The shareholder base of modern U.S. public companies is diverse. At one end of the spectrum are large asset managers like BlackRock, which by itself has almost $7 trillion in assets under management. At the far other end are ordinary people—so-called “retail” investors. And between these two ends lie a hodgepodge of institutions, including public pension funds, hedge funds, insurance companies, and university endowments. Should corporate law assume that these shareholders all share a common goal?
According to Professor Ann Lipton’s timely and clear-eyed article, Shareholder Divorce Court, the answer is an emphatic “no.” While corporate law has traditionally elided the messy reality of shareholder heterogeneity by assuming that all types of shareholders have the same interest—wealth maximization—the landscape has changed. But as courts in recent years have adjusted and accommodated shareholder preferences that deviate from wealth maximization, they have created a new problem: smaller, less diversified shareholders may now be forced to accept suboptimal transactions that are not designed to promote their interests. Lipton’s account is important. In making her case and exploring how the right of appraisal can be reconfigured to act as a remedy, Lipton excavates yet another consequence of Delaware’s newfound confidence in the efficacy of the shareholder franchise.
As Lipton explains, corporate law traditionally “papered over” the problem of divergent shareholder preferences by entrusting directors, not shareholders, with most corporate decision-making and deferring to directors’ judgments. Nevertheless, under circumstances when the heterogeneous interests of shareholders were too blatant to ignore, courts stepped in to enforce the fiction that shareholders have a uniform preference for wealth maximization. For example, in vote-buying cases, courts have said that a bought vote becomes illegitimate when it does not “reflect rational, economic self-interest arguably common to all shareholders.”
The rise of large, sophisticated, and diversified institutional investors changed things. First, in Lipton’s telling, the “growth of institutional ownership has led to increasing—and increasingly visible—conflicts” between investors’ preferences. Institutional investors are now frequently invested in companies on both sides of a transaction, own both stock and debt in the same company, hold derivatives, and so forth—all of which give rise to idiosyncratic interests that are not shared by less diversified or retail shareholders.
Second, “[i]nstitutional investors’ size and sophistication puts significant strain on the doctrinal axiom that shareholders are too inexpert, or do not have sufficient incentives, to meaningfully contribute to corporate governance,” which had been the original justification for restricting shareholders’ power within the corporation. Recognizing this, the law evolved. Through cases like Kahn v. M&F Worldwide and Corwin v. KKR Financial Holdings, corporate doctrine has “shifted away from judicial enforcement of a fictionalized wealth-maximization norm, and toward accommodation of actual shareholder preferences.”
By connecting these two developments, Lipton deftly leads us to the problem she has identified. The law has moved toward allowing shareholders as a group to choose their own objectives—to choose to depart from maximizing wealth—but it continues to treat shareholders as a monolith, ignoring shareholder conflicts and the reality that certain types of shareholders are systematically more powerful than others. As it stands, the largest institutional investors may use their voting power to induce deals that advance their private interests at the expense of the interests of the corporation or its other shareholders. Smaller shareholders “whose interests do not align with those of the largest institutions” are now “left without an advocate,” and therefore may be “trapped in suboptimal transactions.”
This insight alone is a valuable contribution to the corporate law scholarship. But Lipton does not stop there—she concludes with an elegant solution to the problem using the right of appraisal. According to Lipton, past versions of appraisal had been used to manage shareholder heterogeneity, and appraisal today can be modified to serve its original purpose. Appraisal permits shareholders who dissent from certain actions to receive the appraised fair value of their shares. Lipton argues that a reformed appraisal can be a mechanism to ensure that institutional shareholders will, “in effect, pay other shareholders for the privilege” of inducing the corporation to pursue opportunities that sacrifice wealth maximization in favor of advancing idiosyncratic benefits. Appraisal, in other words, can allow shareholders to effectuate an amicable “divorce.”
Lipton’s works are often prescient, and this article is no exception. As she points out in the very first sentence, “Corporate law is designed to address conflicts of interests among stockholders and managers.” But a different type of conflict—inter-shareholder conflicts of interest—is now too obvious to ignore, so the law must adjust. Lipton’s article does an excellent job of launching this conversation.