Over the past two decades, delisting from an exchange has become a popular choice for many public companies. Several studies attribute this trend to a number of factors, including the increased concentration of U.S. markets, which made many small and medium size public firms less viable; tightening of regulatory requirements (SOX, for example); and emergence of capital-raising alternatives for small and medium size private firms (for example, private equity funds). In sum, the net benefit of staying an exchange-listed firm has diminished, and various going private legal procedures have become popular.
The most common delisting method in the U.S. is merger into another company. However, a more interesting and thought provoking method, limited to companies with controlling shareholders, is freeze-outs, in which the controlling shareholder buys all the publicly held shares of a company.
Corporate law provides for two main freeze-out mechanisms: tender offers and mergers. In tender offers, controlling shareholders offer to buy all minority shares at a premium over their market price. If enough minority shareholders tender their shares, and the controlling shareholders reach a required threshold of ownership (90 percent of firm equity, for example), the rest of the minority shareholders are forced to sell their shares to the controlling shareholders at the offer price. In the second freeze-out method, the reverse triangular merger, the public firm is acquired and merged into a company fully owned by the controlling company. The acquisition price is usually negotiated with a special committee (“SC”) of independent directors and approved by a majority of “disinterested” shareholders (majority-of-the-minority, or “MOM”).
The Legal Debate over Freeze-outs
For decades, Delaware has debated how to regulate freeze-outs. Regulation of freeze-out mergers has remained relatively stable over the past two decades, with one major exception being the MFW case from 2013, which declared that the combination of SC and MOM may substitute for an entire fairness review by the Delaware chancery courts.
In contrast, the regulation and judicial approach concerning tender offers’ freeze-outs have been inconsistent. In 2001 (the Siliconix case), tenders were exempt from entire fairness, a decision partially reversed in 2002 (the Pure Resources case, which recommended MOM as a safeguard against entire fairness), and in 2010 (the CNX Gas case, which to some degree empowered the SC). Later on, in 2014, the Delaware General Corporation Law (DGCL) allowed a hybrid technique based on Section 251(h) of DGCL. This new freeze-out technique, sometimes called an intermediate-form merger, is essentially a tender offer negotiated with an SC and approved by the MOM tendering their shares. This new tender technique has since become the most popular tender freeze-out method.
In sum, Delaware’s law has evolved and converged into what is now known as the unified theory for the judicial review of freeze-outs. The tender procedure was restrained, and the merger approach eased, to a point where the differences between the merger and tender freeze-out techniques are minimal.
The convergence of U.S. freeze-out procedures raises several questions. Does the traditional tender freeze-out method really yield different outcomes than merger freeze-outs? Are offer premia and offer acceptance or deal completion rates different in merger and tender freeze-outs? The answer in both cases is “yes,” as our recent paper shows.
We start with a theoretical model that portrays a controlling shareholder that contemplates a freeze-out of minority shareholders and must decide on the mechanism: tender offer or merger. There are two differences between the tender offer and merger procedures. The first is the majority of the minority requirement, as discussed above. The second is that the merger procedure takes significantly longer than the tender offer procedure, creating the opportunity for disclosing more detailed information about the distribution of minority shareholders’ valuations prior to calculation of the takeover premium. The controlling shareholder then determines the freeze-out approach that will maximize her expected profits.
The empirical predictions of the model are that freeze-out offer premiums increase with the pre-offer holdings of the controlling shareholders (the proportion of shares held by them) and with the dispersion in minority shareholders’ valuations of the stock (breadth of the distribution of their selling prices). In addition, the probability of freeze-out deal completion is shown to depend positively on the pre-offer controlling shareholders’ holdings and negatively on the dispersion of minority shareholders’ valuations of the stock.
Our empirical tests use data from Israel, where the bifurcation between freeze-out merger and tender offer regulation is most extreme. In Israel, tender offers involve very few formalities. Controlling shareholders may announce a tender offer to the public with no prior board of directors discussion, with minimal disclosure (a short document detailing offer terms and a few price-history statistics), and with no court or regulatory consent or discussion. In contrast, the merger freeze-out procedure is structured much like the current one in the U.S., including special committee negotiations and a majority of the minority approval requirement. Our Israeli sample, comprising 329 freeze-out offers in 2000-2019, is also larger than that of any previous study of freeze-outs.
The empirical findings are generally consistent with the model. However, even simple comparisons of U.S. and Israeli freeze-out evidence yield some key insights. We find that in Israel (1) most controlling shareholders elect the simple and quick tender offer method of taking their company private, (2) the average premiums in tender offers are lower than in mergers, and (3) tender offers have a relatively large (40 percent) rejection rate. This Israeli evidence diverges from the U.S. evidence of a preference for merger freeze-outs, and higher completion rates and somewhat higher premiums in freeze-out tender offers relative to freeze-out mergers.
We propose that the lighter tender offer regulation standards of Israel are at least partly responsible for these U.S.-Israel differences, as the freeze-out merger procedures in both countries are similar. In Israel, due to the “soft” tender offer procedure (which does not require even a board discussion), some controlling shareholders may be tempted to attempt a freeze-out at below-fair premiums, and a suspicious public may respond to such attempts by rejecting offers more often.
Our theoretical model and the comparison of U.S. and Israeli evidence demonstrate that the tender offer freeze-out procedure is a relatively delicate and flexible technique that can be modified in several ways. This is perhaps our most important contribution, and it justifies the legal debate over freeze-outs and explains Delaware’s continuous quest for an optimal freeze-out tender procedure. On one hand, Delaware’s current unified approach to freeze-outs protects minority shareholders, while on the other hand it probably impedes execution of some efficient freeze-outs.
This post comes to us from professors Beni Lauterbach at Bar-Ilan University’s Graduate School of Business Administration and the European Corporate Governance Institute (ECGI), Evgeny Lyandres at Tel Aviv University, Yevgeny Mugerman at Bar-Ilan University, and Barak Yarkoni at Ariel University and Bar-Ilan University. It is based on their recent article, “The Choice Between Various Freeze-out Procedures and its Consequences,” available here.