Financial Articulation of a Fiduciary Duty to Bondholders with ...

More documents

Recommendations

Info

CREIGHTON LAW REVIEW [Vol. 20 problem is solved, in general, by a rule of corporate current-marketvalue maximization15 which states that "given perfect capital markets, optimal operating decisions for a firm at any point in time involve maximizing the market value of those securities outstanding before the operating decision is made.' 6 If the corporation complies with this rule and efficiently uses corporate assets, then all of the corporation's securityholders agree on the corporation's operating decisions and are indifferent about the corporation's financing decisions. 17 Therefore, this rule is a ground for independent professional decision-making by corporate officers and directors. 18 An anomaly in this rule occurs when there exists risky debt without side payments because of the possibility that an operating decision which efficiently uses corporate assets to maximize the current market value of the corporation might not also maximize the separate current market values of the corporation's bonds and stocks. 19 The significance of this anomaly depends on the facts of each case. 20 The manifestation of this anomaly through a corporate policy of inefficient use of corporate assets is rectified by the capital market: capital market anticipation of such a policy is reflected in the market values of the corporation's securities, and such a policy makes a corporate takeover profitable under a takeover policy of effi- 2 1 cient use of corporate assets. When maximizing the current market value of the corporation does not also maximize the current market value of its stocks, then the current market value of the corporation's stocks can be maximized by: (1) inefficiently using corporate assets, or (2) efficiently using corporate assets with a bondholder-to-stockholder side payment. 22 If there is a significant chance of corporate bankruptcy, then these means respectively transform into: (1) wasting corporate assets, or (2) preserving corporate assets with a bondholder-to-stockholder side payment. 23 15. E. FAMA & M. MILLER, supra note 9, at 69-73. For a discussion of unanimity theorems, see De Angelo, Competition and Unanimity, 71 AM. ECON. REV. 18, - (1981). 16. E. FAMA & M. MILLER, supra note 9, at 176. For a discussion of perfect capital markets, see id. at 3-41, 176-78. 17. Id. at 69, 145, 176. 18. See id. at 69, 74-75. 19. Id. at 71, n.4, 178-80. 20. Jensen & Meckling, Theory of the Firm: Managerial Behavior, Agency Costs, and Ownership Structure, 3 J. FIN. ECON. 305, 337 n.43 (1976). See W. KLEIN, BUSINESS ORGANIZATION AND FINANCE 190 (1980). 21. Fama, The Effects of a Firm's Investment and Financing Decisions on the Welfare of its Security Holders, 68 AM. ECON. REV. 272, 282-84 (1978). 22. See E. FAMA & M. MILLER, supra note 9, at 180. 23. See Stiglitz, supra note 10, at 460-62.
1986] FIDUCIARY DUTY TO BONDHOLDERS B. THE BLACK-SCHOLES CONCEPTION OF THE CORPORATION An "option" is "[a] contract giving its holder the right to buy or sell... [something] at a predetermined price and predetermined time period. ' 2 4 A "call option" is an option to buy. 25 A "compound option" is "an option on an option. ' 2 6 "Synergy" means that the total effect of a combination is greater than the sum of the individual effects of the components of that combination before that combination occurred. A "nonsynergistic merger" is a merger without corporate market value synergy: the market value of the combined corporation equals the sum of the premerger market values of the corporations merging. 27 An "efficient capital market" is a capital market in which "any new information reaching the market concerning asset values is immediately impounded into security prices.128 The "debt capacity" of a corporation is the profile of the maximum market value of bonds that the corporation can have outstanding in the capital market for a 2 9 range of interest rates. Aristotle said that "the house is there that men may live in it, but it is also there because the builders have laid one stone upon an- other. ' 30 The Black-Scholes option-pricing framework is an example of such a duality because it scientifically describes both option prices and the bondholder-stockholder corporate-financial mechanism. 31 This framework is based on postulates regarding the capital 24. Dow JONES & CO., INC., THE ABC's OF OPTION TRADING 30 (1981). 25. Id. at 29. 26. K. Shastri, Valuing Corporate Securities: Some Effects of Mergers by Exchange Offers 10 (University of Pittsburgh WP-517 Jan. 1982). 27. See Galai & Masulis, The Option Pricing Model and the Risk Factor of Stock, 3 J. FIN. ECON. 53, 66 & n.38, 68 (1976). 28. Id. at 72. See generally E. FAMA, FOUNDATIONS OF FINANCE 133-68 (1976) (discussing four models of efficient capital market equilibrium). 29. See Stapleton, Mergers, Debt Capacity, and the Valuation of Corporate Loans, in MERGERS AND ACQUISITIONS 9, 9-10, 14 (1982) (discussing the Black-Scholes option pricing framework). 30. D. THOMPSON, ON GROWTH AND FORM 6 (1942) (providing a statement of the parable). 31. See Smith, Jr., Option Pricing: A Review, 3 J. FIN. ECON. 3, 4 (1976). The Black-Scholes option pricing model is the limiting case of the binomial option pricing formula. Cox, Ross & Rubinstein, Option Pricing: A Simplified Approach, 7 J. FIN. ECON. 229, 250-54 (1979). The model "seeks to price the securities whose values are contingent upon the value of the underlying asset." Hsia, Coherence of the Modern Theories of Finance, 1981 FIN. REV. 27, 36. The model values a call option when its underlying asset does not make asset distributions before the call's maturity. Smith, Jr., supra, at 4-5, 25 (discussing European and nondividend-paying American calls). A combination model values a call option when its underlying asset makes known future asset distributions before the call's maturity. Roll, An Analytic Valuation Formula for Unprotected American Call Options on Stocks with Known Dividends, 5 J. FIN. ECON. 251, - (1977). A compound model values a call option on a call option. See Geske, The Valuation of Corporate Liabilities as Compound Options, 12 J. FIN. & QUAN. ANAL. 541, - (1977).
Page 1 and 2: THE FINANCIAL ARTICULATION OF A FID
Page 3: 1986] FIDUCIARY DUTY TO BONDHOLDERS
Page 7 and 8: 1986] FIDUCIARY DUTY TO BONDHOLDERS
Page 37 and 38: 19861 FIDUCIARY DUTY TO BONDHOLDERS

Financial Articulation of a Fiduciary Duty to Bondholders with ...

You also want an ePaper? Increase the reach of your titles

Delete template?

Save as template?