Voting Rights, Private Benefits, and Takeovers

T his article presents a textbook exposition of the effects that institutional design of the firm has on allocation of control over assets. The efficient allocation of control over the assets bundled up in the firm is necessary for the optimal allocation of its resources. Dynamic efficiency in resource allocation presupposes that control over firms will change hands when a given allocation turns suboptimal. The institutional framework within which control changes hands is called the market for corporate control. This market is closely linked to the stock market as control rights over the assets of the firm are linked to voting stock. We analyze how the allocation of shareholder voting rights and other organizational designs of the firm affect the firm’s stock market valuation and the allocation of control over its assets. Transactions in the market for corporate control have increased greatly over the last decade both in number and value. Figure 1 shows that in the United States the number of acquisitions of publicly traded companies quadrupled between a trough in 1991 and a recent peak in 1999. Measured in dollar terms (without inflation adjustment), the rise in acquisitions of publicly traded companies was 30-fold during that period. Among the 50 industries distinguished by Mergerstat (2000, pp. 61-69), “Banking & Finance” was among the seven most active industries in any year in the 1996-2000 period as measured by number of transactions announced. Based on the dollar value offered in announced acquisitions, Banking & Finance was among the six most active industries in that same period and topped the rankings in the years 1997 and 1998. The mechanics of the market for corporate control are determined by the legal system. Most importantly, the legal system shapes the incentive structure to which the participants in the market for corporate control respond in their actions. Moreover, the incentive structure in place has important efficiency implications. If designed optimally, society’s legal system directs the self-interest of economic agents toward the optimal social outcome. Most significant to the legal framework of the market for corporate control are the firm’s articles of association and bylaws. There is also Securities and Exchange Commission (SEC) regulation, and there are the specific rules of the respective stock exchanges (such as the New York Stock Exchange, Nasdaq, and the American Stock Exchange). Articles of association and bylaws vary across corporations. For instance, corporations may have the choice to amend their articles of association such that unsolicited bidders find it difficult to obtain control over the assets. The legal options that are available to corporations vary across state lines. For instance, a wide variety of anti-takeover amendments exist for Delaware corporations, such as supermajority rules for decisions that pertain to mergers or to the removal of board members.1 There are also cross-country differences in corporations’ articles of association, which become important in crossborder merger and acquisitions transactions. Acquisitions of publicly traded companies typically involve block trades or tender offers. In a block trade, an investor acquires a block of shares from a large shareholder. In a tender offer, an investor bids for shares that are dispersed across a multitude of mostly small shareholders. Block trades are public transactions, while tender offers are private deals. Both types of transactions might be preceded, accompanied, or followed by acquisitions of shares in the open market. Changes in control that occur through block trades are common on the European continent, where tender offers are rare.2 In the United States, on the other hand, 27 percent of all acquisitions of publicly traded companies in 2000 were brought about through tender offers (see Figure 2). Two kinds of value matter for wealthmaximization when control over the firm changes hands. First, there is what is commonly referred to as the public value of the firm, i.e., the market value of its securities. Second, there might be a private value of the firm, through which an investor enjoys some benefit while exercising control over the firm. Private control benefits are most significant for entrepreneurial start-ups, established family-owned businesses, and organizations where personal investors also pursue non-pecuniary goals, such