Balancing Board and Shareholder Rights: Air Products Aborted Takeover of Airgas

question 118

Essay

Balancing Board and Shareholder Rights: Air Products Aborted Takeover of Airgas

Defining the right balance of power between corporate boards and shareholders remains elusive.
The Delaware court has ruled that a board can take as long as necessary to consider a bid and can prevent shareholders from voting on takeover bids.
Activist investors are increasingly urging shareholders to pressure firms to drop staggered boards because of the potential to entrench management.
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When, if ever, is it appropriate for a board to agree to a current bid to buy the firm if it, in good faith, believes that the bid undervalues the firm based on the board’s knowledge of the long-term outlook for the firm? When, if ever, is it appropriate for a board to prevent shareholder votes on such matters? The answers to these questions are rooted in whether boards are perceived to be acting in the interests of all shareholders or simply attempting to entrench themselves and current management. How these questions are answered will determine whether the board or shareholders will have leverage in hostile takeover negotiations. What follows is a discussion of what is an important judicial precedent pertaining to board and shareholder rights.

The unsolicited offer by Air Products for Airgas on February 2, 2010, has been one of the longest-running hostile bids in U.S. history. After having revised up its offer twice, Air Products sought to bring this process to a close when it asked the Delaware Chancery Court to invalidate Airgas’s poison pill. On February 15, 2011, the court ruled that the board has the right to prevent shareholders from voting on the takeover offer as long as it is acting in good faith. In the wake of the court’s ruling, Air Products withdrew its bid.

The court argued that the Airgas board determined, using a good-faith effort, that the Air Products offer of $70 per share was inadequate and allowed Airgas to use a poison pill to defeat the hostile bid by Air Products. A firm is believed to have undertaken a good-faith effort when it has exhausted all reasonable means of resolving an issue. Airgas’s board had demanded a bid of $78 per share. Because the Air Products bid was viewed as inadequate, the court ruled that Airgas could keep the poison pill in place against the will of the shareholders. The court also argued that the poison pill was not preventing Air Products from changing the composition of the board but, rather, extending the amount of time required to do so. The court also ruled that directors have the right to prevent shareholder votes if they believe that shareholders would accept a bid that undervalued the firm out of ignorance of the firm’s true value.

In practice, the additional time that would have been required to change the composition of the board when the board is classified, as was the case with Airgas, is usually enough to force the bidder to walk away. Once an unsolicited bid is initiated, the composition of a target firm’s shareholders moves from its long-term investors, who often sell when the offer is announced, to arbitrageurs and hedge funds, seeking to profit from temporary differences in the offer price and the target’s short-term share price. From their perspective, the faster a deal is done, the greater their return on investment. Reflecting the change in composition of their shareholder base, target boards come under intense pressure to sell. However, the fiduciary responsibility of boards is to ensure that any bids are in the best interests of their shareholders; takeover defenses in the view of the board give them more time to evaluate the initial offer and to hold out for higher bids.

The court’s decision illustrates how a poison pill can work in concert with a classified or staggered board, in which directors are elected one-third at a time. Bidders must therefore wait two years to elect a majority of the total board and force the poison pill to be rescinded. This combination has proven to be a highly potent antitakeover defense. Air Products’ bid for Airgas highlights the challenges of attempting to take control of another firm’s board. Even if Air Products had been successful in electing a majority of board members, there was no assurance the new board would have supported the $70 Air Products bid. The Airgas rejection of their bid came after three new directors nominated by Air Products had been elected to the Airgas board in 2009. Instead of campaigning for a sale, the three new directors joined the rest of the Airgas board in demanding a higher price from Air Products.

The outcome of the court’s ruling has implications for future hostile takeovers. The ruling upholds Delaware’s long tradition of respecting managerial discretion as long as the board is found to be acting in good faith and abiding by its fiduciary responsibilities to the firm’s shareholders. The ruling allows target firm boards to use a poison pill as long as the board deems justified, and it is far-reaching because Delaware law governs most U.S. publicly traded firms.
-Do you believe that shareholders should always have the right to vote on a sale of the firm under any circumstances? Explain your answer.

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