Analysis on determinants of exercising dissenter's rights

Abstract

Minority shareholders are granted limited statutory rights as a check against rampant majority rules. One such right is the ability of shareholders to dissent from structural corporate changes such as M&A, transfer of business, and stock exchange and to sell their shares at their appraised fair value. This is known as "dissenter's rights" or "appraisal remedy." The main purpose of dissenter's rights is to protect minority shareholders from their expected losses caused by the corporate change. Unlike the cases in the U.S. and Japan, a listed company in. Korea should usually redeem dissenter's shares at the price pre-determined by the formula of Securities and Exchange Law. According to the formula, the redemption price is calculated by the arithmetic mean of 3 trading volume weighted average prices for 2 months', 1 month's, and 1 week's trading days prior to the declaration of the corporate change by, board of directors. This paper identifies dissenter's rights in Korea as put options of the stock forward contract that should deliver dissenter's shares to the corresponding company at the redemption price. When a company decides a corporate change generating dissenter's rights, the company grants dissenters put options of the forward contract. Since the value of dissenter's rights increases as the stock price decreases, dissenters are more likely to exercise their rights when the stock price is lower than the redemption value. The paper examines whether the immediate response of the stock price to declaration by board of directors motivates dissenters to exercise their rights. According to the semi-strong form efficient market hypothesis, the information of a certain event is reflected immediately after the information is revealed to the public. As such, if the price response is negatively associated with the ratio of exercising dissenter's rights to the outstanding shares, the negative association implies that dissenter's rights in Korea play a role in compensating minority shareholders for their losses caused by the corporate change. The paper provides the empirical results by using the data of exercised dissenter's rights from January of 2000 through August of 2004 obtained from Korea Securities Depository. The main results of multiple regressions show that there are three major factors that significantly affect the ratios of exercising dissenter's rights. First, the ratio of the market price at the closing day to the redemption price (named as RP2) has a significant negative effect on the ratio of exercising dissenter's rights. This negative relation is consistent with the economic notion that the dissenter's rights are put options of the forward contract. Second, the larger capitalization value the corresponding company has, the more shareholders tend to exercise dissenter's rights. Third, exercising dissenter's rights is more likely to increase when the market index decreases at the closing day of exercising dissenter's rights, other things being equal. Price responses to the information of the corporate changes; however, it does not appear to significantly affect exercising dissenter's rights. The price responses are measured by both the market adjusted model and the market model, referred to as CAR(-10, 10), CAR (-5, 5) and CAR(-2, 1). When the samples are divided into 4 groups based on CAR(-10, 10) and RP2, the average ratio of exercising dissenter's rights in case of CAR(-10, 10) < 0 is not statistically higher than that in case of CAR(-10, 10) >= 0. However, the average ratio of exercising dissenter's rights in case of RP2 < 1 is significantly higher than that in case of RP2 >= 0. Since RP2 appears to have strong positive association with the market index, exercising dissenter's rights is more likely to be associated with the decline of the market index that can be hardly attributed to the corporate actions of individual companies. In conclusion, current dissenter's rights in Korea do not appear to fulfill its main purpose that is to protect minority shareholders from their expected losses when corporate changes occur. Therefore, the paper suggests that the redemption price rule for the listed companies, pre-determined by the formula of Securities and Exchange Law, be reformed.