Post-Siliconix Freeze-Outs: Theory, Evidence, and Policy
Guhan Subramanian
Harvard Law School
Preliminary, Incomplete Draft – Please do not cite without permission
February 2004
ABSTRACT: At approximately the same time that the Sarbanes-Oxley Act increased the cost of
being a publicly-traded company, important Delaware case law created a difference in the
standard of judicial review for the two basic methods of freezing out minority shareholders.
While a freeze-out executed as a statutory merger is subject to stringent “entire fairness” review,
the Delaware Chancery Court in In re Siliconix Shareholders’ Litigation held that a freeze-out
executed as a tender offer is not. Commentators have debated whether this doctrinal difference
has created differences in practice, and, if so, how the Delaware courts and policymakers should
respond. This paper identifies an additional constraint in the controller’s negotiations with the
minority, beyond the “shadow” of judicial review, that arises from the need for minority
shareholder approval in virtually all freeze-out transactions. Because a controller with less than
an 80% stake needs supermajority approval from the minority in a tender offer, but not in a
statutory merger, I demonstrate that the doctrinal loophole provided by the Delaware courts
through the tender offer route may be less useful than prior commentators have argued.
I test this theory against a new database of all freeze-outs announced and resolved since
Siliconix. Consistent with the predictions of the model, I find that the likelihood of a tender offer
increases with the size of the controller’s pre-deal stake. I also find that the negotiated price, as
measured by the increase over the controller’s first offer and premiums over the pre-deal market
price, is lower, on average, for minority shareholders when the controller holds a large stake and
uses a tender offer, but is statistically indistinguishable from freeze-out mergers in all other
cases. One interpretation of these findings is that the built-in protection of supermajority
approval adequately protects minority shareholders when the controller is relatively small, but
not when the controller is large. These findings identify an efficiency loss from the current
doctrinal regime that bolsters proposals for convergence between tender offers and statutory
mergers (e.g., Gilson & Gordon 2003, Aronstam, Balotti & Rehbock 2003). These findings also
provide guidance on how such convergence might best be achieved.
Post-Siliconix Freeze-Outs: Theory, Evidence, and Policy
Guhan Subramanian*
1. Introduction
Due at least in part to the increased costs of being a public company under the SarbanesOxley Act of 2002,1 as well as the general decline of the stock market since 2000, freeze-outs
have been on the rise. Between July 2001 and December 2003, 38 controlling shareholders per
year, on average, have frozen out their minority shareholders, nearly three times the rate reported
by Coates (1999) for the period 1985-1996. At the same time that freeze-out activity began
increasing, important Delaware case law created a difference in the standard of judicial review
for the two basic methods of freezing out minority shareholders. While a freeze-out executed as
a statutory merger is subject to stringent “entire fairness” review, the Delaware Chancery Court
in In re Siliconix Shareholders’ Litigation held that a freeze-out executed as a tender offer is not.
Academic commentators and practitioners have debated whether and to what extent this
difference has created meaningful differences in practice, and if so, how judges and
policymakers should respond.
This paper introduces an additional constraint in the controller’s negotiations with the
minority, beyond the “shadow” of judicial view, that arises from the need for minority
shareholder approval in virtually all freeze-outs. The introduction of this constraint demonstrates
that tender offers and statutory mergers are not equivalent mechanisms for freezing out the
minority. Because a controller who holds less than an 80% stake needs supermajority approval
from the minority in a tender offer, but not in a statutory merger, the doctrinal loophole provided
by the Delaware courts through the tender offer route is most useful when the controller holds a
large stake, and may not be useful when the controller holds a small stake.
I test this theory against a new database of all freeze-out transactions that were announced
and resolved in the current doctrinal regime (n=96). Consistent with the predictions of my
model, I find that the likelihood of a tender offer increases with the controller’s stake. I also find
*
Harvard Law School. Comments welcome at subraman@law.harvard.edu. I thank the corporate law lunch group
at Harvard Law School for helpful conversations.
1
See Deborah Solomon & Cassell Bryan-Low, Companies Complain About Cost of Corporate-Governance Rules,
WALL ST. J. (Feb. 10, 2004) at A1.
1
that the negotiated price, as measured by the increase over the controller’s first offer and
premiums over the pre-deal market price, is lower for minority shareholders when the controller
holds a large stake and uses a tender offer, but is statistically indistinguishable from freeze-out
mergers in all other cases. One interpretation of these findings is that the built-in protection of
supermajority approval adequately protects minority shareholders when the controller is
relatively small, but not when the controller is large.
On policy, these findings identify an efficiency loss from the current regime that challenges
arguments that have been made in defense of the status quo (e.g., Pritchard 2003), and generally
supports proposals for doctrinal convergence between tender offers and statutory mergers (e.g.,
Gilson & Gordon 2003; Aronstam, Balotti & Rehbock 2003). These findings also provide
specific guidance on how such convergence might best be achieved. If the Delaware Supreme
Court chooses to overrule Siliconix and impose entire fairness review on freeze-out tender offers,
the findings presented here suggest that the controller’s pre-deal stake should be an important
factor for courts to consider in applying the fair process prong of entire fairness review. If
instead, the Delaware Supreme Court preserves Siliconix but enhances the procedural protections
provided to minority shareholders in tender offer freeze-outs, the evidence presented here
suggests that the anti-coercion conditions enumerated in Pure Resources should be supplemented
with meaningful special committee bargaining power, through, importantly, veto power that
comes from the ability to deploy a poison pill.
The remainder of this paper proceeds as follows. Part 2 provides background on freeze-out
mechanics, describes the recent developments in the Delaware case law on freeze-outs, and
summarizes the academic and practitioner literature commenting on these developments. Part 3
develops a new model of freeze-outs that yields three testable hypotheses. Part 4 tests these
hypotheses against a new database of all post-Siliconix freeze-outs. Part 5 discusses implications
of these findings. Part 6 concludes.
2. Background
A freeze-out (also known, with some occasional loss of precision, as a “going private
merger,” a “squeeze-out,” a “parent-subsidiary merger,” a “minority buyout,” or a “cash-out
merger”) is a transaction in which a controlling shareholder buys out the minority shareholders
2
for cash or the controller’s stock. The most common route for executing a freeze-out uses the
process outlined by the Delaware Supreme Court in Weinberger v. UOP2 and Kahn v. Lynch
Communication Systems:3 the target board establishes a special committee of directors (SC) who
are independent from the controller; the SC hires bankers and lawyers to advise it; and the SC
negotiates with the controller over the terms of the deal, most importantly the price to be paid to
the minority shareholders. If the controller and the SC reach agreement, the deal is submitted for
full board approval and then to the minority shareholders at a special meeting. If approved by a
majority of the minority shareholders, the transaction is usually executed as a statutory merger or
a two-step tender offer (that is, a first-step tender offer followed by a short-form merger), though
occasionally it is structured as a reverse stock split or an asset acquisition by the controlling
shareholder.
2.1. Recent judicial developments
Freeze-outs are generally subject to “entire fairness” review by the Delaware courts, a
stringent standard of review, because of their self-dealing nature (self-dealing because the
controller is the buyer and typically dominates the seller’s board). Even procedural protections
such as the use of a special committee merely shift the burden of proof on entire fairness to the
plaintiff. In June 2001, however, the Delaware Chancery Court in In re Siliconix Inc.
Shareholders Litigation4 held that entire fairness review does not apply to a tender offer made
directly to the minority shareholders, “unless actual coercion or disclosure violations are shown,”
because the Delaware corporate code does not provide a statutory role for the target board in
such an offer. Just one month after Siliconix, the Delaware Supreme Court in Glassman v.
Unocal Exploration Corp.5 held that a short-form merger under §253 of the Delaware corporate
code is also not subject to entire fairness review. Taken together, Siliconix and Glassman allow
a controlling shareholder to avoid entire fairness review by executing its freeze-out as a tender
offer followed by a short-form merger.6 The result is that the Delaware courts now afford
2
457 A.2d 701, 709 n.7 (Del. 1983).
638 A.2d 1110 (Del. 1994).
4
2001 WL 716787 (Del. Ch. 2001).
5
777 A.2d 242 (Del. 2001).
6
See, e.g., Next Level Communications Scheduled 14D-9 (filed Jan. 23, 2003) (“Q: Why would Motorola launch an
unsolicited tender offer, as opposed to discussing the matter and negotiating with Next Level’s Board of Directors?
A: By making a tender offer directly to stockholders, Motorola is attempting to avoid having to negotiate with Next
Level’s Independent Directors, who have a fiduciary responsibility to protect you. . . . Under Delaware case law, if
3
3
different standards of judicial scrutiny to transactional forms that achieve the same result in
practice, namely, the elimination of the minority shareholders.
One year after the Siliconix/Glassman combination, the Delaware Chancery Court in In re
Pure Resources held that a tender offer is not coercive, and therefore the Siliconix safe harbor
applies, only if the offer is subject to a non-waivable majority of the minority tender condition;
the controller guarantees to consummate a prompt §253 short-form merger at the same price if it
obtains more than 90% of the shares; and the controller makes no “retributive threats” in its
negotiations with the special committee.7 The court confirmed, however, that if these conditions
are met a freeze-out tender offer is not subject to entire fairness review.
2.2. Academic and practitioner commentary
Conventional wisdom among practitioners suggested that these doctrinal developments
would have a significant impact on freeze-out transactional form and outcomes. According to
the Wall Street Journal, “A couple of major court decisions handed down last year . . .
essentially permit those big holders to buy the minority investors out on the cheap.”8 And the
Corporate Control Alert stated: “The current thinking on minority buyouts, many lawyers say,
boils down to two words: tender offer.”9 Academic commentators have divided on how judges
and policymakers should respond. At one end of the spectrum, Cannon (2003) and Resnick
(2003) argue for doctrinal convergence through entire fairness review for tender offer freezeouts. Gilson & Gordon (2003) propose a hybrid approach that eliminates entire fairness review
if the controller has complied with the procedural protections identified in Pure Resources and
the SC has veto power over the transaction, but imposes entire fairness review if the controller
goes directly to shareholders through a tender offer. Aronstam, Balotti & Rehbock (2003)
similarly take a middle-ground position, urging a “limited fairness hearing” for freeze-out tender
Motorola were to negotiate a transaction agreement with the Independent Directors, Motorla would have a legal duty
to deal ‘fairly’ with the minority stockholders and to pay a ‘fair price’ for your shares. Through the unsolicited
tender offer, Motorola is trying to avoid its legal duty to pay you a fair price for your shares in any negotiated
transaction and to treat you fairly as minority stockholders.”).
7
In re Pure Resources Shareholders Litigation, 808 A.2d 421 (Del. Ch. 2002).
8
Robin Sidel, Takeover Targets Force Up Offers in ‘Minority Squeeze-Out’ Deals, WALL ST. J. (May 10, 2002) at
C3.
9
David Marcus, Cleaning Up Your Corporate Structure, CORPORATE CONTROL ALERT, at 20 (July 2003). .
4
offers, or an amendment to the Delaware appraisal statute to require the controller to pay all
minority shareholders the appraised valued of their shares.
At the other end of the spectrum, some commentators defend the Siliconix/Glassman
doctrinal contour. Pritchard (2004) argues that the gap in standards of review represents a onetime wealth transfer from minority shareholders to controllers that will be solved ex ante through
lower prices that investors will pay for a minority stake. Pritchard (2004) and Abramczyk,
Cincilla & Honaker (2003) argue that minority shareholders have adequate protections against
coercive tender offers even in the absence of entire fairness review. To support this view, some
commentators point to the fact that target boards generally establish a special committee to
negotiate with the controller even if the controller proceeds via tender offer. As illustrations,
practitioners point to Intimate Brands’ negotiation with its controlling shareholder Limited; TD
Waterhouse’s negotiation with its controller Toronto-Dominion Bank; and Prodigy
Communications’ negotiation with its controller SBC Communications. All three of these deals
were post-Siliconix freeze-outs executed through a tender offer. In all three transactions, the
target established a special committee of independent directors to negotiate with the controller.
And in all three, the special committee was able to negotiate a substantial increase over the
controller’s initial offer. This anecdotal evidence suggests that a special committee might have
as much bargaining power against the controlling shareholder in a freeze-out tender offer as it
does in a freeze-out statutory merger.
2.3. Assessment
The debate on post-Siliconix freeze-outs is problematic in two respects. First, at the level of
theory, both sides of this debate focus on the direct causal link from the transactional form used,
through the standard of review, to the price paid to the minority shareholders. In the next Part I
introduce a second link between the standard of review and price paid, running through the
requirement of minority shareholder approval. I demonstrate that once this second connection is
introduced, tender offers and statutory mergers are not substitute routes for achieving the same
end-goal.
Second, the debate on the implications of the Siliconix/Glassman mechanism for freezing out
minority shareholders has been hindered by the absence of any systematic empirical evidence.
5
Basic questions remain unanswered: What fraction of freeze-outs are executed as mergers versus
tender offers? If both transactional forms continue after Siliconix, how do controllers decide
which to use? Are outcomes different by transactional form? In the next Part I formalize my
approach to these questions by developing a theory of freeze-outs that yields specific predictions
and testable hypotheses. In Part 4 I test these hypotheses against a new database of all postSiliconix freeze-outs.
3. A theory of freeze-outs
The current debate on freeze-outs focuses on the link from the form of the transaction to the
standard of review to the price paid by the controller to the minority. The argument is that the
higher standard of review for statutory mergers may increase price ex post through a judiciallymandated payout to the minority, or ex ante due to the shadow of a judicially mandated-payout,
or both. Gilson & Gordon (2003), Aronstam, Balotti & Rehbock (2003), Cannon (2003), and
Resnick (2003) assume that the current freeze-out regime creates substantive differences
between the statutory merger and tender offer route, while Pritchard (2003) and Abramczyk,
Cincilla & Honaker (2003) argue that the procedural protections provided in tender offers,
notably the use of a special committee as a bargaining agent, provide the same protections for
minority shareholders as they receive in statutory mergers.
Both sides of this debate miss a second connection between transactional form and price,
running through the shareholder approval requirement. All statutory mergers require shareholder
approval under the corporate law of all states. The existence of a controlling shareholder does not
make this vote a formality, because the Weinberger/Kahn roadmap mandates a non-waivable
majority of the minority condition in order to shift the burden to the plaintiff on entire fairness.
Tender offers also require shareholder approval, in the form of tendered shares. However, the
two transactional forms depart in the level of minority shareholder approval that is required in
order to consummate the transaction.
A statutory merger with a standard majority-of-the-
minority condition requires support from 51% of the outstanding minority shares. In contrast, a
controller who proceeds via tender offer must get to 90% voting control in order to then execute
a short-form merger under §253 of the Delaware corporate code. In a tender offer, therefore, the
level of support required from the minority decreases as the controller’s stake increases. Figure
6
1 compares the level of support needed from minority shareholders in the two transactional
forms.
Figure 1: Minority Shareholder Support Required for Tender Offer vs. Merger
90
% of minority shares needed
80
70
60
50
40
30
Tender Offer
Merger
20
10
88
85
82
79
76
73
70
67
64
61
58
55
52
49
46
43
40
0
Controller's Pre-Deal Stake
Starting with the simpler case, a statutory merger with a standard majority-of-the-minority
condition requires 51% of the minority shares outstanding to support the merger, regardless of
the controller’s pre-deal stake. For example, if the controller holds 40% initially, 51% of the
minority, or 31% of the total outstanding shares, must support the freeze-out. If the controller
holds 80% initially, again 51% of the minority, which this time amounts to 11% of the total
outstanding shares, must support the freeze-out.
In contrast, in a tender offer the level of support required from minority shareholders depends
on the controller’s pre-deal stake. As shown in Figure 1, if the controller holds 40%, it needs
another 50% of shares outstanding, or 83% of the minority shares (50% out of the 60% of total
shares held by the minority) in order to achieve the 90% voting control that allows it to execute a
short-form merger. If instead the controller already holds 85%, then it only needs another 5% of
shares outstanding, or 33% of the minority shares (5% out of the total 15% held by the minority)
to get to 90%.10 Because virtually all post-Siliconix freeze-outs structured as tender offers
10
The break-even between a statutory merger and a tender offer occurs at 80%: at this level the controller needs
51% support from the minority in both a statutory merger and a tender offer. A corollary of this point is that a nonwaivable majority-of-the-minority condition in a tender offer freeze-out, as urged by the Delaware Chancery Court
7
include a back-end short-form merger at the same price or exchange ratio as the front-end tender
offer (in order to avoid the inevitable claim of structural coercion that would follow the
consummation of a two-tier offer),11 and because business reasons motivate the controller to
execute the back-end freeze-out as quickly as possible (Subramanian 2003a, Pritchard 2004),
shareholders will make an “undistorted choice” (Bebchuk 1985) with respect to the consideration
offered by the controller in a freeze-out tender offer. As a result the controller must offer a price
that is high enough to attract the necessary supermajority.
Anecdotal evidence suggests that this requirement is non-trivial, particularly for smaller
controlling shareholders. For example, in February 2002, the KPN Group announced a tender
offer at $2.25 cash per share for the remaining 47% of EuroWeb International that it did not own.
As a 53% controller KPN needed 79% of the minority to tender (37% out of the remaining 47%)
in order to achieve 90% voting control that would allow it to execute a short-form merger.
EuroWeb formed a SC that recommended against the proposal, and a slim majority of the
minority (55%) tendered into the offer.12 Still needing another 24% of the minority to tender,
KPN increased its offer to $2.70 per share. The SC recommended against this sweetened offer,
and in April 2002 the KPN tender offer expired with insufficient shares tendered.
KPN
withdrew its proposal and EuroWeb remains a public company today.
As another example with a different outcome, in August 2002 Unocal announced a tender
offer for the remaining 35% of Pure Resources (“Pure”) that it did not own. Unocal initially
offered 0.6527 Unocal shares for every Pure share; the Pure SC recommended against the offer;
and approximately 3% of minority shareholders tendered. Unocal then proposed 0.7 Unocal
in Pure Resources, is a non-binding constraint unless the controller holds more than 80% of the target’s stock. If the
tender offer does in fact include a majority-of-the-minority condition, then a tender offer freeze-out requires the
same level of minority support (not lower support, as shown in Figure 1) than a statutory merger for transactions in
which the controller holds more than 80%. See, e.g., TD Waterhouse Group 14D-9 (Oct. 11, 2001) (“The Special
Committee noted that because of the Majority of the Minority Condition, the Revised Offer cannot succeed unless a
majority of the publicly-owned Shares are tendered. Absent that condition, due to TD Bank’s ownership of 88% of
the Shares, the Purchaser and TD Bank would be able to attain ownership of 90% of the Shares even if only 16.6%
of the Shares they do not already own were tendered in response to the Offer or the Revised Offer.”).
11
See, e.g., RDO Equipment SC-TO-C filed by Ronald D. Offutt (Dec. 17, 2002) (“If the conditions to his offer
were satisfied and the offer completed, Mr. Offutt stated that he would subsequently effect a ‘short-form’ merger of
the Company with his acquisition entity. In this merger, the remaining Company stockholders would receive the
same price paid in the tender offer, except for those stockholders who elected to exercise their appraisal rights under
Delaware corporate law.”).
12
See EuroWeb International 13E-3/A (filed March 20, 2002).
8
shares for every Pure share; again the SC recommended against the offer and this time 31% of
minority shareholders tendered. Only when Unocal increased its offer a second time, to 0.74
Unocal shares, did it get to the necessary 71% of the minority that it needed (25% out of the
remaining 35%) in order to proceed with its short-form merger.
These case studies suggest that the supply curve for minority shares in a tender offer is
upward sloping and elastic. The controller cannot price discriminate against this supply curve
because SEC Rule 14d-10 requires the offeror to pay a single price to all shareholders who sell
into a single tender offer. It follows, then, that the price that the controller must offer in a tender
offer is positively correlated with the fraction of shares needed; or, equivalently, the price that
the controller must offer is inversely correlated with the fraction of shares held by the controller.
This analysis reveals a previously unnoticed connection between transactional form and price.
Figure 2 summarizes this point (with “+’s” indicating positive correlations).
Figure 2: A Theory of Freeze-Out Pricing
Extension to
existing theory
Transactional
form
Shareholder
approval
required
Standard
of review
+
Consummation
risk
+
Price paid
to minority s/h
+
The theory developed in this Part therefore provides three testable hypotheses:
H1: The likelihood of executing a freeze-out through a tender offer increases with the
controller’s stake, because a tender offer becomes more attractive as the necessary level of
minority support declines.
9
H2: There is no difference in outcomes for minority shareholders between tender offers and
statutory mergers when the controller’s stake is small, because the supermajority vote needed
from the minority in a tender offer provides built-in protection that compensates for the lower
standard of judicial review that the tender offer receives.
H3: Minority shareholders receive lower prices for their shares in tender offer freeze-outs
than in statutory merger freeze-outs when the controller’s stake is large, because the standard of
judicial review, rather than the approval required from minority shareholders, becomes the
binding constraint.
In the next Part I test these hypotheses against the available empirical evidence.
4. Evidence
In this Part I test the hypotheses developed in Part 3 against a new database of all freeze-out
transactions announced and resolved since Siliconix. Part 4.1 presents the methodology. Part 4.2
provides summary statistics. Part 4.3 presents evidence on post-Siliconix deal form. Part 4.4
presents evidence on post-Siliconix deal outcomes, using the controller’s patterns of concession
to the target’s special committee as well as premiums paid by the controller in order to
quantitatively assess the outcomes for minority shareholders.
4.1. Methodology
I begin with all transactions coded as “Acquisitions of Remaining Interest” in Thomson
Financial Corporation’s Mergers & Acquisitions database, announced between June 19, 2001,
the date of the Delaware Chancery Court’s opinion in Siliconix, and December 31, 2003.
Although TFC uses a 50% cutoff to distinguish acquisitions of remaining interests from
acquisitions of a controlling interest, as a matter of Delaware corporate law (as well as real-world
practicality) a shareholder with as little as a 40% holding can be a controlling shareholder.13 I
therefore supplement TFC’s remaining-interest category with transactions in which the acquirer
holds 40-50% when the freeze-out is initiated.
13
See, e.g., Kahn v. Lynch Communication Systems, 638 A.2d 1110 (Del. 1994) (finding a 43.3% shareholder to be
a controller). Admittedly, the 40% cutoff is arbitrary, and some courts have found shareholders to be controllers
with even smaller holdings. See, e.g., In re Cysive Inc. Shareholders Litigation, 836 A.2d 531 (Del. Ch. 2003)
(finding a 35% stockholder to be a controller).
10
I exclude transactions in which the acquirer held more than 90% of the target’s voting shares,
because such transactions can be executed as short-form mergers that do not require a
shareholder vote.14 I also exclude remaining-interest acquisitions that are the second step of a
third-party tender offer, because the second step is invariably at the same price as the first step
and the first step was negotiated at arms-length.15 The final database includes 96 freeze-out
transactions.
For each transaction, I examine SEC filings by the controller and the target company
(primarily 8-K, 14D-9, 13E-3, and 14A filings), news reports, and company press releases to
collect data on the bargaining process, such as the dates and sequence of offers and counteroffers, whether a special committee of independent directors was formed to assess the
transaction, whether financial and legal advisors were hired, and the terms of the final
agreement, if one was reached. Stock price data for each target company are taken from TFC
and the Center for Research in Securities Pricing (CRSP) database.
I classify each freeze-out as either a statutory merger or a tender offer.
I classify seven
statutory merger freeze-outs that were executed as two-step tender offers as statutory mergers,
because the Delaware Chancery Court has held that these transactions are subject to entire
fairness review.16 Though admittedly a closer call, I also classify two freeze-outs that were
executed as reverse stock splits as statutory mergers, because the requirement of board action
that seems to distinguish statutory mergers from tender offers seems to be met, and because the
Chancery Court has subjected reverse stock splits to fairness review in other (non-freezeout)
contexts.17 The findings reported in this Part are the same if I exclude reverse stock splits from
the analysis.
14
See DEL. GEN. CORP. L. §253.
There is a gray area in distinguishing an arms-length transaction from a freeze-out if there is delay between the
first and second steps of the transaction. See, e.g., Cede & Co. v. Technicolor, 684 A.2d 289 (Del. 1996). As a
practical matter, most arms-length acquirers today wish to execute the second-step tender offer as quickly as
possible in order to gain 100% of the anticipated economic benefit, to avoid uncertainty in applying dissenters’
appraisal rights, to eliminate potential plaintiffs, to delist from the stock exchange, and to deregister under the 1934
Act. (Subramanian 2003a) Perhaps as a result, self-dealing and arms-length transactions were clearly
distinguishable in my database, with no transactions in this potential gray area.
16
Hartley v. Peapod, C.A. No. 19025 (Del. Ch. Feb. 27, 2002).
17
Applebaum v. Avaya, 805 A.2d 209 (Del. Ch. 2002).
15
11
4.2. Summary statistics
Figure 3 shows the breakdown of the transactions in the sample based on the transaction
form used, the resulting negotiation between the controller and the target, and the outcome of the
negotiation.
Figure 3: Freeze-out Roadmap (number of post-Siliconix transactions)
Yes (25)
Tender
offer
(27)
SC
formed?
Yes (23)
No (2)
No (0)
No (2)
Controller
withdraws
Tender offer
succeeds?
Yes (2)
Controller
expression
of interest
Statutory
merger
(69)
Tender offer
succeeds?
SC
recommendation
Two-step
Tender offer
(7)
Deal (51)
SC formed to
negotiate with
controller
No Deal (18)
Tender offer Yes
succeeds?
Short-form
merger
Deal
closes
No
Deal
structure
Merger (44)
Controller
withdraws
Shareholder
vote
Controller
withdraws
At the highest level, Figure 3 shows that 72% of post-Siliconix freeze-outs are still executed
through statutory mergers, and, conversely, only 28% of deals have taken advantage of the “getout-of-jail-free card” (Gilson & Gordon 2002) that Siliconix seems to provide. This basic
finding is in tension with the common assumption in the academic literature that practitioners
have made frequent use of the Siliconix roadmap to avoid entire fairness review, and with some
practitioner claims that virtually all freeze-outs since Siliconix have been executed via tender
offer.18 I explore this point in Part 4.3 below.
18
For example, a partner at Cleary, Gottlieb, Steen & Hamilton in New York City states: “I am not sure I can think
of a going-private deal since Pure Resources [in August 2002] that has been done the old-fashioned way of
negotiating a one-step merger agreement with a special committee of the target.” David Marcus, Cleaning Up Your
Corporate Structure, CORPORATE CONTROL ALERT, at 20 (July 2003). In fact there have been 35 of these “old
12
Examining further the twenty-seven deals that were executed via tender offer, in only two
situations (both cases in which there were ostensibly no independent directors) did the target not
establish a special committee of independent directors to assess the transaction, negotiate with
the controller, and provide a recommendation to the minority shareholders.
This finding
supports the point made by Pritchard (2004) and Abramczyk, Cincilla & Honaker (2003) that
minority shareholders in a tender offer freeze-out still (almost always) have a bargaining agent in
the form of a special committee. The question still remains, however, whether the special
committee can bargain as effectively in a tender offer context as in a statutory merger. A final
point on the upper half of Figure 3 is that the consummation rate for tender offer freeze-outs is
high: 25 out of 27, or 93%, compared to 51 out of 69 (74%) for statutory merger freeze-outs.
Turning to the lower half of the Figure 3 roadmap, of the 74% of statutory merger freeze-outs
that were approved by the special committee, 44 out of 51 (86%) were executed through a
standard one-step merger that requires majority of the minority approval in a shareholder vote.
The remaining seven deals (14%) were executed through a first-step tender offer followed by a
short-form merger, presumably to avoid the need for a shareholder meeting if the controller gets
to 90% in the first step. Interestingly, all 51 statutory merger freeze-outs that were approved by
the special committee and then approved by the full target board were eventually consummated,
suggesting that board approval rather than minority shareholder approval was the more difficult
hurdle to executing the freeze-out.
Table 1 provides further summary statistics, for all freeze-outs and broken down by
transactional form.
[insert Table 1 about here]
Table 1 shows that tender offers are larger deals, on average, though this difference is not
statistically significant. I examine this finding more carefully in Part 4.3 below. Sixty-three
percent of freeze-out targets are Delaware corporations, substantially higher than Delaware’s
fashioned” deals since Pure Resources, and (as shown in Figure 3) 69 since Siliconix. Cf. Pure Resources, 808 A.2d
at 443 (“The absence of convincing reasons for this disparity in treatment inspires the plaintiffs to urge me to apply
the entire fairness standard of review to Unocal’s offer. Otherwise, they say, the important protections set forth in
the Lynch line of cases will be rendered useless, as all controlling shareholders will simply choose to proceed to
make subsidiary acquisitions by way of a tender offer and later short-form merger.”) (emphasis added).
13
overall market share of approximately 50% among U.S. publicly-traded companies
(Subramanian 2002, Bebchuk & Cohen 2003). Delaware’s larger market share among freezeouts may be due to its more well-developed case law, which might promote freeze-outs, or
because companies that contemplate moving between public and private status are more likely to
incorporate in Delaware, or both.
On the identity of the controller, Table 1 shows that approximately one-quarter are a founder
or a family group; another quarter are private equity firms; and approximately half are corporate
parents. Table 1 also shows that corporate parents are over-represented in the tender offer arena.
To the extent that corporate parents are more likely to hold controlling stakes in larger
companies, relative to private equity investors or family groups, this finding is consistent with
the result noted above that tender offers are also likely to be larger deals.
As revealed in Figure 3, tender offers are more likely to close than statutory mergers (93%
consummation rate versus 74%). This finding is consistent with evidence showing that armslength mergers are also more likely to be consummated when structured as a tender offer rather
than as a merger. (Coates & Subramanian 2000) One important benefit for tender offers in
terms of consummation is their quicker timing: Table 1 shows that freeze-out tender offers close
in 100 days on average, compared to 189 days for statutory mergers. This timing difference is
consistent with conventional wisdom among practitioners that tender offers get cash or stock to
minority shareholders more quickly.19
Table 1 also shows that approximately 20% of freeze-outs overall, including tender offer
freeze-outs, involve stock rather than cash. This finding is inconsistent with Gilson & Gordon’s
claim that most post-Siliconix freeze-out tender offers have been for stock,20 and also reveals that
19
See, e.g., WorldPort Communications SC-TO-T (filed Dec. 23, 2002) (“Q: Why is [the controlling shareholder]
not seeking approval of its offer from WorldPort’s independent directors? A: We want to begin to realize the
benefits of taking WorldPort private as soon as possible and believe that making a tender offer directly to WorldPort
stockholders will be significantly faster than making a proposal for consideration by WorldPort's independent
directors and negotiating a merger agreement with those directors. We believe that the WorldPort stockholders are
capable of evaluating the fairness of the Offer. We also note that over 80% of the shares not owned by us would
need to be tendered to satisfy the Minimum Condition. Accordingly, we are not seeking to negotiate our Offer with
WorldPort.”).
20
Gilson & Gordon at 785 n.172 (“[T]he new wave of freeze-out tender offers has mainly involved exchange
offers.”)
14
the disclosure of the bankers’ valuation opinion, as urged in Pure Resources, is redundant for the
80% of freeze-outs that are subject to the same requirement under SEC Rule 13e-3.
Finally, and perhaps most interestingly, Table 1 reveals statistically significant differences in
the outcome of the bargaining process between tender offers and statutory mergers. Consistent
with the basic theory of freeze-outs described in Part 3, predicting that a higher standard of
review yields a higher price, Table 1 shows that negotiated prices, as measured by increases over
controllers’ first offers and premiums over the pre-deal market prices, are higher, on average,
when the controller uses a statutory merger compared to a tender offer. These differences are
statistically and economically significant: a 9.5% difference in increases over first offers, and 1530% differences in premiums. I explore these differences in more detail in Part 4.4 below.
Because post-Siliconix tender offer freeze-outs are the mechanism of primary interest, Table
2 provides additional detail on these twenty-seven deals.
[insert Table 2 about here]
Following Figure 3, Table 2 shows that all but two freeze-out tender offers (93%) used
special committees, the two exceptions being cases in which the target boards had no directors
who were independent from the controller.
All but one target board (96%) hired outside
financial and legal advisors. On offer conditions, all but three of the deals (89%) included a nonwaivable majority of the condition, and all but one (96%) included a back-end guarantee at the
same price as the initial offer.21 Putting these findings together leads to the conclusion that the
vast majority of post-Siliconix tender offer freeze-outs included the procedural protections
described in Pure Resources. This conclusion is perhaps unsurprising for tender offer freezeouts executed after Pure, but 19 out of 27 (70%) of the deals summarized in Table 2 occurred in
21
One back-end guarantee in the sample was not airtight. See SBC Communications Schedule SC-TO-T (“Q: If
SBC Internet consummates the tender offer, what are its plans with respect to all the shares that are not tendered in
the offer? A: If we consummate the tender offer, we intend to cause a merger to occur between Prodigy and SBC
Internet . . . SBC Internet presently intends that the cash consideration paid in the merger will be the same as paid in
the tender offer.”) (emphasis added). I record this deal as having a back-end guarantee because, absent a change in
circumstances, a lower price would have exposed SBC to a strong fair price claim. Delaware law seems to require
“the statement of intent to be sufficiently clear as to expose it [the controller] to potential liability in the event that it
were to obtain 90% and not consummate the short-form merger at the same price.” See Pure Resources, 808 A.2d
421, 447 n.51.
15
the one-year window between Siliconix and Pure Resources. I discuss the implications of this
finding in Part 5 below.
On outcomes, 74% of minority shareholders, on average, tendered into the front-end tender
offer, though these outcomes mask variation that ranges from 20% minority shareholder
approval (IIC Industries) to 99% (National Home Centers). Note that the average tender is lower
than the supermajority needed for a controller with less than a 62% stake in the target. This
finding is consistent with the anecdotal evidence presented in the previous Part suggesting that
the supermajority vote requirement is non-trivial for controllers with a small stake. In fact, Table
2 shows that both unsuccessful tender offers in the sample occurred in cases where the controller
had less than a 65% stake. The converse of this point is that all controllers who held more than a
65% pre-deal stake and proceeded via tender offer were successful. While some practitioners
perceive tender offers to be the riskier route to freezing out the minority, this does not seem to
have been the case when the controller held more than the median stake.
4.3. Transactional form
I now turn to the determinants of transactional form between statutory mergers and tender
offers. The theory presented in Part 3 predicts that the likelihood of using a tender offer should
be increasing in the controller’s stake (H1). Using the median controlling stake of 65%, I find
that the controller used a tender offer in 17% of freeze-outs when the controller had a belowmedian pre-deal stake, and in 39% of transactions when the controller had an above-median predeal stake. This difference is statistically significant at 99% confidence and is directionally
consistent with the theoretical model.
I also run a multivariate regression to control for other factors that might influence choice of
transactional form. The variable of interest is a continuous variable CONTROL, measuring the
controller’s percentage stake in the target (ranging from 40 to 90). I also include several
controls. First, I control for the size of the deal, measured as the natural log of the deal value.
Because there are substantial fixed costs in making a tender offer, a tender offer might become
more attractive as the size of the deal increases.
Second, I control for whether the target is
incorporated in Delaware. Although other states generally follow Delaware corporate law on
most issues involving fundamental transactions (e.g., Subramanian 2003b), other states have not
16
yet explicitly articulated a standard of review for freeze-out transactions executed through tender
offer. The relative certainty for Delaware targets on this question may make tender offers more
likely in Delaware. I also control for the identity of the controller (using the same categories as
reported in Table 1) and whether the consideration is stock or cash (0/1). The model is run as a
logit regression, with the dependent variable TENDER set to 1 if the controller executed the
freeze-out through a tender offer, and 0 if the controller executed the freeze-out through a
statutory merger. The results are reported in Table 3.
[insert Table 3 about here]
Beginning with the variable of interest, CONTROL is statistically significant and positive in
all models. The magnitude of the coefficient is also economically meaningful. Using the
method of recycled predictions, I find that a 5% increase in the controller’s stake increases the
likelihood of a tender offer by 4.3% for the median target in the sample.
Control variables are also of interest. The Delaware coefficient is positive but statistically
insignificant in all models, consistent with the view that practitioners do not perceive differences
between Delaware corporate law and corporate law in other states, or that practitioners assume
that other states will follow Delaware corporate law absent explicit statutory law or case law to
the contrary. In unreported regressions I run Model #1 on Delaware targets only. The results are
directionally the same as the overall results reported in Table 3, though the CONTROL
coefficient becomes significant only at the 10% level, likely due at least in part to the smaller
number of observations (n=60).
Consistent with the fixed-cost theory of tender offers, the likelihood of a tender offer
increases with the size of the transaction. Table 3 also shows that a controller who offers stock is
less likely to proceed via tender offer. If disclosure were the motivation, one would expect the
opposite result: because Rule 13e-3 does not require the target board to disclose its fairness
opinion in exchange offers to the minority, one might expect a higher incidence of tender offers
(exchange offers) when the controller is using stock, at least until Pure Resources arguably
leveled the playing field between stock and cash offers with respect to the disclosure required.
This finding therefore represents something of a puzzle.
17
In order to address the possibility that consideration used is endogenous to transactional
form, I also run the model without the STOCK dummy variable. In these models (columns #2 &
#4), CONTROL continues to be statistically and economically significant in the predicted
direction. Deal size, however, is no longer statistically significant at 95% confidence in this
reduced model.
Overall, the results reported in Table 3 support Hypothesis H1 that the likelihood of
executing a freeze-out through a tender offer increases with the size of the controller’s pre-deal
stake. One intuitive explanation for this finding is that choice of transactional form is influenced
by the level of approval needed from minority shareholders. However, an important puzzle
remains: why would a controller ever use a statutory merger rather than a tender offer to execute
its freeze-out when it has a large stake in the target, say, 80% or more? In this scenario, theory
would predict that a tender offer should dominate a statutory merger because a tender offer
provides both a lower standard of review and an equal or lower level of minority support
required. One possible explanation is that these differences in standards of review and minority
support do not influence price. I now turn to this question.
4.4. Outcomes
In this Part I examine the outcomes of freeze-out negotiations between the controller and the
special committee, taking the transactional form used by the controller as exogenous. Although
quantitatively assessing the effectiveness of the special committee against the controller is
inherently difficult, I use two measures that have some intuitive appeal and that are often cited
by the special committee itself in its communications to shareholders advocating the
transaction:22 first, the percentage increase from the controller’s first offer to the controller’s
final offer; and second, the premium paid by the controller over the pre-deal market price of the
stock, using baseline dates one day prior, one week prior, and four weeks prior to the initiation of
the transaction.
22
See, e.g., National Home Centers, Schedule 14D-9 (filed August 14, 2001) (“The Offer Price represents a 22%
premium over the $1.15 closing price per share of NHC common stock on October 4, 2001, the last trading day prior
to the public announcement by NHC of the Offer Price. Based upon the course of discussions with the Purchaser,
including the fact that Mr. Newman [the controlling shareholder] raised his initial proposed offer price from $1.20
per share, the Special Committee and the Board believed that the Purchaser would not be willing to pay more than
$1.40 per Share.”).
18
4.4.1. Patterns of concession by the controller
I first examine the percentage increase from the controller’s first offer to the controller’s final
offer. I define the first offer as the first formal offer that the controller makes to the target board.
This offer is sometimes disclosed publicly at the time it is made, through a press release and 8-K
filing by the target company, though more often it is disclosed after the transaction is announced
in the company’s Schedule 14A filing. In five transactions the controller proposed a price range
as its first offer;23 in these cases I use the midpoint of the range as the first offer. Interestingly, in
no case did the special committee make the first offer, although in some transactions there was
substantial discussion between the controller and the special committee before the controller
made its offer. Eight transactions provide insufficient information in the target’s SEC filings in
order to be able to determine the controller’s first offer. These transactions are omitted from the
results reported in this Part.
I define the final offer as the final agreed price at which the transaction closes. Because a
final offer requires a completed transaction, I exclude failed transactions from the analysis. The
first offer and final offer for freeze-outs using stock are the proposed and agreed upon stock
exchange ratios. This approach avoids having to convert exchange ratios into cash equivalents,
which may introduce noise due to stock price fluctuations during the negotiation. So, for
example, if the controller increases the exchange ratio in a freeze-out for stock from 0.50 shares
to 0.55 shares, this is recorded as a 10% increase rather than converting 0.50 shares and 0.55
shares to cash equivalents on the dates that these offers were made.
As a starting point, Table 1 shows a large and statistically significant difference in the
percentage increase from the first offer to the final offer based on the transactional form used:
when the freeze-out is structured as a statutory merger, the controller increases its offer by 16.7%
on average, compared to 7.2%, on average, when the freeze-out is executed as a tender offer.
Median increases are equally striking: 11.2% for statutory mergers, compared to 4.2% for tender
offers. These findings are consistent with the general prediction that the lower standard of
23
See, e.g., RDO Equipment Press Release (Dec. 16, 2002) (“Mr. Offutt [the controller] stated in his letter that he
has not yet finally decided the offering price he is willing to pay for the Company shares he does not own.
However, he has indicated that he is currently considering an offer in a range of $5.22 to $5.66 per share.”).
19
review for tender offers should lead to greater bargaining power for (and hence fewer
concessions from) the controller.
To test the theory developed in Part 3, I further divide the aggregate statistics according to
whether the controller holds more or less than the median pre-deal stake (65%). Table 4A
reports the results.
[insert Table 4A about here]
Table 4A reveals that the overall difference in the controller’s increase between tender offers
and statutory mergers, as reported in Table 1, is driven entirely by transactions in which the
controller holds more than the median stake. When the controller holds less than 65% of the
target, the increase over the first offer is statistically indistinguishable between tender offers and
statutory mergers. This finding is consistent with hypothesis H2. In contrast, when the controller
holds more than 65% of the target, it increases its first offer by 19.0% in a statutory merger, on
average, but only 4.6% in a tender offer. This difference is statistically significant at 95%
confidence and is consistent with hypothesis H3. Figure 4 provides the breakdown of increases
over the controller’s initial offer, when the controller holds more than 65%.
Figure 4: Large Controllers’ Increase over First Offer by Transaction Form
60%
Statutory Merger
50%
% of transactions
Tender Offer
40%
30%
20%
10%
0%
0
1-5%
5-10%
10-15%
15-20%
20-25%
>25%
Increase over first offer
20
Figure 4 provides additional detail on the aggregate results reported in Table 4A. Figure 4
shows that half of all large controllers who execute successful tender offer freeze-outs do not
increase their first offers. This basic finding is in tension with practitioner and academic claims
that special committees have substantial bargaining power in tender offer freeze-outs.
In
addition, only 2 out of 18 controllers increased their first offer by more than 15% in tender offer
freeze-outs, and no controller increased its first offer by more than 25%. One interpretation for
these findings is that the elimination of entire fairness review, combined with simple majority
approval from the minority, gives the controller substantial bargaining power that it uses to pay
toward the lower end of the bargaining range.
Figure 4 reveals a different picture when the freeze-out is structured as a statutory merger. In
this case, half of all large controllers (10 out of 20) increase their first offers by at least 15%, and
one quarter of large controllers (5 out of 20) increase their first offers by 25% or more. One
interpretation for this finding is that the possibility for entire fairness review gives the special
committee bargaining power against the controller. These results also leave open the puzzle
identified in the previous Part, as to why a large controlling shareholder would structure a freezeout as a statutory merger in the post-Siliconix era. I return to this question in Part 5.
Of course, one concern with the analysis presented thus far is that first offers may be
endogenous to transactional form. For example, because Figure 4 shows that first offers are
more likely to “stick” in the case of a tender offer, a controller who knows this fact may be more
likely to offer closer to its best price as a first offer. If first offers are endogenous, then increases
over first offers do not provide an accurate measure of the controller’s concession to the special
committee. To attempt to address this concern, I now turn to evidence on deal premiums relative
to the targets’ pre-deal market price.
4.4.2. Premiums over pre-deal price24
In contrast to first offers, pre-deal market prices are relatively exogenous to the negotiation
process between the controller and the target’s special committee. However, using premiums
over market price as a measure of the special committee’s bargaining power suffers from other
24
The findings presented in this Part are particularly preliminary.
21
drawbacks because the minority stock in companies with a controlling shareholder is often thinly
traded; in fact it is this point that often motivates the controller to freeze out the minority in the
first place. In this Part I present data on premiums paid in freeze-out transactions over the predeal market price, again divided between tender offer and statutory merger freeze-outs. Because
market prices fluctuate, and because, more specifically, the pre-deal stock price may increase due
to rumors of an impending freeze-out, I use three baseline dates: one day prior to the date of the
first offer; one week prior to the date of the first offer; and four weeks prior. Tables 4B, 4C, and
4D present univariate statistics.
[insert Tables 4B, 4C & 4D about here]
Examining the first row of each of these tables, when the controller holds a below-median
stake, premiums received by minority shareholders in tender offers are lower than premiums
received in statutory mergers, but these differences are not statistically significant. When the
controller holds more than the median stake in the target, minority shareholders receive
premiums that are lower and statistically significant using certain baseline dates: 14.8% lower,
on average, using premiums over market price 1 day prior to first offer; 19.5% lower using
premiums over market price one week prior (a statistically significant difference at 90%
confidence); and 30.5% lower using premiums over market price four weeks prior (a statistically
significant difference at 95% confidence).
In general, the results presented in Tables 4B-4D are consistent with the results presented in
Table 4A and with hypotheses H2 and H3. The premium measures also provide some evidence
on the endogeneity of first offers to final outcomes. Putting together the findings from Tables
4A and 4D, I estimate that the average first offer in a tender offer freeze-out represents a 15%
premium over the pre-deal market price, and the average first offer in a statutory merger freezeout represents a 27% premium over pre-deal market price.25 This finding is inconsistent with the
theory that first offers are endogenous to final outcomes, which would predict that controllers in
freeze-out tender offers should make higher first offers, relative to pre-deal market price, because
25
Consider a target company with a pre-deal stock price of $100, and a controller with an above-median stake.
Using the premium data from Table 4D, the predicted final outcome in a tender offer freeze-out would be $120.70
per share and the predicted outcome in a statutory merger freeze-out would be $151.20. Table 4A then permits
working back to first offers: $115.39 for the tender offer (=$120.70 / 1.046) and $127.06 (= $151.20 / 1.19) for the
statutory merger, implying premiums of 15% and 27%, respectively.
22
such offers need to be increased by less. This finding also highlights the bargaining power that a
large controller has in a freeze-out tender offer: the controller starts lower, and increases its offer
by less, compared to a large controller in a statutory merger freeze-out.
In the next Part I control for other factors that might plausibly influence the bargaining
process between the controller and the special committee in freeze-outs.
4.4.3. Multivariate analysis
Following the same general approach as with transactional form, I now control for three
types of factors that might influence the bargaining relationship between the controller and the
special committee: target characteristics, controlling shareholder characteristics, and deal
characteristics. For the dependent variable I use the four outcome measures as described above:
the percentage increase over the controller’s first offer, and premiums paid over the pre-deal
market price of the stock one day prior, one week prior, and four weeks prior to the date of the
controller’s first offer.
In one model, I include the continuous variable CONTROL, the binary variable TENDER,
and the interaction CONTROL*TENDER. This specification allows different intercepts and
different slopes for tender offers across different controlling stakes, and permits a full test of
hypotheses H2 and H3. If hypothesis H2 is correct, then the coefficients for TENDER and
CONTROL should be statistically insignificant. If hypothesis H3 is correct, then the coefficient
for CONTROL*TENDER should be statistically significant and negative. In another model, I
replace the continuous variable CONTROL with the binary variable LOWCONTROL (set to 1 if
the controller holds less than the median stake) and the continuous interaction variable
CONTROL*TENDER with the binary variable LOWCONTROL*TENDER. In this model, the
prediction is that LOWCONTROL and LOWCONTROL*TENDER will be statistically
insignificant (H2) and that TENDER will be statistically significant and negative (H3).
All models are run as ordinary least squares (OLS) regressions. The results are reported in
Table 5.
[insert Table 5 about here]
23
In Panel A, CONTROL and TENDER are statistically insignificant in all models, consistent
with hypothesis H2. The interaction CONTROL*TENDER is negative in all models, consistent
with hypothesis H3, but it is not statistically significant in any of the models.
The only
statistically significant result at 95% confidence is that private equity buyers seem to pay higher
premiums in certain models, but again this result is unstable and not statistically significant in
other models.
In Panel B, the TENDER coefficient is negative in all models, consistent with hypothesis H3,
and highly significant with respect to increases over first offers and premiums over market price
four weeks prior to announcement.26
LOWCONTROL, as well as the interaction term
LOWCONTROL*TENDER, are statistically insignificant at 95% confidence in all models,
consistent with hypothesis H2.
5. Discussion
5.1. Interpretation of results
The results presented in this paper suggest that the size of the controller’s pre-deal stake
influences the choice of transactional form between tender offer and statutory merger. This
finding supports the intuitive claim that controllers will seek to avoid supermajority approval
from the minority when possible. It also confirms the point that tender offers and statutory
mergers are not substitute mechanisms for eliminating minority shareholders, as some
commentators have assumed.
On outcomes, I find no evidence that outcomes are different for minority shareholders
between tender offers and statutory mergers when the controller’s stake is relatively small, below
65%. This finding is inconsistent with academic commentary that assumes that standard of
review influences the price paid, but is consistent with the model developed in this paper
suggesting that the supermajority approval required from the minority in a tender offer can
provide built-in protection for minority shareholders that adequately substitutes for the lower
standard of judicial review.
26
In unreported regressions I run the Panel B model on Delaware targets only. In this model the coefficient for
TENDER continues to be negative in all models and statistically significant at 90% confidence with respect to
increases over first offers and premiums over market price four weeks prior to initiation.
24
In contrast, when the controller holds a relatively large stake, this paper presents some
evidence that controllers pay less in tender offer freeze-outs than in statutory merger freeze-outs.
Measured by increases over first offers, the evidence is quite strong: large controllers are less
likely to increase their first offer, and when they do so make smaller increases, in tender offers
compared to statutory mergers. Measured by premiums over pre-deal market price, the evidence
is directionally consistent with the findings on first offers, but is statistically significant only in
some models. The lower level of statistical significance for premiums may be due to the
noisiness of the measure (because minority stock is often thinly traded), the small sample, or
both.
Still, the overall picture is broadly consistent with the notion that large controllers can (and
do) wield bargaining power over the minority, while smaller controllers cannot. Put colloquially,
one interpretation of these results is that small controllers cannot “turn the screws” on the special
committee because of the need for supermajority approval from the minority; therefore they
cannot make use of the loophole provided by Siliconix on entire fairness review.
Large
controllers, in contrast, can turn the screws on the special committee if they proceed via tender
offer because they do not need supermajority approval from the minority and they avoid entire
fairness review.
Of course, if these conclusions are correct then a puzzle remains: why do large controllers
ever proceed via statutory merger, in the aftermath of Siliconix? One possibility is that largecontroller statutory mergers will become a historical artifact as practitioners fully understand the
implications of Siliconix. However, this “learning” story is in tension with the evidence from my
sample indicating no time trend in the data toward tender offers and away from statutory mergers
for large controllers. Another, related, possibility is that certain lawyers and law firms are more
comfortable proceeding through the traditional statutory merger route rather than through the
relatively unexplored tender offer route. In particular, given the pronouncements by some New
York City lawyers that all or virtually all freeze-outs are now done through tender offers to the
minority, one might expect a split between New York City law firms (which would advise large
controllers to use tender offers) and non-New York City law firms (which would not). However,
preliminary analysis of controller-side legal advisors suggests no such divide. A final possibility
is that practitioners are wary of pushing the Siliconix mechanism too far because of the fear that
25
the Delaware Supreme Court will overrule Siliconix and close the loophole.
As described by
Charles Nathan, a partner at Latham & Watkins in New York City: “The risk is being the poster
child for the reversal of Siliconix.”27 Of course, this risk would be substantially reduced if the
Delaware Supreme Court were to endorse Siliconix.
5.2. Implications
As a threshold issue, the results presented in this paper bolster the argument for doctrinal
convergence between tender offers and statutory mergers by identifying an efficiency loss (not
just a one-time wealth transfer) that the current regime creates. Practitioners and some academic
commentators have suspected that the differences in standards of review have created differences
in outcomes for minority shareholders; this paper presents empirical evidence that is consistent
with this intuition. This difference in outcomes, combined with the continued use of both
transactional forms, introduces systematic (non-diversifiable) risk to the extent that all publiclyheld companies have some likelihood of becoming (or currently are) controlled companies.
Because important factors such as the controller’s stake and transactional form at exit cannot
always be predicted ex ante through observable firm characteristics, even fully-diversified
investors will need to be compensated for this market-wide increased risk at exit.
Thus the
Siliconix/Glassman regime creates an efficiency loss, not just a one-time wealth transfer from
minority shareholders to the controller.
The question then becomes how best to resolve the doctrinal tension. If the Delaware
Supreme Court chooses to overrule Siliconix and impose entire fairness review on freeze-out
tender offers, the findings presented here suggest that the controller’s pre-deal stake should be an
important factor in applying the fair process prong of entire fairness review. Specifically, when
the controller is small, the supermajority vote required from the minority should serve as strong
evidence on fair process. This approach would reserve a full-blown entire fairness inquiry for
cases where the controller is large and minority shareholders therefore do not have the built-in
protection of a supermajority approval requirement.
27
Charles Nathan, Daily Deal 2001.
26
If instead the Delaware Supreme Court chooses to preserve Siliconix but provide procedural
protections for minority shareholders in tender offers, the evidence presented in this paper
suggests that the protections enumerated in Pure Resources do not go far enough. This paper
presents evidence that virtually all post-Siliconix freeze-out tender offers include a majority-ofthe-minority condition and a back-end guarantee, yet minority shareholders in these deals seem
to receive lower prices than minority shareholders in freeze-out mergers when the controller is
large. The explanation for this finding can potentially be found through an examination of first
principles of Delaware freeze-out law. At the highest level, the corporate law objective in
freeze-outs is to provide minority shareholders with adequate proxies for both elements of the
§251 statutory merger process, namely, board approval and shareholder approval. The anticoercion conditions in Pure address the second element of this statutory scheme but not the first,
and the evidence presented in this paper suggests that the two steps are not substitutes for each
other: that is, the binary choice of a tender decision by a minority shareholder does not serve the
same function as vigorous bargaining by a special committee. In particular, the threat of a
withheld tender might be effective against grossly inadequate offers but may not be effective in
providing more than the low end of the bargaining range, much less a “fair” price.
If the Delaware Supreme Court chooses to preserve Siliconix, then, the Pure anti-coercion
condition should be supplemented with meaningful SC bargaining power. In the statutory
merger context, Delaware courts have looked to the SC’s veto power as the primary source of
bargaining leverage against the controller.28 In this respect there is a significant difference
between the two transactional forms.
While a statutory merger freeze-out cannot proceed
without SC approval, a tender offer freeze-out does not require SC approval and, in fact, is often
initiated by the controller before the SC is even formed. A promising expansion of Pure, then,
would bestow veto power for SC’s in tender offer freeze-outs by mandating SC authority to
adopt a pill.29 Doctrinally, the Delaware Supreme Court might expand fiduciary duty concepts
so that the SC should seek, and the target board should give, the ability to block the bid through
28
See, e.g., Kahn v. Lynch Communications, Inc., 638 A.2d 1110 (Del. 1994); In re Western Nat’l Corp., 2000 WL
710192 (2000).
29
This approach is also advocated by Gilson & Gordon (2003), who would require SC power to adopt an Intercostyle pill in addition to the Pure Resources procedural protections in order to avoid entire fairness review. The
Delaware Chancery Court has recently confirmed the legal validity of such a maneuver. See Creo, Inc. v. Printcafe
Software, Inc (Del. Ch. Feb. 21, 2003) (unpublished opinion).
27
the use of a pill, even if the offer is not coercive to minority shareholders. This expansion was
considered and rejected in Pure Resources itself, though Vice Chancellor Leo Strine noted in his
opinion the “analytical and normative appeal” of such an approach.30
To date, a special committee has adopted a pill against a controller only once, in ICN
Pharmaceutical’s June 2003 freeze-out tender offer for the remaining 19.9% interest in
Ribapharm. This move yielded a 12% increase over ICN’s initial offer, which is toward the
higher end of increases extracted by special committees against controllers in freeze-out tender
offers.31
This one experience with SC veto power through a pill, therefore, seems to be
consistent with the goal of providing the SC equal bargaining power in a freeze-out tender that it
has in a freeze-out statutory merger.
6. Conclusion
Cross-country analysis indicates a connection between corporate value and legal protections
for minority shareholders. (La Porta, Lopes-de-Silanes, Shleifer & Vishny, 2002) While this link
is likely to be muted within the United States, perhaps due to the relative effectiveness of private
ordering (e.g., Subramanian 2004), recent changes in the protection afforded minority
shareholders under the Delaware common law have attracted considerable practitioner and
academic commentary over the past three years. This paper presents the first econometric
evidence on the influence of these doctrinal movements on freeze-out transactional form and
freeze-out outcomes.
There are three principal findings.
First, consistent with the model
developed in this paper, I find that the size of the controller’s pre-deal stake is an important
factor in determining transactional form. Second, I find no evidence that outcomes for minority
shareholders are different between freeze-out tender offers and freeze-out mergers when the
controller is relatively small.
Finally, I find some evidence that outcomes for minority
shareholders are worse in freeze-out tender offers relative to freeze-out mergers when the
controller is relatively large. Taken together, these findings are consistent with the view that a
30
See Pure Resources, 808 A.2d 421, 446. It appears that the Vice Chancellor rejected this argument in order to
preserve the possibility of reduced managerial discretion in deploying pills against third-party hostile tender offers.
There are, however, ways of achieving this goal with respect to third-party tender offers while taking as given the
validity of a “Just Say No” pill. Put differently, it would not require a retreat to an Interco-style pill with respect to
third-party offers in order to achieve a more vibrant market for corporate control. See, e.g., Bebchuk, Coates &
Subramanian 2002a, 2002b, 2003.
31
See Figure 4.
28
controlling shareholder has considerable bargaining power against the special committee and
minority shareholders when it holds a large pre-deal stake in the target, but not when it holds a
small pre-deal stake.
Conversations with Delaware Supreme Court and Chancery Court judges, as well as
conversations with New York City and Wilmington, Delaware practitioners, suggest that the
Delaware Supreme Court will need to address the doctrinal question raised by Siliconix, namely,
the appropriate standard of judicial review for freeze-out tender offers. The findings presented
in this paper might provide some guidance to the Court in handling this issue. If the Delaware
Supreme Court overrules Siliconix and imposes entire fairness review on freeze-out tender
offers, the evidence presented here suggests that the controller’s pre-deal stake should be an
important factor in applying the fair process prong of entire fairness review. If instead, the
Supreme Court endorses Siliconix and confirms that freeze-out tender offers are not subject to
entire fairness review, the Court should extend the procedural protections enumerated by the
Chancery Court in Pure Resources to include special committee veto power in tender offer
freeze-outs, through the ability to adopt a poison pill.
29
References
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Coates, J.C., 1999. “Fair value” as an avoidable rule of corporate law: minority discounts in
conflict transactions. University of Pennsylvania Law Review 147, 1251-1353.
30
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31
Table 1: Summary Statistics by Transaction Form
This table reports summary statistics on all freeze-out transactions announced and resolved between June 19, 2001,
when the Delaware Chancery Court issued its opinion in Siliconix, and December 31, 2003 (n=96). Two reverse
stock splits are categorized as statutory mergers for reasons described in the text. * = statistically significant
difference between means at 90% confidence; ** = statistically significant at 95% confidence; *** = statistically
significant at 99% confidence
Mean (median)
Target Characteristics
Transaction value ($MM)
Delaware incorporation
Controller pre-announcement stake
Controlling Shareholder
Founder or family group
Private equity firm
Corporate parent
Deal Characteristics
Controller success rate
Stock consideration
Days between initiation and close
Bargaining process (successful deals)
Increase over first offer
Final premium over pre-announcement
trading price:
1 day prior
1 week prior
4 weeks prior
All Transactions
(n=96)
Tender Offers
(n=27)
Statutory Mergers
(n=69)
142.7 (16.8)
62.5%
64.5% (65.0%)
194.4 (25.5)
74.1%
70.2% (72.7%)
122.5 (12.1)
58.0%
62.6% (62.9%)
26.4%
24.2%
49.5%
17.9%
14.3%
67.9%**
30.2%
28.6%
41.3%**
79.2%
20.8%
158 (135)
92.6%
18.5%
100 (100)***
73.9%
21.7%
189 (185)***
13.3% (8.3%)
7.2% (4.2%)***
16.7% (11.2%)***
44.9% (30.7%)
43.6% (32.8%)
43.9% (35.9%)
35.6% (28.6%)*
28.5% (27.4%)***
24.4% (25.2%)***
50.0% (33.3%)*
51.6% (33.1%)***
54.5% (43.6%)***
32
Table 2: Summary Statistics for Tender Offers, by Controller Stake
This table reports summary statistics on all freeze-out tender offers announced and resolved between June 19, 2001,
when the Delaware Chancery Court issued its opinion in Siliconix, and December 31, 2003 (n=27). * = statistically
significant difference between means at 90% confidence; ** = statistically significant at 95% confidence; *** =
statistically significant at 99% confidence.
% of deals, or Mean (median)
All Tender Offers
(n=27)
Controller’s Stake
Below Median
(n=8)
Controller’s Stake
Above Median
(n=19)
Negotiation process:
SC formed
SC hires financial & legal advisors
92.6%
96.3%
100%
100%
89.5%
94.7%
SC recommendation:
Approve
Neutral
Reject
No SC
66.7%
11.1%
14.8%
7.4%
75.0%
0.0%
25.0%
0.0%
63.2%
15.8%
10.5%
10.5%
88.9%
75.0%
94.7%
96.3%
100%
94.7%
73.7% (78.0%)
92.6%
72.6% (84.0%)
75.0%
74.2% (76.9%)
100%
Offer conditions:
Non-waivable majority-of-theminority condition
Back-end guarantee at same price
Outcome:
Tendered into front-end offer (%)
Completed (%)
33
Table 3: Transaction Form – Multivariate Analysis
This table reports regression estimates on the association between the controller’s choice of transactional form
(tender offer or statutory merger) and target, controller, and deal characteristics. The dependent variable in all
models is TENDER, set to 1 if the freeze-out is structured as a tender offer and 0 otherwise. Statutory mergers
executed as two-step tender offers and reverse stock splits are grouped with statutory mergers. * = statistically
significant at 90% confidence; ** = statistically significant at 95% confidence; *** = statistically significant at 99%
confidence. All models are run as logit regressions and include a constant term (not reported).
All Deals
Successful Deals Only
#3
#4
#1
#2
0.41 (0.16)**
0.72 (0.58)
0.05 (0.02)**
0.22 (0.13)*
0.42 (0.55)
0.05 (0.02)**
0.37 (0.17)**
0.48 (0.64)
0.07 (0.03)***
0.21 (0.14)
0.14 (0.60)
0.07 (0.03)***
Controlling Shareholder
Private equity firm?
Corporate parent
0.08 (0.98)
0.81 (0.67)
0.13 (0.96)
0.42 (0.66)
-0.13 (1.29)
0.68 (0.71)
-0.10 (1.28)
0.34 (0.69)
Deal Characteristics
Stock consideration used
-2.11 (0.81)***
Number of observations
Pseudo R-sq
96
20.1%
Target Characteristics
Log(transaction value)
Delaware incorporation
Controller’s stake
-1.81 (0.85)**
96
13.1%
76
19.9%
76
14.7%
34
Table 4A-4D: Negotiated Outcomes by Controller’s Stake, Transactional Form
This table reports the outcomes by the controlling stake of the acquirer and the transactional form used. Median
control stake in the sample is 65% of the voting shares. For reasons discussed in the text, statutory mergers
executed as two-step tender offers and reverse stock splits are grouped with statutory mergers. * = statistically
significant difference between means at 90% confidence; ** = statistically significant at 95% confidence; *** =
statistically significant at 99% confidence.
Table 4A: Increases Over First Offer
Mean (median)
Controller’s stake:
Transactional form:
Tender Offer
Statutory Merger
Below median
14.8% (13.6%)
14.8% (10.4%)
Above median
4.6 (1.6%)**
19.0% (13.7%)**
Table 4B: Premium Paid Over Market Price 1 Day Prior to Deal Initiation
Mean (median)
Controller’s stake:
Transactional form:
Tender Offer
Statutory Merger
Below median
52.2% (43.8%)
53.1% (34.0%)
Above median
29.8% (25.0%)
44.6% (32.6%)
Table 4C: Premium Paid Over Market Price 1 Week Prior to Deal Initiation
Mean (median)
Controller’s stake:
Transactional form:
Tender Offer
Statutory Merger
Below median
39.6% (41.4%)
55.3% (31.9%)
Above median
25.3% (22.6%)*
44.8% (35.6%)*
Table 4D: Premium Paid Over Market Price 4 Weeks Prior to Deal Initiation
Mean (median)
Controller’s stake:
Transactional form:
Tender Offer
Statutory Merger
Below median
35.8% (38.2%)
56.4% (39.6%)
Above median
20.7% (23.6%)**
51.2% (48.5%)**
35
Table 5: Negotiated Outcomes – Multivariate Analysis
This table reports regression estimates on the association between the outcome for minority shareholders and target,
controller, and deal characteristics. In Panel A I use a continuous variable CONTROL measuring the controller’s
voting control of the target. In Panel B I use a dichotomous variable LOWCONTROL?, set to 1 if the controller
holds less than the median stake (65%) in the target and 0 otherwise. * = statistically significant at 90% confidence;
** = statistically significant at 95% confidence; *** = statistically significant at 99% confidence. All models are
run as ordinary least squares (OLS) regressions and include a constant term (not reported).
Panel A: Continuous measure of control
Dependent variable Î
Increase over
first offer
Premium over
market price 1 day
prior to initiation
Premium over
market price 1 week
prior to initiation
Premium over
market price 4 weeks
prior to initiation
Target Characteristics
Log(transaction value)
Delaware incorporation
-1.65 (1.20)
8.37 (4.50)*
-4.53 (3.36)
7.33 (10.90)
-4.28 (3.47)
5.33 (11.26)
-4.11 (3.23)
0.71 (10.54)
Controlling Shareholder
Private equity firm?
Corporate parent?
Controller stake
Controller stake * Tender offer
-11.40 (7.84)
-1.61 (5.24)
0.12 (0.26)
-0.56 (0.39)
38.50 (17.97)**
16.92 (13.07)
-0.35 (0.56)
-0.43 (0.89)
38.92 (18.37)**
10.40 (13.59)
-0.22 (0.57)
-0.19 (0.98)
27.06 (17.84)
6.19 (12.56)
-0.09 (0.56)
-0.36 (0.88)
Deal Characteristics
Tender offer
Stock consideration used
29.64 (26.96)
9.05 (6.28)
21.95 (61.71)
-12.75 (15.09)
-2.36 (69.57)
-10.96 (15.46)
-0.13 (61.07)
-13.41 (14.70)
Number of observations
Adj. R-sq
67
13.6%
65
9.6%
64
11.3%
68
14.5%
Panel B: Binary measure of control
Dependent variable Î
Increase over
first offer
Premium over
market price 1 day
prior to initiation
Premium over
market price 1 week
prior to initiation
Premium over
market price 4 weeks
prior to initiation
Target Characteristics
Log(transaction value)
Delaware incorporation
-1.64 (1.15)
9.17 (4.50)**
-4.08 (3.31)
7.93 (10.81)
-4.07 (3.40)
6.02 (11.19)
-4.05 (3.21)
0.73 (10.47)
Controlling Shareholder
Private equity firm?
Corporate parent
Low control (below median)
Low control * Tender offer
-10.97 (7.40)
-0.71 (5.26)
-4.23 (5.36)
17.87 (9.65)*
41.70 (17.46)**
19.79 (13.33)
9.10 (13.12)
17.25 (23.10)
40.79 (17.83)**
13.58 (13.92)
9.57 (13.41)
8.88 (24.82)
27.76 (17.40)
8.01 (12.76)
4.92 (12.61)
8.35 (22.77)
Deal Characteristics
Tender offer
Stock consideration used
-15.46 (5.58)***
9.69 (6.28)
-14.92 (14.21)
-14.43 (15.25)
-18.33 (14.52)
-12.79 (15.62)
-27.70 (13.78)**
-14.18 (14.83)
Number of observations
Adj. R-sq
67
14.9%
65
10.6%
64
12.6%
68
14.7%
36