Yearly Archives: 2011

Voluntary Disclosures That Disavow the Reliability of Mandated Fair Value Information

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Friday, November 11, 2011
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The following post comes to us from Walter Blacconiere (deceased); James Frederickson, Professor of Accounting at the Melbourne Business School; Marilyn Johnson of the Department of Accounting at Michigan State University; and Melissa Lewis of the Department of Accounting at the University of Utah.

U.S. and international accounting standards mandate recognition and/or disclosure of fair value information for an increasing number of items. Fair value estimates require judgment, introducing the possibility of biases in measurements, measurers, and/or models. In addition, unanticipated changes in market risk result in realized values differing from fair value estimates. Accompanying the shift to fair value accounting is the emergence of voluntary disclosures in audited financial statement footnotes that alert investors to management’s concerns about the reliability of mandated fair value information. We refer to such disclosures as reliability disavowals (hereafter, disavowals). In our paper, Are voluntary disclosures that disavow the reliability of mandated fair value information informative or opportunistic? forthcoming in the Journal of Accounting and Economics as published by Elsevier, we examine whether disavowals are informative; that is whether they are a truthful revelation by management that their fair value estimates are unreliable. We also consider that managerial opportunism may contribute to—or even solely motivate—the decision to disavow.

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The Volcker Rule Proposals on Bank Investments in Private Funds

Posted by Noam Noked, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Thursday, November 10, 2011
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The following post comes to us from Michael P. Harrell, corporate partner and Co-Chair of the global Private Equity Funds and Investment Management Groups at Debevoise & Plimpton LLP, and is based on a Debevoise & Plimpton Client Update by Mr. Harrell, Satish M. Kini, Rebecca F. Silberstein, Gregory J. Lyons, Kenneth J. Berman, Paul L. Lee, David A. Luigs and Gregory T. Larkin.

On October 11th and 12th, the Federal Reserve, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency and the Securities and Exchange Commission (the “regulators”) proposed for comment implementing rules (the “Proposed Rules”) for Section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Volcker Rule”). The Volcker Rule generally prohibits “banking entities” from engaging in proprietary trading and investing in hedge funds or private equity funds, subject to certain exemptions.

The Proposed Rules, which provide guidance on how the Volcker Rule is proposed to be applied in practice, address a number of significant issues raised by the statutory text of the Volcker Rule but leave open many important questions. Indeed, the release proposing the Proposed Rules (the “Proposing Release”) includes almost 400 questions requesting comment on a range of issues, suggesting both that the Proposed Rules are a work in progress and that the regulators have not achieved consensus on many of the elements of the proposal. This memorandum focuses on the most significant issues relating to the prohibition on banking entities investing in and sponsoring private equity and hedge funds.

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Moving S&P 500 Companies Toward Board Declassification: Post-Proxy Season Update from the ACGI

Posted by the Harvard Law School Forum on Corporate Governance & Financial Regulation, on
Wednesday, November 9, 2011
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Editor’s Note: Lucian Bebchuk and Scott Hirst are Professor of Law, Economics and Finance and Lecturer on Law, respectively, at Harvard Law School. Their earlier post about the work of the ACGI is available here.

This post provides an updated overview of the outcomes resulting from the work by the American Corporate Governance Institute (ACGI) during the 2011 proxy season to contribute to moving S&P 500 companies toward board declassification. During the 2011 proxy season the ACGI represented and advised two institutional investors, the Florida State Board of Administration (SBA) and the Nathan Cummings Foundation (NCF), in connection with the submission of shareholder declassification proposals. In addition to the results described in an earlier post, we were pleased by subsequent developments in two companies:

  • Thermo Fisher Scientific Inc. (TMO): Following a vote at the 2011 annual meeting in which 87% of the shareholder votes cast were in favor of the SBA’s declassification proposal, the board of directors amended the company’s bylaws to declassify the board. Starting at the 2012 annual meeting, directors will be elected for one year terms, with the entire board serving one-year terms from the 2014 annual meeting.
  • eBay Inc. (EBAY): Following the submission of a proposal by the NCF, negotiations between eBay (represented by Wachtell Lipton) and the NCF (represented by the ACGI) produced an agreement pursuant to which the company committed to complete a full review of declassifying the board of directors and moving to annual elections of all directors. Following the completion of the review, the company announced that it will bring a management proposal to declassify the board for a vote at the 2012 annual meeting.

With these developments, the ACGI’s work during the single 2011 proxy season has contributed to (i) eight companies which have already declassified, (ii) seven companies which have already committed to bring a management declassification proposal at their 2012 meeting, and (iii) eight companies which have yet to respond to the substantial shareholder majority votes in support of declassification at their 2011 annual meetings, as described below.

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The Influence of Governance on Investment

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Wednesday, November 9, 2011
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The following post comes to us from Matthew T. Billett, Professor of Finance at Indiana University; Jon A. Garfinkel, Associate Professor of Finance at the University of Iowa; and Yi Jiang, Assistant Professor of Finance at California State University.

The governance structure of a firm can influence any number of its policies and actions, sometimes to the benefit and sometimes to the detriment of shareholders. Among the many studies of these relationships, numerous ones investigate the link between firm governance and corporate investment; however, the findings are inconclusive. Some studies report results suggesting poor governance associates with excessive investment (over-investment or empire-building), while others suggest the opposite (poorly governed managers may prefer the “quiet life”).

In our paper, The Influence of Governance on Investment: Evidence from a Hazard Model, forthcoming in the Journal of Financial Economics, we revisit the question of how governance affects corporate investment behavior in an attempt to reconcile these conflicting findings. Unlike prior studies we use a hazard framework, wherein we study how governance influences the time between large investment expenditures. This empirical approach helps alleviate some of the concerns with the methods of prior studies and also provides an unexplored perspective. In this framework, we find that governance does influence the time between major investments (investment spikes). Poor governance associates with shorter periods between spikes than that for firms with stronger governance. We further show that this relation is due to poorly governed firms over-investing, rather than stronger governance firms under-investing.

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Harvard Convenes the Institutional Investors Roundtable

Posted by the Harvard Law School Forum on Corporate Governance & Financial Regulation, on
Tuesday, November 8, 2011
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The Harvard Institutional Investors Roundtable will convene tomorrow. The event will bring together prominent members of the institutional investor world to discuss a number of related issues concerning shareholder voting.

During the morning sessions, the roundtable discussion will focus on lessons from the first year of advisory votes on executives compensation and on how institutions should vote on compensation arrangements in the future. During the second half of the day, the roundtable discussion will focus on majority voting and withhold votes, as well as on the reporting of proxy votes to beneficiaries. The event will start with a keynote talk by and discussion with Larry Summers.

The event, which is co-organized by Lucian Bebchuk and Robert Pozen, is jointly sponsored by the Harvard Law School Program on Institutional Investors, the Harvard Law School Program on Corporate Governance, Harvard Business School, and the Harvard Kennedy School Center for Business and Government, and supported by the Investment Company Institute.

Participants in the Harvard Institutional Investors Roundtable will include:

  • F. Gregory Ahern, Chief Public Communications Officer, Investment Company Institute (ICI)
  • Joe Bachelder, Founder and Senior Partner, The Law Offices of Joseph E. Bachelder
  • Lucian A. Bebchuk, William J. Friedman and Alicia Townsend Friedman Professor of Law, Economics, and Finance; Director, Program on Corporate Governance, Harvard Law School
  • Bo Becker, Assistant Professor, Harvard Business School
  • Allison Bennington, Partner and General Counsel, ValueAct Capital
  • Kenneth A. Bertsch, President and CEO, Society of Corporate Secretaries and Governance Professionals
  • Glenn Booraem, Principle and Fund Controller, Vanguard
  • Carol Bowie, Executive Director, Institutional Shareholder Services Inc. (ISS)
  • Richard C. Breeden, Chairman, Breeden Capital Management
  • Jay Chaudhuri, General Counsel and Senior Policy Advisor, North Carolina Department of State Treasurer
  • Robert C. Clark, Harvard Distinguished Service Professor, Harvard Law School
  • John C. Coates IV, John F. Cogan, Jr. Professor of Law and Economics, Harvard Law School
  • Jack Cogan, Non-Executive Chairman, Pioneer Investment Management USA, Inc.

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November 2011 Dodd-Frank Rulemaking Progress Report

Posted by Noam Noked, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Tuesday, November 8, 2011
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The following post comes to us from Margaret E. Tahyar and Gabriel D. Rosenberg of the Financial Institutions Group at Davis Polk & Wardwell LLP. This post discusses a Davis Polk report which is available here. A post about the previous progress report is available here. Other posts about the Dodd-Frank Act are available here.

This posting, the November Davis Polk Dodd-Frank Progress Report, is the eighth in a series of Davis Polk presentations that illustrate graphically the progress of the rulemaking work that has been done and is yet to occur under the Dodd-Frank Act. The Progress Report has been prepared using data from the Davis Polk Regulatory Tracker™, an online subscription service offered by Davis Polk to help market participants understand the Dodd-Frank Act and follow regulatory developments on a real-time basis.

In this report:

  • 37 New Deadlines – The Halfway Point. The 37 rulemaking deadlines due in October bring the number to date up to 200 – half of the 400 total required by the statute. To this point, only 23% of the rules due have been finalized.
  • 10 Requirements Met, 30 Proposed, 37 Missed. A number of rulemakings were proposed or finalized this month, including:
    • Proposed Volcker Rule Regulations – The FDIC, Federal Reserve, OCC and SEC released a coordinated proposed rule to implement the Volcker Rule. The CFTC has not yet released its proposed rule.
    • FSOC Re-Proposal on SIFI Designation – The FSOC re-proposed a rule, along with guidance, on designation of nonbank financial companies as “systemically important.”
    • SEC Proposed Rule on Registration – The SEC issued a proposed rule on registration of security-based swap dealers and major security-based swap participants.
    • CFTC Proposal on Effective Date for Swap Regulation – The CFTC issued a proposed rule that would extend the latest date for its temporary Title VII relief until July 2012.
    • CFTC Final Rule on Position Limits – The CFTC approved a final rule on position limits.
    • CFTC Final Rule on DCOs – The CFTC approved a final rule on regulation of derivatives clearing organizations, combining several proposals into one 485-page final rule release.

The Effect of Enforcement on Timely Loss Recognition

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Monday, November 7, 2011
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The following post comes to us from Sudarshan Jayaraman of the Department of Accounting at Washington University in Saint Louis.

In the paper, The Effect of Enforcement on Timely Loss Recognition: Evidence from Insider Trading Laws, forthcoming in the Journal of Accounting and Economics as published by Elsevier, I examine how first-time enforcement of insider trading laws affects the extent of timely loss recognition (TLR) in financial statements. A growing literature examines how cross-country variation in institutional characteristics shape financial reporting outcomes (e.g., Ball et al. 2000; 2003; Ball and Shivakumar 2005, Bushman and Piotroski 2006, Hail and Leuz 2006). These studies find that variation in the demand for accounting information in contracts drives differences in the quality of financial reporting across countries. As the usefulness of accounting information in contracts depends on how well these contracts are enforced, the effectiveness of enforcement of securities laws is an important determinant of reporting quality.

I use the first-time enforcement of insider trading laws across sixteen countries as a shock to enforcement and examine its influence on TLR. Prior studies (e.g., Bekaert and Harvey 1997, 2000; Bhattacharya and Daouk 2002; Daouk et al. 2006) provide evidence that first-time enforcement of insider trading laws results in an overall increase in the level of enforcement of securities laws and property rights. Countries that enforce these laws for the first time follow it up with several initiatives designed to sustain the increased level of enforcement. These result in improvements in sovereign credit ratings and greater lending by foreign investors – the ones more likely to rely on financial statements for monitoring (Ball et al. 2000; Leuz et al. 2009).

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How Conflicts of Interest Thwart Institutional Investor Stewardship

Posted by the Harvard Law School Forum on Corporate Governance & Financial Regulation, on
Sunday, November 6, 2011
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Editor’s Note: Simon Wong is a Partner at Governance for Owners, an Adjunct Professor of Law at the Northwestern University School of Law, and a Visiting Fellow at the London School of Economics and Political Science. This post is based on an article by Mr. Wong that appeared in Butterworths Journal of International Banking and Financial Law, which is available here.

In its recent green paper, the European Commission expressed concern about the effects of conflicts of interest on institutional investors’ willingness and ability to engage investee companies actively on corporate governance matters. Given the pervasiveness of asset manager conflicts and their adverse impact on shareholder engagement and voting behaviour, the remedies pursued must venture beyond the EC’s proposal of requiring ‘independence of the asset manager’s governing body’.

Three Layers of Conflicts

Conflicts of interest at investment firms arise at three levels – institution, individual, and group – all of which pose risks to effective stewardship by institutional investors.

Institutional conflicts

Institutionally, the core conflict of interest pertains to asset managers’ unwillingness to actively engage and hold the boards and management of investee companies accountable because they fear losing corporate business. In reality, the risk of commercial harm varies by market. In the UK, for example, companies do not usually retaliate by withholding business when investment managers vote against management’s proposals. Nonetheless, the occasional veiled threat – such as when the company secretary of a UK manufacturer reminded a fund manager who was intending to vote against the company’s remuneration report that his firm was bidding for an investment mandate from the corporation’s pension plan – may be enough to make investment houses hesitate about embracing stewardship.

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Reacting to Shareholder Proxy Access Proposals

Posted by Noam Noked, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Saturday, November 5, 2011
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The following post comes to us from Robert K. Morris, partner at Reed Smith LLP, and is based on a Reed Smith White Paper by Mr. Morris. Related work on proxy access by the Program on Corporate Governance includes Private Ordering and the Proxy Access Debate by Bebchuk and Hirst, and the proceedings of The Harvard Law School Proxy Access Roundtable.

This year, as a result of recent amendments to SEC rules, shareholder proponents can require companies for the first time to allow shareholders to vote on the company’s proxy card for proposals to amend the bylaws to facilitate contested elections for directors. If approved, these proposals (“proxy access” proposals) would require a company in the future to permit voting on the company’s proxy card for persons that shareholders nominate for election as directors, thus enabling shareholders to mount contested elections at minimal cost.

The deadline for requesting inclusion of proposals in company proxy materials for the spring meeting season is in November. To assist companies in considering possible responses to these proposals, this paper will discuss:

  • the historically varying and current terms of the “election exclusion” in Rule 14a-8(i)(8);
  • the likelihood of receiving a proxy access proposal;
  • possible procedural grounds for excluding a proxy access proposal from the company’s proxy statement; and
  • a possible state corporation law basis for excluding a proxy access proposal.

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Corporate Governance Development Framework

Posted by the Harvard Law School Forum on Corporate Governance & Financial Regulation, on
Friday, November 4, 2011
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Editor’s Note: The following post comes to us from Darrin Hartzler, Manager of the Corporate Governance Unit in the Environment, Social and Governance Department at the International Finance Corporation.

IFC recently joined 28 other development finance institutions (DFIs) – with combined assets of approximately $852 billion – to launch the Corporate Governance Development Framework. This new initiative provides DFIs with a common set of tools to evaluate the governance of their client companies, many of whom work in some of the world’s most challenging markets.

The framework helps DFIs strengthen their due diligence processes and work with their clients to improve weak areas in their corporate governance. By adopting a common approach, signatory DFIs will set consistent standards for corporate governance and common expectations from clients.

Corporate governance helps companies operate more efficiently, gain access to capital, and safeguard against corruption and mismanagement. It makes companies more accountable and transparent to investors and enables them to respond to legitimate stakeholder concerns, such as responsible environmental and social practices. As providers of financing to companies in emerging markets, DFIs play a significant role in promoting good corporate governance across a broad range of regions and sectors. Our hope is that by working together, we can help make corporate governance a cornerstone of sustainable development.

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