Monthly Archives: April 2008

The Role and Effect of Compensation Consultants on CEO Pay

I, along with my co-authors Mary Ellen Carter and Stephen Hillegeist, have recently posted a new working paper entitled The Role and Effect of Compensation Consultants on CEO Pay.

The paper examines how compensation consultants influence the level, form and pay-performance sensitivity of CEO pay for a sample of 880 firms from the S&P 1500 for fiscal year 2006. The sample was collected by looking at the Compensation Disclosure and Analysis (CD&A) report in the annual proxy statement, which is required for filings on or after December 15, 2006. Our final sample of 880 firms all have December fiscal year ends. In addition, 86% of the firms in our sample disclosed that they retained a compensation consultant, suggesting that the use of consultants is widespread.

We find evidence of greater compensation in the presence of a compensation consultant, consistent with theory that these consultants facilitate rent extraction. However, we find no evidence of less pay-performance sensitivity when compensation consultants are hired. Among firms that retain consultants, we also examine whether there is greater rent extraction for clients of consultants with potentially greater conflicts of interest. Using a variety of specifications, we are unable to find widespread evidence of more lucrative CEO pay packages for clients of conflicted consultants despite anecdotal evidence to the contrary. Overall, we conclude from our findings that the potential conflict of interest between the firm and consultant is not a primary driver of excessive CEO pay.

The full paper is available for download here.

The Delaware General Corporation Law for the 21st Century

Editor’s Note: This post is from 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.

You are cordially invited to a very special symposium that marks and celebrates the 40th anniversary of the landmark 1967 revision of the Delaware General Corporation Law:

The Delaware General Corporation Law for the 21st Century

The Symposium will be held on May 5th at Widener University School of Law in Wilmington, Delaware. The event has been approved for 6 CLE credits in Pennsylvania and 6.3 CLE credits in Delaware (no ethics). Materials will be provided for self-reporting CLE for other states. We hope you will join us either in person, or remotely via a Live Video Webcast. There is no charge for participants attending remotely who do not need DE or PA CLE. (There is a $100 fee for remote attendance where DE or PA CLE is provided, and for in-person attendance).

For further information and to register, please click here. Corporation Service Company is the principal sponsor of the event.

In the current issue of The Delaware Lawyer, a variety of practitioners and academics (including Lucian Bebchuk, Robert Thompson, Michael Dooley and Charles Elson) present brief appeals for reform of Delaware’s corporate statutes. Many of these individuals, joined by Professors Jennifer Hill, Brett McDonnell, Faith Kahn, Elizabeth Nowicki, and Ann Conaway), will present more extended remarks about their proposals for reform at the Symposium. Vice Chancellor Leo E. Strine, Jr. will present the keynote address. Panels will address these subjects: The Delaware General Corporation Law and Takeovers; Stockholder Litigation Under the
DGCL; Stockholders in Corporate Governance; and What We Can Learn From Other Statutory Schemes.

Levitt Corp. v. Office Depot, Inc.

This post is from Steven M. Haas of Hunton & Williams LLP. 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.

The Delaware Court of Chancery recently held in Levitt Corp. v. Office Depot, Inc., that a bylaw restricting business that could be conducted at annual meetings to (i) matters contained in the meeting notice and (ii) matters otherwise properly brought by the board or by stockholders (in accordance with advance notice provisions) did not preclude a dissident who failed to give advance notice from nominating directors at the company’s upcoming annual meeting. Vice Chancellor John W. Noble reasoned that the stockholder did not have to give advance notice of its director nominations because the annual meeting notice stated broadly that the business of director elections would be considered. Levitt follows last months’ decision in JANA as the second recent Delaware opinion finding holes in advance notice bylaws. Jim Morphy’s analysis of JANA is available here.

In Levitt, the court began with the threshold matter of interpreting a bylaw providing that “only such business shall be conducted as shall have been properly brought before the meeting.” The dissident argued that the term “business” did not apply to director elections. The court concluded, however, that the plain meaning of “business” included both stockholder proposals and stockholder director-nominations. As a result, the dissident’s director nominations were required to comply with the bylaw provision governing the conduct of annual meetings.

The court then turned to the key bylaw provision at issue, which stated that “[t]o be properly brought before an annual meeting, business must be (i) specified in the notice of the meeting… (ii) otherwise properly brought before the meeting by or at the direction of the Board of Directors or (iii) otherwise properly brought before the meeting by a stockholder… who complied with the notice procedures [including a 120-day advance notice requirement] set forth in this Section.” The corporation argued that the dissident stockholder failed to comply with the advance notice requirement and, therefore, the stockholder nominations would not be business “properly brought” before the meeting. The dissident responded that the nominations would be proper because, under clause (i) of the bylaw, the corporation’s notice of the annual meeting stated that one of the items of business was to “elect twelve (12) members of the Board of Directors.” The court agreed with the dissident, finding that the notice was sufficiently broad to allow for all director nominations—not just those on management’s slate. In other words, because the company “specified in the notice of the meeting” that director elections generally would be a matter of business, all stockholder nominations of directors will be “properly brought before the meeting” in accordance with the bylaws.

The court observed that the notice could have been drafted to avoid this outcome. Presumably, this means that the notice should have said, for example, that the stockholders would vote on the twelve nominees proposed by the nominating committee or specifically identified in the company’s proxy statement. The court also noted that the bylaws did not otherwise expressly address the director nomination process. Thus, a corporation whose bylaws have separate sections addressing stockholder proposals and stockholder director nominations may not need to change the generic language regarding director elections in its annual meeting notice. That corporation may want to make clear, however, that its bylaws distinguish between “director elections” and “business other than the election of directors.” This would avoid any ambiguity created by the court’s finding that “business” meant both director nominations and other proposals.

The Levittt opinion is available here and may be appealed to the Delaware Supreme Court.

DOJ Establishes Guidelines For Corporate Monitors

This post is by John Savarese of Wachtell, Lipton, Rosen & Katz.

My colleague David B. Anders and I have written a memorandum commenting on the guidance recently provided by the Acting Deputy Attorney General Craig S. Mortford concerning principles that DOJ will now consider when negotiating and finalizing monitor provisions for deferred prosecution arrangements. The DOJ guidance addresses, among other matters, possible criteria for monitor selection, the independent nature of the monitor, procedures for resolving disputes over the monitor’s suggestions, and ways to determine the appropriate terms of any monitorship.

The memorandum is available here.

Public and Private Enforcement of Securities Laws

Editor’s Note: This post is from Howell Jackson of Harvard Law School.

On April 14, my co-author Mark Roe and I presented our paper entitled Public and Private Enforcement of Securities Laws: Resource-Based Evidence at the Law and Economics Seminar here at the Law School.

Recent academic work in finance has generally found that private enforcement for investor protection via disclosure and lawsuits among contracting parties is a relatively more important determinant of financial outcomes than public enforcement via financial, regulatory, and even criminal rules and penalties. However, much legal scholarship has long seen private enforcement of securities laws in the United States as poorly designed, with firms, and hence wronged shareholders, often bearing the cost of insiders’ errors and disclosure failure. Our paper seeks to clarify the discrepancy between these two areas of research.

In our paper, we develop an enforcement variable based on securities regulators’ real resources—their staffing levels and budgets. We then examine financial outcomes around the world, including stock market capitalization, trading volume, the number of domestic firms, and the number of IPOs, in light of these resource-based measures of public enforcement. We find that more intense public enforcement regularly correlates with strong financial outcomes. In comparisons between our measures of public enforcement and the measures of private enforcement prominent in recent finance scholarship, public enforcement is typically at least as important as private enforcement in explaining important financial market outcomes around the world.

The full paper is available for download here.

Treasury Proposes Financial Regulatory Overhaul

Treasury Secretary Henry M. Paulson, Jr. has proposed a sweeping overhaul of the U.S. financial regulatory system that, for the first time, would bring insurance companies, hedge funds, private equity funds, venture capital funds and mortgage originators under direct federal supervision. The proposals, contained in a Blueprint for Financial Regulatory Reform officially released on March 31, would also reorganize the existing financial regulatory infrastructure in ways more fundamental than the United States has seen since the enactment of the Glass-Steagall Act of 1933 and the Securities Exchange Act of 1934.

Although some commentators are suggesting that the details of the Blueprint reflect an effort to limit the federal government’s role in the financial markets, the fact that these proposals have been put forward by a Republican administration in the middle of a financial crisis in the last months of its tenure may indicate that a shift of thought has occurred among federal policymakers. In addition, the Administration can expect both the Federal Reserve and Democratic members of Congress to insist that the Federal Reserve have a broader and more permanent regulatory role with respect to the activities and capital requirements of any groups that have access to the discount window.

The Blueprint acknowledges the practical hurdles to achieving its objectives. Factors such as traditional notions of federalism, the existing Congressional committee structure, the agencies’ powerful instincts for self-preservation and organized pressure from industry lobbyists, are likely to substantially delay or paralyze any attempt at a fundamental overhaul of the U.S. financial regulatory system.

A Davis Polk memorandum describing the highlights of the recommendations in the Blueprint is available here.

Federal District Court Reaffirms Board Primacy

This post is from Theodore Mirvis of Wachtell, Lipton, Rosen & Katz.

It is not often that the Southern District of New York (aka The Mother Court) rules on a stockholder derivative case. Here is a recent ruling in which Judge Swain of the SDNY forcefully applied Delaware law in dismissing a stockholder attack on the Morgan Stanley board arising out of management changes in 2005. The opinion also treats important issues that intersect federal disclosure obligations and corporate governance responsibilities. Our memorandum is available here.

Responding to Hedge Fund Activism

This post is by Matteo Tonello of The Conference Board Governance Center.

The Conference Board’s Working Group on Hedge Fund Activism, established in May 2007, recently released a set of proposed recommendations for those public companies and institutional investors who might find themselves involved in an activism campaign mounted by hedge funds. The proposed recommendations are supported by a white paper discussing the Working Group’s findings. The paper is available here.

The Working Group focused on the following areas:

1. What corporations can do to better monitor securities holdings and learn about those accumulations of stock or extraordinary trading patterns that may reveal a hedge fund’s activism tactic.

2. What measures corporations can adopt to avoid becoming a target.

3. How boards and senior executives can react to an activism campaign and how they should respond to requests for change made by hedge funds.

4. How companies and large institutional investors can ensure integrity of the voting process in those situations where hedge funds borrow shares for the sole purpose of influencing a shareholders’ vote.

5. What considerations institutional investors should be mindful of when allocating some of their assets to hedge funds pursuing activism strategies.

Any interested party is invited to comment on the white paper and proposed recommendations. Comments and requests for information should be addressed to the author, Matteo Tonello, at 212-339-0335 or [email protected]. The comment period will run until April 30, 2008.

Option Backdating and Its Implications

This post is from Jesse Fried of Harvard Law School. The blog featured earlier posts on the option backdating and its corporate governance implications by Larry Ribstein here, by Ted Mirvis and Paul Rowe here, and by Lucian Bebchuk here, here, here, here, and here.

I have just posted on SSRN a paper that analyzes three forms of secret option backdating used by public firms and their significance for various corporate governance debates: Option Backdating and Its Implications. The current draft is available on SSRN here.

The three forms of option backdating analyzed are: (1) the backdating of executives’ option grants; (2) the backdating of non-executive employees’ option grants; and (3) the backdating of executives’ option exercises. The paper shows that each type of backdating less likely reflects arm’s-length contracting than a desire to inflate and camouflage executive pay. Secret backdating thus provides further evidence that pay arrangements have been shaped by executives’ influence over their boards. The fact that thousands of firms continued to secretly backdate after the Sarbanes Oxley Act, in blatant violation of its reporting requirements, suggests recent reforms may have failed to adequately curb such managerial power.

As I am continuing to work on this paper and a number of related projects, any comments would be most welcome.

NYCERS v. Apache Corp: Remember Cracker Barrel?

Editor’s Note: This post is from Broc Romanek of

Ah, Cracker Barrel. A decade ago, the biggest Corp Fin-related controversy was the shareholder proposal’s “ordinary business” exclusion basis and the SEC Staff’s Cracker Barrel no-action letter under Rule 14a-8(c)(7) (the basis has since been renumbered to 14a-8(i)(7)). Those were much simpler times. Back then, the SEC’s dealings in corporate governance matters were pretty much limited to the shareholder proposal rule.

The Cracker Barrel saga arose due to a ’92 no-action letter under which Corp Fin allowed that company to exclude a anti-sexual orientation discrimination proposal by stating that all employment-related proposals raising social issues were excludable. Enough fuss was raised so that the Commission specifically overruled its Staff’s position in a ’98 rulemaking and returned the agency’s position on social issues to a “case-by-case analytical approach.” Corp Fin has been making this case-by-case determination when deliberating on social proposals ever since.

Now, a similar case has been brought in the US District Court, Southern District of Texas, by Apache Corporation, which is seeking a declaratory judgment supporting its exclusion of a shareholder proposal submitted by the New York City Employees’ Retirement System. This case seeks to enjoin a lawsuit brought by NYCERS in the Southern District of New York. The facts are as follows:

– For the last two years, NYCERS has submitted proposals to companies in a campaign designed to fight discrimination against gays/lesbians and transgendered people (eg. asking companies to amend their EEO statements a la Cracker Barrel).

– This proxy season, NYCERS submits a proposal to Apache asking for the implementation of a program based on “equality principles” that include additional steps to avoid discrimination against this group of people.

– On March 5th, Corp Fin provides no-action relief allowing Apache to omit the proposal on ordinary business grounds, noting that some of the principles in the proposal relate to ordinary business.

– On April 8th, Apache filed for a temporary restraining order to try to prevent NYCERS from delaying its annual meeting and mailing supplemental materials.

– On April 9th, NYCERS files a lawsuit in SDNY, arguing – among other things – that Corp Fin had denied no-action relief for similar proposals in the past (specifically citing these no-action responses: Armor Holdings ((i)(7) denied on burden grounds) (4/3/07) and Aquila ((i)(10) denied)(3/2/06)) and that the Court doesn’t owe deference to Corp Fin’s positions anyways.

– After it filed its lawsuit, NYCERS subsequently filed for a temporary restraining order, but then quickly changed its request to an affirmative/mandatory injunction to force Apache to deliver supplemental proxy materials ahead of its May 8th annual meeting.

This is where this battle stands today, although it promises to move quickly. We have posted all of the documents filed in the SDTX and SDNY so far in our “Shareholder Proposals” Practice Area on

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