Corporate Takeovers, the Commerce Clause, and the Efficient Anonymity of Shareholders

Antitakeover laws reduce the possibility of competition in the market for corporate control and thereby deny shareholders a significant opportunity to lower the cost of specifying and monitoring managerial performance. However, state legislatures evidently think that antitakeover laws generate benefits or else they would not enact them, as Indiana did in 1986. Empirical evidence suggests that Indiana’s law – and laws patterned after it – would harm certain parties. By impeding the market for control of Indiana corporations, Indiana’s antitakeover statute would be expected to reduce the wealth of shareholders of Indiana corporations. This diminution in wealth occurs because a corporation’s shares are more valuable when the possibility exists that a rival team of managers might take control and manage the corporation’s assets more profitably. Although Indiana is free to subsidize one in-state constituency at the expense of another, it is not free to effect the subsidy at the expense of out-of-state parties. The Supreme Court has long interpreted the “dormant” or “negative” commerce clause of the Constitution to limit a state’s power to regulate or impede interstate commerce. In Pike v. Bruce Church, the Court expressed this inferred limitation on interstate exploitation in terms of an explicit cost-benefit balancing test: “Where the statute regulates evenhandedly to effectuate a legitimate local public interest, and its effects on interstate commerce are only incidental, it will be upheld unless the burden imposed on such commerce is clearly excessive in relation to the putative local benefits.”

The doctrine of the dormant commerce clause is necessary in a federal system of representative government. State regulations sometimes harm other jurisdictions. For some of these externalities the causal link between state action and extrajurisdictional harm is subtle, either because the victims are diffuse and physically distant from the source of the harm or because the harm is first transmitted into a common pool, such as an organized market or exchange. Externalities from state antitakeover statutes are particularly troublesome in this respect.

In 1982, the Supreme Court held in Edgar v. MITE Corp. that an Illinois statute that directly regulated corporate takeoversviolated the dormant commerce clause. Some states subsequently enacted “second generation” antitakeover statutes, which purport to regulate only a corporation’s structure and the rights of its shareholders – both traditional issues of state law. When one of these statutes was challenged, the Court reversed course, holding in 1987 in CTS Corp. v. Dynamics Corp. of America that Indiana’s second generation antitakeover statute did not violate the dormant commerce clause. Although the CTS majority never explicitly said that it was using the Pike test to balance out-of-state costs against in-state benefits, it nevertheless concluded that, “to the limited extent that the Act affects interstate commerce, this is justified by the State’s interests in defining the attributes of shares in its corporations and in protecting shareholders.”

Much scholarly criticism of CTS has focused on Justice Scalia’s argument in his concurrence that the Court should not even undertake the balancing analysis articulated in Pike. Our focus is different. We do not dispute the Court’s selection of constitutional doctrine; rather, we dispute the credibility of its application of that doctrine to Indiana’s antitakeover legislation. We examine the costs and benefits of the Indiana antitakeover statute and conclude that a neutral application of the Pike test in CTS should have produced a very different result as a matter of constitutional law. Furthermore, we believe that our study demonstrates that Pike balancing is empirically possible in corporate control cases, even if it is used only prescriptively as the justification for a simpler formulation of the applicable legal rule.

In Part I we theorize that the anonymity of shareholders, which second generation antitakeover statutes like Indiana’s diminish, is an efficient attribute of the corporate form that increases shareholder wealth by enhancing liquidity and thereby facilitating corporate control transactions. In Part II we test empirically whether Indiana’s antitakeover statute increased or decreased the wealth of shareholders of Indiana corporations. We find that the statute cost those shareholders $2.41 billion in market value, which is about 6% of a portfolio that would have been worth $43.11 billion without the statute. Because only a small percentage of the shareholders of Indiana corporations resides in Indiana, almost all of this loss befell shareholders residing in other states, creating an interstate externality of vast proportions. In Part III we argue that it is highly unlikely as an empirical matter that the local benefits of the Indiana statute “clearly” exceeded the costs imposed on nonresidents, as Pike supposedly requires. Thus, if Pike is still valid precedent (despite being neglected by the majority in CTS and repudiated by Justice Scalia in his concurrence), our empirical evidence supports the conclusion that, as a matter of constitutional law, CTS was wrong in holding that Indiana’s statute does not violate the dormant commerce clause. This result raises new doubt about the constitutionality of other antitakeover statutes.

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