Expropriating control: the case of Rights Offers

Leeor Ofer has just published a post in the Harvard #Corpgov blog, (1) where she summarizes her forthcoming article on “Control Expropriation via Rights offers”, (2).

A rights offer is a way to raise capital, on a current shareholding pro-rata basis, normally offering a discount on the trading price. Shareholders can then use the right and buy the shares, thus keeping their pro-rata on the company´s equity, (or sell their rights and get the discount value, if this possibility exists, and the market for the rights is efficient).

Rights offers are advantageous: (i) they may not require a shareholder approval if a previous general approval is in place; (ii) undervalued issuers may use it and avoid granting value to third parties; (iii) transaction costs are reduced; and (iv) as rights offers grant all shareholders the same options, the business judgement rule (BJR) is easily applied to these board decisions aiming at organizing a rights offer.

There is a possibility that dominant shareholders or insiders use the rights offer in order to acquire cheap stock, so as to improve the value to be captured by their investment, as small shareholders might not have enough funds, or could face uncertainty over whether the share is over or underpriced, thus using only a part of their rights to actually acquire shares, (cheap-stock tunnelling, as Fried and Spamann have recently argued (3)).

Rights offers designed to achieve control this way or the way explained below, avoiding takeover requirements and stricter fiduciary duties´control, can harm corporate governance standards.

Leeor Ofer explains that a third expropriation method may be used by dominant but non-controlling shareholders. If the offer is overpriced, (completely outside the uncertainty price area), even absent all other impediments, outsiders would avoid participating in it. This is why insiders would be able to increase their control, and afterwards extract private benefits (making the price attractive), to the detriment of minority shareholders.