Monthly Archives: January 2010

CEO Cash Compensation and Poor Firm Performance

This post comes to us from Ken Shaw and May Zhang, both Assistant Professors of Accounting at the University of Missouri Trulaske College of Business.

In our paper, Is CEO Cash Compensation Punished for Poor Firm Performance?, which was recently accepted for publication in the Accounting Review, we examine the asymmetry in the CEO pay-performance relation. In particular, we examine whether CEO pay is more sensitive to poor stock price performance than to good performance, as claimed by Leone, Wu, and Zimmerman (2006, Journal of Accounting and Economics).

Our main sample consists of 14,632 firm-year observations over 1993-2005. We measure firm performance using the change in return on assets (ROA) and stock returns. We use a three-way performance partition to identify firm-year observations as strong, intermediate, or poor performers. We regress changes in CEO cash compensation on change in ROA and stock return performance variables, allowing for differing slopes among the performance partitions and controlling for firm size, book-market ratio, leverage, cash constraints, and the issuance of new equity or debt securities. We find no asymmetry in CEO cash compensation for firms with low stock returns. Further, we find that CEO cash compensation is less sensitive to poor earnings performance than it is to better earnings performance. These results suggest CEO cash compensation is not punished for poor firm performance.

In additional analyses, we test whether CEO pay is punished for poor firm performance in subsamples of firms with strong corporate governance. We alternatively define firms with strong corporate governance as those with a low G-Index, a high percentage of independent directors, or a high percentage of shares owned by institutional investors. Even among the worst-performing firms with the strongest corporate governance, we are unable to find evidence of CEO pay being punished for poor firm performance.

The full paper is available for download here.

Letters of Intent — Ties that Bind?

David Fox is a partner at Kirkland & Ellis LLP, focusing on complex mergers and acquisitions as a member of that firm’s Corporate Group. This post is based on a Kirkland & Ellis M&A Update by Daniel Wolf, a partner at Kirkland & Ellis specializing in mergers and acquisitions, corporate finance, securities and general corporate matters. 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.

A recent Delaware bench decision from newly appointed VC Laster on a motion for a temporary restraining order offers a timely reminder of potential pitfalls for parties entering into letters of intent or term sheets (for ease of reference, collectively referred to as LOIs) with the expectation that they merely represent an unenforceable “agreement to agree.”

In the present case, the plaintiff, Global Asset Capital, entered into a letter of intent with the defendant, Rubicon U.S. REIT, that contemplated Rubicon filing for bankruptcy in conjunction with Global signing an agreement to act as the stalking horse bidder with the benefit of a break-up fee in a court-supervised auction. While the recitation and findings of fact are extremely limited given the preliminary nature of the proceedings, the court did grant injunctive relief based on colorable claims that the exclusivity and confidentiality provisions of the LOI were breached by Rubicon and that Rubicon had failed to negotiate in good faith with Global as required by the LOI.


Maintaining Board Confidentiality

Charles Nathan is Of Counsel at Latham & Watkins and is Global Co-Chair of the firm’s Mergers and Acquisitions Group. This post is based on a Latham & Watkins Corporate Governance Commentary by Mr. Nathan, Stephen Amdur and Colin Bumby.

The increasing success of shareholder activists in designating or electing directors is altering the composition of public company boards. It is also posing challenges to long-held assumptions about the sanctity of board deliberations and the nature of a director’s confidentiality obligations to fellow directors and the company.

The almost certain advent of proxy access will exacerbate these issues because it will inevitably increase the number of shareholder-nominated directors in the board room.

Notwithstanding the theoretical implications of the legal principle that a director, no matter how nominated or by whom, owes fiduciary duties to all shareholders, as a practical matter shareholder-nominated directors are often viewed, and in fact act, as representatives of their shareholder sponsors—what some call “special interest” or “constituency” directors.

The presence of constituency directors in a board room heightens concerns about confidentiality in two important, but often distinct, realms.


Compensation in the Financial Industry

Editor’s Note: This post is the written testimony (with footnotes omitted) submitted by Professor Lucian Bebchuk to the Committee on Financial Services, United States House of Representatives. Professor Bebchuk will be testifying today in the hearing on “Compensation in the Financial Industry.” The hearing will begin today at 10 a.m., and information about it and a link to a webcast of it can be found here. Professor Bebchuk’s complete written testimony (including footnotes) can be found here.

Chairman Frank, Ranking Member Bachus, and distinguished members of the Committee, thank you very much for inviting me to testify today.

Below I provide a brief account of some of the key issues facing us in examining compensation in the financial industry. My views on some of these issues are provided in more detail in the following three research papers from which this written testimony draws:

  • The Wages of Failure: Executive Compensation at Bear Stearns and Lehman 2000-2008 (with Alma Cohen and Holger Spamann)
    Harvard Law and Economics Discussion Paper No. 657, (December 2009).
    Forthcoming, Yale Journal on Regulation (2010).
    Available at SSRN:
  • Paying for Long-Term Performance (with Jesse Fried)
    Harvard Law and Economics Discussion Paper No. 658 (December 2009).
    Available at SSRN:
  • Regulating Bankers’ Pay (with Holger Spamann)
    Harvard Law and Economics Discussion Paper No. 641 (October 2009).
    Forthcoming, Georgetown Law Journal (2010).
    Available at SSRN:

Incentives for Risk-Taking

Standard compensation arrangements in publicly traded firms have rewarded executives for short-term results even when these results were subsequently reversed. Such arrangements have provided executives with excessive incentives to focus on short-term results. This problem, first highlighted in a book and accompanying articles that Jesse Fried and I published five years ago,2 has become widely recognized in the aftermath of the financial crisis. In financial firms, where risk-taking decisions are especially important, rewards for short-term results provide executives with incentives to improve such results even at the risk of an implosion later on.


Governance Problems in Closely-Held Corporations

This post comes to us from Venky Nagar, Associate Professor of Accounting at the University of Michigan, Kathy Petroni, Professor of Accounting at Michigan State University, and Daniel Wolfenzon, Professor of Finance and Economics at Columbia Business School.

The notion of balance of power, as any schoolchild or immigration test-taker knows, was central to our Founding Fathers’ conception of effective governance. Their deep insight on human behavior not only shaped our political institutions, but also cleanly translated to the design of modern corporations. As Berle and Means have noted, owners of a corporation that separates ownership from control have to remain ever-vigilant about expropriation by the controlling party. One way to achieve balance of power is to share ownership across individuals, so that no individual can unilaterally expropriate. However, the benefits of shared ownership are difficult to assess in public firms for two reasons. First, the large number of owners implies that each owner free rides with respect to the monitoring efforts of other owners (the individual owner may also not have the relevant expertise). Second, the liquid market of a company’s shares enables ownership structures to evolve endogenously. In equilibrium, the ownership structure of firms depends on their specific conditions and, as a result, it is difficult for an outsider to disentangle the effect of ownership structure from the effect of other firm characteristics.


The Board’s Role in Succession Planning

Jeffrey Stein is a partner in the Corporate Practice Group at King & Spalding LLP. This post is by Mr. Stein, Bill Baxley and Rob Leclerc, and relates to a report on a recent meeting of the Lead Director Network, which is available here.

One of the most challenging aspects of the recent financial crisis has been the significant increase in the number of CEOs who have left their companies unexpectedly or on short notice. Despite this trend and the widespread view that succession planning is a critical board function, directors of many public companies are not fully satisfied with the effectiveness of their succession planning.

Against this background, the Lead Director Network, a group of lead directors, presiding directors and non-executive chairmen from many of America’s leading companies, met recently to discuss the board’s role in succession planning. Following this meeting, King & Spalding and Tapestry Networks have published the ViewPoints report here to present highlights of the discussion that occurred at the meeting and to stimulate further consideration of this subject.


Worldwide Investor Preferences for Performance Measures

This post comes to us from Jan Barton, Associate Professor of Accounting at Emory University, Bowe Hansen, Assistant Professor at the University of New Hampshire, and Grace Pownall, Professor of Accounting at Emory University.

In our paper, Which Performance Measures Do Investors around the World Value the Most – and Why?, which was recently accepted for publication in the Accounting Review, we examine the value relevance of a comprehensive set of summary performance measures including sales, earnings, comprehensive income, and operating cash flows.

Academics and practitioners have recently begun to move away from proposing “better” measures of earnings to instead focusing on earnings quality attributes—such as persistence, predictability, smoothness, and timeliness—that may make a particular earnings measure more useful in equity valuation, especially if such attributes capture some dimension of information risk about the firm’s future performance.


A Stewardship Code for Institutional Investors

Editor’s Note: Ben W. Heineman, Jr., the former GE Senior Vice President for Law and Public Affairs, is senior fellow at the Harvard Law School Program on Corporate Governance and the Harvard Law School Program on the Legal Profession, as well as senior fellow at Harvard Kennedy School’s Belfer Center for Science and International Affairs. This post is based on an article by Mr. Heineman published today in the Harvard Business Review Online.

The role of shareholders in corporate governance has become one of the hot-button issues following the credit melt-down and economic crisis. Would more active involvement by shareholders have helped to prevent or lessen the crisis?

Broadly speaking, there are those who believe that short-term institutional shareholders — with concern about making their own quarterly or annual numbers, with opaque governance and improper incentives for fund-managers — are part of the problem, and that they have been one of the causes of short-sighted, risk-indifferent behavior by financial institutions.

On the other hand, there are those who believe that longer-term institutional shareholders are part of the solution — that increased shareholder involvement in governance, not just through exercise of market power, is essential to creation of sustainable, long-term corporate value, and to holding boards of directors and senior business leaders accountable. Such shareholder proponents advocate regulation or voluntary corporate action on key issues like “say on pay” or “proxy access.”

A “third way” emerged late last year in the UK — a “Stewardship Code” for institutional investors.


Risks to Overbidders Under Delaware Law

William Savitt is a partner in the Litigation Department of Wachtell, Lipton, Rosen & Katz. This post is based on a Wachtell Lipton client memorandum by Mr. Savitt and Ryan A. McLeod, an associate in Wachtell Lipton’s Litigation Department. 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.

A recent Delaware Court of Chancery decision refusing to dismiss damages claims by NACCO Industries arising out of its failed attempt to acquire Applica Inc. provides important guidance for parties contemplating an overbid and highlights the risks that remain even after a topping deal is successfully closed. NACCO Indus., Inc. v. Applica Inc., C.A. No. 2541-VCL (Dec. 22, 2009).

The complaint alleged that while NACCO and Applica were negotiating a merger agreement in 2006, Applica insiders provided information to principals at the Harbinger hedge funds, which were then considering their own bid for Applica. During this period, Harbinger amassed a substantial stake in Applica (which ultimately reached 40 percent) but reported only an “investment” purpose on its Schedule 13D filings, disclaiming any intent to control the company. After NACCO signed up the merger, the complaint alleged, communications between Harbinger and Applica management about a topping bid continued. Eventually, Harbinger amended its Schedule 13D disclosures and made a topping bid for Applica, which then terminated the NACCO merger agreement. After a bidding contest with NACCO, Harbinger succeeded in acquiring the company.


Looking Ahead at 2010 By Looking Back at 2009

Francis H. Byrd is Managing Director and Corporate Governance Advisory Practice Co-Leader at The Altman Group. This post is based on an Altman Group Governance and Proxy Review by Mr. Byrd.

Now this is not the end. It is not even the beginning of the end. But it is, perhaps, the end of the beginning. – Sir Winston Spencer Churchill

Don’t look back. Something might be gaining on you. – Leroy (Satchel) Paige

As 2009 comes to a close and we prepare for the 2010 proxy season, it is time to contemplate the changes that have occurred, and what they might portend for 2010. The two quotes above seem to best encapsulate both the mood and the reality of those involved in corporate governance.

As 2009 started, advisors and observers hunkered down to weather all of the dramatic changes that appeared to be certainties: Proxy Access, ‘Say on Pay’ (SOP), and separation of the role of Chairman from that of Chief Executive would altered by legislative fiat or regulatory order. Yet despite all of the motion and noise, only one major governance change took place in 2009, that of the Securities and Exchange Commission amending the broker discretionary vote, NYSE Rule 452, relating to director elections. 2009 might have been an even more dramatic year for corporate governance had it not been for the Obama administration focus on health care. This shift in attention on the part of the White House has been cited by numerous commentators as a key reason for the decrease in momentum of financial and governance-related regulation and legislation.


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