Finding the Right Balance in Appraisal Litigation: Deal Price, Deal Process, and Synergies
Lawrence A. Hamermesh and Michael L. Wachter, 73(4) 961-1010 (Fall 2018)
This article examines the evolution of Delaware appraisal litigation and concludes that recent precedents have created a satisfactory framework in which the remedy is most effective in the case of transactions where there is the greatest reason to question the efficacy of the market for corporate control, and vice versa. We suggest that, in effect, the developing framework invites the courts to accept the deal price as the proper measure of fair value, not because of any presumption that would operate in the absence of proof, but where the proponent of the transaction affirmatively demonstrates that the transaction would survive judicial review under the enhanced scrutiny standard applicable to fiduciary duty-based challenges to sales of corporate control. We also suggest, however, that the courts and expert witnesses should and are likely to refine the manner in which elements of value (synergies) should, as a matter of well-established law, be deducted from the deal price to arrive at an appropriate estimate of fair value.
Appraisal Rights and Economic Growth
Richard A. Booth, 73(4) 1011-1030 (Fall 2018)
In disputes relating to valuation where there is reason to doubt the fairness of deal price, the courts prefer the discounted cash flow (DCF) method and the capital asset pricing model (CAPM). Under this approach the standard practice is to calculate value year-by-year for the coming five years (the projection period), to use projected average cash flow to calculate value for the period thereafter (the terminal period), and to sum the two. Because cash flow differs from GAAP earnings primarily by netting out funds reinvested in the firm (plowback), future returns can be expected to grow. Thus, one must adjust for expected growth during the terminal period, which is typically accomplished by reducing the discount rate by the projected inflation rate plus the GDP growth rate, because a firm must keep up with inflation (lest the firm disappear over time) and because economic growth comes from returns generated by business. But if plowback generates return at the same rate ordinarily required of the firm, growth in value will be equal to plowback. Thus, it would be simpler to use projected GAAP earnings as the measure of return for the terminal period without any adjustment to the discount rate. To use cash flow together with an adjusted discount rate is akin to making Maraschino cherries—which are first soaked in lye to remove color and flavor and then soaked in food coloring and sugar to put it back. The question is whether long-term growth in firm value is limited to growth from plowback. There is good reason to think that it is so limited because opportunities to generate above normal returns (economic rents) are likely to dissipate because of competition. Still, it is possible that firms do grow by more than can be explained by plowback. But data are to the contrary. Since 1930, S&P 500 growth can be fully explained by plowback (GAAP earnings less dividends) together with likely reinvestment by investors. Although plowback during this period has been just enough to match inflation, remaining growth in stock prices is slightly less than would be expected by dividend reinvestment, which is consistent with diversion of some portion of dividends to consumption. The data since 2000 are somewhat different in that plowback has been less than inflation, but stock prices have nonetheless increased consistent with reinvestment. The bottom line is that real stock prices seem to grow at a rate slightly more than the real GDP growth rate but a bit less than the plowback rate plus the likely reinvestment rate. It follows that there is no reason for stockholders to expect growth at any greater rate and thus no need for courts to struggle with estimating growth rates: By using projected GAAP earnings as the measure of average long-term return, the courts can use an unadjusted discount rate to calculate terminal value.
How Efficient Is Sufficient: Applying the Concept of Market Efficiency in Litigation Bradford Cornell and John Haut, 74(2) 417-434 (Spring 2019)
The concept of market efficiency has been adopted by courts in a variety of contexts. In reality, markets can never be perfectly efficient or inefficient, but exist somewhere in between depending on the facts and circumstances. Courts, therefore, face a problem in deciding how efficient is sufficient in any particular legal context. Because market prices incorporate the views of numerous market participants, courts have often been willing to presume that a market is efficient so long as the appropriate criteria are satisfied. However, those criteria are different for different types of cases, such as securities class actions, appraisal actions, and cram downs in bankruptcy.
Asking the Right Question: The Statutory Right of Appraisal and Efficient Markets
Jonathan Macey and Joshua Mitts, 74(4): 1015-1064
In this article, we make several contributions to the literature on appraisal rights and similar cases in which courts assign values to a company’s shares in the litigation context. First, we applaud the recent trend in Delaware cases to consider the market prices of the stock of the company being valued if that stock trades in an efficient market, and we defend this market-oriented methodology against claims that recent discoveries in behavioral finance indicate that share prices are unreliable due to various cognitive biases. Next, we propose that the framework and methodology for utilizing market prices be clarified. We maintain that courts should look at the market price of the securities of a target company whose shares are being valued, unadjusted for the news of the merger, rather than at the deal price that was reached by the parties in the transaction.