Chapter 34 "Corporate Management"
Managers are in violation of the corporate opportunity doctrine if they compete against the corporation without its consent.
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Managers serve at least three masters: themselves, shareholders, and other stakeholders. These masters have conflicting goals: • Managers want two things: first, to keep their jobs, and second, to build an institution that will survive them. Mark Willes, chairman of The Los Angeles Times, wept when his company was sold despite the immense wealth he received from the sale. To him, the job was what mattered. • Shareholders want a high stock price, right now, not five years from now. As owners, the members of the Chandler family cared more about their own profits than they did about the newspaper and its important role in the life of the city. • Stakeholders, those who work for the Los Angeles Times, read it, sell it ink, or own the food shop across the street from its plant want the newspaper to stay in business. The speaker of the California State Assembly lamented the sale because the paper had been a booster for the whole city of Los Angeles. (Generally, managers are not included in the stakeholder category because their interests may be different from those of lower-level employees.)
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The business judgment rule is two shields in one: it protects both the manager and her decision. If a manager has complied with the rule, a court will not hold her personally liable for any harm her decision has caused the company, nor will the court rescind her decision. If the manager violates the business judgment rule, then she has the burden of proving that her decision was entirely fair to the shareholders. If it was not entirely fair, she may be held personally liable and the decision can be rescinded. The business judgment rule accomplishes three goals: • It permits directors to do their job. Business is risky.No one can guarantee perfect decision making all the time. If directors were afraid they would be liable for every decision that led to a loss, they would never make a decision, or at least not a risky one. • It keeps judges out of corporate management. Shareholders would generally prefer that their investments be overseen by experienced corporate managers, not judges. Without the business judgment rule, judges would be tempted, if not required, to second-guess managers' decisions. • It encourages directors to serve. No one in his right mind would serve as a director if he knew that every decision was open to attack in the courtroom. Even if the company pays the legal bills, who wants to spend years in litigation?
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Self Dealing
A self-dealing transaction is valid in any one of the following situations: • The disinterested members of the board of directors approve the transaction. Disinterested directors are those who do not themselves benefit from the transaction. • The disinterested shareholders approve it. The transaction is valid if the shareholders who do not benefit from it are willing to approve it. • The transaction was entirely fair to the corporation. In determining fairness, the courts will consider whether the price was reasonable and the impact of the transaction on the corporation.
Officers and directors have a fiduciary duty to act in the best interests of their stockholders, but under the business judgment rule, the courts allow managers great leeway in carrying out this responsibility. The business judgment rule is a common law concept that has achieved national acceptance. It is a fundamental principle of corporate law. To be protected by the business judgment rule, managers must act in good faith:
Duty of Loyalty - Without a conflict of interest Duty of Care - With the care that an ordinarily prudent person would take in a similar situation, and in a manner they reasonably believe to be in the best interests of the corporation
Courts are generally unsympathetic to managers who engage in illegal behavior, even if their goal is to help the company.
Generally, courts will protect managers who make an informed decision, even if the decision ultimately harms the company. Making an informed decision means carefully investigating the facts. However, even if the decision is uninformed, the directors will not be held liable if the decision was entirely fair to the shareholders
In addition to the duty of loyalty, managers also owe a duty of care.The duty of care requires officers and directors to act in the best interests of the corporation and to use the same care that an ordinarily prudent person would in a similar situation.
If a decision does not have a rational business purpose, the managers are liable and the decision can be rescinded. If a court decides that there is a rational business purpose, both the manager and the decision are protected.
The duty of loyalty prohibits managers from making a decision that benefits them at the expense of the corporation.
Self-dealing means that a manager makes a decision benefiting either himself or another company with which he has a relationship.
The courts have generally held that managers have a fiduciary (involving trust) duty to act in the best interests of the corporation's shareholders
Since shareholders are primarily concerned about their return on investment, managers must maximize shareholder value, which means providing shareholders with the highest possible financial return from dividends and stock price
There are three ways to acquire control of a company: • Buy the company's assets. Such a sale must be approved by both the shareholders and the board of directors of the acquired company. - Merge with the company. In a merger, one company absorbs another. The acquired company ceases to exist. A merger must be approved by the shareholders and the board of directors of the target. - Buy stock from the shareholders. This method is called a tender offer because the acquirer asks shareholders to "tender," or offer their stock for sale. As long as shareholders tender enough stock, the acquirer gains control. - A tender offer is called a hostile takeover if the board of the target resists. Two scenarios are common in hostile takeovers: • The target has assets that the bidder genuinely wants. • A speculator plans to acquire control and then resell all or part of the company at a profit. Speculators, sometimes called corporate raiders, often say that they are acquiring stock in a company because it is undervalued; their ostensible goal is to improve management and raise stock prices. In practice, however, oftentimes another bidder comes along who buys their stock at a higher price; the raiders dismember the company and sell its parts
The Williams Act applies only if the target company's stock is publicly traded. Under the Williams Act: • Any individual or group who together acquire more than 5 percent of a company's stock must file a public disclosure document (called a "Schedule 13D") with the Securities and Exchange Commission (SEC). On the day a tender offer begins, a bidder must file a disclosure statement with the SEC; • A bidder must keep a tender offer open for at least 20 business days initially, and for at least 10 business days after any substantial change in the terms of the offer; • Any shareholder may withdraw acceptance of the tender offer at any time while the offer is still open; • If the bidder raises the price offered, all selling shareholders must be paid the higher price, regardless of when they tendered; and • If the stockholders tender more shares than the bidder wants to buy, it must purchase shares pro rata (in other words, it must buy the same proportion from everyone, not first come, first served)
To protect themselves from hostile takeovers, companies adopt defensive measures known as antitakeover devices or shark repellents. (The acquiring shareholder in a hostile takeover is sometimes referred to as a "shark.") Common shark repellents include the following: • Asset lockup. The target sells off the assets that the shark most wants. Suppose that Ingrid is the CEO of Casablanca, Inc., a successful film production company that owns a vast and valuable library of old films. Turner has indicated that he may want to acquire Casablanca because he covets its library. Ingrid tries to pass the bait to someone else, either by selling the film library or by giving someone else the option to buy it. • Greenmail. The target buys back the shark's stock at a premium price. Ingrid suspects that Turner is not really interested in owning Casablanca stock; he simply wants to turn a quick profit. Ingrid offers to buy back Turner's stock at a price 30 percent higher than he paid for it. • Shareholder rights plan ( "poison pill"). When an outside shareholder acquires more than a certain percentage of company stock, a rights plan dilutes the value of these shares.10 Now Ingrid becomes truly creative. She gets Casablanca to issue a special share of preferred stock to each current shareholder.If the shark purchases more than 20 percent of Casablanca's stock and subsequently merges with Casablanca, this preferred stock can be converted into 10 shares of the acquiring company. Thus, for each share of Casablanca that Turner buys, he also has to give away 10 of his own shares, making the takeover much more expensive for him. No wonder these, and other similar tactics, are called "poison pills;" they could certainly prove fatal to a shark. - Chewable poison pills. These pills are exactly like a poison pill except that they expire automatically if a cash tender offer is made for 100 percent of the company's stock, at a price at least, say, 25 percent above market value. - Dead-hand poison pills. A dead-hand poison pill can be removed only by vote of the directors who installed the pill or by their handpicked successors. In this way, the decision is in the "dead hands" of the prior board - Staggered board of directors. With a typical board of directors, all directors run for election each year, with the result that the entire board can be voted out at the same time. With a staggered board, only a portion of the directors are elected each year - Supermajority voting. Ordinarily, shareholders can approve charter amendments by a majority vote, but some companies require a higher percentage to approve important changes. - White knight. A white knight is another company that rescues the target from a hostile takeover
When establishing takeover defenses, shareholder welfare must be the board's primary concern. The directors may institute shark repellents, but they must do so to ensure that bids are high, not to protect their own jobs. A poison pill is acceptable if it gives management enough bargaining power to negotiate a high price for shareholders, but not if it makes a takeover impossible. If it is clear that the company will ultimately be sold, the board must auction the company to the highest bidder; it cannot give preferential treatment to a lower bidder. The board cannot sell the company to a white knight at a lower price than someone else has offered, no matter how much management might personally dislike the shark. Most states have now passed laws to deter hostile takeovers. Among the common varieties are the following: • Statutes that automatically impede hostile takeovers. These statutes, for instance, might ban hostile mergers for five years after the acquirer buys 10 percent of a company. Or investors who acquire as much as 20 percent of a company lose their voting rights unless the other shareholders move to reinstate the rights (not likely!). These provisions do not apply to bids that have been approved by the board of directors of the target company. In many states, such as Delaware, the board can opt out of the statute altogether and refuse to accept its protection. • Statutes that authorize companies to fight off hostile takeovers. These statutes typically permit management, when responding to a hostile takeover, to consider the welfare of company stakeholders, such as the community, customers, suppliers, and employees. Some even go so far as to allow management to consider the regional or national economy. Since takeovers are almost always harmful to these other constituencies, company management has a ready excuse for fighting the takeover.
Stakeholder
anyone who is affected by the activities of a corporation, such as employees, customers, creditors, suppliers, shareholders and neighbors.