The New Italian Law on Merger Leveraged Buy-outs: A Law and Economics Perspective

Abstract

Leveraged buy-outs (‘LBOs’) are often perceived as an indirect and fraudulent instance of financial assistance and, as such, are not immune to the ban imposed by Article 23 of Directive 77/91/EEC. In several LBO cases, Italian courts have enforced this type of financial assistance prohibition under Article 2358 Cod. civ. This treatment still largely applies to those leveraged transactions that lie outside the scope of the recently enacted Article 2501 bis Cod. civ., which de facto legitimises merger leveraged buy-outs (‘MLBOs’) subject to the fulfilment of additional information disclosure requirements. In this respect, Italian LBO regulation is broadly similar to that of other European countries. In contrast, US law, which largely relies on fraudulent conveyance statutes, stands at the opposite end of the spectrum. American courts acknowledge the social utility of LBOs and are reluctant to take a negative prejudicial stance against this acquisition method. The US legal treatment draws an ex post distinction between ‘illegal’ and ‘legal’ LBOs on the basis of whether or not such transfers are intentionally fraudulent.

In light of the remarkable differences existing between these two regulatory approaches, we resort to economic analysis in order to understand which legal strategy, if any, is more efficient and why. Our analysis suggests that an outright prohibition on LBOs is an undesirable legal measure. This type of rule has numerous social costs. It reduces efficiency by weakening the market for corporate control and imposes monitoring and administrative expenses. Despite its disadvantages, we show that the prohibition does not mitigate any of the principal-agency problems that characterise an LBO. This task is often better performed by alternative market, contractual and legal strategies.

On balance, the ex post legal strategy seems to be more desirable. However, this type of intervention is faced with a shortcoming that an ex ante prohibition does not have: the problem of ‘hindsight’ bias in the adjudication process. We therefore recommend the adoption of some additional information disclosure requirements along the lines of those required under Article 2501 bis Cod. civ. as a suitable way to mitigate this bias.