Yearly Archives: 2010

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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Preparing for Mandatory Say-on-Pay

Posted by Scott Hirst, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Sunday, August 8, 2010
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This post comes to us from John J. Cannon, a partner in the Executive Compensation and Employee Benefits Group Shearman & Sterling LLP, and is based on a Shearman & Sterling Client Publication.

With enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act, mandatory say-on-pay has become federal law. [1] Say-on-pay under the Reform Act requires significant preparation on the part of issuers and their boards of directors and is one step in what we anticipate will be a long and ongoing dialogue with investors about compensation. The requirement is effective for shareholder meetings held on or after January 21, 2011.

The Reform Act and Say-on-Pay

Say-on-pay refers to a shareholder advisory vote on the compensation of an issuer’s named executive officers. Say-on-pay has been a focus of shareholder advocates and the frequent subject of shareholder proposals on executive compensation for several years. [2] Prior to the Reform Act, a number of legislative proposals included a say-on-pay requirement and, in 2009, mandatory say-on-pay became the rule for participants in the Troubled Asset Relief Program.

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Predicting the Future of Corporate Boards

Posted by the Harvard Law School Forum on Corporate Governance & Financial Regulation, on
Saturday, August 7, 2010
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This post comes to us from William Klepper, a Professor of Management at Columbia Business School. The post is based on Professor Klepper’s recent book, The CEO’s Boss: Tough Love in the Boardroom.

The current recession and business failures have brought renewed attention to corporate governance.

Over a period of years, I have developed and presented a series of business cases to corporate directors in my role as professor of management and Academic Director of Executive Education at Columbia Business School. These cases allowed the directors to consider inflections within the business cycle, and how they could survive the subsequent demands on them and their CEOs. As the discussion ensued with these directors, it became apparent to me that an organized body of knowledge could help facilitate their fiduciary roles as the CEO’s boss. With that knowledge, it becomes much easier to understand what they need out of their CEO, and when they need to step in and show a little “tough love” to a CEO going off-course, and what the future holds for boards of directors. In my recently published book, The CEO’s Boss: Tough Love in the Boardroom, I make several predictions about how the dynamics of the board will change; the following is an extract. [1]

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Creditor Mandated Purchases of Corporate Insurance

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Friday, August 6, 2010

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The following post comes to us from Brian Cheyne and Greg Nini of the Insurance and Risk Management Department at the University of Pennsylvania.

In our paper, Creditor Mandated Purchases of Corporate Insurance, which was recently made publicly available on SSRN, we provide the first large-sample evidence on the use and nature of insurance requirements in credit agreements for publicly-traded companies. We show that lenders nearly always mandate that borrowers have some form of insurance and in many cases tailor the requirement to the borrower’s specific situation. In addition to a requirement simply to have insurance, credit agreements also frequently include four additional provisions: (1) a requirement that the borrower purchase specific types of coverage, such as liability or property insurance; (2) a requirement that the lender be named as an additional loss payee; (3) a requirement that any proceeds from insurance payments be used to pay down loan balances; and (4) explicit permission that the borrower may self-insure. Given that over three-quarters of public firms use credit agreements of the type we study (Sufi, 2007), creditor mandated purchases of insurance are indeed an important source to explain the depth and variety of corporate insurance that we see in practice.

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Extraterritoriality After Dodd-Frank

Posted by George T. Conway III, Wachtell, Lipton, Rosen & Katz, on
Thursday, August 5, 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. Other posts relating to the Dodd-Frank Act are available here.

As our memo of June 24 reported (available on the Forum here), the Supreme Court in Morrison v. National Australia Bank Ltd., No. 08-1191 (U.S. June 24, 2010), held that Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5 do not apply to securities transactions that take place outside the United States. The Dodd-Frank Wall Street Reform and Consumer Protection Act, signed into law by President Obama today, contains two provisions, Sections 929P(b) and 929Y, that concern the territorial scope of the federal securities laws. But neither provision overturns National Australia Bank, and neither should extend the substantive reach of the securities laws extraterritorially at all.

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Shaping Up Your Top-Up Option

Posted by David Fox, Kirkland & Ellis LLP, on
Thursday, August 5, 2010
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David Fox is a partner at Kirkland & Ellis LLP, focusing on complex mergers and acquisitions as a member of that firm’s Corporate Group. This post is based on a Kirkland & Ellis M&A Update by Mr. Fox, R. Scott Falk and Daniel Wolf.

As we noted in an M&A Update last year (available on Forum here), tender offers are an increasingly common feature of the M&A landscape. In conjunction with this uptick in tender offer activity, the use of “top-up” options has become nearly universal. Under a top-up option, the target company grants the buyer an option (sometimes mandatorily exercisable) to purchase at the deal price, upon successful completion of the tender offer at or above the minimum condition level (usually 50%), a number of newly issued shares of the target (assuming sufficient shares are authorized and unissued) such that in aggregate the buyer will own at least 90% of the target’s shares. Crossing the 90% threshold (in Delaware) allows the buyer to complete the back-end squeeze-out as a simple short-form merger. Top-up options have been justified as merely representing an acceleration of a foregone conclusion as the buyer, having acquired more than 50% of the target’s shares, is already assured of the ability to effect the back-end squeeze-out (if necessary, via a long-form merger). The accelerated short-form merger timetable benefits both the buyer and the target’s remaining shareholders by hastening the now inevitable exchange of 100% control for cash.

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Private and Public Merger Waves

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Wednesday, August 4, 2010

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The following post comes to us from Vojislav Maksimovic, Professor of Finance at the University of Maryland, Gordon Phillips, Professor of Finance at the University of Maryland, and Liu Yang of the Finance Department at the University of California, Los Angeles.

In our paper, Private and Public Merger Waves, which was recently made publicly available on SSRN, we examine the participation of public and private firms in merger waves. We find that public firms participate more in the market for assets, especially during merger waves, than private firms. Acquisitions by public firms are more likely to lead to an increase in productivity of acquired assets, especially when the assets are acquired from other public firms. Public firms also acquire and sell assets more when they are productive and when there is increased liquidity in the financial market.

However, differences in participation are not just driven by liquidity and access to capital market. First, we find that acquisition activity differs between public and private firms because of their fundamentals differ. Larger and more productive firms select public status, and these firms also engage in more acquisitions in the long run, all other things being equal. Using initial productivity from over five and ten years prior to the transaction, we show that better firms select to become public and later participate more in acquisitions. Second, public status causes a differential in response to measured firm fundamentals or macro-economic shocks. Public firms participate more because they have the option to access public financial markets at more favorable or easier terms than otherwise identical private firms. These effects are reflected in the differences in the estimated coefficients between public and private firms.

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The Next Phase in Financial Regulatory Reform

Posted by the Harvard Law School Forum on Corporate Governance & Financial Regulation, on
Tuesday, August 3, 2010
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Editor’s Note: Mary Schapiro is Chairman of the U.S. Securities and Exchange Commission. This post is based on Chairman Schapiro’s recent remarks at the U.S. Chamber of Commerce’s Center for Capital Markets Competitiveness, which are available here. The views expressed in the post are those of Chairman Schapiro and do not necessarily reflect those of the Securities and Exchange Commission, the other Commissioners, or the Staff.

The past couple of years have been very trying for our markets and our economy. And the path forward still poses significant challenges. But to be fully successful in meeting those challenges, it will require broad engagement—that means business, regulators, consumers and investors alike.

A key part of that challenge will be continuing to strengthen and improve our capital markets.

At the SEC, we routinely hear from investors with concerns and ideas for doing just that. We hear how investors—large and small—are worried about the structure of today’s market, concerned that they are at a disadvantage to the relative handful of sophisticated traders and market intermediaries with unfair access and built-in advantages. We hear about increased volatility and instability. These are issues the SEC has been addressing.

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