Document Type

Article

Publication Title

Yale Law Journal

Abstract

One of the most important debates of current corporate law practice and scholarship is about the appropriate role of target management confronted with a takeover bid. The controversy turns on the identification of a criterion for evaluating takeovers and target management defensive tactics. An influential body of opinion contends that maximization of shareholder wealth is the appropriate criterion because, first, traditional notions of fiduciary duty generally require managers to act in the shareholders' interest, and, second, shareholder wealth maximization is seen as the best available proxy for social wealth maximization. On this view, takeovers are desirable because they can increase shareholder wealth in two ways: first, by moving assets to managers who can produce the greatest economic return from them; and second, by increasing pressure on current management to maximize economic return from assets under their stewardship. From this starting point, management has only two justifiable options for responding to a takeover bid. Some argue that management should respond passively. Passivity will maximize shareholder wealth by increasing the returns to search for takeover targets, which raises the number of value-increasing bids. Others contend that management may abandon passivity, but only to the extent necessary to instigate an auction for the firm. An auction will ensure that the user who most highly values the target assets will gain control over them (without the transaction costs of successive sales) while maximizing the payoff to target shareholders. Which of these responses would in fact maximize shareholder wealth is a matter of dispute. Those who favor permitting target management responses that instigate auctions must face the problem of the divergence of shareholder and target management interests in a takeover. A successful auction means that target managers will possibly lose their jobs and certainly their autonomy. In adopting tactics that would tend to produce an auction, management may be hoping to thwart the takeover altogether. On the assumption that target management will act in a self-interested way, how should we distinguish tactics that will increase shareholder wealth from those that will not? Two recent papers propose to answer this question for a particular class of management defensive tactics: target firm buybacks of its own stock. The papers, Bradley and Rosenzweig, Defensive Stock Repurchases, and Macey and McChesney, A Theoretical Analysis of Corporate Greenmail, come to similar conclusions: Even assuming management self-interest, some but not all target stock buybacks may increase shareholder wealth because of the resulting auctions. More specifically, Bradley and Rosenzweig generally endorse target self-tender offers because they contribute to an auction process, but criticize target open market repurchases because they distort shareholder choice. Macey and McChesney offer a defense of target buybacks of bidders' stock-better known as greenmail-on a similar ground. Economic models, explicit in Bradley and Rosenzweig's article and implicit in Macey and McChesney's article, underlie the conclusions. Each model, however, makes key hidden assumptions. In exploring those assumptions, we conclude that for each article, the case for the particular defensive tactic is "not proved." Indeed, our analysis of each model strongly suggests the opposite: that target stock buybacks are unlikely to increase shareholder wealth as a general matter and, on a shareholder wealth criterion, should not be permitted as a defensive tactic.

First Page

295

DOI

https://doi.org/10.2307/796418

Volume

96

Publication Date

1986

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