Henry Manne is “credited with the first significant application of law and economics scholarship to takeover theory” with his 1965 article that supported a free market for corporate control on an efficiency theory: when a corporation is run inefficiently, its stock price will fall below its potential level, and third parties will come in to takeover the company to bring it to its more efficient value. Moreover, fear of such discipline would make corporate managers run companies more efficiently in the first place. Belief in such a theory would argue for passivity from Boards of Directors in takeover battles and mandating shareholder primacy in takeover decisions.
In the takeover boom of the 1980's, however, the law decidedly developed in a contrary direction. In response to corporate raiders, “poison pill” defenses that allowed companies to fend off takeovers in proxy battles received judicial and legislative approval. Steve traces these battles and their aftermath, as law and economics scholars retrenched, offering “efficient” alternatives to their preferred unregulated market and eventually began engaging in empirical scholarship that sought to “sway takeover doctrine,” by demonstrating the wealth destroying effect of certain anti-takeover devices. Eventually, with the decline of the efficient market hypothesis, “a cornerstone of Manne’s theory,” “the academic theory on the proper scope of takeover regulation was increasingly fractured.” The result is a lessened but still ubiquitous influence of law and economics on takeover scholarship. Beyond that, however, it is a law and economics transformed, far more nuanced and diverse in its approaches than in its early days, while finding a confluence with current doctrinal developments such as the “corporate governance movement and its increasing emphasis on shareholder authority in decision-making.” In a final section, Steven also points to comparative work as fruitful avenue in this area going forward, as there are other countries with substantial experience with legislation that goes much further than U.S. law in restricting takeover defenses.