Monthly Archives: August 2008

Financial reporting and conflicting managerial incentives: The case of management buyouts

This post comes from Paul E. Fischer and Henock Louis from the Smeal College of Business at Pennsylvania State University.

In our forthcoming Management Science paper, Financial reporting and conflicting managerial incentives: The case of management buyouts, we analyze the effect of external financing considerations on manager’s financial reporting behavior prior to management buyouts (MBOs). Our main motivation for choosing the MBO setting is the potential conflicting financial reporting incentive associated with external financing considerations. Managers planning to undertake an MBO want to purchase their firms‚ equity at as low a price as possible. Consequently, previous studies hypothesize that managers have an incentive to release less favorable earnings reports to equity market participants prior to an MBO in an attempt to reduce the MBO purchase price. We consider the possibility that managers have a conflicting earnings management incentive prior to MBOs that is attributable to external financing concerns, which are thought to be substantial.

In the framework we employ for our analysis, the financing related reporting incentive is driven by management’s concerns regarding their ability to obtain MBO financing from external parties and their desire to obtain that financing at a favorable cost. The financing incentive conflicts with the equity market incentive because the financing incentive suggests that managers should manage earnings upward. Consequently, to the extent that an external financing incentive exists, we expect it to temper the equity market incentive. Based upon our framework, we hypothesize that financing related earnings management incentives are more pronounced when the funds needed to execute the buyout must be raised to a greater extent from external parties. In addition, we hypothesize that the increase in financing related incentives arising from increased external financing is greater when there are fewer fixed assets available to secure loans.

Using a sample of 138 MBOs that occurred between 1985 and 2005, we find evidence consistent with both hypotheses. We find that firms that use more external funds to finance their MBO report less negative abnormal accruals. We also find that the positive effect of external financing on earnings management decrease as the amount of fixed assets increases, which is consistent with the conjecture that the effect of external financing on the marginal cost of managing earnings down prior to MBOs increases as the firm has fewer physical assets that it can use as collateral.

The full paper is available here.

New York Courts Dismiss ‘Grasso’ Compensation Case

Editor’s Note: This article from Joseph E. Bachelder appeared in the New York Law Journal this week.

Courts do not like being arbiters of disputes over what is reasonable compensation. The recent, abrupt conclusion of the state of New York’s lawsuit against Richard A. Grasso is a case in point.

The lawsuit began on May 24, 2004 at the initiative of then-Attorney General Eliot L. Spitzer, claiming that the payment of a lump-sum amount of $139.5 million to Mr. Grasso was unreasonable compensation.(1) The action was brought under the New York Not-For-Profit Corporation Law (N-PCL).

Earmarks of Dubious Behavior

This case appeared to offer an ideal opportunity for New York courts to address the issue of what is reasonable compensation. It had all the earmarks of an egregious case of overpayment of compensation to an executive together with evidence of dubious corporate behavior in the setting of that compensation. Earmarks included:

• The payment of $139.5 million, in a lump sum, to the CEO of a relatively small not-for-profit trade organization and regulator (albeit a well-known and very powerful one).

• According to the complaint (and there is substantial publicly available data to support this) the compensation and benefits for Mr. Grasso expensed over the period of 2000-2002 equaled slightly less than 100 percent of the New York Stock Exchange’s (NYSE) net income over this same period. Complaint, para. 34. Over these three years, this represented $130.3 million of compensation and benefits to Mr. Grasso compared to $132.8 million of net income. Id.

• Many of the directors of the NYSE (including members of the Compensation Committee) were subject to regulation by Mr. Grasso himself, as chairman and CEO of the NYSE. During the periods relevant to the litigation, Mr. Grasso was authorized to appoint the members of the Compensation Committee (subject to board approval) and to select one of the members as the chairperson of the committee (the selection of the committee chairperson did not require board approval). See, for example, Charter: Human Resources and Compensation Committee, adopted June 7, 2001; see also Complaint, paras. 5, 6 and 25.

• For the Aug. 7, 2003 meeting of the board that approved Mr. Grasso’s 2003 compensation arrangements, including the lump-sum payment of $139.5 million, no advance notice (or virtually none) was given to board members. Statement by the Director of Human Resources of the NYSE (HRD Statement), Exhibit A to Exhibit 1 to Complaint, paras. 37-38. Apparently due to this lack of notice neither of the outside consultants who had been working on the matter was available to attend the meeting. HRD Statement, Id. at para. 41. It would appear that, at the Aug. 7, 2003 meeting, the board had very little time (and very little information) before voting to approve Mr. Grasso’s compensation package including the lump-sum payment of $139.5 million.

• The NYSE Compensation Committees that approved Mr. Grasso’s compensation arrangements over several years, including 2003, apparently were not given accurate and complete information on Mr. Grasso’s compensation. HRD Statement, Id. at para. 50; see also Assurance of Discontinuance Agreement with Consultant, Exhibit 2 to Complaint at pp. 1-2.(2)

Attorney General’s Standing

Apart from the facts and alleged facts in this case, the attorney general appeared to have standing to bring this action. The bases for this conclusion were as follows:

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New Rules for Investors in German Listed Companies

This post is from John F. Olson of Gibson, Dunn & Crutcher LLP.

Recently, the German legislature adopted the Risk Limitation Act (Risikobegrenzungsgesetz, the “Act”) aimed at the limitation of perceived risks deriving from financial investors. Following the notorious “locust debate” in Germany, the new law is the result of the still ongoing discussions about the impact of foreign hedge funds and private equity investors. It provides for a number of amendments to securities law and corporate law applicable to domestic and international investors in public companies. The Act is scheduled to be formally announced later this summer or fall.

Acting in Concert

The Act will modify the existing rules on “acting in concert”, i.e., the rules under which the shareholdings of investors forming a “group” must be aggregated. This is relevant in two areas, namely (i) the reporting thresholds for shareholdings in German listed companies and (ii) the rules on public offers:

• Regarding the former, an investor reaching, exceeding or falling short of 3%, 5%, 10%, 15%, 20%, 25%, 30%, 50% or 75% of the voting rights attached to shares must notify the company and the German financial supervisory authority within four trading days at the latest. Otherwise the shareholder’s rights are suspended and it can be fined. The company is required to publish such notification within three trading days.

• The rules on public offers also refer to an important threshold: An investor holding less than 30% of the voting rights must launch a public takeover offer once it decides to acquire (additional) shares aimed at reaching or exceeding the 30% threshold. An investor who reaches the 30% threshold other than in the course of a takeover offer must launch a mandatory public offer to acquire all outstanding shares in the target.

When several shareholders are found to be “acting in concert”, their shareholdings are mutually attributed; therefore, each of them is subject to notification and offer duties if the aggregate of their shareholdings reaches, exceeds or falls short of one of the above thresholds. Until now, the Federal Supreme Court held that only investors who coordinate their voting within the general meetings of the company were acting in concert.

The Act will broaden the scope of the rules on acting in concert. The new rules will also apply to cooperating in a way that aims at a steady and substantial change of the strategic orientation (unternehmerische Ausrichtung) of the company. Thus, the scope of application will no longer be limited to coordination with regard to the exercise of voting rights, but will also include cooperation on the level of the supervisory board or even outside any corporate bodies, provided that the investors concerned intend to steadily and substantially change the business of the company. Fortunately, the German legislature abstained from further extensions of the rules: Pursuant to initial draft bills of the Act, the mere cooperation of investors with respect to the acquisition of shares would have been considered acting in concert, too. What is more, it would have been sufficient if the coordination referred to an individual case or had an either steady or substantial influence on the business of the company. The German legislature changed its opinion after harsh criticism from legal scholars and international investors.

As a result, the impact of the changes will be limited. For example, investors will generally still be able to initiate public takeovers by agreeing on standstill agreements with shareholders or accepting irrevocable undertakings from them. Until German courts begin to interpret the new rules, however, there will be legal uncertainty for some time about what shareholders may agree on regarding the business and strategy of the company without triggering a mutual attribution of voting rights.

Aggregation of Voting Shares and other Securities giving the Right to Acquire Shares

Holders of marketable securities giving the right to acquire voting shares (e.g., marketable call options) have similar notification duties if their securities refer to a shareholding which reaches, exceeds or falls short of the above thresholds (except for the 3% threshold). Under the current rules, the positions in voting shares and other financial instruments are not aggregated. Presently, an investor who acquires (i) up to 2.99% of voting shares of the company and (ii) other securities giving the right to acquire up to 4.99% of the voting shares does not need to make any notification.

The Act provides for the aggregation of these two positions with the effect that in the above example, the investor will be obligated to report the excess of the 3% and the 5% threshold. Nonetheless, the 3% threshold will still be irrelevant for an investor who only holds marketable securities other than voting shares.

Extension of Sanctions in Case of Violation of Notification Duties

In the past, non-compliance with the aforementioned notification requirements, apart from the risk of administrative fines, has only led to a suspension of the shareholder rights (in particular, voting rights and rights to dividends) until the missing or wrongful notification was made or corrected. Hence, verifying compliance with the notification duties immediately prior to a general meeting was sufficient to avoid any impact on these rights. Under the Act, the suspension of shareholder rights would only be lifted six months after the late or corrected notification, provided the violation (i) was due to gross negligence or intent and (ii) reached a certain degree of non-compliance: If the investor did not completely fail to make a required notification and the deviation of the notified shareholding from the actual shareholding was less than 10% of the actual shareholding, the six months period will not apply.

New Disclosure Duties Relating to Significant Shareholdings

Further, the Act will implement new disclosure duties for investors holding at least 10% of the voting rights in a German listed company. Such significant shareholders will be required to disclose to the company their intentions with respect to the shares and the origin of the funds used to purchase the shares. These duties (as well as the existing notification duties) will not only apply to direct shareholders but also to investors to which the shares of third parties are attributed due to certain circumstances. Examples of such attribution are: (i) controlling influence over the direct shareholder, (ii) holding shares of a third party in trust without further instructions of the third party with regard to the exercise of voting rights, and (iii) acting in concert (see above). The new disclosure duties also apply to investors who already hold 10% or more of the voting rights in a German listed company once they reach or exceed another threshold.

These significant shareholders will be required to disclose their intentions with respect to the shares and the origin of the funds within 20 trading days unless the articles of association of the company waive such duty. Significant shareholders must also disclose all changes to their intentions.

With regard to its intentions each requested investor will be required to disclose whether:

• the investment aims to attain strategic goals or to achieve trading profits,

• it plans to obtain further voting rights within the next 12 months by way of purchase or otherwise,

• it strives for representation in corporate bodies of the company, and

• it strives for substantial changes of the capital structure of the company, in particular with regard to the ratio of equity financing and debt financing as well as to the dividend policy.

When disclosing the origin of the funds, the investor will be obliged to indicate whether and to what extent it has used equity or debt.

The company will be required to publish (i) the information received from the investor or (ii), if applicable, non-compliance of the investor with the disclosure duties. The Act does not provide for any additional consequences in case of non-compliance and the above mentioned suspension of shareholder rights will not apply. Please note, however, that non-compliance with these duties may, under certain circumstances, violate the prohibitions on market manipulation and insider trading.

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Voluntary Disclosures Regarding Insiders’ Rule 10b5-1 Trading Plans

This post is from M. Todd Henderson of the University of Chicago Law School.

If a firm insider has private information and intends to trade on the basis of this information, the conventional wisdom is that the insider garners no strategic advantage from disclosing in advance of the trade the information or the intention to trade. This account, however, ignores the potential litigation benefit from pre-trade disclosure of trading plans. If an insider discloses many months in advance the intent to trade at certain times, this can be expected to reduce the likelihood of a lawsuit (either alleging insider trading alone or as an element of a securities fraud suit), since disclosure may rebut any allegation that the insider was acting with the requisite scienter when the trade executed. The insider who pre-discloses may be turning Brandeis’s aphorism that “sunlight is the best disinfectant” on its head – the insider is using transparency for strategic advantage, what we might call “hiding in plain sight.”

In a new paper, entitled Scienter Disclosure, Alan D. Jagolinzer, Karl A. Muller and I show the existence of the strategic advantage from disclosure – what we call “scienter disclosure” – in a study of insider voluntary disclosure under Rule 10b5-1 trading plans. The SEC promulgated Rule 10b5-1 in 2000 to provide an affirmative defense for insiders who pre-commit to trades in the future at times when they do not possess inside information, even if they do possess such information when the trades ultimately execute. There is evidence, however, that Rule 10b5-1 may provide insiders with strategic trade opportunities that generate abnormal trade returns. Insiders may, for example, pre-plan trade based on longer-term nonpublic information because of perceived lower legal risk. Insiders may also strategically modify the content or timing of disclosure to increase profitability of previously planned trades. Finally, insiders may also terminate Rule 10b5-1 plans when they possess material nonpublic information that indicates a hold strategy would be more profitable than allowing pre-planned sales to continue. We show insiders use these features of the Rule to earn abnormal returns.

The paper has two primary findings based on insiders’ voluntary disclosure choices. First, we show Rule 10b5-1 disclosure increases with firm litigation risk and insider strategic trade potential. Firms with higher expected litigation risk and greater opportunities for insiders to earn profits from private information are much more likely to disclose, meaning insiders see disclosure as a litigation prophylactic.

Second, we show Rule 10b5-1 disclosure is associated with greater abnormal returns to insiders’ trades, especially for firms disclosing specific plan details. The SEC intended Rule 10b5-1 to provide insiders greater opportunities (than the normal blackout windows allow) for uninformed, diversification trades, but we present data showing that insiders who use the Rule earn large abnormal returns compared with those not using the Rule, and that these returns are increasing in the amount of disclosure. (The returns are about 12 percent in six months for insiders making specific disclosures.) The intuition here is that disclosure is not just a litigation risk reducer, but also has costs. Making specific disclosures, say about the dates and amounts of trades, provides the most litigation protection but it also raises the costs for insiders who may terminate their plans if it turns out a hold strategy is superior. Therefore, only the most bearish insiders will adopt a specific disclosure strategy, since the termination option is less valuable to them. Insiders making limited disclosures get less litigation protection, but they preserve the termination option. These insiders are less confident of negative private information, so their expected abnormal returns are lower than the specific disclosure group.

The paper also presents findings about the interaction of disclosure choice and firm governance, and makes some preliminary policy recommendations for regulators, firms, and other corporate stakeholders. Most obviously, a disclosure requirement is unlikely to provide much benefit, since it is the insiders not disclosing who are acting the way the SEC intended.

The paper is available here.

DOJ Seeks To Avoid Legislation By Adopting Revised Policies on Corporate Prosecutions

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

Facing the prospect of Congressional legislation that would forbid federal prosecutors and civil enforcement lawyers from requesting any communications protected by the attorney-client privilege or work product doctrine, the Department of Justice has indicated that it will, yet again, revise its Principles of Federal Prosecution of Business Organizations (“Principles”). The current version of the Principles, known as the “McNulty Memo,” has been the subject of criticism since its issuance in December 2006 for not going far enough to guard against encroachments on the attorney-client privilege and work product doctrine.

On June 26, 2008, Senator Arlen Specter re-introduced the Attorney-Client Privilege Protection Act of 2008, which is a modified version of legislation that he had previously introduced. (See Year End Review: Current Regulatory and Enforcement Climate, January 2, 2007). Apparently in response to this legislation and the continuing criticism of the Principles, on July 9, 2008, the Deputy Attorney General, Mark Filip, wrote a letter to Senators Specter and Patrick Leahy, indicating that DOJ intended to make certain changes to the Principles in the coming weeks.

The Deputy Attorney General identified the following changes:

• Cooperation will be measured by the extent to which a corporation discloses
relevant facts and evidence, not its waiver of attorney-client privilege or work product;

• Federal prosecutors will not demand the disclosure of non-factual attorney work
product or core attorney-client communications as a condition for cooperation credit;

• Federal prosecutors will not take into consideration in evaluating cooperation whether a corporation has (i) advanced attorneys’ fees to its employees; (ii) entered into a joint defense or common-interest agreement; or (iii) retained or sanctioned employees involved in alleged wrongdoing.

There are at least two significant limitations to addressing the problem of government interference with the attorney-client privilege or work product doctrine through a revision of DOJ’s Principles. First, unlike the proposed Attorney-Client Privilege Protection Act, the Principles do not apply to the SEC or other federal regulators. Second, the Principles do not have the force of law, but would require corporations to rely on self-policing by DOJ.

If implemented, the new Principles will have a significant impact on how corporations respond to federal criminal investigations. But what must not be lost in considering these proposed changes is the continuing fundamental requirement that, under the Principles, corporations must cooperate with government investigations to help avoid indictment. Corporations will still need to be forthcoming with detailed and relevant factual information to be perceived as cooperative.

Neighborhood Matters: The Impact of Location on Broad Based Stock Option Plans

This post comes from Simi Kedia at Rutgers Business School and Shivaram Rajgopal at the University of Washington Michael G. Foster School of Business.

Our forthcoming paper in the Journal of Financial Economics, Neighborhood Matters: The Impact of Location on Broad Based Stock Option Plans, provides the first evidence on the importance of geographic effects on broad based stock option plans. The question of why broad based option plans are so prevalent in the real world remains a puzzle for standard economic theory. Broad based options are a costly form of compensation relative to other alternatives, such as cash, because: (i) employees can expect to only garner trivial personal gains from their contribution to firm value or profits; and (ii) holding stock options in their employer exposes employees to stock price risk which is highly correlated with the risk in their human capital. Yet, broad based equity plans are commonly observed in corporate America. We show that the geographically segmented labor markets for rank and file talent is a hitherto unexplored explanation for why we observe broad-based option plans.

Using data on rank and file option grants from over 9,000 firm-years from Execucomp over the years 1992-2004 intersected with geographical data gathered from several sources such as the U.S. Census Bureau, we find that firms grant more options to rank and file workers when a higher fraction of firms in the local community (firms located within a 100 or a 250 km of its headquarters) grant more broad based options. This result holds regardless of whether we analyze aggregate state-level, or county-level, or individual firm-level patterns in broad-based option usage. We recognize that firms of certain industries cluster in certain geographical areas. However, the effect of the local community’s option usage on an individual firm’s holds even after controlling for industry membership and other traditional variables known to account for broad based option usage such as firm size, investment opportunity, leverage, cash constraints of the firm, its tax status and its stock return performance.

The neighborhood’s option granting practices can affect an individual firm’s option usage for two reasons: (i) influence through the labor market circumscribed by firm’s geographical neighborhood; and (ii) influence of other exemplary peer firms in the neighborhood. Our empirical results find consistent and strong support for the role of tight labor markets in an individual firm’s option granting decisions. In particular, we find that the neighborhood’s option granting affects an individual firm’s option grants when (i) the neighborhood has more rather than fewer firms, a proxy for the demand of rank and file labor; and (ii) the firm has a higher local beta. Further, the effect of a firm’s local beta on its broad based options usage is statistically significant only when the firm faces a tight labor market in its neighborhood. There is some empirical support for the peer-influence story in that the neighborhood’s option granting practices matter to an individual firm’s option granting when exemplar firms are present in its neighborhood. However, this result is not robust to the introduction of proxies for tight labor markets, suggesting, in effect, that tight labor markets, in general, and Oyer’s (2004) wage indexation explanation in the presence of tight labor markets, in particular, are the key reasons why the community’s broad based option grants explain option usage for individual firms.

The full paper is available for download here.

Delaware Decision Highlights Need for Director Protection

This post is from David A. Katz of Wachtell, Lipton, Rosen & Katz. 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.

My colleague Laura A. McIntosh and I have written an article entitled “Delaware Decision Highlights Need for Director Protection,” which discusses the Delaware Chancery Court case of Schoon v. Troy Corp. The decision, which is on appeal, clarifies that in Delaware, unless otherwise provided in the bylaws or agreed by contract, a director’s right to advancement of expenses does not vest until the company’s obligation is triggered. This result is significant since the advancement of expenses in corporation-related lawsuits, along with broad indemnification, is an important feature of director protection. The decision may leave former directors, in particular, vulnerable to bylaw amendments affecting their right to advancement of expenses. In the article we address some of the many options available to consider to protect a director’s right to advancement of expenses, including the company revising its bylaws, directors entering into indemnification agreements and former directors purchasing D&O liability insurance specifically for themselves in some cases.

The article is available here.

Competing with the NYSE

This post comes from Harold Mulherin of the Terry College of Business at the University of Georgia, and William Brown and Marc Weidenmier of Claremont McKenna College.

For a significant part of its 213-year history, the New York Stock Exchange (NYSE) has reigned as the leading stock exchange both within the United States and across the world. Recently, ongoing changes in technology and the globalization of stock trading have given rise to a number of competitors that threaten the NYSE’s position as the preeminent stock exchange. These changes, as well as the NYSE’s proposed merger with Archipelago, raise many questions about the effects of direct stock market competition with the NYSE.

In a forthcoming article in the Quarterly Journal of Economics, Competing with the NYSE, we investigate whether the NYSE is susceptible to significant competition. We provide new evidence on both the viability and the nature of direct trading competition with the NYSE. We study the Consolidated Stock Exchange, a rival stock exchange that competed directly with the “Big Board” from 1885 to 1926. For almost 42 years, the Consolidated was an important competitor and garnered an average annual market share reaching as high as 60 percent of NYSE trading volume. This sustained incidence of competition with the NYSE came at a time of significant technological change in securities trading and thereby has direct relevance to the current competitive forces confronting the NYSE today.

Our analyses focuses on the effects of competition on the bid-ask spreads for NYSE stocks. We employ two complementary tests to identify the effects of stock market competition. We first study the impact of competition on bid-ask spreads when the Consolidated began to trade NYSE stocks in 1885. Then we analyze the effects of competition on bid-ask spreads for approximately 40 years of the stock exchange rivalry. Our results suggest that NYSE bid-ask spreads fell by more than 10 percent when the Consolidated began to trade NYSE stocks while bid-ask spreads for our control group of stocks trading on the regional exchanges remain unchanged. The effect persisted across the 42-year rivalry between the two exchanges. The finding is robust to a wide variety of changes in the empirical model and estimation technique. Overall, our results suggest that the NYSE has faced significant long-run competition and may be susceptible to a similar level of competition in the future.

The full paper is available for download here.

The View from Delaware

The article below, just published in the Delaware Law Weekly, came to us from its author Elizabeth Bennett. 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 First State’s unique position as the corporate capital of the United States means that cutting-edge developments in corporate governance often come in the form of opinions from the Delaware Supreme Court and the Court of Chancery.

Of course, Delaware’s federal courts also decide giant cases in bankruptcy and intellectual property litigation, sometimes involving billions of dollars.

Given this, it’s no surprise that the number of blogs started by Delaware practitioners, or that address Delaware law, has grown since this publication first reported on the development in 2005.

Francis G.X. Pileggi, a partner in the Wilmington office of Fox Rothschild, was a pioneer. He started his ‘‘Delaware Corporate and Commercial Litigation Blog’’ in April 2005, and reports that traffic is seven or eight times more than when he started.

Wilmington firm Morris James now has three blogs: the “Delaware Business Litigation Report,’’ the “Delaware Patent Litigation Report’’ and the “Delaware Business Bankruptcy Report.’’

Edward M. McNally, a partner who edits the blogs, said they are up to about 4,000 hits per month.

Young Conaway Stargatt & Taylor also fields a blog called the “Delaware IP Law Blog.’’ Karen Keller, an associate with the firm, who writes some of the entries, reported that as of the end of 2007, the blog got an average of about 41 visitors per day from 69 different countries.

But the regent by far of all the blogs with a Delaware connection is the ‘‘Harvard Law School Corporate Governance Blog,’’ which has been hit nearly two million times in its roughly two years of existence. This is in part a testament to the importance of Delaware corporate law.

Lucian A. Bebchuk, Harvard Law School professor and director of the Program on Corporate Governance that runs the blog, said that a significant element of its entries “is following Delaware cases and presenting different normative viewpoints about them as well as thoughts about what they mean going forward.”

The blog was conceived about two years ago by Bebchuk and Vice Chancellor Leo E. Strine Jr. of the Court of Chancery, who has been teaching at Harvard Law for five years or so and is a fellow of the Program on Corporate Governance.

The vice chancellor “has been helping us a great deal in making the connection between academia and practice,” Bebchuk said.

The idea for the blog came when Strine and Bebchuk were brainstorming about making the scholarship produced by the academics of the program more available to practitioners.

Strine said he was also seeking ways to bring together the commentary of practitioners involved with the program, who write on corporate governance issues and who are scattered all over the country.

“We had some electronic newsletters that sent out the research products of the program,” Bebchuk said. “Leo [Strine] thought it would be good to have something that is more dynamic and something [that] would have some kind [of] back and forth and give and take of different ideas.”

Bebchuk said traffic on the blog has been growing exponentially. It is now visited by about 200,000 people per month.

“It’s a very open community,” Strine said “It’s not dominated by any one view. There are people who represent stockholder plaintiffs and people who represent managers, and professors from all kinds of law schools.”

“I don’t think anybody would have expected as much content or as much readership interest,” Strine said, adding that the Program on Corporate Governance has invited outside academics and practitioners to participate in order to create an open forum that can serve as a resource.

“As a result there is a lot of content people find provocative,” he said. There have been some pretty interesting dust ups among the contributors.”

Local contributors to the Harvard blog include an array of experienced Delaware practitioners such as A. Gilchrist Sparks III of Morris Nichols Arsht & Tunnell, Mark A. Morton of Potter Anderson & Corroon, Robert S. Saunders of Skadden Arps Slate Meagher & Flom, Jay Eisenhofer of Grant & Eisenhofer and Pileggi of Fox Rothschild, who also has his own blog, as noted above.

Lawrence A. Hamermesh, a professor at the Widener University School of Law and director of its Institute on Delaware Corporate and Business Law, is a frequent contributor and Andrea Unterberger has contributed as well.

Unterberger is assistant general counsel and director of CSC Media for the Corporation Service Company in Wilmington, which also sponsors the blog. She and the blog’s managing editor did a lot of hard work in the early days on the design and to build the community, Strine said.

“It sort of took off so they don’t need as much of our help as this point,” Unterberger said.

Rodman Ward Jr., of counsel in Skadden’s Wilmington office, sits on the board of CSC and is the grandson of its founder. He said Strine asked him if the company would consider sponsoring the blog. When he brought the idea to the leadership of the company, they went for it.

Ward said it is important that the blog not discriminate on the basis of ideology.

“We wanted the only criteria on which the posts would be chosen to be the academic quality,” Ward said. “They’ve been very good about it.”

While some core subjects for the blog are Delaware law and the Securities and Exchange Commission, Unterberger said, “there are opinions all over the country and all over the world that use Delaware law and that impact corporate governance and principles. There are academics now from all over the country that are posting. … It’s a must-read blog at this point.”

The range and breadth of the guest contributors has grown, Bebchuk said.

“We have the problems that come with success,” he said. “We have a lot of people who want to contribute but at the same time we don’t want to overwhelm readers.”

The goal is to try and maintain a balance to keep the site valuable for both academics and practitioners. Bebchuk said the success has been gratifying.

“We see how our materials are picked up by The Economist, The Wall Street Journal and by the mainstream media,” he said. “We feel there is a world out there that is paying attention to what we post on our blog.”

Corporate Voting vs. Market Price Setting

This post is by Yair Listokin of Yale Law School.

Corporations have two primary means of aggregating dispersed information and making decisions—voting and price setting. When shareholders vote on a merger or in a contested director election (two examples of “proxy fights”), they aggregate diffuse opinions through voting; the corporation pursues the outcome favored by the holders of a majority of shares. Corporations also receive feedback from diffuse investors through stock prices. When price-setting shareholders support a company’s actions, the price of the company will rise. Indeed, the market’s ability to aggregate diffuse information into prices forms the basis for all event studies.

My paper entitled “Corporate Voting vs. Market Price Setting” evaluates these two information aggregation mechanisms from an empirical perspective. I estimate how the price-setting shareholder perceives the decisions of the median voter in a corporate election. I do this by examining stock market responses to the announcement of the outcomes of close votes. The stock market response to close votes has two desirable attributes for measuring the price setting market participant’s view of the median voter’s opinion. First, the outcome of close votes is uncertain, providing information to price setting shareholders.

Second, close votes suggest that the median shareholder/voter is nearly indifferent between the two voting options in a proxy contest. The median voter in a proxy contest is the shareholder in the exact middle of a ranking of voters along the dimension of preference for one side in a proxy contest. If shareholders vote for management so long as they prefer management and the vote is a perfect tie, then the median voter is exactly indifferent between management and “dissidents”. If the vote is not a perfect tie but closely favors existing management, then the median voter slightly prefers the winning option, but is relatively “close” to indifference.

The market response to close votes in proxy voting contests is striking. In close elections—when the median voter should be close to indifferent regarding either outcome– the price setting shareholder is far from indifferent. Stock price responds systematically to the announcement of vote outcomes. When management wins a close election, market value declines; when a dissident wins, the value goes up.

I conclude that the price-setting shareholder places lower value upon management control of companies than the median voter. If price-setting shareholders provide a reasonably accurate gauge of value (a proposition that underlies every event study) and value maximization is the goal of corporate law (as most assume)—then the results suggest a need for corporate voting reforms.

The full paper is available for download here.

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    Paul Hilal
    Carl Icahn
    Jack B. Jacobs
    Paula Loop
    David Millstone
    Theodore Mirvis
    Toby Myerson
    Morton Pierce
    Barry Rosenstein
    Paul Rowe
    Marc Trevino
    Adam Weinstein
    Daniel Wolf