Monthly Archives: September 2010

Institutional Investors as Minority Shareholders

Assaf Hamdani is an Associate Professor of Law at Hebrew University.

In the paper, Institutional Investors as Minority Shareholders, which was recently made publicly available on SSRN, my co-author, Yishay Yafeh, and I study the role of institutional investors in markets where concentrated ownership and business groups are prevalent. Whereas investors in dispersedly-owned firms are primarily concerned with disciplining managers, investors in firms with a controlling shareholder are concerned with self-dealing and “tunneling.” Institutional investors, however, can effectively use voting to discipline corporate insiders only when the law empowers minority shareholders to influence vote outcomes. Moreover, the presence of powerful families who control many public companies through business groups creates new potential conflicts for institutional investors.

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When Fund Directors Get Sued

This post comes to us from David Geffen. Mr. Geffen is counsel at Dechert LLP, focusing his practice on investment companies and advisers. This post is based on two articles by Mr. Geffen, Robert W. Helm, William K. Dodds, and Jeanette Wingler, which first appeared in The Investment Lawyer; those articles, including footnotes, can be found here and here.

Prior to the last decade, most litigation against funds (both open-and closed-end) and their advisers and directors involved claims of excessive fees pursuant to § 36(b) under the Investment Company Act of 1940 (ICA) and non-disclosure lawsuits under the Securities Act of 1933 (Securities Act). The collapse of the “dot com” bubble post-2001 left the mutual fund industry under stress, as assets under management for many managers had deflated materially. The aggressive quest for new assets to manage led some managers to adopt or expand marketing practices that became the focus of regulatory inquiries.

Beginning in 2003, the industry saw the beginning of several highly publicized regulatory investigations concerning market timing and improper revenue sharing arrangements. Scores of lawsuits were instigated against advisers, distributors, funds, and, in some cases, a fund’s independent directors. While independent directors were named defendants in prior lawsuits—for example, § 36(b) excessive fee lawsuits—the scope of litigation that followed 2003 was without precedent both in terms of the number of lawsuits and the number of those suits naming directors as defendants. Moreover, the lawsuits against fund directors coincided with an increase in suits against directors of companies outside of the fund industry. Both the number of lawsuits and the scope of litigation reflect the increased scrutiny to which the conduct of fund directors is subject.

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Corporate Political Speech: Who Decides?

Lucian Bebchuk is a Professor of Law, Economics, and Finance at Harvard Law School. Robert J. Jackson, Jr. is an Associate Professor of Law at Columbia Law School. This post is based on their paper “Corporate Political Speech: Who Decides?” available here.

The Harvard Law School Program on Corporate Governance recently issued our discussion paper, “Corporate Political Speech: Who Decides?” The paper will be published in the Harvard Law Review’s Supreme Court issue this November.

As long as corporations have the freedom to engage in political spending — a freedom expanded by the Supreme Court’s recent decision in Citizens United v. FEC — the law will have to provide rules governing how corporations decide to exercise that freedom. Our paper focuses on what rules should govern public corporations’ decisions to spend corporate funds on politics. The paper is dedicated to Professor Victor Brudney, who long ago anticipated the significance of corporate law rules for regulating corporate speech.

Under existing corporate-law rules, corporate political speech decisions are subject to the same rules as ordinary business decisions. Consequently, political speech decisions can be made without input from shareholders, a role for independent directors, or detailed disclosure — the safeguards that corporate law rules establish for special corporate decisions. We argue that the interests of directors and executives may significantly diverge from those of shareholders with respect to political speech decisions, and that these decisions may carry special expressive significance from shareholders. Accordingly, we suggest, political speech decisions are fundamentally different from, and should not be subject to the same rules as, ordinary business decisions.

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The 2010 Proxy Season: A Brave New World

This post comes to us from David Drake, President of Georgeson Inc, and is based on the executive summary of the Georgeson 2010 Annual Corporate Governance Review by Mr. Drake, Rhonda L. Brauer, Rajeev Kumar and Steven Pantina. The full review is available here (registration required).

A brief look back to the 2009 proxy season reveals one of the most contentious seasons in recent memory. Investor support for board nominees was at an all-time low, proxy contests were at an all-time high and support for shareholder-sponsored resolutions had dramatically risen. As the 2010 proxy season approached, corporate directors knew that it was incumbent on them to restore the trust that was shattered by the market downturn.

The 2010 proxy season was the dawning of a new era in the way director nominees are elected because, for the first time, uncontested director elections were to be considered “non-routine” under New York Stock Exchange (“NYSE”) rules and thus could not be bolstered by the uninstructed broker discretionary vote. Companies also had to make adjustments in anticipation of the new legislation being drafted by Congress that had squarely focused its attention on reforming our financial system and that would impose new requirements on publicly traded companies to rein in perceived egregious compensation practices. Although companies knew that the reform efforts could not be enacted during the current proxy season, they were aware that the proposed changes could reshape the landscape of corporate governance in the United States. The past season demonstrated that companies are starting to prepare for the brave new world that shareholder activism and congressional reform are in the process of creating.

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CEO Ownership and External Governance

E. Han Kim is the Fred M. Taylor Professor of Finance and Director of Mitsui Financial Research Center at the University of Michigan.

In the paper, CEO Ownership and External Governance, which was recently made publicly available on SSRN, my co-author, Yao Lu, and I demonstrate that studying only one part of the governance system, in isolation from other governance mechanisms in place, may lead to inaccurate conclusions. Because there are multiple governance mechanisms at work, both internally and externally, understanding of corporate governance requires analysis on how various governance mechanisms interact in affecting agency problems and firm performance, and the channels through which the interactive effects take place. In this paper, we make that attempt by examining how CEO share ownership and the strength of external governance (EG) interactively affect firm value and R&D investments.

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The General Counsel as Lawyer-Statesman

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. This post is based on a Blue Paper published by the Harvard Law School Program on the Legal Profession.*

The Fundamental Mission of The Corporation

The foundational goals of the modern corporation should be the fusion of high performance with high integrity. The ideal of the modern general counsel is a lawyer-statesman who is an acute lawyer, a wise counselor and company leader and who has a major role assisting the corporation achieve that fundamental fusion which should, indeed, be the foundation of global capitalism.

I believe that this concept of General Counsel as lawyer-statesman has strong roots in major American companies, is growing in the UK and has adherents in some companies elsewhere in the world. Trends over the past 25 years have made possible a powerful, affirmative leadership role for General Counsels, at least in large transnational enterprises. But to understand the role, it is necessary, first, to understand in some detail what (in my view) should be the mission of the contemporary global corporation.

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The Mechanisms of Voting Efficiency

This post comes to us from Michael Schouten, a Visiting Fellow at the Cambridge University, Centre for Business Research.

In the wake of the financial crisis, shareholders are increasingly relied upon to monitor directors. But while much has been written about directors’ flawed judgments, remarkably little is known about shareholders’ ability to make accurate judgments. What determines whether shareholders make the right decision when asked to vote on, say, a merger? In my paper The Mechanisms of Voting Efficiency, which has just become available on SSRN, I take a novel approach to this question by drawing an analogy between corporate voting and another system to aggregate information on estimated values: stock trading.

Using insights on stock market efficiency, the paper makes three contributions to our understanding of voting efficiency. First, the paper identifies four key mechanisms of voting efficiency: (1) informed voting, which implies that shareholders have some information to base their voting decision on; (2) rational voting, which implies that such information is processed in a rational, unbiased way; (3) independent voting, which implies that each shareholder arrives at a judgment by making use of his or her personal cognitive skills, and (4) sincere voting, which implies that shareholders vote with a view to furthering the common interest of maximizing shareholder value rather than their own private interest. The paper explores the operation of each mechanism, and demonstrates that the mechanisms interact in various ways.

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Audited Financial Reporting and Voluntary Disclosure as Complements

The following post comes to us from Ray Ball, Professor of Accounting at the University of Chicago, Sudarshan Jayaraman of the Accounting Department at Washington University, and Lakshmanan Shivakumar, Professor of Accounting at London Business School.

In the paper, Audited Financial Reporting and Voluntary Disclosure as Complements: A Test of the Confirmation Hypothesis, which was recently made publicly available on SSRN, we examine the hypothesis that audited financial reporting and voluntary disclosure of managers’ private information are complementary mechanisms for communicating with investors, not substitutes. More specifically, we test the hypothesis in Ball (2001) that independent verification and reporting of financial outcomes encourages managers to be more truthful and hence more precise in their disclosures. This allows managers to credibly disclose private information that is not directly verifiable, alleviating the problem (Crawford and Sobel, 1982) that private information disclosure as a stand-alone mechanism is uninformative because in equilibrium it is untruthful.

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The SEC Departs from an Important Safeguard

Wayne Carlin is a partner in the Litigation Department at Wachtell, Lipton, Rosen & Katz. This post is based on a Wachtell Lipton firm memorandum by Mr. Carlin and Theodore A. Levine.

Recently, the SEC made permanent the delegation of its statutory formal order investigation authority to the Director of the Division of Enforcement. This delegation, which the Enforcement Director has sub-delegated to senior enforcement staff, essentially transfers the SEC’s broad authority to invoke its subpoena power to numerous of its enforcement staff without any apparent oversight.

There is a serious question whether the delegation is authorized under the relevant statutes. Congress gave the power to the Commission (not the staff) to define the scope of a formal investigation and to establish limits within which the staff could resort to compulsory process. In short, the requirement of a formal order is a structural mechanism to keep the staff’s subsequent investigation and use of subpoena power within certain confines. Subpoenas are enforceable only to the extent they seek information which is reasonably relevant to matters within the scope of the formal order, but the staff now defines the scope of their own inquiry. As a result of this delegation and other delegations of authority to the Division Director and senior enforcement staff, the staff can start a formal investigation, subpoena anyone for anything, enforce the subpoena judicially and close the matter with no Commission involvement or oversight.

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Subprime Crisis and Board (In-)Competence

The following post comes to us from Harald Hau of the Finance Department at INSEAD and Marcel Thum, Professor of Business and Economics at TU Dresden.

In the paper, Subprime Crisis and Board (In-)Competence: Private vs. Public Banks in Germany, which was recently made publicly available on SSRN, we examine evidence for a systematic underperformance of Germany’s state-owned banks in the current financial crisis and study if the bank losses can be traced to the quality of bank governance.

For this purpose, we examine the biographical background of 593 supervisory board members in the 29 largest banks and find a pronounced difference in the finance and management experience of board representatives across private and state-owned banks. Measures of “boardroom competence” are then related directly to the magnitude of bank losses in the recent financial crisis. Our data confirms that supervisory board (in-)competence in finance is related to losses in the financial crisis.

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