Monthly Archives: April 2011

A New Legal Theory to Test Executive Pay: Contractual Unconscionability

The following post comes to us from Lawrence A. Cunningham, Professor of Law at the George Washington University Law School, and is based on Professor Cunningham’s paper from the Iowa Law Review, available here.

Executive pay has skyrocketed in recent decades, in absolute terms and compared to average wages. The area of largest growth has been in stock-based components, including stock options, often tending to focus on the short-term, with associated risks we’ve seen. A vigorous academic debate has run for more than a decade, becoming a popular political discussion amid the financial crisis that arcane debate to public scrutiny.

Growth could be laudable, explained as creating proper incentives to align manager interests with shareholder interests and to promote optimal risk taking. In this view, if there is a problem, it is narrow and limited. Critics are skeptical whether this story holds up. They worry that managerial power has strengthened to enable top executives to control setting their own compensation. In this view, the problem is pervasive and warrants a comprehensive response—and proposals abound.

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Monitoring Managers: Does It Matter?

The following post comes to us from Francesca Cornelli, Professor of Finance at the London Business School; Zbigniew Kominek of the European Bank for Reconstruction and Development; and Alexander Ljungqvist, Professor of Finance at New York University.

In the paper, Monitoring Managers: Does It Matter? which was recently made publicly available on SSRN, we investigate how boards of directors monitor management, under what circumstances they fire CEOs, and whether these actions improve performance. Boards of directors are tasked with ensuring that firms are run by competent managers who act in their shareholders’ interest by providing appropriate incentives and through “active monitoring,” that is, collecting information about the firm’s operations or the manager’s ability and firing the manager if necessary. Much of the economic literature on corporate governance and boards studies the provision of incentives and pays less attention to monitoring. In this paper, we ask if boards with large shareholders indeed engage in active monitoring and whether such monitoring in turn improves performance.

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Delaware Court of Chancery Addresses Multi-Forum Deal Litigation

Theodore Mirvis is a partner in the Litigation Department at Wachtell, Lipton, Rosen & Katz. This post is based on a Wachtell Lipton firm memorandum by Mr. Mirvis, William Savitt and Ryan A. McLeod. This post is part of the Delaware law series, which is cosponsored by the Forum and Corporation Service Company; links to other posts in the series are available here.

The pot of multi-forum stockholder litigation against deals continues to boil. The recent Allion decision, the subject of our recent memo, spotlights one solution that our Firm developed that has shown some promise.

That litigation follows in the wake of a deal’s announcement is nothing new. But participants in the M&A markets are still grappling with the increasingly prevalent trend of multiple shareholder actions challenging the same deal in different courts. The Delaware Court of Chancery recently endorsed a pragmatic solution to this endemic problem. In re Allion Healthcare Inc. S’holders Litig., C.A. No. 5022-CC (Del. Ch. Mar. 29, 2011).

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Exemplifying Fundamentals — Back to Basics in Securities Regulation

Editor’s Note: Luis A. Aguilar is a Commissioner at the U.S. Securities and Exchange Commission. This post is based on Commissioner Aguilar’s remarks at the annual NASAA 19(d) conference; the complete remarks are available here. The views expressed in the post are those of Commissioner Aguilar and do not necessarily reflect those of the Securities and Exchange Commission, the other Commissioners, or the Staff.

For the last several years, we have been engaged in an uphill fight to restore the securities regulation framework at global, federal, and state levels to where it should be. Financial services exist to serve investors and our markets, and a focus on investors is absolutely essential to any credible regulatory restructuring.

It is time for everyone involved in the financial services industry to re-dedicate themselves to the fundamentals of regulation. It is time to go back to basics. I am going to spend my time today discussing with you our shared goal — ensuring that securities regulation works as it was fundamentally intended.

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Excess-Pay Clawbacks

Jesse Fried is a Professor of Law at Harvard Law School.

In the paper, Excess-Pay Clawbacks, which was recently made publicly available on SSRN, Nitzan Shilon and I identify substantial deficiencies in the clawback arrangements of public companies. We also explain why the Dodd-Frank Act’s clawback requirement is likely to improve these arrangements, but does not go far enough.

The paper begins by highlighting the problem of “excess pay” – excessively high payouts to executives arising from errors in earnings and other compensation-related metrics. Such excess pay, we explain, can impose substantial costs on shareholders even if there is no manipulation or other misconduct. Unfortunately, directors frequently use their discretion to let current and departed executives keep excess pay. Thus, an optimal clawback policy would require directors to recover excess pay from either current or departed executives.

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The Shifting Landscape of Corporate Governance

This post comes to us from John J. Madden, a member of the Mergers & Acquisitions Group at Shearman & Sterling LLP, and is based on an article that first appeared in the BNA Corporate Governance Report and appears with permission; the complete article is available here.

The widespread public criticism of boards of directors arising from the financial crisis, and the ensuing governance reform initiatives, should not have come as a surprise to those following trends in corporate governance. Instead, they should be seen as part of a series of developments in the evolving relationship between shareholders and their boards in the United States that has been underway for the past two decades. As the shareholder base has largely consolidated into the institutional investor community and those investors have become more organized and focused on exerting the influence inherent in their substantial ownership stakes, we have seen in recent years an accelerating shift in the “balance of authority” exercised by boards and shareholders in the corporate decision-making process.

There is no indication that this trend will reverse or even slow down significantly. Accordingly, directors should understand the origins and key drivers involved, and determine how they can most effectively adapt to this changing environment and secure the confidence and support of their companies’ shareholders.

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UN Guiding Principles for Business & Human Rights

John Ruggie, the Berthold Beitz Professor of International Affairs at the Kennedy School of Government, is currently serving as the United Nations Secretary-General’s Special Representative for Business and Human Rights. This post relates to the final version of the Guiding Principles on Implementing the United Nations “Protect, Respect and Remedy” Framework for Business and Human Rights drafted by the Special Representative, which are available here.

In March, as the final product under my UN mandate as Special Representative to the Secretary-General for Business and Human Rights, I released a set of Guiding Principles for Business and Human Rights. The Guiding Principles seek to provide for the first time an authoritative global standard for preventing and addressing the risk of adverse human rights impacts linked to business activity. The UN Human Rights Council will consider formal endorsement of the text at its June 2011 session.

The Guiding Principles are the product of six years of research and extensive consultations involving governments, companies, business associations, civil society, affected individuals and groups, investors and others around the world. They outline how States and businesses should implement the UN “Protect, Respect and Remedy” Framework in order to better manage business and human rights challenges. That Framework, which I proposed in 2008, was unanimously welcomed by the Human Rights Council at the time, and has since enjoyed extensive uptake by international and national governmental organizations, business, civil society and other stakeholders.

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The Market Value of Corporate Votes

The following post comes to us from Avner Kalay, Professor of Finance at the University of Utah; Oguzhan Karakas of the Finance Department at Boston College; and Shagun Pant of the Finance Department at Texas A&M University.

In our paper, The Market Value of Corporate Votes: Theory and Evidence from Option Prices, which was recently made publicly available on SSRN, we propose a new method to measure the market value of the right to vote. We quantify the market value of the right to vote as the difference in the prices of the stock and the corresponding synthetic stock. The synthetic (non-voting) stock is constructed using option prices, particularly facilitating the put-call parity relationship. The main insight is that the owners of common stocks have both cash flow rights and voting rights, whereas holders of synthetic stocks have the cash flow rights but not the voting rights. Hence, the difference in the price of the stock and the synthetic stock quantifies the market value of the vote during the expected life of the synthetic stock.

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The U.S. Left Behind: The Rise of IPO Activity Around the World

René Stulz is a Professor of Finance at Ohio State University.

Craig Doidge, Andrew Karolyi and I have posted on SSRN a new working paper titled The U.S. Left Behind: The Rise of IPO Activity Around the World. We show that there has been a striking evolution over time in IPO activity across countries. We build a comprehensive sample of 29,361 IPOs from 89 countries constituting almost $2.6 trillion (constant 2007 U.S. dollars) of capital raised over 1990 to 2007. Although the share of IPO activity by U.S. firms still ranks near the top worldwide, during the 2000s IPOs in the U.S. have not kept up with the economic importance of the U.S. In the 1990s, the yearly average of the number of U.S. IPOs comprised 26.7% of all IPOs in the world while the U.S. accounted for 27% of world Gross Domestic Product (GDP). Since 2000, the U.S. share of all IPOs has fallen to 11.7% whereas its share of worldwide GDP has averaged 30%. The average size of a typical IPO in the U.S. is larger than that in the rest of the world so that IPO proceeds may be a more relevant metric. Yet, in the last five years of our sample, total U.S. IPO proceeds drop to 16.2% of world IPO proceeds despite the fact that during that period the market capitalization of the U.S. relative to the world stock market capitalization averages 41%.

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Criticism Distorts Value ISS Provides to Boards

Don Delves is founder and president of The Delves Group, an executive compensation and corporate governance consultancy serving boards of directors. This post is based on an article that appeared in Agenda; the paper discussed in the article is available here.

Last month, as the new federal requirement for say on pay took effect, the Center on Executive Compensation (CEC) issued a white paper that includes a well-reasoned critique of Institutional Shareholder Services. Titled “A Call for Change in the Proxy Advisory Industry Status Quo,” the white paper criticizes ISS for a lack of transparency regarding its rating models. It also argues that ISS’s corporate consulting services pose a conflict of interest, and that the organization has become too powerful.

As shareholders and directors assess these criticisms, they should consider ISS’s long-term record. Clearly, that record is one of doing far more good than harm. The organization’s positions have benefited both shareholders and boards at many companies over the past 10 to 15 years by helping them rein in excessive executive compensation. In eradicating or tamping down some of the worst pay practices, the organization has brought more rationality — indeed, more sanity — to executive compensation.

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