114 S. Dasgupta and R.G. Hansen
tions, in which the seller is trying to secure the best price for the firm’s shareholders by
committing to a selling mechanism.
This perspective is misleading, for several reasons. First, the board has a formal re-
sponsibility to be an “auctioneer”. Under Delaware law,^22 a company’s board must act
as “auctioneers charged with getting the best price for the stock-holders at a sale of the
company”. In several well-publicized cases, after potential bidders had indicated their
interest in acquiring the company, the board of directors of the target company have
conducted an auction.^23 Although procedures similar to the ascending auction are most
commonly used, boards have also held single, and sometimes even multiple, rounds of
sealed-bid auctions (e.g., in the well-documented case of RJR Nabisco).
The commitment issue discussed above may influence the board’s choice of auction
mechanism. For example, the board might have a preference for ascending auctions
because, under alternative auction rules such as the sealed-bid auction, should a losing
bidder offer a higher subsequent bid, it may be difficult to reject that bid if the board
is required to obtain the “best price for the shareholders”. In other words, it may be
difficult to commit to a single round of bidding.
Legal scholars, however, have taken the view that whether or not it is feasible for the
board to pursue a particular auction mechanism depends, ultimately, on how the courts
view it. If, in a given context, the courts consider that a particular auction mechanism
can generate higher revenue for the shareholders ex-ante than the more commonly used
ones, there is no reason why a board cannot adopt it as a selling scheme. Further, if
the shareholders do not perceive a particular selling scheme to be against their interests
ex-ante, there is no reason why a board cannot secure shareholder approval prior to
conducting a sale. It is exactly in this spirit that legal scholars have looked at alternative
selling procedures (see, for example,Cramton and Schwartz, 1991). The focus of this
literature has very much been on what one can learn from economic theory (in particular,
auction theory) to “inform” takeover regulation or selling practices.
Second, the board’s commitment power is sometimes underestimated. Boards can
commit to awarding an object to a “winner” from a given round of bidding even when
better bids might subsequently emerge—thereby undermining the auction—in a variety
of ways. The most common practice is to enter into a lock-up arrangement^24 with the
declared winner, together with an agreement to pay a break-up fee should the sale be
(^22) The Delaware law is significant because many U.S. public companies are incorporated in Delaware.
(^23) For example, in the takeover battle for Paramount between Viacom and QVC, the Paramount board even-
tually conducted an auction in an effort to “select the bidder providing the greatest value to shareholders”.
(^24) Lockups are “agreements that give the acquirer the right to buy a significant division, subsidiary or other
asset of the target at an agreed (and generally favorable) price when a competing bidder acquires a stated
percentage of the target’s shares”(seeHerzel and Shepro, 1990). They may also involve options to buy a
block of target shares from the target that may make acquisition by a competing bidder more difficult. Lockup
agreements are quite common in takeover contests. The legal status of lockups is unclear, as some courts have
upheld them, while others have not. For an account of the legal literature on lockups, seeKahan and Klausner
(1996a, 1996b).