Hedge Fund Activism: New Myths and Old Realities

Two recent developments have changed the playing field of corporate governance: (1) the Delaware Chancery Court’s ruling this month on the use of a two-tier poison pill in the Sotheby’s case (and Sotheby’s quick and conciliatory settlement two days later, which conceded three  seats on Sotheby’s expanded board to Third Point LLC, a particularly aggressive hedge fund),[1] and (2) the joint $50 billion bid of Pershing Square Capital Management and Valeant Pharmaceuticals International Inc. for Allergan Inc.[2]  In their wake, every pundit has announced that this is the heyday of hedge fund activism.  Fund managers now hold the whip hand, and many believe that managements must appease these new activists and accommodate their agendas.  This could be true (although in fact Sotheby’s was uniquely exposed because its board and management held less than 1% of the company’s stock, while, as noted below, hedge funds had accumulated over 30% of its stock by the time of the vote).  Still, much of this commentary has missed the forest for the trees.

Particularly among academics, the analysis has been one-sided and shallow.  Many legal academics view the Sotheby’s battle as an uncomplicated morality play with “good” hedge funds fighting an “entrenched” management that was seeking to use a “discriminatory” poison pill to block the shareholders’ “true” will.  These academics have bought into the view that hedge funds and other activist investors are the catalysts who will at long last arouse institutional investors from their rational apathy and induce them to assert themselves as owners.[3]  This view will likely persist, both because academics tend to herd and because they are relying on empirical studies without analyzing carefully what those studies truly show.  Accordingly, this column will take a closer look at the empirical evidence on hedge fund activism and then will turn to the issues surrounding the particular form of poison pill adopted by Sotheby’s.  This author cannot claim complete objectivity (at least in this rare instance) because he did serve as an expert witness for Sotheby’s in the foregoing litigation.  Precisely for that reason, however, the focus of this column will not be on the “inside baseball” of the Sotheby’s case,[4] but rather on the empirical evidence.  For practitioners, that focus is relevant because the Sotheby’s battle will likely foreshadow many proxy fights to come, as imitation is the sincerest form of flattery.  Undoubtedly, other hedge funds will be motivated to mimic Third Point (possibly to their later regret.)

In overview, there are four lessons to be learned from the Sotheby’s battle, the first two of which are uncontroversial and the last two both controversial and counter-intuitive:

Lesson One.  Unocal trumps Blasius![5]  Third Point had argued that Sotheby’s two-tier poison pill offended the Blasius standard (which would require a compelling justification for any curtailment of voting rights[6]) because it was intended to thwart a proxy contest and thus impede voting rights.  Not surprisingly, this view was squarely rejected by the Chancery Court.  If a proxy context exception had been grafted onto Unocal, Unocal would have become meaningless. That Sotheby’s two-tier pill discriminated in favor of “passive” shareholders and against “active” shareholders did concern Vice Chancellor Parsons, but ultimately did not move him, perhaps because all flip-in pills are “discriminatory” (in that they dilute only the acquirer who crosses the defined threshold). Ultimately, the pill’s focus on “active” shareholders struck him as a proportionate response to the threat of a “creeping control” acquisition and the impact of the gathering of a “wolf pack” (in his phrase) of hedge funds.

Lesson Two: Winning the war in the courtroom does not win the war on the proxy battlefield!  In fact, the reverse may be true.  Sotheby’s pill was upheld, but so what?  Sotheby’s still had to sue for peace and accept all three insurgent directors (even though Institutional Shareholder Services (I.S.S.) had only recommended votes for two of them).  Also, Third Point’s counsel made great use in court of e-mails showing some Sotheby’s directors to share Third Point’s doubts about internal governance and compensation levels at Sotheby’s.  Legally, this evidence probably demonstrated the independence of the Sotheby’s directors and illustrated a robust and candid internal debate.  But at the practical level, it may have convinced those still undecided voters that new voices were needed on the Sotheby’s board.  For the practitioner, the lesson here is that directors need to realize that, when litigation is foreseeable, every email among directors and/or senior executives effectively begins with the caption: “Dear Ladies and Gentlemen of the Jury.”[7]

Lesson Three: Proxy fights cause losses as well as gains! It is not clear if Third Point will win a financial victory (Sotheby’s stock price has actually fallen since its settlement with Third Point).  Indeed, the clearest winner to date has to be Christie’s, Sotheby’s major rival. Together, the two firms share a virtual duopoly in a unique market for personal services that is dependent on “relationships.”  Instability at Sotheby’s can and will be exploited by its rival, Christie’s.  In fact, this often happens.

Still, on this score, Sotheby’s may be uniquely vulnerable.  The most important clients for both Sotheby’s and Christie’s are the limited number of executors of major estates who need to auction art portfolios that may have aggregate values in the multi-billion range.  Often, this business requires special services, extended negotiations, guarantees and handshake deals.  In such an environment, the fact that Third Point wants to oust the senior management of Sotheby’s may imply that any eventual successor management at Sotheby’s will not be aware of, or feel bound by, understandings reached by the current management.  Even if this problem can be addressed, Christie’s can still assert that the current Sotheby’s management is too preoccupied with governance matters to give their full attention to clients.  Unless the new board can play nicely together in the sandbox, the most valuable clients—current and prospective—may flee.

Even if Sotheby’s is more vulnerable than most, this prospect of injury to the proxy target is not unique to its case (as J.C. Penney, an even clearer victim of hedge fund activism, well knows).  Proxy battles can both increase and decrease value for shareholders, typically, because such battles can produce internal disruption and instability. As later shown, the empirical evidence bears this out and shows a wide divergence in outcomes.

Lesson Four: The poison pill may be losing its toxicity!  In part, this may reflect a deliberate choice, as the target’s defenders dare not alienate I.S.S.  Sotheby’s two-tier poison pill was a kinder, gentler pill because it did not bar a 100% tender offer, but only a “creeping” acquisition. Largely unnoticed by the press, Sotheby’s two-tier shareholder rights plan was designed to achieve only a limited purpose.  Because it only barred a “creeping control” campaign, it represents a more “shareholder friendly” approach to takeovers that both redefines the role of the poison pill and actually may bring U.S. practice into closer conformity with Europe and England (where partial bids and creeping acquisitions are largely blocked by statute).  Desirable as this goal is, however, it may not be obtainable without legal change.

I.            The Evidence on Activism

The case for hedge fund activism rests heavily on the claim that interventions in corporate governance by activist investors enhance value for shareholders.  The most frequently cited study supporting this conclusion appeared in the Journal of Finance in 2008 and found an average abnormal return of 7% to 8% around the filing of a Schedule 13D announcing the activist’s acquisition of a 5% or greater stake in the target.[8]  But this evidence, which was noted by both Professor Daniel Fischel (the expert for Third Point) and myself in our rival affidavits in the Sotheby’s litigation, goes only to the short-term return over the 20-day window on both sides of that announcement.  If we look instead to the long-term abnormal returns in this same study, we find that over the period beginning one month prior to the announcement of the activist’s position and concluding with the activist’s exit from that position, the returns are very different and ranged widely.  One quarter of these firms had a size-adjusted, long-term abnormal return of -25% or worse, and 50% experienced a size-adjusted, long-term abnormal return of only 0.3% or less.[9]  Thus, the shareholders of half of all the firms in this sample received a return that was either negligible or worse (and 25% incurred very negative returns).  To be sure, the mean return was 14.3% on this same basis, but that was largely because the return was very high to the top 25% of the firms in this sample.[10]  Put more simply, the target firm stalked by the activist fund faces an outcome that may either be a feast or a famine.  That binary prospect should concern a reasonable board of directors, who manage not a portfolio of bets (as financial managers do), but a single company facing a very risky “boom or bust” future.

What is going on here?  Another study in the Journal of Financial Economics shows that the long-term returns from shareholder activism are concentrated in those firms that ultimately get acquired, while targets that remain independent do not experience any long-term share price improvement.[11]  Several other studies, including one co-authored by Professor Lucian Bebchuk (no enemy of activism), find little evidence of long-term average abnormal returns in the years following the filing of the Schedule 13D.[12]  A more recent study in 2013 does find that targeted firms experience positive abnormal returns on average over the two years following the commencement of activist hedge fund’s campaign, but also that the distribution of these returns is again heavily skewed.[13]  Most importantly, 52% of the targets in this study showed negative excess returns over both the one and two year periods.  Thus, even though the mean long-term abnormal return was positive in this study, the majority of firms actually experienced a negative long-term abnormal return.  Again, this shows that extraordinary returns in those cases where activism produces a takeover drive the aggregate results (and hide the reality that the majority of companies experience negative returns).  For the holder of a diversified portfolio, this is of little concern, but for a board of directors of a single company, their fiduciary duty is to protect their company.

The evidence of activism’s impact on operational performance and reported profits is more mixed, but several studies find no improvement between the year before the filing of the Schedule 13D and the year after.[14]  Symptomatically, some studies also find a significant decrease in investment levels at the target firm and a concomitant increase in leverage.[15]  This evidence is read by these scholars to be “consistent with [the] hypothesis that activists have few levers in creating shareholder value over the long-term rather than a takeover.”[16]

In this light, the prospect that Daniel Loeb and Third Point might run Sotheby’s differently than its current management is hardly reassuring. That was also the goal of Mr. Ackman and Pershing Square at J.C. Penney, when Pershing Square acquired a 16.5% stake in the firm.  Ackman in fact attempted such a strategy and imposed a new CEO at the firm; the result was disaster. While J.C. Penney’s shares went up initially, its share price declined by 59.5% over the period between the initial schedule 13D filing and Ackman’s eventual resignation from the board (while the market as a whole soared over this same period.)[17]

The empirical studies also demonstrate another counter-intuitive finding: while a Schedule 13D filing or the announcement of a proxy contest may spur a stock price increase, it does not usually matter who wins the proxy fight.  One well-known study by Mulherin and Poulsen finds no difference in abnormal returns between contests in which the dissident wins a board seat and contests in which the dissident loses.[18]  They generalize that the gains come not from the identity of the victor, but from the predictable tendency of the incumbent management to implement the “specific changes” sought by the insurgents.[19]  The Sotheby’s contest was consistent with this pattern, as in 2014 (well after the hedge funds had begun to circle around Sotheby’s) Sotheby’s announced a combined dividend and stock repurchase totaling $450 million (or roughly 15% of its $3 billion market capitalization).

Some studies actually find that the average abnormal returns in proxy contests are higher when the incumbent management wins,[20] and at least one has found negative abnormal returns (and also declining operational performance) following proxy contests in which the insurgent wins seats.[21]  All this evidence is consistent with a basic story: if the incumbent management will modify its policies in response to the challenge, shareholders are better off than in the case of an insurgent victory (probably because shareholders are spared the risk of a headstrong or even egomaniacal insurgent taking control of the company). The wealth gains from proxy contests appear to largely stem from takeovers (which happen only in the minority of cases) and from large dispositions of assets and dividends (which tend to happen before the shareholder vote).  The market does not expect improved operational performance in the wake of an insurgent proxy victory (nor do we observe it in fact).

II.            The Role of the Poison Pill

The Sotheby’s proxy contest featured an atypical form of shareholder rights plan that was the focus of much attention because of three distinctive features: (1) it imposed a 10% ceiling on shareholders who filed a Schedule 13D, but only a 20% ceiling on shareholders filing a Schedule 13G; (2) it did not apply to any tender offer for 100% of the shares (provided that the offer was kept open for at least 100 days in order to permit a value-maximizing auction); and (3) it had a duration of only one year (unless extended by a shareholder vote).

Of these three features, most of the attention focused on the least important one: namely, the distinction drawn between “active” and “passive” shareholders.  Third Point saw this as “discrimination” against “active” shareholders, arguing that shareholders who filed a Schedule 13D were more likely to vote against management than Schedule 13G filers.

Curiously, this “discriminatory” feature has the most precedent supporting it.  In my expert report in the case, I noted that some 73 corporations have adopted shareholder rights plans that distinguish “active” from “passive” investors and permit higher ownership levels for the latter.[22]  These date back to 1986 when United Continental Holdings did it first; the most recent such adoption was by Avid Technology in January 2014.  Some 40.3% of these shareholder rights plans place the ceiling for activist shareholders at 10%, while another 54.2% use a 15% ceiling for “active” shareholders (the overall average ceiling was 13.2%). The ceiling for passive investing was typically placed at 20%.

Why is this disparity justifiable?  In my judgment, it has a thoroughly defensible and even commendable purpose: it protects against a “creeping control” acquisition.  In the Sotheby’s litigation, the chief executive officer of MacKenzie Partners, a major proxy solicitation firm, submitted an expert report estimating that 32.86% of Sotheby’s stock was then held by hedge funds.  He further estimated that the level of hedge fund ownership had risen from 13% of all Sotheby’s shares (as of a year earlier) to 23.22% as of the record date for the Sotheby’s annual 2014 meeting.  Thus, if Third Point had won the right that it sought to increase its ownership level to 20%, then on that basis over 43% of the Sotheby’s stock would be held by hedge funds.  That would mean the ballgame was over.

Nonetheless, some academic colleagues respond to this evidence by telling me: “You do not know those other hedge funds will vote with Third Point.”  Such an assertion illustrates the academic tendency to wear self-imposed blindfolds.  This rapid build-up is evidence of the recurrent pattern that Vice Chancellor Parsons described in his decision as the formation of the “wolf pack.”  No plausible explanation exists for the sudden interest of hedge funds in a relatively small company in a low-growth market—other than the opportunity to make a short-term profit from the proxy contest (and, more specifically, from the announcement of the Schedule 13D filing).

The simple truth then is that “birds of a feather will flock together.”  If hedge funds can learn of an activist campaign in advance of the Schedule 13D filing, they are assured of a profit (unless they hold for the long-term and the stock declines). One hedge fund tipping another does not amount to insider trading because there is no breach of a fiduciary duty.  Only if one hedge fund tipped another of an approaching tender offer would the securities laws be violated (and only then if the prospective bidder had already taken a “substantial step” towards commencing the tender offer[23]). This ability to engage in “conscious parallelism” (in Vice Chancellor Parson’s apt phrase) without becoming a member of a Section 13(d) “group” probably fuels much hedge fund activism because it offers a high return with little risk.

Why should this behavior concern us? The short answer is that creeping control acquisitions deny the public shareholders their opportunity for a control premium, and traditionally the key function of the target’s board of directors in the takeover context is to protect this opportunity.  This danger of a lost opportunity for a control premium can result from either of two alternative scenarios.  First, the participating hedge funds may assemble a de facto control block of, say, 30% or more.  Such a block carries what Delaware Chief Justice Leo Strine has recently termed “negative control.”[24] Based on this block, the hedge funds (or their leader) might negotiate a merger between the target and a chosen acquirer on terms that assures the acquirer that it will not become subject to an auction.[25]  If a 30% block stands behind the acquirer, a rival acquirer will be less likely to challenge the transaction for a variety of reasons.[26] A variation on this first scenario is that the hedge fund could partner up, itself, with a strategic acquirer and make a joint tender offer at a price that was below what otherwise would have to be paid in a more open market.  More or less, this joint bid is what Pershing Square has just done with Valeant in their bid for Allergen, and it refutes the claim that hedge funds never seek control.

Second, the hedge fund might not pursue a takeover, but rather might seek, itself, to exercise control over the target as its largest shareholder with a seat (or more) on its board.  It might do this either in the belief that it knew more (as Pershing Square seemed to believe it did in its disastrous intervention at J.C. Penney) or in order to obtain the “private benefits of control.”  The “private benefits of control” are diverse and include prestige and public importance. In this light, it is relevant that Daniel Loeb is an avid art collector.  The opportunity to be the chairman or CEO of Sotheby’s might well interest him simply for the ego gratification inherent in such visibility.  Economists miss this, but it explains much human behavior.  By analogy, if this author had a multi-billion dollar hedge fund behind him, he might seek to buy a 40% (and controlling) interest in the New York Yankees—in order to play general manager.  The private benefits of control include the “right to play with the trains.”  But both in my own case and that of Loeb, the result of such megalomania is likely to be disastrous for the other shareholders.  Confident as I am, cooler heads may believe that I know less about the business of baseball than the typical general manager.  In the case of Sotheby’s, a passionate art collector might make its worst possible CEO (because the avid collector and the auctioneer have very different perspectives and valuations).

The irony in all the criticism focused on Sotheby’s poison pill is that it was less toxic and blocks much less than the traditional pill.  Basically, it only prevents (and for only a limited period) a creeping control acquisition.  Thus, it neither stops a hostile tender offer nor forces the bidder to conduct a contemporaneous proxy fight to redeem the poison pill.  This both gives the bidder greater flexibility as to timing (i.e., it need not wait for the annual meeting) and reduces the bidder’s overall costs.  Finally, the Sotheby’s pill only lasted for one year (unless extended by a shareholder vote).  All in all, the Sotheby’s pill was far more shareholder-friendly than most of its predecessors.  Probably, it was so structured to comply with I.S.S.’s guidelines,[27] but nonetheless, the bottom line is this: the significance of the poison pill may be diminishing.  It is becoming more a road bump than a barrier.

For the future, other potential targets may be unlikely to copy the two-tier “discriminatory” feature in Sotheby’s shareholder right’s plan.  Because the Chancery Court’s decision upheld a 10% limit, there may be little reason to give “passive” shareholders a higher 20% ceiling.  Few institutional investors want to go to the 20% level because such ownership will take them over the 10% line that triggers Section 16(b)’s “short swing” profits provision.  Crossing that line seriously restricts the liquidity that they much desire.  No shareholder crossed this 10% line in the Sotheby’s battle.

Thus, the future may see many poison pills, adopted probably shortly after the filing of a Schedule 13D by an activist investor, that will have a short, one year duration and do not block a 100% bid.  If so, hedge fund activism should only increase, as their goal would be to put the target in play, with the “wolf pack” acquiring in the aggregate as much as a 20% to 35% block.  Such a block could usually elect at least a short slate of directors.  I.S.S. appears to favor short slates, and its support could swing most proxy contests to the insurgent, at least in the initial round.

Ultimately, this strategy is significantly dependent on the current 10 day “window” under Section 13(d) of the 1934 Act, which gives the activist hedge fund 10 days after it has acquired 5% or more of a class to increase its holdings (and also to tip lawfully its allies in the hedge fund community) before it must make its Schedule 13(d) filing.[28]  Undeniably, this state of affairs motivates hedge funds to activism, but by the same token it also denies any control premium or enhanced share price to those shareholders who sell while the “wolf pack” is increasing its aggregate holding to 30% or more.  In short, there are winners and losers in this process.

Despite my misgivings, the standard (and knee-jerk) response from the activist side is that large profits to those who buy before the Schedule 13D filing are justifiable because they motivate a desirable activism.  Yet, Mr. Ackman and Pershing Square are reported to have quickly generated over a $1 billion paper profit when they announced their campaign for Allergan.[29]  That may be more incentive than anyone needs.  Finally, those studies that show more companies losing value than gaining value from hedge fund activism call into question whether more incentive is even desirable.  The more that one doubts (or considers unproven) the long-term beneficial effects of hedge fund activism, the more the case grows for shortening the Section 13(d) “window.”  The more that the poison pill seems to be losing its blocking power (as the Sotheby’s case seemingly shows), the more that “closing the §13D window” becomes the only feasible response that will work.

To conclude, the “new” myth is that the efficiency gains from hedge fund activism justify relaxing the shareholders’ protection against “creeping control” acquisitions, and the “old” reality is that shareholders still need that protection (but may be losing it).  Increased transparency is the simplest, safest reform.



[1] See Third Point LLC v. Ruprecht, 2014 Del. Ch. LEXIS 64 (May 2, 2014). In the settlement, announced days later, the Sotheby’s board was expanded from 12 to 15 and the three Third Point nominees were seated (along with the Sotheby’s nominees); Third Point accepted a 15% standstill restriction (and was reimbursed for $10 million of its expenses).  See Stephen Foley, “Sotheby’s bows to Loeb over board seats in fresh victory for activists,” Financial Times, May 6, 2014, at p. 1.

[2] See David Gelles, Michael J. De La Merced and Alexandra Stevenson, An Unusual Hostile Bid for the Maker of Botox; Hedge Fund Manager Allies With Drug Maker to Acquire Allergan,” International New York Times, April 23, 2014 at p. 15 (noting 9.7% stake in target acquired by Pershing Square).

[3] For the leading articles in this new genre, see Ronald J. Gilson & Jeffrey N. Gordon, The Agency Costs of Agency Capitalism: Activist Investors and the Revaluation of Governance Rights, 113 Colum. L. Rev. 863 (2013); Lucian A. Bebchuk, The Myth That Insulating Boards Serves Long-Term Value, 113 Colum. L. Rev. 1637 (2013). Hordes of other articles are following.

[4] There is indeed much gossip that could be discovered by journalists about the behavior of some of the contestants in this drama, but you will not learn it here.

[5] See Blasius Industries, Inc. v. Atlas Corp., 564 A.2d 651 (Del. Ch. 1988); Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946 (Del. 1985). The most important recent decision is probably Yucaipa American Alliance Fund II, L.P. v Riggio, 1 A.3d 310 (Del. Ch. 2010)(involving a similar fact pattern).

[6] In a later decision, the Delaware Supreme Court held that the Blasius standard applies “only when the primary purpose of the board’s action is to interfere with or impede the exercise of the shareholder franchise and the shareholders are not given a full and fair opportunity to vote effectively.” MM Cos. v Liquid Audio, Inc., 813 A.2d 1118, 1130 (Del 2003).

[7] I recognize, of course, that jury trials do not occur in the Delaware Chancery Court, but they do occur in the Court of Public Opinion, when proxy fights are tried.

[8] See Alon Brav, et al., Hedge Fund Activism, Corporate Governance, and Firm Performance, 63 J. of Fin. 1729 (2008).

[9] Id. at 1761

[10] According to Table VI in this study, the top 1% earned a 439% annualized size-adjusted return and the top 5% earned a 146% similar return. Id. at 1761. The top 25% earned on this same basis a roughly 25% return.

[11] See R. Greenwood and M. Schor, Investor Activism and Takeovers, 92 J. Fin. Econ. 362, 368-70 (2009).

[12] See, e.g., L. Bebchuk, A. Brav and Wei Jiang, The Long-Term Effects of Hedge Fund Activism, Working Paper (available at http://ssrn.com/abstract=2291577) (April 10, 2014) at p. 22 (finding no statistically significant evidence of abnormal stock performance for the three and five year periods after the filing of the Schedule 13D). They interpret this evidence as showing no long-term underperformance by stocks targeted by activists, but the evidence also does not support superior performance.  For a more skeptical view, see C.P. Clifford, Value Creation or Destruction? Hedge Funds As Shareholder Activists, 14 Journal of Corp. Finance 323, 324-26, 332 (2008). Others find a positive impact on long-term returns, but only in cases where the Schedule 13D was filed by a hedge fund or investor engaged in a hostile campaign. See A. Klein and E. Zur, Entrepreneurial Shareholder Activism: Hedge Funds and Other Private Investors, 64 J. of Fin. 187, 220.

[13] See A. Khorena, E. Hooper, A. Shivdasani, G Sigurdsson and M. Zhang, “Rising Tide of Global Shareholder Activism,”  Citi Corporate and Investment Banking (2013) at p. 13-14.

[14] See Greenwood and Schor, supra note 11, at 329-31 (finding no significant change in return on assets, operating return on assets, payout ratio, asset growth or share growth in year before and after filing of Schedule 13D); L. Bebchuk et al., supra note 12, at 9-10 (no increase in industry-adjusted return on assets for firms targeted by activists). A. Brav et al., supra note 8, did find improvements in operating performance under some tests, but not others. Id. at 1769-1772.

[15] See Greenwood and Schor, supra note 11, at 371; Klein and Zur, supra note 12, at 223-224.

[16] Greenwood and Schor, supra note 11, at 371.

[17] For a critical review of Ackman’s hubris in undertaking this campaign, see James Surowiecki, “When Shareholder Activism Goes Too Far,” The New Yorker, August 15, 2013.

[18] J.H. Mulherin and A.B. Poulsen, Proxy Contests and Corporate Change: Change Implications for Shareholder Wealth, 47 J. Fin. Econ. 279 (1998).

[19] Id. at 300-302.

[20] See C.R. Alexander, M.A. Chen, D.J. Seppi, and C.S. Spatt, Interim News and the Role of Proxy Voting Advice, 23 Review of Financial Studies 4419, 4435 (2010).

[21] See D. Ikenberry and J. Lakonishok, Corporate Governance Through the Proxy Contest: Evidence and Implications, 66 J. of Business 465 (1993).

[22] Although I have reviewed the documents, the identification of these 73 cases was made by The Analysis Group, which also computed the averages.

[23] See SEC Rule 14e-3(a), 17 C.F.R. See SEC Rule 14e-3(a), 17 C.F.R. § 240. 14e-3(a).

[24] As Chief Justice Strine has recently explained,

“The pill works to prevent a creeping takeover whereby effective negative control over a corporation is acquired without the payment of a control premium.”

See Leo E. Strine, Jr., Can We Do Better By Ordinary Investors? A Pragmatic Reaction to the Dueling Ideological Mythologists of Corporate Law, 114 Colum. L. Rev. 449, 497 (2014). He goes on to explain that such a block would be a “huge deterrent to any potential acquirer.” Id.

[25] Bidders in fact often seek “support agreements” from institutional blockholders under which the latter agree to vote for a proposed acquisition.  If the first bidder obtains such an agreement from major hedge funds holding a 20% block or more, rival bidders will be unlikely to challenge its offer.

[26] Even in the absence of a support agreement favoring the first bidder, a second bidder will know that to effect a “squeeze out” merger and consolidate the target, it will need to establish the “intrinsic fairness” of its merger proposal, unless it can obtain a “majority of the minority” vote.  Unless it has the support of the large blockholders, such a vote will be difficult.

[27] I.S.S. objects to any poison pill adopted by the board that has a duration of greater than one year.  A longer duration in its view should require shareholder approval.  If a proxy contest is underway, I.S.S.’s support can be crucial and may swing between 10% and 30% of the vote.  See Yonca Ertimur, Fabrizio Ferri, and David Oesch, Shareholder Votes and Proxy Advisors: Evidence from Say on Pay, Working Paper (available at http://ssrn.com/abstract=2019239 (August 2, 2013)).

[28] See Section 13(d)(1) of the Securities Exchange Act, 15 U.S.C. §78m(d)(1). Most of the financially developed nations have narrowed this window, typically to two business days, but the U.S. remains an outlier.

[29] Pershing Square acquired a 9.7% stake in Allergan for approximately $4 billion, and Allergan’s shares have since risen over 36%.  Thus, the paper profit is probably closer to $1.4 billion, but it could go up or down depending on whether a rival bidder surfaces with an even higher offer.

John C. Coffee Jr. is the Adolf A. Berle Professor of Law at Columbia Law School and Director of its Center on Corporate Governance.