Microsoft Word - 4. Griffin_Print.docx GRIFFIN_FINAL THE HIDDEN COST OF M&A Caleb N. Griffin* The shareholder wealth maximization norm exerts tremen- dous influence on both business practice and corporate legal scholarship. Widespread acceptance of the norm has produced substantial focus among corporate executives, analysts, and scholars on one key metric: share price. The norm and the re- lated focus on equity prices rest on two key assumptions: (1) that the pursuit of shareholder wealth maximization, as meas- ured by share price, effectively maximizes the wealth of actual shareholders and (2) that the pursuit of shareholder wealth maximization, as measured by share price, is socially benefi- cial. If the shareholder wealth maximization norm does not truly maximize shareholder wealth, it fails by its own terms. If pursuing shareholder wealth maximization does not produce a net social benefit but instead generates a net social harm, the pursuit of shareholder wealth maximization no longer consti- tutes a “win-win” for businesses and consumers but instead el- evates business interests in a zero-sum competition between the two groups. This Article addresses one context where the pursuit of share price gains both fails to maximize the wealth of all share- holders and fails to benefit society: corporate mergers and ac- quisitions activity. Since Henry Manne’s seminal paper, The Market for Corporate Control, it has been generally accepted that merger gains accrue either through efficiency or market power. Efficiency gains involve creating synergies and elimi- nating redundancies, thus enabling merged entities to do more with less. To the extent that merger gains accrue via this route, mergers benefit everyone involved: shareholders benefit from a boost in share prices, society benefits from a more efficient mar- ketplace, and consumers benefit from lower prices for goods * Assistant Professor of Law, Regent Law School. I thank Lyman John- son and Joan Heminway for their thoughtful comments on early drafts of this Article. GRIFFIN_FINAL No. 1:70] THE HIDDEN COST OF M&A 71 and services. In contrast, market power gains enable the merged entity to increase the price of the goods it sells or the services it provides, thereby reducing consumer welfare. Be- cause of the increased cost to consumers, this second option pits the interests of some groups against others. Wealthy sharehold- ers likely benefit more from share price increases than they are harmed by the increased cost of goods and services, since these shareholders tend to own substantial amounts of stock and to make substantial sums from that stock. However, the reverse may be true for less wealthy shareholders and society at large. Corporate legal scholarship has largely failed to address this hidden cost. Historically, economic literature has left unsettled whether merger gains accrue primarily through the former or latter routes, leaving scholars free to assume that merger gains do not necessarily come at the expense of consumers or society. Re- cent research, however, reveals that most gains in U.S. mergers come from market power increases. This finding exposes two key shortcomings of traditionalist interpretations of the share- holder wealth maximization norm: (1) share price gains serve as an inadequate proxy for increased financial welfare for all shareholders, and (2) share price gains serve as an inadequate proxy for increased social welfare. If we truly desire to maxim- ize the wealth of all shareholders and to benefit society as a whole, then we cannot rely on share price gains as a proxy for the interests of all constituencies. I. Introduction ................................................................. 73 II. Core Assumptions of the Shareholder Wealth Maximization Norm ..................................................... 78 A. The Purpose of a Corporation is to Benefit Shareholders Financially ...................................... 78 B. “Shareholders” Refers to Personified Stock .......... 79 C. Shareholder Wealth Maximization Benefits Society as a Whole.............................................................. 84 III. The Shareholder Wealth Maximization Norm and M&A Activity: Theoretical Perspectives ..................... 85 IV. A Summary of Economic Research on the Source of Merger Gains ............................................................... 94 GRIFFIN_FINAL 72 COLUMBIA BUSINESS LAW REVIEW [Vol. 2018 A. Identifying the Source of Merger Gains: The Problem with Case Study Data ............................. 97 B. Identifying the Source of Merger Gains: Conclusions from Broad-Based Data .................... 99 C. The Economic Effects of Market Power Increases .............................................................. 106 D. The Implications of Market Power Increases for Consumers & Society .......................................... 108 V. Examining the Implications of Economic Data ......... 110 A. The Traits of American Shareholders ................. 110 B. The Implications of the Traits of American Shareholders for the Shareholder Wealth Maximization Norm ............................................ 113 C. Implications for Well-Meaning Directors ........... 114 D. Implications for Well-Meaning Mutual Fund Managers ............................................................. 116 E. Implications for Well-Meaning Pension Fund Managers ............................................................. 118 F. Implications for Well-Meaning Hedge Fund Managers ............................................................. 122 G. Implications for Scholars..................................... 128 VI. Conclusion .................................................................. 128 This Article seeks to answer two questions. First, does the shareholder wealth maximization norm, as currently under- stood, actually result in wealth maximization for a typical shareholder? Second, does pursuing shareholder wealth max- imization benefit or harm society at large? Complete answers to these questions would require an analysis of all corporate activity. This Article instead attempts to answer these ques- tions within a narrow scope—in the context of corporate mer- gers and acquisitions (collectively, “M&A”). Empirical evidence suggests that, to the extent that M&A activity generates returns to shareholders, these gains accrue largely through socially harmful increases in market power rather than through socially beneficial increases in GRIFFIN_FINAL No. 1:70] THE HIDDEN COST OF M&A 73 efficiency.1 M&A activity that increases efficiency can create wealth for both consumers and shareholders: consumers ben- efit from lower prices and the firm (i.e., the shareholders) ben- efits from increased profits. M&A activity that increases mar- ket power raises the price of goods and services. Although this price increase is profitable for the firm, consumers pay higher prices while receiving no corresponding increase in value for themselves. Since M&A gains accrue through market power increases and not efficiency increases, these gains result not from wealth creation, but from wealth transfers. Importantly for purposes of shareholder wealth maximization, these wealth transfers sometimes come from consumers who are also share- holders. Shareholders of modest means spend a substantial portion of their income on consumer goods and services, and thus, for these individuals, the negative impact of increased consumer prices may more than offset any share price gains, especially if equity ownership is small or if price increases are significant. An examination of the source of share price gains in M&A ultimately reveals a story of divergent shareholder interests and significant harms to some classes of sharehold- ers and to society at large. I. INTRODUCTION It is commonly believed that the purpose of a corporation is to maximize the wealth of its shareholders.2 This 1 See infra Sections IV.A–B. 2 See, e.g., Stephen M. Bainbridge, Executive Compensation: Who De- cides?, 83 TEX. L. REV 1615, 1616 (2005) (reviewing LUCIAN BEBCHUK & JESSE FRIED, THE UNFULFILLED PROMISE OF EXECUTIVE COMPENSATION (2004)) (“The discretionary powers thus conferred on directors and officers, however, are to be directed towards a single end; namely, the maximization of shareholder wealth.”); David Millon, New Game Plan or Business as Usual? A Critique of the Team Production Model of Corporate Law, 86 VA. L. REV. 1001, 1002–03 (2000) (arguing that rival theories of the purpose of the corporation “have made only limited headway in the legal academy, where shareholder primacy and its narrow vision of corporate manage- ment’s obligations continue to predominate”); Milton Friedman, A Fried- man Doctrine—The Social Responsibility of Business Is to Increase Its GRIFFIN_FINAL 74 COLUMBIA BUSINESS LAW REVIEW [Vol. 2018 shareholder wealth maximization norm permeates top busi- ness and law school curricula, where the future leaders of American enterprise, law, and government are routinely taught a shareholder wealth maximization approach to corpo- rate purpose.3 It is manifest in the practices of corporate lead- ers,4 who widely assert that it is their duty to maximize share- holder wealth at the expense of other interests.5 It is pervasive in academic literature, where scholars frequently repeat statements such as “[t]here is strong support for the idea that shareholder wealth maximization should be the primary norm underlying the governance of for-profit corporations,”6 “law- yers have commonly assumed that the managers must con- duct the institution with single-minded devotion to Profits, N.Y. TIMES MAG., Sept. 13, 1970, at 126 (“[T]here is one and only one social responsibility of business—to use its resources and engage in activi- ties designed to increase its profits.”); Henry Hansmann & Reinier Kraak- man, The End of History for Corporate Law, 89 GEO. L.J. 439, 439 (2001) (“There is no longer any serious competitor to the view that corporate law should principally strive to increase long-term shareholder value.”); DAR- RELL WEST, THE PURPOSE OF THE CORPORATION IN BUSINESS AND LAW SCHOOL CURRICULA 10–12 (2011) (surveying professors at leading law schools who describe this view of corporate purpose as “dominant,” “settled law,” “take[n] as a given,” and “absolutely the dominant perspective in law schools”). 3 West, supra note 2, at 1–2 (finding, based upon a review of law and business school curricula, that such curricula often “emphasize the goal of maximizing shareholder value, especially in law schools”). 4 STEPHEN M. BAINBRIDGE, CORPORATION LAW AND ECONOMICS 417 (2002) (“Although some claim that directors do not adhere to the share- holder wealth maximization norm, the weight of the evidence is to the con- trary.”). 5 See, e.g., Jacob M. Rose, Corporate Directors and Social Responsibil- ity: Ethics Versus Shareholder Value, 73 J. BUS. ETHICS 319, 326–27 (2007) (finding that when seventeen directors of Fortune 200 companies faced a conflict between shareholder interests and social welfare in their capacity as a director, all directors but one justified their decisions based upon a per- ceived legal obligation to maximize shareholder value). 6 Bernard S. Sharfman, Shareholder Wealth Maximization and Its Im- plementation Under Corporate Law, 66 FLA. L. REV. 389, 391 (2014). GRIFFIN_FINAL No. 1:70] THE HIDDEN COST OF M&A 75 stockholder profit,”7 “the persistent common perception seems to be that directorial duties require placing shareholder wealth at the forefront,”8 “that shareholder wealth maximiza- tion is not only a goal for the corporation, but in fact the only legitimate goal, has become the dominant normative theory of the corporation,”9 and “[s]hareholder wealth maximization long has been the fundamental norm which guides U.S. corpo- rate decisionmakers.”10 To be sure, this norm has not gone uncontested. In the early 1930s, E. Merrick Dodd argued that corporate duties le- gally can and normatively ought to go beyond shareholder wealth maximization to include “a social service as well as a profit-making function.”11 In the 1980s and 90s, Robert Phil- lips, R. Edward Freeman, Andrew C. Wicks and their col- leagues formulated stakeholder theory as a challenge to the shareholder wealth maximization norm.12 Stakeholder theory argues that the goal of a corporation is not merely to serve shareholders, but also to advance the interests and well-being of the many stakeholders—employees, creditors, consumers, etc.—whose inputs prove vital to corporate success.13 In 1999, Margaret M. Blair and Lynn A. Stout put forth the team pro- duction model, which provides that the corporate form exists not to promote shareholder interests above all others but to protect the “investments of all the members of the corporate 7 E. Merrick Dodd, Jr., For Whom Are Corporate Managers Trustees?, 45 HARV. L. REV. 1145, 1163 (1932). 8 J. Haskell Murray, Choose Your Own Master: Social Enterprise, Cer- tifications, and Benefit Corporation Statutes, 2 AM. U. BUS. L. REV. 1, 17 (2012) (emphasis omitted). 9 Grant M. Hayden & Matthew T. Bodie, One Share, One Vote and the False Promise of Shareholder Homogeneity, 30 CARDOZO L. REV. 445, 492 (2008). 10 Stephen M. Bainbridge, In Defense of the Shareholder Wealth Maxi- mization Norm: A Reply to Professor Green, 50 WASH. & LEE L. REV. 1423, 1423 (1993). 11 Dodd, supra note 7, at 1148. 12 Robert Phillips et al., What Stakeholder Theory Is Not, 13 BUS. ETH- ICS Q. 479, 481 (2003). 13 Id. GRIFFIN_FINAL 76 COLUMBIA BUSINESS LAW REVIEW [Vol. 2018 ‘team,’ including shareholders, managers, rank and file em- ployees, and possibly . . . creditors.”14 Likewise, Lyman John- son and David Millon recently argued for pluralism in corpo- rate purpose, making a strong case that a corporation can be formed for “any lawful purpose,” not just the maximization of shareholder wealth.15 Yet, despite these efforts to expand conceptions of corpo- rate purpose, the shareholder wealth maximization norm still informs much of corporate decision-making. In fact, even legal developments that at first glance seem to best embrace alter- native views of the corporation in practice reinforce the per- ception that shareholder wealth maximization should reign supreme—at least with respect to the traditional corporation. For example, the emergence of blended corporations such as “benefit corporations,” “flexible purpose corporations,” and “social purpose corporations” arguably evinces a desire on the part of businesspeople and consumers for businesses to pur- sue both profit and social good.16 Yet, by forming a separate and distinct category of corporations that aim to benefit both shareholders and society at large, these corporate forms in fact reinforce the notion that traditional corporations exist only to maximize the wealth of shareholders.17 Moreover, arguments that collapse the distinction between shareholder wealth maximization and social welfare make it easier to dismiss challenges to the shareholder wealth maxi- mization norm. These arguments essentially contend that when directors and managers ruthlessly pursue shareholder 14 Margaret M. Blair & Lynn A. Stout, A Team Production Theory of Corporate Law, 85 VA. L. REV. 247, 253 (1999) (emphasis omitted). 15 Lyman Johnson & David Millon, Corporate Law After Hobby Lobby, 70 BUS. LAW. 1, 31 (2014). 16 Lyman Johnson, Pluralism in Corporate Form: Corporate Law and Benefit Corps., 25 REGENT U. L. REV. 269, 269 (2013) (noting that the social enterprise movement has led to the proliferation of dual mission entities, as well as legal and business reform); see also Murray, supra note 8, at 3–5. 17 Johnson, supra note 16, at 295 (noting the possibility that “legisla- tion authorizing special vehicles for social enterprise—i.e., Benefit Corps.— implies that traditional corporations should maintain, if not heighten, their predominant focus on profits and shareholder wealth”). GRIFFIN_FINAL No. 1:70] THE HIDDEN COST OF M&A 77 wealth maximization, they create jobs, economic growth, and technological advancements that ultimately maximize social welfare—or, in other words, that it is ultimately in the inter- est of shareholders to promote stakeholder interests, as good community relations, loyal employees, and loyal customers are vital to the long-term health of any company.18 As Stephen Bainbridge states in one permutation of this argument, “For many years, the basic rule that shareholder interests come first has governed public corporations. That rule has helped produce an economy that is dominated by public corporations, which in turn has produced the highest standard of living of any society in the history of the world.”19 Such arguments are appealing because they turn a conten- tious debate into a win-win situation. Corporations have their shareholder wealth maximization cake and society eats it too. However, whether shareholder wealth maximization actu- ally advances stakeholder welfare (and vice versa) is an em- pirical question that proves nearly impossible to answer. While it is easy to contemplate hypothetical situations where stakeholder and shareholder interests conflict, it is far more difficult to empirically prove or disprove the notion that, when all corporations make shareholder wealth maximization their principal goal, society is better off than they would be if all (or some) corporations sought to promote both social welfare and shareholder interests in tandem. Such an answer would re- quire either a nationwide experiment or an unfathomably so- phisticated economic modeling system—both of which are out of academics’ grasp. This Article attempts to answer only a small sliver of that empirical question by examining whether one decision— whether to pursue M&A—tends to benefit shareholders and society in tandem or instead tends to pit the interests of share- holders and society against each other. In so doing, this Article seeks to assess the validity of the shareholder wealth 18 Leo E. Strine, Jr., The Social Responsibility of Boards of Directors and Stockholders in Change of Control Transactions: Is There Any “There” There?, 75 S. CAL. L. REV. 1169, 1172–74 (2002). 19 Bainbridge, supra note 10, at 1446. GRIFFIN_FINAL 78 COLUMBIA BUSINESS LAW REVIEW [Vol. 2018 maximization norm generally and shed light on how directors, institutional investors, proxy advisors, scholars, and policy- makers ought to approach the shareholder wealth maximiza- tion norm in the context of M&A specifically. This Article begins with an analysis of the corollary as- sumptions subsumed in the shareholder wealth maximization norm in Part II. Part III proceeds to analyze how these as- sumptions have shaped theoretical understandings of M&A activity. Part IV proceeds to analyze the economic validity of these assumptions, and Part V uses economic data to promote a reexamination of the shareholder wealth maximization norm and its implications for several key corporate actors. II. CORE ASSUMPTIONS OF THE SHAREHOLDER WEALTH MAXIMIZATION NORM A. The Purpose of a Corporation is to Benefit Shareholders Financially The most basic tenet of the shareholder wealth maximiza- tion norm is that the purpose of a corporation is to benefit its shareholders financially. This tenet has been expressed in subtly different forms. The name of the norm itself refers to the maximization of shareholder wealth. The case Dodge v. Ford Motor Co., however, states this tenet in terms of stock- holder profits: A business corporation is organized and carried on pri- marily for the profit of the stockholders. The powers of the directors are to be employed for that end. The dis- cretion of directors is to be exercised in the choice of means to attain that end, and does not extend to a change in the end itself, to the reduction of profits, or to the nondistribution of profits among stockholders in order to devote them to other purposes.20 Milton Friedman similarly focuses on the profit of stock- holders in his famous article The Friedman Doctrine—The 20 Dodge v. Ford Motor Co., 170 N.W. 668, 684 (Mich. 1919) (emphasis added). GRIFFIN_FINAL No. 1:70] THE HIDDEN COST OF M&A 79 Social Responsibility of Business Is to Increase Its Profits.21 The American Law Institute’s Principles of Corporate Govern- ance, meanwhile, uses both the terms corporate profit and shareholder gain, stating “a corporation . . . should have as its objective the conduct of business activities with a view to en- hancing corporate profit and shareholder gain.”22 Though the terminology differs slightly, the core of the idea is that a corporation exists to benefit shareholders financially. This Article will use the term “shareholder financial benefit” to encompass the various iterations of the norm. B. “Shareholders” Refers to Personified Stock The pursuit of shareholder financial benefit, however, re- quires corporate directors to have a sense of who shareholders are and what shareholders care about financially. Indeed, those persons that own stock—whether directly or indi- rectly—are real, flesh-and-blood human beings, and human beings necessarily have a host of complex financial concerns. Different shareholders likely have different risk tolerance lev- els, divergent time horizons for achieving financial goals, var- ying levels of diversification, and heightened interests in the stability of the particular companies where they are em- ployed.23 A recent college graduate may well prefer a more ag- gressive financial approach than a retiree. An employee, even one who holds stock in his or her company, might care more about preventing layoffs than a small change in share price. Day-traders and long-term stock owners also likely have 21 See Friedman, supra note 2. 22 PRINCIPLES OF CORPORATE GOVERNANCE: ANALYSIS AND RECOMMENDA- TIONS § 2.01 (AM. LAW INST. 1994) (emphasis added). 23 Lynn A. Stout, Why We Should Stop Teaching Dodge v. Ford, 3 VA. L. & BUS. REV. 163, 174 (2008) (“Different shareholders have different in- vestment time frames, different tax concerns, different attitudes toward firm-level risk due to different levels of diversification, different interests in other investments that might be affected by corporate activities, and differ- ent views about the extent to which they are willing to sacrifice corporate profits to promote broader social interests . . . .”). GRIFFIN_FINAL 80 COLUMBIA BUSINESS LAW REVIEW [Vol. 2018 different financial preferences, as do very wealthy investors and working-class investors. Despite these complexities, the shareholder wealth maxi- mization norm does not require directors to measure the ac- tual financial preferences of their real-world shareholders. In- stead, the norm as it is generally understood permits directors to simplify their task of benefitting shareholders financially by focusing on how their activities impact a “fictional share- holder.”24 As Daniel Greenwood describes, this “fictional shareholder” is “a person with no interests other than its shareholdings in the particular corporation at issue, and no will other than the desire to maximize the value of that share- holding. It is, then, no more than a personification of a share of the particular corporation.”25 Thus, in practice, the notion of “shareholder financial benefit” means financial benefit to the fictionalized, non-diversified holders of shares in one par- ticular company, or, more simply, the pursuit of the best pos- sible stock performance for the shares of a given firm. 24 Gregory Scott Crespi, Maximizing the Wealth of Fictional Sharehold- ers: Which Fiction Should Directors Embrace?, 32 J. CORP. L. 381, 383–84 (2007) (stating that the law “allows directors to greatly reduce the burden of discharging their fiduciary duties to this diverse group of shareholders by permitting them to consider only the impacts of their actions upon a generic ‘fictional shareholder’ abstraction”); see also Lawrence E. Mitchell, The Hu- man Corporation: Some Thoughts on Hume, Smith, and Buffett, 19 CARDOZO L. REV. 341, 358 (1997) (referring to “the current fictionalized model of the stockholder” as a person “with the single goal of maximizing profits”); Dan- iel J.H. Greenwood, Fictional Shareholders: For Whom Are Corporate Man- agers Trustees, Revisited, 69 S. CAL. L. REV. 1021, 1031 (1996) (describing the notion of a shareholder as “a fictional person whose sole interest is the shares it owns”). 25 Id. at 1058; see also FRANK H. EASTERBROOK & DANIEL R. FISCHEL, THE ECONOMIC STRUCTURE OF CORPORATE LAW 124 (1991) (describing “[m]arket [v]alue as a [b]enchmark under the [f]iduciary [p]rinciple”); Rich- ard A. Booth, Stockholders, Stakeholders, and Bagholders (or How Investor Diversification Affects Fiduciary Duty), 53 BUS. LAW. 429, 434 (1998) (“[I]t is the undiversified stockholder—an investor who is focused on the fortunes of a single company—who is the traditional model for the hypothetical rea- sonable stockholder to whom management duty is owed.”). GRIFFIN_FINAL No. 1:70] THE HIDDEN COST OF M&A 81 This is not to say that the conflation of shareholder inter- ests with stock performance has gone unquestioned—the no- tion that stockholders are not a homogeneous group of indi- viduals fixated on wealth maximization has gained increasing attention. Commentators have pointed to the potential for substantial deviation in shareholder financial interests, such as the aforementioned variations in risk tolerance,26 time horizon,27 diversification,28 and their employment situation.29 In so doing, they have problematized the traditionalist inter- pretation of the shareholder wealth maximization norm and, 26 See, e.g., Eric W. Orts, The Complexity and Legitimacy of Corporate Law, 50 WASH. & LEE L. REV. 1565, 1591 (1993) (“Shareholders have differ- ent time and risk preferences that managers must somehow factor together, if they are to represent fairly the artificially unified interest of ‘the share- holders’ in general.”); Henry T.C. Hu, Risk, Time, and Fiduciary Principles in Corporate Investment, 38 UCLA L. REV. 277, 287 (1990) (“Each share- holder has unique risk preferences . . . .”); Iman Anabtawi, Some Skepticism About Increasing Shareholder Power, 53 UCLA L. REV. 561, 586 (2006) (comparing the risk tolerance of inside and outside shareholders). 27 See, e.g., Stephen M. Bainbridge, The Board of Directors as Nexus of Contracts, 88 IOWA L. REV. 1, 21 (2002) (noting that shareholders have di- vergent time horizons); Leo E. Strine, Jr., Who Bleeds When the Wolves Bite?: A Flesh-and-Blood Perspective on Hedge Fund Activism and Our Strange Corporate Governance System, 126 YALE L.J. 1870, 1884–85 (2017) (noting that human investors have a longer time horizon for their invest- ments); John C. Coffee, Jr. & Darius Palia, The Wolf at the Door: The Impact of Hedge Fund Activism on Corporate Governance, 41 J. CORP. L. 545, 573 (2016) (remarking that the typical hedge fund investor has a shorter time horizon than other groups of investors); Orts, supra note 26, at 1591 (re- marking on divergent time preferences as an obstacle for corporate manag- ers who seek to pursue shareholder interests uniformly). 28 See, e.g., Stout, supra note 23, at 174 (noting that different share- holders have different interests due in part to variances in their level of diversification); JAMES P. HAWLEY & ANDREW T. WILLIAMS, THE RISE OF FI- DUCIARY CAPITALISM 21 (2000) (noting the unique interests of highly diver- sified “universal owner[s]”); Hayden & Bodie, supra note 9, at 493 (“[S]hare- holders with a diversified portfolio have different interests than shareholders with most of their wealth tied up in one company.”). 29 See, e.g., Strine, supra note 27, at 1876–77 (noting that jobs, not stock performance, drive wealth creation for all but the very rich); Anabtawi, su- pra note 26, at 586 (comparing the interests of employee-stockholders and non-employee-stockholders). GRIFFIN_FINAL 82 COLUMBIA BUSINESS LAW REVIEW [Vol. 2018 in particular, the presumed focus on stock performance as a proxy for true financial benefit. Despite this attention to the variation in stockholders’ characteristics,30 corporate law theorists have stressed the ab- straction of a homogenous shareholder personified by the shares themselves as a necessary assumption of the model, as it enables directors to make coherent decisions and prevents them from using potential discrepancies in shareholder inter- ests to justify acts actually taken in pursuit of personal gain.31 Scholars have further argued that stock performance is the ideal metric because “it is the only judgment that cannot be manipulated, at least not for long,” implying that other sub- stitutes for stock performance are thereby inferior.32 Commentators have also argued that potential deviations in shareholder financial preferences are inconsequential. For instance, scholars have dismissed concerns related to share- holders’ different time horizons by theorizing that share price reflects the present value of projected future prices and that, thus, there is no true conflict between shareholders interested in short-term stock performance and those interested in long- term stock performance.33 Likewise, scholars have dismissed concerns related to shareholders’ various risk preferences by postulating that so long as a corporation seeks to maximize stock performance in its pursuit of risk, risk-tolerant stock- holders will benefit from risky endeavors that match their 30 Paul H. Edelman & Randall S. Thomas, Corporate Voting and the Takeover Debate, 58 VAND. L. REV. 453, 464 (2005) (noting that models by Lucian Bebchuck, Oliver Hart, Ronald Gilson, and Alan Schwartz “make unrealistic assumptions about the homogeneity of shareholders, both in the size of their holdings and in their voting behavior. [The models] also ignore differences in the signal to which the shareholders listen.”). 31 Bainbridge, supra note 10, at 1445. 32 ROBERT A.G. MONKS & NELL MINNOW, CORPORATE GOVERNANCE 67 (3d ed. 2004). 33 Michael C. Jensen, Value Maximization, Stakeholder Theory, and the Corporate Objective Function, 12 BUS. ETHICS Q. 235, 241 (2002); see also George W. Dent, Jr., Stakeholder Governance: A Bad Idea Getting Worse, 58 CASE W. RES. L. REV. 1107, 1109–11 (2008) (denying that a problem with short-termism exists). GRIFFIN_FINAL No. 1:70] THE HIDDEN COST OF M&A 83 own risk preferences, and risk-averse stockholders can sell their stocks at an increased price to avoid the risk.34 Scholars have alternatively dismissed these concerns by arguing that differences in risk preferences can be ignored because risk- averse investors have better (and cheaper) methods to miti- gate risk, such as diversification and investment in low-risk instruments, than relying on corporate boards to mitigate risk for them.35 Finally, scholars have dismissed concerns related to the special interests of employee-stockholders by maintain- ing that widespread adherence to the shareholder wealth maximization norm will yield better salaries, opportunities, and working conditions for all employees.36 Such a rebuttal implies that even employee-stockholders are better with the shareholder wealth maximization norm than without it.37 Moreover, while it is easy to hypothesize about potential conflicts between subgroups of shareholders or to point to an- ecdotal examples of such conflicts, it is more difficult to estab- lish empirically that such conflicts exist, which facilitates the dismissal of such concerns. These concerns become a question of proof, and it is difficult to prove that, for instance, risk- averse shareholders would be better off financially if directors incorporated their risk preferences into corporate decision- making, or that shareholders who prefer short-term gains would benefit financially if directors incorporated that prefer- ence into their business strategies. Because answering these questions requires reliance on counterfactuals, it is hard to find convincing evidence that shareholders with divergent in- terests do not uniformly benefit from director adherence to the shareholder wealth maximization norm as measured by stock performance. Ultimately, despite numerous critiques, reliance 34 Hu, supra note 26, at 289–90. 35 EASTERBROOK & FISCHEL, supra note 25, at 29. 36 Mark J. Roe, The Shareholder Wealth Maximization Norm and In- dustrial Organization, 149 U. PA. L. REV. 2063, 2065 (2001). 37 Id. GRIFFIN_FINAL 84 COLUMBIA BUSINESS LAW REVIEW [Vol. 2018 on stock performance as a measure of a shareholder’s financial well-being remains commonplace.38 C. Shareholder Wealth Maximization Benefits Society as a Whole A third component of the shareholder wealth maximization norm is the assumption that adherence to the norm simulta- neously benefits the corporation’s shareholders, the corpora- tion’s stakeholders, and, more generally, society as a whole. In its simplest form, this argument provides that if an enter- prise’s business operations prosper, then so too will the rest of society, which stands to gain from a “stronger corporate econ- omy and brighter economic future.”39 A second variation of this argument asserts that an exclusive focus on profit maxi- mization prevents directors from using societal welfare as a way to disguise acts taken primarily out of self-interest.40 And a third variation of this argument stresses that profit maxi- mization provides society at large with a mechanism for iden- tifying and pursuing the most beneficial result when making tradeoff decisions.41 Regardless of the exact contours of this argument, the core of the idea remains the same: the profit maximization norm provides the optimal results for share- holders, stakeholders, and society. This assumption entails a less obvious corollary: corporate law scholars use profit maximization as a vehicle to norma- tively assess the legitimacy or desirability of various corporate 38 MICHAEL USEEM, EXECUTIVE DEFENSE: SHAREHOLDER POWER AND CORPORATE REORGANIZATION 8–11 (1993). 39 Charles M. Elson & Nicholas J. Goossen, E. Merrick Dodd and the Rise and Fall of Corporate Stakeholder Theory, 72 BUS. LAW. 735, 754 (2017); see also Martin Lipton & Steven A. Rosenblum, A New System of Corporate Governance: The Quinquennial Election of Directors, 58 U. CHI. L. REV. 187, 227–28 (1991). 40 See, e.g., Bainbridge, supra note 10, at 1445; Bernard S. Black, Agents Watching Agents: The Promise of Institutional Investor Voice, 39 UCLA L. REV. 811, 821 (1992). 41 Jensen, supra note 33, at 241. GRIFFIN_FINAL No. 1:70] THE HIDDEN COST OF M&A 85 law policies.42 These scholars justify or militate against a given policy because of its effect on shareholder value.43 In so doing, they imply that policymakers and directors share the same goal—maximizing shareholder value—rather than es- tablishing whether and to what extent maximizing share- holder value promotes commonly-held goals such as advanc- ing social welfare. This conflation of goals is justifiable only when presuming that shareholder wealth maximization serves as a sufficient proxy for social welfare. III. THE SHAREHOLDER WEALTH MAXIMIZATION NORM AND M&A ACTIVITY: THEORETICAL PERSPECTIVES The aforementioned components of the shareholder wealth maximization norm—and, in particular, the twin assumptions that (1) the purpose of a corporation is to benefit shareholders financially and (2) financial benefit is measured through stock performance—have shaped the lens through which corporate law scholars view M&A activity. Indeed, pursuant to the shareholder wealth maximization norm, activities that enrich shareholders are deemed proper. Thus, the norm requires that if M&A activity increases shareholder wealth, then such ac- tivity necessarily ought to be pursued. The focus on shareholder wealth as the proper measure of the desirability of M&A activity can be seen throughout the 42 See, e.g., Michael Abramowicz, Speeding Up the Crawl to the Top, 20 YALE J. ON REG. 139, 146 (2003). 43 See, e.g., Lucian Arye Bebchuk, The Case Against Board Veto in Cor- porate Takeovers, 69 U. CHI. L. REV. 973, 989 (2002) (focusing on the impact of board veto on various shareholder returns); Lucian Arye Bebchuk et al., The Powerful Antitakeover Force of Staggered Boards: Theory, Evidence, and Policy, 54 STAN. L. REV. 887, 939 (2002) (noting the effect of classified boards on shareholder returns); Robert Comment & G. William Schwert, Poison or Placebo? Evidence on the Deterrence and Wealth Effects of Modern Antitakeover Measures, 39 J. FIN. ECON. 3, 7–8 (1995) (discussing studies that assess the wealth effects of antitakeover provisions); see also infra notes 47, 49. GRIFFIN_FINAL 86 COLUMBIA BUSINESS LAW REVIEW [Vol. 2018 literature on the topic.44 In the context of negotiated merger deals, scholars have argued that deal protection devices, such as voting agreements, lockups, and defensive tactics, are de- sirable because they benefit shareholders through increased returns and that these same devices are detrimental because they harm shareholders by reducing returns.45 In the context of hostile takeovers, scholars have vigorously debated the value of takeover defenses by assessing whether these devices benefit or harm shareholders, using various measures of shareholder wealth as their criterion.46 Numerous others have argued that various types of M&A are beneficial or 44 Robert T. Miller, Inefficient Results in the Market for Corporate Con- trol: Highest Bidders, Highest-Value Users, and Socially Optimal Owners, 39 J. CORP. L. 71, 73–74 (2013). 45 See, e.g., Frank H. Easterbrook & Daniel R. Fischel, The Proper Role of a Target’s Management in Responding to a Tender Offer, 94 HARV. L. REV. 1161, 1164 (1981) (arguing that shareholders’ welfare is maximized where the sum of “the price that will prevail in the market if there is no successful offer (multiplied by the likelihood that there will be none) and the price that will be paid in a future tender offer (multiplied by the likelihood that some offer will succeed)” is also maximized); Fernán Restrepo & Guhan Subra- manian, The New Look of Deal Protection, 69 STAN. L. REV. 1013, 1018 (2017) (arguing that “allocational efficiency . . . requires a balance” in order to best promote shareholder returns); Ian Ayres, Analyzing Stock Lock-Ups: Do Target Treasury Sales Foreclose or Facilitate Takeover Auctions?, 90 COLUM. L. REV. 682, 713 (1990) (noting that target shareholders may gain financially through stock lockups); Thanos Panagopoulos, Thinking Inside the Box: Analyzing Judicial Scrutiny of Deal Protection Devices in Delaware, 3 BERKLEY BUS. L.J. 437, 439–40 (2006) (assessing whether deal protection devices create value for the buyers and sellers in a transaction); Matthew T. Bodie, Workers, Information, and Corporate Combinations: The Case for Nonbinding Employee Referenda in Transformative Transactions, 85 WASH. U. L. REV. 871, 881 (2007) (“[T]he corporation’s organizing principle should be the maximization of the residual returns payable to shareholders.”). 46 See, e.g., Bebchuk, supra note 43, at 989 (focusing on the impact of board veto on shareholder returns); Bebchuk et al., supra note 43, at 939 (noting the effect of classified boards on shareholder returns); Comment & Schwert, supra note 43, at 23–24 (collecting studies that assess the effects of antitakeover provisions). GRIFFIN_FINAL No. 1:70] THE HIDDEN COST OF M&A 87 harmful by appealing to their effect on wealth for the share- holders of the target and/or the acquirer.47 Of course, the desirability of M&A activity is not a settled matter and remains a considerable source of debate. In recent years, much of this debate has focused on whether sharehold- ers or directors should serve as the decision makers charged with determining whether a given merger will enrich share- holders.48 This debate thus serves as a platform for the spar- ring director primacy advocates and shareholder primacy ad- vocates to make their cases. On one side of the debate, shareholder primacy scholars argue that empowering share- holders to make decisions regarding takeovers promotes im- proved corporate governance. Ex-ante, shareholder empower- ment is thought to motivate directors to improve performance for fear of a corrective response by shareholders in the event 47 See, e.g., Frank H. Easterbrook & Daniel R. Fischel, Takeover Bids, Defensive Tactics, and Shareholders’ Welfare, 36 BUS. LAW. 1733, 1737–39 (1981) (assessing the financial impact of defensive tactics); Frank H. Easter- brook & Gregg A. Jarrell, Do Targets Gain from Defeating Tender Offers?, 59 N.Y.U. L. REV. 277, 280–81 (1984) (looking at returns following success- ful and defeated tender offers); Stephen M. Bainbridge, Director Primacy: The Means and Ends of Corporate Governance, 97 NW. U. L. REV. 547, 604 n.282 (2003) (citing data on shareholder returns to demonstrate that share- holders benefit financially from M&A activity); Gregg A. Jarrell et al., The Market for Corporate Control: The Empirical Evidence Since 1980, 2 J. ECON. PERSP. 49, 51–53 (1988) (summarizing empirical data on returns to bidders and targets); Michael C. Jensen & Richard S. Ruback, The Market for Corporate Control: The Scientific Evidence, 11 J. FIN. ECON. 5, 47 (1983) (finding that corporate takeovers generate positive gains that benefit target shareholders and do not harm bidding shareholders); Michael Bradley, In- terfirm Tender Offers and the Market for Corporate Control, 53 J. BUS. 345, 347 (1980) (“[T]he underlying synergy [from tender offer deals] is presumed to have a value-increasing effect on the shares of both firms.”); MARK L. SI- ROWER, THE SYNERGY TRAP: HOW COMPANIES LOSE THE ACQUISITION GAME (1997) (analyzing empirical evidence and finding that bidders earn little or slightly negative average returns on acquisitions). 48 Luca Enriques et al., The Case for an Unbiased Takeover Law (with an Application to the European Union), 4 HARV. BUS. L. REV. 85, 86–87 (2014); see also William T. Allen et al., The Great Takeover Debate: A Medi- tation on Bridging the Conceptual Divide, 69 U. CHI. L. REV. 1067, 1071, 1074–77 (2002). GRIFFIN_FINAL 88 COLUMBIA BUSINESS LAW REVIEW [Vol. 2018 of poor performance.49 Ex-post, shareholder empowerment ar- guably improves corporate performance by providing a mech- anism to replace underperforming directors with superior di- rectors.50 On the other side of the debate, director primacy scholars contend that directors have better information than shareholders as to whether or not a given merger will promote shareholder value51 and that directors will promote the long- term interest of shareholders better than shareholders them- selves, who may myopically focus on short-term gains to the detriment of long-term growth and investment.52 Note, however, that the nexus of this shareholder-director primacy debate centers on who should decide whether a given merger promotes shareholder value,53 and not whether M&A activity that results in increased shareholder wealth should be pursued, which is a generally accepted premise on both sides of the debate.54 Indeed, those who advocate for share- holders as merger decision makers, such as Professors Lucian Bebchuk, John C. Coates IV, and Guhan Subramanian, fre- quently use evidence of positive shareholder returns to justify shareholder empowerment and evidence of negative share- holder returns to criticize pro-board provisions.55 Even those 49 EASTERBROOK & FISCHEL, supra note 25, at 162–71. 50 Luca Enriques et al., supra note 48, at 86. 51 See, e.g., Stephen M. Bainbridge, Response, Director Primacy in Cor- porate Takeovers: Preliminary Reflections, 55 STAN. L. REV. 791, 799–800 (2002) (noting that the board of directors has superior access to information than other constituencies). 52 See, e.g., Martin Lipton, Corporate Governance in the Age of Finance Corporatism, 136 U. PA. L. REV. 1, 5–6 (1987) (noting that institutional in- vestors’ short-termism resulted in a detrimental surge of takeovers that harm shareholders themselves and the larger economy). 53 Bainbridge, supra note 47, at 605. 54 See, e.g., id. at 550 (“[T]he director primacy theory embraces the shareholder wealth maximization norm. . . .”). 55 See, e.g., Lucian Arye Bebchuk, The Case for Increasing Shareholder Power, 118 HARV. L. REV. 833, 853 (2005) (citing evidence that a staggered board “considerably reduces the returns to the target’s shareholders both in the short-run and in the long-run”); Lucian Bebchuk et al., What Matters in Corporate Governance?, 39 (John M. Olin Ctr. for Law, Econ. & Bus., Dis- cussion Paper No. 491, 2004) (finding that “entrenching provisions” GRIFFIN_FINAL No. 1:70] THE HIDDEN COST OF M&A 89 who believe that directors are the proper decision makers seek to legitimize the board’s role in merger decision-making by cit- ing both directors’ willingness to pursue mergers that gener- ate gains for stockholders and the beneficial effects of pro- board provisions on stockholder returns.56 On both sides of the debate, then, scholars are united in the belief that, whoever the appropriate decision maker may be, that decision maker ought to pursue M&A that increases shareholder wealth. To be sure, some scholars have argued that a proper anal- ysis of M&A activity should extend beyond a narrow focus on shareholder wealth. One common criticism is that M&A activ- ity imposes substantial costs on managers, creditors, employ- ees, customers, suppliers, and local communities and that these costs should be factored into assessments of merger de- sirability.57 A related criticism argues that directors should consider stakeholder interests when deciding whether to pur- sue mergers.58 Such arguments beg the question of whether correlated negatively with stock returns from 1990–2003); Bebchuk et al., supra note 43, at 891 (arguing that staggered boards reduce shareholder returns). 56 See, e.g., Stephen M. Bainbridge, Unocal at 20: Director Primacy in Corporate Takeovers, 31 DEL. J. CORP. L. 769, 820 (2006); Martin Lipton & Paul K. Rowe, Response, Pills, Polls and Professors: A Reply to Professor Gilson, 27 DEL. J. CORP. L. 1, 21 (2002) (citing evidence that pills increase shareholder returns). 57 Strine, supra note 27, at 1945–47; see also Alexander C. Gavis, A Framework for Satisfying Corporate Directors’ Responsibilities Under State Nonshareholder Constituency Statutes: The Use of Explicit Contracts, 138 U. PA. L. REV. 1451, 1453 (1990). 58 See, e.g., Blair & Stout, supra note 14, at 304–05 (applying the me- diating hierarchy model to director decision-making); John C. Coffee, Jr., The Uncertain Case for Takeover Reform: An Essay on Stockholders, Stake- holders and Bust-Ups, 1988 WIS. L. REV. 435 (1988) (arguing for the consid- eration of stakeholder interests when evaluating takeovers); PETER O. STEI- NER, MERGERS: MOTIVES, EFFECTS, POLICIES 47–74 (1975) (indicating that synergy gains can come from the cost reductions involved in combining two businesses); Joseph F. Brodley, Antitrust Standing in Private Merger Cases: Reconciling Private Incentives and Public Enforcement Goals, 94 MICH. L. REV. 1, 88 (1995) (noting that collusive mergers can harm stakeholder groups). GRIFFIN_FINAL 90 COLUMBIA BUSINESS LAW REVIEW [Vol. 2018 shareholder wealth maximization in the context of M&A deals comes at the cost of broader societal welfare. Proponents of the shareholder wealth maximization norm are not indifferent to the source of financial gains to share- holders, and many justifications exist for how shareholder gains from M&A activity translate to increased societal wel- fare. Merger gains are often attributed to the efficiency gains that come from displacing inefficient incumbent managers59 or to the synergistic gains from eliminating redundancies.60 Merger gains have also been explained by the “integration of production [and] more effective use of information,” both of which have a beneficial effect on society overall. 61 These jus- tifications, coupled with arguments that M&A activity pro- vides net benefits to both shareholders and society, have led scholars to conclude that negative externalities arising from M&A activity do not render those M&A activities undesirable. 62 59 See e.g., Easterbrook & Fischel, supra note 45, at 1184 (“Society ben- efits from an active takeover market, therefore, because it simultaneously provides an incentive to all corporate managers to operate efficiently and a mechanism for displacing inefficient managers.”); Ronald J. Gilson, A Struc- tural Approach to Corporations: The Case Against Defensive Tactics in Ten- der Offers, 33 STAN. L. REV. 819, 838–39 (1981) (noting that replacing inef- ficient management can yield gains); Marcel Kahan & Michael Klausner, Lockups and the Market for Corporate Control, 48 STAN. L. REV. 1539, 1542 (1996) (stating that the replacement of inefficient management through M&A activity “can increase the value of a company by moving its assets to a more efficient management team”). 60 See, e.g., Stephen M. Bainbridge, Interpreting Nonshareholder Con- stituency Statutes, 19 PEPP. L. REV. 971, 1009 (1992) (citing “synergistic gains” as a “fairly standard explanation” for takeover gains); Michael C. Jensen, Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers, 76 AM. ECON. REV. 323, 327 (1986) (noting that efficiency gains stemmed from certain takeovers in the oil industry); Jensen & Ruback, supra note 47, at 9 (“[T]akeover gains apparently come from the realization of increased efficiencies or synergies, but the evidence is not sufficient to identify their exact sources”). 61 Frank H. Easterbrook & Daniel R. Fischel, Auctions and Sunk Costs in Tender Offers, 35 STAN. L. REV. 1, 1 (1982). 62 See, e.g., Lucian Arye Bebchuk, Toward Undistorted Choice and Equal Treatment in Corporate Takeovers, 98 HARV. L. REV. 1693, 1696 GRIFFIN_FINAL No. 1:70] THE HIDDEN COST OF M&A 91 Since Henry G. Manne’s seminal paper in 1965, Mergers and the Market for Corporate Control, it has been commonly accepted that the ways in which mergers might increase the value of the merging parties fall into one of two categories. The first involves efficiencies promoted by the market for cor- porate control, in which mergers provide an important route for resources to flow to their highest-valued use.63 The second involves diminished competition,64 which would increase the market power of the merged entity and enable the merged en- tity to raise its prices, thereby enriching its shareholders.65 To the extent that merger gains accrue through the first route, social welfare and shareholder wealth maximization are not at odds, but are, in fact, complementary. Synergistic efficiencies benefit consumers by improving the production and distribution of goods and services, while a vigorous mar- ket for corporate control is thought to motivate managers to engage in more efficient practices or to yield a change in man- agement when firms are being run suboptimally.66 This first route benefits society in numerous ways, including the “less- ening of wasteful bankruptcy proceedings, more efficient man- agement of corporations, the protection afforded non-control- ling corporate investors, increased mobility of capital, and generally a more efficient allocation of resources.”67 To the extent that merger gains accrue through the second route, however, increased shareholder wealth comes at the ex- pense of social welfare. Market power influences the degree to (1985) (implying that an efficient takeover market ultimately fosters social welfare by promoting the efficient allocation of corporate assets); Easter- brook & Fischel, supra note 45, at 1174 (arguing that “takeovers are bene- ficial to both shareholders and society”). 63 Henry G. Manne, Mergers and the Market for Corporate Control, 73 J. POL. ECON. 110, 112 (1965). 64 Id. at 120. 65 Fred S. McChesney, Manne, Mergers, and the Market for Corporate Control, 50 CASE W. RES. L. REV. 245, 248 (1999). 66 Peter C. Carstensen, The Philadelphia National Bank Presumption: Merger Analysis in an Unpredictable World, 80 ANTITRUST L.J. 219, 252 (2015). 67 Manne, supra note 63, at 119. GRIFFIN_FINAL 92 COLUMBIA BUSINESS LAW REVIEW [Vol. 2018 which firms can increase markups on their products.68 This can be profitable for the firm, but it also imposes costs on con- sumers.69 In fact, gains in market power can work as a pow- erful mechanism for transferring wealth from the poor and working class to equity investors and other wealthy citizens by turning “the disposable income of the many into capital gains, dividends, and executive compensation for the few.”70 Moreover, increased market power can also harm workers, since the firm faces less pressure from competitors to raise wages or provide better working conditions for its employ- ees.71 In this way, increased market power may yield employ- ment and wage levels below the socially optimal level.72 Problematically, increased market power is not likely to be a temporary result from M&A activity, as firms benefitting from market power tend to invest in preserving their market position by increasing barriers to entry in the market and by opposing efforts to increase competition.73 In this way, in- creased market power functions as a long-term harm involv- ing a sustained period of higher prices and decreased compe- tition in a given industry. Judges, academics, and practitioners often share a general belief that a merger is a desirable event, likely to benefit 68 Guy Rolnik & Asher Schechter, Do Mergers Benefit or Harm the Economy? Q&A with Bruce Blonigen, PROMARKET (Dec. 23, 2016), https://promarket.org/do-mergers-harm-economy-qa-with-bruce-blonigen [perma.cc/C3V5-4EFY]. 69 A. Douglas Melamed, Response, Antitrust Law Is Not That Compli- cated, 130 HARV. L. REV. F. 163, 166–67 (2017) (“[M]arket power is costly. It generally means higher prices and reduced output and often means dimin- ished incentive to engage aggressively in welfare-enhancing conduct.”). 70 Lina Khan & Sandeep Vaheesan, Market Power and Inequality: The Antitrust Counterrevolution and Its Discontents, 11 HARV. L. & POL’Y REV. 235, 236 (2017). 71 COUNCIL OF ECON. ADVISORS, BENEFITS OF COMPETITION AND INDICA- TORS OF MARKET POWER 2 (2016), https://obamawhitehouse.ar- chives.gov/sites/default/files/page/files/20160414_cea_competition_is- sue_brief.pdf [perma.cc/7W45-G64D]. 72 Id. 73 Carstensen, supra note 66, at 251. GRIFFIN_FINAL No. 1:70] THE HIDDEN COST OF M&A 93 shareholders via efficiency gains and unlikely to result in harmful increases in market power.74 This presumption re- sults at least in part from the scholarship of Robert Bork. In his book The Antitrust Paradox, Bork argued that the typical horizontal merger would not harm consumers.75 His essential premise was that mergers that allow at least three large enti- ties to remain in an industry would be unlikely to result in any harm to competition.76 His theories, along with Chicago School precepts corroborating that mergers typically have be- nign or beneficial effects on competition, have shaped philo- sophical and practical approaches to mergers in recent years.77 However, such arguments are increasingly subject to challenge on empirical grounds.78 Of course, to those who embrace the twin assumptions that (1) the purpose of the corporation is to benefit shareholders financially, and (2) benefit to shareholders is measured through stock performance, the source of increased share- holder gains may be inconsequential. Indeed, the shareholder wealth maximization norm obligates corporate managers to maximize shareholders’ wealth, even when those gains come at the expense of other stakeholders and society as a whole.79 A broader understanding of shareholder benefits changes the analysis. Shareholders are not merely fictional beings with a financial interest in the performance of a single com- pany, but flesh-and-blood-humans. These “human investors,” to use Chief Justice Leo Strine’s term, care not only about the performance of a single stock, but likely have a substantial, and more acute, financial interest in the performance of their 74 Id. at 252. 75 Orley Ashenfelter et al., Did Robert Bork Understate the Competitive Impact of Mergers? Evidence from Consummated Mergers, 57 J. L. & ECON. S67, S95–96 (2014). 76 Id. at S96. 77 Khan & Vaheesan, supra note 70, at 270–71. 78 Christopher R. Leslie, Antitrust Made (Too) Simple, 79 ANTITRUST L.J. 917, 921–26 (2014). 79 Joel Slawotsky, The Virtues of Shareholder Value Driven Activism: Avoiding Governance Pitfalls, 12 HASTINGS BUS. L.J. 521, 521 (2016). GRIFFIN_FINAL 94 COLUMBIA BUSINESS LAW REVIEW [Vol. 2018 diversified retirement portfolio, the stability of their employ- ment, the performance of the overall economy, and, relevant to present purposes, the prices they must pay for goods.80 To human investors, it matters a great deal whether the gains that come from M&A activity accrue at the expense of the American consumer and the American economy or, rather, whether merger gains and economic growth occur in tandem. For investors such as these, understanding the source of merger gains provides important insight into the utility of stock price as a measure of shareholder financial benefit. In- deed, if the gain to share price is offset by a loss to sharehold- ers due to price increases, the utility of the limited conception of shareholder wealth maximization is called into question. More broadly, for those who support shareholder wealth max- imization on the grounds that adherence to the norm yields increased societal welfare, it also matters a great deal whether merger gains come at the expense of or in conjunction with social welfare. If merger gains accrue primarily through market power-induced price increases rather than efficiency gains, then using shareholder wealth maximization as a method of increasing social welfare is suspect. Given these considerations, it is critical to determine whether and to what extent M&A activity generates efficiency gains rather than market power increases. Such information can demonstrate (1) whether M&A activity benefits share- holders beyond the mere performance of one single stock and (2) whether M&A activity serves society as a whole. Thus, this Article will now analyze whether returns from M&A activity result from efficiency gains or increases in market power. IV. A SUMMARY OF ECONOMIC RESEARCH ON THE SOURCE OF MERGER GAINS The source of gains from M&A activity is an important and controversial subject. As mentioned above, there are two main channels through which M&A activity may enhance 80 See Strine, supra note 27, at 1945. GRIFFIN_FINAL No. 1:70] THE HIDDEN COST OF M&A 95 profitability: (1) increased efficiency or (2) increased market power.81 Traditionally, when one company acquires or merges with another, management highlights purported efficiency gains as a means to justify the merger.82 Efficiency gains, sometimes referred to as productivity or “synergy” gains, may encompass a wide variety of corporate activities, such as im- plementing a more effective corporate strategy, eliminating duplicative employees, or closing underperforming plants.83 Efficiency gains have the beneficial social effect of lowering prices for consumers.84 Thus, increases in efficiency mean that consumers will pay less for the same good or service than before the merger. Although efficiency gains are sometimes controversial—especially those that involve job losses— 81 Bruce A. Blonigen & Justin R. Pierce, Evidence for the Effects of Mer- gers on Market Power and Efficiency 2 (Nat’l Bureau of Econ. Res., Working Paper No. 22750, 2016), http://www.nber.org/papers/w22750.pdf [perma.cc/6H2L-9VBT]. 82 See, e.g., Marriott International to Acquire Starwood Hotels & Re- sorts Worldwide, Creating the World’s Largest Hotel Company, MARRIOTT NEWS CTR. (Nov. 16, 2015), http://news.marriott.com/2015/11/marriott-in- ternational-to-acquire-starwood-hotels-resorts-worldwide-creating-the- worlds-largest-hotel-company/ [perma.cc/SB5Z-CVBA] (noting that the transaction would “unlock additional value for Marriott and Starwood shareholders” by, among other things, “leveraging operating and G&A effi- ciencies”); Knight Transportation and Swift Transportation Announce All Stock Transaction with a Combined Enterprise Value of $6 Billion, BUS. WIRE (Apr. 10, 2017, 7:00 AM), http://www.business- wire.com/news/home/20170410005557/en/Knight-Transportation-Swift- Transportation-Announce-Stock-Transaction [perma.cc/U43Y-G6BR] (“In- deed, by coming together under common ownership, the companies will be able to capitalize on economies of scale to achieve substantial synergies.”); Tesla and SolarCity to Combine, TESLA (Aug. 1, 2016), https://www.tesla.com/blog/tesla-and-solarcity-combine [perma.cc/G82D- Z3TG] (“We expect to achieve cost synergies of $150 million in the first full year after closing. We also expect to save customers money by lowering hardware costs, reducing installation costs, improving our manufacturing efficiency and reducing our customer acquisition costs.”). 83 Strine, supra note 27, at 1945. 84 Dario Focarelli & Fabio Panetta, Are Mergers Beneficial to Consu- mers? Evidence from the Market for Bank Deposits, 93 AM. ECON. REV. 1152, 1152 (2003). GRIFFIN_FINAL 96 COLUMBIA BUSINESS LAW REVIEW [Vol. 2018 economists generally believe that increases in efficiency and productivity, in the aggregate, have positive effects on the overall economy.85 Gains from increased market power present a different sit- uation. When two competing firms merge, the resulting firm’s market power may increase—that is, the firm may now face decreased competitive pressures. Market power influences “how much firms can mark up their prices above marginal cost.”86 As market power increases, firms can charge higher prices for their products. This can be profitable for the firm, but it imposes costs on consumers. Increases in market power may mean that consumers will pay more for the same good or service than before the merger. Because these costs to con- sumers can be shown to exceed the extra profits to the firm— generating what economists refer to as “deadweight loss”—the process reduces overall social welfare.87 Thus, when merged firms utilize their increased market power to increase the price of their products, this results in a net loss both to con- sumers and to society overall. Efficiency gains and market power gains are not mutually exclusive; an individual merger may increase both market power and efficiency for the new, larger company. In order to determine the impact of the merger on consumers, it is neces- sary to determine the relative magnitude of each effect. If the merger produces greater efficiency gains than market power gains, the merger will lower costs and benefit consumers.88 However, if the market power gains outweigh the efficiency gains, the merger will raise costs and harm consumers.89 85 See, e.g., STEPHEN PALMER & DAVID J. TORGERSON, ECONOMIC NOTES: DEFINITIONS OF EFFICIENCY, 318 BRIT. MED. J. 1136, 1136 (1999) (stating “Economists argue that the achievement of (greater) efficiency from scarce resources should be a major criterion for priority setting”). 86 Rolnik & Schechter, supra note 68. 87 Lars-Hendrik Röller et al., Efficiency Gains from Mergers, in EURO- PEAN MERGER CONTROL: DO WE NEED AN EFFICIENCY DEFENCE? 98 (Fa- bienne Ilzkovitz & Roderick Meiklejohn, eds., 2006). 88 Focarelli & Panetta, supra note 84, at 1152. 89 Id. GRIFFIN_FINAL No. 1:70] THE HIDDEN COST OF M&A 97 Aggregating the effects of many individual mergers and acqui- sitions provides insight to the overall social and economic im- pact of M&A activity. A. Identifying the Source of Merger Gains: The Problem with Case Study Data Many scholars have examined the source of gains produced by M&A activity in the economics literature. However, such studies have historically had a number of important limita- tions. Because of difficulty acquiring the necessary data, scholars have typically taken a case study approach, examin- ing at most a few mergers within the same or comparable in- dustries.90 Due to the nature of this approach, such studies are often very limited in scope.91 Case studies tend to be less representative of M&A transactions generally due to selection bias or the tendency to disproportionately study the most prominent and newsworthy mergers.92 Although some studies have gone beyond the case study approach, they are generally confined to only one out of a small handful of industries—for instance, airlines, banking, hospitals, and petroleum.93 These studies produce mixed results, some suggesting that efficiency gains outweigh market power gains and some sug- gesting the opposite. Results appear to vary considerably ac- cording to market composition, industry, and geographic loca- tion, a fact that further calls into question the utility of the case study approach. 94 One review of the literature suggested 90 Ashenfelter et al., supra note 75, at S77. 91 See, e.g., Orley C. Ashenfelter et al., Efficiencies Brewed: Pricing and Consolidation in the US Beer Industry, 46 RAND J. ECON. 328 (2015) (ex- amining the merger between Miller and Coors); Denis A. Breen, The Union Pacific/Southern Pacific Rail Merger: A Retrospective on Merger Benefits, 3 REV. NETWORK ECON. 283 (2004) (examining a large railroad merger). 92 Blonigen & Pierce, supra note 81, at 5. 93 Ashenfelter et al., supra note 75, at S77. 94 Further complicating the issue, scholars have posited detrimental market power effects from bank mergers, such as reductions in cost effi- ciency, that are even more damaging than price increases and that are in- frequently measured in traditional studies. See Allen N. Berger & Timothy GRIFFIN_FINAL 98 COLUMBIA BUSINESS LAW REVIEW [Vol. 2018 that efficiency gains predominated in North American and European bank mergers.95 In contrast, a study of Asian bank mergers found no observable efficiency effects.96 Studies of railroad industry mergers are also mixed, but may show evi- dence of net efficiency gains.97 In the electric power industry, evidence suggests there are no net efficiency gains from M&A.98 Economists John Kwoka and Michael Pollitt summa- rize the ongoing controversy as follows: Despite their importance, the effects of mergers re- main in dispute. Advocates allude to the ‘market for corporate control,’ which views mergers and acquisi- tions as methods for efficiency-enhancing transfers of underperforming assets to firms that can utilize those assets better and thereby realize the value gain. Skep- tics note that while many mergers may be benign or beneficial, others are motivated by market power, hu- bris, or simple mistakes, all of which result in societal H. Hannan, The Efficiency Cost of Market Power in the Banking Industry: A Test of the “Quiet Life” and Related Hypotheses, 80 REV. ECON. & STAT. 454, 455 (1998). 95 Robert DeYoung et al., Mergers and Acquisitions of Financial Insti- tutions: A Review of the Post-2000 Literature, 36 J. FIN. SERV. REV. 87 (2009). 96 Sue-Fung Wang et al., The Long-Run Performance of Asian Commer- cial Bank Mergers and Acquisition, 5 MOD. ECON. 341, 341 (2014) (“We find the Asian acquiring banks experience negative long-term abnormal returns and are not efficiency improving . . . . In general, the long-run stock perfor- mance and operating performance of Asian commercial bank merger[s] . . . cannot create synergy in the long run.”). 97 See, e.g., Breen, supra note 91, at 25 (finding dominant efficiency gains in one large railroad merger); John D. Bitzan & Wesley W. Wilson, Industry Costs and Consolidation: Efficiency Gains and Mergers in the U.S. Railroad Industry, 30 REV. INDUS. ORG. 81 (2007) (finding efficiency gains in railroad mergers generally); Clifford Winston et al., Long-Run Effects of Mergers: The Case of U.S. Western Railroads, 54 J.L. & ECON. 275 (2011) (finding negligible effects on consumer welfare). But see Huey-Lian Sun & Alex P. Tang, The Sources of Railroad Merger Gains: Evidence from Stock Price Reaction and Operating Performance, 39 TRANSP. J. 14, 25 (2000) (find- ing that market power effects predominate). 98 See John Kwoka & Michael Pollitt, Do Mergers Improve Efficiency? Evidence from Restructuring the US Electric Power Sector, 28 INT’L J. INDUS. ORG. 645, 646 (2010). GRIFFIN_FINAL No. 1:70] THE HIDDEN COST OF M&A 99 costs. Evidence exists supporting each view. Stock market event studies routinely find shareholder gains from mergers, at least in the short term, seemingly corroborating the efficient-merger hypothesis. Studies of actual operating effects, on the other hand, more of- ten tend to show that gains from merger are the ex- ception rather than the rule.99 Although industry-specific and case study evidence on whether these gains come from improvements in actual oper- ating efficiency is somewhat mixed, the evidence that mergers regularly produce efficiency gains is weak at best. In fact, one “study of studies” surveyed data from previous case studies in order to provide a broader view of M&A activity and its effects on the market. Economists Ashenfelter, Hosken, and Wein- berg reviewed forty-nine studies and found that nearly three- quarters of them showed mergers resulting in price in- creases.100 Overall, while case studies can contribute to understand- ing a specific merger or industry at issue and while meta-anal- yses of these studies can point generally towards the causes of merger gains, the idiosyncrasies of the specific companies and sectors involved limit the ability to generalize from the data. Without more broad-based data, it has historically been diffi- cult to understand the systemic impact of M&A on efficiency and market power. B. Identifying the Source of Merger Gains: Conclusions from Broad-Based Data Recently, it appears that the evidence for pronounced mar- ket power effects from M&A activity is increasing.101 There 99 Id. 100 Ashenfelter et al., supra note 75, at S78. 101 One recent study finds evidence of “synergy gains” from M&A activ- ities. However, this study defines synergy gains as “the market-value- weighted average of acquirer and target CARs where data for the target is available on CRSP,” and as such does not distinguish between market power GRIFFIN_FINAL 100 COLUMBIA BUSINESS LAW REVIEW [Vol. 2018 have been important advances in the ability of researchers to analyze the sources of gains in M&A transactions, as a num- ber of researchers have now been able to use “micro-level data for a broad set of firms . . . across the economy.”102 These broad-based studies allow researchers to overcome the limita- tions of the case study approach and provide useful infor- mation about the source of gains from M&A activity on the national level. Only a few studies have attempted to use de- tailed plant- or firm-level data covering a broad set of U.S. firms to draw more representative conclusions about the av- erage effects of M&A activity. Such studies likely provide more generalizable results about the average effects of M&A activity due to their larger sample sizes and more representa- tive compositions.103 This Section will outline some of the most important examples of such recent research. One important study used detailed data on a large set of manufacturers to study efficiency gains following different types of asset transfers.104 In the study, economists Vojislav Maksimovic and Gordon Phillips measured the effects of M&A involving the ownership transfer of 17,720 plants.105 Although the authors examined multiple types of asset transfers be- tween firms, including those that involve a transfer of only part of a firm’s assets, they were able to differentiate between partial asset sales and M&A involving entire firms.106 The au- thors found either zero or negative efficiency effects from M&A activity.107 These effects were modulated by the relative initial productivity of the assets of the buyer and target effects and efficiency effects. See G. Alexandridis et al., Value Creation from M&As: New Evidence, 45 J. CORP. FIN. 632, 641 (2017). 102 Blonigen & Pierce, supra note 81, at 6. 103 See, e.g., id. at 2 n.3 (noting that their sample encompassed approx- imately fifty percent of all M&A activity during the time period). 104 Vojislav Maksimovic & Gordon Phillips, The Market for Corporate Assets: Who Engages in Mergers and Asset Sales and Are There Efficiency Gains?, 56 J. FIN. 2019, 2020 (2001). 105 Id. at 2030. 106 Id. at 2056. 107 In contrast, the authors found that asset sales that did not consti- tute M&A positively impacted efficiency. See id. at 2056–57. GRIFFIN_FINAL No. 1:70] THE HIDDEN COST OF M&A 101 firms.108 Maksimovic and Phillips found no evidence of effi- ciency effects in M&A transactions where the buyer’s assets demonstrated initial productivity exceeding those of the tar- get firm.109 They found negative efficiency effects in M&A transactions where the target firm’s assets demonstrated ini- tial productivity exceeding those of the buyer.110 Overall, the researchers found no evidence that aggregate M&A activity produced any gains in efficiency in the firms studied.111 Their results suggest that, when examining detailed data on a broad sample of firms, M&A activity does not generate aggregate ef- ficiency gains. Another highly ambitious study attempted to quantify the effects of all mergers in the world occurring over a period of fifteen years.112 Economist Klaus Gugler and his coauthors measured the effects of mergers on market power and effi- ciency by examining detailed accounting data on firm profits and sales.113 Although the researchers utilized a global data set, roughly half of the mergers in their sample occurred in the United States.114 The study shows similar results between domestic mergers and the larger global sample group.115 The authors found that a majority of global mergers over the time period studied either increased market power, reduced effi- ciency, or both, and could thus be categorized as “welfare re- ducing.”116 Overall, the study found that only 29.1% of mer- gers appear to result in efficiency gains, with approximately the same number actually reducing efficiency.117 108 Id. at 2056–57. 109 Id. 110 Id. 111 Id. 112 See Klaus Gugler et al., The Effects of Mergers: An International Comparison, 21 INT’L. J. INDUS. ORG. 625 (2003). 113 Id. at 625. 114 Id. at 632. 115 Id. at 637. 116 Id. at 651. 117 Id. at 649. GRIFFIN_FINAL 102 COLUMBIA BUSINESS LAW REVIEW [Vol. 2018 The authors also made a number of more granular find- ings. First, they found that “the average profitable merger . . . appear[s] to have increased market power.”118 Next, they found that the remaining (unprofitable) mergers likely gener- ate negative efficiency effects.119 Taken together, these find- ings indicate that aggregate global M&A activity, both profit- able and unprofitable, generates negative social and economic effects. The study also conducted an examination of the highest and lowest quartiles of M&A activity, measured by the differ- ence between actual and projected profits, which yielded prob- lematic findings.120 The data indicated that the most profita- ble mergers tend to generate market power increases.121 As one might expect, the mergers in the bottom quartile appear to generate even more significant negative efficiency effects than the average unprofitable merger.122 The study further breaks down the results by different types of M&A transactions.123 Profitable instances of both horizontal mergers and conglomerate mergers appear to gen- erate market power gains.124 However, the results indicate that profitable vertical mergers are “weakly consistent” with the hypothesis that they generate efficiency gains, although the results in this area are not statistically significant.125 The results for unprofitable horizontal, conglomerate, and vertical mergers suggest that these transactions result in losses to ef- ficiency.126 Thus, although the results for efficiency are broadly similar across different types of mergers, different types of mergers may have distinct effects on firms’ market power. 118 Id. at 643. 119 Id. at 644. 120 Id. 121 Id. at 645. 122 Id. 123 Id. at 644–45. 124 Id. at 644. 125 Id. at 646. 126 Id. at 645. GRIFFIN_FINAL No. 1:70] THE HIDDEN COST OF M&A 103 Finally, the authors made an important distinction be- tween mergers involving firms of different sizes.127 In their analysis, “large firms” had average sales of approximately $5.7 billion per year, while “small firms” had average sales of approximately $341 million per year, roughly 6% of the mag- nitude of their larger counterparts.128 The authors found evi- dence suggesting that profitable small mergers generate pos- itive efficiency gains.129 In contrast, they found that profitable large mergers, as with their sample of all profitable mergers, appear to generate market power gains, and that increased size correlates with increased market power.130 The authors again examined the unprofitable corollaries for mergers of each size, finding that these mergers generate negative effi- ciency effects.131 These results again suggest that, although mergers in the aggregate may have negative social and eco- nomic effects, certain subsets of mergers can generate positive results. In all, this study reaffirms the notion that mergers, in the aggregate, are “welfare reducing.”132 The most recent study obtained highly-detailed data for companies representing approximately fifty percent of all M&A activity in the United States.133 In the study, Bruce Blonigen and Justin Pierce presented data from the entire universe of U.S. manufacturing industries, analyzed over a ten-year horizon.134 The authors described the breadth of in- dustries their data represents, noting that the data covers “a very broad and diverse set of industries and firms and sectors . . . from timber companies to high-end electronics to toys to printing services.”135 Using novel research techniques and de- tailed plant-level productivity data, they were able to 127 Id. at 646–47. 128 Id. at 646 n.19. 129 Id. at 646–47. 130 Id. at 646, 649–50. 131 Id. at 646–7. 132 Id. at 651. 133 Blonigen & Pierce, supra note 81, at 2 n.3. 134 Id. at 7. 135 Rolnik & Schechter, supra note 68. GRIFFIN_FINAL 104 COLUMBIA BUSINESS LAW REVIEW [Vol. 2018 distinguish between potential gains in efficiency and market power with greater specificity and over a much larger set of companies than was possible in most prior studies.136 Their research convincingly demonstrates that the average merger increased market power.137 Further, they found that despite promises of synergy and increased efficiency, one subtype of mergers, horizontal mergers (or mergers between competi- tors), may actually reduce firm productivity on average.138 They also found no statistically significant evidence for effi- ciency or productivity gains resulting from the full sample of mergers they examined.139 In order to ensure that no possible sources of efficiency gains were missed, the authors examined a number of diverse channels often touted as sources of productivity and efficiency gains.140 First, they tested for efficiency gains that would have increased productivity at the plants in their sample. They found no evidence of efficiency gains through this channel.141 Despite finding no increases in average plant-level productiv- ity, they hypothesized that firms in the wake of a merger may shift production from low to high-performing plants.142 This would leave average plant-level productivity unchanged while still increasing productivity at the firm level.143 However, the authors found no evidence of enhanced productivity through this channel either.144 The authors also hypothesized that firm-level productivity could be enhanced if firms were to close down underperforming plants following completion of M&A transactions.145 Here, too, the evidence failed to support the 136 Blonigen & Pierce, supra note 81, at 2. 137 Id. at 3. 138 Id. at 21. 139 Id. at 3 (“We find that M&As significantly increase markups on av- erage, but have no statistically significant average effect on productivity.”). 140 Id. at 4. 141 Id. at 19. 142 Id. at 22. 143 Id. 144 Id. 145 Id. GRIFFIN_FINAL No. 1:70] THE HIDDEN COST OF M&A 105 hypothesis.146 Next, the authors examined another important potential source of efficiency gains: “realizing economies of scale in non-production activities,” such as combining non- productive general and administrative activities.147 Theoreti- cally, such efficiency gains create value by eliminating redun- dancies and enabling the company to pass the ensuing savings on to its consumers. However, the authors found “no signifi- cant M&A effects on non-production employment of the M&A plants and firms, ruling out efficiency effects from realizing scale economies in headquarter services after an M&A.”148 Thus, their research provides strong evidence that economic gains from M&A activity in horizontal mergers come not from the commonly-cited channels for efficiency gains, but instead from increases in market power. Together, these three broad-based studies suggest an an- swer to the prior question about the source of gains from M&A activity: merger gains stem from market power increases. Im- portantly, these studies provide information only in the aggre- gate, and individual mergers may be more or less likely to in- duce gains from market power or efficiency.149 However, this data paints a useful picture of the effects of recent M&A activ- ity and reveals that this activity tends to lead to decreased competition and increased market power in given industries. Consequently, this Article now turns to the economic effects of increased market power. 146 Id. at 23. 147 Id. 148 Id. at 24. 149 There is some evidence, for example, that non-horizontal mergers, such as vertical and conglomerate mergers, on average produce positive ef- ficiency gains. See id. at 21. Thus, the type of merger, and other factors such as the existing degree of competition in the market, barriers to entry, and the nature of the industry, likely play an important role in determining whether a given merger will result in positive, neutral, or negative net effi- ciency gains. This implies that determining the desirability of a merger is a situation-specific inquiry, with the type of merger as well as other factors likely playing a role in whether or not a given merger will promote an opti- mal result for shareholders and/or society. GRIFFIN_FINAL 106 COLUMBIA BUSINESS LAW REVIEW [Vol. 2018 C. The Economic Effects of Market Power Increases Market power increases enable firms to raise prices in a given industry to the detriment of consumers. A number of studies suggest that such an effect is indeed occurring in a worrying number of industries, corroborating the evidence that merger gains accrue through market power increases. Evidence exists that M&A activity has resulted in market power gains and price increases150 in industries as diverse as healthcare,151 airlines,152 banking,153 and home appli- ances.154 These findings indicate that M&A-induced market power increases have resulted in increased prices in a number of important sectors. Other recent scholarship paints a similar picture regard- ing the substantial growth in market power due to M&A ac- tivity and sheds light on the resulting negative social and eco- nomic effects. A recent meta-analysis of post-merger studies confirms that antitrust regulators in the United States have routinely allowed M&A activity that increases prices. Thirty- 150 See JOHN KWOKA, MERGERS, MERGER CONTROL, AND REMEDIES: A RETROSPECTIVE ANALYSIS OF U.S. POLICY 158 (2015). 151 See, e.g., Robert A. Berenson et al., The Growing Power of Some Pro- viders to Win Steep Payment Increases from Insurers Suggests Policy Reme- dies May Be Needed, 31 HEALTH AFF. 973, 975–76 (2012); Avik Roy, Hospital Monopolies: The Biggest Driver of Health Costs that Nobody Talks About, FORBES: THE APOTHECARY (Aug. 22, 2011, 7:00 PM), https://www.forbes.com/sites/theapothecary/2011/08/22/hospital-monopo- lies-the-biggest-driver-of-health-costs-that-nobody-talks-about/ [perma.cc/T5S3-GHND]. 152 See, e.g., John Kwoka & Eugenia Shumilkina, The Price Effect of Eliminating Potential Competition: Evidence from an Airline Merger, 58 J. INDUS. ECON. 767, 780 (2010) (finding market power gains due to USAir/Piedmont merger). 153 See, e.g., Ashenfelter et al., supra note 75, at S82–83 (finding that five of seven studies of mergers in the banking industry showed price in- creases). 154 See, e.g., Orley Ashenfelter et al., The Price Effects of a Large Merger of Manufacturers: A Case Study of Maytag-Whirlpool, 5 AM. ECON. J.: ECON. POL’Y 239, 259 (2013) (finding that the merger of Maytag and Whirlpool led to price increases and harmed U.S. consumers). GRIFFIN_FINAL No. 1:70] THE HIDDEN COST OF M&A 107 four of the forty-two mergers studied (81%) resulted in “often substantial” price increases, while only eight showed price de- creases.155 The meta-analysis also found negative effects to product and service quality post-merger as well as other neg- ative anti-competitive effects.156 These studies illustrate that, post-merger, consumers must pay higher prices, settle for lesser goods, or both. Further research has shown that excessive market power poses a serious threat to consumers in the United States. Lina Khan and Sandeep Vaheesan write, “[e]vidence across a num- ber of key industries in the United States indicates that ex- cessive market power is a serious problem. Firms in industries ranging from agriculture to airlines collude, merge and ex- clude rivals, and raise consumer prices above competitive lev- els, while pushing prices below competitive levels for suppli- ers.”157 Thus, there is evidence that excessive market power harms consumers across a range of industries and that M&A activity contributes to this harm. Problematically, once a corporation achieves substantial market power, it can be difficult to undo the damage caused by market concentration.158 As discussed above, increased market concentration makes it more difficult for new compet- itors to emerge and for rivals to expand their operations, lead- ing to damaging effects beyond the noted price increases.159 Historically, it was the case that “there simply is no good empirical evidence that any class of stakeholders is systemat- ically harmed by takeovers.”160 However, recent evidence 155 Carstensen, supra note 66, at 248. 156 Id. at 248–49. 157 Khan & Vaheesan, supra note 70, at 236. 158 Carstensen, supra note 66, at 246 (“[U]ndoing [market] concentra- tion by new entry or expansion by marginal competitors has proven of min- imal significance despite the theoretical appeal of the contested markets hypothesis. As markets become concentrated, the effect is to ‘raise rivals costs’ of entry or expansion.”). 159 Id. at 251. 160 Bainbridge, supra note 60, at 1008. GRIFFIN_FINAL 108 COLUMBIA BUSINESS LAW REVIEW [Vol. 2018 strongly suggests that, in the aggregate, M&A activity has in- creased prices for American consumers. It is no longer possible to assume away the market power effects of M&A activity and the resultant harms to consumers. Thus, this Article now turns to an analysis of the implications of the new research for consumers and society at large. D. The Implications of Market Power Increases for Consumers & Society The foregoing Sections have demonstrated that M&A, in the aggregate, leads to increased market power, which in turn yields increased prices. This finding has significant implica- tions for consumer welfare. It also has important distribu- tional effects. This Section will outline the detrimental effects of M&A on consumer welfare and economic inequality. The most obvious way that price increases harm consum- ers is that they reduce the amount of goods and services con- sumers can afford. When prices increase without a corre- sponding increase in quality or value, consumers must pay more for the same goods or services. This, of course, leaves less to spend on other goods and services, making consumers worse off than before. Likewise, when the quality of goods de- creases without a decrease in price, consumers are similarly worse off. Somewhat less obviously, price increases due to market power gains increase economic inequality. Imagine that Com- pany A and Company B are competitors selling the same prod- uct for $1.00. When consumers purchase the product from Company A or Company B, the respective company’s wealth increases by $1.00, while each consumer’s wealth decreases by $1.00. Now, imagine that Company A and Company B merge. The combined entity has greater market power and raises the price of the product by X amount while leaving the quality un- changed. In this new scenario, when consumers buy the com- bined entity’s new, pricier products, the company’s wealth is increased $1.00 + X, while each consumer’s wealth is reduced by $1.00 + X. As a result of the merger, each transaction now GRIFFIN_FINAL No. 1:70] THE HIDDEN COST OF M&A 109 includes an additional transfer of X amount of wealth from consumers to the company. Looking at the ownership structure of most companies, im- portant distributional effects are evident. On average, corpo- rate shareholders are wealthier than the median consumer, and, therefore, they disproportionately benefit from stock price increases and are disproportionately less affected by price increases.161 Additionally, corporate managers often own large amounts of stock due to the increasing use of stock options and restricted stock in executive compensation, mak- ing price increases another way that wealth is transferred from consumers to top executives.162 It is possible that certain wealth transfers from consumers to shareholders can have the opposite effect. For example, if a group of middle-class trades- men owned a business making yachts, wealth transfers from rich consumers purchasing yachts to the middle-class owners may act to reduce inequality.163 However, such instances are rare.164 Thus, in the aggregate, M&A-induced price increases operate to increase economic inequality. The aggregate impact of wealth transfers due to market power is quite significant. Some scholars estimate a lower bound for wealth transfers due to market power on the order of hundreds of billions of dollars per year.165 In a political en- vironment where economic inequality is especially salient, these effects are likely of special relevance to policymakers and scholars, as well as to boards and other fiduciaries charged with managing our companies and stock portfolios. 161 See William S. Comanor & Robert H. Smiley, Monopoly and the Dis- tribution of Wealth, 89 Q.J. ECON. 177, 189 (1975) (stating that market power has “a major impact on the degree of [wealth] inequality” in the United States). 162 John C. Coffee, Jr., What Caused Enron? A Capsule Social and Eco- nomic History of the 1990s, 89 CORNELL L. REV. 269, 274 (2004); see also Sharon Hannes & Avraham Tabbach, Executive Stock Options: The Effects of Manipulation on Risk Taking, 38 J. CORP. L. 533, 540 (2013). 163 Jonathan B. Baker & Steven C. Salop, Antitrust, Competition Pol- icy, and Inequality, 104 GEO. L.J. 1, 17 (2015). 164 Id. 165 Khan & Vaheesan, supra note 70, at 236. GRIFFIN_FINAL 110 COLUMBIA BUSINESS LAW REVIEW [Vol. 2018 V. EXAMINING THE IMPLICATIONS OF ECONOMIC DATA The above data on the source of gains from M&A activity reveals theoretical problems for the shareholder wealth max- imization norm and its corollary assumptions. In particular, the fact that mergers increase share prices at the expense of consumers implies that wealthy stockholders have divergent interests from middle class, working class, and poor stock- holders. This divergence in interests calls into question the utility of share price as an exclusive measurement of financial well-being for all shareholders. Additionally, the fact that mergers increase share prices at the expense of consumers also implies that stockholders in the aggregate have different interests than American society as a whole. Thus, adherence to the shareholder wealth maximization norm in this case does not result in societal betterment, but rather in social harm. This Part examines the traits of American sharehold- ers, the implications of those traits in the context of the share- holder wealth maximization norm, and key lessons for well- meaning corporate directors and corporate law scholars. A. The Traits of American Shareholders It is very difficult to speak of the “average” American stock- holder, because while roughly half of the population owns some amount of stock, a very small percentage of the popula- tion owns a very large percentage of total stock.166 Thus, the average American stockholder, looking at the pool of all stock- holders, varies greatly from the stockholder who owns the av- erage stock, when looking at the pool of all stocks owned. In- deed, the average American stockholder tends to be a middle class person with a relatively modest income, while the aver- age American stock is held by a wealthy person with a rela- tively large income.167 166 Greenwood, supra note 24, at 1035. 167 See Edward N. Wolff, Who Owns Stock in American Corporations?, 158 PROC. AM. PHIL. SOC’Y 372, 387–88 (2014). GRIFFIN_FINAL No. 1:70] THE HIDDEN COST OF M&A 111 This situation highlights that American stock ownership is highly correlated with economic class. The very wealthy are very likely to own stock and tend to own a very large amount of stock. For example, 94.9% of the top 1% owns stock directly or indirectly, and this small subset of the population owns 35% of all individually-owned stock.168 Members of the middle class are somewhat less likely to own stock and tend to own smaller amounts of stock. As an illustration, 44.6% of the mid- dle quintile of Americans own stock directly or indirectly, and this entire quintile only owns 1.8% of all individually-owned stock despite constituting 20% of the overall population.169 The poor and working class are least likely to own stock, and they tend to own the smallest amount of stock. Only 21.8% of the bottom quintile owns any stock, and this group accounts for only 0.4% of all individually-owned stock.170 In all, about half of all individually-owned stocks in America are owned by individuals making over $250,000 per year, while half of all individually-owned stocks are owned by individuals making less than $250,000 per year.171 Importantly, wealthy stockholders with large portfolios tend to have different financial concerns than middle class or poor stockholders with more modest portfolios. Indeed, earn- ings from stocks matter far more to the financial bottom line of the wealthy than they do for the middle class and the poor. Investment earnings and retirement funds provide the top 1% with 30% of their annual income, while these income sources provide only 13% of the middle quintile’s annual income and just 5% of the bottom quintile’s annual income.172 168 This data includes direct ownership of stock shares as well as indi- rect ownership through mutual funds, trusts, IRAs, Keogh plans, 401(k) plans, and other retirement accounts. Id. at 387. 169 Id. 170 Id. 171 Id. at 388. 172 JOSEPH ROSENBERG, TAX POLICY CTR., URBAN INST. & BROOKINGS INST. MEASURING INCOME FOR DISTRIBUTIONAL ANALYSIS 5 (2013), http://www.taxpolicycenter.org/sites/default/files/alfresco/publication- pdfs/412871-Measuring-Income-for-Distributional-Analysis.PDF [perma.cc/R76P-RCPV]. GRIFFIN_FINAL 112 COLUMBIA BUSINESS LAW REVIEW [Vol. 2018 Additionally, the rich tend to invest far more than they spend, since they have the discretionary income to do so.173 In con- trast, the poor tend to spend far more than they invest, with the very poor spending roughly eight times as much as they invest.174 Relatedly, different wealth classes also have vastly different marginal propensities to consume—a measurement which reflects the relative importance of consumer goods prices to each income level. The top 1% spend about 5 cents for each additional dollar brought in, while the middle quintile spends 19 cents for each additional dollar, and the bottom quintile spends 48 cents for each additional dollar.175 These facts reveal three different classes of Americans. The first class consists of a few exceedingly wealthy share- holders, who are not very different in their financial interests from the fictionalized caricature of a shareholder.176 These in- dividuals own a hefty amount of stock, earn a substantial sum from these stockholdings, and are more or less unaffected by price fluctuations in the consumer goods market.177 This group of Americans cares very much about stock performance, at least from a financial perspective, and likely benefits from M&A activity that yields both increased stock prices and in- creased consumer goods prices. A second class of Americans consists of all other shareholders. This group of individuals tends to own modest amounts of stock that provide relatively little income. This group spends more on consumer goods and is far more vulnerable to fluctuations in the price of consumer goods.178 Thus, M&A activity that boosts share prices while inflating consumer goods prices likely harms this subset of 173 Max Ehrenfreund, Where the Poor and Rich Really Spend their Money, WASH. POST: WONKBLOG (Apr. 14, 2015), https://www.washing- tonpost.com/news/wonk/wp/2015/04/14/where-the-poor-and-rich-spend-re- ally-spend-their-money/ [perma.cc/HF88-G58A]. 174 Id. 175 Christopher Carroll et al., The Distribution of Wealth and the Mar- ginal Propensity to Consume, QUANTITATIVE ECON. (forthcoming June 2017). 176 Crespi, supra note 24, at 388–89. 177 See supra notes 167–174 and accompanying text. 178 Id. GRIFFIN_FINAL No. 1:70] THE HIDDEN COST OF M&A 113 Americans. A third class of Americans represents the inter- ests of American society as a whole. These “average Ameri- cans” are more likely not to own any stock than they are to have even a small amount of stockholdings.179 Moreover, the “average American” earned $74,664 before taxes and had $57,311 worth of annual expenditures, leaving them with very little discretionary income.180 This group is thus very likely to be harmed by price increases and unlikely to significantly ben- efit from share price increases.181 Ultimately, only the first, numerically small class of Americans likely benefits from M&A activity, while the other two classes are likely harmed. B. The Implications of the Traits of American Shareholders for the Shareholder Wealth Maximization Norm Given that merger gains accrue, in the aggregate, through price increases, the assumption that shareholder financial benefit can be effectively measured by stock performance does not hold for all stockholders. It is true that, for the very wealthy stockholder, stock price gains likely offset any price increases that they must pay for goods, given that they tend to earn substantial sums of money from stock and spend a rel- atively small portion of their wealth on consumer goods. For this subset of stockholders, then, stock performance likely does provide a suitable measure of their financial well-being. Middle class and poor shareholders, however, tend to spend more than they invest and to make relatively little from their stockholdings. For such shareholders, the excess costs that they must pay for goods and services likely dwarf any gains that may accrue to their stock portfolio, meaning that stock performance provides an incomplete and misleading view of 179 Wolff, supra note 167, at 388. 180 News Release, Bureau of Labor Statistics, U.S. Dept. of Labor, Con- sumer Expenditures—2016 (Aug. 29, 2017), https://www.bls.gov/ news.re- lease/pdf/cesan.pdf [perma.cc/Q7Z5-DRLG]. 181 Greenwood, supra note 24, at 1083. GRIFFIN_FINAL 114 COLUMBIA BUSINESS LAW REVIEW [Vol. 2018 the net financial effect of M&A activity on this group of share- holders. Additionally, the data demonstrating that merger gains derive from price increases rather than synergy gains also complicates the assumption that adherence to the shareholder wealth maximization norm promotes social welfare. Indeed, given that merger gains primarily come at the expense of the consumer, improved stock performance in this context is actu- ally at odds with overall social welfare. When a merger causes stocks to do better, it also causes consumers to do worse. Be- cause very few Americans own substantial amounts of stock, stock market gains through M&A are not a boon to society as a whole. When merger gains must be paid for at the grocery store, pharmacy, or shopping mall, they constitute a net harm to the majority of Americans. C. Implications for Well-Meaning Directors Given the foregoing, what is a well-meaning corporate di- rector to do when faced with the decision of whether or not to pursue a merger? A well-meaning corporate director adhering to the shareholder wealth maximization norm in its tradi- tional form should pursue M&A activity that boosts share price, even with the knowledge that those gains come at the expense of both consumers and some portion of the company’s shareholders. Indeed, if directors are responsible for maxim- izing shareholders’ wealth, and if that wealth is to be meas- ured by stock performance, then M&A activity that provides a boost to share prices should be embraced and celebrated. However, if a corporate director chooses to instead embrace shareholder wealth maximization in a broader sense than the narrow focus on share price increases, then marginal M&A activity may become less appealing. Although most directors facing the prospect of a takeover are (and should be) focused primarily on the adequacy of the merger premium, in close cases, directors should consider the potential impact of M&A- induced price increases on their shareholders. At the margins, this may tip the balance of directors’ decisions on whether cer- tain mergers provide a net benefit to shareholders, or whether GRIFFIN_FINAL No. 1:70] THE HIDDEN COST OF M&A 115 they should negotiate for a higher premium. Moreover, de- pending on the magnitude of the merger premium and the re- sulting price increases to the firm’s goods and services, such a merger may actually constitute a net harm to a sizable portion of that firm’s stockholders. Thus, a director might conclude that, to truly maximize his or her shareholders’ welfare, firm resources are better spent on alternate strategies for growth, such as research and development, than on the pursuit of M&A activities.182 Corporate constituency statutes present another wrinkle for the well-meaning director. Forty-four states have passed “other constituency” statutes that permit directors and man- agers to consider other constituencies’ interests in their corpo- rate decision-making processes.183 Under these statutes, di- rectors are able to take non-shareholders’ interests into account.184 Although directors would be unconcerned with the 182 Strine, supra note 27, at 1908. 183 Examples of “other constituency” statutes include: CONN. GEN. STAT. § 33-756 (2017); 805 ILL. COMP. STAT. § 5/8.85 (1989); KY. REV. STAT. ANN. § 271B.12-210 (West 1988); MASS. GEN. LAWS ch. 156B, § 65 (1996); MINN. STAT. § 302A.251 (2006); N.Y. BUS. CORP. LAW § 717 (McKinney 1989). Only six states—Alabama, Arkansas, Kansas, Michigan, North Carolina, and Oklahoma—have not passed similar legislation. See Carol Liao, A Critical Canadian Perspective on the Benefit Corporation, 40 SEATTLE U. L. REV. 683, 687 (2017). 184 See e.g., CONN. GEN. STAT. § 33-756 (2017) (providing that a director “may consider in determining what [he or she] reasonably believes to be in the best interests of the corporation . . . the interests of the corporation’s employees, customers, creditors and suppliers, and . . . community and so- cietal considerations”); 805 ILL. COMP. STAT. 5/8.85 (1989) (allowing that cor- porate directors and officers “may, in considering the best long term and short term interests of the corporation, consider the effects of any action . . . upon employees, suppliers and customers of the corporation or its subsidi- aries, communities in which offices or other establishments of the corpora- tion or its subsidiaries are located, and all other pertinent factors”); IND. CODE § 23-1-35-1 (2009) (permitting that “[a] director may, in considering the best interests of a corporation, consider the effects of any action on shareholders, employees, suppliers, and customers of the corporation, and communities in which offices or other facilities of the corporation are lo- cated, and any other factors the director considers pertinent”); MISS. CODE ANN. § 79-4-8.30 (West 1999) (permitting that “a director, in determining GRIFFIN_FINAL 116 COLUMBIA BUSINESS LAW REVIEW [Vol. 2018 impact of their M&A activity on society as a whole under the shareholder wealth maximization norm, corporate constitu- ency statutes in many states allow directors to take such con- siderations into account. Because M&A activity that increases prices is likely to cause financial harm to some shareholders and society as a whole, directors of firms incorporated in states with corporate constituency statutes may be especially obliged to consider potential price increases for their goods and services when determining whether to approve M&A ac- tivity. D. Implications for Well-Meaning Mutual Fund Managers Of course, corporate directors are not the only agents with the ability to influence whether and to what extent a given firm pursues M&A activity. Because they often control signif- icant portions of a corporation’s shares, institutional investors have the power to sway directors towards certain decisions— including the decision to pursue more or less M&A activity.185 Mutual funds—investment vehicles that pool money from many investors—are currently the biggest bloc of institutional investors, controlling 20.5% of all U.S. equities as of 2015.186 Though their activism efforts have been more muted than those of other institutional investors, mutual funds what he reasonably believes to be in the best interests of the corporation, shall consider the interests of the corporation’s shareholders and, in his dis- cretion, may consider . . . [t]he interests of the corporation’s employees, sup- pliers, creditors and customers; . . . [t]he economy of the state and nation; . . . [c]ommunity and societal considerations; . . . [t]he long-term as well as short-term interests of the corporation and its shareholders”); NEB. REV. STAT. § 21-2,102 (2017) (providing that “[a] director may, but need not, in considering the best interests of the corporation, consider, among other things, the effects of any action on employees, suppliers, creditors, and cus- tomers of the corporation and communities in which offices or other facili- ties of the corporation are located”). 185 See Martin Gelter, The Pension System and the Rise of Shareholder Primacy, 43 SETON HALL L. REV. 909, 958–60 (2013). 186 See SIFMA, 2016 FACT BOOK 83 (2016), https://www.sifma.org/wp- content/uploads/2017/05/sifma-fact-book-2016.pdf [perma.cc/6QVD-J7KY]. GRIFFIN_FINAL No. 1:70] THE HIDDEN COST OF M&A 117 traditionally have influenced management decisions by opting or threatening to redirect capital to other investments, and they have increasingly engaged in other forms of activism in recent years.187 Their power to influence corporate decision-making raises an important question: what is a well-meaning mutual fund manager to do when faced with the decisions of whether to vote for a merger and whether to urge management to pursue potential M&A activity? Research suggests that many mutual fund managers believe it to be their primary or even sole duty to maximize fund performance.188 An understanding of the best interests of fund shareholders as essentially indistin- guishable from fund performance mimics traditional concep- tualizations of the shareholder wealth maximization norm that stress stock performance as the proper measure of stock- holders’ financial well-being. A mutual fund manager thusly focused on performance would be inclined to urge firms to- wards M&A activity that increases share prices, even if such increases come at the expense of consumers. However, to truly maximize the wealth of fund shareholders, mutual fund man- agers ought to consider their shareholders’ financial interests more broadly, as some mutual fund members might benefit more from a competitive marketplace and competitively- priced goods than from improved stock performance.189 In fact, mutual fund shareholders are even more likely than the typical shareholder to be disadvantaged by the mar- ket power gains and price increases that tend to accompany M&A activity. While half of all shareholders make more than $250,000 annually, 39% of mutual fund shareholders earn less than $75,000 annually, and 55% earn less than $100,000 187 Gelter, supra note 185, at 960. 188 Alan R. Palmiter, Mutual Fund Voting of Portfolio Shares: Why Not Disclose?, 23 CARDOZO L. REV. 1419, 1461 (2002). 189 Robert Ashford, Binary Economics, Fiduciary Duties, and Corporate Social Responsibility: Comprehending Corporate Wealth Maximization and Distribution for Stockholders, Stakeholders, and Society, 76 TUL. L. REV. 1531, 1574 (2002). GRIFFIN_FINAL 118 COLUMBIA BUSINESS LAW REVIEW [Vol. 2018 annually.190 Due to this income differential, mutual fund own- ers have comparatively less disposable income than tradi- tional shareholders, making them more vulnerable to price in- creases. Additionally, the purpose of 92% of mutual fund investment is saving for retirement, but 76% of mutual fund owners are employed and thus they have yet to achieve their investment goal.191 Increased costs for goods and services likely reduce the ability of many mutual fund members to con- tribute additional capital to their retirement plan, thus hin- dering their ability to pursue their stated financial goals or forcing them to reduce spending in other areas to compen- sate.192 In these ways, mutual fund shareholders are espe- cially likely to be disadvantaged by M&A activity. Given the characteristics of mutual fund members, mutual fund managers ought to be reluctant to support marginal M&A activity, lest they indirectly subvert the financial well- being of their shareholders. Indeed, depending on the relative magnitude of the change in share price and the increased cost of goods and services, a merger that results in price increases might disserve the majority of mutual fund shareholders by raising prices for goods. In close cases, mutual fund managers considering this broadened conception of shareholder wealth maximization may be more likely to steer management away from M&A activity and towards alternate courses of action more likely to generate net financial benefits for the typical mutual fund member. E. Implications for Well-Meaning Pension Fund Managers Pension funds are another group with substantial influ- ence over whether, when, and to what extent directors pursue 190 Wolff, supra note 167, at 388; Kimberly Burham et al., Characteris- tics of Mutual Fund Investors, 2015, ICI RES. PERSP., Nov. 2015, at 1, 5. 191 INV. CO. INST., 2017 INVESTMENT COMPANY FACT BOOK 113 (57th ed. 2017) (ebook). 192 See Strine, supra note 27, at 1880 (noting that most Americans have relatively little surplus to contribute to retirement funds, thus suggesting that increased expenses would further deplete that surplus). GRIFFIN_FINAL No. 1:70] THE HIDDEN COST OF M&A 119 M&A activity. In essence, pension funds are retirement plans that pool contributions from fund members and their employ- ers. Upon retirement, members receive either a pre-set amount (as in a defined benefit plan) or an amount dependent upon stock performance (as in a defined contribution plan).193 In all, pension funds control roughly fourteen percent of all U.S. equities, and, as such, these entities hold substantial power over U.S. corporations through their voting power, ac- tivism, and ability to redirect capital.194 In fact, pension funds are some of the “most active institutional investors in terms of their attempts to change the management practices of the companies in which they invest.”195 To what ends should pension funds wield their considera- ble influence in the context of corporate M&A activity? Alt- hough pension fund managers are not the archetypal actor in the shareholder wealth maximization norm, these managers have increasingly adopted the goal of shareholder wealth maximization as an important end for their members.196 In adhering to this norm, pension fund managers would likely be inclined to promote M&A activity that they believe will in- crease share prices under the assumption that doing so would yield financial benefits for plan members. However, do such activities actually benefit the typical pension fund member? An analysis of the characteristics of pension fund members sheds some light on this issue. The money invested via pensions represents a substantial portion of the retirement funds for a wide swath of American 193 S. Burcu Avci et al., How Should Retirement Plans Be Organized?, 13 N.Y.U. J. L. & BUS. 337, 346, 348 (2017). 194 See SIFMA, supra note 186, at 83. The 14% figure is the sum of three percentages in the U.S. Holdings of Equities by Type of Holder da- taset: (1) private pension fund holdings, which were 6.6% in 2015; (2) state and local government retirement fund holdings, which were 6.5% in 2015; and (3) federal government retirement fund holdings, which were 0.6% in 2015. 195 David Hess, Protecting and Politicizing Public Pension Fund Assets: Empirical Evidence on the Effects of Governance Structures and Practices, 39 U.C. DAVIS L. REV. 187, 206 (2005). 196 Gelter, supra note 185, at 963. GRIFFIN_FINAL 120 COLUMBIA BUSINESS LAW REVIEW [Vol. 2018 workers, such as school teachers, firefighters, police officers, office workers, and sanitation workers.197 The benefits re- ceived from pension funds are generally relatively modest in size. For example, the average amount paid out to public pen- sion fund retirees in 2010 was just under $26,000 per year, roughly half the median income in the U.S.198 This regular income nonetheless provides an important source of financial security to many Americans. One study found that poverty rates among the elderly were six times greater for those that lacked pension income than for those with it, and that 4.7 mil- lion households managed to escape poverty or near-poverty due to their pension income.199 In all, pensions provided the elderly with 18% of their income as of 2013.200 This data suggests that pension fund members tend to be individuals who depend upon their plans for subsistence dur- ing retirement. These individuals likely would not benefit from a transfer of wealth from consumers to stockholders and would be more likely to be harmed by M&A activity that yielded market power increases and inflated prices.201 They would, however, benefit from a corporate governance system focused on sustainable wealth creation by generating jobs, wage growth, and efficiency gains.202 Moreover, increases in 197 David H. Webber, Is “Pay-to-Play” Driving Public Pension Fund Ac- tivism in Securities Class Actions? An Empirical Study, 90 B.U. L. REV. 2031, 2034 (2010). 198 Luis A. Aguilar, U.S. Sec. & Exch. Comm’r, Keynote Address at the NAPPA 2012 Legal Education Conference: Pension Funds as Owners and Investors: A Voice for Working Families (June 27, 2012), https://www.sec.gov/news/speech/2012-spch062712laahtm [perma.cc/45KB -H9KD]; KIRBY G. POSEY, U.S. CENSUS BUREAU, HOUSEHOLD INCOME: 2015 1–2 (2016). 199 NAT’L INST. ON RET. SEC., WHY DO PENSIONS MATTER? 8 (2010) https://www.nirsonline.org/wp-content/uploads/2017/11/final_module2_ why_do_pensions_matter.pdf [perma.cc/F8BA-7LUW]. 200 SOC. SEC. ADMIN., NO. 13-11785, FAST FACTS & FIGURES ABOUT SO- CIAL SECURITY, 2015, at 7 (2015), https://www.ssa.gov/policy/docs/chart books/fast_facts/2015/fast_facts15.pdf [perma.cc/LNS7-E5KN]. 201 Greenwood, supra note 24, at 1083. 202 Strine, supra note 27, at 1882. GRIFFIN_FINAL No. 1:70] THE HIDDEN COST OF M&A 121 consumer goods prices likely detract from the amount that pension fund members with defined contribution plans can contribute to their retirement, thus coming at the expense of their financial security in retirement. Those pension fund members with defined benefit plans are likely to be even more negatively impacted by M&A activ- ity than other working- and middle-class individuals. Mem- bers of traditional “defined benefit plans” receive a set benefit upon retirement.203 Because this benefit is “set,” individual pensioners will receive the same benefits upon retirement re- gardless of the performance of the investments in the plan. This means that they are unable to capture any of the gains in the pension plan’s investments. Certainly, individual pen- sioners hope that the pension plan remains solvent enough to pay out their claims upon retirement, but, beyond this thresh- old, they are, for good or ill, significantly insulated from stock market returns. In the case of M&A activity, this insulation likely turns out to be for their ill. Pension fund members will directly bear the increased prices resulting from aggregate M&A activity in their capacity as consumers, but will only in- directly, if at all, capture any of the gains generated by these mergers in their capacity as indirect shareholders. In this way, pension fund members with defined benefit plans are forced to bear the negative externalities of M&A without fully—and, sometimes, at all—sharing in its gains. In light of these facts, it appears that working- and middle- class pension fund members, particularly those with tradi- tional defined benefit pension plans, may be uniquely disad- vantaged by M&A activity. Pension fund managers ought to look holistically at the financial concerns of plan members when selecting investments, voting on corporate matters, and engaging in activist efforts. To that end, pension fund manag- ers should wield their considerable power to oppose marginal M&A activity, as the harms to pension fund recipients in their capacity as consumers of goods and services may exceed any benefits in the form of share price gains. Only by looking at 203 See id. at 1879 n.20. GRIFFIN_FINAL 122 COLUMBIA BUSINESS LAW REVIEW [Vol. 2018 the interests of pension members in a broader sense than gains to share price can pension fund managers truly act in the financial best interests of the typical pension fund mem- ber. F. Implications for Well-Meaning Hedge Fund Managers Hedge funds form a third group of institutional investors with considerable power over whether and to what extent cor- porate directors pursue M&A activity. The hedge fund indus- try’s influence comes not only from its control of over $3 tril- lion worth of assets, but also from the tendency of hedge funds to be more active and involved investors relative to other fi- nancial market actors, such as mutual and pension funds.204 Many “activist” hedge funds aggressively push for specific changes at the companies in which they invest. Although ac- tivist hedge funds represent a minority of all hedge funds, their numbers and activity have ballooned in recent years, driving them to the forefront of corporate executives’ collective consciousness.205 A great deal has been written regarding the effects of hedge fund activism on U.S equity markets. Consistent with the shareholder wealth maximization norm, research on hedge fund activism tends to focus on its effect on stock per- formance. Some scholars argue that activism positively 204 Hedge Fund Industry Capital Surpasses Historic $3 Trillion Dollar Milestone, HEDGE FUND RES. (Jan. 20, 2017), https://www.hedge- fundresearch.com/news/hedge-fund-industry-capital-surpasses-historic-3- trillion-dollar-milestone [perma.cc/KQT2-TEJC]; Marcel Kahan & Edward Rock, Hedge Fund Activism in the Enforcement of Bondholder Rights, 103 NW. U. L. REV. 281, 282 (2009) (“[H]edge funds tend to pursue active and aggressive investment strategies.”). 205 See, e.g., Coffee & Palia, supra note 27, at 548 (“Hedge fund activism has recently spiked, almost hyperbolically.”); see also Marcel Kahan & Ed- ward B. Rock, Hedge Funds in Corporate Governance and Corporate Con- trol, 155 U. PA. L. REV. 1021, 1026 (2007). GRIFFIN_FINAL No. 1:70] THE HIDDEN COST OF M&A 123 influences returns to shareholders.206 Others contend that while the short-term returns may be positive, hedge fund ac- tivism can be harmful to companies in ways that are only ev- ident over longer time horizons.207 This issue, while hotly con- tested, remains unsettled. Regardless of whether hedge fund activism generates short-term or long-term returns, it is clear that one of the pri- mary strategies for achieving these returns involves M&A ac- tivity. In fact, pushing the target company into M&A activity 206 See, e.g., Lucian A. Bebchuk et al., The Long-Term Effects of Hedge Fund Activism, 115 COLUM. L. REV. 1085, 1155 (2015) (noting that there is an “initial positive stock-price spike accompanying activist interventions” and that this spike reflects “correctly the intervention’s long-term conse- quences”); Alon Brav et al., Hedge Fund Activism, Corporate Governance, and Firm Performance, 63 J. FIN. 1729, 1730 (2008) (summarizing their findings that “find that the market reacts favorably to activism, consistent with the view that it creates value”); April Klein & Emanuel Zur, Entrepre- neurial Shareholder Activism: Hedge Funds and Other Private Investors, 64 J. FIN. 187, 189 (2009) (finding a significantly positive market reaction for activist hedge funds’ activities). 207 See, e.g., Leo E. Strine, Jr., One Fundamental Corporate Governance Question We Face: Can Corporations Be Managed for the Long Term Unless Their Powerful Electorates Also Act and Think Long Term?, 66 BUS. LAW. 1, 12 (2010) (“[I]t is increasingly the case that the agenda setters in corporate policy discussions are highly leveraged hedge funds, with no long-term com- mitment to the corporations in which they invest.”); Martin Lipton, Empir- icism and Experience; Activism and Short-Termism; the Real World of Busi- ness, HARV. L. SCH. F. ON CORP. GOVERNANCE & FIN. REG. (Oct. 28, 2013), http://blogs.law.harvard.edu/corpgov/2013/10/28 /empiricism-and-experience-activism-and-short-termism-the-real-world-of- business/ [perma.cc/T6TL-Z922] (“While there is no question that almost every attack, or even rumor of an attack, by an activist hedge fund will re- sult in an immediate increase in the stock market price of the target, such gains are not necessarily indicative of real value creation. To the contrary, the attacks and the efforts by companies to adopt short-term strategies to avoid becoming a target have had very serious adverse effects on the com- panies, their long-term shareholders, and the American economy.”); Anab- tawi, supra note 26, at 564 (“[T]he hedge fund is likely to favor policies by the firms in which it invests that produce short-term gains, even if a more patient investment orientation would generate higher returns over the long term.”). GRIFFIN_FINAL 124 COLUMBIA BUSINESS LAW REVIEW [Vol. 2018 is by far hedge fund activists’ most lucrative strategy.208 Suc- cessful takeovers serve as the driving force behind activist hedge funds’ ability to generate long-term abnormal positive returns.209 Numerous scholars concur in this sentiment. Yvan Allaire & François Dauphin write, “[g]etting companies merged or sold off is a clear driver of hedge fund perfor- mance.”210 John Coffee and Darius Palia note that the “evi- dence suggests that changes in the expected takeover pre- mium, more than operating improvements, account for most of the stock price gain, both in short-term and long-term stud- ies.”211 Indeed, an analysis of 1740 activist interventions showed that the returns from a takeover of the target com- pany were almost double those of any other strategy employed by activist hedge funds.212 Another study by Alon Brav, Wei Jiang, Frank Partnoy, and Randall Thomas generated similar data, also finding that activism aimed at pushing the target company to sell produced better returns than any other strat- egy.213 Further confirmation comes from Robin Greenwood and Michael Schor, who find that targets of hedge fund activ- ism that are ultimately acquired generate positive abnormal returns but that targets which are not acquired generate ab- normal returns of zero.214 William W. Bratton concludes, after conducting a review of the relevant literature, “[t]here is no question that activism prompts mergers.”215 208 Marco Becht et al., Returns to Hedge Fund Activism: An Interna- tional Study, 30 REV. FIN. STUD. 2933, 2935 (2017). 209 Coffee & Palia, supra note 27, at 588. 210 Yvan Allaire & François Dauphin, The Game of ‘Activist’ Hedge Funds: Cui Bono?, INT’L J. DISCLOSURE & GOVERNANCE, Nov. 2015, at 25. 211 Coffee & Palia, supra note 27, at 588. 212 See Becht et al., supra note 208, at 2954–55. 213 Brav et al., supra note 206, at 1759. 214 Robin Greenwood & Michael Schor, Investor Activism and Takeo- vers, 92 J. FIN. ECON. 362, 363 (2009) (“[T]he returns associated with activ- ism are largely explained by the ability of activists to force target firms into a takeover, thereby collecting a takeover premium.”). 215 William W. Bratton, Hedge Fund Activism, Poison Pills, and the Ju- risprudence of Threat 13 (U. Pa. L. Sch. Inst. L. & Econ. Research Paper GRIFFIN_FINAL No. 1:70] THE HIDDEN COST OF M&A 125 The increased M&A activity prompted by mergers has sig- nificant negative implications. As discussed at length in Part IV of this paper, studies indicate that, in the aggregate, M&A activity increases prices and produces zero, or sometimes neg- ative, efficiency effects.216 As we have seen, hedge fund activ- ism relies on pushing target companies into mergers to gener- ate the bulk of activists’ returns. Thus, based on the existing research, it is likely that hedge fund activists’ most profitable strategies result in increased prices and reductions in con- sumer surplus. This represents an important, and heretofore unmentioned, negative externality of hedge fund activism. Indeed, if merely reflective of M&A activity in general, the increased M&A activity due to hedge fund activism would re- sult in the same level of increased prices and reductions to consumer surplus as other M&A transactions. However, be- cause of the nature of hedge fund activism, the particular M&A activity generated by activist hedge funds may be even more damaging. By their nature, activist hedge funds tend to conduct their activism within large, publicly-traded compa- nies. When a hedge fund makes use of its most lucrative strat- egy, pushing the target company to sell, the pool of potential buyers for a large, publicly-traded company is largely re- stricted to other large, publicly-traded companies.217 This is a perfect recipe for increases in market concentration and mar- ket power. If restricted to large, publicly-traded companies, theory predicts an increase in the negative externalities of M&A activity. First, publicly-traded companies are likely to have already reached levels of production that limit efficiency gains from economies of scale.218 This means that these large Series, Paper No. 16-20, 2016), https://papers.ssrn.com/ sol3/papers.cfm?ab- stract_id=2835610## [perma.cc/WF27-PKVA]. 216 See generally Blonigen & Pierce, supra note 81. 217 In fact, there is evidence that the companies that activists target for sale are substantially larger than the median company targeted by activists. See Allaire & Dauphin, supra note 210, at 20. 218 Carstensen, supra note 66, at 252 (“First, as a matter of logic, it is unlikely that mergers among major market competitors will significantly affect economies of scale or scope. Empirical studies provide significant sup- port for this conclusion.”). GRIFFIN_FINAL 126 COLUMBIA BUSINESS LAW REVIEW [Vol. 2018 M&A transactions may be even less likely than the average M&A deal to result in meaningful efficiency gains. Second, be- cause of their large size, there is an increased probability that the combination of such firms will increase market power.219 All else being equal, the combination of two large firms will produce an entity with greater market power than will the combination of two smaller firms. Because activist hedge fund returns largely depend on finding buyers for large, publicly- traded firms, one would theoretically expect that their activity results in market power increases that are even more damag- ing than the average M&A transaction. Empirical results con- firm this theory, as evidence suggests that, relative to mergers by small firms, mergers by large firms are both less likely to generate efficiency gains and more likely to generate market power gains.220 Thus, both theory and evidence suggest that hedge fund activism produces M&A activity that is norma- tively worse than the average M&A transaction from the per- spective of both efficiency gains and market power gains. The fact that hedge funds promote M&A activity that harms consumers in the aggregate raises an important ques- tion: how should hedge fund managers balance the need to generate returns for the fund against the very real negative effects that M&A-induced price increases have on consumers? To the extent that hedge funds embody their stereotype as the investment vehicle of the ultra-wealthy and adhere to the shareholder wealth maximization norm, hedge fund manag- ers ought to continue to promote M&A activity even given in- creasing awareness of resultant market power effects, since the wealthy likely receive a net financial benefit from such ac- tivity.221 219 Allaire & Dauphin report that larger firms (in the top quintile of market capitalization for companies sampled) are even more likely to be pushed into sale than a standard activist target. See Allaire & Dauphin, supra note 210, at 23. 220 Gugler et al., supra note 112, at 646. 221 ROBERT A. JAEGER, ALL ABOUT HEDGE FUNDS vii (2003) (remarking on the stereotypical representation of hedge funds as “secretive, GRIFFIN_FINAL No. 1:70] THE HIDDEN COST OF M&A 127 Data, however, suggests that many hedge funds indirectly serve investors of more modest means—pension funds mem- bers.222 In all, pension funds provide approximately forty per- cent of hedge funds’ capital.223 Because pension funds can qualify as “accredited investors,”224 they are able to funnel money to hedge funds from individuals who otherwise would be barred from hedge fund investments.225 These individuals are likely to be sensitive to the price increases and resulting negative impacts on consumer welfare caused by hedge fund activism mediated through M&A activity. In fact, it is likely that these individuals are more negatively impacted than other working- and middle-class individuals. As discussed above, those pension fund members who take part in tradi- tional defined-benefit pension plans are insulated from stock market gains and are uniquely harmed by M&A-induced price increases. When considering that the M&A activity generated by hedge fund activism likely results in even greater market power gains than the average M&A transaction, this harm is magnified. Thus, hedge fund activism is likely uniquely harm- ful to many pension fund members. In this light, hedge fund activism and its focus on promoting M&A activity may be dis- advantageous for a substantial subset of hedge fund investors. Hedge fund managers who take a more holistic view of their members’ well-being should be more hesitant to promote M&A activity, and pension fund managers should likewise be much more hesitant to invest in activist hedge funds. unregulated investment vehicles that enable wealthy individuals to make highly leveraged speculative bets in the global financial and commodity markets”). 222 See Strine, supra note 27, at 1959 (“The hedge fund industry cannot function at its current scale without finding investments from pension funds and the like . . . .”). 223 PREQIN, 2014 PREQIN GLOBAL HEDGE FUND REPORT 10 fig.7.22 (2014), https://www.preqin.com/docs/reports/The_2014_Preqin_Global_ Hedge_Fund_Report_Sample_Pages.pdf [perma.cc/4MU3-WDQ3]. 224 See 17 C.F.R. § 230.501(a) (2016). 225 Strine, supra note 27, at 1935. GRIFFIN_FINAL 128 COLUMBIA BUSINESS LAW REVIEW [Vol. 2018 G. Implications for Scholars In his essay The American Scholar, Ralph Waldo Emerson outlines the duties of a scholar: “[t]he office of the scholar is to cheer, to raise, and to guide men by showing them facts amidst appearances.”226 It is clear that the traditional conceptualiza- tion of the purpose of a corporation involves many appear- ances. Stock performance appears to be an acceptable way to measure shareholder financial benefit. Adherence to the shareholder wealth maximization norm appears to benefit so- ciety as a whole. In the context of gains from M&A activity, these appearances do not translate into facts. Stock perfor- mance provides an imperfect measure of shareholder financial benefit, and it can actually be used to hide concrete harms to the “human investors” who make up a sizable percentage of the stockholding population. Perhaps even more problemati- cally, adherence to the shareholder wealth maximization norm can generate substantial harms to society as a whole, serving more as a transfer of wealth from poor and working class consumers to extremely wealthy investors than as a “ris- ing tide” lifting all boats. Scholars thus have a duty to look beyond stock performance and examine alternative measures of financial well-being and to question the assumption that gains to shareholders will necessarily translate to gains for society as a whole. In order to provide sound advice for policy- makers, these scholars need to look critically at corporate practices generally and M&A activity in particular to expose the areas where shareholders’ financial interests may be at odds with each other and with social welfare. It is only with this perspective that directors and policymakers can pursue the strategies and policies that best serve American society. VI. CONCLUSION This Article advances two central arguments: first, share price gains do not always represent increases in the welfare of 226 RALPH WALDO EMERSON, The American Scholar, in RALPH WALDO EMERSON ESSAYS & LECTURES 51, 63 (Joel Porte ed., 1983). GRIFFIN_FINAL No. 1:70] THE HIDDEN COST OF M&A 129 individual shareholders; and second, share price gains do not always represent increases in societal welfare. In advancing these arguments, this Article presents a challenge to the tra- ditional conception of the shareholder wealth maximization norm. This conception has allowed boards of directors and other corporate actors to serve fictionalized versions of their real shareholders. It has also allowed corporate actors to ig- nore the true impact of their actions on the very individuals in whose best interests they purport to act. This Article uses M&A activity as a lens through which to examine some of the central claims of the shareholder wealth maximization norm. This examination reveals that the tradi- tionalist conception of shareholder wealth maximization is limited and problematic in a number of ways. Although M&A activity may increase share prices, the evidence suggests that it also produces undesirable social and economic effects. De- spite the fact that these results emerge in the context of M&A activity, they should perhaps cause us to reexamine the im- pact of the shareholder wealth maximization norm in other areas as well. Further study in this area is therefore advisa- ble. This Article does not attempt to prove that the shareholder wealth maximization norm is “wrong,” either positively or nor- matively, but rather that it is overly narrow and that the costs it imposes on society are both significant and poorly under- stood. Even so, it may still be the best and most workable con- ception of corporate purpose. However, as scholars continue the spirited debate regarding corporate purpose, a more accu- rate understanding of the costs and benefits of the share- holder wealth maximization norm is essential. If these costs are ignored, it is to the detriment of substantial numbers of shareholders and consumers.