Appraisal is a remedy for shareholders who believe a merger is being consummated at below fair value. Appraisal is also a check on management and boards of directors – specifically, providing a ‘backcheck’ on whether the shareholder fiduciaries are achieving fair value for the company. Management buyouts are an acute case of mixed incentives for company insiders, and accordingly are a place where the appraisal remedy is particularly critical.
Enter a recent paper from the Journal of Financial Economics analyzing MBOs and freezeouts. Analyzing MBOs and other mergers from 1980 forward, the authors find evidence that MBOS and freezeout transactions are timed to take advantage of industry-wide under valuations. In other words – the insiders, with the most industry knowledge, are sometimes able to purchase companies on the cheap from existing shareholders when the overall industry is being undervalued by the market. This allows the buyer (management) to “capture the value” between the target’s value and the bid price in a time of industry undervaluation.
It is worth noting that the authors evidence applies to the “average” MBO – i.e., MBO’s in general – and not to any particular MBO. Management does not time its bid to industry undervaluation in every instance, or in any particular instance, but there is evidence that management does so across the aggregate of MBOs.
Data like this highlights the importance of the appraisal remedy. When MBOs are able to accrue value to the bidder, and not shareholders, shareholders need a remedy (like appraisal) to check the buyer (in this case – management’s!) gains. The data also highlights that appraisal may be particularly relevant in MBOs or other instances where the buyer has superior information to the market at large – something that was seen in Dell and other appraisal cases.