Monthly Archives: January 2011

Inside Debt and the Design of Corporate Contract

The following post comes to us from Divya Anantharaman of the Accounting Department at Rutgers University, Vivian Fang of the Accounting Department at Rutgers University, and Guojin Gong of the Accounting Department at Pennsylvania State University.

In the paper, Inside Debt and the Design of Corporate Contract, which was recently made publicly available on SSRN, we investigate whether debtholders recognize the incentive effects of executive debt-like compensation when contracting with the firm. Top executives in the United States are commonly compensated with both equity and debt. While prior research has examined the incentive effects of equity-based compensation extensively, most academic work has ignored the incentive effects of debt-like compensation. The greater the ratio of CEO debt-to-equity compensation to corporate leverage, the more aligned the CEO’s interests should be with debtholders vis-à-vis stockholders. If debtholders recognize these implications, we expect firms with higher CEO relative leverage to have lower cost of debt and fewer covenants restricting managers’ activities after debt issuance.


Value Judgments: Tried and True Techniques Bridge Divergent Valuations

Edward Herlihy is a partner and co-chairman of the Executive Committee at Wachtell, Lipton, Rosen & Katz. This post is based on a Wachtell Lipton firm memorandum.

Valuation is usually the fundamental issue in getting to agreement on a bank deal. Persistent high unemployment, the housing slowdown and significant and changing government policy have combined to exacerbate uncertainty over future performance of bank assets. This can create challenges for parties to get to agreement on how to value a bank’s balance sheet and accordingly on a deal price.

Some recent bank deals have brought back traditional solutions, seen in prior generations of bank deals, to bridge the valuation gap. To account for portfolio performance in the period between signing and closing, parties to recent deals have included purchase price adjustments tied to a target’s loan portfolio and/or shareholders’ equity. In other deals, the buyer has negotiated the ability to exit the deal if the target’s loan portfolio deteriorates beyond a specified level, or the target bank suffers a decline in core deposits below a threshold level – offering a potentially more objective exit trigger than the traditional “material adverse effect.”


CEO Education, CEO Turnover, and Firm Performance

The following post comes to us from Sanjai Bhagat, Professor of Finance at the University of Colorado; Brian Bolton of the Finance Department at the University of New Hampshire, and Ajay Subramanian of the Risk Management and Insurance Department at Georgia State University.

In the paper, CEO Education, CEO Turnover, and Firm Performance, which was recently made publicly available on SSRN, we analyze the effects of CEO education on CEO turnover (firing and replacement) and firm performance. Our primary interest is on the role that CEO education plays in a firm’s decision to replace its current CEO, the role that it plays in selecting a new CEO, and on whether CEO education significantly affects performance.

We use six main measures of CEO education: whether or not the CEO attended a Top-20 undergraduate school, whether or not the CEO has an MBA, law or masters‟ degree, and whether or not the MBA or law degree is from a Top-20 program. Our study includes more than 14,500 CEO-years and more than 2,600 cases of CEO turnover from 1993-2007.


Trends in Asset Allocation and Portfolio Composition

This post comes to us from Matteo Tonello, Director of Corporate Governance for The Conference Board, Inc., and is based on a recent paper published by the Conference Board, which is available here.

In its annual Institutional Investment Report, which was released on November 11, The Conference Board provides a comprehensive analysis of the asset growth and portfolio composition of institutional investors operating in the United States. It documents the presence over 30 years of different types of institutional investors in single asset classes such as equity, debt securities, alternative instruments, and foreign securities, drawing on data from a wide range of sources. This year’s report includes definitive data for 2009 and focuses on the impact of the financial market rebound on institutional asset value and investment decisions.

Following 2008’s dramatic decline of the securities markets, by the end of 2009 the investment industry had registered substantial gains across virtually all classes of financial instruments, with total institutional assets rising 14 percent to $25,351.1 billion—a level similar to that recorded between 2005 and 2006. This constitutes an extraordinary upward movement from the 21.3 percent plunge of 2008, albeit still far from the best performances of an industry that between 1995 and 2007 had experienced unprecedented growth of 23.3 percent on an annualized basis. Of course, the historical significance of this finding should also be put in context with the new economic uncertainties and the added market volatility of the last few months.

The following are the other major findings discussed in the report.


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