Monthly Archives: November 2008

Do Stock Mergers Create Value for Acquirers?

Posted by Jim Naughton, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Friday, November 21, 2008
,
More from: ,

This post is from Pavel Savor at the Wharton School at the University of Pennsylvania and Qi Lu is at the Kellogg School of Management at Northwestern University.

In our forthcoming Journal of Finance article entitled Do Stock Mergers Create Value for Acquirers?, we investigate and find support for the hypothesis that overvalued firms create value for long-term shareholders by using their equity as currency, which is consistent with a market-timing theory of acquisitions.

One of the primary empirical predictions of the market-timing theory of acquisitions is that the acquirer’s long-term shareholders benefit from the bid, even though it might entail no real synergies. The only requirement is that the chosen target be less overvalued than the acquirer. A famous example of such a deal is America Online’s (AOL) stock-financed acquisition of Time Warner, which was one of the defining moments of the Internet bubble. Despite the high premium paid by AOL (48% using the announcement day closing price) and the drop in its stock price upon announcement (17.5% measured over a three-day window), the deal is now almost universally regarded as beneficial to AOL.s long-term shareholders, not for the synergies it delivered, but simply because AOL.s equity was overpriced at the time.

We approach our principal question of whether stock acquirers would have performed better in the absence of the merger by creating a sample of both successful and unsuccessful mergers, and by using the unsuccessful acquirers as a proxy for how the successful ones would have performed had they not managed to close their transactions. Since we do not want the bid termination to be related to the acquirer’s valuation, we research every failed transaction in our sample and create a subsample of those that did not succeed for exogenous reasons. (In this context, exogenous means unrelated to the valuation of the acquirer.) The subsample includes bids that failed because of regulatory disapproval (mostly antitrust action), subsequent competing offers, or unexpected target developments. We also restrict this subsample to non-hostile bids, since hostile bids are more likely to fail and targets might be more inclined to resist offers by overvalued. We find that unsuccessful stock bidders significantly underperform successful ones. Failure to consummate is costlier for richly priced firms, and the unrealized acquirer-target combination would have earned higher returns. None of these results hold for cash bids.

The full paper is available for download here.

EESA Limits on Executive Pay at Affected Institutions

Posted by Joseph E. Bachelder III, Law Offices of Joseph E. Bachelder, on
Friday, November 21, 2008
, , , ,
More from:

This article from Joseph E. Bachelder originally appeared in the New York Law Journal on November 14, 2008.


On Oct. 3, the Emergency Economic Stabilization Act of 2008 (the EESA) became law.[1] The EESA authorizes the U.S. Treasury Department to acquire up to $700 billion in “troubled assets” from financial institutions.[2] It designates the overall program as the Troubled Assets Relief Program (TARP).

The authority of the Treasury to acquire troubled assets continues through Dec. 31, 2009 but the secretary of the Treasury can extend this authority for a period ending Oct. 3, 2010 upon certifying to Congress the need for the extension and its expected cost to taxpayers.

TARP Programs

Three TARP programs have been initiated thus far:

1. Capital Purchase Program (CPP).[3] This program applies to those financial institutions that enter into agreements pursuant to this program for the purchase by the Treasury of their preferred stock.[4] The executive compensation aspects of the program are derived from §§111 and 302 of the EESA, described, respectively, as “Executive Compensation and Corporate Governance” and “Special Rules for Tax Treatment of Executive Compensation of Employers Participating in the Troubled Assets Relief Program.” As of the date this column was written, it was reported that approximately 50 financial institutions had elected to participate in CPP.[5]

READ MORE »

The Impact of Shareholder Activism on Financial Reporting and Compensation: The Case of Employee Stock Options Expensing

Posted by Fabrizio Ferri, Columbia University, on
Thursday, November 20, 2008
, , , , ,
More from:

This post is by Fabrizio Ferri of the NYU Stern School of Business.

In our paper forthcoming in The Accounting Review, “The Impact of Shareholder Activism on Financial Reporting and Compensation: The Case of Employee Stock Options Expensing,” my co-author Tatiana Sandino and I examine the economic consequences of more than 150 shareholder proposals to expense employee stock options (ESO) submitted during the proxy seasons of 2003 and 2004. This was the first instance where the SEC allowed a shareholder vote on an accounting matter. Activists had argued that lack of ESO expensing had led to an excessive use of option-based compensation.

Under the current legal regime, shareholder proposals are typically non-binding, raising the question of their real economic consequences. Overall, our findings reveal an increasing influence of shareholder proposals on governance practices.

With respect to accounting choices, we find that firms targeted by ESO expensing proposals were significantly more likely to subsequently adopt ESO expensing relative to a control sample of S&P 500 firms, particularly when the proposals received a high degree of voting support. We also find that non-targeted firms were more likely to adopt ESO expensing when a peer firm was targeted by an ESO expensing shareholder proposal, suggesting the presence of spillover effects of this shareholder initiative.

READ MORE »

Underfunded Pension Liability: Lenders and Buyers Beware

Posted by Arthur Fleischer Jr., Fried Frank, Harris, Shriver & Jacobson LLP, on
Wednesday, November 19, 2008
, ,
More from:

This post is by Arthur Fleischer Jr. of Fried Frank, Harris, Shriver & Jacobson LLP.

My firm has recently issued a memorandum entitled “Underfunded Pension Liability: Lenders and Buyers Beware,” which considers the risks posed by underfunded defined benefit pension plans to sponsors and acquirers of and lenders to companies with such plans. These risks have been heightened by the current market downturn, low interests rates and the impact of the Pension Protection Act of 2006. Moreover, although the new FASB Statement No. 158 requires a company to recognize the underfunded status of defined benefit plans as a liability on its balance sheet and to recognize changes in that funded status in the year such changes occur, the ultimate liability is still uncertain. The company’s consolidated balance sheet and the footnotes to its financials provide certain historical information based on assumptions made as of the date of such statements and do not have sufficient detail to make an exact determination as to the company’s potential liability. The memo outlines in detail the risks facing sponsors, acquirers and lenders, the new pension rules and outlines strategies to avoid pension plan issues in the current market.

The memorandum is available here.

Broken Deals: Who’s to Blame?

Posted by Holger Spamann, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Wednesday, November 19, 2008
,
More from:

Who’s to blame when a signed deal falls through? This question is especially relevant with respect to LBO buyers these days. Deals negotiated when times were good and credit was easy look much less appealing if not disastrous now that the short term economic outlook is bleak and the credit environment has soured. In particular, banks are weary of lending into LBOs when their ability to securitize and sell off the loans has waned. Private equity buyers may want to extricate themselves from signed deals, or be forced to do so because debt financing is not forthcoming. What contractual rights do sellers, buyers, and financiers have against one another in such a situation? What reputational effects, if any, constrain them from exercising those rights? And how should a seller’s board trade off deal certainty against price when choosing between competing transactions? Isaac Corré of Eton Park, Steven Davidoff a/k/a The Deal Professor, John Finley of Simpson Thacher, and Jim Morphy of Sullivan & Cromwell debated these questions with Vice Chancellor Leo Strine, Jr. and Professor Robert C. Clark in their Mergers, Acquisitions, and Split-Ups class here at Harvard Law School last week.

The video of the event is available here. (video no longer available)

A Pragmatic Approach to the Phased Consolidation of Financial Regulation in the United States

Posted by the Harvard Law School Forum on Corporate Governance & Financial Regulation, on
Tuesday, November 18, 2008
, ,
More from:
Editor’s Note: This post is by Howell Jackson of Harvard Law School.

I recently issued a paper entitled A Pragmatic Approach to the Phased Consolidation of Financial Regulation in the United States, which recommends an approach to reforming the US system of financial regulation. The proposal comes against the backdrop of dramatic increases in market volatility, unprecedented interventions by the Federal Reserve Board to sustain securities firms, palpable failures to protect consumers in mortgage lending markets, and lingering concerns over the competitiveness of the American financial services industry, which have all combined to put regulatory reorganization — and related issues of regulatory consolidation — on the national agenda.

One recurring theme in recent events has been short-term initiatives to expand the role of the Federal Reserve Board for issues related to market stability. In some cases, such as the creation of the new credit and liquidity facilities of the past few months, the Board itself has expanded its supervisory reach under existing statutory powers. In other cases, such as the recent memorandum of understanding between the Federal Reserve Board and the SEC, the expansion has been effected through improved information sharing agreements with other regulatory bodies. And, in yet other cases, such as recent legislative proposals coming in congressional testimony from Treasury Secretary Paulson and Federal Reserve Board Chairman Bernanke, the expansion of Federal Reserve authority would necessitate legislative action. To a considerable degree, these initiatives are consistent with the long-term vision for an optimal system of regulatory reform articulated by the Treasury Department in its Blueprint for a Modernized Financial Regulatory Structure in March.

What has not yet received attention is whether other aspects of the Blueprint ’s proposals for consolidation should be implemented and, if so, how those other aspects relate to the on-going expansion of Federal Reserve Board authority and its role in ensuring market stability. My paper addresses those issues. Drawing on lessons learned from the experiences in other jurisdictions, the paper explains why consolidated oversight as implemented in leading jurisdictions around the world offers a demonstrably superior model of supervision for the modern financial services industry. It also discusses the different ways in which financial supervisory systems can be consolidated and how the process of consolidation can be staged. It recommends the establishment of an independent umbrella organization — the US Financial Services Authority — and that reorganization be staged in a series of phased steps whereby the most important coordinating and oversight functions are first consolidated under this organization and the supervisory components of the industry integrated at a later date.

This recommended path to consolidated supervision has many advantages over the approach proposed in the Treasury Blueprint. A key one is that the coordination of market conduct and prudential functions is handled within a single regulatory body, free from inter-agency disputes or potential litigation. With appropriate safeguards, the regulatory body, as an independent agency, may be protected from excessive political interference and more likely to attract and retain high-quality staff, particularly in senior positions. The recommended approach is also fully consistent with the establishment of the Federal Reserve Board as the agency responsible for ensuring market stability across the financial services industry.

The paper elaborates upon this approach to reforming our system of financial regulation. Many aspects of the program would entail federal regulation. Without proposing specific statutory language, the paper outlines the key issues that would need to be addressed, emphasizing areas in which the new consolidated regulatory agency should be delegated authority to develop appropriate administrative structures and resolve jurisdictional disputes.

The paper is available here.

Performance Pay and Wage Inequality

Posted by Jim Naughton, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Monday, November 17, 2008
, ,
More from: , ,

This post comes from Thomas Lemieux of the University of British Columbia, W. Bentley MacLeod of Columbia University, and Daniel Parent of McGill University.

In Performance Pay and Wage Inequality, which is forthcoming in the Quarterly Journal of Economics, we evaluate the change in components of pay across different types of jobs, and investigate whether these changes have lead to the increase in wage inequality.

We use data from the Panel Study of Income Dynamics (PSID), and our empirical strategy builds upon two of the most prevalent solutions to how best to set employee pay. The first begins with an evaluation of the needs of a job, and then fixes compensation equal to job value. Under such a system, compensation is effectively fixed before the worker is hired. This implies that compensation is mainly determined by characteristics of the job, with the relationship between worker ability and compensation driven by selection: firms hire the most able person that applies for the job. The second approach is premised on the concept of pay for the person. This system entails rewarding a person’s productivity rather than the job. Under such a regime, the base pay reflects job value, with additional compensation paid after employment to reward the worker for realized performance.

We find that the incidence of performance-pay has increased substantially since the late 1970s. This increase is consistent with the view that the cost of collecting and processing information has declined over time with advances in information and communication technologies. Second, we show that wages are less equally distributed in performance-pay jobs than in other jobs because the return to productive characteristics like education is larger in performance-pay jobs. Putting together these observations, and the fact that the incidence of performance has increased over the same time period, we find that about a quarter of the increase in the variance of wages between the late 1970s and early 1990s is associated with the increased use of performance-pay. Even more striking, we can explain nearly all of the increase in wage inequality above the 80th percentile. This is particularly important because changes in inequality are increasingly concentrated at the top levels of the wage distribution.

The full paper is available for download here.

Renegotiation of Cash Flow Rights in the Sale of VC-Backed Firms

Posted by Jesse Fried, Harvard Law School, on
Sunday, November 16, 2008
, ,
More from:

This post is by Jesse Fried of Harvard Law School.

In our paper “Renegotiation of Cash Flow Rights in the Sale of VC-Backed Firms”, which was recently accepted for publication in the Journal of Financial Economics, Brian Broughman and I investigate the performance of VCs’ cash flow rights in sales of portfolio firms.

When VCs seek to sell a portfolio firm, the firm’s executives and other common shareholders may try to use their board seats and other control rights to hold up the sale of the firm, particularly when satisfaction of VCs’ liquidation preferences would leave little for common shareholders. The threat of holdup may lead VCs to “carve out” part of their cash flow rights for common stockholders. Unfortunately, there is little evidence on how VCs’ cash flow rights perform in private sales. Are VC cash flow rights renegotiated in private sales, and, if so, are such renegotiations caused by common stock’s holdup power?

To answer these questions, the paper uses a hand-collected dataset of 50 VC-backed Silicon Valley firms sold to acquirers in 2003 and 2004. For each firm, we gather data on the allocation of control rights and cash flow rights from the initial VC financing to the sale. We then document the distribution of sale proceeds among the VCs and the original common shareholders. We can thus compare VCs’ cash flow rights at the time of sale to the amounts they actually receive.

We find that in most sales VCs receive their full cash flow rights. In 11 of the sales, however, VCs carve out part of their cash flow rights to common shareholders. In these cases, all of which involved the VCs exiting as preferred shareholders, the average deviation between the VCs’ cash flow rights and their actual payout is $3.7 million, approximately 11% of the VCs’ cash flow rights. Across all 50 firms, the average deviation was 2.3% (1.9% dollar-weighted). Our study thus suggests that VCs’ cash flow rights are quite reliable in private sales, even when the VCs exit as preferred shareholders and are most likely to be held up.

We also show that the likelihood and magnitude of deviations from VCs’ cash flow rights in favor of common shareholders are larger when common shareholders have more power vis-à-vis the VCs. Everything else equal, the expected deviation is about $1.5 million larger if VCs lack a board majority and roughly $1.6 million larger if the firm is incorporated in California (rather than Delaware), which gives common shareholders relatively more leverage against the VCs through that state’s bundle of common shareholder rights. This suggests that such deviations are driven, at least in part, by the allocation of control within the firm. Our findings linking common shareholder power to deviations from VCs’ cash flow rights are generally robust to alternative econometric specifications.

The full paper is available for download here.

2008 Proxy Season Postscript: Shareholders Focused on Stability

Posted by David A. Katz, Wachtell, Lipton, Rosen & Katz, on
Saturday, November 15, 2008
, ,
More from: ,

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

My colleague Laura A. McIntosh and I have written an article entitled “Shareholders Focused on Stability in Proxy Votes,” in which we discuss the outcomes and lessons from the recently completed proxy season. Although the season was expected by some to generate increased activism, it now appears to have been the season in which shareholders began to put governance reform proposals back into perspective. As the credit crisis worsened and market turbulence became increasingly worrisome, shareholders appeared less concerned with governance issues and instead focused on corporate stability: directors generally were reelected with 90-plus percent support, backing for governance proposals fell from 2007 levels in many cases, and the number of governance proposals brought to a vote by shareholders decreased as some prominent activist investors dropped planned campaigns. The 2008 proxy season also brought a high number of proxy contests, although most of these contests involved campaigns to elect “short slates” of directors as opposed to proxy contests for control. The memo discusses the importance of effective communication between among companies and their shareholders as well as the value of takeover defenses in a down market.

The memo is available here.

Delaware Chancery Court Converts Voting Preferred Stock Issued to Controlling Stockholder

Posted by Arthur Fleischer Jr., Fried Frank, Harris, Shriver & Jacobson LLP, on
Friday, November 14, 2008
, , , ,
More from:

This post is by Arthur Fleischer Jr. of Fried Frank, Harris, Shriver & Jacobson LLP. This post is part of the Delaware law series, which is co-sponsored by the Forum and Corporation Service Company; links to other posts in the series are available here.

My partner Peter S. Golden has prepared a memorandum discussing the extraordinary remedy ordered by the Delaware Chancery Court in the recent decision of In Re Loral Space and Communications Inc. Consolidated Litigation. Finding that the terms of $300 million of convertible preferred stock issued by Loral Space and Communications Inc. to its controlling stockholder were unfair, the Court fashioned a remedy by converting the preferred stock into non-voting common stock based upon a court-determined “fair price” for Loral common stock. Although Loral had created a special committee of directors to negotiate the transaction, the Court criticized the committee as a special committee in name only. In Re Loral Space and Communications Inc. Consolidated Litigation demonstrates that controlling stockholders have a strong interest in ensuring that a well-advised committee of truly independent directors represent the interests of public stockholders in any transaction involving the controlling stockholder and the public company it controls.

Applying the entire fairness standard of review because a majority of the Loral board of directors was affiliated with the controlling stockholder, Vice Chancellor Strine found that the Loral preferred stock issuance was neither the result of fair dealing nor priced fairly. With respect to fair dealing, the key issue was whether the Loral Special Committee functioned as an effective proxy for arms-length bargaining. Holding that the Loral Committee did not, Vice Chancellor Strine was critical of almost every aspect of the Special Committee process. The memo, available here, analyzes the decision and highlights the lessons from it for those advising special committees.

Page 2 of 4
1 2 3 4