February 26, 2019

Go-Shops: Have Dealmakers Gamed the System?

Over the weekend, I came across this blog from Prof. Ann Lipton discussing a recent study suggesting that “go-shops” may not be as effective in smoking out higher priced deals as they once were. The study argues that the reason for this may be that dealmakers have learned how to game the system:

There are a lot of interesting observations in the new paper, with the basic point being that deal attorneys – aware that Delaware courts focus a lot on things like the size of termination fees – instead manipulate aspects of the go-shop that tend to escape judicial notice, and that collectively function to make go-shops less effective. One particular point that stood out: The authors note that PE firms have changed how they compensate CEOs who remain with the company after the buyout.

Today, they pay based on whether the firm achieves certain multiples of invested capital, a metric that CEOs might view as functionally guaranteeing them a healthy payout, and one that incentivizes them to keep the deal price as low as possible. (The authors contrast with earlier IRR-based payouts, which were so difficult to achieve as to render compensation speculative). And even if the CEO does not negotiate compensation with the PE firm until after a deal price is reached, the CEO will know the PE firm’s practices and past history.

The new study follows up the authors’ 2008 study that generally supported the use of go-shops. The blog points out that the new study contains a bombshell quote from an unnamed PE investor to the effect that his firm tries to “corrupt” management – and that the multiple-of-invested-capital compensation structure helps accomplish that contributes to that corruption.

I’m not thinking this quote is going to play real well in Chancery Court.

John Jenkins