Delaware's Court of Chancery

The Delaware Chancery Court issued an important decision early this month (May 5th), allowing Sotheby's to proceed with its annual stockholders' meeting the following day.

The significance of that? -- the court is taking a laissez-faire attitude toward a new more aggressive use of the "poison pill" by corporate boards.

A "poison pill" in corporate law is the colloquial term for certain shareholder rights plans devised back in the 1980s to make hostile takeovers more difficult. Typically, a plan will provide that when a particular shareholder owns more than some threshold percentage of the equity (say, 15%), there will be a new issuance of shares, to the other shareholders, at a discounted price.

The block of shares that puts the potential trouble maker over the 15% mark then, is in two senses "poisoned." It dilutes the value of his equity (for the obvious supply/demand reason) and it significantly lessens the trouble maker's weight in proxy-voting terms.

The courts, especially the particularly-relevant Delaware courts, have long upheld poison pills against challenges.
They were criticized initially for the obvious reasons: by short-circuiting the market for corporate control, they allow directors to entrench themselves regardless of the sort of poor performance that might otherwise have led to a takeover. Also, directors can use the possibility of a poison pill not just to entrench but to enrich themselves -- effectively eliciting compensation for their removal of the plan or otherwise for their consent to a takeover.
What is new is that incumbent boards are getting more aggressive about the design of such plans. They now use similar plans not merely to make the cost of a hostile takeover ruinously expensive, but to deter activist investors who might merely want enough shares to ensure a couple of seats on the board and a voice in discussion of corporate policy.
The Sotheby's plan created two different thresholds, one for passive investors and the other (lower one) for active investors: that is, investors who wanted to have a say in how the company would be run would be served poison pills a lot more quickly than their passive counterparts. THAT passed review from the Chancery Court earlier this month.

Of course corporations are free to incorporate in places other than Delaware, including states of the US that have quite different rules, including some that wouldn't allow such a plan.

Presumably, if this sort of ruling disadvantages equity investors beyond a certain pain threshold, it would create a reason for some corporations to want to charter or re-charter themselves in those other places, as a way of saying to investors upfront, "we won't lock out challenges -- we won't become a shell of one of those entrenched lazy boards you've heard about." Is that a sufficient mechanism/alternative to remove the fishy smell from poison pills in general and this aggressive Sotheby's plan in particular?

Also: what would happen in an anarcho-cap world? with no Delaware and no alternative chartering states or nation-states either? Presuming there would still be mutual stock institutions under some name, and that conventions would arise as to the internal governance of those institutions: would those conventions encourage or discourage poison pills?

Just some thoughts....

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