Defining Appraisal Fair Value

Note — Volume 106, Issue 5

106 Va. L. Rev. 1183
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*J.D. & M.B.A., University of Virginia, 2020. I am very grateful to Professor Quinn Curtis, who introduced me to corporate law and advised me on this Note. For helpful comments and suggestions, I thank Wade Houston, Will Walsh, George Geis, Joe Fore, Nick Carey, Rebecca Lamb, F.D. Carroll, Matt Hoffer-Hawlik, and Matt Levine. I thank Charlotte K. Newell for educating me about the history of Delaware’s appraisal statute, and the staff of the Virginia Law Review for their input and editorial work on this Note—especially Matt West.Show More

Appraisal is a statutory mechanism that entitles dissenting stockholders of Delaware merger targets to receive a judicially determined valuation of their shares. During a decade when Delaware courts significantly constrained other legal avenues of merger dissent, appraisal petitions increased dramatically, with individual cases potentially implicating billions of dollars of stockholder value. Recent appraisal case law has sparked considerable controversy over the role of market prices in courts’ appraisal valuations. Courts and commentators have struggled to articulate exactly when market prices are the best evidence of fair value, as well as what types of market prices are most relevant to appraisal fair value. This Note presents a revised conception of appraisal fair value that is informed by economic theory and rooted in Delaware corporate law’s longstanding goals of facilitating capital formation and maximizing stockholder value.

This Note proposes two changes to existing conceptions of merger deal prices in appraisal cases. First, the appraisal statute should be understood to exclude the value of reduced agency costs from appraisal awards. Second, when material non-public information is disclosed to the buyer but withheld from the market, both the appraisal statute and basic notions of market efficiency demand that courts take cognizance of it. The best way to operationalize these conceptual modifications is to presume that the target’s unaffected stock price equals fair value unless the petitioner establishes that material information was withheld from the market.

This approach adds needed clarity to the Delaware Supreme Court’s salutary recent embrace of the efficient capital markets hypothesis in the appraisal context. Adopting it would increase stockholder value, encourage efficient change-of-control transactions, and simplify appraisal proceedings. It preserves appraisal’s foundational role as a safeguard against the exploitation of minority stockholders by compensating them when the deal price omits suppressed material information.

I. Introduction

Section 262 of the Delaware General Corporation Law (“DGCL”) provides that a dissenting target stockholder in a merger or consolidation transaction may petition the Court of Chancery for an award of the fair value of her shares.1.Del. Code Ann. tit. 8, § 262 (2020). The appraisal remedy is limited to two types of transactions: “squeeze-outs” effected under §§ 253 and 267, and other mergers or consolidation transactions involving some cash consideration. See id.Show More Appraisal is a critical safety net for minority stockholders, and appraisal petitions increased dramatically during the past decade as Delaware courts have constrained other methods for challenging change-of-control transactions.2.See infra notes 20–22 and accompanying text.Show More Disagreement persists about whether and when the market price, the deal price, or some other metric is the best indicator of fair value. Each of these approaches is rooted in an incomplete conception of the determinants of merger prices. This Note presents a revised model of merger deal prices that resolves many of the theoretical and practical impediments to articulating a properly functional appraisal remedy. It then suggests a method for operationalizing the revised model.

In two 2017 decisions, the Delaware Supreme Court (“Supreme Court”) relied on the Efficient Capital Markets Hypothesis (“ECMH”) to reverse the Court of Chancery and endorse the deal price as the best evidence of fair value. The decisions and the Supreme Court’s treatment of the ECMH sparked widespread debate about the proper role of the ECMH in appraisal law and the broader purposes of the appraisal statute. Unresolved questions about the proper role of the ECMH and its broader purposes remain pending before the Supreme Court as of the time of this writing. Although Delaware’s recent emphasis on the ECMH is a welcome development, its failure to account for the role of reduced agency costs and the value of non-public information threatens to undermine the benefits of adopting the ECMH. A more complete theory of appraisal law must acknowledge two critical facts. First, agency cost reductions—the value created by replacing existing managers with more effective ones—are a key motivation for pursuing mergers, and they should belong to the acquirer. To incentivize efficient change-of-control transactions, courts should exclude the value of reduced agency costs from appraisal awards. Second, the value of non-public information about the target company is often a key element of merger prices. By relying on the ECMH without explicitly incorporating the value of non-public information into appraisal fair value, courts subvert the theory’s ability to provide reliable estimates of fair value. The best formulation of the appraisal remedy—and the one most consistent with the ECMH, the appraisal statute, and the purposes of Delaware corporate law—presumes market prices are fair in the absence of evidence that material non-public information was withheld from the market.

To define the “fair value” of an appraisal petitioner’s shares, it is first necessary to re-examine the composition of merger deal prices. If the target company’s stock trades in an efficient market, then its stock price “reflects all publicly available information as a consensus, per-share valuation.”3.Dell, Inc. v. Magnetar Glob. Event Driven Master Fund Ltd. (Dell), 177 A.3d 1, 16 (Del. 2017).Show More The existing stock price sets the presumptive baseline for merger fair value because no rational stockholder would tender her shares to an acquirer at a lower price than she would receive on the open market.4.It is assumed that the Supreme Court has endorsed the ECMH inclusive of that theory’s conventional assumption that market participants are rational. See Steven M. Sheffrin, Rational Expectations 99 (2d ed. 1996). This assumption is uncontroversial in the present context—i.e., it is beyond doubt that no reasonable shareholder would tender her shares at a lower price than she could readily receive elsewhere—but it has been contested in others. See, e.g., Franco Modigliani & Richard A. Cohn, Inflation, Rational Valuation and the Market, 35 Fin. Analysts J. 24, 24 (1979) (arguing that persistent inflation distorts market prices of securities, a finding inconsistent with some forms of the ECMH); Lawrence H. Summers, Does the Stock Market Rationally Reflect Fundamental Values?, 41 J. Fin. 591 (1986) (arguing that empirical evidence does not conclusively confirm the ECMH and that market prices do not always rationally reflect the fundamental values of securities). This Note does not aspire to contribute to scholarly commentary on the ECMH; like the Supreme Court, it adopts the hypothesis as a tool for deciding appraisal cases. See Dell, 177 A.3d at 24; see also Are Markets Efficient?, Chi. Booth Rev. (June 30, 2016), https://review.chicagobooth.edu/­economics/2016/video/are-markets-efficient [https://perma.cc/7HBU-C4ZL] (interview with Eugene Fama and Richard Thaler) (“The point is not that markets are efficient. . . . It’s just a model.”).Show More The second component of merger prices is the value of merger “synergies,” the value created by combining formerly separate business units. Agency cost reductions are a third source of value, created when an acquirer replaces existing management with superior business administrators. Finally, material non-public information (MNPI) is an often-overlooked fourth component of merger value. Prospective buyers receive MNPI during the diligence phase of merger transactions.5.See infra Section III.B.Show More MNPI is by definition relevant to company value; it is information which “would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information available” about the company.6.Klang v. Smith’s Food & Drug Ctrs., Inc., 702 A.2d 150, 156 (Del. 1997) (quoting Rosenblatt v. Getty Oil Co., 493 A.2d 929, 944 (Del. 1985)). Note, too, that MNPI may be value-positive or value-negative. See infra Section III.D.Show More

The appraisal statute excludes from appraisal awards “any element of value arising from the accomplishment or expectation of the merger,”7.Del. Code Ann. tit. 8, § 262(h) (2020).Show More and synergies are consequently not included in appraisal awards. This Note will argue that the statute should also bar appraisal petitioners from recovering the value of agency cost reductions because they, too, are created by the transaction itself. This observation has important policy implications for capital formation; most importantly, excluding reduced agency costs is essential to incentivizing efficient change-of-control transactions.

Courts and academics analyzing appraisal have neglected to account for the value of non-public information as a determinant of merger prices. MNPI is definitionally value-laden, but in a world governed by the ECMH, it is not incorporated into market prices.8.This Note adopts the “semi-strong” form of the ECMH embraced by the Supreme Court, which holds that market prices incorporate all publicly available information about asset prices. See Verition Partners Master Fund Ltd. v. Aruba Networks, Inc. (Aruba III), 210 A.3d 128, 137–38, 138 n.53 (Del. 2019).Show More When MNPI disseminated to the buyer is withheld from the market (e.g., if the board fails to disclose a conflict when it recommends stockholders vote in favor of a merger), the risk of minority stockholder exploitation is high. Appraisal analysis should therefore explicitly acknowledge that suppressed MNPI is relevant to company value. However, MNPI will often be prohibitively difficult for courts to value. For example, suppose that an appraisal petitioner establishes at trial that the merger buyer induced the target’s CEO to support an unfairly low deal price by secretly offering her employment at the merged firm. It will likely be very difficult to determine with precision how this undisclosed conflict affected the ultimate sale price; the petitioner certainly should have received a better price for her shares, but it is not clear how much. This presents a dilemma for implementing the proposed merger deal price model in appraisal cases.

The solution is to define market prices as the baseline for appraisal fair value, presuming that the target’s unaffected stock price is the best evidence of the company’s value. This automatically excises synergies and agency cost reductions from appraisal awards. The presumption can be surmounted by evidence of MNPI suppression. Where this threshold is met, the court should exercise its discretion to determine the appraisal award, as it currently does, bearing in mind that buyers are entitled to the value they create through synergies and reduced agency costs. This approach will meaningfully simplify appraisal proceedings and refocus the remedy on the policy goals it serves—facilitating capital formation and encouraging efficient, non-exploitative mergers.

Part II situates the appraisal remedy within its doctrinal context. It introduces appraisal as an important safeguard against minority stockholder exploitation in change-of-control transactions, one that operates outside of the traditional breach of fiduciary duty merger litigation arena. It details several cases that collectively embody the recent controversy over the ECMH’s role in appraisal proceedings and concludes with an economic analysis of appraisal’s role in the broader corporate contract. Part III presents the revised merger deal price framework. Starting with the assumption that Delaware corporate law exists to facilitate investment and maximize long-term stockholder value, it argues that courts should exclude agency cost reductions and include the value of MNPI. It then develops the foregoing analysis into a method for adjudicating appraisal petitions that relies on a rebuttable presumption that market prices are fair.

Part IV analyzes the proposed framework’s likely consequences. It applies the framework to three noteworthy recent appraisal cases, reaching divergent results from the Delaware courts in each. It then argues that, if adopted, the adjudicatory model would bring much-needed clarity and rigor to the Supreme Court’s embrace of the ECMH, enabling courts to more fully utilize the ECMH’s analytical advantages. It would reduce some of the complexity associated with judicial determinations of company value, decrease the volume of appraisal petitions, and discourage speculative appraisal petitions—an outcome consistent with recent trends in Delaware deal jurisprudence. Next, it considers the likely effects on capital formation and the broader merger and acquisition (“M&A”) market. Excluding agency cost reductions would allow M&A buyers to retain the value they create when they replace inefficient management, increasing their incentives to pursue efficient corporate control transactions. It would also further the goal of maximizing stockholder value by eliminating appraisal premia. And, by incorporating MNPI into the fair value calculation, the suggested framework would discourage collusion between targets and buyers during the deal process, thereby preserving appraisal’s traditional function as a check on process adequacy. Part IV closes by describing appraisal’s continuing importance under the revised framework. Many firms’ shares do not trade in efficient markets, and this Note makes no attempt to supplant appraisal’s established role in such cases. Furthermore, appraisal will remain an effective judicial tool for policing process adequacy, particularly in conflict transactions. A brief conclusion follows in Part V.

  1. * J.D. & M.B.A., University of Virginia, 2020. I am very grateful to Professor Quinn Curtis, who introduced me to corporate law and advised me on this Note. For helpful comments and suggestions, I thank Wade Houston, Will Walsh, George Geis, Joe Fore, Nick Carey, Rebecca Lamb, F.D. Carroll, Matt Hoffer-Hawlik, and Matt Levine. I thank Charlotte K. Newell for educating me about the history of Delaware’s appraisal statute, and the staff of the Virginia Law Review for their input and editorial work on this Note—especially Matt West.
  2. Del. Code Ann. tit. 8, § 262 (2020). The appraisal remedy is limited to two types of transactions: “squeeze-outs” effected under §§ 253 and 267, and other mergers or consolidation transactions involving some cash consideration. See id.
  3. See infra notes 20–22 and accompanying text.
  4. Dell, Inc. v. Magnetar Glob. Event Driven Master Fund Ltd. (Dell), 177 A.3d 1, 16 (Del. 2017).
  5. It is assumed that the Supreme Court has endorsed the ECMH inclusive of that theory’s conventional assumption that market participants are rational. See Steven M. Sheffrin, Rational Expectations 99 (2d ed. 1996). This assumption is uncontroversial in the present context—i.e., it is beyond doubt that no reasonable shareholder would tender her shares at a lower price than she could readily receive elsewhere—but it has been contested in others. See, e.g., Franco Modigliani & Richard A. Cohn, Inflation, Rational Valuation and the Market, 35 Fin. Analysts J. 24, 24 (1979) (arguing that persistent inflation distorts market prices of securities, a finding inconsistent with some forms of the ECMH); Lawrence H. Summers, Does the Stock Market Rationally Reflect Fundamental Values?, 41 J. Fin. 591 (1986) (arguing that empirical evidence does not conclusively confirm the ECMH and that market prices do not always rationally reflect the fundamental values of securities). This Note does not aspire to contribute to scholarly commentary on the ECMH; like the Supreme Court, it adopts the hypothesis as a tool for deciding appraisal cases. See Dell, 177 A.3d at 24; see also Are Markets Efficient?, Chi. Booth Rev. (June 30, 2016), https://review.chicagobooth.edu/­economics/2016/video/are-markets-efficient [https://perma.cc/7HBU-C4ZL] (interview with Eugene Fama and Richard Thaler) (“The point is not that markets are efficient. . . . It’s just a model.”).
  6. See infra Section III.B.
  7. Klang v. Smith’s Food & Drug Ctrs., Inc., 702 A.2d 150, 156 (Del. 1997) (quoting Rosenblatt v. Getty Oil Co., 493 A.2d 929, 944 (Del. 1985)). Note, too, that MNPI may be value-positive or value-negative. See infra Section III.D.
  8. Del. Code Ann. tit. 8, § 262(h) (2020).
  9. This Note adopts the “semi-strong” form of the ECMH embraced by the Supreme Court, which holds that market prices incorporate all publicly available information about asset prices. See Verition Partners Master Fund Ltd. v. Aruba Networks, Inc. (Aruba III), 210 A.3d 128, 137–38, 138 n.53 (Del. 2019).

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