Yearly Archives: 2010

Regulation and Distrust

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Friday, August 20, 2010
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The following post comes to us from Philippe Aghion, Professor of Economics at Harvard University; Yann Algan, Professor of Economics at Sciences Po; Pierre Cahuc, Professor of Economics at École Polytechnique; and Andrei Shleifer, Professor of Economics at Harvard University.

In the paper, Regulation and Distrust, which is forthcoming in the Quarterly Journal of Economics, we document and try to explain the strong, negative correlation between government regulation and social capital found in a cross-section of countries. The correlation works for a range of measures of social capital, from trust in others to trust in corporations and political institutions, as well as for a range of measures of regulation, from product markets, to labor markets, to judicial procedures.

We present a simple model explaining this correlation. In the model, people make two decisions: whether or not to become civic (invest in social capital), and whether to become entrepreneurs or choose routine (perhaps state) production. We accept a broad view of civicness or social capital, namely that it is a broad cultural attitude. Those who have not invested in social capital impose a negative externality on others when they become entrepreneurs (e.g., pollute), while those who have invested do not. The community (whether through voting or through some other political mechanism) regulates entry into entrepreneurial activity when the expected negative externalities are large. But regulation itself must be implemented by government officials, who demand bribes if they had not invested in social capital. As a consequence, when entrepreneurship is restricted through regulation, investment in social capital may not pay.

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Including Credit Ratings in Registration Statements

Posted by Scott Hirst, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Thursday, August 19, 2010
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This post comes to us from Jeffrey Bagner, a corporate partner resident in Fried Frank’s New York office, and is based on a Fried Frank Client Memorandum by Mr. Bagner, Stuart H. Gelfond and Colleen R. Duncan.

One of the lesser publicized provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) requires a registrant to obtain the written consent of a Nationally Recognized Statistical Rating Organization (“NRSRO”) in order to disclose in a registration statement or prospectus (or documents incorporated by reference into registration statements or prospectuses) that NRSRO’s credit rating of any class of debt securities, convertible debt securities or preferred stock of the registrant.

Rule 436(a) under the Securities Act of 1933 (the “Securities Act”) requires issuers to file consents for portions of reports of expert opinions used in a registration statement or prospectus. Rule 436(g), which was repealed by the Dodd-Frank Act, had provided an exception to Rule 436(a) by providing that credit ratings assigned to a class of debt securities, a class of convertible debt securities or preferred stock by an NRSRO were not considered part of a registration statement prepared or certified by an expert within the meaning of Sections 7 and 11 of the Securities Act. Therefore, prior to the repeal of Rule 436(g), issuers did not need to obtain an NRSRO’s consent in order to provide ratings information in a registration statement or prospectus. In response to the Dodd-Frank Act, certain NRSROs have stated that they will not consent to the use of their ratings in Securities Act registration statements and prospectuses since by doing so it would expose them to potential Section 11 liability for material misstatements or omissions. This position may lead to a decrease in the disclosure of ratings in registered offerings.

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When the Government Is the Controlling Shareholder

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Wednesday, August 18, 2010
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This post comes to us from Marcel Kahan, Professor of Law at New York University and Edward Rock, Professor of Business Law at the University of Pennsylvania.

In our paper When the Government Is the Controlling Shareholder, recently made publicly available on SSRN, we analyze the ways in which existing corporate law structures of accountability change when the government is the controlling shareholder, and the extent to which federal “public law” structures substitute for displaced state “private law” norms.

As a result of the 2008 bailouts, the United States Government is now the controlling shareholder in AIG, Citigroup, GM, GMAC, Fannie Mae and Freddie Mac. Corporate law provides a complex and comprehensive set of standards of conduct to protect noncontrolling shareholders from controlling shareholders who have goals other than maximizing firm value, but are designed with private parties in mind. We show that when the government is the controlling shareholder, the Delaware restrictions are largely displaced, but hardly replaced, by federal provisions. When GM goes public again, government ownership of a controlling position will be a significant “risk factor.”

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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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