A Shareholders' Put Option: Counteracting the Acquirer Overpayment Problem

By Afra Afsharipour. Full text here.

Acquisition transactions are often the most significant activity undertaken by corporations. Despite the plethora of acquisition transactions, numerous empirical studies find that large-scale acquisition transactions involving public companies result in significant losses for acquiring firms and their shareholders. Finance scholars have attributed these losses to managerial agency costs (such as personal benefits in the form of increased compensation for management) and behavioral biases (such as ego and hubris) of boards and management.

Curiously, corporate law has remained largely silent in the face of this evidence. Acquisition transactions involve fundamental questions pertaining to the allocation of power between managers and shareholders. While corporate law has robust doctrines pertaining to the rights of shareholders of selling firms, it gives little attention to shareholders of acquiring firms. Under current statutory schemes, acquirer shareholders rarely enjoy any decision-making role in acquisitions. Moreover, judicial doctrine’s deferential stance toward the acquirer’s management means that acquirer shareholders are unable to seek any redress through the courts.

The Article proposes a novel solution to alter the stark imbalances in power between managers and shareholders of acquiring firms: a shareholders’ put option. The market pricing and shareholder direct participation contemplated by this proposal offer a referendum and monetary mechanism through which shareholders of acquiring firms could participate in acquisition decisions. The Article also provides a market-oriented incentive and process through which boards of acquiring firms could meaningfully consider whether to acquire another firm and how to properly value it. A diligent board could in fact use the put option to signal a well-valued transaction. Moreover, if exercised, a shareholders’ put option would force the acquirer’s management to internalize the costs of a value-destroying acquisition. If successfully used, a shareholders’ put option may be an optimal way to alter the balance of power in acquisition transactions so as to address the destruction of value suffered by acquirer shareholders.