Monthly Archives: August 2010

Why Bankers’ Pay is the Government’s Business

Posted by the Harvard Law School Forum on Corporate Governance & Financial Regulation, on
Tuesday, August 17, 2010
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Editor’s Note: Lucian Bebchuk is a Professor of Law, Economics, and Finance at Harvard Law School. This post is the text of a statement that Professor Bebchuk posted at the invitation of the Economist magazine as part of a debate, available on the magazine’s website, on the motion “This house believes that bosses’ pay is none of the government’s business.” The statement draws on Bebchuk’s earlier work on government involvement in this area, including his testimony before the House Financial Services Committee, his article “Regulating Bankers’ Pay” with Holger Spamann, and his other writings.

The Federal Reserve now has in place a policy for supervising executive pay in banks as part of its programme for ensuring the banking system’s safety and soundness. Governments around the world have adopted or are considering regulations concerning pay in financial institutions. I have been an early proponent of such government involvement, advocating it in congressional testimony, in “Regulating Bankers’ Pay,” an article co-authored with Holger Spamann, and in other writings. In contrast to what Mark Calabria argues in his supporting statement for the motion, public officials have good reason to pay close attention to executive pay in banks and to reject assertions that it should be none of the government’s business. (By banks I refer throughout to any financial institutions that are deemed to pose systemic risk and are subject to financial regulation for this reason.)

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The Takeover Directive as a Protectionist Tool?

Posted by Paul Davies, University of Oxford, on
Monday, August 16, 2010
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Paul Davies is the Allen & Overy Professor of Corporate Law at the University of Oxford.

In the paper The Takeover Directive as a Protectionist Tool? forthcoming in WG Ringe and U Bernitz (eds) Company Law and Economic Protectionism (Oxford/New York: Oxford University Press 2010), my co-authors (Edmund-Philipp Schuster and Emilie van de Walle de Ghelcke) and I examine how the implementation of the European Takeover Directive changed the takeover rules applicable to European companies. When the European Commission first proposed a harmonized legal framework for takeovers in the EU, its aim was to facilitate takeover bids in order to create a more efficient and competitive corporate landscape and to further the single market. In the view of the Commission, a functioning market of corporate control required rebalancing the division of powers between shareholders and management in companies facing a takeover bid. Taking the UK, EU’s most active takeover market, as a model, the Commission proposed to assign the sole decision-making power regarding the bid to the shareholders, with management primarily playing an advisory role.

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Inside Debt

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Sunday, August 15, 2010
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The following post comes to us from Alex Edmans and Qi Liu, both of the Finance Department at the University of Pennsylvania.

In the paper, Inside Debt, which is forthcoming in the Review of Finance, we show that CEOs should be paid with debt in their own firm, to deter them from taking risky actions (e.g. sub-prime lending) that hurt bondholders, as was common in the recent financial crisis. Our theory justifies the substantial use of debt compensation documented by recent evidence, and underpins recent proposals to tie CEOs to the value of their debt to prevent future crises (as recently implemented at AIG).

Three decades of theoretical research on CEO pay have focused almost exclusively on justifying compensating CEOs with equity-like instruments alone, such as stock and options. This has likely been driven by the long-standing belief that, empirically, executives don’t hold debt. However, this belief arose not because CEOs actually don’t hold debt, but because disclosure of debt compensation was extremely limited and so researchers missed this component of compensation. New disclosures mandated by the SEC from March 2007 show that CEOs hold substantial debt in their own firms (known as “inside debt”) in the form of deferred compensation and defined benefit pensions. Indeed, in some cases, CEOs hold even more debt than they do equity. Since the use of debt sharply contrasts with existing theories which advocate only equity, some commentators have argued that it must be inefficient. By contrast, we show that inside debt can be optimal, and that it should be used in the types of firms in which they are indeed used in reality.

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Whose Risk Is It? Corporate Catastrophe and Human Rights

Posted by John Ruggie, Kennedy School of Government and Harvard Law School, on
Saturday, August 14, 2010
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John Ruggie, the Berthold Beitz Professor of International Affairs at the Kennedy School of Government, is currently serving as the United Nations Secretary-General’s Special Representative for Business and Human Rights. This post is based on an article by John Sherman, a Senior Fellow at the Corporate Social Responsibility Initiative at the Kennedy School, Vice Chair of the Corporate Responsibility Committee of the International Bar Association and a member of the UN Global Compact Human Rights Working Group. The article was first published by the International Bar Association.

Assuring the existence of internal systems for effective risk management is a core component of corporate governance, embedded in best practice and the laws of many countries. [1] Yet the global recession caused by the financial meltdown and the runaway Deepwater Horizon leak in the Gulf of Mexico show, yet again, that the consequences of a business failure to anticipate and plan for catastrophic risks can devastate companies, society, communities, and the environment.

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Making Sense Out of “Clawbacks”

Posted by the Harvard Law School Forum on Corporate Governance & Financial Regulation, on
Friday, August 13, 2010
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Editor’s Note: Ben W. Heineman, Jr. is a former GE senior vice president for law and public affairs and a senior fellow at Harvard University’s schools of law and government. A version of this article appeared today in Business Week online.

The “clawback” of pay from high-level executives for malfeasance is a hot but complex topic. Designed properly, such a policy is a significant mechanism for corporate accountability.

The Dodd-Frank bill, passed last month, mandated substantive clawback requirements for any company listed on a U.S. securities exchange if it has material financial restatements. Also in July, the European Parliament passed legislation requiring clawbacks , and the UK’s Financial Services Authority revised a proposed rule on remuneration, effective next January, which has a new provision that will define clawbacks. Prior to these regulatory developments, 212 of the S&P 500 had adopted a variety of “clawback” policies, but hundreds of public companies still don’t have such compensation recovery policies as required by Dodd-Frank.

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SEC Issues Concept Release on “Proxy Plumbing”

Posted by Edward F. Greene, Cleary Gottlieb Steen & Hamilton LLP, on
Friday, August 13, 2010
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Edward F. Greene is a partner at Cleary Gottlieb Steen & Hamilton LLP focusing on corporate law matters. This post is based on a Cleary Gottlieb Alert Memo, and relates to the Securities and Exchange Commission’s recent concept release seeking public comment on issues relating to the mechanics of communications and voting under the proxy rules; the concept release is available here.

At its open meeting on July 14, 2010, the SEC voted unanimously to publish a concept release seeking public comment on a variety of issues relating to the mechanics of communications and voting under the SEC’s proxy rules (so-called “proxy plumbing”). The release may be found here. Comments must be filed with the SEC on or before 90 days after publication of the release in the Federal Register.

“Proxy plumbing” has attracted significant attention among companies, investors and other market participants in recent years, particularly as contested shareholder votes have grown more common. In her opening remarks, Chairman Schapiro noted that changes in “shareholder demographics, the structure of share holdings, technology, and the potential economic significance of each proxy vote” have driven a need to consider whether changes to the proxy voting system are merited. Reflecting the complexity of the subject, the concept release begins with an extended discussion of the mechanics of share ownership and proxy voting.

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Some Dodd-Frank Executive Compensation Action Items

Posted by Jeremy L. Goldstein, Wachtell, Lipton, Rosen & Katz, on
Thursday, August 12, 2010
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Jeremy Goldstein is a partner at Wachtell, Lipton, Rosen & Katz active in the firm’s executive compensation and corporate governance practices. This post is based on a Wachtell Lipton firm memorandum by Mr. Goldstein, David E. Kahan and Adam J. Kaminsky. Additional posts on the Dodd-Frank Act are available here.

Washington’s focus on changing the rules regarding executive compensation continues with the recently enacted Dodd-Frank Wall Street Reform and Consumer Protection Act. Set forth below is a discussion of certain executive compensation provisions of the Act and some recommended action items.

Say-on-Pay

The Act requires that companies include in their annual proxy statement a non-binding resolution seeking shareholder approval of named executive officer compensation at shareholder meetings at least once every three years, and mandates a separate vote to determine how often the say-on-pay vote will be held (every one, two or three years), with such separate vote to be held at least once every six years. The frequency vote represents a welcome departure from earlier drafts of the bill, which required an annual say-on-pay vote. As discussed in our memo of September 30, 2009 (available on the Forum here, triennial say-on-pay votes more closely align sayon- pay with the goal of avoiding short-termism in corporate governance and executive pay arrangements than do annual say-on-pay votes. We therefore recommend that most companies seek to implement a triennial approach. Targeted shareholder outreach, shareholder surveys regarding executive compensation and effective use of the compensation disclosure and analysis section of the proxy can be part of the arsenal of effective shareholder communication in connection with the say-on-pay vote and the frequency vote. Companies should be cognizant of (although not unduly deferential to) voting policies of institutional shareholders and proxy advisory services for say-on-pay, given that these groups may recommend withhold/against votes on the re-election of directors if concerns raised through say-on-pay votes are not adequately addressed.

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Reputation Penalties for Poor Monitoring of Executive Pay

Posted by Fabrizio Ferri, Columbia University, on
Wednesday, August 11, 2010
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Fabrizio Ferri is an Assistant Professor of Accounting at the New York University Stern School of Business.

In the paper Reputation Penalties for Poor Monitoring of Executive Pay: Evidence from Option Backdating, which was recently made publicly available on SSRN, my co-authors (Yonca Ertimur of Duke University and David Maber of the University of Southern California), and I examine whether directors are held accountable for poor monitoring of executive compensation.

Theoretical and empirical work suggests that directors suffer reputation penalties in the director labor market for poor monitoring. However, it is unclear whether these penalties extend to poor monitoring of executive pay. A widely held view—articulated by Prof. Bebchuk and Prof. Fried in their book Pay without Performance—is that there is little or no accountability for excessive or abusive pay practices. However, no study has empirically examined this question. Part of the reason is the difficulty of defining and identifying “poor monitoring” with respect to executive pay. In most cases, pay levels and structures can be justified on economic grounds (e.g. retention, incentives, attraction of talent) and with reference to the behavior of peer firms. Unless these practices are perceived as clearly “outrageous,” it is unlikely that directors will be concerned about reputation costs. Opacity in pay disclosures makes it even more difficult to assess the quality of pay practices.

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Applying the Supreme Court’s Limits to “Foreign Squared” Litigation

Posted by George T. Conway III, Wachtell, Lipton, Rosen & Katz, on
Tuesday, August 10, 2010
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George Conway is partner in the Litigation Department at Wachtell, Lipton, Rosen & Katz. This post is based on a Wachtell Lipton firm memorandum by Mr. Conway and Kevin S. Schwartz. Additional posts relating to the decision in Morrison v. National Australia Bank are available here.

In the first significant opinion applying the United States Supreme Court’s decision in Morrison v. National Australia Bank Ltd., No. 08-1191 (U.S. June 24, 2010), the United States District Court for the Southern District of New York ruled yesterday that Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5 do not apply to “foreign squared” claims — claims asserted by American investors who have purchased securities of foreign issuers on foreign exchanges. Cornwell v. Credit Suisse Group, No. 08 Civ. 3758 (S.D.N.Y. July 27, 2010).

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Cyclicality of Credit Supply

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Monday, August 9, 2010
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The following post comes to us from Bo Becker and Victoria Ivashina, both of the Finance Unit at Harvard Business School.

In the paper, Cyclicality of Credit Supply: Firm Level Evidence, which was recently made publicly available on SSRN, we study bank loan supply through the business cycle using firm level data from 1990 to 2009. It is well known that lending is cyclical. The contribution of our paper is to address two of the main empirical challenges in identifying whether this reflects the effects of bank credit supply. First, we focus on firms’ choice between two close forms of external debt financing: bank debt and public bonds. By conditioning the sample on firms raising new debt, we can rule out a demand explanation for the drop in bank borrowing which coincides with downturns. Second, by doing the analysis at the firm level, we can directly address how the composition of firms raising finance varies through time. This allows us to rule out compositional changes in the pool of firms seeking debt finance as an explanation of our findings.

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