Yearly Archives: 2010

Market Reactions to CEO Inside Debt Holdings

Posted by the Harvard Law School Forum on Corporate Governance & Financial Regulation, on
Tuesday, January 12, 2010
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Editor’s Note: This post comes to us from David Yermack, the Albert Fingerhut Professor of Finance and Business Transformation at New York University, and Chenyang Wei, economist at the Federal Reserve Bank of New York.

In our recently updated working paper Stockholder and Bondholder Reactions to Revelations of Large CEO Inside Debt Holdings: An Empirical Analysis, we investigate investor reactions to the first disclosures of the values of CEOs’ pensions and deferred compensation. These two items together comprise managers’ “inside debt” claims against their firms, since each represents a fixed liability owed by the companies to their executives at a future date.

We identify 231 companies whose CEOs have positive inside debt holdings and whose proxy statements with 2006 compensation data are filed in early 2007 during the first wave of disclosures under the SEC’s new executive compensation disclosure regulations. About 45% of these CEOs have excessive inside debt, as their personal inside debt-equity ratios exceed the external debt-equity ratios of their firms. As expected, we find evidence of transfers of value away from equity and toward debt upon revelations that top managers hold large pension and deferred compensation claims. Our results show that bond prices rise, equity prices fall, and the volatility of both securities drops at the time of disclosures by firms whose CEOs have large inside debt.

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Ten Thoughts for Ordering Governance Relationships in 2010

Posted by Holly Gregory, Weil, Gotshal & Manges LLP, on
Monday, January 11, 2010
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Holly Gregory is a Corporate Partner specializing in corporate governance at Weil, Gotshal & Manges LLP. This post is based on a Weil Gotshal client memorandum by Ms. Gregory, Ira M. Millstein and Rebecca C. Grapsas. The complete memorandum is available here.

As the 2010 proxy season nears, we encourage both boards and shareholders to rethink the contours of their relationship. We expect institutional shareholders to have greater influence in director elections this year given the increasing prevalence of majority voting requirements and, for the first time, the absence of discretionary voting by brokers of uninstructed shares. Institutional shareholder power will expand further in 2011 if the SEC moves forward with proxy access rules and Congress enacts legislation mandating majority voting and “say on pay.” In this environment, boards and shareholders will be well served by considering in an open way how this shift in influence should be reflected in changes in behavior.

For boards, the challenge will be to understand the key concerns of the company’s shareholder base and get out ahead on these issues. Boards should also consider whether company disclosures and communications can be improved to better inform shareholders and encourage them to make company-specific decisions through a long-term lens. This will require devoting more attention, resources and creativity to communications and relations with shareholders. Boards that are insensitive to shareholder concerns risk bruising election battles, while providing further inducement for the homogenized governance mandates currently percolating in Washington.

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Additional Views on What TARP Has Achieved

Posted by the Harvard Law School Forum on Corporate Governance & Financial Regulation, on
Sunday, January 10, 2010
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Editor’s Note: Damon Silvers is Associate General Counsel for the AFL-CIO and a member of the Congressional Oversight Panel established in 2008 to review the current state of financial markets and the regulatory system. This post is based on Mr. Silver’s additional views on the recent report of the Panel, which was the subject of this post by Professor Elizabeth Warren.

This separate view does not reflect a disagreement with the Panel report in any respect. Rather I wish to say in a somewhat briefer and perhaps blunter way what I believe the Panel report as a whole says about TARP.

The Emergency Economic Stabilization Act of 2008 and the Troubled Asset Relief Program it created, in my opinion, were significant contributors to stabilizing a full blown financial panic in October 2008. It is clear to me that for that reason, we are better off as a nation for the existence of TARP than if we had done nothing. Of course this proposition is very hard to prove, but I am convinced it is true. Many people deserve credit for doing TARP rather than doing nothing, but three people who in particular deserve credit are Federal Reserve Chairman Ben Bernanke, Treasury Secretary Timothy Geithner, and in particular, former-Treasury Secretary Henry Paulson.

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Compensation and Risk Under New SEC Rules

Posted by Edward F. Greene, Cleary Gottlieb Steen & Hamilton LLP, on
Saturday, January 9, 2010
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Edward Greene is a partner at Cleary Gottlieb Steen & Hamilton LLP focusing on corporate law matters. This post is based on a Cleary Gottlieb Steen & Hamilton alert memorandum.

The SEC has amended its disclosure rules to require, among other matters, a discussion about a company’s compensation policies and practices for all employees if they create risks that are “reasonably likely” to have a material adverse effect on the company. [1] Prior SEC guidance, to which the SEC referred in adopting the amendments, indicates that the “reasonably likely” threshold is higher than “possible” but lower than “more likely than not.”

We are skeptical that any compensation committee knowingly approves compensation programs and arrangements that place the company at material risk, and insofar as the standard imports a “risk factor”-type threshold, we question whether it will elicit meaningful disclosure. That said, a conclusion that the disclosure trigger is not met necessarily rests on an assessment of the balance of risk and reward implied by the company’s compensation program design and incentive targets, taken as a whole. As with many SEC rules in the post-SOX era, process will be key. Because the compensation committee plays a central role in that process, we suggest below practical considerations relevant to its deliberations. We also note that most compensation committees do not now routinely review compensation arrangements for rank and file employees. A predicate for analyzing the disclosure question will therefore be an inventory and review of the operation of compensation programs for all employees, which should be undertaken immediately in light of the effective date of the rules. [2]

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Board of Directors Meeting Agendas

Posted by Martin Lipton, Wachtell, Lipton, Rosen & Katz, on
Friday, January 8, 2010

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Martin Lipton is a founding partner of Wachtell, Lipton, Rosen & Katz, specializing in mergers and acquisition and matters affecting corporate policy and strategy. This post is based on a Wachtell, Lipton, Rosen & Katz client memorandum by Mr. Lipton, Steven A. Rosenblum, and Karessa L. Cain.

The numerous legislative and regulatory initiatives adopted or proposed in response to the economic crisis, and the increased corporate governance activism by shareholders and their advisory organizations, raise the question of what are the key matters that a board should be considering on a regular basis. As a supplement to our recent post on the Forum, entitled Some Thoughts for Boards of Directors in 2010, we developed the following list of matters. Some matters could be visited once a year; and some should be visited at each meeting. Some companies will need to add matters to this list in view of relevant business, corporate governance or other issues specific to their companies. Boards should also consider the extent to which some of these matters should be addressed more fully by board committees. Each company should tailor the scope of, and the allocation of time to, the matters, and the frequency of their consideration, to its particular circumstances.

  • Performance of the business, including comparison to budget and peers
  • CEO succession and exposure of senior executives to the board

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Basel Committee Proposes Strengthening Bank Capital and Liquidity Regulation

Posted by H. Rodgin Cohen, Sullivan & Cromwell LLP, on
Thursday, January 7, 2010
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H. Rodgin Cohen is a partner and chairman of Sullivan & Cromwell LLP focusing on acquisition, corporate governance, regulatory and securities law matters. This post is based on a Sullivan & Cromwell client memorandum.

On December 17, 2009, the Basel Committee issued two consultative documents proposing reforms to bank capital and liquidity regulation, which are intended to address lessons learned from the financial crisis that began in 2007. [1] The document titled Strengthening the Resilience of the Banking Sector proposes fundamental, although in many respects anticipated, changes to bank capital requirements. The document titled International Framework for Liquidity Risk Measurement, Standards and Monitoring proposes specific liquidity tests that, although similar in many respects to tests historically applied by banks and regulators for management and supervisory purposes, going forward would be required by regulation.

The proposals in the first document, which we refer to as the “capital proposals”, would significantly revise – and, as described by the consultative document, simplify – the definitions of Tier 1 Capital and Tier 2 Capital, with the most significant changes being to Tier 1 Capital. Among other things, the proposals would disqualify innovative capital instruments – including U.S.-style trust preferred securities and other instruments that effectively pay cumulative distributions, and in many cases are debt for tax purposes – from Tier 1 Capital status. They would also re-emphasize that Common Equity is the “predominant” component of Tier 1 Capital by (i) adding a minimum Common Equity to risk-weighted assets ratio, with the ratio itself to be determined based on the outcome of an impact study that the Committee is conducting, and (ii) requiring that goodwill, general intangibles and certain other items that currently must be deducted from Tier 1 Capital instead be deducted from Common Equity as a component of Tier 1 Capital. This approach could have a significant impact on acquisitions in which goodwill arises.

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Mandatory Accounting Standards and the Cost of Equity Capital

Posted by Siqi Li, Santa Clara University, on
Wednesday, January 6, 2010
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This post comes to us from Siqi Li, Assistant Professor of Accounting at Santa Clara University.

In my forthcoming Accounting Review paper Does Mandatory Adoption of International Financial Reporting Standards in the European Union Reduce the Cost of Equity Capital? I test whether mandatory IFRS adoption affects the cost of equity capital using a sample of 6,456 observations representing 1,084 distinct firms in 18 EU countries during the period of 1995 to 2006. I define firms that do not adopt IFRS until it becomes mandatory in 2005 as mandatory adopters, firms that adopt IFRS before 2005 as voluntary adopters, and I divide the sample period into pre- and post-mandatory adoption periods.

My primary analysis consists of regressing the cost of equity (using average estimates from four implied cost of capital models) on a dummy variable indicating the type of adopter (mandatory versus voluntary), a dummy variable indicating the time period (pre- versus post-mandatory adoption period), the interaction between these two dummies, and a set of control variables that include whether a firm is cross-listed in the U.S., country-specific inflation rate, firm size, return variability, financial leverage, as well as industry and country fixed effects. This difference-in-differences design, which includes the population of both mandatory and voluntary adopters over the period of 1995 through 2006, compares the change in the cost of equity for mandatory adopters before and after the mandatory switch, relative to the corresponding change in the cost of equity for voluntary adopters.

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Federal Court Rejects Claim that Merger Negotiations are Required to be Disclosed

Posted by Paul Vizcarrondo, Wachtell, Lipton, Rosen & Katz, on
Tuesday, January 5, 2010
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Paul Vizcarrondo Jr. is a partner in the Litigation Department of Wachtell, Lipton, Rosen & Katz specializing in corporate and securities litigation and regulatory and white collar criminal matters. This post is based on a Wachtell Lipton client memorandum by Mr. Vizcarrondo and Jonathon R. La Chapelle, associate in Wachtell Lipton’s Litigation Department.

The United Stated District Court in Chicago has granted summary judgment dismissing a class action claiming that statements by Sears about its business that did not also disclose that it was negotiating a merger with Kmart constituted federal securities fraud. Levie v. Sears Roebuck & Co., No. 04C7643 (N.D. Ill. December 18, 2009).

Sears and Kmart had briefly discussed in the spring of 2004 the possibility of Sears acquiring Kmart through a merger, but instead Sears agreed in June 2004 to buy 54 Kmart stores. The complaint alleged that the merger negotiations continued after that, and Sears’ failure to disclose their existence made its public statements about its business plans materially misleading. In declining to dismiss the complaint, the Court stated that “[i]f the merger negotiations became material at a point in time when the Sears defendants were making announcements about the purchase of Kmart stores, a jury could find that the existence of the merger negotiations was a material fact necessary to make the store purchase statements not misleading.”

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Creditor Rights and Corporate Risk-Taking

Posted by Jim Naughton, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Monday, January 4, 2010
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This post comes to us from Viral Acharya, Professor of Finance at New York University, Yakov Amihud, Professor of Finance at New York University, and Lubomir Litov, Assistant Professor of Finance at Washington University in St. Louis.

In a recent working paper Creditor Rights and Corporate Risk-Taking, we study the effect of creditor rights in bankruptcy on corporate risk-taking. In particular, we ask: What effect does the strength of creditor rights have on firms’ investment decisions? In other words, while a harsh penalty in default reduces fraud and opportunistic behavior by debtors, might it also inhibit entrepreneurial, bona-fide risky investment?

Our empirical analysis uses as an explanatory variable the variation of creditor rights across countries in their bankruptcy codes, documented by La Porta et al. (1998), which are largely a function of the country’s legal origin and exogenous to the nature of the country’s overall corporate investments. We employ several different measures of corporate risk-taking and examine their relationship to creditor rights across countries and over time.

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Drafting Disclosure Relating to Board Leadership and Risk Oversight

Posted by Jeffrey Stein, King & Spalding LLP, on
Sunday, January 3, 2010
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Jeffrey Stein is a partner in the Corporate Practice Group at King & Spalding LLP. This post is by Mr. Stein and Bill Baxley, a partner in King & Spalding’s Corporate Practice and co-head of the firm’s Mergers & Acquisitions initiative.

For some years now, corporate governance experts have debated the best model of board leadership for public companies.  Studies have compared the historically prevailing U.S. model – in which the chief executive officer also serves as chairman of the board — with different approaches that are more common in other countries, such as the typical approach in many European markets of having an independent board chair.  As U.S. public companies were caught off guard by the depth and severity of the most recent financial crisis, what seemed before to be primarily an academic subject became very real for U.S. public companies.  Some observers suggested that the U.S. board leadership model (and specifically the failure of U.S. regulators to require an independent board chair) contributed to the crisis and to the failure of U.S. public companies to be prepared for the effects of the crisis. Legislators and regulators picked up on this theme, with suggestions that public companies should be required to have an independent board chair.

In the years between Sarbanes-Oxley and the 2008/2009 financial crisis, many boards realized that there were alternatives to having an independent board chair.  For example, many companies continue to have a combined CEO/chairman, but have appointed a “lead” or “presiding” director.  Even where there is no director holding such a title, many boards have called on particular directors (for example, the chair of the audit committee or the chair of the governance committee) to take leadership roles, on behalf of the independent directors.  Moreover, with the tumult in some board rooms and executive suites arising out of the most recent financial crisis, boards in certain instances have chosen, in response to their specific circumstances, to go the route of having an independent board chair, at least until the crisis passes.  Accordingly, as we enter 2010, it is no longer appropriate to say that there is one “prevailing” model of board leadership for U.S. public companies.  Rather, boards increasingly are choosing their leadership models based on their specific circumstances, such as the talent and experience of the chief executive officer, the challenges that the company is facing, and the preferences of their large shareholders.

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