Monthly Archives: January 2010

Mandatory Accounting Standards and the Cost of Equity Capital

This post comes to us from Siqi Li, Assistant Professor of Accounting at Santa Clara University.

In my forthcoming Accounting Review paper Does Mandatory Adoption of International Financial Reporting Standards in the European Union Reduce the Cost of Equity Capital? I test whether mandatory IFRS adoption affects the cost of equity capital using a sample of 6,456 observations representing 1,084 distinct firms in 18 EU countries during the period of 1995 to 2006. I define firms that do not adopt IFRS until it becomes mandatory in 2005 as mandatory adopters, firms that adopt IFRS before 2005 as voluntary adopters, and I divide the sample period into pre- and post-mandatory adoption periods.

My primary analysis consists of regressing the cost of equity (using average estimates from four implied cost of capital models) on a dummy variable indicating the type of adopter (mandatory versus voluntary), a dummy variable indicating the time period (pre- versus post-mandatory adoption period), the interaction between these two dummies, and a set of control variables that include whether a firm is cross-listed in the U.S., country-specific inflation rate, firm size, return variability, financial leverage, as well as industry and country fixed effects. This difference-in-differences design, which includes the population of both mandatory and voluntary adopters over the period of 1995 through 2006, compares the change in the cost of equity for mandatory adopters before and after the mandatory switch, relative to the corresponding change in the cost of equity for voluntary adopters.


Federal Court Rejects Claim that Merger Negotiations are Required to be Disclosed

Paul Vizcarrondo Jr. is a partner in the Litigation Department of Wachtell, Lipton, Rosen & Katz specializing in corporate and securities litigation and regulatory and white collar criminal matters. This post is based on a Wachtell Lipton client memorandum by Mr. Vizcarrondo and Jonathon R. La Chapelle, associate in Wachtell Lipton’s Litigation Department.

The United Stated District Court in Chicago has granted summary judgment dismissing a class action claiming that statements by Sears about its business that did not also disclose that it was negotiating a merger with Kmart constituted federal securities fraud. Levie v. Sears Roebuck & Co., No. 04C7643 (N.D. Ill. December 18, 2009).

Sears and Kmart had briefly discussed in the spring of 2004 the possibility of Sears acquiring Kmart through a merger, but instead Sears agreed in June 2004 to buy 54 Kmart stores. The complaint alleged that the merger negotiations continued after that, and Sears’ failure to disclose their existence made its public statements about its business plans materially misleading. In declining to dismiss the complaint, the Court stated that “[i]f the merger negotiations became material at a point in time when the Sears defendants were making announcements about the purchase of Kmart stores, a jury could find that the existence of the merger negotiations was a material fact necessary to make the store purchase statements not misleading.”


Creditor Rights and Corporate Risk-Taking

This post comes to us from Viral Acharya, Professor of Finance at New York University, Yakov Amihud, Professor of Finance at New York University, and Lubomir Litov, Assistant Professor of Finance at Washington University in St. Louis.

In a recent working paper Creditor Rights and Corporate Risk-Taking, we study the effect of creditor rights in bankruptcy on corporate risk-taking. In particular, we ask: What effect does the strength of creditor rights have on firms’ investment decisions? In other words, while a harsh penalty in default reduces fraud and opportunistic behavior by debtors, might it also inhibit entrepreneurial, bona-fide risky investment?

Our empirical analysis uses as an explanatory variable the variation of creditor rights across countries in their bankruptcy codes, documented by La Porta et al. (1998), which are largely a function of the country’s legal origin and exogenous to the nature of the country’s overall corporate investments. We employ several different measures of corporate risk-taking and examine their relationship to creditor rights across countries and over time.


Drafting Disclosure Relating to Board Leadership and Risk Oversight

Jeffrey Stein is a partner in the Corporate Practice Group at King & Spalding LLP. This post is by Mr. Stein and Bill Baxley, a partner in King & Spalding’s Corporate Practice and co-head of the firm’s Mergers & Acquisitions initiative.

For some years now, corporate governance experts have debated the best model of board leadership for public companies.  Studies have compared the historically prevailing U.S. model – in which the chief executive officer also serves as chairman of the board — with different approaches that are more common in other countries, such as the typical approach in many European markets of having an independent board chair.  As U.S. public companies were caught off guard by the depth and severity of the most recent financial crisis, what seemed before to be primarily an academic subject became very real for U.S. public companies.  Some observers suggested that the U.S. board leadership model (and specifically the failure of U.S. regulators to require an independent board chair) contributed to the crisis and to the failure of U.S. public companies to be prepared for the effects of the crisis. Legislators and regulators picked up on this theme, with suggestions that public companies should be required to have an independent board chair.

In the years between Sarbanes-Oxley and the 2008/2009 financial crisis, many boards realized that there were alternatives to having an independent board chair.  For example, many companies continue to have a combined CEO/chairman, but have appointed a “lead” or “presiding” director.  Even where there is no director holding such a title, many boards have called on particular directors (for example, the chair of the audit committee or the chair of the governance committee) to take leadership roles, on behalf of the independent directors.  Moreover, with the tumult in some board rooms and executive suites arising out of the most recent financial crisis, boards in certain instances have chosen, in response to their specific circumstances, to go the route of having an independent board chair, at least until the crisis passes.  Accordingly, as we enter 2010, it is no longer appropriate to say that there is one “prevailing” model of board leadership for U.S. public companies.  Rather, boards increasingly are choosing their leadership models based on their specific circumstances, such as the talent and experience of the chief executive officer, the challenges that the company is facing, and the preferences of their large shareholders.


Taking Stock: What Has the Troubled Asset Relief Program Achieved?

Editor’s Note: Elizabeth Warren is the Leo Gottlieb Professor of Law at Harvard Law School, and the Chair of the Congressional Oversight Panel established in 2008 to review the current state of financial markets and the regulatory system. This post is based on a recent report of the Panel. The complete report is available here.

The financial crisis that gripped the United States last fall was unprecedented in type and magnitude. It began with an asset bubble in housing, expanded into the subprime mortgage crisis, escalated into a severe freeze-up of the interbank lending market, and culminated in intervention by the United States and other industrialized countries to rescue their banking systems.

The centerpiece of the federal government’s response to the financial crisis was the Emergency Economic Stabilization Act of 2008 (EESA), which authorized the Treasury Secretary to establish the $700 billion Troubled Asset Relief Program (TARP) and created the Congressional Oversight Panel to oversee the TARP. In a recent report, Taking Stock: What Has the Troubled Asset Relief Program Achieved? (available here), issued at the end of the first full year of TARP’s existence, the Panel is taking stock of the TARP’s progress: reviewing what the TARP has accomplished to date, and exploring where it has fallen short.


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