Academic journal article Northwestern University Law Review

Fairness Opinions and the Business Judgment Rule: An Empirical Investigation of Target Firms' Use of Fairness Opinions

Academic journal article Northwestern University Law Review

Fairness Opinions and the Business Judgment Rule: An Empirical Investigation of Target Firms' Use of Fairness Opinions

Article excerpt

A man's judgment cannot be better than the information on which he has based it.1


In 1985, the Delaware Supreme Court made a decision that has had a profound impact on corporate governance, the market for corporate control, and the financial advising industry.2 Addressing shareholder lawsuits, the court decided that the board of directors of Trans Union Corporation, while acting in good faith, had nonetheless been grossly negligent in recommending a merger offer even though the offer provided shareholders with a 39% to 62% premium, in part, because the board had not made an "informed" decision. In its decision in Smith v. Van Gorkom,3 the Delaware Supreme Court, seeking to insure that corporate boards of directors make informed recommendations regarding business decisions, created the obligation that when evaluating a takeover proposal, the corporate boards of target firms must inform themselves of all reasonably available and relevant information to the decision.

The Van Gorkom decision has generated a significant amount of case law and commentary. Although the decision has been credited-many would say blamed-for practices now perceived to be standard in corporate

transactions, there have been few attempts to empirically examine its effects. This Article focuses on the frequency of use of fairness opinions by target firms, pre- and post- Van Gorkom, and the portion of financial advisor revenues earned from fairness opinions.

The empirical results in this Article cast some doubt on widely held perceptions concerning the use of fairness opinions: First, contrary to the view that, as a result of the Van Gorkom decision, it is now uniform practice for target firms to obtain fairness opinions, only 61% were found to do so from 1980 through 1999.(4) Second, although target firms' use of fairness opinions did increase immediately following the Van Gorkom decision, the average frequency of use from 1986 to 1990 58.2%) is not materially different from the 1980 to 1985 period (57.2%).5 Last, there is no significant increase in the portion of revenues earned by financial advisors from fairness opinions in the post- Van Gorkom era.6


Van Gorkom was decided during the fourth of five major merger waves in the Twentieth Century. The first two merger waves occurred before 1930.(7) The third wave, which occurred in the 1960s, actually motivated many of the mergers that took place during the fourth merger wave of the 1980s. The resumption of the bull stock market in the early-to-mid 1990s fueled the fifth major merger wave of the last century.

The merger wave of the 1960s was the only period in which corporate diversification was the primary reason for acquisitions. There is general agreement that the resulting conglomerate mergers did not produce value for the acquiring firms' shareholders and were motivated instead by the interests of management.8 Managers engaged in acquisition activity to maximize firm size because they perceived that compensation, power, and prestige would be gained by managing a larger firm. However, these conglomerate acquisitions resulted in decreased shareholder value. Evidence shows that acquisitions motivated by diversification are the only group found consistently to generate shareholder losses.9 Also, focused firms are valued more highly by the market relative to diversified firms10 and there

exists a "diversification discount" because, in general, conglomerate firms are valued lower than the sum of their parts.11

The Trans Union acquisition was among the first of the transactions that characterized the merger wave of the 1980s. During the 1980s, acquisitions were often not motivated by managers seeking to form conglomerates, nor were they primarily motivated to create economies of scope or scale through operations. Instead, acquiring firms sought targets that offered the opportunity to liberate cash by some method of post-acquisition restructuring or to take advantage of investment tax credits (ITCs). …

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