Monthly Archives: January 2010

Tackling the Root Causes of Shareholder Passivity and Short-Termism

Simon Wong is Managing Director at Governance for Owners and Adjunct Professor of Law at Northwestern University School of Law.

Streams of recommendations have begun to flow from bodies tasked with remedying the persistent problem of institutional investor passivity and short-termism. While the suggestions of the Institutional Shareholders’ Committee (ISC) and Walker Review are generally sensible, they are incomplete because significant asset owner issues remain unresolved. Until the root causes – particularly the inability of pension funds and other institutional asset owners to robustly monitor asset managers and the misalignment of interest between the two parties – are tackled head-on, reforms in this area will have limited impact.

Current reform efforts assume that asset owners maintain a strong interest in, and possess capabilities to meaningfully evaluate, their fund managers’ corporate governance activities. Many don’t.

To fulfill obligations under the Myners Principles to monitor fund managers’ adherence to the ISC Statement of Principles on the Responsibilities of Institutional Shareholders and Agents, many asset owners ask their investment managers the following annually: “Does your firm comply with the ISC Principles?” It is disconcerting that a perfunctory “yes” is often a sufficient response. Equally worrying, this exercise frequently transpires between the owner’s pension consultants and the manager’s client relationship team. Little or no effort is made by pension fund trustees or staff to speak directly with investment firm personnel who vote and engage on their behalf to discuss successful and problematic interventions, sufficiency of allocated resources, and areas for improvement.


Street Name Registration: An Antiquated Idea

This post comes to us from James McRitchie, Editor of and Glyn Holton, Executive Director, United States Proxy Exchange.

“Street name registration” largely took root under emergency conditions stemming from a paperwork crisis during the 1960s, before networked computers were ubiquitous in trading markets. Immobilizing stock and registering it in the name Cede &Co., which was presumed by many to a temporary measure, now undermines our ownership culture.

Just as poker chips allow us to play under rules that often favor the house, those holding “security entitlements,” instead of registered stock, do not acquire the rights of real shareowners.

Street name registration, and the costs associated with shareowners learning each other’s identity, escalates the cost of proxy solicitations to hundreds of thousands of dollars—and that exorbitant cost is why entrenched boards routinely run unopposed. Eliminating street name registration, in favor of a direct registration system (DRS), could bring the cost of proxy solicitation down to a few thousand dollars. That could have a bigger impact on shareowner rights than the SEC’s proposed proxy access initiative.


A Gap-filling Theory of Corporate Debt Maturity Choice

This post comes to us from Robin Greenwood, Associate Professor of Business Administration at Harvard Business School, Samuel Hanson, Ph.D. Candidate in Business Economics at Harvard University, and Jeremy Stein, Professor of Economics at Harvard University.

In our paper A Gap-filling Theory of Corporate Debt Maturity Choice, which was recently accepted for publication in the Journal of Finance, we develop a new theory to explain time-variation in corporate maturity choice. As in BGW (2003), our theory allows for predictability in bond market returns and has the feature that corporate issuers tend to benefit from this predictability – ­i.e., they use short-term debt more heavily when its expected returns are lower than the expected returns on long-term debt. Crucially, however, we do not assume any forecasting advantage for corporate issuers: they have no special ability to predict future returns, or to recognize sentiment shocks. Instead, the key comparative advantage that corporate issuers have relative to other players in our model is an advantage in macro liquidity provision.


FDIC and Private Capital: Moving the Goal Lines

Editor’s Note: Margaret E. Tahyar is a partner and member of the New York Financial Institutions Group at Davis Polk & Wardwell LLP. This post is based on a Davis Polk client memorandum by John Douglas, Luigi De Ghenghi, Arthur Long and William Taylor.

For the second time since adopting its Final Statement of Policy for Failed Bank Acquisitions (the “Policy Statement”), the FDIC has issued “Questions and Answers” (the “Revised Q&As”) about the Policy Statement that appear to make it more difficult for private investors to avoid the onerous standards and requirements of the Policy Statement. [1] The FDIC will now presume that, if more than two-thirds of the total voting stock of an insured depository institution or its holding company that acquires a failed bank or thrift is held by private investors that each own 5% or less of the voting stock, the private investors are acting in concert as a single investor group. The private investors will be subject to the requirements of the Policy Statement unless they can satisfy the FDIC that the presumption has been rebutted. This position seems to confirm the FDIC’s preference for transactions in which an existing bank holding company owns at least two-thirds of the voting stock of the acquiring depository institution or its holding company or is itself the acquirer (with new private investors limited to no more than one-third of the existing bank holding company’s total equity).


Why Investment Bankers Should Have (Some) Personal Liability

This post comes to us from Claire Hill and Richard Painter. Claire Hill is the Solly Robins Distinguished Research Fellow and Professor of Law at the University of Minnesota Law School; Richard Painter is the S. Walter Richey Professor of Corporate Law at the University of Minnesota Law School. The post relates to a recent paper by Professors Hill and Painter, which is available here.

Commentators on this blog and elsewhere have discussed solutions to problems that caused the most recent financial crisis. A pervasive theme has been the excessive appetite for risk in the banking industry and the impact of compensation on attitudes toward risk.

Some commentators have proposed making stock-based compensation more “long term” by requiring bankers to retain stock holdings in their employers. Others such as Lucian Bebchuk and Holger Spamann have recommended that bankers’ compensation be tied to the fortunes of creditors, not just shareholders. (Learn more about their views here.) Many of these proposals would be an improvement upon the status quo.

We are concerned, however, that these proposals – and others currently being considered in Congress – do not go far enough in linking the financial interest of bankers with the financial health of their banks. Bankers may lose upside profits if their banks do not do well, but they do not share the downside impact that their own risk taking has on broad segments of society – creditors, customers, employees and ultimately, taxpayers.


Restoring Trust in Corporate Governance

Editor’s Note: Ben W. Heineman, Jr. is a former GE senior vice president for law and public affairs, a senior fellow at Harvard University’s schools of law and government and trustee of the Committee for Economic Development. This post is based on a Policy Brief by Mr. Heineman published by the Committee for Economic Development, which is available here. This article also appeared in Business Week Online.

The business community faces a crisis in confidence both in its own ranks and in the broader society. Many are asking: how can corporations govern themselves more effectively – and truly be held accountable?

One answer is increased public regulation. The origins of the Great Recession include bad business decision-making caused in no small part by excessive and poorly structured corporate compensation. Not surprisingly, there are now energetic public policy debates about the governance both of the financial sector (a variety of measures are being considered to ensure safety and soundness) and of all publicly held corporations (with focus on an enhanced shareholder role and mandated compensation and risk processes.

Six Essential Tasks

But, regardless of regulatory outcomes, boards of directors and business leaders will still have to make complex decisions that direct the destiny of corporations. In doing so, they must, in my view, discharge six essential, interrelated tasks which are the foundation for rebuilding trust in corporate governance and addressing the ultimate questions of corporate accountability which underlie the governance debates.


Financial Strength and Product Market Behavior

This post comes to us from Laurent Fresard, Assistant Professor of Finance at HEC Paris.

Seldom has corporate strategy been turned on its head so quickly. Not long ago, cash holdings were considered a dangerous thing to accumulate and companies that hoarded large cash positions were viewed with a great deal of suspicion. However, the recent market turmoil and the resultant tightening of credit have clearly emphasized the advantage of maintaining a liquid balance sheet, as many firms are desperately seeking to avoid a cash squeeze. This rapidly changing perspective underscores the need for a deeper understanding of what the implications of corporate cash policy really are. Indeed, although recent developments have considerably broadened our knowledge of the various determinants of corporate cash holdings, the literature has so far paid little attention to whether cash holdings have a material effect on firms’ day-to-day operations. My paper, Financial Strength and Product Market Behavior: The Real Effects of Corporate Cash Holdings, forthcoming in the Journal of Finance, helps bridge that gap by examining whether cash holdings include a strategic dimension that affects firms’ product market decisions.


Supreme Court Strikes Down Restrictions on Corporate Speech

Ted Olson is a partner at Gibson, Dunn & Crutcher LLP and former Solicitor General of the United States; this post is based on a Gibson Dunn Update by Mr. Olson, Matthew D. McGill and Amir C. Tayrani. Messrs. Olson, McGill and Tayrani, and Ryan J. Watson briefed Citizens United v. Federal Election Commission on behalf of Citizens United; Mr. Olson argued the case in the U.S. Supreme Court in March 2009 and re-argued the case in September 2009.

On January 21, 2010, the U.S. Supreme Court issued a groundbreaking decision in Citizens United v. Federal Election Commission, which held that portions of the McCain-Feingold campaign finance law banning corporate and union expenditures on political speech violate the First Amendment. The decision also calls into question similar restrictions on corporate speech in two dozen States.

The case arose out of Citizens United’s January 2008 release of Hillary: The Movie, a 90-minute critical documentary about then-Senator Hillary Clinton, who was a candidate for the Democratic Party’s presidential nomination. Citizens United sought to distribute the movie through Video On Demand, but was prohibited from doing so because federal law made it a felony for corporations–including nonprofit corporations–to use their general treasury funds for political advocacy. Citizens United filed suit challenging those restrictions. After Citizens United lost before a three-judge district court, the Supreme Court granted review and set the case for argument in March 2009. At its final sitting before its summer recess, the Court then took the highly unusual step of ordering re-argument of the case at a special September 2009 sitting.


The Corporate Consequences of the Supreme Court’s Decision

Mark Roe is a professor at Harvard Law School, where he teaches bankruptcy and corporate law. This post is based on an op-ed by Professor Roe that appeared today in the Financial Times.

Last week, the US Supreme Court ruled that the Congressional limit on corporations and labor unions advertising for and against political candidates violates free speech principles.

Constitutional law scholars, the media and the public will debate whether corporations are entitled to free speech protections and Congress may revisit campaign contribution limits and public funding.

But the potential corporate, business and economic consequences of the decision, assuming it stands, are profound. Conservative and business media have thus far favored the decision as helpful to business; but it’s not at all clear that it is favorable to the economy. It’s likely to hurt the dynamism of the American economy, perhaps severely.

The Court’s decision will strengthen the hand of incumbent interests over unorganized emerging interests. That is not good. Incumbent business interests often see upstarts as competing unfairly, as needing to be regulated, and as deserving of being suppressed. Incumbent businesses like politicians to squelch new entrants. With their checkbooks now opened up, they will support politicians who seek to regulate and suppress upstarts.


The Harvard Law School Proxy Access Roundtable: The Transcript

The Harvard Law School Program on Corporate Governance recently released as a working paper the transcript of the Program’s Proxy Access Roundtable, which was held late last year.  The working paper containing the transcript is available here. The editors, Lucian Bebchuk and Scott Hirst, have also submitted the transcript to the Securities and Exchange Commission as a comment on the Commission’s proposed rule on proxy access, Facilitating Shareholder Director Nominations, and hope that it will be a useful contribution as the Commission considers rulemaking on the subject.

The Roundtable brought together prominent participants in the debate – representing a range of perspectives and experiences – for a day of discussion on the subject.  The day’s first two sessions focused on the question of whether the Securities and Exchange Commission should provide an access regime, or whether it should leave the adoption of access arrangements, if any, to private ordering on a company-by-company basis. The third session focused on how a proxy access regime should be designed, assuming the Securities and Exchange Commission were to adopt such an access regime. The final session went beyond proxy access and focused on whether there are any further changes to the arrangements governing corporate elections that should be considered. Further information about the Roundtable is available here.  The transcript was edited by the participants and the editors, with the aim of retaining the spirit of the Roundtable while ensuring that the message of each participant is clearly and accurately conveyed to readers.


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