Just about everything the courts said about the duty of directors to shareholders in the early takeover cases was reversed in the case involving the Time Warner merger. That case represents probably the greatest incursion in United States business history into the rights of shareholders. The Delaware Court allowed the directors of Time to redesign completely its proposed business combination with Warner, just to keep the decision away from the shareholders.

This is the chronology: Time, Inc. and Warner Communications, Inc. originally negotiated a stock-for-stock merger in which the shareholders of Time would have the chance to vote whether to exchange their Time shares for new pieces of paper worth about $125 per share. Paramount entered the situation with a cash bid of $175 per Time share, later raised to $200. According to most commentators, Paramount was prepared to raise this sum still further, to $225 a share. Time and Warner, concerned that shareholders would not support their merger, revised their deal so that it would no longer require shareholder approval. When the contest reached the Delaware Supreme Court, the court examined the history of the Time Warner merger as initially proposed, and concluded that because it had been under discussion for more than two years, it was proper to proceed with it, even as radically revised in a very short time, and even in the face of a legitimate alternative.

This approach is consistent in process but not in substance with the factors that the Delaware courts consider in evaluating maneuvers which may be characterized as defensive. It is appropriate to consider the motives of directors to determine whether such actions are taken in good faith, and therefore deserve the broad protection of the business judgment rule. But it is not appropriate to give weight to an action just because it has been considered for a long time. First, it has nothing to do with an obligation to respond to something like the Paramount offer, which could not be predicted. Second, it creates a very perverse incentive for boards to have their lawyers read aloud a list of every possible defensive action and every possible business combination at each board meeting, just to make sure that it is on the record as having considered it, but leaving entirely open the question of whether that consideration has been at all meaningful.

The Time v. Paramount case presents a clear question. The court put it this way: “Did Time’s board, having developed a strategic plan of global expansion to be launched through a business combination with Warner, come under a fiduciary duty to jettison its plan and put the corporation’s future in the hands of its shareholders?”[i] The Delaware courts anwered, “No,” a result that must be viewed against an offering price of $200 in cash versus a price on August 23, 1990, little more than a year later, of $76 7/8. When the authors of this book wrote a letter objecting to the deal (reproduced on page 390), Michael Dingman, an outside director of Time, responded. Monks asked Dingman whether he didn’t think that there was a problem in giving managers such broad discretion in a deal where their own compensation played such an important role. Mike was characteristically direct: “To put it bluntly, I believe that the directors of Time did an extraordinary job of preventing the shareholders from getting screwed.”

In the litigation over the merger, a great deal of financial data was introduced to the court with various extrapolations of projected long-term value. The Warner transaction valued Time stock at $125, compared to the Paramount offer of $200 per share. It is hard to imagine a way that a shareholder could not do better with $200 cash, which he would be free to invest in any venture of her choice, than with a $125 investment in Time Warner, even with the most competent management ever known. How could any fact finder ignore the simple fact that starting with 60 percent more capital is virtually certain to make more money? What this suggests is that the case is not about money; that the Delaware courts have devised a language to resolve disputes that does not include a vocabulary for maximizing owners’ value.

What are owners left with after Time? Michael Klein, who argued as special counsel for the Bass Brothers in this case put it: “When the marketplace has put a 25-percent or 30-percent premium on one answer as opposed to another, why should the legal system be constructed so as to deny institutional and other shareholders the opportunity to accept that premium? What’s heinous about this case is the manipulation of the corporate machinery by the directors of Time to accomplish an avoidance of the shareholder franchise.”[ii] In this case, as in Moran v. Household International, management deliberately structured the transaction to avoid having to seek shareholder approval. The issue here was not merely the difference between antitakeover provisions; it was the very essence of the transaction. Time conceived of the deal as providing a capital base which would give it the capacity to be an aggressive worldwide competitor. As the Supreme Court of Delaware found:

The Time representatives lauded the lack of debt to the United States Senate and to the President of the United States. Public reaction to the announcement of the merger was positive. Time Warner would be a media colossus with international scope.[iii]

Following Paramount’s initial $175 a share offer, however:

[C]ertain Time directors expressed their concern that Time stockholders would not comprehend the long-term benefits of the Warner merger. Large quantities of Time shares were held by institutional investors. The board feared that even though there appeared to be wide support of the Warner transaction, Paramount’s cash premium would be a tempting prospect to these investors. In mid-June, Time sought permission from the New York Stock Exchange to alter its rules and allow the Time Warner merger to proceed without shareholder approval. Time did so at Warner’s insistence. The New York Stock Exchange rejected Time’s request . . .[iv]

Thereafter, “Time’s board decided to recast its consolidation with Warner into an outright cash and securities acquisition . . . [t]o provide the funds required for its outright acquisition of Warner, Time would assume 7–10 billion dollars worth of debt, thus eliminating one of the principal transaction-related benefits of the original merger agreement.”[v] The decision utterly to alter the capital structure of the surviving company to heavy leverage was made in a matter of days and appeared to undercut the purported rationale of the entire transaction.

Furthermore, Time’s commitment to the merger with Warner was less than its commitment to making sure Mr. Ross had a fixed retirement date. Negotiations were broken off for several months, until Mr. Ross was induced “to re-evaluate his position and to agree upon a date when he would step down as co-CEO.”[vi] The agreement reached was that Ross would retire five years after the merger and that Nicholas would then become the sole CEO of Time Warner. (So much for the role of shareholders and boards in selecting management.) The decision finds that “other aspects of the agreement came easily.”[vii] Despite the evidence about the importance of compensation and succession (these parts of the deal remained as the rest of it was completely restructured), somehow Chancellor Allen found that “there is insufficient basis to suppose at this juncture that such concerns have caused the directors to sacrifice or ignore their duty to seek to maximize in the long run financial returns to the corporation and its stockholders.” The concerns he referred to as “corporate culture” seemed to be focused only on compensation.

An enterprise and its equity securities are a function of two components – their businesses and their capitalization. There is an enormous difference between an equity-funded worldwide communications colossus and a debt-ridden venture. That the courts would base a decision on the long-standing plan respecting the businesses and ignore the quickly cobbled-together complete change with respect to capitalization suggests that Delaware courts will endorse any action of management, even if self-interested. “Finally, we note that although Time was required, as a result of Paramount’s hostile offer, to incur a heavy debt to finance its acquisition of Warner, that fact alone does not render the board’s decision unreasonable so long as the directors could reasonably perceive the debt load not to be so injurious to the corporation as to jeopardize its well being.”[viii] Rarely has the irrelevance of shareholder significance been so clearly articulated. Why pretend that there is such a thing as shareholder rights?

In the lower court decision, the Chancellor stated his position with a double negative: “I am not persuaded that there may not be an instance in which the law might recognize as valid a perceived threat to a ‘corporate culture’ that is shown to be palpable (for lack of a better word), distinctive and advantageous.” Of course there is an instance in which the law recognizes the validity of a “corporate culture.” The instance is in the value that corporate culture provides to shareholders. Time shareholders want the company to be able to reap the benefits of its culture, whether alone, or in a productive synergy with another company. But it is difficult for Time to claim that its culture and editorial in-dependence could not have been preserved with Paramount, since they did not even meet with Paramount to discuss it.

Chancellor Allen was correct in saying that “Directors may operate on the theory that the stock market valuation is ‘wrong’ in some sense without breaching faith with shareholders.” But they may only operate on that theory if they base it on fact. Let them demonstrate to the shareholders that they can do better. Without that, we abandon any pretense of a market test, in favor of “expert opinion,” paid for by management, usually with a contingent “success factor.” Even Chancellor Allen was appalled at the company’s estimated valuation of $208–$402 for Time Warner stock in 1993, calling it “a range that a Texan might feel at home on.”[ix]

Are there any limits, short of explicit fraud or corruption, to the deference that the court will give to management’s determination of value? Is there any level to justify, even require, judicial intervention?

The obvious reluctance of courts to involve themselves in second-guessing management of enterprises is understandable, even justifiable. But the result denied owners both the right to vote on the merger of Time with Warner and the right to sell their shares to a willing buyer at a mutually agreeable price.

The Time board did not fulfill in an objective, independent manner its critical role coordinating the restructuring for the benefit of those to whom it owes the most scrupulous fiduciary duty, the shareholders. The court did not object. As Michael Klein pointed out, the Time Warner decision theoretically allows companies to “create a high threshold of risk, and then do everything deliberately to deprive shareholders of any alternative. The Time Warner directors did not even need to confront, evaluate or compare alternatives.”[x] The “Revlon mode” (requiring directors to preside over an auction) should be triggered whenever a conflict of interests between shareholders and management arises, because that is the key issue, not some formal notion of whether the company is “for sale.” At that point, the board must step back and preside over an orderly evaluation of all alternatives, to decide which will provide the best long-term return for the shareholders.

Within three years, Paramount switched sides, and again found itself losing in the Delaware courts. This time it was Paramount, headed by Martin S. Davis, that wanted to preserve a business combination, over the objections of another would-be bidder. Paramount, a producer and distributor of entertainment, including movies, records, television programs, and books, agreed to a merger with Viacom, an entertainment and communications company whose core businesses include cable networks like MTV and Nickeoldeon. Viacom is controlled by Sumner M. Redstone. QVC, a retailer that operates a home-shopping cable channel, run by Barry Diller, sought to acquire Paramount instead.

In announcing the merger, Redstone and Davis made it clear that Paramount was for sale only to Viacom, and other bids were not welcome. Redstone called Diller and John Malone, a large block holder in QVC, to discourage them from making a bid. The agreement with Viacom had several provisions specifically designed to discourage other bidders. One was a $100 million “termination fee” to be paid to Viacom if for some reason the deal would not go through. Another was a stock option agreement that gave Viacom the right to buy 19.9 percent of Paramount’s stock for $1 a share in cash and seven-year subordinated notes for the remainder (about $1.6 billion). If triggered, both of these provisions would have a significant adverse impact on the Paramount’s value.

Nevertheless, Diller wrote to Davis, proposing that QVC acquire Paramount. Both potential acquirers escalated their offers. The board continued to support the Viacom deal, and QVC and a shareholder group brought the issue to court.

The Delaware Chancery court granted QVC’s motion for a preliminary injunction, and sent the issue back to the board. The Delaware Supreme Court agreed. Both found significant differences making it impossible to give the board the broad deference to “business judgment” they granted in the Time Warner case. It is important to remember that the Delaware courts apply different levels of scrutiny to board decisions, based on what is at stake. The most significant factor in the courts’ decision to apply a stricter level of review was the fact that the Paramount-Viacom deal was a change of control, not from Paramount management to Viacom management, but from the outside shareholders to inside management. When a group loses control, it is entitled to a control premium. While the Viacom deal had such a premium, it was less than that offered by QVC.

Paramount tried to argue, as Time did successfully in blocking its bid, that the Viacom merger would carry out a pre-existing strategy, afford higher value to long-term holders, and be in the corporation’s best long-run interests; therefore they were not obligated to forego these returns for short-term profit. The Chancery court said, “What is at risk here is the adequacy of the protection of the property interest of shareholders who are involuntarily being made dependent upon the directors to protect that interest. In such circumstances fairness and our law require that the directors’ conduct be made subject to the enhanced judicial scrutiny. . . .”

When that scrutiny was applied, the court found it was clear the directors had not had sufficient information. The court said the directors had to make their decision based on “a body of reliable evidence.” It did not have to be an auction or a market canvass, but it had to be as reliable as those options. The court noted, “Even if the board did not intend to deter bidding (with the lock up and stock option provisions), it had no informed basis upon which to grant an option with these Draconian features . . .”

Copy of correspondence between Robert A.G. Monks and Time director, Mike Dingman

July 21, 1989

Dear (Shareholders):

Delaware’s Chancellor William Allen, in his decision to permit the merger of Time and Warner, has not just missed the forest for the trees; he has missed the forest for the bark.

As the Delaware Supreme Court prepares to hear oral argument in the challenge to the Time decision he issued last Friday, we wanted to let you know how we see the issues. We believe that Chancellor Allen missed the central issue, which is this: Can we justify a transaction that presents directors with a conflict of interest, by protecting their employment and compensation, but denies shareholders the opportunity express their views?

As you know, Time and Warner negotiated a stock-for-stock merger in which the shareholders of Time would end up with new pieces of paper worth approx-imately $125 per share. Paramount entered the situation with a cash bid of $175 per Time share, later raised to $200. Time and Warner, concerned that shareholders would not support their merger, revised their deal so that it would no longer require shareholder approval. The revision also meant that the new company – and its shareholders – would have an enormous debt burden, at least $7 billion of new debt and possibly more than $10 billion. Reported earning will be essentially eliminated, because $9 billion of goodwill will have to be amortized. The equity deal was based on both industrial and financial logic. The debt was justified by the same industrial logic, but there was no longer any financial justification for the deal.

What this means is that Time’s management (1) devised and began to put into place a plan that was at least $50–75 per share under the market’s evaluation of the stock, (2) refused to meet with Paramount to discuss its offer, and (3) completely restructured the deal, along lines considered and rejected in favor of the original merger, to prevent shareholder involvement. Their utter disregard for the rights of shareholders was demonstrated even further by the line of succession they locked in for directing the company. This is one of the most important rights reserved to shareholders. All of this was permitted by Chancellor Allen’s decision.

He also concluded that because the merger had been under discussion for more than two years, it was proper to proceed with it. But the deal he allowed to go forward was not the one they designed during that period of deliberation; it was one they rejected and then put together quickly to obstruct Paramount. Furthermore, the original deal was developed without reference to Paramount’s offer. At the very least, that offer should have forced the board to determine why it was so much higher than the share value realized in their merger. Chancellor Allen said, in one of a series of double negatives, “I am not persuaded that there may not be instances in which the law might recognize as valid a perceived threat to a ‘corporate culture’ that is shown to be palpable (for a lack of a better word), distinctive, and advantageous.” The facts suggest that it was not the “corporate culture” that Time management was planning to preserve but the extremely favorable employment and compensation schemes they had nego-tiated with Warner. Chancellor Allen notes that the “Time culture” issue was of concern in setting the compensation for Time executives, but that this was resolved by paying them at a higher level, though still on the same basis, rather than revising it along the formula used at Warner.

The Time board has not fulfilled its critical role in coordinating the restructuring in an objective, independent manner, for the benefit of those to whom it owes the most scrupulous fiduciary duty, the shareholders. The court has not objected. The issue is the same one as that presented by management buyouts, a question of conflict of interests. The “Revlon mode” should be triggered whenever such a conflict arises, because that is the key issue, not some formal notion of whether the company is “for sale.” At that point, the board must step back and preside over an orderly evaluation of all alternatives to decide which will provide the best long-term return for the shareholders.

When directors, due to the impact various alternatives will have on their compensation and employment, have a conflict of interest that prevents their fulfilling their obligation as fiduciaries to protect the interests of the shareholders, then the decision should be made by the shareholders. That is the critical issue ignored by the court. We hope that the Supreme Court will reverse this decision. If not, shareholders have the choice of seeking legislative change, either in Delaware or at the federal level, or using their ownership rights to reincorporate the companies they hold in states with more respect for the interests of shareholders.

We will continue to keep you posted. In the meantime, if you have any comments or questions, please do not hesitate to call.

Sincerely,

R.A.G. Monks

August 15, 1989

Dear Bob,

Your letter of July 21st has been brought to my attention.

As you know, when it comes to shareholder value, I’ve believed, espoused, and supported many of the same things as you. In fact, in cases like Santa Fe, I’ve earned a reputation as an opponent of poison pills and entrenched management. But with the Time Warner merger, we part company. In the main, I find your opinions to be ill-informed and off-target.

Paramount’s highly conditional offer of $175 or $200 per share was not only ludicrously low but transparently cynical. In making it, Mr. Davis (Chairman and CEO of Paramount Communications Inc.) had two motives. The first was tactical. He wanted to sabotage Time Inc.’s carefully considered merger with Warner and thereby destroy or weaken a competitor that would dwarf his own newly created media/entertainment company. The second was opportunistic. If his public relations campaign succeeded, Mr. Davis saw a chance to panic the board into letting him pick up Time Inc. for a song.

He wasn’t that lucky. Unlike the role played by Paramount’s board in ratifying the tender offer to Time Inc., we weren’t about to rubber-stamp a managerial fait accompli. That’s not the way the Time board works. We had been looking at the merger with Warner for over two years and had considered the long-range payoff for shareholders, as well as the strategic and financial implications.

In the media coverage surrounding Paramount’s tender offer, it was the universal consensus that the Time board was composed of eight outside directors with reputations as hard-nosed individualists, men and women equally unwilling to do the bidding of either Time Inc.’s management or Mr. Davis. In this, at least, the media were on the money.

As a participant in the board’s deliberations, I was a witness to the demanding independence of the other seven outside directors. They lived up to their reputations as mavericks, asking all the tough questions and looking without sentiment or illusion at the offers on the table. In the end, all of us, without a single dissent, voted to proceed with the Time Warner deal.

I have no regrets about that decision. None. We’ve created the strongest and potentially most profitable media/entertainment company in the world. And if Mr. Davis succeeded in changing the terms of the orginal deal, nothing he said or did changed its rationale. It remains an extraordinary opportunity to improve dramatically the value of Time Inc. stock.

Frankly, I find it more ridiculous than insulting for you to accuse me and the other outside directors of a “conflict of interest.” No one – not even Paramount’s lawyers – raised this as an issue. In fact, if you really think I’m worried about my “employment” (sic) as a Time director or depend in any way on the compensation it entails, then you are probably beyond the reach of rational argument.

The ultimate outcome of the Time Warner situation will be decided in the near future as the managements come together to build what they set out to. Despite whatever speculative losses some investors may have incurred in betting on Paramount’s bid, I do hope you and others try to make an honest appraisal of the values represented by this new company.

There’s no question in my mind that the eventual outcome will resemble what happened at Disney after Saul Steinberg was paid his greenmail of $19.25 per share. Michael Eisner and his management team left the employ of Martin Davis and Paramount and brought a whole new energy and direction to Disney. At some point you may wish to examine for yourself why Eisner and other creative managers left Paramount, but this much is already certain: They have revived the company’s fortunes. Disney stock is now selling at $120 per share.

Dick Munro, Steve Ross, and Nick Nicholas have proven records of attracting and holding the best talent in the media/entertainment business. They have shown that they can create substantial value for shareholders, and now that the fight with Paramount is over, they will make an immense success out of their new venture.

I don’t mean to oversimplify all the issues that surrounded the Time Warner deal. It was a complex transaction that required some very tough judgments. And, in my opinion, the press did such a miserable job of covering the facts and issues involved that I can’t really blame you and your colleagues – never mind the ordinary shareholder – for being confused.

To put it bluntly, I believe the directors of Time did an extraordinary job of preventing the shareholders from getting screwed. And except for a few major shareholders like Capital Research – who understood the real values at stake and stood by their beliefs – they did it alone.

I look forward to seeing you in the future and discussing this at greater length. In the meantime, I felt it necessary to express my personal opinion concerning your previous letters.

Sincerely,

Mike Dingman

August 23, 1989

Dear Mike,

I very much appreciate your thoughtful response of August 15, to my letter about the Time/Warner decision issued by Chancellor Allen, and since then upheld by the Delaware Supreme Court. Although you described my “opinions to be ill-informed and off-target”, I think we agree more than we disagree. I can support many of the points you made, and still think that the courts (and the board of Time) were wrong to disregard the rights of the shareholders. And I suspect that both of our positions lead to the same ultimate diagnosis, even the same solution.

I agree with you that the directors of corporations should have the power to consummate mergers; however this must be done in a way that recognizes the clear conflicts of interest that exist for top management in such situations. Even though it imposes an additional burden on the “outside” director, I see no alter-native to their taking over the merger process, much in the same way and for the same reason that they have been required by this same Delaware court to take over the “auction” process, as in RJR and McMillan. The chief advantage of outside directors is that they can bring some objectivity and discipline to the process. (I agree with your characterization of the Time Board. Indeed, I have frequently cited your involvement as conclusive evidence that the problem is systemic and not personal.)

Here is where I think we disagree. To my way of thinking there is a world of difference between “outside” and “inside” directors. The Time Board apparently chose to conduct the merger (acquisition) negotiations without limiting the participation of the “inside” directors. That the “outside” acquiesced in and supported direction of the transactions by “insiders” – and not that I am “beyond the reach of rational argument” – is why I refer to a conflict of interest by the Board.

Corporate reorganizations ultimately devolve into a question of who gets how much. There is no objective standard – no Mosaic decalogue – that proscribes how much shareholders, how much management and how much of the total consideration should be allocated to other corporate constituencies. When, as I am sure you will agree was the case with Time, the consideration to be paid the principal executives is not immaterial, isn’t it better practice to limit their role in leading the negotiations? Should anybody be in the position of being the ultimate arbiter of their own entitlement? Should those with the largest personal stake continue to select and direct the professional advisers and thus the information reaching the Board? I think of the transaction as one where the top management took the top dollar for themselves, whether or not it was in the long-term best interest of the company and the shareholders as parties whose interest is far more genuinely long term than that of the people who put this transaction together.

Let’s look at the transaction for a moment. It is ironic that the original proposal required shareholder approval, under the rules of the New York Stock Exchange, while the revised plan, far worse from the shareholders’ perspective because of the debt burden, did not. Time was easily able to take the choice away from the shareholders, by redesigning the deal to make it much worse for them, and the shareholders did not have any way to get it back.

The court gave great deference to the fact that the merger with Warner was negotiated over a period of two years. However, the business combination that was actually executed was put together in days, in response to the Paramount offer, on terms that were explicitly considered and rejected during that two-year period of deliberation, terms that left the company with a gigantic burden of debt. The fact that the record showed compensation and succession of the top management to be the most contentious issues (apparently the only contentious issues) did not suggest to the court that perhaps self-interest might have been the primary factor in setting the terms of the merger. It does suggest it to me.

You could very well be right that the merger between Time and Warner makes more sense than a merger between Time and Paramount. The question is who makes that decision. You suggest that it should not be shareholders, because they are uninformed and only look to the short term. I suggest that it should not be top management, acting without meaningful accountability, because they have a fundamental conflict of interest. I have the same problem with MBOs. There simply cannot be a level playing field when one party has all of the resources and all of the information. In this case, Time’s management also had all of the power.

I do not think that institutional shareholders are irretrievably short term in their orientation. If they take short-term gains, they then have to find another place to invest them, and that is a real problem. Furthermore, most institutions have highly diversified portfolios, with major investments in thousands of companies. Many of our clients were investors not only in Time, but also in Warner and Paramount, not only in stocks, but also in bonds. They must look to the net impact of any proposed transaction, as fiduciaries and as prudent investors. This militates against a short-term orientation.

I agree that the institutional shareholders have a way to go before they can persuade those, like you, who are convinced that they look no further than the quarterly returns. In this regard, it is important to note the escalating portion of institutional investments that today are de facto or de jure indexed. Over the last few years, the index funds have performed better than the managed funds, which makes them hard for any “prudent and diligent” asset manager to ignore. I am enclosing testimony that I gave earlier in the year before the Markey subcommittee, where I recommended that indexed investments be deemed per se prudent under ERISA. It is essential to take some step to encourage (possibly, even, to ensure) that the largest class of institutional investor – one for whom liquidity serves no private or public objective – to be a genuine “long-term” holder and source of “patient capital,” and, therefore, begin to function as a permanent shareholder. I recognize that a gap exists today between my desired world of a solid core of long-term institutional shareholders and the arbitrageur driven world of contemporary takeovers.

If the arbs were the only institutions, I would find it difficult to argue that a governance system be organized for their benefit; on the other hand, I see no reason to disqualify ownership as the fundamental object of governance just because arbs are involved. No one has suggested that newly elected CEOs have any the less authority because of the brevity of their tenure, nor are directors required to serve an apprenticeship period.

I suggest that to the extent that the institutions have a short-term orientation, it is in large part attributable to the failure of the governance system. If you were an investment manager with a large holding in Time, your alternatives would be quite limited, even under the terms of the original deal with Warner. But if you had a real voice, a real relationship with management based on real account-ability, to give you confidence in the long term, there would be no incentive to go for a short-term gain.

Under the current system, managers and boards and shareholders face real impediments to making the best long-term decisions on these issues. But the obstacles to shareholders can be removed, while the essential conflicts presented to managers and boards will always be there. As Professor Roberta Romano has noted, “We focus on enhancing shareholder value because when looking at a corporation, it is difficult to conceive of who else’s interests would be appropriate for determining the efficient allocation of resources in the economy.” That is why it makes more sense to entrust these decisions to shareholders than to the people whose employment and income is at stake.

I am not at all convinced that the Delaware Courts consider these issues fairly. (You and I have been in agreement on this point in times past!) I am certain that the “Delaware interest” factor played an important role in the Time decision, as it did in Polaroid and many others. Delaware risks losing its title as champion of the race to the bottom. The Pillsbury and McMillan decisions led to Marty Lipton’s call to reincorporate elsewhere, and the Supreme Court’s CTS decision gave the domicile states’ authority a boost. Pennsylvania and other states are moving quickly to pass laws even more accommodating than Delaware’s, with the “stakeholder” laws the latest fad.[xi] I testified before the Delaware state legislature, arguing against adoption of the antitakeover law, along with every other shareholder representative. When the parade of CEOs came in, saying that they sure would hate to have to reincorporate elsewhere, it was no contest.

In order to protect Delaware’s economic interest in accommodating the Fortune 500, the courts have created a special language of takeovers that has no base in law or economics, and they make that language go through all kinds of acrobatics to make precedent appear to apply. This gives us the “Revlon” and “Unocal” modes. And it gives us the contortions that Chancellor Allen went through to keep Time out of those modes.

Another element of Delaware’s special language is the “business judgment” rule. Certainly, managements need and deserve the widest indulgence of courts in deferring to their “business judgment.” No one thinks that they should second-guess these decisions. But the courts should be there to make sure there is a process in place that promotes fair treatment – or at least one that does not impede it. Shareholders deserve a level playing field, too. The original Time/Warner proposed transaction can and should be supported. This represents a determination by management that ownership values can be maximized within the framework of a merger company, virtually debt free, that can be the aggressive competitor in a multinational world. The Time management has made three judgments for its owners: (i) the business of Time can best be carried out in tandem with Warner; (ii) the merged businesses can best be conducted with a solid equity base, permitting capital investment and acquisitions on a global basis; and (iii) that this merger is the best way to bridge the “value gap” for Time shareholders. At this point, the Paramount offer gave some public indication of the exact size of the “value gap.” Paramount offered $200 per share and was willing to offer more; Time management dismissed this as inadequate notwithstanding that the market valued common stock in its proposed merger at $120 per share. Time then decided to buy Warner. While this preserved the face of the “business logic” of the merger, clearly a debt-encumbered survivor is not going to be able to pursue the course of multinational aggressive dominance that was the apparent keystone of the original merger. Management thus has turned 180 degrees from an equity-heavy company to one drowning in debt.

Should there not be some common sense limit to the extent of deference paid to “business judgment” when deference is paid to a business strategy based on all equity and then it is paid again to a strategy based on all debt? Conceivably, one of these is correct. Both cannot be, and yet deference is paid to both. And, can the courts ignore arithmetic? How many years, and at what implicit rate of return, does a holder of Time common have to wait until his stock will achieve the levels that Paramount offered in 1989 in cash? Should there be any limit to this, or should deference extend indefinitely? Chancellor Allen conjures up only the most unsatisfactory “red herring” of limits based on fraud.

What is to be done? The Time/Warner decisions represents a real failure of the system of governance. America cannot simply give over the assets and power of the private corporate system to managers who are not meaningfully accountable to anyone. I personally have little appetite for the federalization of corporate law, and yet I recognize that “Delaware interest” decisions like Time/Warner will tend to make federal pre-emption more appealing.

What I have been interested in for the past several years is fortuity of large fiduciary ownership. What seems to me to be a beginning point is to require that institutional owners act as such; that those with long-term interests be required to be long-term investors; that we stop regulating institutional fiduciaries in the interest of service providers and that we elevate the interests of the beneficiaries, who constitute an adequate proxy for the national interest.

Of one thing do I feel certain, had Michael Dingman been a large shareholder of Time, the transaction would not have been consummated without the meaningful involvement of owners.

I look forward very much to the opportunity to spend a few hours together to talk of this and so many other things of mutual interest.

With respect,

Your Friend,

R.A.G. Monks

August 31, 1989

Dear Bob,

Thank you for your letter of August 23, 1989. If we keep this up, we’ll be able to publish a book – The Monks–Dingman Correspondence!

You’re right. We agree on more than we disagree. But not on everything. For example, you believe that once a corporate merger comes under consideration, management and the inside directors should at some point turn the process over to the outside directors. (In your words, “Even though it imposes an additional burden on the ‘outside’ director, I see no alternative to their taking over the merger process. . . .”) Then, at some later point – again unspecified – the outside directors should step aside and let the shareholders decide.

I believe this would turn corporate governance into a muddle. More to the point, it has little bearing on the case of the Time Warner merger. The outside directors were in charge. Every step was reviewed and approved by us, and we weren’t the empty vessels you seem to believe we were, filled with whatever ideas and information management cared to pour in our ears. We challenged management every step of the way. We asked the kind of questions that we would ask of our own employees, and we didn’t settle for stock answers. In the end, we agreed that the merger was a magnificent opportunity that should be pursued.

You use the word “acquiesce,” i.e. “to accept quietly or passively.” We did a lot of things in the unfolding of the merger. Argued. Probed. Questioned. Inquired. Cross-examined. It went on and on until we were satisfied. But we never acquiesced.

One final thing. The central issue in the Time Warner deal was neither debt, nor compensation. Paramount would have loaded on more debt than Time’s acquisition of Warner, and provided a far less significant cash flow with which to service it. And Michael Eisner and Frank Wells were offered an extraordinary package by Disney, and they’ve proved themselves worth every dime. If Steve Ross can deliver the same return to Time Warner that he has for Warner, a company he built from scratch, his compensation will be more than justified.

The board wanted to build Time Inc. so it could provide the very best return for shareholders. I think we did.

You raise a number of interesting points in your letter and, if I had the time, I’d like to look at them all. But I don’t. The reality of creating shareholder value doesn’t leave much space for dwelling on theories. Sometime in the future, when we can manage it, I look forward to sitting down and discussing the whole matter of Time Warner, as well as its wider implications. I hope that we’ll both learn something.

There is one thing I am absolutely against and that is the federalization of corporations and/or the establishment of more government rules concerning how businesses, managements, shareholders, et al. interact. I hope we agree on this point as well, and please stay away from Mr. Metzenbaum.

Again, thank you for your thoughtful response to my letter.

Sincerely,

Mike

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[i] Paramount v. Time, 571 A.2d 1140, 1149, 1150 (Del. Sup. 1990).

[ii] Directors & Boards, 14, 2, Winter 1990, p. 35.

[iii] Paramount v. Time, at p. 1147.

[iv] Id., p. 1148.

[v] Id., at p. 1148 (emphasis added).

[vi] Fed. Sec. Law Rep. 94, 514, 93, 269.

[vii] Id., at p. 93, 269.

[viii] Paramount v. Time, 571 A.2d 1140, 1155.

[ix] Fed. Sec. Law Reporter, p. 93, 273.

[x] Interview with Michael Klein, July 6, 1990.

[xi] This is a standard to which one cannot be held accountable. He who is responsible to many, is responsible to none.