Professor Bainbridge...on law, politics, religion, culture & food

Holman Jenkins on Control Premia

In a WSJ op-ed criticizing Kirk Kerkorian's securities fraud suit against DaimlerChrysler (among other current corporate governance disputes), Holman Jenkins says some very sensible things, such as:

Amid all the bellyaching about corporate governance, it's good to recall that the purpose of corporations is to create wealth. We ought to be careful before giving up too much vitality and risktaking in return for the false security of lawyers and prosecutors crawling all over management night and day.

Yet, he also makes a fundamental economic error in describing Kerkorian's suit. When Daimler and Chrysler merged, the deal was structured as a merger of equals. Unlike most corporate acquisitions, in most mergers of equals shareholders of neither constituent corporation receive a control permium for their shares (instead they just end up owning an equivalent amount of shares in the newly combined entity). In his suit, Kerkorian claims that the deal ended up being a de facto acquisition of Chrysler by Daimler, that Daimler planned it that way all along, and that Daimler's failure to disclose its alleged true intentions constituted securities fraud. Kerkorian's claim strikes me as being a bit of a stretch, but Jenkins' cavalier dismissal of it is clearly erroneous. Jenkins claims:

A "control premium" is a mythical concept: The large premium sometimes paid above market value in takeovers is purely a function of the presence or likely emergence of other bidders. Bidders weren't exactly lining up for Chrysler.

Wrong. The likelihood of competitive bidding may affect the size of the control premium offered by the initial bidder, and the emergence of competing bids definitely drives up the control premium that is ultimately paid, but a control premium is not dependent on either the existence of nor the prospect of competitive bids. I identified one source of control premia at page 213 of my text Mergers and Acquisitions:

Stock consists of two rights: economic and voting. A single share of stock gives the owner little control over the company. The market price of a share of stock thus reflects nothing more than the estimated present value of the future stream of dividends payable on that share. Someone buying a control block of stock, however, obtains significant control through the ability to elect the board of directors. Such control might be valuable if the purchaser believes it can use its position to extract nonpro rata special benefits from the corporation, such as generous salaries, perquisites, and the like. Note that such a sale does not necessarily leave the minority shareholders any worse off. The selling shareholder may well have been doing the same thing. Alternatively, the purchaser may believe that the shares will be worth more in its hands than in those of the incumbent. Perhaps the incumbent is a poor manager. If the stock price is depressed due to poor management, replacing the incumbents with more competent managers should raise the stock price and enable the purchaser to profit.

An alternative explanation for why control premia are paid in acquisitions has to do with the hypothesis that the demand curves for stock slope downward. I discuss that explanation at pages 55-56. But if you want the details on that one, you'll have to buy the book! (Heh.)