The Golden Ratio of Corporate Deal-Making

Abstract

2015 and 2016 mark the thirtieth anniversaries of the Delaware Supreme Court's landmark decisions in Unocal and Revlon, respectively. Those cases and their progeny called for enhanced scrutiny standards to be applied in change of control transactions as well as to deal protection devices – contractual provisions which deter third parties from overbidding between signing and closing. Since those decisions, the courts have struggled with the application of these enhanced scrutiny standards. This Article uses auction theory principles and the related concept of information costs to correlate deal protection devices to the pre-signing sale process in change of control transactions. More specifically, this Article argues that the more extensive the pre-signing sale process, the more information that both the selling company, or target, and buyer have gathered. Specifically, the target board (who has a duty to maximize stockholder value in change of control transactions) achieves greater certainty regarding maximum value from engaging in a more extensive pre-signing sale process. Similarly, the buyer has greater certainty regarding the target's value. At the same time, information costs incurred on both sides is higher – as the parties expend more to learn about the value of the company, there is a lower likelihood that a third party will overbid. In this case, the courts should be more tolerant of more restrictive deal protection devices because of this information certainty.

Conversely, when the target has engaged in only a single bidder negotiation, information costs are lower as is certainty that maximum shareholder value has been achieved. In that case, because of this lack of certainty regarding the achievable maximum value of the target, the courts should be less tolerant of restrictive deal protection devices. In other words there should be a direct proportional relationship between the information gathering process (i.e., the pre-signing sale process) and the resulting deal protection devices. This proportion – the Golden Ratio of Corporate Deal-making – is supported by auction theory principles as well as Delaware Court of Chancery rhetoric. Despite, however, rhetoric that more extensive sale processes should lead to more restrictive deal protection devices, the Court of Chancery has not differentiated deal protection devices contained in single bidder transactions from those in deals resulting from a more extensive pre-signing sale process. The Golden Ratio of Corporate Deal-making seeks to provide a template from which the courts can engage in a more nuanced analysis. If applied, in reviewing deal protection devices, the courts would be making distinctions based off of the pre-signing sale process rather than what they deem to be standard or "market" terms.

Keywords: Revlon, Unocal, deal protection devices, sale process, auction, single bidder, lock-ups, information costs, auction theory

JEL Classification: K22, K2, K12