Monthly Archives: July 2008

Delaware Supreme Court Issues Opinion on Shareholder-adopted Bylaws

The Delaware Supreme Court has issued its opinion in the AFSCME/CA matter. The opinion is available here. We have earlier posted on this important case here, here, and here. 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.

We have received communications from several of our guest contributors.

Ted Mirvis of Wachtell, Lipton, Rosen & Katz writes:

The Delaware Supreme Court much-awaited decision on the AFSCME stockholder bylaw proposal did not disappoint. It is a thoughtful and important treatment of the intersection of stockholder and director authority. The director-centric view won. Here is our memo on the decision.

John F. Olson of Gibson, Dunn & Crutcher LLP offered a different perspective:

While the Delaware Supreme Court’s unanimous opinion, responding to the SEC’s two certified questions, is a clear victory for CA, Inc., and the SEC has already issued the requested no action release, the opinion of the Court provides a road map for different mandatory by-laws dealing with the election of directors that can be adopted by shareholders without offending Delaware law, even if some corporate expense is involved. The key is to leave room for director fiduciary discretion to prevent abuses. Thus, there is something for both sides to cheer about and, in Delaware, the fun has just begun.

J.W. Verret of George Mason University School of Law, who posted with us on the case here, offered the following comments:

For more analysis on this issue, see my essay on SEC Certification to the Delaware Supreme Court here. The verdict is in. First, let’s review the issues. The SEC certified two questions to the Delaware Supreme Court:

1) Is the AFSCME Proposal a proper subject for action by shareholders as a matter of Delaware law?

2) Would the AFSCME Proposal, if adopted, cause CA to violate any Delaware law to which it is subject?

The Court’s ruling is an affirmative answer to both questions. Shareholder proposals like the one at issue in this case are a proper subject of shareholder action, and are not invalid encroachments on Board authority merely because they mandate a payment of money. Yet, as the Court could conceive of a way in which mandated payment could cause the Board to violate its fiduciary duty to the shareholders, the bylaw is illegal under Delaware Corporate Law for lack of a “fiduciary-out” exception.

My prior post, and an analysis from Professor Bainbridge here, describes the recursive loop between DGCL 141 and DGCL 109(a). More commentary from Larry Ribstein, and his compilation of links to other commentators, can be
found here. Rather than avoiding the question, as both counsel invited them to do, the Court faced this paradox head on. Boards and shareholders are both granted the right to amend the bylaws in the DGCL. Shareholder authority to amend bylaws is limited by 141, but the extent of that limitation has been mired in uncertainty. The Court also rejected CA’s argument that any limitations on Board’s authority must be contained in the Certificate of Incorporation.

The Court has given us its first look into the contours of 141’s limit on 109(a). The Court rested in a process/substance distinction outlined in previous Court of Chancery opinions. Bylaws mandating substantive business decisions are impermissible, but bylaws altering the process whereby Boards make decisions are permitted. In analyzing this bylaw, the Court announced “We conclude that the Bylaw, even though infelicitously couched as a substantive-sounding mandate to expend corporate funds, has both the intent and the effect of regulating the process for electing directors of CA.”

As to the second question, the Court held that, because of conceivable circumstances in which the bylaw could require the Board to reimburse insurgents running solely for personal reasons, there are conceivable situations in which the bylaw would require the Board to violate its fiduciary duty. This relied on similar holdings in Quickturn and Paramount v. QVC. The Court was unconvinced that the fact that limitation was shareholder adopted reduced the impact on the board’s ability to discharge its fiduciary duties. (Though including this mandate in the Certificate of Incorporation would be permissible.) The Court relied on its prior holding in Hibbert v. Hollywood Park for the proposition that only reimbursement for contests involving substantive differences about corporation policy are permitted.

Technically this is a loss for AFSCME, but the opinion should be considered a measured victory for the shareholder activist community. A reimbursement bylaw with a fiduciary duty out exception does not eliminate all of the risk associated with funding a proxy campaign. Only proxy access to the corporate ballot can do that. But such a bylaw would significantly reduce the risk associated with funding a proxy campaign. There is a good chance that a Board’s decision to withhold reimbursement through claims that its fiduciary duty requires it would be subject to heightened review under Blasius, since the Court has accepted that this bylaw is intimately connected with the election process and candidate’s incentives to run for election.

FedEx Corporation Agrees to Adopt a Pill-Limiting Bylaw

Editor’s Note: This post is from Lucian Bebchuk of Harvard Law School.

FedEx Corporation became the fourth major company this proxy season to reach an agreement with me under which it adopted a pill-limiting bylaw. Under the new bylaw, any poison pill plan adopted by the board without prior stockholder approval shall expire no later than one year following its adoption if not ratified by a stockholder vote.

The agreement followed my submission of a shareholder proposal to amend FedEx’s bylaws. Following the agreement, the board of FedEx adopted the new bylaw and I withdrew the shareholder proposal. While the bylaw’s limitation on poison pills not approved by stockholders is consistent with Fed Ex’s preexisting policy statement on poison pills, the board’s action incorporates this limitation in the company’s legally binding bylaws.

In addition to Fed Ex, other companies that, following my shareholder proposals, agreed to amend their bylaws to incorporate pill-limiting provisions are JCPenney, Safeway, CVS Caremark, Disney, and Bristol-Myers Squibb. I hope that other public companies will follow the example set by these six companies.

I would like to express my appreciation again to Michael Barry and Ananda Chaudhuri from the law firm of Grant & Eisenhofer for their valuable legal advice and legal representation in connection with my shareholder proposals in general and the pill bylaw proposals in particular. I also wish to thank again Greg Taxin and Julie Gresham of Spotlight Capital Management for advising me on engagement with companies.

The amended bylaws of FedEx, filed yesterday with the SEC, and containing the new Section 13 of Article III, are available here.

Regulatory Show and Tell: Lessons from International Statutory Regimes

Editor’s Note: The post below comes to us from Jennifer G. Hill of the University of Sydney, Australia, who has a continuing position as Visiting Professor at Vanderbilt Law School.

In Unocal Corp v Mesa Petroleum Co (493 A. 2d 946, 957 (Del SC, 1985), the Delaware Supreme Court stated that “our corporate law is not static. It must grow and develop in response to, indeed in anticipation of, evolving concepts and needs”. Historically, however, this evolution and growth has occurred with only limited and sporadic attention to international corporate governance regimes.

In my recent paper, Regulatory Show and Tell: Lessons from International Statutory Regimes, which was recently presented at a recent Symposium at Widener University to mark the 40th anniversary of major revisions to the Delaware General Corporation Law, I examine reasons for the relative lack of attention in the US to international corporate regimes. One possible reason is the influence of competition for corporate charter theory in the US. Another is the fact that it is often assumed that a standardized Anglo-US model of corporate governance exists, and that US corporate law reflects the law in other common law jurisdictions.

The paper challenges the assumption that there is a harmonized common law model of corporate law, by reference to differences between the approach of the US and some other common law jurisdictions in the topical area of shareholder rights. The paper argues that, at a time when there is growing skepticism about the influence today of the competition for corporate charters, it makes sense for the US to examine and test how international jurisdictions address common problems in corporate regulation. One recent event reflecting growing interest in this regard was the announcement by the SEC in March 2008 that it had entered into a pilot mutual recognition program with Australia in relation to securities market regulation.

The paper is available here.

Harvard’s Contribution to the Year’s Ten Best Corporate Articles

Writings by three Harvard Law School professors — Lucian Bebchuk, Mark Roe, and Guhan Subramanian – were selected to be among the 10 Best Corporate and Securities Articles of 2007 in the annual poll of corporate and securities law faculty around the country. This is a repeat appearance on the top ten list for each of these authors.

Bebchuk’s articles appeared on the top-ten list of the year’s best corporate and securities articles in each of the last six years. The 2007 top ten list included his article The Myth of the Shareholder Franchise. In addition, he had seven articles in the top-ten lists of the preceding five years:

Letting Shareholders Set the Rules in the 2006 top-ten list;

The Case for Increasing Shareholder Power in the 2005 top-ten list;

Firms’ Decisions Where to Incorporate (with Alma Cohen) in the 2004 list;

Does The Evidence Favor State Competition In Corporate Law? (with Alma Cohen and Allen Ferrell) and The Powerful Antitakeover Force of Staggered Boards: Further Findings and a Reply to Symposium Participants (with John Coates and Guhan Subramanian) in the 2003 list; and

Managerial Power and Rent Extraction in the Design of Executive Compensation (with Jesse Fried and David Walker) and Powerful Antitakeover Force of Staggered Boards: Theory, Evidence, and Policy (with John Coates and Guhan Subramanian) in the 2002 list.

Roe’s article in the 2007 top-ten list is Legal Origins, Politics, and Modern Stock Markets. He has three other articles in the top-ten lists of the preceding five years:

Delaware’s Politics in the 2005 list;

Delaware’s Competition in the 2003 list; and

Corporate Law’s Limits in the 2002 list.

Subramanian’s article selected for the 2007 top-ten list is Post-Siliconix Freeze-outs: Theory and Evidence. His prior contributions to the top-ten lists are:

Fixing Freezeouts in the 2005 list;

Bargaining in the Shadows of Takeover Defenses and The Disappearing Delaware Effect in the 2004 list;

The Powerful Antitakeover Force of Staggered Boards: Further Findings and a Reply to Symposium Participants (with Lucian Bebchuk and John Coates) in the 2003 list; and

The Powerful Antitakeover Force of Staggered Boards: Theory, Evidence, and Policy (with Lucian Bebchuk and John Coates) in the 2002 list.

The full list of the best corporate and securities law articles of 2007 is available here.

Acquisition of Troubled Financial Institutions and Assisted Transactions

This post is from Edward D. Herlihy of Wachtell, Lipton, Rosen & Katz.

My partners Craig M. Wasserman, Richard K. Kim, Lawrence S. Makow, Nicholas G. Demmo and Matthew M. Guest and I have recently issued a memorandum entitled “Acquisition of Troubled Financial Institutions and Assisted Transactions.” The memorandum discusses the credit-related losses suffered by some financial institutions, their efforts to raise capital, and the increasingly prominent role played by federal and state regulators in monitoring and shoring up the capital and liquidity situations of struggling institutions. Against this backdrop, the memorandum discusses the FDIC’s historical approach to addressing failures of insured depository institutions. In this context, the FDIC is required by law to guarantee insured deposits and dispose of the failed institution’s assets in the manner least costly to the FDIC’s deposit insured fund. We also discuss the FDIC’s formal resolution process, which may include a managed auction to dispose of failed bank franchises, and explain the options open to the FDIC after a bank has been declared insolvent. In view of distinguishing features of the current economic downturn, we expect a more receptive regulatory climate for private investments into banks and thrifts.

The memorandum is available here.

Economic Characteristics, Corporate Governance, and the Influence of Compensation Consultants on Executive Pay Levels

This post is from David F. Larcker of the Stanford Graduate School of Business. Posts by Brian Cadman and Tatiana Sandino, available here and here also analyzed the role of compensation consultants in setting pay.

In a recent working paper, Christopher Armstrong, Christopher Ittner and I investigate the relation between the use of compensation consultants and CEO pay levels. We conduct an analysis using proxy disclosures by a diverse sample of 2,116 companies. Consistent with claims that executive pay levels in clients of compensation consultants are higher than justified by economic characteristics, ordinary least squares (OLS) regressions that control for a wide variety of economic determinants of compensation indicate that total pay is higher for clients of most (but not all) of the consulting firms relative to companies without consultants. The OLS results also suggest that pay levels of clients of the larger, most frequently used compensation consultants are higher than those of firms using other consulting firms (most of which are smaller, boutique compensation consultants) in some model specifications. However, when more sophisticated propensity score matched pair analyses are used to relax the stringent functional form assumptions imposed by OLS models and to assess correlated omitted variables problems, most differences between the individual consulting firms disappear, though the statistically higher levels of total pay at companies using compensation consultants persist.

When we add governance variables, we continue to find higher pay in clients of most consulting firms in OLS regressions. In contrast, we find no significant differences in total pay levels between users and non-users of consultants or among the various consulting firms when propensity score matched pair analyses are used. This evidence indicates that once companies with similar economic and governance characteristics are compared and OLS’s strict functional form is relaxed, pay levels are not significantly different, suggesting that governance differences account for much of the unexplained pay differences between consultant users and non-users.

Further analysis indicates that these results are due (at least partially) to pay levels for clients of individual consulting firms varying with governance strength, with weaker governance within clients of a given consultant associated with higher total pay. These results suggest that the higher pay found in consulting clients is at least partially explained by the link between weaker governance and higher pay in companies using consultants. This is consistent with the rent extraction view of the association between compensation consultant use and CEO pay. Finally, we find no support for claims that CEO pay is higher for clients of potentially “conflicted” consultants that offer a broad range of advisory services relative to clients of specialized, “non-conflicted” compensation consulting firms.

The full paper is available for download here.

Shareholder Activism and the “Eclipse of the Public Corporation”: Response to Marty Lipton

This post is by John F. Olson and Amy L. Goodman, partners at Gibson, Dunn & Crutcher LLP in Washington, DC.

In a post to this blog on June 25th, Marty Lipton presented a paper entitled “Shareholder Activism and the Eclipse of the Public Corporation: Is the Current Wave of Activism Causing Another Tectonic Shift in the Public Corporation?,” in which he expressed concern about the eroding centrality of the board and its vulnerability to pressure to seize short-term value at the expense of long-term value creation. Marty is one of our most experienced and thoughtful observers of corporate governance trends, based in large part from his front row seat as an advisor to many corporate boards and managements. However, while his points of caution are well worth bearing in mind, we think that directors and those who advise them must do more than decry what to many are troublesome trends that erode the ability of the board to take decisive action on behalf of the corporate enterprise.

The new world of inexpensive and constant communication is not limited to the corporation and its constituents; it is part of everyday life in every realm. Shareholder and other interest groups are going to make themselves heard; proxy contests are going to be cheaper and more accessible to those who may have short term goals; regulation will continue to be hard pressed to adapt quickly to these changes. In response to this environment, which we argue is inescapable, we submit that it’s time to move beyond the us (corporate board/managers) versus them (shareholder) mindset and recognize the commonality of interest that exists between boards and most shareholders in creating long-term value. We are preparing a paper that will develop these ideas in more detail but wanted to encourage more dialogue surrounding these important issues now.

Given the increasingly complex and global world facing corporations today, we need to get away from focusing on the corporate governance issue du jour or per annum to assisting the Board in addressing its complex role. In recent years, there has been an annual “hot” corporate governance issue–from declassifying boards, to shareholder approval of poison pills, to majority voting for directors, to an advisory vote on pay. While companies have embraced many of these proposals, boards of directors are becoming increasingly concerned about the amount of time and attention they, management and the company’s advisors must spend on responding to the corporate governance issue du jour. It may be time to step back and consider whether other issues should take priority, especially given the state of the economy and the many challenges facing corporate America.

In our upcoming paper, we will address some of the issues that deserve focus from shareholders, directors, business executives and other interested stakeholders.

• First, and not necessarily in order of importance, we need to develop effective methods of board/shareholder communication that build on new electronic capabilities but are not burdensome and do not increase liability risks.

• Second, boards and business executives need to effectively and regularly communicate corporate strategy and the board’s oversight role to investors, the business press and analysts, once again without fear of increased liability.

• Third, companies need to make good investor relations, and “good listening” a day to day corporate priority, and shareholders need to take advantage of these opportunities to present their views to business executives and directors.

• Fourth, shareholders need to think for themselves and reduce their reliance on proxy advisory services and be more transparent in their proxy voting decision-making processes.

• Fifth, companies, boards and their advisors need to figure out a way for directors to spend more time addressing strategy and risk and less time on compliance.

• Finally, while efforts to better educate directors about corporate governance and their fiduciary responsibilities has been salutary, we now need to shift our efforts to better educating directors in understanding the businesses, including the risks, of their companies.

Delaware Supreme Court Case on Shareholder-Adopted Bylaws: Today’s Oral Argument

Editor’s Note: This post from J.W. Verret of George Mason University summarizes today’s oral argument in Delaware. For previous posts on the Blog about the case, and for the parties’ briefs, see here and here. 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.

AFSCME Employees Pension Plan submitted a shareholder proposal for inclusion in CA’s proxy materials for their annual meeting scheduled to be held on September 9, 2008. That proposal sought to amend CA’s bylaws to require the company to reimburse the reasonable expenses incurred by a dissident nominating a rival slate of directors, provided that at least one nominee from the dissident slate was victorious. CA sought no-action relief from the SEC permitting it to exclude that proposal under Rule 14a-8 as illegal under Delaware law, and the SEC certified the question to the Delaware Supreme Court. The Court’s opinion stands to re-define the nature of corporate federalism and ring in a new collaborative relationship between the Delaware Courts and the SEC. Indeed, it may encourage the SEC to include more state law carve-outs in future rule-making.

I wrote an essay (available here) on this issue in March predicting that the SEC would certify the bylaw question to Delaware soon. For more on the growing trend of shareholder democracy behind this challenge, see Pandora’s Ballot Box, or a Proxy with Moxie: Majority Voting, Corporate Ballot Access, and the Legend of Martin Lipton Re-Examined (available here). For more on bylaws, see Profs. Coates and Faris’s work (Second-Generation Shareholder Bylaws: Post-Quickturn Alternatives, 56 Bus. Law. 1323 (2001) (with B. Faris)) and Prof. Hamermesh’s article (available here). Anticipating that the opinion in this difficult case might make use of dicta guidance, see also my article with Chief Justice Steele on the Delaware Guidance Function (available here).

This post summarizes a very lively oral argument in Dover, Delaware this morning. The Justices and the parties displayed a rigorous command of this intricate subject, working in a very short timeframe. It was fascinating to watch these masters of the Delaware General Corporation Law at the height of their craft.

Arguing on behalf of Computer Associates was Robert Guiffra of Sullivan & Cromwell. His presentation focused on two key issues: first, he argued that this bylaw does not relate to an election of directors, but merely comes into play after the election, and thus is not protected by the principles in the Blasius line of cases. As a mandated payment of expenses it relates to control of the corporate treasury, part of the business and affairs of the corporation as defined in Rule 141(a). As such, limitations on the Board’s authority may only appear in its Certificate of Incorporation, not its bylaws. Second, he argued that the Board must be permitted to make a determination of whether a reimbursement was consistent with its fiduciary duty, where this bylaw mandated payment under all circumstances.

Arguing on behalf of AFSCME was Michael Barry of Grant & Eisenhofer. His presentation focused on two key issues: first, he argued that this bylaw relates to an election, implicates the shareholder franchise and Blasius review, and is not a part of the ordinary business affairs of the corporation. As such, it does not undermine the Board’s authority under section 141. He also argued that where directors are mandated to reimburse expenses, they cannot be doing so for the purposes of entrenchment, and thus cannot logically do so in violation of their fiduciary duties. He also cited Delaware’s approval of mandatory indemnification bylaws as binding precedent on this issue.

Both Counsel admitted that, though the bylaw was unclear, reimbursement of expenses for the full contest and not just for the successful nominee was anticipated. Both parties also skillfully argued that the Court need not permanently resolve any looming contradiction between section 109 and section 141(a) to rule in their favor. Section 109 of the DGCL grants shareholders the right to adopt bylaws, and section 141(a) reads that “the business and affairs of every corporation…shall be managed by…a board of directors.” Thus, the oft referenced “recursive loop” in which a bylaw adopted under section 109 might limit a board’s authority under 141(a). The Court nevertheless asked counsel’s opinion concerning the intent of the legislature in creating two conceivably conflicting sections of the code.

Questions from the Court during oral argument make any predictions difficult. The Justices pushed counsel for CA over whether the prospect of reimbursement was inextricably linked to the success of an election, and whether the bylaw would be legal if adopted by the Board. The Justices pushed counsel for AFSCME over whether there might be any circumstances under which a bylaw could force inequitable reimbursement and whether the Board’s authority to adopt bylaws was co-extensive with that of shareholders. Interestingly, Justice Berger, when she served as a Vice Chancellor, suggested in dicta that stockholders create a bylaw limiting the board’s power to amend a stockholder adopted bylaw in American Int’l Rent a Car, an opinion from 1984, which may indicate her view on whether the right to adopt bylaws is co-extensive. The Court also questioned whether the “reasonable” qualifier in this bylaw left enough room for board discretion not to reimburse wasteful expenses.

My own prediction is a substantive victory for AFSCME is possible, but the holding would be limited. If the Court allows election bylaws that mandate board action, it may require bylaws mandating board action have a “fiduciary out” clause similar to what we see in deal lock-in measures. This could be accomplished, I think, either by ruling that the bylaw is illegal only for lack of a fiduciary-out or ruling that the bylaw is legal but that a Board could ignore it if it’s fiduciary duty required it (board action which would then be critically reviewed under subsequent challenge, and the standard of that review for such a decision could be formulated in this opinion). The one thing I am most confident about is that the Court is likely to leave open the possibility to rule that other forms of bylaws, especially poison pill related bylaws, run afoul of 141(a).

Delaware Supreme Court Case on Shareholder-Adopted Bylaws: The Parties’ Briefs

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.

In advance of the scheduled Delaware Supreme Court hearing tomorrow on the validity of the proposed shareholder-adopted election bylaw submitted for inclusion in the proxy materials of Delaware corporation CA, Inc, we are posting the briefs of the two sides, which were filed yesterday. As previously reported on the Blog, the case is before the Court on two questions certified by the Securities and Exchange Commission and accepted by the Court. Submitted by AFSCME Employees Pension Plan, the bylaw would require the company to reimburse reasonable stockholder expenses incurred in running a short slate of director nominees for election.

The brief of CA, Inc is here, and the brief of AFSCME Employees Pension Plan and its appendix are here and here. Oral argument is scheduled for tomorrow, July 9, at 10:00 a.m.

Liquidation Values and the Credibility of Financial Contract Renegotiation: Evidence from U.S. Airlines

This post is from Effi Benmelech of Harvard University.

My paper “Liquidation Values and the Credibility of Financial Contract Renegotiation: Evidence from U.S. Airlines” co-written with Nittai Bergman, which is forthcoming in the Quarterly Journal of Economics, documents empirically the conditions under which airlines renegotiate aircraft leases in the United States. The control rights that financial contracts provide over firms’ underlying assets play a fundamental role in the incomplete contracting literature since the threat of asset liquidation motivates debtors to avoid default. Thus, in the incomplete contracting literature, asset liquidation values play a key role in the ex-post determination of debt payments. To date, there is little empirical evidence analyzing the ability of firms to renegotiate their financial liabilities and the role asset values play in such renegotiations. This paper attempts to fill this gap.

We develop an incomplete-contracting model of financial contract renegotiation and estimate it using data on the airline industry in the United States. Our model has two testable implications. First, firms will be able to credibly renegotiate their financial commitments only when their financial situation is sufficiently poor. Second, when a firm’s financial position is sufficiently poor, and hence its renegotiation threat is credible, a reduction in the liquidation value of assets increases the concessions that the firm obtains in renegotiation.

Our empirical analysis examines renegotiation of leases amongst U.S. airlines. We collect data on all publicly traded, passenger-carriers and construct a dataset which includes information about contracted lease payments, actual lease payments, and fleet composition by aircraft type.

In addition, we construct four different measures of the ease of overall re-deployability of an airline’s leased aircraft. We find that publicly traded airlines often renegotiate their lease contracts. Furthermore, we show that aircraft lease renegotiations take place when liquidation values are low and airlines’ financial condition is poor. We supplement our analysis by studying lease renegotiation out of bankruptcy. We find that, even out of bankruptcy, airlines in poor financial condition can reduce their lease payments and that lower fleet re-deployability enables these airlines to extract greater concessions from their lessors.

The full paper is available for download here.

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