W I T N E S S E T H:

Unearthing the Household International poison pill

In the course of a project I'm working on related to "rights agreements" (poison pills), I discovered that the ThomsonOne service has some limited availability of paper filings from the pre-EDGAR era. I searched for the earliest poison pills and was unable to find them for Lenox and El Paso (believed to be the first poison pills). However, I found the one from Household International that was the subject of the landmark Supreme Court case validating the poison pill (Moran v. Household International).

I uploaded here a  copy of the 8-A filing with the pill document attached in case readers are interested in delving into this little piece of M&A history. I inserted below the first page of the pill from the document. Many of the terms are almost verbatim identical to those used today, with the exception that the Household Pill did not contain the now-standard "flip in" feature.

The Peculiar Persistence of Par Value

The concept of par value of stock is universally regarded as a relic. Most law professors reluctantly and apologetically teach about par value in Business Associations classes and students wonder why they need to learn the concept. As for practicing lawyers, they generally set par values as low as possible as to avoid the largely historical pitfalls of watered stock and legal capital restrictions on dividends. Hence, readers of balance sheets encounter the puzzling $0.000005 par value per share of Twitter, for example.

Yet, somewhat peculiarly lawyers rarely create stock with a par value of zero. Although lawyers try to set the par value arbitrarily low, and although it often goes lower through stock splits, par value is very persistent, at least among publicly traded companies. So how many public companies are there with no-par stock? A review of 10-K filings from the first three quarters of 2018 revealed the following distribution of par values among reporting companies.

Par value per share	Number of Companies	Percentage of Companies
$0.01	1396	31.9%
$0.001	1228	28.0%
$0.0001	600	13.7%
$0 (no par)	357	8.1%
$1	222	5.0%
$0.10	126	2.9%
$0.00001	94	2.1%
OTHER	359	8.2%

The reporting company with the lowest par value was MEI Pharma, Inc. with a par value of $0.00000002 per share (they should use scientific notation!) and the reporting company with the highest par value was Brighthouse Life Insurance Company with a par value of $25,000 per share (high par values are more common in regulated industries such as insurance, banking, and utilities).

Notably, of the 4,382 companies reviewed, only 357 (or 8.1%) had zero par value. Although it's possible the script missed a few (see Note on Methodology below), this estimate is likely close to the percentage of public companies with no par stock. 

This is peculiar because the idea of stock without par value is not a recent innovation. States had begun reforms allowing no par value stock in the early 20th Century. There was even a law review article in 1924 lamenting the "dangers" of the growing reform movement toward shares without par value. Yet those "dangers" are no longer feared by any contemporary commentator or practitioner, so far as I'm aware. So what's the explanation for the peculiar persistence of par value?

Like so many other things in lawyering, the answer is likely one of default decision-making and inertia among transactional lawyers. One can imagine the response, "We always use $0.01 par value per share, and it's never caused any problems." The (not at all irrational) culture of transactional law is not to change what's working. There's no compelling reason to move from vanishingly small par values to zero par values, and lawyers perceive there might be some risk of doing so (for example, inadvertently allocating the entire purchase price of shares to legal capital). Thus, no change takes place.

Another example of a similar dynamic at work is the Delaware incorporation choice. Although the most recent evidence (including my own work with Jeff Manns) suggests Delaware incorporation has either no value or negligible value, Delaware continues to dominate the incorporation market. The decision of where to incorporate is largely driven by lawyers, and a company's choice of lawyer largely determines its choice of state of incorporation, as I've argued in my article, The Delaware Trap. The story of transactional legal inertia and default thinking is one that dominates many areas of corporate law and practice, and understanding these factors is vital to understanding transactional law and its evolution.

In fact, these two "cultural" traditions (Delaware incorporation and the persistence of par value) show a relationship in the data. Among Delaware incorporated companies, only 29 of 2124 companies (1.4%) had zero par value. Of the non-Delaware incorporated companies, 305 of the 1995 non-Delaware companies (15.3%) had zero par value. Thus, Delaware companies tend to retain par value stock at higher rates than non-Delaware companies. This is true despite the fact that companies with very high par values (greater than or equal to $1.00) incorporated in states other than Delaware at a higher rate (67.5% for those with a par value > $1 versus 46.2% for those with par value < $1). So companies incorporated in states other than Delaware are more likely to have high or zero par values, whereas Delaware companies are more likely to have nominal (but not zero) par value.

* Note on methodology. The computer script used the 10-K XBRL elements for par value of common stock and preferred stock, rather than reviewing the charter documents. It is possible that the XBRL par value figure was entered differently from the relevant charter documents. Stock was classified as no par when the 10-K contained XBRL with a CommonStockNoParValue element or a CommonStockParOrStatedValuePerShare element with a value of 0. 10-K filings with the words "no par value" or "without par value" in the first few pages were reviewed for accuracy.

 

Why is Delaware so dominant in corporate law?

Why is Delaware so dominant in corporate law? The traditional story among most practicing corporate lawyers is that Delaware's superior corporate law, judiciary, and responsiveness allowed it to win an interstate competition for corporate charters. According to this perspective, Delaware is "just better." But as many, many academic papers have argued, however, the true reason for Delaware's continued dominance is likely much more complex.

In my recent paper, The Delaware Trap: An Empirical Study of Incorporation Decisions, I attempt to provide some new information to help explain the drivers of incorporation decisions. Using a large dataset of corporate finance filings, I find that one of the strongest predictors of a company's choice of incorporation state is its choice of law firm. In other words, the data suggest that many companies are not choosing Delaware over other states because of the quality of its law or because of the companies' individual needs, but rather companies choose the type of law firm, and the type of law firm largely dictates the state of incorporation. These results suggest that we may need to rethink much of the research on state competition in corporate law.

Here is the abstract:

One of the most enduring debates in corporate law centers on why Delaware has become the dominant state in the market for corporate charters. Traditionally, two perspectives dominated the debate, the “race to the top” perspective that sees competition among states as driving legal rules toward efficiency and the “race to the bottom” perspective that sees competition among states as driving legal rules toward the interests of corporate managers. The two dominant perspectives have struggled to explain why approximately half of companies incorporate in Delaware, while the other half incorporate in their home states. Whether the choices are attributable to the quality of state law or to characteristics of the companies themselves or both has given rise to a large, but inconclusive empirical literature.

This Article uses a large dataset of corporate financings to shed new light on this mystery and uncovers strong evidence that some of the strongest factors in incorporation choice are factors unrelated to either the quality of state law or the characteristics of individual companies. Instead, the data strongly suggest that demographic markers of sophistication, such as choice of law firm and headquarters location, predict the jurisdictional choice about as well as state law or the business attributes of companies. Companies with more demographic markers of sophistication tend to choose Delaware incorporation, and companies with fewer demographic markers of sophistication tend to choose home-state incorporation. The finding persists even when other attributes of the company are controlled for, such as its industry classification, the amount of money raised, or whether the company is public or private. Indeed, the sophistication factors arguably predict Delaware incorporation as well or better than any factors documented in the vast literature on state competition for corporate charters.

The findings have important implications for the state “race-to-the-top” debate in corporate law. At a minimum the results in this Article make it clear that the choice of legal representation is an important missing variable in models of incorporation decisions. The fact that the choice of law firms drives the jurisdictional choice has far broader implications. If law firms drive the jurisdictional choice they may steer companies toward states that serve the law firms’ own interests without regard to the quality of legal rules or the needs of the client. When the state chosen is Delaware, as it often is, there are few alternative jurisdictions that shareholders and managers can agree on. As a result, companies inadvertently fall into a “governance trap” from which reincorporation out of state is nearly impossible. This interpretation would suggest that Delaware’s carefully calibrated positioning in the charter market has largely eliminated meaningful competition among the states for the quality of corporate law.

My paper is available on SSRN here. 

Do the capital markets value Delaware corporate law?

In a recent paper, Jeffrey Manns (GW Law) and I use a new empirical technique to estimate the value of Delaware corporate law relative to that of other states. We find that the capital markets place little, if any, value on Delaware corporate law, suggesting that Delaware's dominance is instead the result of herding effects and network externalities. You can read the paper here, and the abstract is pasted below:

Delaware dominates the market for company incorporations, which places one of America’s smallest states in charge of determining the corporate governance framework for most public and private companies. The unresolved question is the basis for Delaware’s appeal compared to other states. We set out to test empirically the two leading schools of thought which hold that Delaware’s appeal lies either in its superior legal regime that enhances shareholder value better than other states or in Delaware’s protectionist appeal in adding “managerial value” by entrenching corporate managers at shareholders’ expense. We apply an innovative technique to show empirically that both the “race to the top” and “race to the bottom” schools of thought are based on false assumptions because Delaware law adds no value compared to other states.

Our “merger reincorporation” approach leverages the fact that each inter-state merger forces the acquirer to assess the merits of Delaware law when choosing the state of incorporation for the surviving company. This fact creates the opportunity to gauge the market’s assessment of the value of Delaware law relative to that of other states by comparing the pre- and post-acquisition value of acquirers and targets in a cross-section of intra- and inter-state mergers. We analyzed an eleven year data set of mergers (from 2001 to 2011) and found that financial markets place no economically consequential value on Delaware law relative to that of other states, which contradicts both of the leading schools of thought. This result suggests that lawyers are engaging in default decision-making based on Delaware’s past preeminence, rather than actively weighing the value-added Delaware and other states offer to their clients. Lawyers appear to turn to Delaware because it is the law they are most familiar with; they assume markets value Delaware law; and they regard Delaware as a safe default which would trigger no pushback from corporate managers. To break up herding effects among lawyers and spur lawyers to assess this opportunity to add value to transactions, we argue policymakers should introduce “shareholder say” on the state of incorporation. Empowering shareholders to vote on retaining or changing the state of incorporation would subject this decision to greater scrutiny and give shareholders the opportunity to address this principal-agent failure. This approach would dampen Delaware-centric herding and foster greater state competition.

How I visualize the evolution of Delaware corporate law

... that is, somewhat like a random walk.