Academic journal article Stanford Journal of Law, Business & Finance

Using Derivatives to Manipulate the Market for Corporate Control

Academic journal article Stanford Journal of Law, Business & Finance

Using Derivatives to Manipulate the Market for Corporate Control

Article excerpt


The shareholder vote is a fundamental means by which corporate governance systems constrain managers' discretion over vast aggregations of property they do not own.1 The efficacy of that constraint, however, depends upon the existence of shareholders who will vote in their own economic interest.2 Vote-buying, by definition, divorces this link between voting and equity, thus eroding one of the main theoretical underpinnings of our corporate governance framework.

This article examines risk arbitrage, and one of the relatively new ways it has been used. Many scholars believe that risk arbitrage is a form of vote-buying and should be governed under the same principles and laws. Indeed, the economics behind both transactions, vote-buying and risk arbitrage, will ultimately leave the user in the same position. Buying votes, under any circumstances, has been considered improper for years.3 While the case against vote-buying in a political context is more robust,4 buying a shareholder's vote in the corporate setting is, by statute, illegal in some states,5 illegal but subject to a rebuttable presumption in others,6 and generally understood by many scholars to lead to perverse economic results.7

Despite the existence of statutes and common law doctrine prohibiting vote-buying and general academic consensus as to its dangerous consequences,8 the recent case of High River Limited Partnership v. Mylan Laboratories, Inc.9 confirmed a possible loophole and threat in our corporate laws that many had feared and suspected.10 Using complicated financial maneuvers and complex hedging techniques, the Perry Hedge Fund was able to separate its vote from its economic interest in the company, thus allowing it to influence managerial decisions without bearing the consequences of its actions.11

By hedging its risk, the hedge fund was able to vote in the company's affairs, but faced zero financial exposure to the consequences of its decisions. This is exactly what buying a shareholder's vote does - it is buying the vote, but not the equity or financial interest, to obtain the desired result. This is precisely the action that many fear can lead to inefficient and economically damaging results.12

Naturally, the implications of what I will call "de facto vote-buying" troubles many commentators.13 Heightening the complexity of the issue are the problematic legal questions that arise. Because the financial arbitrage techniques that separate the economic interest from the power to vote are so novel,14 and because the Mylan lawsuit was eventually dropped,15 we simply do not know how a court would adjudicate the legality of de facto vote-buying.16 Practitioners and academics are split as to whether the current body of statutory and case law is broad enough to cover these unanticipated financial innovations, or whether, despite the publicity, we must accept that under current law these practices are legal.17 The question of the legality of such techniques has grown even more pressing because these hedging techniques seem to be happening with greater frequency18 and are sparking a large public outcry.19

It is likely that a case with facts similar to Mylan will be brought to the Court sometime in the near future.20 With commentators severely conflicted on whether existing laws indeed do cover these sophisticated swap techniques that succeed in separating the vote from the ownership,21 this article will analyze the legal framework within which such a case would arise by analytically examining the current law regarding vote-buying. Only after first answering the threshold question of whether existing law prohibits these practices can we turn to the normative questions of whether they should be prohibited, and if so, how such issues can be addressed. This article attempts to take that critical first step in an effort to resolve the current debate in corporate law.

The preliminary analysis seeks to examine the similarities between risk arbitrage and vote-buying to determine whether our current vote-buying jurisprudence covers risk arbitrage. …

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