Monthly Archives: December 2010

Are Two Heads Really Better Than One? Evidence from the Thrift Crisis

The following post comes to us from John Byrd of the Department of Finance at the University of Colorado at Denver; Donald Fraser, Professor of Finance at Texas A&M, D. Scott Lee, Professor of Finance at Texas A&M; and Semih Tartaroglu of the Department of Finance, Real Estate, and Decision Sciences at Wichita State University.

In the paper, Are Two Heads Really Better Than One? Evidence from the Thrift Crisis, which was recently made publicly available on SSRN, we provide the first explicit tests of whether unitary leadership protects the interests of taxpayers, who become the residual claimants when financial institutions exploit underpriced deposit insurance through more risky investment policies. We make no attempt to consider shareholders’ best interests. Failure means that shareholders lose, but limited liability assures that they lose no more than their equity stake in the firm and such losses may be nothing more than the bad ex post outcome of a rational ex ante investment to a diversified investor.

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Enforceability and Effectiveness of Typical Shareholders Agreement Provisions

This post comes to us from Nancy Sanborn and Alexander Macleod. Ms. Sanborn and Mr. Macleod are lawyers at Davis Polk & Wardwell LLP and, respectively, Chair and Secretary of the Corporation Law Committee of the Association of the Bar of the City of New York.

The Corporation Law Committee of the Association of the Bar of the City of New York prepared a report on The Enforceability and Effectiveness of Typical Shareholders Agreement Provisions, which was published in the August 2010 issue of The Business Lawyer.

In this report, the Corporation Law Committee reviews provisions that are often contained in shareholders agreements, including the composition of the corporation’s board of directors and related corporate governance matters, share transfer provisions, tag-along and drag-along rights, mechanisms for resolving deadlocks, preemptive rights and other provisions.  Although “freedom of contract” is the legal principle that governs many provisions to some extent, there are numerous legal consideration that affect their enforceability and effectiveness.  The report describes the statutory and case law that apply to each (focusing on Delaware and New York law) and offers drafting tips to avoid traps for the unwary.

Although each shareholders agreement is unique, the issues addressed by this report are common.  This report should therefore be a “must read” for any lawyer drafting or negotiating a shareholders agreement.

The full report is available for download here.

CEO Turnover, CEO-Related Factors, and Innovation Performance

The following post comes to us from Frederick Bereskin of the Finance Department at the University of Delaware and Po-Hsuan Hsu of the Finance Department at the University of Connecticut.

In the paper New Dogs New Tricks: CEO Turnover, CEO-Related Factors, and Innovation Performance, which was recently made publicly available on SSRN, we examine the association between CEO turnover and innovation performance in the sample period 1993-2005. We find strong empirical support for the notion that CEO turnover is associated with higher levels of innovation, which we measure with patent counts and citations. After controlling for the endogeneity of CEO turnover, we present evidence consistent with CEO turnover increasing a firm’s patent counts, patent citations, patents per research and development dollar, and citations per patent in the subsequent three and five years. We also find that internal new CEOs create more innovation than external new CEOs. Moreover, we find that relatively overconfident CEOs, CEOs with higher option compensation, and an environment with relatively high information asymmetries are associated with more (and higher quality) innovation. Finally, we find that stock-option compensation and information asymmetries are negatively associated with subsequent innovation around the time of CEO turnover.

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HP Severance Case Raises Governance Concerns

Joseph Bachelder is founder and senior partner of the Bachelder Law Firm. This post is based on an article by Mr. Bachelder that first appeared in the New York Law Journal. An earlier column by Mr. Bachelder regarding severance at Hewlett-Packard is available here.

On Aug. 6, 2010, Mark Hurd stepped down as chairman, president and chief executive officer of Hewlett-Packard Company. His resignation was at HP’s request. He was provided, among other things, a severance payment of approximately $12 million. Today’s column considers whether the severance payment, given the circumstances involved in Mr. Hurd’s departure, can be reconciled with the HP Severance Plan for Executive Officers pursuant to which it was paid. Specifically, the question is whether the separation qualified as one “not for cause,” a condition to payment under that plan.

A severance of another HP CEO, Carly Fiorina, involving entirely different circumstances, was the subject of this column on March 24, 2005.

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Earnings Quality and International IPO Underpricing

The following post comes to us from Thomas Boulton of the Finance Department at Miami University, Scott Smart of the Finance Department at Indiana University, and Chad Zutter of the Finance Department at the University of Pittsburgh.

In the paper, Earnings Quality and International IPO Underpricing, forthcoming in The Accounting Review, we examine the impact of country-level earnings quality on IPO underpricing. When firms convert from private to public ownership through an initial public offering (IPO), they typically sell shares at a price that is below the market price that prevails once secondary market trading begins. This “underpricing” cost, which is prevalent in virtually every stock market around the world, is one of the largest costs that firms must bear when going public. Underpricing also varies widely between countries.

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Don’t Divorce the GC and Compliance Officer

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. This article originally appeared in Corporate Counsel magazine.

The role of the chief compliance (and ethics) officer is currently a hot, if confused topic. What does she do — ensure good process or enforce strict compliance? To whom does she report — GC/ CFO or to CEO/board? What is her role in shaping the company’s voluntary adoption of ethical standards — beyond what the law requires?

This issue has been thrust into high relief by regulators and enforcers who, in light of various scandals, want a more independent compliance function in corporations. For example, changes in the federal sentencing guidelines would give corporations extra credit if the “specific individual” in the corporation with “day-to-day operational responsibility for the compliance and ethics program” has direct access to the board of directors. The issue has also received attention in the resolution of various high-profile cases, including a recent Pfizer Inc. settlement of criminal and civil matters with the U.S. Department of Justice and the U.S. Department of Health and Human Services, which required that the company’s chief compliance officer bypass the GC and report directly to the CEO.

Let me offer a somewhat contrarian, more nuanced view about the critical importance of a chief compliance officer, but in a right-sized role.

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How the Government Is Creating Another Housing Bubble

Editor’s Note: Peter J. Wallison is a senior fellow at the American Enterprise Institute. This post is based on an article by Mr. Wallison and Edward J. Pinto, a resident fellow at the AEI.

It is hard to believe, but it looks like the government will soon use the taxpayers’ checkbook again to create a vast market for mortgages with low or no down payments and for overstretched borrowers with blemished credit. As in the period leading to the 2008 financial crisis, these loans will again contribute to a housing bubble, which will feed on government funding and grow to enormous size. When it collapses, housing prices will drop and a financial crisis will ensue. And, once again, the taxpayers will have to bear the costs.

In doing this, Congress is repeating the same policy mistake it made in 1992. Back then, it mandated that Fannie Mae and Freddie Mac compete with the Federal Housing Administration (FHA) for high-risk loans. Unhappily for both their shareholders and the taxpayers, Fannie and Freddie won that battle.

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Litigation in Mergers and Acquisitions

Randall Thomas is a Professor of Law and Business at Vanderbilt University. This post relates to a recent paper by Professor Thomas, C. N. V. Krishnan, Ronald W. Masulis and Robert B. Thompson; that paper is available here.

Litigation is often triggered by the announcement of a merger or acquisition (M&A) proposal. Using hand-collected data, we document the types of suits triggered by M&A offers, the factors that influence whether offers are targeted by litigation, the impact of M&A lawsuits on offer outcomes (offer completion rates and takeover premium in completed deals), and the factors that influence whether these cases settle for positive monetary damages.

We find that about 12% of M&A offers announced in our sample period, 1999-2000, lead to litigation. Shareholder lawsuits form the vast majority of all lawsuits. We document that (a) federal court lawsuits, though far fewer than state court lawsuits, attract a significantly higher proportion of bidder and target initiated litigation than state courts; (b) bidder and target lawsuits have significantly lower rates of settlements than other types of lawsuits, and deals involving target lawsuits have lower completion rates, but higher takeover premiums if completed. Target managers typically want to either kill the deal as originally proposed or obtain a higher premium, which will lead to both a lower completion rate and a higher average premium in completed deals; and (c) Offer completion rates are the highest for controlling shareholder squeeze-out offers relative to other M&A offer types. This is not surprising given that a controlling shareholder can unilaterally insure that a deal is completed, simply by having a target board of directors propose a merger transaction and then voting its controlling share interest in favor of the transaction.

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Capital Structure and Debt Maturity Choices

The following post comes to us from Joseph Fan, Professor of Finance at the Chinese University of Hong Kong; Garry Twite, Professor of Finance at the Australian National University; and Sheridan Titman, Professor of Finance at the University of Texas at Austin.

In the paper, An International Comparison of Capital Structure and Debt Maturity Choices, forthcoming in the Journal of Financial and Quantitative Analysis, my co-authors (Joseph Fan and Garry Twite) and I examine the influence of institutional environment on capital structure and debt maturity choices by examining a cross-section of firms in 39 developed and developing countries.

The country in which a firm resides has a greater influence on its capital structure than its industry affiliation. Specifically, a regression of firm leverage, measured as the book value of debt over the market value of the firm, on firm-specific variables, industry fixed effects and country fixed effects, has an adjusted R-square of 0.19. When the regression is estimated with industry but not country fixed effects, the adjusted R-square is reduced to 0.15. However, in a regression that includes country dummies but not industry dummies the adjusted R-square is reduced by only half as much, to 0.17. A similar regression with debt maturity, measured as the book value of long-term debt to the book value of total debt, as the dependent variable, has an R-square of 0.25, when all variables are included. When country fixed effects are excluded from the regression the R-square is substantially reduced to 0.09, but when the country fixed effect are included, but the industry fixed effects are excluded, the R-square is only slightly reduced to 0.23.

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The 2010 Governance Stars

Global Proxy Watch, the international corporate governance newsletter just announced its annual selection of “governance stars” – the “10 people around the world who had the most impact on corporate governance in the previous year.” This year’s list includes Lucian Bebchuk, director of Harvard’s Program on Corporate Governance. In announcing its selection, Global Proxy noted Bebchuk’s “world-class studies.”

Other members of the list includes Christopher Dodd and Barney Frank, who led passage of the landmark Dodd-Frank financial reform law, Mary Schapiro, the SEC’s chair, and Stephen Haddrill, CEO of the UK Financial Reporting Council.

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