The Ties Between Loyalty and Shareholder Value

In 2000, Delaware departed from nearly two centuries of legal tradition when it changed its laws to allow companies to waive the so-called corporate opportunities doctrine, which bars managers from seizing business opportunities for themselves without first offering them to the company.

But until about a year-and-a-half ago, realized Eric Talley, Isidor and Seville Sulzbacher Professor of Law at Columbia, nobody had assessed how companies have responded to the reform (since adopted by eight other states) or evaluated the implications of those responses.

“This was a big deal,” recalls Talley, who soon discovered that the lack of an appraisal tied to a gap in the law, which failed to specify how waivers had to be effectuated.

Companies could put them in the certificate of incorporation or bylaws, or implement them by resolution or contract. The lack of clarity created “an incredibly unwieldy research problem,” he notes. “You had no idea where to look.”

Talley, together with Gabriel Rauterberg, an assistant professor of law at Michigan, set out to fill the void. They wrote computer code that they used to train a machine-learning algorithm to examine millions of filings by publicly listed U.S. companies over a period of 22 years that ended in January 2016. 

What they found upended conventional wisdom, which held that few companies availed themselves of corporate opportunity waivers and that such waivers came at the expense of shareholders. As it happens, well over a thousand companies had waived the corporate opportunity restriction over the period studied and those companies tended, on average, to outperform their peers.

Such companies “typically generate sizeable revenues, and they tend to deliver larger overall market returns to their capital investors by comparison to other public companies,” the authors wrote recently in an article in the Columbia Law Review that details their findings.

“As a descriptive matter, then, it does not appear that companies that execute waivers are systematically the unscrupulous bottom feeders of the corporate ecosystem. To the contrary, they appear – by and large – to be healthy, growing, and profitable business organizations,” they add.

When companies issue waivers, “the market doesn’t punish them,” notes Talley. “In fact, it tends to reward them in terms of an uptick in stock price.”

Discovery fueled by artificial intelligence

The finding that shareholders would reward a company that does away with a duty to protect their interests ties to the reality of raising capital, say Talley and Rauterberg, who was a research scholar at the Law School when the duo began their study.

Corporate opportunity waivers reflect the capital markets, where firms rely frequently on investments of venture capital or private equity. Such investors tend to invest in multiple companies and to install their partners on the boards of many of them. 

Absent a waiver, Talley explains, funds whose partners learn of an opportunity might be obligated to disclose the opportunity to several portfolio companies simultaneously. That could result in the companies all bidding for the same opportunities, a circumstance Talley calls “the worst possible outcome.”

The authors cite the example of Prosper Marketplace, among the largest companies in the business of peer-to-peer loans, which waived the restriction on corporate opportunities to cover any member of its board who was not also an employee. The waiver enabled service by four directors (three of whom represented venture capital) who among them served as directors of at least 14 other companies, including another online commercial market.

Though Talley and Rauterberg found a tie between waivers and increases in shareholder value, “there is no guarantee that [waivers] similarly serve broader social welfare goals,” they write.

One concern, they note, ties to “the potentially anticompetitive effects of common ownership of natural competitors within the same industry” and parallels a dramatic rise in large ownership stakes by a relatively small number of big investors.

Talley says he plans to study that question, adding that the analysis would not be possible without the data science that allows researchers to comb through filings.

“You couldn’t have done this 15 years ago,” he says.

Talley is helping to organize the Empirical Legal Studies Replication Conference, to be held April 2018 at Claremont McKenna College. 

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Posted on September 21, 2017