Yearly Archives: 2008

The Future of Transactional Legal Practice

Posted by the Harvard Law School Forum on Corporate Governance & Financial Regulation, on
Monday, March 10, 2008
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On Wednesday February 27, HLS Professor George Triantis delivered his inaugural lecture “The Future of Transactional Legal Practice” marking his appointment to the Eli Goldston Professorship of Law.

In his lecture, Triantis surveyed the reasons why major U.S. law firms have enjoyed robust growth in their transactional practices over the past several decades, including the fact that they have often provided their clients with substantial business guidance in addition to legal advice. But he warned that many of the services they’ve offered are increasingly provided by others—investment bankers, management consultants, accountants, offshore outsourcing firms, and other business professionals—more cheaply.

Triantis observed that transactional firms grew and rose to prominence by negotiating and drafting three kinds of contracts: “standardized” contracts that are easily adaptable for use by successive clients; “innovative” contracts; and “tailored” contracts uniquely geared to their clients’ particular circumstances. But increasingly, he said, law firms are losing market share to other players in all three categories.

To recapture lost market share and to stem the tide against further erosion, Triantis said, law firms should refocus on innovative contract design that does what other business professionals can’t do as well: anticipate and plan for what happens if and when a deal doesn’t work out—litigation.

“Litigation, in its various forms, is the core competency from which lawyers can derive comparative advantage in designing transactions for their clients,” said Triantis. “Lawyers can help their clients choose the mode of enforcement and mold their legal commitments accordingly, knowing that they will be enforced through or in the shadow of an adversarial judicial process. …The modern law firm is organized around practice groups. Two of these groups—litigation practice and corporate transactions—often fail to mesh at the interface of particular transactions because the firm that litigates a transaction is often not the firm that did the deal in the first instance. … By connecting these two services, rather than treating them as distinct tasks or modules, law firms can recapture some of the lost revenues.”

Click here for a webcast of this event.

Securities Class Actions: Time to Fix Broken System

Posted by Andrew Tuch, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Thursday, March 6, 2008
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The National Law Journal recently published Securities Class Actions: Time to Fix Broken System, an opinion piece by defense counsel Daniel Small. The piece explains the rationale underpinning the existence of class actions and focuses on aspects of the system the author regards as broken. The piece is critical of the ability of the first “victim” in the court house to “help decide which [law] firm is lead counsel, help approve settlement and fee agreements and take other important actions.” The author suggests that 1995 amendments designed to minimize the perverse incentives created by the system suffered from a lack of regulatory oversight. The author cites events surrounding the sentencing of Seymour Lazar in support of his critique, but cautions against focusing on the wrongdoing of particular individuals or law firms if this would obscure systemic problems requiring attention.

Mr Small recommends systemic changes to securities class actions, which include the following: limiting the number of times one person (or family) can be a class representative; limiting class representatives to shareholders who satisfy stiffer requirements concerning their shareholding; requiring attorneys to sign the class representative certification; and limiting attorney fees.

The article is available here.

Perpetuities, Taxes, and Asset Protection

Posted by Robert Sitkoff, Harvard Law School, on
Wednesday, March 5, 2008
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This post is from Robert Sitkoff of Harvard Law School.

The Program on Corporate Governance has recently released a new discussion paper entitled Perpetuities, Taxes, and Asset Protection: An Empirical Assessment of the Jurisdictional Competition for Trust Funds, which I co-wrote with Max Schanzenbach. The paper abstract is as follows:

This chapter provides an accessible overview of our previous work on the impact of the abolition of the Rule Against Perpetuities (RAP) on trust fund situs. The implementation of the Generation Skipping Transfer (GST) Tax by the Tax Reform Act of 1986 sparked a movement to repeal the RAP. Since 1986, nearly half the states have abolished or effectively abolished the RAP as applied to interests in trust. Prior to 1986, only three states had abolished the RAP. We find no evidence that abolishing the RAP prior to the 1986 GST tax attracted trust business. By contrast, between 1986 and 2003, abolishing states reported an average increase in trust assets of $6 billion (a 20 percent increase). In addition, average account size in abolishing states increased by $200,000, implying that abolishing the rule attracted relatively larger trusts. Our findings imply that roughly $100 billion in trust funds have moved to take advantage of the abolition of the RAP. Further, we can trace these results to the subset of abolishing states that did not levy a tax on income accumulated in trusts attracted from out of state. This finding, which implies that abolishing the RAP does not directly increase state tax revenue, bears on the scholarly debate over the mechanisms of jurisdictional competition. Our analysis also controls for whether a state validated the so-called self-settled asset protection trust (APT). We did not find consistent evidence that validating APTs increases a state’s reported trust business, but in the period studied few states had validated APTs, so we draw no firm conclusions.

We conclude that the jurisdictional competition for trust funds is real and intense, with the primary margin of competition being the rules that bear on trust duration, and that the enactment of the GST tax sparked the rise of the perpetual trust. In future work using more refined data, we intend to revisit the jurisdictional competition for trust funds and to expand our inquiry to include directed trustee statutes and the recent reforms to trust-investment laws.

Hedge Fund Activism, Corporate Governance, and Firm Performance

Posted by Randall S. Thomas, Vanderbilt University, on
Tuesday, March 4, 2008
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This post is from Randall S. Thomas of Vanderbilt University.

Alon Brav, Wei Jiang and Frank Partnoy and I have recently released a paper, entitled Hedge Fund Activism, Corporate Governance, and Firm Performance. The abstract is as follows:

Using a large hand-collected data set from 2001 to 2006, we find that activist hedge funds in the U.S. propose strategic, operational, and financial remedies and attain success or partial success in two-thirds of the cases. Hedge funds seldom seek control and in most cases are nonconfrontational. The abnormal return around the announcement of activism is approximately 7%, with no reversal during the subsequent year. Target firms experience increases in payout, operating performance, and higher CEO turnover after activism. Our analysis provides important new evidence on the mechanisms and effects of informed shareholder monitoring.

Fiduciary Duties for Activist Shareholders

Posted by Lynn A. Stout, UCLA School of Law, on
Monday, March 3, 2008
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This post is from Lynn A. Stout of UCLA School of Law.

Together with Iman Anabtawi, I have just issued a new article on SSRN entitled Fiduciary Duties for Activist Shareholders. The article is to be published in the Stanford Law Review, and a current draft is available here. The article was recently profiled in the Financial Times.

Fiduciary Duties for Activist Shareholders argues that corporate law seems to impose few or no fiduciary duties on minority shareholders in public corporations because historically, minority shareholders in public firms enjoyed little or no power or influence within the firm. The most important trend in corporate governance today, however, is the move toward “shareholder democracy.” Activist investors, especially hedge funds, are using their new power to pressure managers and directors into pursuing corporate transactions ranging from share repurchases, to special dividends, to the sale of assets or even the entire firm. In many cases these transactions benefit the activist while failing to benefit, or even harming, the firm and other shareholders.

Greater shareholder power should be coupled with greater shareholder responsibility. Fiduciary Duties for Activist Shareholders argues that the rules of fiduciary duty traditionally applied to officers and directors and, more rarely, to controlling shareholders, should be applied to activist minority investors as well. There is no reason to believe that newly-empowered activist shareholders are immune to the forces of greed and self-interest widely understood to tempt corporate officers and directors. Corporate law can and should adapt to this reality.

Do Investment Banks Advising on M&A Deals Misuse Confidential Information?

Posted by Andrew Tuch, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Thursday, February 28, 2008
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The post below comes to us from Andriy Bodnaruk of the University of Maastricht, Massimo Massa of INSEAD, and Andrei Simonov of the Stockholm School of Economics and CEPR.

We have recently released a paper, entitled The Dark Role of Investment Banks in the Market for Corporate Control. Our paper studies M&A transactions in the US in the 20 year-period 1984 to 2003. Its focus is on transactions in which the investment bank advising the bidder in an M&A transaction also holds a stake in the shares of the target company at the time the deal was announced. In broad terms, the paper provides evidence as to (1) the extent to which investment banks advising bidders took advantage of confidential information garnered from their advisory assignments to acquire stakes in the target prior to the deal’s announcement; and (2) the extent to which the investment bank’s stake in the target compromised the financial interests of the bank’s bidder client.

We show that the presence of advisors helps to predict if a firm will be a takeover target. Conditioning on firms with similar industry and size characteristics, firms in which the advisors to the bidder hold a stake are 45 percentage points more likely to become targets, with the probability of becoming a target increasing from the unconditional sample mean of 4.2% to 6.1%. When we build the trading strategy long in the actual positions of the advising investment banks and short in the positions of the non-advisory banks, we find the strategy delivers 1.40% per month (adjusted for risk). This provides a lower bound estimate of the informational advantage that the advisory bank has relative to other sophisticated market players.

We further show that where an investment bank advising the bidder holds a stake in the target, the bidder will pay a higher premium for the target relative to deals in which the advisor holds no target stake. The target’s premium increases by 590 basis points from 30.6% to 36.5% relative to non-conflicted deals. An increase of one standard deviation in the (dollar value of the) average fraction of the target firm held by the advisor to the bidder implies a premium 310 (290) basis points higher than average. Deals involving the bidder’s advisor holding a stake in the target are more likely to succeed than other deals. Moreover, targets in these deals tend to be overvalued by more than 10% compared to deals in which the bidder’s advisor holds no target stake.

These findings suggest that advisors do take advantage of their privileged position, not only by acquiring positions in the deals on which they advise, but also by directly affecting the outcome of the deal in order to realize higher capital gains from their positions. These results provide important insights into the conflicts of interest affecting financial intermediaries that can both advise on corporate events and invest in the equity market.

The paper is available here.

Harmonization of GAAP and IFRS

Posted by the Harvard Law School Forum on Corporate Governance & Financial Regulation, on
Wednesday, February 27, 2008
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Two committees of the American Accounting Association have produced detailed reports evaluating the SEC’s proposal to accept financial statements prepared in accordance with International Financial Reporting Standards (IFRS) from foreign-private issuers without reconciliation to U.S. GAAP (the SEC subsequently voted in favor of the proposal on November 15, 2007). This proposal was also discussed by Carl Olson in his November 28 post. These two papers highlight the difficult nature of this issue. Despite the common background of the members of each group and the common academic research utilized in preparing each proposal, the recommendations of the two committees are distinctly different.

The Financial Accounting Standards Committee report (available here) argues that since there is no conclusive research evidence that financial reports prepared using U.S. GAAP are better than reports prepared using IFRS, the prudent approach is to promote competition among them. This finding supports adopting the SEC’s proposal to permit foreign private issuers a choice between IFRS and U.S. GAAP.

The Financial Reporting Policy Committee report (available here) concludes that the proposed elimination of the GAAP reconciliation requirement is premature. This conclusion is based on research that finds that material reconciling items exist that are relevant to U.S. investors, that there are differences in the implementation of uniform standards and that compliance to IFRS or U.S. GAAP by foreign firms is a concern, that foreign firms benefit from greater access to capital by listing in the U.S., that U.S. investors tend to prefer U.S. GAAP, and that U.S. GAAP – IFRS harmonization might improve the functioning of the U.S. capital markets.

The Shifting Balance of Power Between Shareholders and the Board

Posted by Jim Naughton, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Tuesday, February 26, 2008
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The post below comes to us from Jennifer G. Hill of the University of Sydney, Australia, who is Visiting Professor at Vanderbilt Law School during Spring 2008 and 2009. 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.

I have recently completed a paper, entitled “The Shifting Balance of Power Between Shareholders and the Board: News Corp’s Exodus to Delaware and Other Antipodean Tales”. The paper is posted on SSRN here.

The abstract to the paper is as follows:

The balance of power between shareholders and the board of directors is a contentious issue in current corporate law debate. It also lay at the heart of a controversy concerning the re-incorporation of News Corporation (News Corp) in Delaware. News Corp has recently been the subject of intense media attention due its successful bid to acquire Dow Jones & Company. Nonetheless, News Corp’s move to the US, which paved the way for this victory, was neither smooth nor a fait accompli. Rather, the original 2004 re-incorporation proposal prompted a revolt by a number of institutional investors, on the basis that a move to Delaware would strengthen managerial power vis-à-vis shareholder power. The institutional investors were particularly concerned about the effect of the re-incorporation on shareholder participatory rights, and the ability of the board of directors to adopt anti-takeover mechanisms, such as poison pills, which are not permissible under Australian law. It was this latter concern, which ultimately led a group of institutional investors to commence legal proceedings in the Delaware Chancery Court in UniSuper Ltd v News Corporation (2005 WL 3529317 (Del Ch)).

The News Corp re-incorporation saga highlights a number of important differences between US, UK and Australian corporate law rules relating to shareholder rights, and provides a valuable comparative law counterpoint to the recent US shareholder empowerment debate. Other recent Australian commercial developments discussed in the article show a tension between legal rules designed to enhance shareholder power, and commercial practices designed to readjust power in favor of the board of directors. These developments are interesting because they demonstrate how some Australian companies have tried to create a de facto corporate governance regime, which mimics certain aspects of Delaware law.

Improving the Structure of Executives’ Equity-based Pay Arrangements

Posted by Jesse Fried, Harvard Law School, on
Monday, February 25, 2008
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This post is from Jesse Fried of Harvard Law School.

I have just posted on SSRN a paper that put forwards a new approach to improving the structure of executives’ equity-based pay arrangements, Hands-Off Options. The current draft is available here.

The abstract is as follows:

Despite recent reforms, public company executives can still use inside information to time their stock sales, secretly boosting their pay. They can also still inflate the stock price before selling. Such insider trading and price manipulation imposes large costs on shareholders. This paper suggests that executives’ options be cashed out according to a pre-specified, gradual schedule. These hands-off options would substantially reduce the costs associated with current equity arrangements while imposing little burden on executives.

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

Contractarians, Waiver of Liability Provisions, and the Race to the Bottom

Posted by J. Robert Brown, Jr., University of Denver Sturm College of Law, and Sandeep Gopalan, Arizona State University Sandra Day O'Connor College of Law, on
Friday, February 22, 2008
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This post is from J. Robert Brown, Jr. of the University of Denver Sturm College of Law.

We have just posted a paper on SSRN, Opting Only In: Contractarians, Waiver of Liability Provisions, and the Race to the Bottom, challenging one of the core positions of the contractarian approach to corporate law. Contractarians espouse an enabling approach to regulation allowing corporations to opt in or opt out and oppose a mandatory approach based on categorical rules. In their view, an enabling approach allows private ordering and enables owners and managers to derive the most efficient set of provisions, tailored to each company’s specific circumstances. This position has been reflected in attacks on legislations like SOX. Many commentators objected to its provisions because they were categorical and did not allow for private ordering.

Our study seeks to test this theory’s explanatory power in one area of corporate law.We chose a recent example of states replacing a categorical requirement with an enabling provision – waiver of liability provisions – for examination.These provisions allow companies to “opt out” of a rule that imposes liability on directors for breach of the duty of care.They may do so through the mechanism of an amendment to the articles.The amendment process requires the consent of both owners and managers, presenting conditions ripe, at least in theory, for the two groups to “bargain.”

We note first that waiver of liability provisions were authorized not in response to Van Gorkom, as is typically represented, but in response to the D&O insurance crisis occurring in the 1980s.In other words, the provisions were designed to interfere in the market for insurance.No evidence was offered, nor could we find any, indicating that this was a more efficient way of dealing with the economic uncertainties that existed at the time.

Second, we examined the waiver of liability provisions implemented by the Fortune 100 (data that we will eventually expand to the Fortune 500). Our analysis does not offer any evidence of private ordering. With one exception, all non-mutual companies in the Fortune 100 have eliminated liability for breach of the duty of care (in some states, this was done statutorily, with no company “opting out” of the no liability regime). Moreover, none of the waiver provisions reflected bargaining, with the wording of the provisions being remarkably similar. The companies in our sample waived liability to the fullest extent permitted by law.

Our analysis shows that one categorical rule favoring shareholders (liability for the breach of the duty of care) was replaced by another categorical rule favoring management (no liability for breach of the duty of care). While we do not rule out the possibility, we are not persuaded that any significant evidence demonstrating that one was more efficient than the other exists.

Our conclusion is supported by the fact that no actual bargaining occurs.Particularly where provisions are implemented by an amendment to the articles, it is management that drafts the language and only management that can initiate adoption or repeal.In other words, whatever theoretical benefit can result from the contractarian view of private ordering, it can only arise in practice if shareholders have the ability to meaningfully participate in the bargaining process.Our evidence suggests that they do not.

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