Monthly Archives: December 2009

Shareholder Choice in a World of Proxy Access

Editor’s Note: Stanley Keller is partner of Edwards Angell Palmer Dodge LLP. This post is by Mr. Keller, Robert Todd Lang and Charles M. Nathan. Mr. Lang is a partner of Weil, Gotshal & Manges LLP; and Mr. Nathan is a partner of Latham & Watkins LLP. The views expressed in this paper are solely those of the authors and not those of other members of their respective firms, any of their firms’ clients or any organizations with which they are associated.

Although there can be legitimate debate over whether there should be a federally-mandated proxy access rule, if we assume that the Securities and Exchange Commission does adopt a final proxy access rule in 2010, two critical issues are whether the rule will allow for shareholder choice and, if so, what paradigm will be used. This paper first addresses the cases for and against shareholder choice and concludes that shareholder choice should be permitted on proxy access. It then explores the two principal paradigms the Commission’s final proxy access rules could utilize to provide shareholder choice and makes recommendations on key implementation issues under each paradigm.

The debate at the Commission’s open meeting in May 2009, preceding its divided vote to propose proxy access rules, centered on issues of shareholder choice and private ordering. As proposed, the proxy access rules would give shareholders only a right to liberalize proxy access, but no right to make the terms of proxy access more restrictive or to opt-out completely. Many commentators have criticized the asymmetrical, “one way street” aspect of this version of shareholder choice and argued for a broader version that would allow greater freedom to shareholders to vary the SEC prescribed access regime in either direction.

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Security Issue Timing

This post comes to us from Dirk Jenter, Assistant Professor of Finance at Stanford University, Katharina Lewellen, Assistant Professor of Business Administration at Dartmouth University, and Jerold Warner, Professor of Business Administration and Finance at the University of Rochester.

In our forthcoming Journal of Finance paper entitled Security Issue Timing: What Do Managers Know, and When Do They Know It?, we complete a large-scale empirical analysis of companies who sell put options on their own stock. A unique feature of our setting is the ability to investigate option exercises and expirations directly. Also, since put sales can be viewed as a levered bet that the stock price will not drop, they offer a unique setting to study market timing by corporations.

We identify firms that sold put options on their own stock by searching annual and quarterly reports available on the Lexis-Nexis, Factiva, and Edgar databases. We eliminate put issues which were sold in conjunction with other equity or debt securities by the same firm, and retain only stand-alone put sales. We match put sellers with data on firm characteristics from Compustat and data on stock returns from CRSP. The final sample contains 137 firms and 802 distinct put issues.

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House Passes Wall Street Reform and Consumer Protection Act

Margaret E. Tahyar is a partner and member of the New York Financial Institutions Group at Davis Polk & Wardwell LLP. This post was prepared by Ms. Tahyar and Christine Graham, an associate at Davis Polk, and relates to a Davis Polk client memorandum summarizing the provisions of the Wall Street Reform and Consumer Protection Act, which is available here.

Financial sector reform legislation continues to progress through Congress. Earlier this month, the House of Representatives passed its version of the legislation, summarized in this Davis Polk memorandum. The Senate is expected to begin discussion of its draft of the legislation when it returns in January 2010.

The House bill, named the Wall Street Reform and Consumer Protection Act, is an omnibus bill covering all major financial sector legislative reforms under consideration by Congress. As the Wall Street Reform and Consumer Protection Act passed by a narrow vote of 223 to 202, with all Republicans and 27 Democrats voting no, it is clear that many elements remain controversial and subject to change in the Senate. The Senate debate is likely to start with Senate Banking Chairman Christopher Dodd’s proposal, published in November 2009, summarized in this Davis Polk memorandum.

As has been widely reported, the House and Senate proposals differ significantly in the institutional arrangements and the role of the Federal Reserve. However, their impact on the day-to-day business models of major financial institutions is strikingly similar.

We summarize the key business model impacts of the House bill below.

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Executive Compensation and the Maturity Structure of Corporate Debt

This post comes to us from Paul Brockman, Professor of Finance at Lehigh University, Xiumin Martin, Assistant Professor of Accounting at Washington University, and Emre Unlu, Assistant Professor of Finance at the University of Nebraska.

In our paper, Executive Compensation and the Maturity Structure of Corporate Debt, which was recently accepted for publication in the Journal of Finance, we investigate the role of short-term debt in reducing agency costs of debt arising from executive incentive contracts. Specifically, we examine the effect of the two portfolio sensitivities on the maturity structure of corporate debt. In addition, we analyze the effect of debt maturity on the relation between portfolio sensitivities and bond yields.

We study the causal link between CEO incentive compensation and corporate debt maturity using a sample of 6,825 firm-year observations during the 14-year period from 1992 to 2005. We employ alternative definitions of short-term debt, follow Core and Guay’s (2002) method for estimating option sensitivities, and then apply several empirical methodologies (e.g., pooled OLS and GMM simultaneous equation estimation, fixed-effect regressions, change-invariables regressions) and an alternative new debt issuance sample to analyze the predicted relations.

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UK Pre-Budget Report Targets Banking Sector

Edward Greene is a partner at Cleary Gottlieb Steen & Hamilton LLP focusing on corporate law matters. This post is based on a Cleary Gottlieb Steen & Hamilton Alert Memo.

As part of today’s UK Pre-Budget Report, the Chancellor of the Exchequer, Alistair Darling, announced two important measures targeting the banking sector. The first is the introduction of the much-heralded bank bonus tax, which will apply with immediate effect until April 5, 2010, to bonuses over £25,000. The second is the introduction of the Code of Practice on Taxation for Banks, which was originally published in draft form in June of this year.

This memorandum summarizes some of the key elements of these measures.

1. Bank Payroll Tax

Summary

Legislation in the Finance Bill 2010 will introduce a new “bank payroll tax” set at a rate of 50%. It will be payable by a bank, on the amount of a bonus to which an employee engaged in banking business is entitled, to the extent that the bonus exceeds £25,000. The tax will apply to bonuses awarded to the employee after the time of today’s announcement up to April 5, 2010. It is intended that in the longer term the remuneration practices of banking businesses will be changed as a result of corporate governance and regulatory reforms.

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A Review of Corporate Governance in UK Banks and other Financial Industry Entities

Sir David Walker is a senior adviser to Morgan Stanley. He was recently tasked by the British government to lead a commission that would review corporate governance in that country’s banks. This post is based on the Executive Summary and Recommendations of Sir David’s final report, which is available here.  Sir David’s previously discussed the consultation paper regarding his review in this post on the Forum.

In February I was asked by the Prime Minister to review corporate governance in UK banks in the light of the experience of critical loss and failure throughout the banking system. The terms of reference were subsequently extended to include other financial institutions.

To limit immediate crisis damage and to stem the risk of further contagion, substantial and wholly unprecedented public policy action has been taken in the form of state injections of equity and takeover of failed institutions, exceptional liquidity support arrangements and materially tougher capital requirements. The recent and current focus of policy debate in the UK and elsewhere has understandably been on the nature, scale and need for continuance of such public policy support and the shape, extent and timing of further regulatory tightening. But serious deficiencies in prudential oversight and financial regulation in the period before the crisis were accompanied by major governance failures within banks. These contributed materially to excessive risk taking and to the breadth and depth of the crisis. The need is now to bring corporate governance issues closer to centre stage. Better financial regulation has much to accomplish, but cannot alone satisfactorily assure performance of the major banks at the heart of the free market economy. These entities must also be better governed.

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The Global Financial Crisis

The Global Financial Crisis, recently published by Foundation Press, describes the basic causes of the financial crisis; analyzes the regulatory, political and market responses to it; and discusses the merits of various recent reform proposals. Written by Hal S. Scott, the Nomura Professor and Director of the Program on International Financial Systems at Harvard Law School, the book represents perhaps the most learned and succinct account of the financial crisis to date. Its careful focus on the terms of regulation – existing and proposed, U.S. and international – and its clear explanation and analysis of scholarly studies set it apart from many other recent offerings on this topic. The author offers rich, forthright insights and skillfully situates events in their historical and regulatory context. The book will likely hold strong appeal for scholars and policy makers and for others with an interest in rigorous, concise analysis of perplexing policy questions.

The book is structured as follows:

  • Chapter 1 – causes and severity of the financial crisis
  • Chapter 2 – measures taken throughout the crisis to stabilize the financial system
  • Chapter 3 – problems afflicting the housing market and proposed solutions
  • Chapter 4 – proposals for reforming regulatory rules
  • Chapter 5 – proposals for reforming U.S. regulatory structure
  • Chapter 6 – international responses to the crisis

Each chapter is further divided and sub-divided into topics, each of which is just a page or two in length. This structured approach aids understanding without compromising the book’s readability. In this brief post I touch on some of the material covered in the book. I cannot convey the depth of the author’s analysis or reproduce his succinct and engaging literary style.

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A Reference Point Theory of Mergers and Acquisitions

This post comes to us from Professor Malcolm Baker and Xin Pan of Harvard University, and Jeffrey Wurgler, Research Professor of Finance at New York University.

In our recently updated working paper A Reference Point Theory of Mergers and Acquisitions, we propose a “reference point” view of mergers which holds that salient but largely irrelevant reference point stock prices of the target help to explain several aspects of mergers and acquisitions, involving both the pricing and the types and quantities of firms traded.

The standard textbook story on mergers emphasizes synergies. The offer price starts with an estimate of the increased value of the combined entity under the new corporate structure, deriving from a variety of cost reductions. This value gain is then divided between the two entities’ shareholders according to their relative bargaining power. In theory, all of this leads to an objective and specific price for the target’s shares. In practice, however, valuing a company is subjective. A large number of assumptions are needed to justify any particular valuation of the combination. In addition, relative bargaining power may not be fully established. These real-life considerations mean the appropriate target price cannot be set with precision, but established only to be within a broad range. We hypothesize that this indeterminacy, in turn, creates space for the price offered and its reception to reflect other influences, in particular the psychological influences on the board of the target and the bidder and target shareholders, who ultimately must approve the price.

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Panels Discuss International Mergers and Acquisitions

Recently, Vice Chancellor Leo Strine, Jr. hosted two sessions on international aspects of mergers & acquisitions practice in his Mergers and Acquisitions class here at Harvard Law School.

In a presentation entitled Viva Là Difference: Anatomy Of A Cross-Border Deal, David Katz, a partner at Wachtell, Lipton, Rosen & Katz, discussed cross-border mergers and acquisitions, focusing on two French transactions that he’d been involved in, as well as discussing several recent developments relevant to cross-border mergers and acquisitions practice. In particular, he focused on Sanofi’s hostile acquisition of Aventis, and contrasted it with the merger of equals of Alcatel and Lucent. The video of this session is available here.

In the second panel, distinguished practitioners and academics discussed takeover transactions in Europe with the Vice Chancellor. The panel consisted of David Katz; Scott Simpson, co-head of Skadden’s Global Transactions Practice; Jaap Winter, a partner at De Brauw Blackstone Westbroek in Amsterdam and professor of international company law at the University of Amsterdam, as well as acting Dean of the Duisenberg school of finance; and John Coates, John F. Cogan, Jr. Professor of Law and Economics here at Harvard Law School. The panel discussed the differences in practice between European Union takeover law and the Delaware regime. Mr. Winter described the EU Takeover Directive, and the panel discussed its effects. A video of their discussion can be accessed here. (video no longer available)

(Videos are in Quicktime .mov format. Click here to download the latest version of Quicktime.)

Some Thoughts for Boards of Directors in 2010

Steven Rosenblum is a partner in the Corporate Department of Wachtell, Lipton, Rosen & Katz. This post is based on a Wachtell, Lipton, Rosen & Katz client memorandum by Mr. Rosenblum, Martin Lipton and Karessa L. Cain, which is available here.

Never before in the history of American business has the role of the corporate director been more important or more challenging. Boards today must navigate a tremendously difficult business environment featuring intense competition from foreign manufacturers, weak consumer confidence, growing unemployment, volatility in financial and commodity markets and a host of other complex challenges. At the same time, directors are currently undergoing intense public and political scrutiny of their basic role and functioning at the helm of public companies. As we begin to emerge from the worst recession since the Great Depression, the search for root causes of the economic crisis and second-guessing of corporate decisions has generated a multitude of corporate governance reform proposals, legislative initiatives and rule-making that seek to shift decision-making authority from boards to institutional shareholders and shareholder activists. Despite the stated intention of these initiatives, this shift will impede the ability of boards to resist pressures for short-term gain and tie their hands at a time when the need for effective board leadership is particularly acute.

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