Monthly Archives: July 2011

The Deterrence Effects of SEC Enforcement and Class Action Litigation

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Monday, July 25, 2011
, ,
More from: , ,

The following post comes to us from Jared Jennings of the Department of Accounting at the University of Washington; Simi Kedia of the Department of Finance & Economics at Rutgers University; and Shivaram Rajgopal, Professor of Accounting at Emory University.

In the paper, The Deterrence Effects of SEC Enforcement and Class Action Litigation, we study whether SEC enforcement actions are associated with significant change in behavior of peer firms towards greater compliance. As complete compliance is not feasible, a rational enforcement policy implies enforcement efforts that maximize deterrence. Maximum deterrence is also explicitly mandated in directives from the US Congress as one of the main objectives of the SEC’s enforcement policy. Private securities class action litigation, though it does not aim to explicitly deter others, also has the potential to generate deterrence as such enforcement is more frequent and imposes higher monetary sanctions than the SEC.

We study accrual based earnings management in peers, operationalized as firms in the same industry, as the targeted firm in the aftermath of SEC enforcement and litigation to ascertain the existence and magnitude of deterrence. The results suggest significant reduction in accruals for peer firms of targets that are subject to SEC enforcement and/or litigation. Such reversal of accruals is not only highly statistically significant but also economically important. On average, every peer firm reduces discretionary accruals to the tune of 14% to 22% of its average ROA. This evidence of significant deterrence is robust to different definition of industry. It is also not isolated to events in a few years. Significant evidence of deterrence is seen in sub-samples and also over the extended time period from 1976 to 2006.

READ MORE »

Inside the Boardroom: Responding to a Negative Say on Pay Vote

Posted by Paul Rowe, Wachtell, Lipton, Rosen & Katz, on
Sunday, July 24, 2011
, , ,
More from: , ,

Paul Rowe is a Partner in the Litigation Department at Wachtell, Lipton, Rosen and Katz. This post is based on a Wachtell Lipton memorandum by Mr. Rowe and Martin Lipton.

When stockholders deliver a negative vote on say on pay, directors face the question whether to change corporate policy in response – even if their best business judgment tells them that existing compensation programs are well-designed and are working well. In fact, a negative vote on say on pay does not change the board’s fiduciary duty to implement compensation policies that the directors believe are the best way to attract, retain and incentivize top-quality managers:

  • The law is clear in all American jurisdictions that setting compensation policy and structuring compensation agreements are decisions reserved for directors and not shareholders. That is why say on pay resolutions are advisory and do not carry mandatory force.
  • Dodd-Frank does not affect this basic legal principle. It specifically provides that say on pay votes do not change the board’s fiduciary duties and traditional powers in this area.

READ MORE »

Change of Control Special Committee: Breathing Life into CNX

Posted by Scott Hirst, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Saturday, July 23, 2011
, , ,
More from:

The following post comes to us from Samuel C. Thompson Jr., Professor of Law and Director of the Center for the Study of Mergers & Acquisitions at the Pennsylvania State University School of Law. This post is part of the Delaware law series, which is co-sponsored by the Forum and Corporation Service Company; links to other posts in the series are available here.

Notwithstanding the excellence of the Delaware judiciary, the multiple standards of review under Delaware law for reviewing the actions of a target’s directors involved in a merger or acquisition transaction are cumbersome, a source of needless litigation, and economically inefficient. In my paper Change of Control Special Committee: Breathing Life into CNX, recently made public on SSRN, I put forward a proposal to resolve these issues through changes in Delaware’s General Corporation Law (“DGCL”). DGCL should be amended to permit the shareholders of a corporation to adopt a provision requiring that if the corporation becomes a target of a bona fide acquisition proposal, the board of the corporation must petition the Delaware Court of Chancery for the appointment of an independent, disinterested, and knowledgeable special committee of the board (a “Change of Control Special Committee”). This Committee would have complete power over the acquisition transaction. At the discretion of the Delaware Court of Chancery, a member of the current board could be appointed to the Change of Control Special Committee.

READ MORE »

D.C. Circuit Strikes Down Proxy Access Rules

Posted by Adam O. Emmerich, Wachtell Lipton Rosen & Katz, on
Friday, July 22, 2011
, ,
More from: ,

Adam Emmerich is a partner in the corporate department at Wachtell, Lipton, Rosen & Katz focusing primarily on mergers and acquisitions and securities law matters. This post is based on a Wachtell Lipton firm memorandum. Other posts about proxy access, including several papers from the Program on Corporate Governance, are available here.

In an opinion issued today in the challenge brought by the Business Roundtable and U.S. Chamber of Commerce to the SEC’s adoption of proxy access,  the U.S. Court of Appeals for the D.C. Circuit vacated the entire proxy access regime as an “arbitrary and capricious” exercise of the SEC’s authority.  The opinion, written by Judge Ginsburg, chides the SEC for failing “adequately to assess the economic effects” of  the rules. The court levels particular criticism at the SEC’s analysis of the likely costs associated with, and the frequency of, proxy contests utilizing the access rules, reliance upon “insufficient empirical data” to support a conclusion that proxy access would improve board performance, and failure to address the possibility that unions and pension funds would use the rules as a bargaining chip in unrelated negotiations with issuers.  While noting that these overall defects in the rule render it invalid with respect to all types of issuers, the opinion offers lengthy criticism in particular of the decision to subject investment companies to the proxy access rules, due to the enhanced regulation imposed by the Investment Company Act of 1940.

READ MORE »

Advisory Directors

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Friday, July 22, 2011
, , , ,
More from: , ,

The following post comes to us from Olubunmi Faleye of the Finance Department at Northeastern University, Rani Hoitash of the Department of Accountancy at Bentley University, and Udi Hoitash of the Accounting Department at Northeastern University.

In our paper, Advisory Directors, which was recently made publicly available on SSRN, we study the characteristics and effects of directors dedicated to providing strategic counsel to the chief executive officer (CEO). The question of how to structure corporate boards for effective oversight of top management has attracted significant academic and regulatory efforts in recent years. In contrast, how best to structure the board for optimal advising remains an important but much less investigated topic.

In an attempt to bridge this gap, we propose that the board’s advising functions are best performed by a distinct class of independent directors minimally involved in monitoring management. Specifically, we define an advisory director as an independent director who does not serve on any of the principal monitoring committees but serves on at least one advisory committee if the company has any. We argue that such directors are best positioned for effective advising because their minimal involvement in monitoring enables them to develop a trusting relationship with the CEO and provides the time needed to focus on strategic issues. This facilitates information exchange with the latter, makes him more likely to seek their opinions, and provides a friendly sounding board for important strategic proposals.

READ MORE »

The Dodd-Frank Act, One Year On

Posted by the Harvard Law School Forum on Corporate Governance & Financial Regulation, on
Thursday, July 21, 2011
, ,
More from:
Editor’s Note: The following post on the Dodd-Frank Act, published on the one-year anniversary of its passage, comes to us from Michael S. Barr, Professor of Law at the University of Michigan Law School and former Assistant Secretary for Financial Institutions at the Department of the Treasury. This post is based on a speech delivered by Professor Barr at the Pew/NYU Stern Conference on Financial Reform. The Forum has published more than one hundred posts related to aspects of the Dodd-Frank Act, and these posts are collected here. Some additional information about the Dodd-Frank Act on today’s anniversary can be found in a report from Morrison & Foerster, available here.

Over two years ago, the United States and the global economy faced the worst economic crisis since the Great Depression. The crisis was rooted in years of unconstrained excess on Wall Street, and prolonged complacency in Washington and in major financial capitals around the world. The crisis made painfully clear what we should have always known–that finance cannot be left to regulate itself; that consumer markets permitted to profit on the basis of tricks and traps rather than to compete on the basis of price and quality will, ultimately, put us all at risk; that financial markets function best where there are clear rules, transparency and accountability; and that markets break down, sometimes catastrophically, where there are not.

For many years, a core strength of the U.S. financial system had been a regulatory structure that sought a careful balance between incentives for innovation and competition, on the one hand, and protections from excessive risk-taking or abuse, on the other.

Over time those great strengths were undermined. The careful mix of protections we created eventually eroded with the development of new products and markets for which those protections had not been designed. And our regulatory system found itself outgrown and outmaneuvered by the institutions and markets it was responsible for regulating and constraining.

READ MORE »

Richard Breeden and Larry Hamdan Join PCG’s Advisory Board

Posted by the Harvard Law School Forum on Corporate Governance & Financial Regulation, on
Wednesday, July 20, 2011

More from: ,

The Forum is pleased to announce that Richard Breeden and Larry Hamdan joined the Advisory Board of the Harvard Law School Program on Corporate Governance. They are joining the existing members of the Board: William Ackman, Peter Atkins, Joseph Bachelder, Richard Climan, Isaac Corré, John Finley, Byron S. Georgiou, Robert Mendelsohn, David Millstone, Theodore Mirvis, James Morphy, Toby Myerson, Eileen Nugent, Paul Rowe, and Rodman Ward.

Richard Breeden is the founder and chairman of Breeden Capital Management LLC and a former chairman of the SEC. His bio is available here. Larry Hamdan is Executive Chairman of Global M&A and Head of Global Industrials M&A at Barclays Capital. He previously served as Vice Chairman of Global M&A and the Global Co-Head of the General Industrial Group at Credit Suisse. His bio is available here. Both Breeden and Hamdan already participated the Program’s recent M&A Roundtable.

The Impact of Common Advisors on Mergers and Acquisitions

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Wednesday, July 20, 2011
, , ,
More from: , , ,

The following post comes to us from Anup Agrawal, Professor of Finance at the University of Alabama; Tommy Cooper of the Department of Finance at Kansas State University; Qin Lian of the Department of Economics and Finance at Louisiana Tech University; and Qiming Wang of the Department of Economics and Finance at Louisiana Tech University.

In our paper, The Impact of Common Advisors on Mergers and Acquisitions, which was recently made publicly available on SSRN, we examine the conflict of interest that an investment bank faces when advising both the target and acquirer in a merger or acquisition (M&A) by investigating how common advisors affect deal outcomes.

When the New York Stock Exchange merged with Archipelago Holdings, Inc. in 2004, Goldman Sachs served as the lead M&A advisor to both sides of the deal. Goldman’s dual role was fraught with obvious conflicts of interest. The rationale given was that the bank, as the former underwriter of Archipelago’s IPO, had valuable insights about the potential synergies from the merger.

Whether a common M&A advisor has an adverse effect on one or both sides of a deal is unclear a priori, for two reasons. First, the advisor may be deterred from exploiting its clients by potential litigation costs, damage to its reputation, and the repeat nature of the business. Second, as considerable empirical evidence suggests, market participants may consider financial intermediaries’ conflicts of interest when making their own decisions.

READ MORE »

Bebchuk Becomes President-Elect of the Western Economic Association International

Posted by the Harvard Law School Forum on Corporate Governance & Financial Regulation, on
Tuesday, July 19, 2011

More from:

In its recent annual meeting held in San Diego, the Western Economic Association International (WEAI) elected Professor Lucian Bebchuk to be its President-Elect during 2011-2012. Bebchuk is scheduled to serve as President of the WEAI during 2012-2013.

Founded in 1922, WEAI is a non-profit, educational organization of economists, with 1,800 members around the world, dedicated to encouraging and communicating economic research and analysis. Its past presidents includes Nobel Laureates James Heckman (2007), Clive Granger (2003), Oliver Williamson (2000), Gary Becker (1997), Milton Friedman (1985), James Buchanan (1984), Kenneth Arrow (1981) and Douglass North (1976).

Derivatives and the Legal Origin of the 2008 Credit Crisis

Posted by Lynn A. Stout, Cornell Law School, on
Tuesday, July 19, 2011
, , ,
More from:

Lynn A. Stout is the Paul Hastings Distinguished Professor of Corporate and Securities Law at the University of California, Los Angeles School of Law. This post is part of a series discussing articles appearing in the inaugural issue of the Harvard Business Law Review, which is published in partnership with the Harvard Law School Program on Corporate Governance.

In the paper Derivatives and the Legal Origin of the 2008 Credit Crisis (published in the inaugural issue of the Harvard Business Law Review), I argue that the credit crisis of 2008 can be traced first and foremost to a little-known statute Congress passed in 2000 called the Commodities Futures Modernization Act (CFMA). In particular, the crisis was the direct and foreseeable (and in fact foreseen, by myself and others) consequence of the CFMA’s sudden and wholesale removal of centuries-old legal constraints on speculative trading in over-the-counter (OTC) derivatives.

Derivatives contracts are probabilistic bets on future events that can be used to hedge (which reduces risk) but also provide attractive vehicles for speculation on disagreement (which can increase risk). The common law recognized the differing welfare consequences of hedging and speculative trading in derivatives by applying a doctrine called “the rule against difference contracts” to discourage derivatives that did not serve a hedging purpose by treating them as unenforceable wagers. Speculators responded by shifting their trading onto organized exchanges that provided private enforcement mechanisms, in particular clearinghouses through which exchange members guaranteed contract performance. The clearinghouses effectively cabined and limited the social cost of derivatives speculation risk. In the twentieth century, the common law rule was replaced by the federal Commodity Exchange Act (CEA). Like the common law, the CEA confined speculative derivatives trading to the organized (and now-regulated) exchanges. This regulatory system also for many decades also kept derivatives speculation from posing significant problems for the larger economy.

READ MORE »

Page 2 of 5
1 2 3 4 5