Does the existence of the appraisal remedy, and its use, have an effect on arbitrage spreads? If the appraisal remedy results in lower arbitrage spreads, then one can conclude that shareholders writ large are benefiting from the appraisal remedy – the argument advanced by Professors Brian Broughman, Audra Boone, and Antonio Macias in their piece “Merger Negotiations in the Shadow of Judicial Appraisal,” published in The Journal of Law and Economics 62, no. 2 (May 2019): 281-319 (originally released in draft form in 2017, and covered here). Mechanistically, this part of the analysis is straightforward: If a stronger appraisal remedy (represented in the article by deals subject to an appraisal challenge) results in a greater “share” of merger consideration going to target company shareholders instead of arbitrage traders, then even shareholders who do not exercise appraisal are benefiting from a strong remedy. (Note that this argument is conceptually different from the argument that a strong appraisal remedy actually results in higher deal premia.)

A new article from authors at Analysis Group seeks to challenge the methodology of the Boone et al. piece. In “Appraisal Challenges and Benefits to Target Shareholders Through Narrowing Arbitrage Spread” (summary available here; article here), the authors argue that there were both data issues and sampling issues with the original analysis, which showed a 6 percent lower post-announcement arbitrage spread for deals subject to appraisal challenge. As to data, the challenger-article argues that there are significant outliers in the Boone et al. data set, and that those outliers drive much of the result. Highlighting instances where arbitrage spreads of 50 percent or even 100 percent appeared (and specifically referring to one instance where the data set recorded the spread as 52.46 percent when the actual spread should have been 9.35 percent), the challenger-article purports to resolve the issue by using medians instead of means to compare arbitrage spreads.

The challenger-article than moves on to a critique based on supposed “sampling bias” – putting forth three factors it contends the Boone et al. article did not sufficiently contend with: (1) time period, (2) deal consideration, and (3) state of incorporation.

1. For time period, the challenger-article breaks the data set down into three periods: “Pre-Crisis,” set as January 2004 to November 2007; “Financial Crisis,” from December 2007 to June 2009; and “Post-Crisis,” from July 2009 to April 2017 (when the Boone study data set terminates). The challenger-article points out that a significantly larger set of the deals subject to an appraisal challenge occurred in the “Post-Crisis” period, compared with deals not subject to an appraisal challenge. In turn, the challenger-article notes that the entire set of deals Post-Crisis exhibited lower arbitrage spreads than did the other time periods.
2. For deal consideration, the authors note that none of the all-stock deals, which exhibited the highest arbitrage spreads, were subject to an appraisal challenge.
3. For state of incorporation, the challenger-article noted that none of the non-Delaware deals were subject to an appraisal challenge, and thus all of the “subject-to-appraisal” deals in the analysis were Delaware deals.

Without reviewing the data set and the quantitative work behind the Boone et al. and challenger-article analyses, we cannot speak to which has the better argument. But we do note that there is a certain path dependence aspect to each of the sampling critiques above. For example, with respect to time period, it is no secret that appraisal rights litigation picked up significantly post-financial crisis, reaching very high levels in the 2010s. Is it possible that the growing number of appraisal cases, and thus the threat to mergers of a possible appraisal, helped narrow arbitrage spreads?

Similarly, as to stock versus cash deals, it’s difficult to know whether the threat of appraisal caused certain deals that otherwise would have had a cash component to shift to all-stock.

Separately, while the pre-2017 data set contained no (public) deals outside Delaware with an appraisal challenge, this has not necessarily remained the case. There is a growing cognizance of the appraisal remedy in other U.S. jurisdictions, and there are cases – ongoing now – outside Delaware, and more are certainly anticipated.

Also, other variables could be tested. For example, appraisal arbitrage cases generally occur in mergers with larger public floats – perhaps the size of merger is a relevant variable to consider.

Appraisal challenges also may occur more frequently in deals that include an interested party as one of the buyers. This may also be a variable to interrogate – if appraisal challenges generally occur in deals that are more likely to close, then the challenger-article may have a point: The arbitrage spreads on such deals may be lower apart from the impact of the appraisal remedy.

We will continue to cover developments in the discussion of if and how the appraisal remedy benefits shareholders writ large. Further, as we noted at the top of this piece, the methodology challenges issued by the challenger-article here go only to a small subset of the potential benefits of the appraisal remedy to shareholders. And of course, the entire debate here is cabined by the data at issue. As time goes on, more appraisal cases are filed, and more data made available, perhaps the conclusions will become clearer.