Academic journal article Journal of Corporation Law

The Drivers of Market Efficiency in Revlon Transactions

Academic journal article Journal of Corporation Law

The Drivers of Market Efficiency in Revlon Transactions

Article excerpt

"The ability to bring somebody in to a situation is far more important than the extra dollar a share at the back end. At the front end, you're probably talking about fifty percent. At the back end you're talking about one or two percent. To this day I think that what we did at Revlon was the right thing to do, and that were it not for our ability to provide an edge to Forstmann we wouldn't have gotten the first higher bid. By saying that you have to be open to the last dollar at the back end, maybe you'd better not start on the front end. That's what I argued in Revlon. But remember, I lost Revlon, so I'm prejudiced."1

-Martin Lipton, Senior Partner, Wachtell, Lipton, Rosen & Katz

I. INTRODUCTION

Thirteen months after Professors Ronald Gilson and Reinier Kraakman published their seminal article The Mechanisms of Market Efficiency,2 Ronald Perelman began his overtures for Revlon that resulted in the Delaware Supreme Court's landmark decision in Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc.3 In Revlon, the court held that when a "sale" or "break-up" of the company becomes "inevitable," the board's duty changes from "defenders of the corporate bastion to auctioneers charged with getting the best price for the stockholders at a sale of the company."4 When Revlon is triggered, derivatively informed trading, to use Gilson & Kraakman's terminology (and more specifically, trade decoding5), becomes more important, relative to professionally informed trading, as a mechanism of market efficiency. But the possibility for noise-free trade decoding for companies in Revlon-mode suggests a reduction in incentives to search: as Gilson & Kraakman put it in the context of the small-block market, "Why would anyone incur the cost and risk of acquiring restricted-access information, if hair-triggered 'decoders' will extract the bulk of its value?"6 Thus Gilson & Kraakman's model identifies a potential problem with respect to Revlon transactions that might be cause for concern for those who believe that takeovers, in general, create value by directing assets to their most valuable use.7

In this Commentary I present evidence from our seventeen years of experience with Revlon that is consistent with the view that incentives to search have remained strong in the U.S. market for corporate control (MCC), despite this potential "Revlon Problem." I then identify three potential explanations for this finding: small net first-bidder costs, preemptive bidding, and heterogeneous buyers. These three "drivers" might explain how value-creating transactions were achieved in the 1990s MCC despite the potentially onerous requirements of Revlon.

The remainder of this Commentary proceeds as follows. Part II extends Gilson & Kraakman's model to the MCC and identifies two important differences between the small-block market, which is the focus of their analysis, and the MCC. Part III describes the substantive requirements imposed by Revlon, the mechanisms of market efficiency with respect to Revlon transactions, and the resulting Revlon Problem. Part IV presents large-sample evidence suggesting that the predictions of the Revlon Problem have not been realized in the 1990s MCC, and discusses three possible explanations for this finding. Part V concludes.

II. EXTENDING GILSON & KRAAKMAN'S MODEL TO THE MARKET FOR CORPORATE CONTROL

Ever since Henry Manne introduced the concept of a "market" for corporate control in his classic 1965 article,8 commentators have debated whether this market and the market for small-block shares represent a single market or two distinct markets.9 The fact that minority shares trade in public markets at a discount,10 and that a seller is entitled to keep a control premium in a control transaction,11 might suggest that the market for small-block shares and the MCC are two distinct markets. By focusing on information flows, however, Gilson & Kraakman's model provides a way of connecting these markets into a continuous whole, while also highlighting important structural differences that give rise to distinct mechanisms that move these markets toward efficiency. …

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