Fair price provision: Meaning, Criticisms & Real-World Uses

What Is Fair Price Provision?

A fair price provision is a clause included in a company's corporate bylaws or charter that requires an acquiring entity to pay a specified, uniform price to all shareholders in a mergers and acquisitions transaction. This provision is a key aspect of corporate governance, designed primarily to protect minority shareholders from coercive or unfair takeover tactics, such as two-tiered tender offers ²⁵, ²⁶, ²⁷. It ensures that all shareholders receive equitable treatment and are not pressured into selling their shares at an undervalued price.

History and Origin

Fair price provisions emerged largely in response to the prevalence of hostile takeovers during the 1980s. During this period, some acquirers would employ strategies like "two-tiered" tender offers, where they would acquire a controlling stake at a high price in a front-end offer, then follow with a lower-priced, less attractive offer for the remaining shares. This tactic could coerce shareholders into tendering their shares quickly, fearing they would be left with an illiquid and less valuable stake if they didn't participate in the initial offer²⁴.

To counteract these coercive tactics and ensure more equitable treatment for all shareholders, companies began adopting fair price provisions as a form of antitakeover measures²³. These provisions aimed to mandate a consistent, "fair" price for all shares, thereby discouraging bids that sought to exploit shareholders. Over time, these amendments became a significant tool for a company's board of directors to negotiate better terms during a takeover attempt and to uphold their fiduciary duties to maximize shareholder value²¹, ²².

Key Takeaways

A fair price provision is a corporate charter amendment designed to protect shareholders during a change of control.
It mandates that all shareholders receive the same, predetermined "fair" price per share in a takeover, preventing discriminatory two-tiered tender offers.
These provisions aim to deter hostile takeovers by making them more expensive for the acquirer.
The "fair price" is often calculated based on historical stock prices or other valuation metrics, as defined in the company's governing documents.
Fair price provisions generally require a supermajority vote of shareholders to be waived or amended.

Interpreting the Fair Price Provision

The interpretation and application of a fair price provision revolve around its objective: ensuring equitable treatment for all shareholders during a change of control event. When a company with a fair price provision becomes a takeover target, the provision typically dictates that the acquiring company must pay a price that meets or exceeds a specified minimum threshold, which is often tied to the highest price paid by the acquirer for any shares during a defined period before the tender offer²⁰.

This mechanism prevents an acquirer from offering a premium only to a select group of shareholders to gain control, then squeezing out remaining shareholders at a lower price. The presence of a fair price provision signals a company's commitment to shareholder protection and can influence the negotiation dynamics of an acquisition, often leading to a higher overall offer price for the target company¹⁸, ¹⁹. Companies define the "fair price" based on various metrics, often including past share prices or the company's book value ¹⁷.

Hypothetical Example

Imagine "Tech Innovations Inc." has a fair price provision in its corporate charter. This provision states that in the event of a takeover, the acquiring company must pay a price per share at least equal to the highest closing stock prices of Tech Innovations Inc. over the 90-day period preceding the initial acquisition announcement.

Suppose "Global Conglomerate" decides to launch a hostile takeover of Tech Innovations Inc. Global Conglomerate initially acquires 15% of Tech Innovations Inc. shares through open market purchases at an average price of $75 per share over a few weeks. The highest closing price for Tech Innovations Inc. in the 90 days prior to Global Conglomerate's public announcement of its intent to acquire was $80.

Under the fair price provision, Global Conglomerate would be required to offer at least $80 per share to acquire any remaining shares from Tech Innovations Inc. shareholders, even though Global Conglomerate itself paid an average of $75 for its initial stake. This prevents Global Conglomerate from making a subsequent, lower offer (e.g., $70 per share) for the remaining shares, thereby protecting those who did not sell in the open market and ensuring all shareholders receive at least the pre-defined "fair price."

Practical Applications

Fair price provisions are primarily found within the charters and bylaws of public companies as a strategic tool in corporate finance and mergers and acquisitions. They serve several practical applications:

Shareholder Protection: The most direct application is protecting shareholders, particularly minority shareholders, from coercive takeover tactics like two-tiered tender offers ¹⁶. By mandating a uniform price for all shares, it ensures equitable treatment.
Deterrent to Hostile Takeovers: These provisions can act as an effective antitakeover measures. They increase the cost and complexity for potential acquirers, as they must be prepared to pay the specified "fair price" to all shareholders, making opportunistic or undervalued bids less attractive¹⁵.
Strengthening Board Negotiation Power: A fair price provision can empower the board of directors to negotiate for better terms in a takeover scenario. Knowing that a lower "back-end" price is prohibited, the board can insist on a price that truly reflects the company's value for all shareholders¹³, ¹⁴.
Alignment with Corporate Governance Principles: These provisions align with broader corporate governance principles that emphasize shareholder rights and equitable treatment. The Organisation for Economic Co-operation and Development (OECD) Principles of Corporate Governance, for example, stress the importance of protecting shareholder rights and ensuring fair and transparent treatment during changes of control¹².

Companies also have to consider the regulatory landscape. The Securities and Exchange Commission (SEC) requires extensive mergers and acquisitions disclosures, which often include a discussion of fairness opinions and how the proposed transaction consideration is deemed fair¹¹.

Limitations and Criticisms

While fair price provisions are intended to protect shareholders, they are not without limitations and criticisms. One common critique is that by making takeovers more expensive, they can inadvertently deter beneficial acquisitions that might otherwise unlock significant shareholder value¹⁰. Some argue that such provisions entrench existing management by reducing the threat of a takeover, potentially leading to complacency or less accountability from the board of directors.

Another limitation lies in the definition and calculation of the "fair price" itself. While typically tied to historical stock prices or common valuation metrics such as price-to-earnings ratio or book value ⁹, determining an objectively "fair" price can be subjective and may not always reflect the true intrinsic value or future potential of the company. Market conditions can change rapidly, and a historical price-based formula might not adequately capture current market realities.

Furthermore, critics suggest that fair price provisions, like other antitakeover measures, can sometimes reduce the potential for a "control premium"—the additional value a buyer might pay to gain control of a company. If all shareholders are guaranteed a uniform, high price, the incentive for a bidder to offer a substantial premium for control might diminish, potentially limiting the highest possible payout for shareholders in some scenarios. Some academic perspectives argue that such provisions can be viewed negatively if they are adopted without significant shareholder consent, though fair price provisions are generally considered more shareholder-friendly than other anti-takeover measures because they aim to ensure a premium for all shareholders.
⁸

Fair Price Provision vs. Appraisal Rights

Fair price provisions and appraisal rights both aim to ensure shareholders receive a fair value for their shares in a corporate transaction, but they operate at different stages and through distinct mechanisms.

A fair price provision is a proactive measure embedded in a company's corporate charter or bylaws. It sets a predetermined minimum price or a formula for calculating the price that an acquirer must pay to all shareholders in a change of control transaction, particularly to prevent discriminatory two-tiered tender offers. ⁷This provision acts as a deterrent to hostile takeovers and gives the board of directors leverage in negotiations. It aims to ensure fairness before a transaction is completed.

In contrast, appraisal rights are a statutory legal remedy available to dissenting shareholders after a fundamental corporate change, such as a merger. If a shareholder votes against or objects to a transaction, they can legally demand that the corporation buy back their shares at a "fair value" determined by a court, rather than accepting the transaction price. ⁶These rights are reactive, providing a judicial recourse for shareholders who believe the offer price is inadequate. For example, Maryland law grants shareholders the right to demand "fair value" for their stock in certain corporate actions, excluding appreciation or depreciation resulting directly from the objected transaction itself. ⁵While a fair price provision attempts to set the price upfront, appraisal rights allow for a judicial reassessment of that value if shareholders are dissatisfied.

FAQs

Why do companies implement fair price provisions?

Companies implement fair price provisions primarily to protect shareholders, especially minority shareholders, from coercive takeover tactics like two-tiered tender offers. These provisions ensure that all shareholders receive an equitable price for their shares if the company is acquired, making hostile takeovers more challenging and expensive for potential acquirers.
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How is the "fair price" typically determined?

The "fair price" specified in a fair price provision is usually defined within the company's corporate charter or bylaws. It often involves a calculation based on the company's historical stock prices over a specified period, or it may incorporate other valuation metrics such as the highest price paid by the acquirer for any shares during a defined period.
², ³

Can a fair price provision be removed or changed?

Yes, a fair price provision can typically be removed or changed, but it often requires a supermajority vote of the company's shareholders. This high voting threshold is designed to make it difficult to dismantle such protections easily, ensuring that any changes are broadly supported by the shareholder base.
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Are fair price provisions common?

Fair price provisions were more commonly adopted during specific periods, such as the 1980s, as a defense against hostile takeovers. While still present in some corporate charters, other antitakeover measures, like poison pills, also exist. Their prevalence can vary depending on corporate legal trends and state laws.