Monthly Archives: July 2010

Sustainability in the Boardroom

This post comes to us from Matteo Tonello, Director of Corporate Governance for The Conference Board, Inc., and is based on a paper by Mr. Tonello titled Sustainability in the Boardroom, which is available here.

In a recent paper, Sustainability in the Boardroom, published as part of the Conference Board’s Director Notes series, I discuss the findings from a survey of board practices in the area of sustainability by 50 public companies of different industries and revenue groups.

The survey revealed flaws in how corporate boards oversee their companies’ social and environmental initiatives. In particular, what appears to be largely missing is access to independent sources of information on the impact of business operations on the environment as well as detailed procedures and metrics for integrating social objectives into daily corporate activities. Directors mostly rely on reports by senior executives (89.2 percent of respondents) and almost never use additional sources (including peer-company benchmarks, environmental reports, director education programs, and consultants) that would help them critically verify and analyze any internally produced information on these matters. For most companies, sustainability discussions with the board only take place in reaction to emergency situations like the oil spill in the Gulf.

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The Future of Institutional Share Voting: Three Paradigms

Charles Nathan is Of Counsel at Latham & Watkins LLP and is co-chair of the firm’s Corporate Governance Task Force. This post is based on a recent Latham Corporate Governance Commentary, and follows up on an earlier Latham Commentary, The Parallel Universes of Institutional Investing and Institutional Voting, which is available here.

In a recent Corporate Governance Commentary, titled “The Parallel Universes of Institutional Investing and Institutional Voting, [1]” we observed the increasing discontinuity at most institutional equity investors between the persons who make the buy and sell decisions (or who create and maintain the quantitative models that make those decisions) and those who make the decisions on how to vote portfolio shares. We analogized the separation of the two functions to parallel universes to highlight the autonomous nature of each function. While we noted that this pattern is not universal among institutional equity investors, we stated our belief that it is the prevailing method by which institutional investors solve the financial dilemma created by the large, and for some institutions literally overwhelming, number of votes they are required to cast each proxy season by the federal government’s imposition of a fiduciary duty to vote all portfolio shares on all matters brought to shareholders.

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Bankruptcy and the Collateral Channel

This post comes to us from Efraim Benmelech of the Department of Economics at Harvard University and Nittai Bergman of the Department of Finance at MIT.

In the paper, Bankruptcy and the Collateral Channel, which is forthcoming in the Journal of Finance, we investigate whether bankrupt firms affect their competitors in a causal manner or whether the observed adverse effects merely reflect changes in the economic environment faced by the industry at large. Using a novel dataset of secured debt tranches issued by U.S. airlines, we provide empirical support for the collateral channel.

Airlines in the U.S. issue tranches of secured debt known as Equipment Trust Certificates (ETCs), Enhanced Equipment Trust Securities (EETCs), and Pass Through Certificates (PTCs). We construct a sample of aircraft tranche issues and then obtain the serial number of all aircraft that were pledged as collateral. For each of the debt tranches in our sample we can identify precisely its underlying collateral. We then identify the ‘collateral channel’ off of both the time-series variation of bankruptcy filings by airlines, and the cross-sectional variation in the overlap between the aircraft types in the collateral of a specific debt tranche and the aircraft types operated by bankrupt airlines. The richness of our data – which includes detailed information on tranches’ underlying collateral and airlines’ fleets – combined with the fairly large number of airline bankruptcies in our sample period, allows us to identify strategic externalities that are likely driven by a collateral channel rather than by an industry shock to the economic environment.

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Meeting the Challenge of Nimble and Effective Regulation

Editor’s Note: Mary Schapiro is Chairman of the U.S. Securities and Exchange Commission. This post is based on Chairman Schapiro’s recent remarks at the National Conference of the Society of Corporate Secretaries and Governance Professionals, which are available here in their entirety. The views expressed in the post are those of Chairman Schapiro and do not necessarily reflect those of the Securities and Exchange Commission, the other Commissioners, or the Staff.

The Society has long been a force for positive change. In fact, your members have played an important role in ensuring that attitudes and practices change as the business and economic environments evolve—a role that may be as important today as it has been at any point in your history.

Your importance within the corporate structure speaks to my reason for coming today. I’m here to talk about change—to remind you why we need it, to tell you how the SEC has embraced it, and to ask for your input as we embark upon new changes going forward.

The events of the last two years have transformed our world. Your companies, the SEC, the markets and our nation, all changed in significant ways, and on short notice, as each of us strove to react to the most significant economic crisis of our lifetimes.

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Dodd-Frank Act Becomes Law

William Sweet is a partner at Skadden, Arps, Slate, Meagher & Flom LLP concentrating in financial institution merger and acquisition, regulatory and enforcement matters. This post is extracted from Skadden’s analysis of the Dodd-Frank Act, which was signed into law today by President Obama. Skadden’s materials, The Dodd Frank Act: Commentary and Insights, are a collection of commentaries coordinated by Mr. Sweet, which summarize and analyze the Dodd-Frank Act; they are available here. Other posts relating to the Dodd-Frank Act are available here.

The Dodd-Frank Wall Street Reform and Consumer Protection Act (henceforth, the “Dodd-Frank Act”), was signed into law by President Obama on Wednesday July 21, 2010. The Act spans over 2,300 pages and affects almost every aspect of the U.S. financial services industry. The objectives ascribed to the Act by its proponents in Congress and by the President include restoring public confidence in the financial system, preventing another financial crisis, and allowing any future asset bubble to be detected and deflated before another financial crisis ensues.

The Dodd-Frank Act effects a profound increase in regulation of the financial services industry. The Act gives U.S. governmental authorities more funding, more information and more power. In broad and significant areas, the Act endows regulators with wholly discretionary authority to write and interpret new rules.

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SEC Prohibits “Pay to Play” for Investment Advisers and Fund Managers

Jack S. Levin is a partner at Kirkland & Ellis LLP, and is regularly a visiting lecturer at Harvard Law School. This post is based on a Kirkland Private Equity Newsletter article by Mr. Levin, Scott A. Moehrke and Nabil Sabki.

On June 30, 2010, the SEC adopted a rule designed to proscribe “pay-to-play” practices by investment advisers (covering virtually all investment advisers, whether or not registered under the Investment Advisers Act— the “IAA”) and many of their employees (called “covered associates”). [1]

In summary, the rule prohibits:

  • (1) A private fund’s investment adviser from receiving compensation (e.g., management fees or carried interest) from a state or local government agency [2] investment plan or program (e.g., a government employees retirement plan or apparently some state university endowment funds) (referred to herein as a “government plan”) for two years after the fund or a covered associate has made a political contribution to a state or local government official or candidate (referred to herein as “an influential government official or candidate”) who could influence the government plan to invest in the private fund.
  • (2) A private fund’s investment adviser and its covered associates from soliciting a political contribution to such an influential government official or candidate or to a political party of a state or locality where the investment adviser provides (or seeks to provide) advisory services to a government plan.
  • (3) A private fund’s investment adviser and its covered associates from paying a third-party placement agent or other solicitor to solicit a government plan to invest in the private fund, unless such third party is an SEC-registered broker-dealer or investment adviser subject to comparable “pay-to-play” restrictions.

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Why Are CEOs Rarely Fired?

This post comes to us from Lucian Taylor of the Finance Department at the University of Pennsylvania.

In the paper, Why Are CEOs Rarely Fired? Evidence from Structural Estimation, which is forthcoming in the Journal of Finance, I evaluate the forced CEO turnover rate and quantify effects on shareholder value by estimating a dynamic model. The model features costly turnover and learning about CEO ability. To fit the observed forced turnover rate, the model needs the average board of directors to behave as if replacing the CEO costs shareholders at least $200 million.

I find three main results. First, the empirical forced turnover rate is low, in the sense that the model needs large turnover costs to fit the data. Second, these costs mainly reflect CEO entrenchment rather than a real cost to shareholders. According to the model, eliminating this entrenchment would raise shareholder value by 3%, assuming we could hold all else constant.

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Recent Delaware Decisions Reaffirm Merger Terminates Derivative Standing

Theodore Mirvis is a partner in the Litigation Department at Wachtell, Lipton, Rosen & Katz. This post is based on a Wachtell Lipton firm memorandum by Eric M. Roth, Stephen R. DiPrima and Graham W. Meli, and relates to the decision of the Delaware Supreme Court in Ark. Teacher Ret. Sys. v. Caiafa, which is available here. 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.

The Delaware Supreme Court has long recognized that a merger terminates the standing of the target corporation’s former shareholders to maintain a derivative action on the target’s behalf, with two narrow exceptions: if the merger is fraudulently designed solely to eliminate derivative standing or if it is merely a “reorganization” that does not affect the shareholders’ ownership of the enterprise. Despite efforts by the plaintiffs’ bar to circumvent this rule, two recent decisions relating to the Countrywide-Bank of America merger have reaffirmed these fundamental principles.

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Regulators Issue Final Guidance on Banking Incentive Compensation

H. Rodgin Cohen is a partner and chairman of Sullivan & Cromwell LLP focusing on acquisition, corporate governance, regulatory and securities law matters. This post is based on a Sullivan & Cromwell client memorandum relating to banking incentive compensation guidance.

Research by the Program on Corporate Governance dealing with regulation of financial firms’ pay structures by bank regulators includes Regulating Bankers’ Pay, by Lucian Bebchuk and Holger Spamann, which was discussed on the Forum here, as well as in Lucian Bebchuk’s testimony in two hearings before the House of Representatives, which are available here and here. Recent Program research on how pay should be designed to reduce risk-taking incentives also includes Paying for Long-Term Performance by Lucian Bebchuk and Jesse Fried, discussed here.

On June 21, 2010, the Board of Governors of the Federal Reserve System, the Office of the Comptroller of the Currency, the Office of Thrift Supervision and the Federal Deposit Insurance Corporation jointly issued comprehensive final guidance designed to ensure that incentive compensation policies do not undermine the safety and soundness of banking organizations by encouraging employees to take imprudent risks. The Guidance finalizes the proposal issued by the Federal Reserve in October 2009.

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The Cost of Debt

This post comes to us from Jules van Binsbergen of the Department of Finance at Northwestern University and Stanford University, John Graham, Professor of Finance at Duke University, and Jie Yang of the Department of Finance at Georgetown University.

In the paper, The Cost of Debt, which is forthcoming in the Journal of Finance, we use panel data from 1980 to 2007 to estimate the marginal cost function for corporate debt. This is the first explicit estimate of the cost of debt function in the literature. We use variation in debt tax benefit curves to help us map out the marginal cost function. We employ two identification strategies: (i) a full panel approach using all time-series and cross-sectional information from 1980 to 2007, (ii) a time series approach focused on the 1986 Tax Reform Act.

The estimated marginal cost of debt functions are positively sloped. The location of the function depends on firm characteristics such as asset collateral, size, book-to-market, asset tangibility, cash flows, and whether the firm pays dividends. Our findings are robust to firm fixed effects, year fixed effects, across time periods, and when accounting for fixed adjustment costs of debt. We provide an easy-to-use formula that allows others to create firm-specific marginal cost of debt functions. We also provide firm-specific recommendations of optimal debt policy against which firms’ actual debt choices can be benchmarked, and we quantify the welfare costs to the firm from deviating from the model-recommended optimum.

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