Yearly Archives: 2007

Does Political Stability Lead to Financial Development?

Posted by Robert Jackson, Managing Editor, Harvard Law School Corporate Governance Blog, on
Thursday, April 19, 2007
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At last week’s Law and Economics Seminar, Mark Roe presented a fascinating new paper (coauthored with Jordan I. Siegel) called Political Instability and Financial Development.  Unlike previous work, which largely attributes financial development to legal origin, Professors Roe and Siegel argue that political stability, at least in part, explains differences in development across countries.  The Abstract explains:

Political instability impedes financial development and is a primary determinant of differences in financial development around the world.  Conventional measures of political instability–such as Alesina and Perotti’s well-known index of instability and a subsequent index derived from Banks’s work–persistently predict a wide rang of national financial development outcomes for recent decades.  These results are quite robust to legal origin, to trade openness, to latitude, and to other measures that have obtained prominence in the past decade.  These findings are for a range of key financial outcomes for all available years and for all available countries over several decades–data that has been previously examined only partially.  Surprisingly, despite the widespread view in the law and finance literature of legal origin’s importance, not only is political stability highly robust to legal origin, but, for many years, our results for key indicators and specifications neither show Common Law to be consistently superior nor French Civil Law to be consistently inferior to other legal families in generated strong financial development outcomes.  The robust significance of political stability tells us that there are powerful channels to financial development running through political stability that go a long way toward explaining cross-country differences in financial development.

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A Corporate Governance Gadfly

Posted by Robert Jackson, Managing Editor, Harvard Law School Corporate Governance Blog, on
Thursday, April 19, 2007
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Fortune magazine has an article about Lucian Bebchuk in its current issue. The article, by Geoffrey Colvin, Fortune’s senior editor at large, discusses both Bebchuk’s bylaws initiative and his academic work. Below is the profile:

A Corporate Governance Gadfly Irks CEOs: Lucian Bebchuk’s Shareholder Initiatives are Shaking Corporations.
by Geoff Colvin

He insists he isn’t an activist. Plenty of America’s CEOs must hope he means it. “I’m mainly a kind of ivory tower academic,” says professor Lucian Bebchuk of Harvard Law School, and that he surely is – the only person I know of with four graduate degrees from Harvard (master’s and doctoral degrees in law and economics).

But as director of the school’s Program on Corporate Governance he has also become America’s most influential critic of CEO pay–to the deep annoyance of many CEOs, who say privately they wish he’d just be quiet. So now that he’s behaving like a shareholder activist as well for the second proxy season in a row, the mere suspicion that it could be a new career cannot be comforting.

Bebchuk is best known for careful research that skewers the way CEOs get paid. From the bosses’ perspective he has been distressingly energetic, not only writing a book (Pay Without Performance) but also delivering lectures, contributing op-ed pieces, conducting seminars and testifying before Congress.

Then, starting last year, he got into the game directly and changed it. Based on a particularly astute reading of corporation law that’s too complicated to describe here, he filed a proposal with CA (formerly Computer Associates), to be voted on by shareholders at the annual meeting, that would change CA’s bylaws regarding the so-called poison-pill takeover defense. Bebchuk and many others see that mechanism as a management entrenchment device that hurts shareholders. His proposed bylaw change would let CA adopt a pill, but only by unanimous vote of the board, which would have to reaffirm the vote unanimously every year.

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AIG Agrees to Amend its Bylaws

Posted by the Harvard Law School Forum on Corporate Governance & Financial Regulation, on
Tuesday, April 10, 2007
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Editor’s Note: This post is by Lucian Bebchuk of Harvard Law School.

American International Group (AIG) and I have reached an agreement under which the company will amend its bylaws to require that CEO compensation be ratified by a majority of independent directors.

Last December I submitted a shareholder proposal to amend AIG’s bylaws. Under the proposed amendment, CEO compensation would not only have to be approved by the company’s compensation committee but also by three-quarters of the company’s independent directors.

In discussions I subsequently held with AIG, AIG informed me that it will adopt a guideline requiring that CEO compensation be approved by a majority of the company’s independent directors, and AIG’s board indeed adopted last month revised governance guidelines containing this provision. Although AIG urged me to withdraw my proposal in light of its willingness to adopt the guideline, I felt that doing so would not be appropriate given that the guideline did not incorporate two key elements of the approach I favor: (1) adoption via a bylaw rather than merely a guideline; and (2) using a super-majority rather than a majority requirement for independent director approval. In subsequent discussions with AIG, we reached a compromise under which the company agreed to adopt element (1) but not (2).

In particular, AIG and I reached an agreement under which my proposal will be withdrawn and a specified bylaw will be proposed for approval by the AIG Board of Directors at its next regularly scheduled meeting, and would be effective immediately upon approval by the Board of Directors. Under the specified bylaw, which would be added as the new Section 2.11, the determination of CEO compensation will be subject to approval or ratification by a majority of the non-employee directors on AIG’s board.

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Jonathan Macey and SOX

Posted by the Harvard Law School Forum on Corporate Governance & Financial Regulation, on
Tuesday, April 10, 2007
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Editor’s Note: This post is by J. Robert Brown, Jr. of the University of Denver Sturm College of Law.

In the weekend edition of the Wall Street Journal, Jonathan Macey (deputy dean at Yale Law School) embarked on an assault on SOX in an article entitled What Sarbox Wrought.  He describes the Act as an “intrusive, circulatory and duplicative grab-bag of rules” and concludes that, because of the adoption of SOX, it is “now fashionable for issuers to avoid U.S. markets.”Put aside that there is evidence suggesting that companies are moving overseas because of the improved quality of foreign trading markets–something one would think would win accolades from those who rely so extensively on market solutions.  Put aside that the decline in IPOs in the US predated the adoption of SOX and that some evidence suggests that the percentage is again increasing. 

The most interesting thing about the editorial is that the proposed solutions are not directly related to SOX at all.  Macey dismisses recent efforts to decrease the costs of compliance with Section 404.  Instead, he calls for a reduction in the “[m]assive litigation risks” and the underwriting fees that “are an order of magnitude higher in the U.S.” than elsewhere.

SOX did not increase underwriting fees, and the so-called “massive” litigation risk predated the Act (it was, after all, the impetus for the PSLRA).  If anything, the data on the Stanford Securities site (and the opinions of Joe Grundfest) suggest that, in a post-SOX world, litigation risks (at least as measured by the number of securities suits filed) are declining (2006 had the lowest number of securities class action fraud suits filed since 1996).  There is at least room to argue that independent audit committees and truly independent auditors have reduced the instances of mistake and fraud, causing a decline in litigation.

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SEC Chairman Cox Expounds on CD&A and Plain English

Posted by the Harvard Law School Forum on Corporate Governance & Financial Regulation, on
Monday, April 9, 2007
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Editor’s Note: This post is by Broc Romanek of TheCorporateCounsel.net.

A few weeks ago, I blogged about SEC Chairman’s Cox‘s first comments on incoming executive compensation disclosures under the new disclosure rules.  Chairman Cox recently gave another speech further explaining why he believes that executive compensation disclosure, and particularly the CD&A, is not in plain English.  The part of the Chairman’s speech that deals with compensation disclosures is quite long.  Below are just a few excerpts to give you a sense of his message:

– “I have to report that we are disappointed with the lack of clarity in much of the narrative disclosure that’s been filed with the SEC so far.  Based on the early returns, the average Compensation Disclosure and Analysis section isn’t anywhere close to plain English.  In fact, according to objective third-party testing, most of it’s as tough to read as a Ph.D. dissertation.”

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A Lobbying Approach to Evaluating SOX

Posted by Lucian Bebchuk, Harvard Law School, on
Tuesday, April 3, 2007
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This post is by Lucian Bebchuk of Harvard Law School.

Yael Hochberg, Paola Sapienza, and Annette Vissing-Jorgensen have a new study, A Lobbying Approach to Evaluating the Sarbanes-Oxley Act of 2002, that pursues a novel and interesting approach to assessing SOX.  The Abstract of the paper is as follows:

We evaluate the net benefits of the Sarbanes-Oxley Act (SOX) for shareholders by studying the lobbying behavior of investors and corporate insiders to affect the final implemented rules under the Act.  Investors lobbied overwhelmingly in favor of strict implementation of SOX, while corporate insiders and business groups lobbied against strict implementation.  We identify the firms most affected by the law as those whose insiders lobbied against strict implementation, and compare their returns to the returns of less affected firms.  Cumulative returns during the four and a half months leading up to passage of SOX were approximately 10 percent higher for corporations whose insiders lobbied against one or more of the SOX disclosure-related provisions than for similar non-lobbying firms.  Analysis of returns of the post-passage implementation period indicates that investors’ positive expectations with regards to the effects of the law were warranted for the enhanced disclosure provisions of SOX.

The full Article is available for download here.

A “Valeant” Effort

Posted by the Harvard Law School Forum on Corporate Governance & Financial Regulation, on
Tuesday, March 27, 2007
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Editor’s Note: This post is by Lawrence A. Hamermesh of the Widener University School of Law. This post is part of the Delaware law series, which is cosponsored by the Forum and Corporation Service Company; links to other posts in the series are available here.

On March 1st, Vice Chancellor Lamb made a significant contribution to the growing body of caselaw involving challenges to executive compensation decisions. The case is Valeant Pharmaceuticals v. Jerney. Fellow guest contributor Broc Romanek has already blogged about the decision, recognizing its educational value on matters of executive pay. (Broc’s post includes a nice summary of the case from Delaware lawyer J. Travis Laster of Abrams & Laster.)

The Valeant opinion is a rare example of a case in which a court awards damages against a director for having approved excessive compensation. The case is not one, however, that blazes a path for challenges to executive compensation decisions made the “kosher” way, i.e., by compensation committees whose members meet stock-exchange-prescribed criteria for independence and who rely on truly independent compensation consultants.

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WLRK Memorandum on The Caremark Chronicles

Posted by Robert Jackson, Managing Editor, Harvard Law School Corporate Governance Blog, on
Tuesday, March 27, 2007
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This post is part of the Delaware law series, which is cosponsored by the Forum and Corporation Service Company; links to other posts in the series are available here.

Notwithstanding Chancellor Chandler‘s order last month delaying a shareholder vote on the deal, CVS and Caremark successfully closed their merger last week.  The Chancellor delayed the vote until Caremark disclosed to shareholders their right to seek an appraisal and the structure of the fees paid to UBS and J.P. Morgan, which stood to gain considerably more from a consummated deal with CVS rather than a deal with Caremark’s other suitor, Express Scripts.

Edward Herlihy, Eric Roth, Craig Wasserman, and Ross Fieldston of Wachtell, Lipton, Rosen and Katz have prepared a highly insightful Memorandum offering an insider’s view of the strategic considerations that guided the Caremark board during the merger process.  The Memorandum sets forth several critical lessons boards of directors can draw from the Caremark experience, including the importance of the strategic choices that permitted CVS to improve its bid without further delaying a shareholder vote.  In light of the increased scrutiny the courts are applying to board decisions made during the auction process, the Memorandum is a must-read for directors and transaction counsel alike.

Ehud Kamar’s Study on the Consequences of SOX

Posted by Robert Jackson, Managing Editor, Harvard Law School Corporate Governance Blog, on
Wednesday, March 21, 2007
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Ehud Kamar presented a fascinating new paper last night at the Law School’s Law and Economics Seminar: Going-Private Decisions and the Sarbanes-Oxley Act of 2002: A Cross-Country Analysis.  The paper, which is coauthored by Pinar Karaca-Mandic and Eric Talley, uses a difference-in-differences approach to measure whether small firms are being driven out of the U.S. capital markets by Sarbanes-Oxley.  The Abstract is as follows:

This article investigates whether the passage and the implementation of the Sarbanes-Oxley Act of 2002 (SOX) drove firms out of the public capital market.  To control for other factors affecting exit decisions, we examine the post-SOX change in the propensity of public American targets to be bought by private acquirers rather than public ones with the corresponding change for foreign targets, which were outside the purview of SOX.  Our findings are consistent with the hypothesis that SOX induced small firms to exit the public capital market during the year following its enactment.  In contrast, SOX appears to have little effect on the going-private propensities of larger firms.

Ehud’s presentation at the Seminar was followed by a lively debate with faculty and students.  Some highlights:

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Chancery Addresses Deficient Board Procedures in Approving Private Equity Transactions

Posted by the Harvard Law School Forum on Corporate Governance & Financial Regulation, on
Tuesday, March 20, 2007
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Editor’s Note:This post is part of the Delaware law series, which is cosponsored by the Forum and Corporation Service Company; links to other posts in the series are available here.

Vice Chancellor Leo Strine, who teaches at Harvard Law each fall, last week issued an opinion with potentially significant implications for shareholder challenges to going-private transactions in In re Netsmart Technologies, Inc.  The opinion holds that a board may fail to meet its Revlon duties when it considers only bids from financial buyers–to the exclusion of strategic acquirers–and that a firm must disclose valuation opinions suggesting that the firm is worth more as a standalone entity in the merger proxy.

Netsmart‘s board considered only bids from financial buyers before signing a merger agreement with a window shopping provision.  (Although Netsmart was prohibited from soliciting a higher bid, the window shopping clause authorized them to accept an unsolicited bid.)  In cases involving larger firms, Chancery has suggested that window shopping clauses ensure that the board accepted the highest bid, for other bidders are free to step in and pay more.  But Netsmart is quite small, and the Vice Chancellor concludes on these facts that a window shopping provision offers little market assurance for small firms because other buyers might not know that the firm is in play and the company is prohibited from actively soliciting a higher bid.

Paul Rowe, a member of the Program on Corporate Governance‘s Advisory Board and a partner at Wachtell, Lipton, Rosen & Katz, has authored a Memorandum on the decision.  The Memorandum notes that the Netsmart board used an increasingly common approach to the auction, and that previous Delaware cases had approved window shopping provisions under different circumstances.  Emphasizing the fact-specific nature of the opinion, Paul concludes that Chancery will probably continue to defer to the judgment of boards in structuring the auction process, but that boards must ensure that the auction procedure they establish is appropriate in light of the particular circumstances of the merger market for the firm.

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