INTRODUCTION II. MANAGING AUTHORITY WITHIN THE CORPORATE FORM A. Directors and Wealth Maximization B. Shareholders and Wealth Maximization III. THE DISRUPTIVE RISE OF THE INSTITUTIONAL SHAREHOLDER A. Consolidation and Conflict in the Shareholder Base B. From Shareholder Fiction to Shareholder Reality 1. The Traditional Role of Wealth Maximization in the M&A Context 2. The Paradigm Shift of M&F and Corwin C. With Great Power Does Not Come Great Responsibility D. More Money, More Problems IV. GROUNDS FOR DIVORCE: SEGMENTING THE SHAREHOLDER BASE A. Decentralized Mutual Fund Voting B. Dissenter-Only Fiduciary Lawsuits C. Appraisal: The Original Solution to Shareholder Heterogeneity 1. The Right of Appraisal 2. Reforming Appraisal for the Modern Market a. Deal Price and "Going Concern" Value b. Expanding Appraisal's Availability c. Simplifying Appraisal Procedures V. CONCLUSION I. INTRODUCTION
Corporate law is designed to address conflicts of interests among stockholders and managers. For decades, the law operated on the assumption that stockholders all have the same interest--wealth maximization--and imposed upon managers a duty to advance that interest. In fact, stockholder interests were never quite so clear cut: for example, stockholder-debtholders might have also wished to protect their loans, while stockholder-employees might have also wished to protect their jobs. Nonetheless, the system managed to elide these messy realities. Stockholders themselves had minimal input into the corporate decision-making process, because votes were rare and accomplished little; meanwhile, judicial deference to managerial decision-making created a space for directors to balance stockholders' competing interests. As practiced, then, in extreme circumstances, the duty of wealth maximization was strictly enforced; at other times, it functioned as a polite fiction, papering over real differences among corporate constituents.
In recent years, however, the landscape has changed. Stockholders have grown larger and more powerful, exacerbating their conflicts with each other. At the same time, courts have begun to acknowledge that strict adherence to a legal requirement of wealth maximization may have deleterious economic effects. As a result, the law has evolved; courts have demonstrated less appetite for enforcing a legal norm of wealth maximization when the majority of the shareholder base would tolerate departure from that mandate. The situation has left minority stockholders less protected against exploitation by the majority.
The shifts are particularly visible when it comes to mergers and acquisitions, where courts have long recognized that directors face special conflicts not present in other kinds of transactions. In earlier years, courts scrutinized directors' actions in the context of a merger to ensure they negotiated with sufficient vigor to obtain the best deal possible under the circumstances. Today, however, courts generally assume that shareholders can perform this task and treat a shareholder vote in favor of a transaction as the final word on its adequacy. Yet, due to the increasing consolidation of the shareholder base, powerful investors may be as conflicted as directors, and may therefore have no interest in driving a hard bargain. In this scenario, minority shareholders are left without an effective advocate for their interests, and may be coerced into suboptimal transactions.
This Article proposes that corporate law respond to shareholders' irreconcilable differences with limited rights of "divorce," in the form of a reconfiguration of the right of appraisal. Appraisal allows a stockholder to surrender her shares in exchange for their fair value. The appraisal right, in other words, forces the majority stockholders to buy off dissenters before changing the corporation's strategy. Though in recent years, appraisal has been championed mainly as a deterrent against exploitative transactions, it can also be used as a mechanism for price discrimination, to allow satisfaction of divergent shareholder preferences. In this state of affairs, the stockholder vote serves a sorting function, to allow investors to signal their preferences and be treated accordingly. To be effective for this purpose, however, certain aspects of appraisal should be changed, including expanding its availability, and adjusting how damages are calculated.
In Part II, I discuss the traditional balance of power and responsibility within the corporate form. In Part III, I describe the disruptions caused by the rise of institutional shareholders. In Part IV, I discuss how shareholders can "divorce" so that their separate interests may be effectively vindicated.
MANAGING AUTHORITY WITHIN THE CORPORATE FORM
In a corporation, investors supply capital that is managed by others. Because this separation of ownership and control--between those who provide capital and those who dictate its use--creates varying opportunities for exploitation and unfairness, corporate law regulates these relationships. In the traditional account, this regulation takes the form of legal constraints on managers' actions, and architectural constraints on the actions of shareholders. In fact, as described below, the arrangement is more nuanced.
Directors and Wealth Maximization
Within a corporation, shareholders, as equity investors, elect directors, and directors in turn are endowed with responsibility for managing the corporation. (1) Directors have near complete discretion to make corporate decisions as they see fit, subject only to certain minimal procedural requirements. (2) For the largest sorts of decisions-- mergers, liquidations, amendments to the charter--directors must obtain shareholder approval before they can act, but directors maintain the sole right to propose such actions in the first instance. (3)
Directors' expansive discretion creates the potential for abuse. In the worst cases, directors may use their control over corporate assets to self-deal, contracting with the corporation on preferred terms. In less extreme circumstances, they may direct corporate business in suboptimal ways to satisfy their personal priorities. Alternatively, they may simply shirk their obligations of oversight, causing the corporation to incur excessive costs and to forego profitable opportunities. Any of these possibilities would concern potential investors, and dissuade them from entrusting directors with their capital.
To reassure investors that their capital will not be squandered, state law imposes fiduciary responsibilities on corporate directors that temper their authority. (4) Directors thus have expansive powers of control, but are bound to use that power in accord with certain legal principles. As the Delaware Supreme Court put it, "inequitable action does not become permissible simply because it is legally possible." (5)
That said, if directors are to be controlled via legal oversight, the state must specify the duties it chooses to impose. Yet surprisingly, the precise nature of these obligations remains subject to dispute. (6) Certainly, directors must take proper care in their decision-making processes by informing themselves about the matters on which they act. (7) They also must be loyal, in the sense that they must not use their positions to enrich themselves personally, and must advance the best interests of the corporation. (8) Less clear, however, is how the "best interests of the corporation" should be defined.
Most modern theories of the corporation subscribe to what is known as "shareholder primacy," i.e., the notion that directors have, or should have, a commitment to manage the corporation in a manner that benefits the shareholders. (9) Yet the concept of shareholder primacy is not monolithic; it encompasses two sharply divergent views of the precise nature of directors' legal obligations. (10)
The first is simply wealth maximization: the primary duty of directors is to ensure that the corporation earns the highest possible profits, and thus offers shareholders the highest possible return on their investment. (11) Commenters in this camp recognize that some shareholders may have other preferences, but assume that at least their sole common ground is a desire to increase corporate wealth, and therefore, it is to that end that managers should direct their energies. (12) The central paradox of this view is that it permits shareholders to vote even for wealth-reducing actions if they so choose, but also holds that directors may not allow those interests to guide their behavior. (13) The tension is often resolved by insisting that shareholders' power within the corporate form be minimized; that way, directors can devote their attention to the project of wealth maximization without the distractions of actual shareholder demands. (14) For this reason, skeptics have derided wealth maximization as advocating for "fictional shareholders" : (15) since very few shareholders would prefer the pursuit of wealth maximization to the exclusion of all other interests--as described in more detail below, (16) all shareholders likely have some other priorities, even if they differ as to which priorities those are--in its purest form, a duty of wealth maximization requires directorial fealty to a set of desires that may not be possessed by any actual shareholder.
The second approach defines shareholder primacy to mean that directors must honor the actual wishes of the shareholder base, typically by granting shareholders greater power within the corporate form. (17) Advocates of this view seek greater shareholder control over such matters as nomination of directors, executive compensation, and corporate political spending. (18) Doing so, however, fails to resolve the problem that shareholders may, in fact, want different things, and therefore risks permitting the majority to exploit the minority. (19) These concerns are generally answered with the argument that...