Irreconcilable Differences: Judicial Resolution of Business Deadlock

Claudia M. Landeo
University of Alberta – Department of Economics

Kathryn E. Spier
Harvard University – Law School – Faculty; National Bureau of Economic Research (NBER)

June 19, 2013

University of Chicago Law Review, Forthcoming

Abstract:

This article studies the judicial resolution of business deadlock. Asset valuation, a necessary component of business divorce procedures, can pose serious problems in cases of closely-held businesses, such as general partnerships and limited liability companies (LLCs). Courts face the challenge of designing valuation mechanisms that will trigger the owners to truthfully reveal their private information.

We theoretically and experimentally assess the ex post judicial design and properties of judicially-mandated Shotgun and Private Auction mechanisms. In the former mechanism, the court would require one owner to name a buy-sell price, and the other owner would be required to either buy or sell his or her shares at the named price. In the latter mechanism, the court would mandate both owners to simultaneously submit a price to buy the other owner’s assets. Our experimental findings support our theory: The Shotgun mechanism with an informed offerer is superior to the Private Auction in terms of an equity criterion. In the Shotgun mechanism, the informed offerer has an incentive to truthfully reveal his private information and, as a result, an equitable outcome is more likely to be achieved. The analysis presented in this article provides an equity rationale for the judicial implementation of the Shotgun mechanism in business divorce cases, and demonstrates the empirical feasibility of our proposal.

Irreconcilable Differences- Judicial Resolution of Business Deadlock

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