Volume 84, Number 5

November 2009

Internal Poison Pills

George S. Geis

Corporate law largely addresses three basic relationships: shareholder versus manager, shareholder versus non-equity investor, and majority shareholder versus minority shareholder. Ever since the pioneering work of Adolf Berle and Gardiner Means, a great deal of scholarly attention has been directed toward the first relationship. The second relationship earned its share of the limelight with the leveraged buyout trend of the 1980s. It is only in this decade, however, that the third relationship has taken center stage—in the wake of several incongruous Delaware cases and a flood of post-Sarbanes-Oxley freezeout mergers.

This scrutiny is certainly warranted, as the tension between majority and minority shareholders presents thorny concerns and has the potential to erode considerable social welfare. In essence, lawmakers must walk a tightrope between two alternative hazards. On the one hand, assigning too much power to minority shareholders can lead to a holdout problem where recalcitrant dissenters demand private tribute before blessing a decision (such as a merger). On the other hand, granting the majority untrammeled discretion to freeze out minority owners can promote tunneling or other abuses of power that will depress the ex ante value of a firm. Thus far, the law has addressed these concerns with disclosure obligations, special committees, judicial review of fiduciary duties, and appraisal rights. But the results are far from satisfying.

This Article offers a novel idea for governing the tension between majority and minority shareholders: an “internal poison pill.” Borrowing conceptually from the famous shareholder rights plans created in the 1980s to address bullying external bidders, I show how an analogous (though economically distinct) financial instrument might be used by shareholders to navigate the twin internal governance tensions of holdout and expropriation. Two key features of this proposal distinguish it from alternative reforms: (1) It focuses on a privately enacted solution with room for contextual customization; and (2) it uses embedded option theory to construct an intermediate legal entitlement (as opposed to an extreme property or liability rule) for both majority and minority shareholders. If successfully scoped and swallowed, these internal poison pills could facilitate efficient freezeouts, chill coercive ones, supplant the awkward remedy of appraisal, and, ultimately, increase the ex ante value of firms by mitigating agency problems between majority and minority shareholders.