Appraisal Arbitrage – Is There a Delaware Advantage?

Abstract

The article examines the extent to which economic incentives may have improved for appraisal arbitrageurs in recent years, which could help explain the observed increase in appraisal activity. We investigate three specific issues. First, we review the economic implications of allowing petitioners to seek appraisal on shares acquired after the record date. We conclude that appraisal arbitrageurs realize an economic benefit from their ability to delay investment for two reasons: (1) it enables arbitrageurs to use better information about the value of the target that may emerge after the record date to assess the potential payoff of bringing an appraisal claim; and (2) it helps minimize arbitrageurs’ exposure to the risk of deal failure. Second, based on a review of the recent Delaware opinions in appraisal matters, as well as fairness opinions issued by targets’ financial advisors, we document that the Delaware Chancery Court seems to prefer a lower equity risk premium than bankers. Such a systematic difference in valuation input choices also works in favor of appraisal arbitrageurs. Finally, we benchmark the Delaware statutory interest rates and find that the statutory rate more than compensates appraisal petitioners for the time value of money or for any bond-like claim that they may have on either the target or the surviving entity. Our findings suggest that, from a policy perspective, it may be useful to limit petitioners’ ability to seek appraisal to shares acquired before the record date. We also posit that, absent any finding of a flawed sales process, the actual transaction price may serve as a useful benchmark for fair value. We conjecture that, while the statutory interest rate may not be the main factor driving appraisal arbitrage, it does help improve the economics for arbitrageurs. Thus, the proposal by the Council of the Delaware Bar Association’s Corporation Law Section to limit the amount of interest paid by appraisal respondents – by allowing them to pay appraisal claimants a sum of money at the beginning of the appraisal action – seems like a practical way to address concerns regarding the statutory rate. However, paying appraisal claimants a portion of the target’s fair value up front is akin to funding claimants’ appraisal actions, which may end up encouraging appraisal arbitrage.