3.4.2 Proxy Solicitation

In theory, soliciting proxies from uninformed shareholders is an effective way of leveraging superior information. By soliciting sufficient proxies, the shareholder with superior information can ensure that the correct option is chosen by majority vote without having to purchase actual shares.1 Thus, if an overconfident management team proposes a merger that an informed shareholder knows will destroy value, she could solicit proxies to prevent the merger from being approved by a majority of the shareholders.

In practice, however, proxy solicitation appears to be an unattractive option to leverage superior information. Arguably the most important barrier is constituted by the free rider problem mentioned earlier. The shareholder with superior information will only internalize a fraction of the potential capital gains, while she will have to incur the full costs of soliciting proxies—costs that can be significant.2 Other issues discouraging the lasinch of a proxy contest are the uphill battle against incumbent management which can deploy corporate funds to solicit proxies and has an informational advantage, the risk that institutional investors may vote with management because of conflicts of interest, the problem that existing shareholders may be skeptical about the challenger 's credibility (which effectively causes a pro-incumbent bias), and so forth.3 As a result, proxy contests are rare. A study of contested solicitations in U.S. firms between 1996 and 2005 identified only seventy-four contests not involving the election of directors, i.e., contests in which shareholders opposed the board on matters such as mergers.4 This suggests that proxy solicitation is of limited use as an arbitrage strategy to leverage superior information, at least under the present mies of the game.