Yearly Archives: 2011

Economic Consequences of Equity Compensation Disclosure

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Monday, March 14, 2011
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The following paper comes to us from Jeremy Bertomeu of the Accounting Information and Management Department at Northwestern University.

In the paper Economic Consequences of Equity Compensation Disclosure, forthcoming in the Journal of Accounting, Auditing, and Finance, we develop a novel mechanism through which a principal may signal a firm’s type to outside investors. In our model, the principal does not need to retain any of the firm’s equity (unlike standard signaling models) but may competitively contract with a manager who is informed and may or may not provide effort.

We show that the choice of effort is affected by both the level of performance-pay chosen by the principal and the quality of the firm. If contracts convey information on the firm, then our analysis shows how and why a firm’s stock price and future operating performance should be associated to the choice of a particular pay package. In this respect, the model offers a framework to tie firm performance and contracting choices, in an optimal contract setting.

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The Professionalization of Shareholder Activism in France

Posted by Matteo Tonello, The Conference Board, on
Sunday, March 13, 2011
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Matteo Tonello is Director of Corporate Governance for The Conference Board, Inc. This post is based on a Conference Board Director Note by Carine Girard and Stephen Gates.

Shareholder activism in France is increasingly influenced by networks of hedge fund investors and other specialized players (including proxy advisory firms and investor associations). In the last few years, these networks have professionalized the way shareholder activism is conducted in the country. This report summarizes notable activism developments in France and examines the phenomenon of professionalization with two recent examples: the Suez-Gaz de France and the Atos Origin cases.

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Claims Traders Beware: More Risk Than You Bargained For!

Posted by Noam Noked, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Saturday, March 12, 2011
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The following post comes to us from Lawrence V. Gelber, David J. Karp and Jamie Powell Schwartz of Schulte Roth & Zabel LLP, and is based on an article that originally appeared in Bloomberg Law Reports.

Bankruptcy claims trading was once largely dominated by trade creditors hoping to receive some value for their claims against a company in bankruptcy. For example, the plumber who was not paid for fixing the sink in an office building might sell his $300 claim against a debtor-building owner to an investment firm in exchange for an immediate pay-out of a fraction of the total claim amount. Over the past several years, however, the size, scope, and nature of the claims trading market has changed dramatically, as has the sophistication of market participants and the complexity of the underlying claims being traded. In many large bankruptcy cases, the small trade creditors have been joined by hedge funds and investment banks as unsecured creditors seeking to unlock liquidity with respect to swap, hedge, or structured financial product claims against large debtors such as Lehman Brothers and Enron. SecondMarket, a claims trading marketplace, has estimated that the potential market for bankruptcy claims is $500 billion, with an estimated $8 billion in claims traded in 2009 [1] and $40 billion in estimated claims traded in 2010 [2] demonstrating tremendous year over year and potential for growth in this asset class. Whether an investment fund looking for exposure to claims or a non-debtor counterparty looking for short term liquidity, parties must understand the potential risks of participation in this market.

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Creditor Control Rights, Corporate Governance, and Firm Value

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Friday, March 11, 2011
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The following post comes to us from Greg Nini of the Insurance and Risk Management Department at the University of Pennsylvania, David Smith of the School of Commerce at the University of Virginia, and Amir Sufi of the Finance Department at the University of Chicago.

In the paper, Creditor Control Rights, Corporate Governance, and Firm Value, which was recently made publicly available on SSRN, we provide evidence that creditors play an active role in the governance of corporations well outside of payment default states. By examining the SEC filings of all U.S. nonfinancial firms from 1996 through 2008, we document that, in any given year, between 10 percent and 20 percent of firms report being in violation of a financial covenant in a credit agreement.

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Petitioners File Reply Brief in Challenge to SEC Proxy Access Rules

Posted by John F. Olson, Gibson, Dunn & Crutcher LLP and Georgetown Law Center, on
Thursday, March 10, 2011
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John Olson is a founding partner of Gibson, Dunn & Crutcher’s Washington, D.C. office and a visiting professor at the Georgetown Law Center. This post is based on an reply brief that was prepared by a Gibson Dunn team representing the Chamber of Commerce and the Business Roundtable; the complete brief is available here. Other posts on the case are available here, and other posts on proxy access, including a number of posts by affiliates of the Program on Corporate Governance, are available here.

On February 25, my colleagues at Gibson Dunn, Gene Scalia, Amy Goodman and Dan Davis, representing petitioners Business Roundtable and the U.S. Chamber of Commerce, filed the petitioners’ reply brief in Business Roundtable v. SEC, a challenge to the Securities and Exchange Commission’s recently promulgated rules providing certain shareholders the right to place board-of-director nominees in company proxy materials.

According to the petitioners, in promulgating the rules the Commission failed to satisfy its statutory duty to assess the rules’ economic consequences. The Commission instead speculated about the rules’ costs, despite record evidence showing that the rules would likely cause expensive election campaigns. The petitioners contend further that the shareholders most likely to use the rules are union and government pension funds, which have a history of using shareholder activism to pursue non-investment-related objectives that depart from other shareholders’ interests. The petitioners fault the Commission for claiming that the rules further shareholder rights, when the mandatory rules instead disenfranchise the vast majority of shareholders, who may wish to avoid the tremendous costs that proxy access would impose on their company.

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Courts Repudiate Attempts to Find Loopholes in Supreme Court Foreign Cubed Decision

Posted by George T. Conway III, Wachtell, Lipton, Rosen & Katz, on
Thursday, March 10, 2011
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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.

Citing the Supreme Court’s decision in Morrison v. National Australia Bank, on February 22 a federal district judge in New York threw out most of a securities class action jury verdict that plaintiffs’ lawyers had estimated was worth $9.3 billion. The jury’s verdict, rendered against the French media conglomerate Vivendi, S.A. thirteen months ago—before National Australia was argued and decided, and thus under now-overturned law—upheld claims that were predominantly “foreign-cubed” (asserted by foreign investors against a foreign issuer for losses on a foreign exchange) and “foreign-squared” (asserted by American investors against a foreign issuer for losses on a foreign exchange). In categorically dismissing all the claims of those investors, the decision in In re Vivendi Universal, S.A. Securities Litigation, No. 02 Civ. 5571 (RJH) (S.D.N.Y. Feb. 23, 2011), according to Vivendi and its counsel, eliminated at least 80%, and perhaps up to 90%, of the liability that the verdict could have produced.

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Corporate Governance and Innovation

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Wednesday, March 9, 2011
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The following post comes to us from Matthew O’Connor, Professor of Finance at Quinnipiac University, and Matthew Rafferty, Professor of Economics at Quinnipiac University.

In the paper, Corporate Governance and Innovation, which was recently made publicly available on SSRN, we examine the effect of corporate governance on innovation as measured by firm research and development (R&D) expenditures. Two different perspectives dominate the academic literature on corporate governance. One perspective emphasizes principal-agent problems and suggests that executives who are protected from shareholder pressure become entrenched. Entrenched executives pursue their own interests at the expense of shareholders. If executives prefer less-risky corporate strategies then an entrenched executive might reduce risky R&D expenditures. An alternative perspective emphasizes that the threat of takeovers forces executives to focus on short-term results so long-term investments such as R&D may suffer. An executive concerned about a takeover threat may reduce R&D expenditures, which are not expensed, to increase short-term profits and stock prices to discourage a hostile takeover. This perspective suggests that entrenched executives who are free from the pressure of hostile takeovers may pursue more R&D expenditures.

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Second Circuit Rules on MD&A Trend Disclosure Requirements

Posted by David A. Katz, Wachtell, Lipton, Rosen & Katz, on
Tuesday, March 8, 2011
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David A. Katz is a partner at Wachtell, Lipton, Rosen & Katz specializing in the areas of mergers and acquisitions and complex securities transactions. This post is based on a Wachtell Lipton firm memorandum by Mr. Katz, Peter C. Hein and S. Christopher Szczerban.

The U.S. Court of Appeals for the Second Circuit recently decided Litwin v. Blackstone Group, L.P. (2d Cir. 2011), addressing “trend disclosure” requirements under Item 303 of Regulation S-K, 17 C.F.R. § 229.303(a)(3)(ii).  This decision highlights the importance of giving appropriate consideration to trend disclosures in public filings, including registration statements as well as annual and quarterly reports.

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Second Circuit Addresses Materiality Standard Under Federal Securities Law

Posted by Brad S. Karp, Paul, Weiss, Rifkind, Wharton & Garrison LLP, on
Tuesday, March 8, 2011
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Brad Karp is chairman and partner at Paul, Weiss, Rifkind, Wharton & Garrison LLP. This post is based on a Paul Weiss client memorandum, and relates to the decision of the Second Circuit Court of Appeals in Landmen Partners v. The Blackstone Group, which is available here.

In an opinion issued on February 10, 2011, in Landmen Partners, Inc. v. The Blackstone Group, L.P., a panel of the United States Court of Appeals for the Second Circuit adopted a view of materiality that may potentially reduce the pleading burden of plaintiffs asserting claims under the federal securities laws. The ruling runs counter to a judicial trend that, since the Supreme Court’s ruling in Bell Atlantic Corp. v. Twombly, 550 U.S. 544 (2007), has applied greater scrutiny to securities class action complaints. It did so by, among other things, minimizing the pleading obligations in claims under Sections 11 and 12(a)(2) of the Securities Act of 1933; focusing its analysis on the importance of the allegedly misleading statements to a corporate segment, rather than the public entity itself; and permitting a claim to be based on corporate and market developments that were publicly known but not specifically described in the registration statement at issue.

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Governance Through Trading and Intervention

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Monday, March 7, 2011
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The following post comes to us from Alex Edmans of the Finance Department at the University of Pennsylvania, and Gustavo Manso of the Finance Department at the Massachusetts Institute of Technology.

In our paper, Governance Through Trading and Intervention: A Theory of Multiple Blockholders, which is forthcoming in the Review of Financial Studies, we analyze the optimal shareholder structure that maximizes the efficiency of corporate governance. Traditional theories argue that shareholders exert governance through directly intervening in a firm’s operations, for example by firing a shirking manager or blocking a wasteful investment. (This is sometimes referred to as “voice”). Under this view, the optimal governance structure features a single concentrated blockholder, as her large stake overcomes free-rider problems and maximizes her incentives to intervene. However, in reality, most firms have multiple small blockholders. This appears to be inefficient as no blockholder has a large enough stake to induce her to bear the cost of intervention. Therefore, some commentators argue that policymakers should encourage more concentrated stakes.

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