SEIZING THE FIRST-MOVER ADVANTAGE: RESOLVING THE TENSION IN DELAWARE LAW BETWEEN BOARDS OF DIRECTORS AND CONTROLLING SHAREHOLDERS

In 2018, the Delaware courts confronted an extraordinary crisis of corporate governance: an open conflict between a corporation’s board of directors and its controlling shareholder. The board of CBS Corporation, a large media firm, voted to issue a dividend that would have diluted the shares of its controlling shareholder, National Amusements, Inc. (NAI). The dividend would have severed NAI’s control, leaving the board in sole command of CBS’s future. NAI challenged the CBS board’s authority to issue the dividend, and litigation ensued. In CBS v. National Amusements, Inc., the Delaware Court of Chancery issued a brief ruling denying CBS’s motion for a temporary restraining order. The opinion described the broader issue in the case as the problem of first-mover advantage. The problem derives from two lines of Delaware cases that place inconsistent demands on boards of directors and controlling shareholders. It can be formulated as follows: When a board of directors reasonably believes that a controlling shareholder threatens to exploit a corporation or its minority shareholders, can it adopt measures to preempt such exploitation by the controller, or can the controller take action to preserve its control by preempting the board’s efforts? But before the court could address this question on the merits, the parties settled. The central corporate governance issue in the case remains unresolved.

This Note proposes that courts respond to contemporary developments in corporate law, chief among them the rise of dual-class stock structures in American corporations, by resolving the first-mover advantage problem raised in CBS v. National Amusements, Inc. The Delaware courts should settle the problem by assigning first-mover advantage to controlling shareholders in corporations with one-share-one-vote regimes and by assigning first-mover advantage to boards of directors in corporations that have dual-class stock structures. By distinguishing among corporations on the basis of their stock structures in assigning first-mover advantage, courts can help restore the balance of power between boards and controllers, alleviate the increased agency costs of corporations with dual-class stock structures, and make progress toward regularizing what remains an unsettled area of corporate law.

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* J.D. Candidate 2020, Columbia Law School. The author would like to thank Jeffrey N. Gordon for his invaluable guidance in connection with this Note. The author would also like to thank Assaf Hamdani, Theodore N. Mirvis, and Charlotte A. Walkovik for their helpful feedback and comments. Finally, the author would like to thank the staff of the Columbia Law Review for their superb editorial support.

Introduction

At the beginning of 2018, CBS Corporation was one of the world’s largest, most successful media companies. 1 See CBS Corp., Annual Report (Form 10-K) II-4 (Feb. 16, 2018), Http://www.annualreports.com/HostedData/AnnualReportArchive/c/NYSE_CBS_2017.pdf [https://perma.cc/3CR8-ELBS] (“For 2017, revenues grew 4% to an all-time high of $13.69 billion . . . .” (emphasis added)). But within a few short months, and despite the record financial strength of the underlying company, a crisis of corporate governance nearly tore the corporation asunder. A dispute broke out between the Board of Directors of CBS and the company’s controlling shareholder, National Amusements, Inc. (NAI). 2 See Keach Hagey & Joe Flint, Shari Redstone Wants New CBS Directors, Renews Push for Merger with Viacom, Wall St. J. (Jan. 17, 2018), https://www.wsj.com/articles/shari-redstone-wants-new-cbs-directors-renews-push-to-merge-cbs-and-viacom-1516217045 (on file with the Columbia Law Review). Rumors emerged that NAI planned to merge CBS with NAI’s troubled subsidiary, Viacom, and that it was willing to replace the board if necessary to do so. 3 See id. (“Shari Redstone is advocating for new blood on the board of CBS Corp. as she renews her push to merge the company with Viacom Inc . . . . Ms. Redstone is already gathering names of possible candidates . . . . Ms. Redstone reached out . . . to jump-start talks about merging CBS and Viacom Inc. . . . .”). The CBS board vehemently disagreed with the proposed merger, and in an unprecedented move, it resolved to take action against the corporation’s own controlling shareholder. 4 Jessica Toonkel & Tom Hals, CBS Sues Controlling Redstone Family in Bid for Independence, Reuters (May 14, 2018), https://www.reuters.com/article/us-viacom-cbs/cbs-sues-controlling-redstone-family-in-bid-for-independence-idUSKCN1IF1TO [https://perma.cc/7APW-2M4M] (“CBS Corp filed a lawsuit on Monday to reduce the voting power of controlling shareholder National Amusements Inc, the movie theater company owned by Sumner and Shari Redstone, in an act of defiance aimed at thwarting the Redstones’ plan to merge CBS with Viacom Inc.”).

In an extraordinary act of defiance, the board decided to vote on whether to issue a stock dividend to dilute NAI’s controlling position. 5 See Keach Hagey & Joe Flint, Shari Redstone Moves to Defend Family’s Voting Power over CBS, Wall St. J. (May 16, 2018), https://www.wsj.com/articles/redstones-call-cbs-maneuver-unprecedented-usurpation-of-voting-power-1526490887 (on file with the Columbia Law Review) (“CBS’s special committee of independent board members . . . is seeking to block National Amusements from replacing board members or modifying the company’s governance documents before CBS convenes a special meeting on Thursday to vote on diluting the Redstones’ control.”). If left unchallenged, the dilutive dividend would have released CBS from NAI’s control, allowing the board to determine the corporation’s future, free from the interference of the controlling shareholder. 6 See CBS Corp. v. Nat’l Amusements, Inc., No. 2018-0342-AGB, 2018 WL 2263385, at *2 (Del. Ch. May 17, 2018). The board sued for a temporary restraining order in the Delaware Court of Chancery, 7 Verified Complaint at 35, CBS, No. 2018-0342-AGB, 2018 WL 2194011. but before the board could vote on the dividend, NAI struck first—it amended the bylaws of the company to effectively preclude the CBS board from issuing the dividend. 8 CBS, 2018 WL 2263385, at *2 (“NAI . . . delivered consents to amend CBS’s bylaws to . . . require approval by 90% of the directors . . . . Given that CBS’s Board currently consists of fourteen members, three of which are NAI-designees, the 90% Bylaw (if valid) would allow NAI to block enactment of the Dividend Proposal.”). The board refused to concede the amendments’ validity and voted to issue the dilutive dividend. The board amended its complaint, seeking a declaration of the legality of the dilutive dividend and the invalidity of the bylaw amendments. 9 See Amended Verified Complaint at 7–8, 64–65, CBS, No. 2018-0342-AGB, 2018 WL 2397715. Yet after receiving only a brief ruling from the Court of Chancery denying CBS’s request for a temporary restraining order against NAI, 10 CBS, 2018 WL 2263385, at *6. the parties settled. 11 Edmund Lee, CBS Board Tries to Move past Moonves Crisis with New Directors, N.Y. Times (Sept. 10, 2018), https://www.nytimes.com/2018/09/10/business/media/cbs-board-les-moonves-shari-redstone.html (on file with the Columbia Law Review) (explaining that, under the terms of the settlement between CBS and NAI, CBS agreed to withdraw its lawsuit). The central corporate governance issue raised by the case remains unresolved.

The court in CBS Corp. v. National Amusements, Inc. described the broader issue in the case as the problem of first-mover advantage. 12 CBS, 2018 WL 2263385, at *3. The problem can be formulated as follows: When a board of directors reasonably believes that a controlling shareholder threatens to exploit a corporation or its minority shareholders, can it adopt measures to preempt such exploitation by the controller, or can the controller take action to preserve its control by preempting the board’s efforts? 13 The problem of first-mover advantage arises when a disagreement between a board of directors and a controlling shareholder escalates into open conflict between the two entities. This scenario implicates an “apparent tension in [Delaware] law between a controlling stockholder’s right to protect its control position and the right of independent directors . . . to respond to a threat posed by a controller . . . .” CBS, 2018 WL 2263385, at *5. The origin of the problem stems from two lines of Delaware cases that place inconsistent demands on boards of directors and controlling shareholders. While one line of Delaware cases appears to empower boards of directors to take action against their controlling shareholders, a parallel line of Delaware cases appears to endorse the reverse—that a controlling shareholder has the right to intervene against an uncooperative board.

This Note argues that Delaware courts should resolve the first-mover advantage problem raised by the tension between the Adlerstein v. Wertheimer 14 No. CIV.A. 19101, 2002 WL 205684 (Del. Ch. Jan. 25, 2002). and Mendel v. Carroll 15 651 A.2d 297 (Del. Ch. 1994). lines of cases by assigning first-mover advantage to controlling shareholders in corporations with one-share-one-vote regimes and by assigning first-mover advantage to boards of directors in corporations that have dual-class stock structures. 16 This Note refers to “one-share-one-vote” regimes (which are also known as “single-class” stock regimes) and “dual-class stock” regimes, but these terms are intended to encompass more than those two structures alone. The term “one-share-one-vote” is used to refer to firms in which there is no wedge between the cash-flow rights and the voting rights of the corporation’s stock. See Glossary of Stock Market Terms, Nasdaq, https://www.nasdaq.com/investing/glossary/o/one-share-one-vote-rule [https://perma.cc/ZM5B-B2M9] (last visited Oct. 12, 2019) (defining the one-share-one-vote rule as “[t]he principle that all shareholders should have equal voting rights in public companies and each shareholder should have one vote”). “Dual-class stock,” on the other hand, is used to refer to firms in which there is a wedge between the cash-flow rights and the voting rights of the corporation’s stock. This wedge can arise from a dual-class stock structure, but it can also arise from other arrangements, such as a pyramidal voting structure. See Hollinger Int’l, Inc. v. Black, 844 A.2d 1022, 1031–33 (Del. Ch. 2004), aff’d, 872 A.2d 559 (Del. 2005) (describing how the controlling shareholder exercised his control over a corporation through a pyramidal ownership structure consisting of a series of intermediate holding corporations); Lucian Arye Bebchuk, Reinier Kraakman & George G. Triantis, Stock Pyramids, Cross-Ownership, and Dual Class Equity: The Mechanisms and Agency Costs of Separating Control from Cash-Flow Rights, in Concentrated Corporate Ownership 295, 298–99 (Randall K. Morck ed., 2000) (explaining how pyramidal structures can be utilized to achieve separation between voting rights and cash-flow rights in the absence of a dual-class stock regime and detailing the incidence of pyramidal structures across jurisdictions). For convenience, this Note uses “dual-class” stock as shorthand for all equity arrangements that create wedges between a corporation’s cash-flow rights and voting rights. Part I surveys the five major cases in which the Delaware courts have addressed open conflicts between controlling shareholders and boards of directors. Part II assesses the implications of a legal rule that would assign first-mover advantage to boards of directors, outlines the consequences of a legal rule that would assign first-mover advantage to controlling shareholders, and explains why Delaware’s existing legal regime fails to vindicate the legitimate concerns raised by the arguments supporting either legal rule. Finally, Part III argues that the tension in the case law described in Part I and the concerns outlined in Part II would best be resolved by a legal rule that assigns first-mover advantage to controlling shareholders in one-share-one-vote companies and to boards of directors in companies with dual-class stock regimes. Part III then concludes by describing the methods by which Delaware courts can assign first-mover advantage in each of these two contexts.