Monthly Archives: July 2009

TARP, ‘Say on Pay’ and Other Legislative Developments

This post by Joseph E. Bachelder recently appeared in the New York Law Jounal.

Executive pay is being buffeted. It has been the subject of much legislative and other attention. The Troubled Assets Relief Program (TARP) has impacted significantly on executive pay at top levels of companies in the financial services industry that have received TARP aid. [1] Several bills pending in Congress would expand regulation of executive pay at companies receiving TARP aid, and other pending legislation would impose regulations on executive pay at public companies generally. The so-called “shareholder rights” movement continues to receive attention, including “Say on Pay” proposals directed at shareholder advisory votes on executive pay.

After a brief look at surveys showing a decrease during 2008 in executive pay levels, today’s column discusses the legislative developments just mentioned, including “Say on Pay” developments. Note also is made of statements about executive pay by leaders of the current administration in Washington.

Downturn in Pay Levels

Several recent surveys indicate that median CEO pay levels declined in 2008; by comparison, in 2007 they increased over 2006.

Summary of Survey Data on CEO Pay: Total Direct Compensation

*All percentage changes shown are based on changes in median Total Direct Compensation for the years involved. (The New York Times (Equilar) survey indicates that certain perquisites and other benefits also are included in that survey.) Methodologies used by the different surveys in computing compensation differ (including, among other things, the companies they include in their respective surveys). For an understanding of the methodologies used, the actual surveys need to be examined.

**The New York Times survey on CEO pay for 2007 (NYT, April 6, 2008) expresses the percent change in 2007 versus 2006 as a change in average level of pay rather than change in median level of pay. On this basis, the New York Times reported the change as an increase of 5% for 2007 over 2006.

Available CEO pay surveys also indicate that Total Cash Compensation (salary plus annual bonus) declined in 2008 from 2007.

Since the end of the 1990s, only one other year, 2002, showed a measurable decrease in Total Direct Compensation of CEOs from the prior year, according to available surveys. (Based on data examined for 2000-2008 (not the same surveys noted in the preceding chart), 2005 was virtually flat with 2004, but all other years before 2008 show an increase over the prior year.) In contrast, over the long term, measured decade over decade, CEO pay has consistently risen during the past half century (increases in the 1950s and 1960s, however, were not significant). [2]

A single year does not represent a “pattern,” and it will take two or three more years, at least, to see whether current economic problems negatively impact on the long-term upward trend in CEO pay. Most likely, once the global economies, including the U.S. economy, return to better performance levels, executive pay levels will resume their customary trend of annual increases.


Why do Insiders Trade?

This post comes to us from Juha-Pekka Kallunki of the University Of Oulu, and Henrik Nilsson and Jörgen Hellström of Umeå University.

Many studies examine whether insiders’ trading activity is informative regarding future return on stocks. An underlying hypothesis tested in these studies is whether insider trades are driven by insiders’ superior information about the prospects of their firm and whether these trades are informative in generating abnormal returns. However, insiders may trade for reasons other than maximizing stock returns. For instance, insiders may sell their insider stocks in an attempt to better diversify their holdings and because of personal liquidity needs. In our paper, Why do insiders trade? Evidence based on unique data on Swedish insiders, which was recently accepted for publication in the Journal of Accounting and Economics, we utilize unique data on Swedish insiders to explore the various motives underlying insiders’ decisions to trade their insider stocks. In particular, we examine whether insiders’ diversification and other personal reasons have an incremental role relative to their information advantage in explaining their trading behavior.

Our data comprise detailed information on all Swedish insiders’ personal wealth including their holdings in their insider and outsider stocks and their other wealth. Moreover, the data include information on insiders’ salaries and other taxable income as well as gender. Furthermore, in our study we are able to control for several other potential factors affecting insider trading, such as the number of granted stocks and options, the number of stock acquired through the exercise of options and earnings announcements. This comprehensive data set allows a thorough investigation of the incremental role of the various motives for insider trading proposed in the literature.

We find strong support for the portfolio diversification/re-balancing hypothesis. That is, insiders with unbalanced portfolios (towards insider stock) relative to their average holdings over the sample period have a higher propensity to sell their insider stocks and they sell in larger trade sizes than insiders with less unbalanced portfolios. Regarding the behavioral biases in insiders’ trading decisions, we find that insiders tend to hold on to their losing insider stocks (the disposition effect) and that male insiders trade more frequently than female insiders (overconfidence). We also find that tax burden associated with the selling of insider stock holdings deters insiders from selling these stocks. Our results also show that insiders’ information advantage and portfolio rebalancing objectives have an interaction effect in their selling decisions. Specifically, we find that, on average, insiders avoid selling before bad news earnings announcements. However, among those insiders who actually sell before bad news earnings announcements, insiders who have allocated a greater (smaller) proportion of their wealth to insider stock sell more (less) before bad news earnings disclosures. Furthermore, our results show that insider selling is the most informative for future returns among those insiders who have allocated a relatively large proportion of their wealth to insider stock or who have the largest insider holdings. These later results suggest that insiders having the strongest economic incentives successfully time their selling to maximize their returns.

Our paper contributes to the literature on insider trading by showing that insiders do not trade solely on the basis of their superior information relative to other market participants. Insiders trade, especially sell, for many personal reasons, such as for portfolio diversification needs. They even seem to show some of the behavioral biases that have been reported to occur among regular investors.

The full paper is available for download here.

The American Corporation and its Shareholders: Dooryard Visits Disallowed?

Editor’s Note: The post below by Commissioner Elisse Walter is a transcript of remarks by her at the Society of Corporate Secretaries and Governance Professionals on June 27, 2009 in San Diego.)

I am delighted to participate in this year’s conference. And, I particularly appreciate your willingness to change the placement of this speech in your program so that I could attend.

I have enormous respect for this Society and its members. In fact, once, long before there were governance professionals, I persuaded David Smith to allow me to join the Society, even though I have never served as a corporate secretary. Although that was years ago, I am delighted to see that there are still familiar faces here today. Most important, as I’ll highlight later, each of you sits at a critical juncture in our corporate governance system.

For those of you whom I haven’t met before, I am a New Yorker by birth, a Washingtonian by trade, and a future Mainer when I retire, but at the moment, my heart is in San Diego, not only because I’m standing before you today, but because both of my sons are living here right now.

Although I returned to government as an SEC Commissioner a little less than a year ago, I now stand second in seniority among our Commissioners. I am not an SEC or securities law newbie, however. I spent 17 years at the Commission in the Office of General Counsel and the Division of Corporation Finance before serving as General Counsel at the CFTC and Senior Executive Vice President, Regulatory Policy & Programs, at FINRA.

I know that each of you is living through the excitement and perils of changes in our legal, regulatory, and business landscapes. We in government are as well. There are a wide range of important issues before the Commission now, but, given that I am the only thing standing between you and the fabulous weather outside, I’d like to focus my comments today on just a couple of topics affecting corporate governance that are very important to me – shareholder access and the role of the corporate secretary as internal gatekeeper.

Before I get too much further, though, let me give you the standard disclaimer that the views I express here today are my own and do not necessarily reflect the views of the Securities and Exchange Commission or my fellow Commissioners. [1]


Why the SEC should not further restrain short selling

This post is by James Chanos of Kynikos Associates LP.

The hedge fund coalition that I chair, the Coalition of Private Investment Companies (CPIC), recently submitted a comment letter to the Securities and Exchange Commission (SEC) in which we laid out our case for why the Commission should drop proposals to further restrain short selling. Under consideration by the regulator is a series of proposals that range from a “national bid test” to “circuit breakers,” which, if triggered, halt short selling transactions.

The SEC has repeatedly acknowledged the benefits of short selling, from improving liquidity in capital markets to enhancing price discovery, and, in the past, the agency has expressed reluctance to restrict an investment strategy that serves as a necessary counterweight to unbridled optimism. But, it has departed from this traditional view in a variety of efforts ─ some misguided ─ to address the circumstances of the largest market drop in decades. When the SEC imposed bans on short selling last summer, investors’ interests were harmed as market quality deteriorated, including higher transaction costs through wider spreads. (More information about short selling is available here.)

Our letter emphasizes, as Commissioner Kathleen Casey did when the SEC announced its newest short sale rule proposals, that the SEC must provide empirical evidence that validates the necessity for action and demonstrates the benefits investors would receive in excess of the harm done from new restraints on short selling.

In proposing several regulatory “speed bumps” on short selling, particularly in down markets, the SEC emphasized two considerations that will guide its decision: that “naked” short selling is a problem demanding regulatory attention and that one cause of the low level of investor confidence is the prevalence of short selling and its role in the fall in stock values.

In our letter, we point to actions already taken by the SEC to eliminate “naked short selling,” which occurs when an investor has failed to have identified or gained commitment for stocks they have shorted. Our industry, including myself, supported those actions. As a result, there has been a further decline in the already very low level of naked short selling that does occur.

As to investor confidence, it is on the rise again albeit it in fits and starts, according to several polls, including that produced by State Street Bank. To gauge investors’ thinking, the State Street survey looks at several macro- and microeconomic factors, which do not include short selling. Given this, we questioned the link the SEC has suggested between the prevalence of short selling and low levels of investor confidence. In another comment letter, an Ohio State University Professor Ingrid Werner similarly questions the link. She concludes that “there appears to be no evidence supporting the hypothesis that high levels of short selling activity contributed to low levels of investor confidence during the recent financial crisis.”

Removing information from the markets — whether it be by posing barriers to short selling or by rolling back mark-to-market accounting standards — as a means to promote “investor confidence” is a terrible precedent.

The full text of the CPIC letter is available here.

SEC Advocates Broad Reforms of Synthetic Ownership Instruments and Markets

This post is based on a client memo by Theodore N. Mirvis and Adam O. Emmerich of Wachtell, Lipton, Rosen & Katz.

As we have pointed out for some time, non-traditional structured and derivative arrangements that create economic exposure to publicly traded securities have allowed activist and short-term investors to exert vast but hidden influence. With respect to equity securities, investors have used such instruments to secretly accumulate large equity positions with a view to exercising control over corporate decisionmaking, with little or no disclosure of the existence or nature of these positions or their plans. With respect to debt securities, such devices have often been used – frequently in conjunction with short selling – to manipulate the market in bear raids, placing companies dependent on access to the capital markets in peril. While these phenomena directly implicate the policies underlying traditional disclosure requirements and anti-manipulation rules, they have thus far largely escaped adequate regulation.

In testimony yesterday before the Senate, advancing Treasury Secretary Geithner’s regulatory reform agenda announced on May 13, SEC Chairman Schapiro has now addressed these concerns foursquare, calling for long-needed fundamental reform in the regulation of derivatives by the SEC. Chairman Schapiro put the matter clearly in saying:

The current regulatory framework has permitted certain opaque securities-related OTC derivatives markets to develop outside of investor protection provisions of the securities laws. These provisions include requiring the disclosure of significant ownership provisions and … prophylactic measures against fraud, manipulation, or insider trading…. … Trading in securities-related OTC derivatives can directly affect trading in the securities markets. From an economic viewpoint, the interchangeability of securities and securities-related OTC derivatives means that they are driven by the same economic forces and are linked by common participants, trading strategies, and hedging activities. … [M]anipulative activities in the markets for securities-related OTC derivatives can affect US issuers in the underlying equity market, thereby damaging the public perception of those companies and raising their cost of capital. To protect the integrity of the markets, trading in all securities-related OTC derivatives should be fully subject to the US regulatory regime designed to facilitate capital formation.

Chairman Schapiro called upon Congress to enact legislation to bring securities-related OTC derivatives clearly under the umbrella of the federal securities laws, including so that the SEC might require regulated central counterparties (CCPs) for derivatives markets, to address concerns about counterparty risk by substituting the creditworthiness and liquidity of the CCP for the creditworthiness and liquidity of counterparties. In her testimony, Chairman Schapiro also recognized that “[a]ny new regulatory framework… should take into consideration the purposes that appropriately regulated derivatives can serve, including affording market participants the ability to hedge positions and effectively manage risk.”

Broad-based reform of the OTC derivatives market to prevent the abuses and dangers exposed by the recent financial crisis – without destroying the ability of financial institutions, corporations and investors to make appropriate use of derivatives to assist in the process of capital formation and risk management – is a complicated project that will require a great deal of judgment and compromise. Disclosure under the Securities Exchange Act of 1934 of equity derivatives so that ownership and transactions in the derivatives would be treated equally with ownership and transactions in the underlying security is but one part of this larger task. It is, however, an important part, and one that we do not believe requires legislation but only rule-making and interpretation by the SEC. For so long as the current loopholes in the 13D reporting regime are not closed, parties seeking to disguise their activities or manipulate the market will try to take advantage of those loopholes. So too with manipulative trading in credit default swaps and short selling. We encourage the SEC to close the gaps in the current disclosure regime and to actively take enforcement action against abusive transactions, even while the SEC, other regulatory bodies, the Congress and the Administration together pursue the larger project of comprehensive reform of the regulation of derivatives that is now under consideration.

Financial Visibility and Going Private

This post comes to us from Hamid Mehran and Stavros Peristiani of the Federal Reserve Bank of New York.

In our forthcoming Review of Financial Studies paper Financial Visibility and the Decision to Go Private we investigate the determinants of the decision to go private over a firm’s entire public life cycle.

We investigate the decision to go private by estimating several variations of the hazard model. Initially, we estimate a broad competing risk model where the decision to remain public or go private is evaluated against all alternative termination outcomes (merger, liquidation, or negative delisting). Most of our analysis, however, focuses on estimating a hazard model that excludes all other competing choices. In this case, the regression sample consists of an annual panel of observations of all IPO firms that either had an LBO or were bought by another private company and all surviving IPO firms that remained in the public market.

Our sample includes completed deals in which an IPO firm was a target in an LBO or was acquired and became a private company from January 1, 1990, to the end of October 2007. Our tests focus on those firms that 1) went public after 1988 and subsequently were buyout targets after January 1, 1990 and 2) were included in Compustat. Our final sample consisted of 262 firms (169 LBO targets and 93 non-LBO firms that were acquired by nonpublic companies or investor groups). Of these 262 IPO firms, 218 (150 LBO and 68 non-LBO targets) were followed by securities analysts.

Our evidence reveals that firms with declining growth in analyst coverage, falling institutional ownership, and low stock turnover were more likely to go private and opted to do so sooner. We argue that a primary reason behind the decision of IPO firms to abandon their public listing was a failure to attract a critical mass of financial visibility and investor interest. Consistent with the findings of earlier literature, we also find strong support for Jensen’s free-cash-flow hypothesis, which argues that these corporate restructurings are a useful tool in capital markets for mitigating agency problems between insiders and outside shareholders.

The full paper is available for download here.

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