Skip to content

Lucian Bebchuk & Marcel Kahan, The 'Lemons Effect' in Corporate Freeze-Outs (Harv. L. Sch. John M. Olin Ctr. Discussion Paper No. 248, Feb. 1999).

Abstract: In a corporate freezeout, the controller is required to compensate minority shareholders for the no-freezeout value of their shares that are taken from them. This paper seeks to highlight the difficulties involved in determining this no-freezeout value when, as is often the case, the controller has private information. In particular, the analysis shows that the pre-freezeout market price of minority shares cannot be used as a proxy for the nofreezeout value that these shares would have in the absence of a freeze-out. It is shown that, under a regime in which frozen out minority shareholders receive a compensation equal to the pre-freezeout market price, the pre-freezeout market price will be set at a level below the expected no-freezeout value of minority shares. The reason for this is a "lemons effect" that arises when a controller uses her private information in deciding whether to effect a freezeout. By showing how controllers are able to use their private information to effect freezeouts at terms favorable to them, this paper demonstrates that freeze-outs can become a significant source for private benefits of control.