Monthly Archives: May 2011

Risk and Incentive: An Event Study Approach

The following post comes to us from Zhonglan Dai of the Accounting and Information Management Department at the University of Texas at Dallas, Li Jin of the Finance Unit at Harvard Business School, and Weining Zhang of the Department of Accounting at the National University of Singapore.

In the paper, Risk and Incentive: An Event Study Approach, which was recently made publicly available on SSRN, we take an event study approach to reexamine the standard principal-agent model prediction with respect to executives who have likely experienced an exogenous risk shock. Existing empirical studies of the relationship between risk and incentives provide mixed results, some positive, some negative, and some showing no relationship. We analyze not only the relation between level of pay-performance-sensitivity and firm risk subsequent to a litigation event, but also incremental incentives (changes in pay-performance-sensitivity embedded in executives’ annual compensation) occasioned by a litigation event.

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Moving toward Board Declassification in Fourteen S&P 500 Companies

Editor’s Note: This post relates to two press releases issued by the American Corporate Governance Institute (the “ACGI”), an organization that Lucian Bebchuk and Scott Hirst are affiliated with. One press release, issued jointly by the ACGI and the Florida State Board of Administration is available here; the other press release, issued jointly by the ACGI and the Nathan Cummings Foundation, is available here.

During this proxy season, the American Corporate Governance Institute (the “ACGI”), an organization with which we are affiliated, assisted two institutional investors in the submission of shareholder declassification proposals. This post reports on the success that these shareholder declassification proposals had in contributing to board declassification in 14 S&P 500 companies.  The declassification of the boards of these companies would produce a 10% reduction in the number of S&P 500 companies with a classified board (currently standing at 139).

The ACGI assisted the Florida State Board of Administration (the “Florida SBA”) in the submission of shareholder declassification proposals for a vote at the 2011 annual meeting of a number of companies. The Florida SBA and the ACGI subsequently negotiated and reached agreements with seven companies, pursuant to which each company will bring a management proposal to declassify its board of directors.

The ACGI also assisted the Nathan Cummings Foundation (the “Foundation”) in the submission of shareholder declassification proposals to a number of companies. The Foundation and the ACGI subsequently negotiated and reached agreements with six companies, pursuant to which each company will bring a management proposal to declassify its board of directors. In addition, following the submission of one of the Foundation’s proposals (to Watson Pharmaceuticals, Inc.), the company announced a plan to bring a declassification proposal to a vote at its 2011 annual meeting.

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Concentrating on Governance

The following post comes to us from Dalida Kadyrzhanova of the Finance Department at the University of Maryland and Matthew Rhodes-Kropf of the Entrepreneurial Management Unit at Harvard Business School.

In our paper, Concentrating on Governance, forthcoming in the Journal of Finance, we develop a unified account of the costs and benefits of external governance and explore the economic determinants of the resulting trade-offs for shareholder value. The importance of corporate governance is broadly recognized, but there is a great deal of disagreement on whether existing governance mechanisms ultimately benefit or hurt shareholders. Our novel perspective explains shareholder governance trade-offs, why they arise, and how they vary across firms and industries.

The classical agency view is that it is costly for shareholders to yield power to managers because managers pursue private benefits of control whenever their jobs are protected from takeovers or shareholder initiatives. A challenge to the agency view comes from the alternative bargaining view, which suggests that it is in the interest of shareholders to yield power to managers, a popular argument among M&A lawyers and practitioners.

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Promising Steps on Bank Pay Reforms

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 that recently appeared in the Butterworths Journal of International Banking and Financial Law, which is available here. The Program on Corporate Governance has published several recent papers on pay at financial institutions, including How to Fix Bankers’ Pay, The Wages of Failure: Executive Compensation at Bear Stearns and Lehman 2000-2008, and Regulating Bankers’ Pay.

Despite greater regulatory oversight and smaller payouts, compensation in the financial sector continues to attract scrutiny and criticism. Yet, an examination of pay reforms at some banks suggests a strengthening alignment of interest among executives, their firms, and wider society.

First, owing to new regulations, a greater proportion of bankers’ pay is exposed to longerterm performance outcomes of their firms. Last December, the Committee of European Banking Supervisors (‘CEBS’) finalised rules requiring 40-60 per cent of executives’ variable pay to be deferred for three to five years and at least 50 per cent of it to be in stock. Equally, CEBS regulations limit upfront cash payments to 20-30 per cent of total remuneration.

Although US regulators have historically been reticent to regulate executive pay, the Federal Deposit Insurance Corporation is proposing to introduce similar requirements at US financial institutions.

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