M & A Law Prof Blog

Editor: Brian JM Quinn
Boston College Law School

Wednesday, June 15, 2011

Don't cry for the shareholders

David Marcus of The Deal discusses an important footnote in Vice Chancellor Strine's opinion in the recent Massey derivative litigation.  

During oral argument, I pointed out that Strine referred to Massey shareholders as the least sympathetic victims in response to plaintiff's arguments that the board should be held accountable for the blatant violations of miner health and safety laws at the Upper Big Branch Mine.  In the written opinion, Vice Chancellor Strine expands on that view in footnote 185.  Given the immediate reaction from plaintiff's counsel to the opinion, it's worth reading and remembering who are the real victims and who benefited from the acts of management:

Footnote 185  The plaintiffs point out that one consequence of the loss of confidence the stock market had in Massey management in the wake of the Upper Big Branch Disaster was a decline in the company’s trading multiple.  The plaintiffs argue, with a rational basis, that Massey now trades at a discount to its fundamental earnings potential in comparison to other industry competitors because those competitors are judged to have a more sound approach to operating a coal company in a durably safe and profitable manner than Massey does.  PX-94 at 8. 

But although this may in fact be a market reality, it seems to me doubtful that this translates into a basis for a future damage award in a derivative case.  An entertainment restaurant corporation whose non-executive Chairman is Warren Buffett and whose CEO is Jimmy Buffett might well trade at a higher multiple than its competitors because the market perceives it to be run by financial geniuses who are better than most.  Its rivals may trade at lower multiples because they have more ordinary management or even because some have management that is perceived to be poor in quality.  Such deviations would not ordinarily provide the basis for any imposition of fiduciary liability.

In a derivative suit, there is no doubt that Massey fiduciaries could face large liability claims.  For example, it is plausible for Massey to seek to hold managers culpable if their nonexculpated breaches of fiduciary duty proximately caused the Upper Big Branch Disaster.  Such proof could subject them to hundreds of millions of dollars in liability for items such as lost mining profits and the cost of settlements and fines.  PX-32 at 8; PX-94 at 14.  But the notion that a derivative judgment could be premised on the delta between Massey’s trading multiple under the former fiduciaries and what it would be under non-breaching fiduciaries is not immediately plausible.  There are numerous problems with such an adventurous approach, not the least of which is that the only damages that could be awarded would be based on an estimate of the extent to which the defendants’ non-exculpated breaches affected the multiple, not the extent to which the market’s overall assessment of their competence diminished the multiple.  That is, to the extent that the market simply viewed the Massey management as grossly negligent or incompetent that would provide no basis for an award, and it would be incredibly difficult to figure out what portion of the delta was attributable to what factors.  Not only that, to the extent that the delta was attributable to other more traditional subjects of a damages award, such as lost profits from the Upper Big Branch mine or fines or settlement costs, that would have to be accounted for in order to avoid double counting.  Given these factors, I am not convinced that an award of this type could be based on anything other than speculation.

This brings up another mundane, but important reality.  The stockholders of Massey had an annual opportunity to elect directors.  If the plaintiffs’ rendition is correct — and it has plausibility — it was publicly and widely known that Massey took an adversarial approach to its relation to its regulators and had suffered adverse legal judgments and excessive miner injuries for years.  The plaintiffs, as investors, continued to invest in a company they say was well known to treat its workers and the environment poorly and that viewed laws as something to avoid, rather than to comply with in good faith. 

The primary protection for stockholders against incompetent management is selecting new directors.  It may well be that the corporate law does not make stockholders whole in situations like this when it is alleged that corporate managers skirted laws protecting other constituencies in order to generate higher profits for the stockholders.  If that be so, it should be no surprise as any human approach to justice will always fall short of the ideal.  It also may be that if stockholders come out a bit worse, then justice is in fact done.  Remember that to the extent that Massey kept costs lower and exposed miners and the environment to excess dangers, Massey’s stockholders enjoyed the short-term benefits in the form of higher profits.  The very reason for laws protecting other constituencies is that those who own businesses stand to gain more if they can keep the operation’s profits and externalize the costs.  Thus, the stockholders of corporations, especially given the short-term nature of holding periods that now predominate in our markets, have poor incentives to monitor corporate compliance with laws protecting society as a whole and may well put strong pressures on corporate management to produce immediate profits.  William W. Bratton, Enron and the Dark Side of Shareholder Value, 76 TUL. L. REV. 275, 1284 (2002) (“For equity investors in recent years, the practice of shareholder value maximization has not meant patient investment. Instead, it has meant obsession with short-term performance numbers.”).  Stockholder pressure to produce profits might increase the already well-known risk that profit-seeking entities have incentives to take the profits of their operations for themselves and externalize the risk of operations to others, be it to their workers or society as a whole in the form of environmental degradation.  

This is not to say that our law does not permit Massey to recoup its proven lost profits and injury if it can link them to non-exculpated breaches of fiduciary duty by its directors and officers.  It does.  Wood v. Baum, 953 A.2d 136, 141 (Del. 2008) (citing Stone ex rel. AmSouth Bancorporation v. Ritter, 911 A.2d 362, 367 (Del. 2006); Malpiede v. Townson, 780 A.2d 1075 (Del. 2001); Guttman v. Huang, 823 A.2d 492, 501 (Del. Ch. 2003)).  But it is to say that to the extent that there is some residual damage to the corporation in a situation like this when the pursuit of profit for stockholders resulted in damage to other constituencies that is not capable of remediation, that might be thought to act as a useful goad to stockholders to give more weight to legal compliance and risk management in making investment decisions and in monitoring corporate performance.  In the end, the most sympathetic victims here were not stockholders, they were Massey’s workers and their families, who suffered injuries and lost lives and loved ones, and the communities who have suffered because of environmental degradation due to of the company’s failure to meet its legal responsibilities.

Don't cry for the shareholders.  Here are the real victims.




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