Appraisal Arbitrage and Shareholder Value

Abstract

Post-merger appraisal rights have been the focus of heated controversy within mergers and acquisitions circles in recent years. Traditionally perceived as an arcane and cabalistic proceeding, the appraisal action has recently come to occupy center stage through the ascendancy of appraisal arbitrage-whereby investors purchase target-company shares shortly after an announcement principally to pursue appraisal. Such strategies became more feasible and profitable a decade ago, on the heels of two seemingly technocratic reforms in Delaware: (i) the statutory codification of prejudgment interest, pegging a presumptive rate at five percent above the federal discount rate; and (ii) the Transkaryotic opinion, which effectively sanctified appraisal claims trading. Several commentators have decried appraisal arbitrage as visiting unnecessary risks and costs on deal certainty and pricing, advancing the position that it reduces / destroys target shareholder value. This paper interrogates such claims both theoretically and empirically, testing the predictions of an auction-design model that assesses appraisal's price and welfare effects. We find-consistent with comparative statics of our model-that the appraisal-liberalizing events of 2007 were associated with a significant increase in deal premia, as the enhanced credibility of appraisal had the effect of raising the de facto "reserve price" associated with M&A auctions. We further find little evidence that liberalized appraisal rights stifled the incidence of appraisal eligible deals. When interpreted through the lens of our auction-design model, our findings suggest that target-company shareholders likely benefited ex ante from liberalized appraisal, regardless of whether they subsequently sought appraisal or not.