Monthly Archives: August 2011

The Timeliness of Bad Earnings News and Litigation Risk

The following post comes to us from Dain Donelson of the Department of Business, Government, and Society at the University of Texas at Austin, John McInnis of the Department of Accounting at the University of Texas at Austin, Richard Mergenthaler of the Department of Accounting at the University of Iowa, and Yong Yu of the Department of Accounting at the University of Texas at Austin.

In our paper, The Timeliness of Bad Earnings News and Litigation Risk, which was recently made publicly available on SSRN, we examine the relation between the timeliness of bad earnings news and the incidence of securities litigation. Skinner (1994) proposes that the earlier revelation of bad news reduces the expected costs of litigation because earlier revelation diminishes the perception that management “hid the truth” and reduces damages by shortening the class period. This litigation reduction hypothesis predicts that timelier revelation of bad earnings news should reduce the likelihood of being sued and/or the costs of resolving lawsuits that do occur.


Disclosure of Corporate Political Spending a Needed First Step

George Dallas is Director of Corporate Governance at F&C Management Ltd. and chair of the Business Ethics Committee at the International Corporate Governance Network. This post is based on an ICGN comment letter by Mr. Dallas and Christianna Wood submitted to the SEC, available here. The petition that is referenced in the comment letter is available on the SEC website here, and a post by Lucian Bebchuk and Robert Jackson, co-chairs of the committee submitting the petition, is available here.

The International Corporate Governance Network (ICGN) would like to voice its support for the recent petition that was sent to the Securities and Exchange Commission on August 3, 2011 by the Committee on Disclosure of Corporate Political Spending, advocating a rulemaking project to require disclosure of corporate political spending to public company shareholders. The ICGN concurs with this group of academic experts in corporate and securities law that more robust disclosure of corporate political spending is of interest to investors. While the ICGN’s purview is a global one, we believe this matter is particularly relevant in the United States given last year’s Supreme Court decision in Citizens United v. FEC, which confirmed the rights of U.S. companies to provide funding for political purposes.

The ICGN recognises that corporate political activity can be positive. However when corporate resources are deployed to seek political influence there is also potential for abuse. In the extreme this can lead to serious breaches of business ethics, particularly when influence is sought through corrupt practices or in ways that are not consistent with promoting the long-term interests of the company and its investors.


Effects of Local Director Markets on Corporate Boards

The following post comes to us from Anzhela Knyazeva and Diana Knyazeva, both of the Department of Finance at the University of Rochester, and from Ronald Masulis, Professor of Finance at the Australian School of Business, University of New South Wales.

In our paper, Effects of Local Director Markets on Corporate Boards, which was recently made publicly available on SSRN, we examine how local director labor markets affect board composition and the quality of corporate governance. We document that the supply of potential directors in the local labor market strongly affects board composition of S&P 1500 companies, namely, the proportion and expertise of independent directors. For instance, in an average sample firm, a third of independent directors in S&P 1500 firms holding executive positions are employed locally.

Our empirical tests show that access to a larger local pool of prospective directors has a positive effect on the proportion of independent directors and a negative effect on the proportion of gray and inside directors found on a typical board of directors. At firms located near larger local pools of prospective directors, a significantly higher fraction of independent directors are employed locally. Overall, boards of firms located near larger pools of managerial talent include a larger percentage of independent directors who are executives from other nearby firms.


Professors Argue Against U.S. Courts Hearing Foreign Securities Claims

The following post comes to us from Richard W. Painter, S. Walter Richey Professor of Corporate Law at the University of Minnesota, and is based on an amicus brief submitted by a group of professors in Elliott Associates v. Porsche, available here. The group submitting the brief includes Harvard Law School Professor J. Mark Ramseyer, along with Forum contributors Joseph A. Grundfest, Lynn A. Stout, Roberta Romano, and Larry E. Ribstein.

A group of professors of American and German securities law submitted an amicus brief to the Second Circuit Court of Appeals in Elliott Associates v. Porsche, on Wednesday August 3, 2011. Amici urged the Court to prevent private parties from using U.S. courts to litigate claims that exceed the subject matter that Congress intended to regulate in Section 10(b) of the Securities Exchange Act as held by the Supreme Court in Morrison v. National Australia Bank. 130 S. Ct. 2869 (2010).

The case was brought by a group of hedge funds and other investors who took short positions in security based swap agreements that referenced the stock of Volkswagen (VW), which is traded in Germany but not in the United States. The plaintiffs sued Porsche for allegedly manipulating the price of VW stock in Germany and for allegedly misrepresenting Porsche’s intentions concerning takeover of VW. The United States District Court for the Southern District of New York (Judge Baer) held that these claims were precluded under Morrison because the plaintiffs’ transactions were the functional equivalent of transactions in VW stock, which was not traded in the United States. Amici urged affirmance of the holding below.


Preparing for Increased Takeover Activity in Europe

The following post comes to us from Laurent Alpert, a partner at Cleary Gottlieb Steen & Hamilton LLP focusing on mergers, acquisitions and leveraged buyouts, and is authored by Klaus Riehmer. This post discusses a Cleary Gottlieb memorandum, which is available here.

In spite of the crisis relating to state debt in certain European countries, 2011 has so far been a year that has seen a resurgence in the field of mergers and acquisitions in Europe. The proposed merger of the NYSE and Deutsche Börse, Volkswagen’s bid for MAN SE, LVHM’s tender offer for jewel company Bulgari and Stanley Black & Decker’s acquisition of Niscayah are just a few of the more publicized deals that have dominated the headlines of the European financial press in 2011. In a world where most of the transactions are cross-border mergers and may touch various juridictions, it is increasingly imperative that legal professionals engaged in these transactions possess the information to quickly access the required legal information in the respective countries.

The attached memorandum, Preparing for Increased Takeover Activity in Europe – Overview of Key Legal Parameters, seeks to provide the M&A practitioner (and the M&A academic) with a basic overview, on a country-by-country basis, of the rules pertaining to takeovers in Belgium, France, Germany, Italy, the UK, the Netherlands and Russia. The specific questions addressed are set forth below:


General Accountability Office Struggles with Dodd-Frank’s Volcker Rule

Bradley Sabel is a partner at Shearman & Sterling LLP. This post is based on a Shearman & Sterling client publication by Mr. Sabel and Donald Lamson. Other posts about the Volcker Rule are available here.

The General Accountability Office (“GAO”) recently completed a study mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act of the risks and conflicts of interest associated with proprietary trading by U.S. banking institutions (the “Study”). Proprietary trading will be prohibited by Dodd-Frank’s Volcker Rule beginning in July 2012, and the Study was intended to provide input for the U.S. bank regulatory agencies in their proposed regulations implementing its requirements, which are expected in the very near future. The Study addresses (1) what is known about the risks and conflicts of interest associated with proprietary trading and the potential effects of the Act’s restrictions and (2) how regulators have overseen such trading and the challenges they face in implementing the restrictions. This is a more limited approach than the scope of the Study that Congress mandated, and already has garnered criticism by two Senators.

GAO completed its Study [1] with a recommendation that regulators should collect and review more comprehensive information on the nature and volume of activities potentially covered by the Act as a predicate to adopting final rules implementing the Volcker Rule. [2] The recommendation is not surprising, given that GAO encountered difficulty in collecting information on proprietary trading to complete its Study. The Treasury Department and the financial regulators have implicitly declined or at most agreed only to consider this as part of their rulemaking, as they apparently have concerns with the scope and direction of the recommendation.


The Effect of Liquidity on Governance

This post comes from Alex Edmans of the Department of Finance at the University of Pennsylvania and NBER, Vivian Fang of the Department of Accounting at Rutgers University, and Emanuel Zur of the Department of Accounting at Baruch College.

In our paper, The Effect of Liquidity on Governance, which was recently made publicly available on SSRN, we study how stock liquidity affects whether and how blockholders choose to exert governance on a firm. We find that liquidity encourages shareholders to acquire blocks (stakes of at least 5%). Conditional upon a block being formed, liquidity discourages blockholders from governing through “voice” (intervention) as it increases the likelihood of them filing Schedule 13G (which conveys a passivist intent) rather than 13D (which conveys an activist intent). This switch has two interpretations: the blockholder is abandoning governance altogether, or instead is switching to the alternative governance mechanism of “exit” (informed trading of a firm’s shares, otherwise known as the “Wall Street Rule” or “Wall Street Walk”).

Our evidence supports the latter: the effect of liquidity on both block acquisition and the switch from 13D to 13G is stronger in firms where the manager is more sensitive to the stock price (and thus the threat of exit), and the market reaction to a 13G filing is significantly positive, particularly among firms with high liquidity. Thus, liquidity causes a switch from voice to exit rather than causing a blockholder to abandon governance altogether. Although liquidity reduces the frequency of voice, conditional on a block being formed, this is outweighed by the positive effect of liquidity on block formation to begin with. Thus, unconditionally, liquidity leads to an increase in both exit and voice and so we demonstrate an overall positive effect of liquidity on governance. We use decimalization as an exogenous shock to liquidity to identify causal effects.


CFTC and SEC Joint Roundtable on Extraterritorial Scope of Swaps Regulation

The following post comes to us from David Felsenthal, partner at Clifford Chance LLP focusing on financial transactions, and is based on a Clifford Chance client memorandum by Mr. Felsenthal, Gareth Old, and David Yeres.

On Monday, August 1, 2011, the Commodity Futures Trading Commission (“CFTC”) and the Securities Exchange Commission (“SEC”, and together with the CFTC, the “Commissions”) jointly held a public roundtable discussion on international issues related to swaps regulations under the Dodd-Frank Act. The roundtable consisted of three sessions on the following topics: cross-border transactions; global entities; and market infrastructure. Each session was moderated by CFTC and/or SEC staff and the participants included market participants representing dealer firms, investors, public interest groups, clearinghouses and derivatives exchanges. Following is a brief summary of some key discussion points and issues.

Cross-border Transactions

Question: What should trigger imposition of U.S. regulation?

There was general agreement among participants that swaps transactions with a “U.S. person” will fall under U.S. regulation. Beyond that bright line, there was disagreement as to what constitutes “direct and significant” activities or effects that would bring a non-U.S. entity or transaction under U.S. regulation under the Dodd-Frank Act.


Corporate Governance in Emerging Markets

George Dallas is Director of Corporate Governance at F&C Investments. This post is based on an International Finance Corporation report by Mr. Dallas and Melsa Ararat, Director of the Corporate Governance Forum of Turkey and faculty member at Sabanci University; the full report is available here.

Emerging markets play an increasingly important role in the global economy, given their high economic growth prospects and their improving physical and legal infrastructures. Combined, these countries account for nearly 40 percent of global gross domestic product, according to the International Monetary Fund.

For some investors, emerging markets offer an attractive opportunity, but they also involve multifaceted risks at the country and company levels. These risks require investors to have a much better understanding of the firm-level governance factors in different markets.

The Complexity of What Matters in Emerging Markets [1]

Over the past two decades, the relationship between corporate governance and firm performance has received considerable attention from inside and outside academia. Most cross-country studies on corporate governance focus on the relationships between economic performance and countries’ different legal systems, particularly the level of investor protections.


Are Busy Boards Detrimental?

The following post comes to us from Laura Casares Field, Michelle Lowry, and Anahit Mkrtchyan, all of the Department of Finance at Pennsylvania State University.

In our paper, Are Busy Boards Detrimental?, which was recently made publicly available on SSRN, we attempt to measure effects of busy directors serving on the boards of venture-backed IPO firms, and by so doing, address concerns that busy boards are detrimental and that multiple directorships should be limited. The issue of busy boards has received considerable attention in the academic literature and popular press. Yet, even though the academic literature has long recognized that venture capitalists are active on the boards of IPO firms in which they have invested, it is silent on the effects, or even the existence, of busy directors on IPO firms’ boards.

A recent Wall Street Journal article, “Start-Ups Grumble About Directors Too Busy To Help” (7/29/2010), discusses this very issue of the costs and benefits of busy directors among young firms. Focusing on the negative aspects of busy boards, the Wall Street Journal article articulates entrepreneurs’ concerns that venture capitalist directors are juggling too many companies and that the hands-on guidance they can provide to their portfolio companies becomes diluted. Consistent with evidence presented in this paper, however, a number of associated commentaries by executives of private companies with busy boards on the website emphasize that busy directors also provide substantial benefits to the companies on which they serve. The following quote from executive Marcie Black of BandGap, Inc. incorporates the sentiments of several executives’ posts: “The article focuses heavily on the amount of attention a board member offers, but it’s the quality of attention that matters. Many abilities of a mentor improve as they sit on more boards—experience, breadth of network, personal skills, and sense of perspective. No matter the issue that we’re confronting, Forest [board member at BandGap Inc. who also serves on 19 other Boards] has seen it before and usually more than once. The clarity I get from a 20 minute conversation is worth hours from a less experienced mentor.” The executive commentaries to the WSJ article are consistent with our evidence that busy directors can provide strong benefits to young firms’ boards.


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