In recent times, corporate-finance scholars have embraced a methodological approach that looks for “shocks” to evaluate a policy change. These “shocks” are often new laws or court rulings that change some existing rule on a certain day. The researcher then makes predictions about how the world will change with the new rule and examines evidence to see if the world is consistent with what the researcher predicts.
The trouble with this research design is that it relies on an assumption that seems non-controversial for many economists but would give most lawyers pause. This assumption is that businesses and the lawyers that advise them instantaneously adapt to new laws and court decisions. In reality, it takes time for lawyers and businesses to adopt and develop new customs and practice to comply with the changes, and subsequent court rulings often are needed to clarify questions about the new legal regime. As a result, it may take months or years for parties to adapt to a legal change, and research designs that look at narrow moments in time may not result in high-quality results.
It is with that backdrop that Professor Abe Cable comes to the question of a recent Delaware Chancery Court hearing that sent shockwaves through Silicon Valley: In re Trados Inc. Shareholder Litigation (“Trados”). The case dealt with a board of directors of a Silicon Valley startup that was financed with two levels of stock: preferred shares and common shares. Simplifying things, the preferred shares had a liquidation preference—a form of downside protection—that meant that they would receive the first $57.9 million in sale proceeds if the firm was sold before common shareholders would get anything. As things turned out, Trados did not become as successful in its software business as its investors had hoped, and its board sold the firm in a sale that resulted in the preferred shareholders receiving $52 million and the common shareholders getting nothing. Common shareholders then sued, and the Delaware Chancery Court upheld the sale after first criticizing the board for not considering the impact of the transaction on common shareholders. Practitioners widely understood that the Delaware Chancery Court was sending a message that venture-backed firms needed to do a better job of considering the interests of common shareholders and the conflicts of interest created by liquidation preferences.
In his article “Does Trados Matter?,” forthcoming in the Journal of Corporation Law, Professor Cable reports results from interviews of 20 lawyers on how Trados has changed Silicon Valley. If the Delaware Chancery Court was hoping that the dicta criticizing the Trados board would lead to a Silicon Valley governance revolution, they would likely be disappointed by what he finds. In sum, he finds some evidence of changes around the edges, but no sea change in the way that Silicon Valley’s lawyers think. He discovers some efforts from trade associations to give preferred shareholders the power to pull the trigger on a sale that only benefits them, with the apparent hope being that taking the board’s discretion from them will immunize them from fiduciary-duty lawsuits for exercising discretion they no longer have. This approach has not been widely adopted. Instead, as Professor Cable reports, lawyers in Silicon Valley are widely familiar with the Trados decision but have not dramatically changed the way they practice after the case. Instead, they now spend more time documenting the board’s attention to the interests of common shareholders and perhaps, in some cases, make the equivalent of hold-up payments to out-of-the-money common shareholders, but these payments had already occurred prior to Trados, making it hard to conclusively link them to the Trados decision. Professor Cable’s rich case study is essential reading on the impact of Trados.