Monthly Archives: November 2007

The Corporate Bar and Being a Director: A Dialogue with Vice Chancellor Strine and Marty Lipton

Editor’s Note: This post comes to us from John L. Reed of Edwards Angell Palmer & Dodge. John has previously posted here on his 2006 Corporate Governance Litigation Review.

On November 27, in Boston, Massachusetts, two corporate law icons–Delaware Vice Chancellor Leo E. Strine, Jr., and Wachtell Lipton Rosen & Katz partner Marty Lipton–will present their views on the current state of and trends in corporation law, as well as significant areas of concern to all directors in both public and private companies, at an upcoming breakfast event at the Boston Harbor Hotel.

Whether you are interested in director responsibilities in connection with a merger, the courts’ standard of review of director action when it comes to stockholder-voting issues, or corporate responsibility for option-pricing irregularities, this program should prove to be invaluable. Both Vice Chancellor Strine and Marty Lipton are at the forefront of shaping best practices, and they will participate in an extended question-and-answer session you will not want to miss.

This exciting program is being presented by the New England Chapter of the National Association of Corporate Directors, with the assistance of the Harvard Law School Program on Corporate Governance. Details for the event are available here, and you can register to attend online here.

More On Loss Causation and Securities Class Actions

This post is from Allen Ferrell of Harvard Law School.

In an earlier post, I discussed my recent discussion paper on loss causation in Rule 10b-5 actions. (The paper is coming out in the November issue of The Business Lawyer.) One of the issues discussed in the paper is the “true financial condition” theory of loss causation.

According to this theory (which we reject), if a negative disclosure by the firm reveals the “true financial condition” of the company that was concealed by an earlier misrepresentation then loss causation, as discussed in the Supreme Court’s decision in Dura Pharmaceuticals, has been satisfied. Our paper points out that, without a concrete link establishing that the negative firm disclosure (such as a downwards earnings projection) revealed to the market the fact that there was a prior misrepresentation, the “true financial condition” theory of loss causation largely vitiates Dura Pharmaceuticals and the loss causation requirement.

In a recent Memorandum Order in Ryan v. Flowserve Corp., the United States District Court for the Northern District of Texas has just denied class certification in a Rule 10b-5 action and dismissed plaintiffs’ claims for failure to establish loss causation. The plaintiffs relied on the “true financial condition” theory to demonstrate loss causation, and the court rejected this argument, citing our paper. (In the interests of full disclosure, I was also an expert on that case).

The Court’s Memorandum Order is available here. Our paper, The Loss Causation Requirement for Rule 10b-5 Causes-of-Action: The Implications of Dura Pharmaceuticals v. Broudo, can be downloaded here.

CEO Centrality

This post is from Lucian Bebchuk of Harvard Law School.

The Harvard Law School Program on Corporate Governance just issued my discussion paper, CEO Centrality, co-authored with Martijn Cremers and Urs Peyer. Our abstract describes the paper as follows:

We investigate the relationship between CEO centrality – the relative importance of the CEO within the top executive team in terms of ability, contribution, or power – and the value and behavior of public firms. Our proxy for CEO centrality is the fraction of the top-five compensation captured by the CEO. We find that CEO centrality is negatively associated with firm value (as measured by industry-adjusted Tobin’s Q). Greater CEO centrality is also correlated with (i) lower (industry-adjusted) accounting profitability, (ii) lower stock returns accompanying acquisitions announced by the firm and higher likelihood of a negative stock return accompanying such announcements, (iii) greater tendency to reward the CEO for luck in the form of positive industry-wide shocks, (iv) lower likelihood of CEO turnover controlling for performance, and (v) lower firm-specific variability of stock returns over time. Overall, our results indicate that differences in CEO centrality are an aspect of firm management and governance that deserves the attention of researchers.

The full paper can be downloaded here.

Corporate Social Policy and the SEC

This post comes to us from Lance E. Lindblom, President and CEO of the Nathan Cummings Foundation. Lance recently gave a presentation on shareholder activism at Harvard Law School; a post describing that talk is available here.

Along with Laura J. Shaffer, Director of Shareholder Activities for the Nathan Cummings Foundation, I have prepared an op-ed on shareholder proposals requesting improved disclosure on major corporate social policy issues, including environmental risk and health care costs. The op-ed runs as follows:

Last year, nearly 40% of the shares of Standard Pacific Corporation, one of the nation’s largest builders of homes, supported a request for disclosure relating to the company’s approach to energy efficiency. The company’s response? This issue is none of your business.


Corporate Integrity and Corporate Performance

On Monday, November 6, Ben Heineman, Jr., former General Counsel of GE, presented at the Law School’s Law and Finance Seminar. Heineman offered his insights on the role that general counsels play in corporate affairs, emphasizing how they can help ensure that the firm is managed to achieve both high performance and high integrity.

The discussion drew on two recent articles Heineman has published based on his experiences as general counsel of one of the world’s largest companies. The first, Avoiding Integrity Land Mines, was published in the Harvard Business Review last spring and is available here. The second piece, Caught in the Middle, was recently published in Corporate Counsel and can be downloaded here.

A video of Heineman’s presentation at the Law and Finance Seminar can be viewed online here.

The Future of Securities Regulation

Brian Cartwright, General Counsel of the SEC and a 1980 graduate of Harvard Law School, recently delivered an address entitled The Future of Securities Litigation. The talk offers a fascinating perspective on how we can expect securities markets–and the SEC’s regulatory approach–to change in the coming years.

The speech emphasizes what Brian calls “deretailization,” or the dwindling presence of retail investors in securities markets. Retail investors, who once owned more than 90% of publicly traded equity, now own less than 30%. Moreover, retail investors do not trade some assets at all, including the billions of dollars annually raised in 144A debt offerings. (Some institutions have recently moved to raise equity in 144A offerings as well.) And private equity and hedge funds, which frequently take publicly traded firms private, generally exclude retail investors altogether.

Over the last twenty years, Brian explains, these asset classes have come to dominate capital markets, and retail investing–once the focus of much regulatory behavior–is no longer central to modern securities markets. Instead, individual investors now choose among intermediaries competing for their funds–with the intermediaries, rather than the individual, directly participating in the capital markets.

In light of these trends, the speech argues, regulators should focus their efforts on ensuring that individuals have the necessary tools to choose among intermediaries. That kind of regulation, Brian explains, might ensure that individuals understand that a mutual fund’s past performance may not repeat itself; that additional disclosure allows investors to calculate an actively managed fund’s alpha, or market-adjusted performance; and that investors are able to evaluate a fund’s market-adjusted performance against the fund’s expenses.

The full text of the speech is available here.

Michael Jensen’s and Werner Erhard’s Talk on Integrity

Last week, in Harvard Law School’s Seminar in Law, Economics, and Organization, Professor Michael Jensen and Werner Erhard presented a paper on integrity that they co-authored with Steve Zaffron. The slides used in their talk are available here.

The abstract of their paper, entitled Integrity: A Positive Model that Incorporates the Normative Phenomena of Morality, Ethics, and Legality, runs as follows:

“We present a positive model of integrity that provides powerful access to increased performance for individuals, groups, organizations, and societies. Our model reveals the causal link between integrity as we distinguish and define it, and increased performance and value-creation for all entities, and provides access to that causal link. Integrity is thus a factor of production as important as knowledge and technology, yet its role in productivity has been largely ignored or unnoticed by economists and others.

The philosophical discourse, and common usage as reflected in dictionary definitions, leave an overlap and confusion among the four phenomena of integrity, morality, ethics, and legality. This overlap and confusion confound the four terms so that the efficacy and potential power of each is seriously diminished.

In this new model, we distinguish all four phenomena–integrity, morality, ethics, and legality–as existing within two separate realms. Furthermore, within their respective realms, each of the four belongs to a distinct and separate domain. Integrity exists in a positive realm devoid of normative content. Morality, ethics and legality exist in a normative realm of virtues, but in separate and distinct domains.

This new model: 1) encompasses all four terms in one consistent theory, 2) makes clear and unambiguous the ‘moral compass’ potentially available in each of the three virtue phenomena, and 3) provides this clarity in a way that raises the likelihood that the now clear moral compasses can actually shape human behavior.

This all falls out primarily from the unique treatment of integrity in our model as a purely positive phenomenon, independent of normative value judgments. Integrity is, thus, not about good or bad, or right or wrong, or what should or should not be.

We distinguish the domain of integrity as the objective state or condition of an object, system, person, group, or organizational entity, and define integrity as: a state or condition of being in whole, complete, unbroken, unimpaired, sound, perfect condition.

We assert that integrity (the condition of being whole and complete) is a necessary condition for workability, and that the resultant level of workability determines the available opportunity for performance. Hence, the way we treat integrity in our model provides an unambiguous and actionable access to the opportunity for superior performance, no matter how one defines performance.

For an individual we distinguish integrity as a matter of that person’s word being whole and complete. For a group or organizational entity we define integrity as what is said by or on behalf of the group or organization being whole and complete. In that context, we define integrity for an individual, group, or organization as: honoring one’s word.

Oversimplifying somewhat, honoring your word, as we define it, means you either keep your word or, as soon as you know that you will not be keeping your word, you say that you will not to those who were counting on your word and clean up any mess caused by not keeping your word. By “keeping your word” we mean doing what you said you would do and by the time you said you would do it.

Honoring your word is also the route to creating whole and complete social and working relationships. In addition, it provides an actionable pathway to earning the trust of others.

We demonstrate that the application of cost-benefit analysis to one’s integrity guarantees you will not be a trustworthy person (thereby reducing the workability of relationships); and, with the exception of some minor qualifications, also ensures that you will not be a person of integrity (thereby reducing the workability of your life). Your performance, therefore, will suffer. The virtually automatic application of cost-benefit analysis to honoring one’s word (an inherent tendency in most of us) lies at the heart of much out-of-integrity and untrustworthy behavior in modern life.

In conclusion, we show that defining integrity as honoring one’s word provides 1) an unambiguous and actionable access to the opportunity for superior performance and competitive advantage at both the individual and organizational level, and 2) empowers the three virtue phenomena of morality, ethics and legality.”

Keynote slides of the presentation are available here.

Are Regulators and Stock Exchanges Irresponsible?

Editor’s Note: This post comes to us from Shann Turnbull, Principal of the International Institute for Self-Governance.

I have recently released a new paper, entitled Correcting the Failures in Corporate Governance Reforms, in which I argue that constructive governance reform will require regulators to recognize and address the shortcomings of existing reforms. I invite readers to respond to one of the central claims of the paper: that regulators and stock exchanges cannot responsibly permit directors to retain absolute power over corporate affairs.

Among other proposals, the paper recommends that regulators prohibit corporate charters from granting directors the sort of “inappropriate powers” described by Bob Monks and Allan Sykes in Capitalism Without Owners Will Fail. For example, Directors typically are provided absolute power to manage their own conflicts of interest. As power tends to corrupt and absolute power tends to corrupt absolutely, how can regulators and those overseeing the various stock exchanges responsibly allow directors to possess such powers?

One explanation may be that regulators and exchanges have become captive of corporate interests. Monks articulates this claim in a short video available here. In my 2004 paper, Agendas for Reforming Corporate Governance, Capitalism and Democracy, I described a series of policy reforms that would give shareholders and stakeholders alike an incentive enhance the political and social legitimacy of large corporations.

Correcting the Failures in Corporate Governance Reforms posits that a contributing cause of the failure of corporate governance reforms is a knowledge gap with respect to how corporate constitutions can be designed both (1) to improve the control of complex firms to enhance their competitiveness and (2) to introduce self-enforcing co-regulation. In The Governance of Firms Controlled by More Than One Board, I offered a series of design criteria for such constitutions, based in part on case studies of self-governing, stakeholder-controlled firms.

The knowledge gap described in Correcting the Failures in Corporate Governance Reforms was pointed out by Al Gore in a 1996 speech in which he described “the growing disconnects between science and democracy.” “Page through a directory of members of Congress,” Gore noted, “and you’ll find well over 150 lawyers, but only six scientists, two engineers, and one science teacher among the 535 people in the House and the Senate. As a result, scientific concepts sometimes elude the vast majority of our elected officials.”

As I argued in The Science of Corporate Governance, the design of governance controls in modern firms is itself a scientific inquiry, requiring careful observation of the science of information and control. Yet those fields are generally ignored in the education of corporate and constitutional lawyers–as well as in the training of social scientists in schools of government, public administration and business.

One of the most fundamental principles of information science is that regulation can only be amplified indirectly through co-regulating agents. This, of course, explains the current failure of top-down regulation of corporate governance, which has taken place largely without bottom-up co-regulation by stakeholders.

Scientific analysis of corporate governance controls offers a methodology that will permit corporations to become self-governing and thus reduce the role of government in corporate affairs. Regulators would do well to incorporate that methodology as they address the failure of corporate governance reforms around the world.

Correcting the Failure in Corporate Governance Reforms is available for download here.

Poison Pills in a Comparative Perspective

Editor’s Note: This post comes to us from Till Immanuel Lefranc at Harvard Law School. Till invites comments at till.lefranc [at]

The French Commercial Code was amended in 2006 in order to make poison pills possible in France. Only two months after the amendments were enacted, the general meeting of fifteen large companies gave its board authority to adopt a pill. Comparing French and American poison pills is interesting for two main reasons:

(1) France is likely to face same problems that the Delaware courts have been dealing with for more than twenty years. Corporate directors may have legitimate reasons for refusing an acquisition, such as finding time to obtain a higher price from a third party. But directors may also be acting out of self interest, and use the pill to entrench themselves–to the detriment of shareholders. How will French institutions regulate the pill to prevent this type of conduct from happening?

(2) On the other hand, the French pill has been carefully designed to mitigate those risks. A new pill must be approved by a general meeting of shareholders, and rights can only be issued by the board with shareholder consent. If shareholders do give the board authority to issue rights, that authority is valid for a maximum of 18 months.

I have prepared a Memorandum that sets forth a comparative analysis of the French poison pill and its implications. The Memorandum is available for download here.

Employers Scoring in Whistleblower Actions

This post comes to us from Jonathan Hayter of the National Law Journal.

The National Law Journal recently published Employers Scoring in Whistleblower Actions, which documents the consistent victories firms have enjoyed against former employees who claim the company retaliated against them for reporting corporate fraud. The Sarbanes-Oxley Act prohibits retaliation against such “whistleblowers,” but since the Act became law five years ago, only 17 retaliation complaints among more than 1,000 filed have been found to have merit.

As the piece explains, Sarbanes-Oxley’s retaliation provision only protects employees reporting a violation of the securities laws, a fraud on shareholders, or a violation of SEC regulations. One reason for employees’ low success rate, then, might be that plaintiffs have attempted to use the Act’s whistleblower protections when reporting corporate conduct not covered by the Act. Another explanation, the piece notes, might be that employers have taken greater care since the passage of the Act to avoid retaliation–and the litigation likely to follow.

The plaintiff’s bar, of course , sees matters differently, urging that a narrow interpretation of whistleblower protections has discouraged employees from coming forward in cases of corporate fraud. As the article points out, the Act requires only that a whistleblower show that he “reasonably believed” that reportable corporate conduct had taken place to be entitled to protection. Plaintiffs’ argue in the piece  that the Administrative Law Judges reviewing whistleblower cases have required employees to meet a higher standard, demanding proof that corporate fraud actually took place before affording the employee protection from retaliation.

The full article is available here.

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