Yearly Archives: 2011

Does It Matter Who Pays for Bond Ratings?

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Friday, November 18, 2011
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The following post comes to us from John (Xuefeng) Jiang, Associate Professor of Accounting at Michigan State University; Mary Stanford, Professor of Accounting at Texas Christian University; and Yuan Xie, Assistant Professor of Accounting at Fordham University.

In our paper, Does It Matter Who Pays for Bond Ratings? Historical Evidence, forthcoming in the Journal of Financial Economics, we examine whether charging issuers for bond ratings is associated with higher credit ratings employing the historical setting wherein S&P switched from an investor-pay to an issuer-pay model in 1974, four years after Moody’s made the same switch.

Many commentators and policy makers claim that charging bond issuers for ratings introduces conflicts of interest into the rating process. For corporate bonds issued between 1971 and 1978, we find that, for the same bond, Moody’s rating is higher than S&P’s rating prior to 1974 when only Moody’s charges issuers. After S&P adopts the issuer-pay model in July 1974, the evidence indicates that S&P’s ratings increase to the extent that they no longer differ from Moody’s ratings. Because we use Moody’s ratings for the same bond as our benchmark, we can conclude that this increase in S&P’s ratings is not due to general changes affecting bond ratings.

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Two New Corporate Forms to Advance Social Benefits in California

Posted by John F. Olson, Gibson, Dunn & Crutcher LLP and Georgetown Law Center, on
Thursday, November 17, 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 a Gibson Dunn alert by David M. Hernand and Stewart L. McDowell.

On October 9, 2011, California Governor Jerry Brown signed into law competing bills that create two new corporate forms in California — a “flexible purpose corporation” and a “benefit corporation” — intended to allow entrepreneurs and investors the choice of organizing companies that can pursue both economic and social objectives. The new corporate forms differ from traditional for-profit corporations that are organized to pursue profit (and not social purposes) and non-profit corporations that must be used solely to promote social benefits. These laws will take effect on January 1, 2012.

The flexible purpose corporation is created by California Senate Bill 201 (“SB 201”), which adds Division 1.5 to Title 1 of the California Corporations Code (the “Code”) and amends other related sections of the Code, and the benefit corporation is created by California Assembly Bill 361 (“AB 361”), which adds Part 13 to Division 3 of Title 1 of the Code. State Senator Mark DeSaulnier authored SB 201, and a full copy is available here. AB 361 was authored by Assemblyman Jared Huffman, and a full copy is available here. Both new laws take effect January 1, 2012.

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EU Proposed Financial Transaction Tax – Fortune or Folly?

Posted by Noam Noked, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Thursday, November 17, 2011
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The following post comes to us from Thomas A. Humphreys, head of the Federal Tax Practice Group as well as co-chair of the Tax Department at Morrison & Foerster LLP, and is based on a Morrison & Foerster bulletin by Mr. Humphreys, Peter J. Green, Jeremy C. Jennings-Mares, and Richard Jerman.

Since the financial crisis, there has been frequent talk of the introduction of a financial transaction tax. This tax, often referred to as “Tobin tax” after its original advocator, James Tobin, in the 1970s, would impose a levy on individual transactions undertaken by a financial institution. The subject has been discussed at G20 summits since Pittsburgh in 2009, [1] and the European Commission (the “Commission”) has made no secret of its desire to implement the taxation across its 27 Member States.

On Wednesday 28 September in the annual State of the Union address, José Manuel Barroso, President of the Commission, announced the long anticipated proposal for a European financial transaction tax. The tax, if implemented, would impact financial transactions between financial institutions from 2014, charging 0.1% against the exchange of shares and bonds and 0.01% across derivative contracts. The Commission believes the tax, with the potential to raise 57 billion euros per year, would “ensure that the financial sector makes a fair contribution at a time of financial consolidation” [2] noting, among other things, the significant government bailouts to support the financial sector during the crisis.

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Endogenous Information Flows and the Clustering of Announcements

Posted by Viral Acharya, New York University, on
Wednesday, November 16, 2011
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Viral Acharya is a Professor of Finance at New York University.

One of the most important ingredients to the process of price discovery in financial markets is the flow of new information, particularly apparent during times of market “crisis,” when it often seems that bad news is being reported simultaneously from multiple sources. While it is not surprising that firms’ news are affected by market and sector conditions (given the correlation of their cash flows), the timing of the announcements is suggestive that these disclosure decisions are not made independently. Indeed, recent empirical work suggests that corporate earnings warnings within an industry are clustered and that firms speed up their warnings in response to poor market conditions. Interestingly, however, such clustering is asymmetric in that good news does not generate such clustering, only bad news does. In the paper, Endogenous Information Flows and the Clustering of Announcements, forthcoming in the American Economic Review, my co-authors (Peter DeMarzo and Ilan Kremer, both of Stanford University) and I provide a theoretical explanation for this asymmetry.

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Say on Pay: Identifying Investor Concerns

Posted by Ann Yerger, Council of Institutional Investors, on
Tuesday, November 15, 2011
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Ann Yerger is Executive Director of the Council of Institutional Investors. This post is based on the executive summary of a CII white paper which was prepared by Robin A. Ferracone and Dayna L. Harris, Executive Chair and Vice President, respectively, at Farient Advisors, LLC; the white paper is available here.

Advisory shareowner votes on executive compensation were the big story of proxy season 2011, the inaugural year for “say on pay” at most U.S. public companies. The Dodd-Frank Wall Street Reform and Consumer Protection Act, which President Obama signed into law in August 2010, requires U.S. public companies to provide their shareowners with a non-binding vote to approve the compensation of senior executives. The Securities and Exchange Commission’s (SEC) implementing rule, adopted on Jan. 25, 2011, requires say-on-pay votes to approve the compensation of the named executive officers (NEO) at larger companies at least once every three years. The SEC granted smaller companies a two-year exemption.

Say on pay gives shareowners a voice in how top executives are paid. Such votes are also a way for a corporate board to determine whether investors view the company’s compensation practices to be in the best interests of shareowners. Say-on-pay votes are purely advisory; U.S. companies are not required to change their executive compensation programs in response to the outcome. But SEC rules do require that in subsequent proxy statements, companies discuss how the most recent say-on-pay voting results affected their executive compensation decisions and overall programs. Such follow-on comments are to be included in the Compensation Discussion and Analysis (CD&A) section of the proxy statement.

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“Presumption of Prudence” for Fiduciaries in ERISA Litigation

Posted by George T. Conway III, Wachtell, Lipton, Rosen & Katz, on
Tuesday, November 15, 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 by Mr. Conway, John F. Lynch, and Bradley R. Wilson. Another memo about the two court cases described below is available from Schulte Roth & Zabel LLP here.

In companion decisions issued recently, the United States Court of Appeals for the Second Circuit has ruled that retirement-plan fiduciaries should have the benefit of a “presumption of prudence” when faced with claims by employees concerning losses on their employer’s stock.  The cases are In re Citigroup ERISA Litigation, No. 09-3804-CV (2d Cir. Oct. 19, 2011), and Gearren v. McGraw-Hill Cos., No. 10-792-CV (2d Cir. Oct. 19, 2011).

The two cases involved the same basic facts.  The retirement plans at issue mandated that employees have as one of their investment options a fund consisting mainly of their employer’s stock — Citigroup in one case, McGraw-Hill in the other.  After each company suffered a stock-price decline, plan participants complained that the fiduciaries should have seen the decline coming and either should have eliminated the employer stock fund as an option under the plan, or else sold the company’s stock out of the fund.  The plaintiffs claimed that the fiduciaries, by failing to do so, violated their duties of prudence and loyalty under the Employee Retirement Income Security Act.

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What Do Boards Really Do? Evidence from Minutes of Board Meetings

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Monday, November 14, 2011
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The following post comes to us from Miriam Schwartz-Ziv of the Department of Finance at the Hebrew University of Jerusalem, and Harvard University; and Michael Weisbach, Professor of Finance at The Ohio State University.

In our paper, What Do Boards Really Do? Evidence from Minutes of Board Meetings, which was recently made available on SSRN, we analyze a unique database from a sample of real-world boardrooms – minutes of board meetings and board-committee meetings of eleven business companies for which the Israeli government holds a substantial equity interest. We use these data to evaluate the underlying assumptions and predictions of models of boards of directors. In recent years, more than a dozen economic models have attempted to examine what boards actually do. However, because board meetings are generally a “black box” to which scholars have very limited access, these models proceed from wildly different underlying assumptions, and accordingly, make very different predictions. These models generally fall into two categories:

  • (1) “Managerial models” – assume boards play a direct role in managing the firm, and that they make the actual decisions pertaining to the business of the firm.
  • (2) “Supervisory models” – assume that the board only observes the CEO’s actions, but does not make any business decisions. Based on the boards’ observations, it evaluates/reevaluates the CEO, and decides whether to retain or fire the CEO.

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Boards Respond to Stakeholder Concerns

Posted by Noam Noked, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Sunday, November 13, 2011
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The following post comes to us from Don Keller, partner at PricewaterhouseCoopers LLP’s Center for Board Governance, and is a summary of PwC’s Annual Corporate Director Survey 2011, which is available here.

The economic crisis, increased rules and regulations, and heightened scrutiny of boards’ roles have corporate directors feeling pressure to be more effective in the boardroom. PwC’s 2011 Annual Corporate Director Survey (the Survey) of 834 corporate directors offers insight into the biggest corporate governance issues facing directors today. Because 67% of respondents represent companies with more than $1 billion in annual revenue, the Survey illustrates the current boardroom thinking of many of the largest companies in the world.

The corporate governance landscape has changed over the past few years, and as it continues to evolve, directors are working to adapt. Their responses to the Survey indicate that executive compensation, risk management, strategy and succession planning are key areas of future focus. They are also concerned about information technology security and fraud.

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Toward Final Position Limit Rules on Certain Derivatives

Posted by the Harvard Law School Forum on Corporate Governance & Financial Regulation, on
Saturday, November 12, 2011
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Editor’s Note: The following post comes to us from Mark D. Young, partner in the Derivatives Regulation and Litigation practice at Skadden, Arps, Slate, Meagher & Flom LLP, and is based on a Skadden memorandum by Mr. Young, Prashina J. Gagoomal, and Timothy S. Kearns.

On Tuesday, October 18, the U.S. Commodity Futures Trading Commission (CFTC) voted 3-2 to adopt final rules imposing speculative position limits on certain agricultural, metals and energy futures and swaps contracts, pursuant to Section 737 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank). The final rules have not yet been published. The following discussion is based on statements made by CFTC staff and commissioners at the October 18 meeting as well as the CFTC-issued fact sheet and Q&A about the final rules.

Opening Statements by Commissioners

At the meeting, Commissioners Scott O’Malia and Jill Sommers made statements opposing the final position limits rule for many reasons, including that the rule was contrary to the Commodity Exchange Act (CEA), as amended by Dodd-Frank. Commissioners O’Malia and Sommers voted against the rule. Commissioner Michael Dunn issued an opening statement noting that he did not believe imposing position limits would have any effect on prices and may actually increase price volatility as well as costs to hedgers, but that Congress had required the CFTC to impose position limits. Despite Commissioner Dunn’s conclusion that “position limits are, at best, a cure for a disease that does not exist or a placebo for one that does,” he voted in favor of the proposal. Commissioner Bart Chilton supported the final rule, emphasizing that although the rule would not please everyone, it would ensure more efficient and effective markets devoid of fraud, abuse and manipulation. Chairman Gary Gensler, who cast the final vote in favor of the proposal, asserted in his statement that Congress had directed the CFTC to impose position limits and narrow the bona fide hedge exemption.

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The 2011 U.S. Director Compensation and Board Practices Report

Posted by Matteo Tonello, The Conference Board, on
Friday, November 11, 2011
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Matteo Tonello is Managing Director of Corporate Leadership at The Conference Board, Inc. This post relates to a study of U.S. public company board practices led by Dr. Tonello; Frank Hatheway, the Chief Economist and Senior Vice President of NASDAQ OMX; and Scott Cutler, Executive Vice President, Co-Head US Listings & Cash Execution, NYSE Euronext. For details regarding how to obtain a copy of the report, contact [email protected].

The Conference Board, NASDAQ OMX and NYSE Euronext jointly released The 2011 U.S. Director Compensation and Board Practices Report, a benchmarking tool with more than 120 corporate governance data points searchable by company size (measurable by revenue and asset value) and industrial sectors.

The report is based on a survey of public companies registered with the U.S. Securities and Exchange Commission. The Harvard Law School Forum on Corporate Governance and Financial Regulation, Stanford University’s Rock Center for Corporate Governance, the National Investor Relations Institute (NIRI) and the Shareholder Forum also endorsed the survey by distributing it to their members and readers.

The Conference Board’s annual benchmark series on director compensation was first released in 1939. In the last decade, the database has been expanded to report on a wide array of governance practices, documenting a steady transformation in the role of public companies’ boards and underscoring the increasing importance of directors’ monitoring responsibilities and the growing influence of shareholders.

The following are the major findings from the 2011 edition of the study.

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