The Perks and Pitfalls of Corporate Opportunity Waivers
The fiduciary duty to loyalty has been a core part of U.S. corporate governance policies for decades. In recent years, though, states have passed corporate opportunity waiver laws that permit companies to waive this duty for managers and fiduciaries who find new business opportunities through their roles.
This change — significant yet gradual, and adopted by nine states between 2000 and 2016 — prompted Trustee Professor of Finance Eliezer Fich, PhD, along with two co-authors, Jarrad Harford of the University of Washington Foster School of Business, and Anh L. Tran of City, University of London Bayes Business School, to look at the effects of these waivers.
Their findings in the paper “Disloyal Managers and Shareholders’ Wealth,” published in the Review of Financial Studies, show differing consequences for two different classes of companies.
As Fich and his co-authors lay out, this waiver had a benign intention: to help startups, small companies and entrepreneurs that need to raise capital. Consider this hypothetical: a small biotech firm looks to venture capital firms to raise funds, but one of those firms is also funding other companies in biotech and is staffing their boards.
“That creates a conflict of interest and is a clear violation of antitrust,” Fich says. “That goes back to the duty of loyalty: that you’re going to be loyal to the stockholders of a company.”
However, these laws were written with unrestricted applicability to firms of all sizes, not just small or early-stage ones. As Fich observes, “every time there’s legislation that targets a specific group but also affects others, there’s the potential for unintended consequences.”
Fich and his co-authors analyzed a select group of publicly traded companies incorporated in states that have adopted corporate opportunity waivers. They drew evidence from many different areas in an effort to triangulate the impact of these waivers: patent activity; merger and acquisition data on acquiring and target companies; board composition; and firm performance, both in terms of stock returns and return on assets.
They find that the waiver has very positive consequences for young firms and startups, but the impact is much more adverse for larger, more mature companies.
At large companies in the states where these waivers have been passed, Fich says, “patent activity slows and organic growth goes down, but companies still need to grow, so they try to grow through acquisitions.”
“That creates a situation where the acquisitions are not value-increasing but in some cases value-destroying, and that’s a disadvantage to the shareholders in the states that have adopted these waivers.”
Fich notes that adoption of these waivers is more common in industries where innovation is an important driver, such as biotech or manufacturing, and it’s especially advantageous for venture-capital firms: “They don’t have to pick and choose as carefully with the companies they back financially, which helps them diversify.”
However, companies that incorporate in these states that have passed these waivers have the ability to waive out of their fiduciary duty, but some companies choose not to do so. Drawing on the policy implications from this paper, a follow-up study could look at what determines whether a company continues to stay within the fiduciary duty or waives out of it.
“Corporate governance is going to play a big role, including the composition of the board, whether incentives are aligned and the role of institutional investors or blockholders that have a big say in what the firm is doing,” Fich says.
Fich also foresees additional research that looks into the incidence of a business opportunity leaving a firm through a fiduciary. “What do these fiduciaries do? Do they sell the idea to someone else, or start a new company based on the idea they walked away with? And what is the performance of those companies afterward?”