Friday, May 13, 2011
Mira Ganor has posted a paper, The Power to Issue Stock. She takes on the question of board discretion to issue stock. In particular, she focuses on the top-up option that has attracted recent attention.
Abstract: Studies of management's disregard of the will of the shareholders have focused on combinations of entrenchment mechanisms and special governance structures. However, management's power to issue stock, a fundamental element of the ability of management to control the corporation regardless of the will of the shareholders, has received scarce attention. This Article highlights the significance of the power to issue stock: When managers choose to ignore the will of the majority of the shareholders or when managers choose to circumvent the veto power of the minority shareholders, they often take advantage of their power to issue stock. A top-up option, for example, which is studied in this Article, is contingent upon the managers' ability to issue shares and dilute the voting power of dissenting minority shareholders. The poison pill is also contingent upon the managers' ability to dilute a hostile-bidder by issuing shares to the shareholders. The ability of managers to use new stock issues as a shareholder-circumventing mechanism is particularly important. It plays a key role in the management’s arsenal and it provides an incentive for managers to reserve this unique power and refrain from diminishing it by, for example, replacing equity-based compensation and equity-financing with less efficient choices. This Article explores the key power of managers to issue stock as well as the current and potential limitations on this power. One such limitation is the size of the authorized capital of the corporation, which provides a ceiling for the total number of shares that can be issued. The ratio of authorized non-outstanding shares to the issued and outstanding shares, what I shall call the "excess-ratio", is an indicator of the magnitude of the managers' power to issue stock. A study of the excess-ratio reveals that corporations go public with a high excess-ratio the number of unissued authorized shares is more than threefold the number of issued shares. Further results of the study of the excess-ratio are analyzed in this Article
With respect to the top-up option she writes:
Top-up options ... are a powerful tool that has been increasingly used to dilute the voting power of opposing shareholders in takeovers supported by the board of directors. The grant of a top-up option as part of a take-over may allow for the consummation of a quick short-form merger without a shareholder meeting and despite the opposition of a significant number of the shareholders in excess of the statutory ceiling of ten percent of the shares. The effect of a top-up option is that a management friendly bidder faces only a truncated supply curve at the tender offer. This is because a top-up option lowers the percentage of shares needed to be tendered in order to have a successful outcome. In addition, the speed of the takeover process makes it harder for a competing bidder to launch an opposing bid. Like the poison pill, top-up options are contingent upon the managers‘ ability to issue a nontrivial number of shares and thus dilute the voting power of the dissenting minority shareholders.
Clearly, she disagrees with Vice Chancellor Laster. I suppose he would respond - "If 70% of the shareholders have tendered, and if the merger agreement ensures that any back end consideration would not be subject to dilution, what are minority shareholders losing with a top-up. It's not like the minority could ever win a shareholder vote for a back-end merger."
I tend to agree with the Vice Chancellor, but I'll admit that I'm uneasy about it. There's no reason why an acquirer can't simply tender for 51% of the public shares and then do a back-end statutory merger. If the shareholders can act by written consent, there's no need to even call a meeting. There's no question that controlling shareholder will win the vote following a successful tender offer, so what's at stake? Time? Protection of minority rights? Minority shareholders can rely on their appraisal rights in the backend merger if they are unhappy with the consideration, but, short of fiduciary duty claims, that's about it.
Top-up options are sure to continue to generate discussion. Ganor's article is a valuable contribution to that puzzle.