Monthly Archives: March 2011

Does Governance Travel Around the World?

The following post comes to us from Reena Aggarwal, Professor of Finance at Georgetown University’s McDonough School of Business; Isil Erel of the Finance Department at The Ohio State University; Miguel Ferreira of the NOVA School of Business and Economics; and Pedro Matos of the Finance Department at the University of Southern California.

In our paper Does Governance Travel Around the World? Evidence from Institutional Investors, forthcoming in the Journal of Financial Economics, we examine whether institutional investors affect corporate governance by analyzing portfolio holdings of institutions in companies from 23 countries during the period 2003-2008.

We find that international institutional investors export good corporate governance practices around the world. In particular, foreign institutional investors and institutions from countries with strong shareholder protection are the main promoters of good governance outside of the U.S. Our results are stronger for firms located in civil-law countries. Thus, international institutional investment is especially effective in improving governance when the investor protection in the institution’s home country is stronger than the one in the portfolio firm’s country.


ISS Goes with Form over Substance

Martin Lipton is a founding partner of Wachtell, Lipton, Rosen & Katz, specializing in mergers and acquisitions and matters affecting corporate policy and strategy. This post is based on a Wachtell Lipton firm memorandum.

The decision by ISS, reported in its March 2, 2011 proxy advisory for the annual meeting of Hewlett-Packard, to recommend against the reelection of members of the nominating committee because of the participation of the Hewlett-Packard CEO in the search for new directors, reflects another mechanistic decision undermining the ability of a board to function collegially. Like many of the positions taken by ISS, it exalts the board’s monitoring functions over its equally important strategic advisory functions.


The Effective Chair-CEO Relationship: Insights from the Boardroom

Stephen M. Davis is the Executive Director of Yale University School of Management’s Millstein Center for Corporate Governance and Performance. This post discusses a report from the Millstein Center by Elise Walton, available here.

The number of U.S. companies that separate the chairman and CEO roles is at a historic high: 40 percent of the S&P 500 now separate the roles, up from 23 percent a decade ago, according to Spencer Stuart. A new report published by Yale’s Millstein Center for Corporate Governance and Performance, The Effective Chair-CEO Relationship: Insight From the Boardroom, examines how this increasingly common relationship works. Based on interviews with CEOs, non-executive Chairs, and stakeholders, the report aims to understand what constitutes a winning relationship between two individuals, each successful in his or her own right. As this leadership structure becomes more prevalent, these insights should be useful to those working together in these interdependent roles.


Does Takeover Activity Cause Managerial Discipline? Evidence from International M&A Laws

The following post comes to us from Darius Miller, Professor of Finance at Southern Methodist University, and Ugur Lel of the Federal of the Federal Reserve Board.

In the paper Does Takeover Activity Cause Managerial Discipline? Evidence from International M&A Laws, which was recently made publicly available on SSRN, we examine if the market for corporate control improves corporate governance. Theory suggests that the threat of takeover is one of the most important external mechanisms for aligning the interests of managers and shareholders. While a large empirical literature analyzes the effects of takeover activity on managerial discipline, it has not been entirely successful in establishing whether an active market for corporate control enhances managerial discipline and often finds mixed results. Partly, this is because many studies rely on sources of variation in the threat of takeover that can generate serious endogeneity and omitted variable biases. For example, tests that employ the mean level of takeover activity as a proxy for the threat of takeover suffer from potential omitted variable biases since overall takeover activity is likely to be accompanied by contemporaneous macroeconomic shocks that could jointly explain management turnover. Further, tests that employ takeover defenses as a proxy for takeover threats suffer from endogeneity concerns as they are often established at the discretion of the firm.


The State of Engagement between U.S. Corporations and Shareholders

The following post comes to us from Jon Lukomnik of the Investor Responsibility Research Center Institute and Marc Goldstein of Institutional Shareholder Services, and is an abridged version of a study conducted by ISS for the IRRC Institute, which is available here.

Study Summary

At a time when engagement is front and center in the public debate about corporate America, this study provides the first-ever benchmarking of the level of engagement between investors and public corporations (issuers) in the United States. As evidenced by the provisions of the Dodd-Frank legislation, various SEC rule-makings and the lawsuits contesting them, engagement has emerged as a central governance process for public companies in America. Despite that fact, there has never been a comprehensive picture of investor/corporate engagement and thus no consensus definition of engagement. This study attempts to rectify that lack. It surveyed 335 issuers of stock and 161 investors, including both asset owners (e.g. pension funds, trusts, etc.) and asset managers.


SEC Disclosure and Corporate Governance: Financial Reporting Challenges for 2011

The following post comes to us from Catherine T. Dixon, a member of the Public Company Advisory Group at Weil, Gotshal & Manges LLP, and is based on a Weil Gotshal Alert.

Companies now focusing on preparation of the upcoming annual report have the benefit of wide-ranging disclosure guidance issued in 2010 and early 2011 by the SEC and its Staff. While many of the issues have been highlighted repeatedly since the financial crisis began to erupt in 2007, the significance of the latest round of guidance has been underscored by a far more aggressive SEC enforcement posture in the financial reporting area. [1]


Economic Consequences of Equity Compensation Disclosure

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.


The Professionalization of Shareholder Activism in France

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.


Claims Traders Beware: More Risk Than You Bargained For!

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.


Creditor Control Rights, Corporate Governance, and Firm Value

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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