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The 'Lemons Effect' in Corporate Freeze-Outs

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Author Info
Lucian Arye Bebchuk
Marcel Kahan

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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.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 6938.

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Date of creation: Feb 1999
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Handle: RePEc:nbr:nberwo:6938

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

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  1. Hermalin, Benjamin & Schwartz, Alan, 1996. "Buyouts in Large Companies," Journal of Legal Studies, University of Chicago Press, vol. 25(2), pages 351-70, June.
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  2. 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. [Downloadable!] (restricted)
  3. Kahan, Marcel, 1993. "Sales of Corporate Control," Journal of Law, Economics and Organization, Oxford University Press, vol. 9(2), pages 368-79, October.
  4. Bebchuk, Lucian Arye, 1994. "Efficient and Inefficient Sales of Corporate Control," The Quarterly Journal of Economics, MIT Press, vol. 109(4), pages 957-93, November. [Downloadable!] (restricted)
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