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The 'Lemons Effect' in Corporate Freeze-Outs

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  • Lucian Arye Bebchuk
  • Marcel Kahan

Abstract

In a corporate freeze-out, the controller is required to compensate minority shareholders for the no-freezeout value of their shares that are taken from them. This paper seeks to highlight the difficulties involved in determining this no-freezeout value when private information. In particular, the analysis shows that the pre-freezeout market price of minority shares cannot be used an a proxy for the no-freezeout value that these shares would have in the absence of a freeze-out. It is shown that, under a regime in which frozen out minority shareholders receive a compensation equal to the pre-freezeout market price, the pre-freezeout market price will be set a level below the expected no-freezeout value of minority shares. The reason for this is a lemons effect' that arises when a controller uses her private information in deciding whether to affect a freeze-out. By showing how controllers are able to use their private information to affect freeze-outs at terms favorable to them, this paper demonstrates that freeze-outs can become a significant source for private benefits of control.

Suggested Citation

  • Lucian Arye Bebchuk & Marcel Kahan, 1999. "The 'Lemons Effect' in Corporate Freeze-Outs," NBER Working Papers 6938, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:6938
    Note: CF LE
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    File URL: http://www.nber.org/papers/w6938.pdf
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    References listed on IDEAS

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    1. Barclay, Michael J. & Holderness, Clifford G., 1989. "Private benefits from control of public corporations," Journal of Financial Economics, Elsevier, vol. 25(2), pages 371-395, December.
    2. Hermalin, Benjamin & Schwartz, Alan, 1996. "Buyouts in Large Companies," The Journal of Legal Studies, University of Chicago Press, vol. 25(2), pages 351-370, June.
    3. George A. Akerlof, 1970. "The Market for "Lemons": Quality Uncertainty and the Market Mechanism," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 84(3), pages 488-500.
    4. Lucian Arye Bebchuk, 1994. "Efficient and Inefficient Sales of Corporate Control," NBER Working Papers 4788, National Bureau of Economic Research, Inc.
    5. Lucian Arye Bebchuk, 1994. "Efficient and Inefficient Sales of Corporate Control," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 109(4), pages 957-993.
    6. Kahan, Marcel, 1993. "Sales of Corporate Control," The Journal of Law, Economics, and Organization, Oxford University Press, vol. 9(2), pages 368-379, October.
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    Citations

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    Cited by:

    1. Boehmer, Ekkehart, 2000. "Business Groups, Bank Control, and Large Shareholders: An Analysis of German Takeovers," Journal of Financial Intermediation, Elsevier, vol. 9(2), pages 117-148, April.
    2. Ben Ali Chiraz, 2009. "Disclosure and minority expropriation: A study of French listed firms," Post-Print halshs-00460161, HAL.
    3. Julien Le Maux, 2004. "Les déterminants de l’ampleur des bénéfices privés:un test sur données françaises," Revue Finance Contrôle Stratégie, revues.org, vol. 7(2), pages 195-231, June.
    4. Julien Le Maux, 2003. "Les bénéfices privés:une rupture de l'égalité entre actionnaires," Revue Finance Contrôle Stratégie, revues.org, vol. 6(1), pages 63-92, March.

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    JEL classification:

    • G30 - Financial Economics - - Corporate Finance and Governance - - - General

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