Back in August 2016, Delaware amended Section 262 of the Delaware General Corporation Law to address the rise of the appraisal arbitrage strategy where certain sophisticated investors would find a target company that is involved in a merger or acquisition, buy stock in the target company, and then invoke appraisal rights under Section 262. The main goal of the strategy is to strong-arm management to settle for a higher sale price in order to avoid litigation costs and/or gain from receiving statutory interest that accrued on the court-appraised amount. The idea behind the 2016 amendments was to curtail this appraisal arbitrage strategy by limiting a shareholder’s appraisal rights under Section 262 in two main respects: (i) by allowing surviving corporations to prepay dissenting shareholders prior to a final court determination in order to avoid paying statutory interest on the final appraisal value, and (ii) by taking away appraisal rights from de minimis shareholders who hold stock that is listed on a national security exchange.
A recent study published by the Harvard Law School has analyzed the effect of the 2016 amendments on appraisal actions in Delaware since the amendments went into place one year ago. The study found that appraisal actions did, in fact, decrease by 33 percent in 2017 as compared to the same period in 2016. The analysis also found that, surprisingly, the average deal premium fell from 28.3 percent in 2016 to 22.4 percent in 2017, the lowest of any year since at least 2005. As deal premiums fell, the average total change-in-control payments to CEOs (i.e. golden parachute payments) rose from 0.9 percent of transaction equity value to 2.1 percent, which brings into question whether CEOs acquiesced in lower deal premiums for higher parachute payments at the conclusion of the transaction. All in all, the study found that the decrease in deal premiums from 2016 to 2017 resulted in target shareholders losing around $77.4 billion, which, by any standards, isn’t a nominal amount.
Interestingly, these findings appear to dispel some arguments by those seeking curtailment of appraisal rights in Delaware. Prior to the 2016 amendments, many proponents of limiting appraisal rights argued that shareholders who invoke their appraisal rights negatively affect non-dissenting shareholders; their thought being that buyers in transactions routinely withhold giving their highest, top-dollar bid due to the risk that some of the buyer’s money will have to be used later to defend against appraisal litigation. Put another way, in the eyes of the buyer, appraisal rights litigation acts as a liability that constantly hangs over the transaction and, in turn, prevents the buyer from ever paying its highest price possible. However, if this theory was true, then deal premiums would have increased after the 2016 amendments.
The increase in change-in-control payments to CEOs also brings into question, once again, the validity and appropriateness of these types of golden parachute payments to CEOs. If a CEO is expecting a large payout if the transaction closes, is he or she really a disinterested party during the negotiation of the deal? Even though the necessary approval of the transaction from the directors of the target company might act as a check on these types of payments to the CEO, the CEO is still a key driver of negotiations between buyer and seller.
While the sample size is small and there may be various causal factors at play, the findings of the study do present a good point of discussion: is the general limitation of appraisal rights in Delaware having unintended negative effects for target shareholders? Regardless of sophisticated investors using the appraisal arbitrage strategy, perhaps having expansive appraisal rights actually benefits target shareholders in the long run? Due to the study’s findings, it might be best if other states take a wait-and-see approach to better understand the impact of Delaware’s amendments before they follow suit.