Monthly Archives: September 2010

What Effect Will Citizens United Have on Shareholder Wealth?

John Coates is the John F. Cogan, Jr. Professor of Law and Economics at Harvard Law School. This post relates to Professor Coates’ working paper, Corporate Governance and Corporate Political Activity: What Effect Will Citizens United Have on Shareholder Wealth?, which is available here.

In Citizens United, the Supreme Court relaxed the ability of corporations to spend money on elections, rejecting a shareholder-protection rationale for restrictions on spending.

The decision was a ‘shock’ to corporate governance of the majority of the largest US companies ­ overturning long-standing understandings about how shareholder money could be used by corporate managers in the political arena. The result is effectively to force future campaign finance regulation to invade and become intertwined with the domain of corporate governance regulation ­ with potential for politicizing that domain in a way that even the Enron crisis and the recent financial meltdown have not achieved.


Manager Characteristics and Capital Structure

The following post comes to us from Sanjai Bhagat, Professor of Finance at the University of Colorado at Boulder; Brian Bolton of the Finance Department at the University of New Hampshire; and Ajay Subramanian of the Risk Management and Insurance Department at Georgia State University.

In the paper, Manager Characteristics and Capital Structure: Theory and Evidence, forthcoming in the Journal of Financial and Quantitative Analysis, we theoretically and empirically investigate the effects of manager characteristics on capital structure. We develop a dynamic principal-agent model that incorporates taxes, bankruptcy costs, and managerial discretion in financing and effort. We derive the manager’s dynamic contract and implement it through financial securities, which leads to a dynamic capital structure for the firm.

We derive novel implications that link manager and firm characteristics to capital structure: (i) Long-term debt declines with manager ability and with her inside equity ownership. (ii) Short-term debt declines with manager ability, and increases with her equity ownership. (iii) Long-term debt declines with long-term risk, and increases with short-term risk. (iv) Short-term debt declines with short-term risk. With the exception of the relation between short-term debt and manager ownership, we show empirical support for the above implications. Our results show that manager characteristics are important determinants of firms’ financial policies.


Delaware Supreme Court Addresses Majority Voting Standards in Director Elections

Steven Haas is an associate at Hunton & Williams specializing in mergers and acquisitions, securities laws and corporate governance matters. [*] This post relates to the decision of the Delaware Supreme Court in City of Westland Police & Fire Retirement System v. Axcelis Technologies, Inc. which is available here. An earlier post on City of Westland v. Axcelis 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.

A recent Delaware Supreme Court decision has significant implications for corporations with majority voting standards where incumbent directors fail to receive the required level of support and tender their resignations to the board of directors. The decision, City of Westland Police & Fire Retirement System v. Axcelis Technologies, Inc., provides stockholders with a roadmap for inspecting a corporation’s books and records after a board refuses to accept the directors’ resignations.


In Axcelis, the corporation had a “plurality plus” governance policy in which directors were elected by a plurality of the votes cast but were subject to a board policy that required directors to tender their resignations if the votes cast “withheld” were greater than the number of votes cast “for” such persons. At its 2008 annual meeting, the three directors who sat on the corporation’s classified board of directors failed to receive majority support from the stockholders and tendered their resignations. The board, however, refused to accept their resignations, noting that one of the directors was the corporation’s lead independent director and each of them sat on key board committees.


The Optimal Duration of Executive Compensation

The following post comes to us from Radhakrishnan Gopalan of the Finance Department at Washington University in Saint Louis; Todd Milbourn, Professor of Finance at Washington University in Saint Louis; Fenghua Song of the Finance Department at Pennsylvania State University; and Anjan Thakor, Professor of Finance at Washington University in St. Louis.

In the paper, The Optimal Duration of Executive Compensation: Theory and Evidence, which was recently made publically available on SSRN, we ask several questions: How long does it take for a typical executive pay contract to vest, and how does this vary in the cross-section? Does the mix of short-term and long-term pay affect executive behavior? We first develop a simple model to understand the determinants of executive pay duration, and then take its predictions to a unique dataset. Our model has two features. First, the stock market can misprice a firm’s equity in the short-run. Second, the executive can engage in inefficient extraction of private benefits which can be partly moderated through a long-term incentive contract. This setting allows us to focus on the shareholders’ tradeoff between short-term and long-term pay for the CEO. Given the potential for short-term mispricing of the firm’s stock, awarding the CEO short-term stock compensation allows her to benefit from the option of selling overvalued stock, which effectively lowers the initial shareholders’ cost of compensating the CEO. However, exclusive reliance on short-term compensation also encourages the CEO to behave myopically, diverting effort to the extraction of inefficient private benefits at the expense of long-term value. Thus, providing the CEO with long-term compensation is essential to attenuate this moral hazard. This model generates three main predictions. First, optimal pay duration is decreasing in the magnitude of stock mispricing. Second, optimal pay duration is longer in firms with poorer corporate governance. Third, CEOs with shorter pay durations are more likely to engage in myopic investment behaviors and this relation between pay duration and investment myopia is stronger when the extent of stock mispricing is larger.


Additional Major Proxy Reforms Are Possible Next Year

This post comes to us from James F. Burke, Managing Director of Special Studies at The Altman Group. This post refers to the SEC’s “Final Rule on Facilitating Shareholder Director Nominations,” available here, as well as the SEC’s “Concept Release on the U.S. Proxy System,” available here. Additional posts on proxy plumbing are available here.

While recent developments have focused attention on the new rule enabling proxy access (Rule 14a-11; available here) and its impact on the 2011 proxy season, the Securities and Exchange Commission (SEC) will also be busy over coming months exploring a major overhaul of the proxy system based on reform concepts presented in their Concept Release on the U.S. Proxy System (“Proxy Mechanics;” available here). Comments on the latter, if you haven’t already submitted them to the Commission, are due on or before October 20, 2010 (SEC File Number S7-14-10).

It was an indication of the Commission’s priorities that it moved to issue new rules on proxy access, which will become effective on November 15, 2010, before completing its review of long-standing, and arguably far more pressing, issues addressed in the concept release. Commissioner Kathleen L. Casey noted in her remarks on the new proxy access rule (Aug. 25, 2010): “a primary, if unstated, objective of this rule is to put the issue of proxy access behind the Commission once and for all…paradoxically, the rule that the Commission” adopted “virtually guarantees that the Commission will be forced to deal with this issue for years to come.” Indeed, there is some uncertainty about whether the eligibility and disclosure requirements under Rule 14a-11 could change as a result of decisions arising out of the Commission’s review of proxy mechanics. Some of the reform concepts and issues raised in the concept release on the U.S. proxy system go directly to questions of eligibility and disclosure requirements under Rule 14a-11. For example, the concept release not only raised the issue of a procedural definition of “empty voting” (e.g., should “voting and investment power” calculations include equity and/or credit derivative-based hedging or short positions), but also the possible prohibition of “empty voting” in situations where a shareholder has a “negative economic interest.”


Governance Lessons from HP

Editor’s Note: This post comes to us from Elise Walton. Ms. Walton is a consultant specializing in corporate governance, strategic organization design and executive leadership. She was formerly a partner at Oliver Wyman for over 18 years, where she led major projects and served as the Corporate Governance practice leader.

HP has provided some interesting summer reading, which will apparently continue well into the fall. HP commentary covers the spectrum of opinion on corporations, executives, and stakeholders. The billionaire attacks the board for dismissing a CEO committed to shareholder wealth. Professors applaud good governance in dismissing a rogue. A shareholder sues over exit pay and labor asks why the CEO wins when jobs suffer. Competitors swipe at weakness; the press focuses on fumbles. Across the many views, the CEO is pre-eminent.

HP market value declines by $15 billion in the three weeks following the CEO departure. Tuesday’s uptick in HP’s stock price is explained on the message boards –the board has decided on the new CEO. The market speaks – it’s all about the CEO.

Yet, as if in spite of the missing CEO, HP keeps moving the ball down the field – winning the 3PAR bidding war (also acquiring Fortify and pursing ArcSight), reporting earnings, initiating a stock buyback, signing up customers (US Airforce, Thorntons and GS1), rolling out a hot new back-to-school lineup including a 3D computer – and even suing the departed CEO. HP is not missing a beat.


Governance Changes Under Dodd-Frank

Andrew R. Brownstein is a partner in the Corporate Department at Wachtell, Lipton, Rosen & Katz. This post is based on a Wachtell Lipton firm memorandum by Mr. Brownstein, Steven A. Rosenblum, Eric S. Robinson, Adam O. Emmerich, Trevor S. Norwitz, and Jenna E. Levine. Additional posts on the Dodd-Frank Act are available here.

The Dodd-Frank Act mandates a variety of changes to the governance, disclosure and compensation practices of all public companies. Many of the provisions of the Act require further SEC rulemaking and interpretation before definitive responses can be implemented, but companies should become familiar with the pending changes and take preparatory steps where possible. The purpose of this memo, which we will periodically update, is to provide a framework for our recommendations by highlighting certain actions companies should consider taking immediately, as well as certain key provisions of the Act which will require responses in the longer term. (Links to our earlier memos are embedded throughout and in the attached index.)


Diversity in the Boardroom is Important and, Unfortunately, Still Rare

Editor’s Note: Luis A. Aguilar is a Commissioner at the U.S. Securities and Exchange Commission. This post is based on Commissioner Aguilar’s remarks at a recent forum titled “Closing the Gender Gap: Global Perspectives on Women in the Boardroom;” his complete remarks are available here. The views expressed in the post are those of Commissioner Aguilar and do not necessarily reflect those of the Securities and Exchange Commission, the other Commissioners, or the Staff.

The persistent lack of diversity in our corporate boardrooms is an issue that requires continuing focus. A focus that needs to be maintained until our corporate boardrooms reflect the America we live in. Many nations have been focused on Board diversity for years. [1] Others are just now beginning to do so.

Today’s forum is also timely because 2010 has been a year in which we have seen countries around the world take steps to correct the persistent lack of diversity in corporate boardrooms. For example, in Australia, companies are now required to disclose the company’s progress related to board-established gender objectives as well as disclose the number of female employees in the entire organization, in senior management, and on the board. [2] In the United Kingdom, companies are now required to “pay due regard to the benefits of diversity on the board, including gender” when searching for and appointing directors. [3]


Access to the Mutual Fund Proxy

This post comes to us from Jennifer Taub, a Senior Lecturer and Coordinator of the Business Law Program at the University of Massachusetts Amherst.

One topic missing from the early analysis of the SEC’s proxy access rulemaking [1] has been mutual funds as issuers. Though, a few experts have recognized the importance of mutual funds as shareholders. For example, Ira Millstein and Stephen Davis welcomed proxy access and noted that it “places a colossal bet that shareholders will patrol the market. Up to now many, including major mutual funds, have simply voted shares on autopilot.” [2]

Indeed, given that they hold 24% of US corporate equity, [3] the sway of mutual funds as shareholders is significant. This voting power might be tapped to reach the threshold to nominate corporate directors. And, this voting power will be used to support or block shareholder director nominees and shareholder proposals related to director nominations and elections. Notwithstanding this capacity, activists should not expect much from the largest mainstream fund families who historically favor management when casting proxy votes on shareholder-sponsored corporate governance proposals. [4]


The Most Influential People in Corporate Governance

A review of the most recent Directorship 100 list – a list of the most influential people in corporate governance put together each year by Directorship magazine – indicates that individuals affiliated with Harvard Law School and its Program on Corporate Governance play a central role in the corporate governance landscape.

This year’s Directorship 100 list includes twenty-eight individuals who are Harvard Law School faculty or fellows, guest Contributors to the Forum on Corporate Governance and Financial Regulation, and/or Harvard Law School alumni. The “Harvard Twenty-Eight” (with graduation year in parenthesis for those who are HLS alumni) are as follows:

The full Directorship 100 list is available here.

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