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Comment:  In my opinion the advantage of the employment at-will doctrine is that it creates flexibility. This may influence the unemployment rate of a country in a positive way. But the application of this rule in U.S. labor law is not the (even not one) reason for the low unemployment rate in this country as you implicated in the course. Otherwise there shouldn't have been high unemployment in the eighties and early nineties since this doctrine was applied during this period as well. The disadvantage of this doctrine is that employees who know that they can be fired at any time do not feel obliged to the company they are working at, which influences their motivation.

Response:  This is an alluring argument.  We all long to work where we are appreciated and valued.  The question, as I see it, is whether an "easy to fire" default rule produces more workplace happiness (and productivity) or whether a "hard to fire" mandatory rule is better.   Remember that under the "hard to fire" mandatory regime an employer and employee cannot choose to have an at-will relationship -- even if the employer prefers it and is willing to pay the employee for the added flexibility.  Moreover, under the "easy to fire" default rule an employer could decide that a "hard to fire" rule would induce worker loyalty and provide job security by contract -- remember that the at-will doctrine it's a default rule.

Perhaps the United States is moving toward a compromise.  The at-will doctrine, with its implied contract gloss, may be inching closer to a default rule in which employees who acquire job security expectations can enforce them in court.

III.A  Nature of public corporation

Question:  i was wondering if companies would strive to become institutionally owned because that would seemingly make their stock less prone to price dips and more stable.  are the large brokerage houses the largest institutional owners, or do the major corporations have more holdings? thanks.

Answer:  U.S. executives of publicly-traded companies sometimes prefer a richer mix of individual shareholders, rather than institutional shareholders, because individuals are thought to be less activist.  That is, they may be reluctant to sell in a takeover or to vote against incumbent management in a proxy fight.  Institutional shareholders (at least public pension funds and mutual funds) tend to be more willing to question management.  But institutional shareholders, it turns out, also tend to be more stable than individual investors -- they increasingly buy and hold for the long term.  There are a couple reasons for this.  Buying and selling often proves to be a poor strategy for institutional investors because of the transactional costs (which become singficant if frequent) and because a large shareholder cannot easily sell without depressing the stock price.

Large brokerage houses (like Merrill Lynch and Schwab) actually hold very few shares for their own accounts.  That is, they are mostly intermediaries for individual and institutional clients, but not signficant principals.

In the larger U.S. companies between 50-70% of the shares are held by institutions  -- for example, General Motors is held 67% by institutional investors.  See http://biz.yahoo.com/p/g/gm.html  You might also want to look at the class outline that contains a table showing Federal Reserve data on U.S. equity ownership.

IV.A.5 Trans Union case - corporate valuation in auction

Comment:  You would have no reason to know this, but I have an econ degree and took a course in Game theory [while in college].  In that course we spent a good amount of time studying various auctions and so I was curious about your comment made last friday in Bus Orgs that an auction wasn't good for the buyer in the sale of a corporation.

I was under the impression that a sequentially bid auction was best for the ultimate buyer because he only has to pay $1 more than the valuation of the second highest bidder, which will be at least equal to and most likely less than his valuation. Therefore in the  majority of auctions, the winner should get a bargain because he never has to bid his true valuation. That is why some auctions take other forms, like sealed bid, or the Dutch auction, or the sequentially bid highest-bid-wins but pays the amount of the second highest bid. What i imagine you were talking about is the non-rational bidder who gets into a "bidding frenzy" and goes over his valuation because emotion gets the better of him, however if this is true, then a corporation interested in getting a better than fair value return should auction itself off because of the likelihood that people will bid over their own valuation. If the corporation is concerned that it won't get the highest amount possible because the person with the highest valuation will only pay $1 more than the second highest, then it should employ an alternative to the sequential bid auction, like those listed above. Anyway, I don't mean to bore you because i am sure you know all this, but I just wanted to know why you thought an auction wasn't a good way to sell a corporation.

Addendum: in case you wanted to see an example consider the following: A and B are bidding on a painting. A's valuation is equal to $20 and B's is $10. When the bidding begins it may go $2 then $4 then $8 but when B bids $10, A will bid $11 and B will no longer bid because the painting isn't worth more than $10 to him and so the painting will sell for $11, even though A would have been willing to pay $20 for it. So A gets a great deal and the seller could have gotten more. If a sealed bid auction was used, then it would be in A's interest to bid his valuation of $20, and B his valuation of $10 and therefore A would still win but the Seller would get more money.

Answer:  Great point, but I have an answer!

You've made two assumptions that might not apply in auctioning a company:

• What about transaction costs?  In an auction, bidders have to spend time and money to value the asset being auctioned and to participate in the process.  These should figure into the overall auction process, along with value of assets.  That is, if it take $5 to figure out the value of a painting and $10 to go the auction house, I probably wouldn't bother participating if I think the painting is worth $16.  Unless I can get it for $1, it's not worth the trouble.
• Why assume that different buyers would value financial assets (a business) differently?  Your example assumes information disequilibirum or bidder asymmetry.  But typically a company in play has the same value whether to an outside financier or inside management (who will rely on outside financing).  Only if one of the bidders is a competitor or company with a symbiotic relationship to the target will there be the possibility of asymmetric valuations.  But even then, an outside bidder knowing that the assets have special value to particular buyers will pay more, knowing that they can be resold to this higher valuing buyer.

Let's look at your example.  If both bidders are fully informed, both will value the company at the same value - let's say $20.  Now assume that A has spent $2 to figure out that $20 is the right price and to get himself to the auction and that B spent $3 in auction sunk costs.  When the bidding gets to $17, B will keep on bidding because if he stops he will have lost $3 with nothing to show for it.  He would rather pay, let's say $17.50, so that he'll have lost only $2.50, not $3.  In fact, he'll keep bidding to $20, as will A!  The result is that the winner is cursed.

This leads rational bidders to lower their bids - to avoid the winner's curse.  Companies are better off selling to a single buyer identified as the most likely to be interested.  This lowers the buyer's transaction costs, and increases the selling price!

For further exposition, see

• French & McCormick, Sealed bids, Sunk Costs and the Process of Competition, 57 J. Bus. 417 (1984)
• Macey, Auction Theory, MBOs and Property RIghts in Corporate Assets, 25 WF Law Review 85 (1990)
• Thomas & Hansen, A Theoretic Analysis of Corporate Auctioneer's Liability Regimes, 1992 Wisc LR 1147 .

A.3. Perlman v. Feldmann (sharing control premia)

Student comment:   So let me see if I have this right:

 In Smith, the buyer approaches Smith in his professional capacity and asks to buy all outstanding stock.  Smith refuses because he does not own all the stock.  He says if you want to buy all the stock, the buyer most go through through the minority shareholders.  However, Smith says, "I will be willing to sell you my control interst for a premium."  Buyer agrees and court says this ok because of the no-sharing rule.

 In Perlman, the buyer approaches Feldman in his professional capacity and asks to merge with Newport.  Feldman refuses the merger.  However, Feldman says "I will be willing to sell you my control interest at a premium." The buyer agrees.  The court says this is an ursurpation of a corporate opportunity.

 I understand the Perlman court's rationale to be that Feldman took advantage of knowledge he gained in his corporate capacity to make money for himself. Smith did as well.  However, the distinction is that Feldman with his controlling interst could have "forced" the minority shareholders to go along with the merger.  Smith, because he did not control the minority shares, could not make the minority owners go along.  In essence the buyer asked Smith to do something it was not possible to do, whereas it
 was possible for Feldman to ok the merger.

 Is that right?  Unless I'm missing something, it seems like a pretty thin distinction.

Answer: I agree with your factual explanations of the two cases - a perfect exposition.  But in the third paragraph you suggest Feldman could have forced the merger - I'm not sure I agree.  Rather, he could have presented the merger idea to the Newport board and they could have recommended it to the shareholders.  (By contrast, Smith never received a merger proposal and had nothing to pass along.)  Instead, Feldman squelched the merger possibility -- a corporate opportunity, one could say --  by telling Wilport he would individually sell his control interest.  But the merger proposal was not his to squelch!

Why didn't the 2d circuit majority use a corporate opportunity rationale?  It's hard to say.  Perhaps it thought itself tied down by the fiduciary sharing theory adopted by the district court.  The judges  may also have wanted to expand fiduciary duties - during the 50s and 60s, the federal courts were a hotbed of corporate activism.

In the end the cases may be factually distinguishable, but their legal rules really aren't. 

Virtual Counsel Memo

Student question:  I remember you saying in class that the SEC will not allow hyperlinks in shareholder proposals or supporting statements because that would circumvent the 500-word limit. I also found a no-action letter to that effect from 1988. However, I looked at some sample memos from last year on the website that did include hyperlinks in the supporting statement.  Which approach should we take? Can we include hyperlinks in the supporting statement?

My answer: According to the SEC you cannot include web links in your shareholder proposal/submission.  This view, to me, is ridiculous.  If you were a lawyer representing a client who wanted to advance some cause, what would you advise?  Push the envelope or play it safe?  (I don't have the right answer.)

Piercing corporate veil, December 4

Student comment:  One remark to piercing the veil:  Generally, I think that the protection of creditors is in some repects too low and in some too high.  The court in Consumer's Co-op v. Olsen stated creditors can waive the right to assert undercapitalization or can be estopped from asserting such a claim when the creditors continued to lend money to the corporation, knowing that the
corporation has financial problems. I think it is not right that such a behavior has this consequence: People (and, thus, banks as well) are risk prone as to losses. A creditor, giving additional money to an almost bankrupt company just acts like most persons
would act. He hopes that he gets all his money back when he gives the corporation just a little bit more of his money first. And I'm sure the creditor did not think about the capitalization of the company when he did  that.  I think the courts did not but should consider this.

My answer:  My impression is that the court in Olsen did in fact consider the behavior of the Co-op in continuing to lend money after becoming aware of the company's financial difficulties.  I'm sure you're right that the Co-op hoped it could pump in enough to turn around a bad situation, but I don't find anything in the opinion that suggests  the court thought the Co-op was naive enough to think that it wasn't taking a calculated risk.  I imagine the Co-op understood the company was inadequately capitalized, and chose to continue dealing on a non-recourse basis -- that is, only looking to the corporate assets.  Why?  Less bother, maybe more efficient on a cost-benefit analysis.

I agree with you that courts should consider the creditor's expectations -- and if the the Co-op had been lulled into believing the company was adequately capitalized, the case could well have come out differently.  But here it seems it was the Co-op that lulled itself into complacency.  The Olsens weren't asked to give personal guarantees, and a court should not impose them after the fact.