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The 'Lemons Effect' in Corporate Freeze-Outs

  • Lucian Arye Bebchuk
  • Marcel Kahan

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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File URL: http://www.nber.org/papers/w6938.pdf
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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
Note: CF LE
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  1. Benjamin E. Hermalin & Alan Schwartz, 1998. "Buyouts in Large Companies," Yale School of Management Working Papers ysm66, Yale School of Management.
  2. Kahan, Marcel, 1993. "Sales of Corporate Control," Journal of Law, Economics and Organization, Oxford University Press, vol. 9(2), pages 368-79, October.
  3. 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.
  4. 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.
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