A Review of Fairness Opinions and Proxy Statements: 2005-2006
Shaked, Israel, Kempainen, Stephen, Journal of Applied Finance
The record merger and acquisition activity of 2006 and 2007 ushered in renewed criticism of fairness opinions. The focus of this research is to determine whether a fairness opinion and its accompanying proxy statement provide information required for shareholders to conclude on the inherent value of the company. Our study of 105 fairness opinions supports the criticism placed on fairness opinions. We find that financial advisors provide partial information to shareholders as to the inputs used in their valuation models and similar to academic scholars, they varied greatly in their application of valuation methodologies. Shareholders are provided little information as to the inherent value of the company.
In a sale, management buyout, going private, or other corporate control transaction involving a publicly traded company, a board of directors, or a committee of the board will frequently, if not always, obtain a fairness opinion from a financial advisor. A fairness opinion does not constitute a recommendation to shareholders whether to vote for the approval of the pending transaction. It also does not provide an opinion as to the inherent value of the company. Instead, a fairness opinion states that the proposed offer for the target company's shares is fair from a financial point of view. In practice, this generally means that the offer price lies somewhere between the low and high valuations determined by the financial advisor providing the fairness opinion. The focus of this research is to determine whether a fairness opinion and its accompanying proxy statement provide information required for shareholders to conclude on the inherent value of the company and as to the fairness of the pending transaction.
Prior to the mid-1980s, obtaining a fairness opinion was not necessarily the modus operandi for boards faced with determining whether to proceed with a transaction. However, in 1985, the Delaware Supreme Court ruled in Smith v. Van Gorkom that the board of Trans Union Corporation ("Trans Union") violated its duty of care because the board's decision "to approve the proposed cash-out merger was not the product of an informed business judgment."1 Among other charges, the Court stated that the directors were uninformed as to the intrinsic value of Trans Union.
The Court ruled that the board violated its duty of care, and as highlighted by Bebchuk and Kahan ( 1 989), Bowers (2002) and Davidoff (2006) among others, the Court emphasized the board's failure to obtain a fairness opinion. From the Smith v. Van Gorkom decision, academics and practitioners inferred that a fairness opinion was essentially a mandatory requirement for target boards making a corporate control decision (Davidoff 2006). However, Bowers (2002) found that while initially after the Smith v. Van Gorkom decision target firms' use of fairness opinions increased, the average frequency of use in the period from 1986 to 1990 (58.2%) was not materially different from the 1980 to 1985 period (57.2%).2 In a follow-up research, Bowers and Latham (2004) found strong evidence that acquirers' behavior had been significantly altered since the Smith v. Van Gorkom ruling, but the results were not as strong for target firms.
At the time the Smith v. Van Gorkom ruling was made, the buyout boom of the 1980s was underway. During that period of active buyout activity, shareholders accused company management and boards of rejecting takeover offers in an attempt to preserve their positions at the firm. Two decades later, as the private equity buyout boom hit a frenzied pace in 2005 and 2006, shareholders again were upset with company management and boards. However, this time it was for agreeing to sell the company at a price that was allegedly too low.3
A common thread that weaves its way through the buyouts of the 1980s to the present is the fairness opinion. In preparing the fairness opinion letter, the financial advisor generally conducts several analyses (e. …