Monthly Archives: November 2011

Say on Pay: Identifying Investor Concerns

Ann Yerger is Executive Director of the Council of Institutional Investors. This post is based on the executive summary of a CII white paper which was prepared by Robin A. Ferracone and Dayna L. Harris, Executive Chair and Vice President, respectively, at Farient Advisors, LLC; the white paper is available here.

Advisory shareowner votes on executive compensation were the big story of proxy season 2011, the inaugural year for “say on pay” at most U.S. public companies. The Dodd-Frank Wall Street Reform and Consumer Protection Act, which President Obama signed into law in August 2010, requires U.S. public companies to provide their shareowners with a non-binding vote to approve the compensation of senior executives. The Securities and Exchange Commission’s (SEC) implementing rule, adopted on Jan. 25, 2011, requires say-on-pay votes to approve the compensation of the named executive officers (NEO) at larger companies at least once every three years. The SEC granted smaller companies a two-year exemption.

Say on pay gives shareowners a voice in how top executives are paid. Such votes are also a way for a corporate board to determine whether investors view the company’s compensation practices to be in the best interests of shareowners. Say-on-pay votes are purely advisory; U.S. companies are not required to change their executive compensation programs in response to the outcome. But SEC rules do require that in subsequent proxy statements, companies discuss how the most recent say-on-pay voting results affected their executive compensation decisions and overall programs. Such follow-on comments are to be included in the Compensation Discussion and Analysis (CD&A) section of the proxy statement.


“Presumption of Prudence” for Fiduciaries in ERISA Litigation

George Conway is partner in the Litigation Department at Wachtell, Lipton, Rosen & Katz. This post is based on a Wachtell Lipton firm memorandum by Mr. Conway, John F. Lynch, and Bradley R. Wilson. Another memo about the two court cases described below is available from Schulte Roth & Zabel LLP here.

In companion decisions issued recently, the United States Court of Appeals for the Second Circuit has ruled that retirement-plan fiduciaries should have the benefit of a “presumption of prudence” when faced with claims by employees concerning losses on their employer’s stock.  The cases are In re Citigroup ERISA Litigation, No. 09-3804-CV (2d Cir. Oct. 19, 2011), and Gearren v. McGraw-Hill Cos., No. 10-792-CV (2d Cir. Oct. 19, 2011).

The two cases involved the same basic facts.  The retirement plans at issue mandated that employees have as one of their investment options a fund consisting mainly of their employer’s stock — Citigroup in one case, McGraw-Hill in the other.  After each company suffered a stock-price decline, plan participants complained that the fiduciaries should have seen the decline coming and either should have eliminated the employer stock fund as an option under the plan, or else sold the company’s stock out of the fund.  The plaintiffs claimed that the fiduciaries, by failing to do so, violated their duties of prudence and loyalty under the Employee Retirement Income Security Act.


What Do Boards Really Do? Evidence from Minutes of Board Meetings

The following post comes to us from Miriam Schwartz-Ziv of the Department of Finance at the Hebrew University of Jerusalem, and Harvard University; and Michael Weisbach, Professor of Finance at The Ohio State University.

In our paper, What Do Boards Really Do? Evidence from Minutes of Board Meetings, which was recently made available on SSRN, we analyze a unique database from a sample of real-world boardrooms – minutes of board meetings and board-committee meetings of eleven business companies for which the Israeli government holds a substantial equity interest. We use these data to evaluate the underlying assumptions and predictions of models of boards of directors. In recent years, more than a dozen economic models have attempted to examine what boards actually do. However, because board meetings are generally a “black box” to which scholars have very limited access, these models proceed from wildly different underlying assumptions, and accordingly, make very different predictions. These models generally fall into two categories:

  • (1) “Managerial models” – assume boards play a direct role in managing the firm, and that they make the actual decisions pertaining to the business of the firm.
  • (2) “Supervisory models” – assume that the board only observes the CEO’s actions, but does not make any business decisions. Based on the boards’ observations, it evaluates/reevaluates the CEO, and decides whether to retain or fire the CEO.


Boards Respond to Stakeholder Concerns

The following post comes to us from Don Keller, partner at PricewaterhouseCoopers LLP’s Center for Board Governance, and is a summary of PwC’s Annual Corporate Director Survey 2011, which is available here.

The economic crisis, increased rules and regulations, and heightened scrutiny of boards’ roles have corporate directors feeling pressure to be more effective in the boardroom. PwC’s 2011 Annual Corporate Director Survey (the Survey) of 834 corporate directors offers insight into the biggest corporate governance issues facing directors today. Because 67% of respondents represent companies with more than $1 billion in annual revenue, the Survey illustrates the current boardroom thinking of many of the largest companies in the world.

The corporate governance landscape has changed over the past few years, and as it continues to evolve, directors are working to adapt. Their responses to the Survey indicate that executive compensation, risk management, strategy and succession planning are key areas of future focus. They are also concerned about information technology security and fraud.


Toward Final Position Limit Rules on Certain Derivatives

Editor’s Note: The following post comes to us from Mark D. Young, partner in the Derivatives Regulation and Litigation practice at Skadden, Arps, Slate, Meagher & Flom LLP, and is based on a Skadden memorandum by Mr. Young, Prashina J. Gagoomal, and Timothy S. Kearns.

On Tuesday, October 18, the U.S. Commodity Futures Trading Commission (CFTC) voted 3-2 to adopt final rules imposing speculative position limits on certain agricultural, metals and energy futures and swaps contracts, pursuant to Section 737 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank). The final rules have not yet been published. The following discussion is based on statements made by CFTC staff and commissioners at the October 18 meeting as well as the CFTC-issued fact sheet and Q&A about the final rules.

Opening Statements by Commissioners

At the meeting, Commissioners Scott O’Malia and Jill Sommers made statements opposing the final position limits rule for many reasons, including that the rule was contrary to the Commodity Exchange Act (CEA), as amended by Dodd-Frank. Commissioners O’Malia and Sommers voted against the rule. Commissioner Michael Dunn issued an opening statement noting that he did not believe imposing position limits would have any effect on prices and may actually increase price volatility as well as costs to hedgers, but that Congress had required the CFTC to impose position limits. Despite Commissioner Dunn’s conclusion that “position limits are, at best, a cure for a disease that does not exist or a placebo for one that does,” he voted in favor of the proposal. Commissioner Bart Chilton supported the final rule, emphasizing that although the rule would not please everyone, it would ensure more efficient and effective markets devoid of fraud, abuse and manipulation. Chairman Gary Gensler, who cast the final vote in favor of the proposal, asserted in his statement that Congress had directed the CFTC to impose position limits and narrow the bona fide hedge exemption.


The 2011 U.S. Director Compensation and Board Practices Report

Matteo Tonello is Managing Director of Corporate Leadership at The Conference Board, Inc. This post relates to a study of U.S. public company board practices led by Dr. Tonello; Frank Hatheway, the Chief Economist and Senior Vice President of NASDAQ OMX; and Scott Cutler, Executive Vice President, Co-Head US Listings & Cash Execution, NYSE Euronext. For details regarding how to obtain a copy of the report, contact [email protected].

The Conference Board, NASDAQ OMX and NYSE Euronext jointly released The 2011 U.S. Director Compensation and Board Practices Report, a benchmarking tool with more than 120 corporate governance data points searchable by company size (measurable by revenue and asset value) and industrial sectors.

The report is based on a survey of public companies registered with the U.S. Securities and Exchange Commission. The Harvard Law School Forum on Corporate Governance and Financial Regulation, Stanford University’s Rock Center for Corporate Governance, the National Investor Relations Institute (NIRI) and the Shareholder Forum also endorsed the survey by distributing it to their members and readers.

The Conference Board’s annual benchmark series on director compensation was first released in 1939. In the last decade, the database has been expanded to report on a wide array of governance practices, documenting a steady transformation in the role of public companies’ boards and underscoring the increasing importance of directors’ monitoring responsibilities and the growing influence of shareholders.

The following are the major findings from the 2011 edition of the study.


Voluntary Disclosures That Disavow the Reliability of Mandated Fair Value Information

The following post comes to us from Walter Blacconiere (deceased); James Frederickson, Professor of Accounting at the Melbourne Business School; Marilyn Johnson of the Department of Accounting at Michigan State University; and Melissa Lewis of the Department of Accounting at the University of Utah.

U.S. and international accounting standards mandate recognition and/or disclosure of fair value information for an increasing number of items. Fair value estimates require judgment, introducing the possibility of biases in measurements, measurers, and/or models. In addition, unanticipated changes in market risk result in realized values differing from fair value estimates. Accompanying the shift to fair value accounting is the emergence of voluntary disclosures in audited financial statement footnotes that alert investors to management’s concerns about the reliability of mandated fair value information. We refer to such disclosures as reliability disavowals (hereafter, disavowals). In our paper, Are voluntary disclosures that disavow the reliability of mandated fair value information informative or opportunistic? forthcoming in the Journal of Accounting and Economics as published by Elsevier, we examine whether disavowals are informative; that is whether they are a truthful revelation by management that their fair value estimates are unreliable. We also consider that managerial opportunism may contribute to—or even solely motivate—the decision to disavow.


The Volcker Rule Proposals on Bank Investments in Private Funds

The following post comes to us from Michael P. Harrell, corporate partner and Co-Chair of the global Private Equity Funds and Investment Management Groups at Debevoise & Plimpton LLP, and is based on a Debevoise & Plimpton Client Update by Mr. Harrell, Satish M. Kini, Rebecca F. Silberstein, Gregory J. Lyons, Kenneth J. Berman, Paul L. Lee, David A. Luigs and Gregory T. Larkin.

On October 11th and 12th, the Federal Reserve, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency and the Securities and Exchange Commission (the “regulators”) proposed for comment implementing rules (the “Proposed Rules”) for Section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Volcker Rule”). The Volcker Rule generally prohibits “banking entities” from engaging in proprietary trading and investing in hedge funds or private equity funds, subject to certain exemptions.

The Proposed Rules, which provide guidance on how the Volcker Rule is proposed to be applied in practice, address a number of significant issues raised by the statutory text of the Volcker Rule but leave open many important questions. Indeed, the release proposing the Proposed Rules (the “Proposing Release”) includes almost 400 questions requesting comment on a range of issues, suggesting both that the Proposed Rules are a work in progress and that the regulators have not achieved consensus on many of the elements of the proposal. This memorandum focuses on the most significant issues relating to the prohibition on banking entities investing in and sponsoring private equity and hedge funds.


Moving S&P 500 Companies Toward Board Declassification: Post-Proxy Season Update from the ACGI

Editor’s Note: Lucian Bebchuk and Scott Hirst are Professor of Law, Economics and Finance and Lecturer on Law, respectively, at Harvard Law School. Their earlier post about the work of the ACGI is available here.

This post provides an updated overview of the outcomes resulting from the work by the American Corporate Governance Institute (ACGI) during the 2011 proxy season to contribute to moving S&P 500 companies toward board declassification. During the 2011 proxy season the ACGI represented and advised two institutional investors, the Florida State Board of Administration (SBA) and the Nathan Cummings Foundation (NCF), in connection with the submission of shareholder declassification proposals. In addition to the results described in an earlier post, we were pleased by subsequent developments in two companies:

  • Thermo Fisher Scientific Inc. (TMO): Following a vote at the 2011 annual meeting in which 87% of the shareholder votes cast were in favor of the SBA’s declassification proposal, the board of directors amended the company’s bylaws to declassify the board. Starting at the 2012 annual meeting, directors will be elected for one year terms, with the entire board serving one-year terms from the 2014 annual meeting.
  • eBay Inc. (EBAY): Following the submission of a proposal by the NCF, negotiations between eBay (represented by Wachtell Lipton) and the NCF (represented by the ACGI) produced an agreement pursuant to which the company committed to complete a full review of declassifying the board of directors and moving to annual elections of all directors. Following the completion of the review, the company announced that it will bring a management proposal to declassify the board for a vote at the 2012 annual meeting.

With these developments, the ACGI’s work during the single 2011 proxy season has contributed to (i) eight companies which have already declassified, (ii) seven companies which have already committed to bring a management declassification proposal at their 2012 meeting, and (iii) eight companies which have yet to respond to the substantial shareholder majority votes in support of declassification at their 2011 annual meetings, as described below.


The Influence of Governance on Investment

The following post comes to us from Matthew T. Billett, Professor of Finance at Indiana University; Jon A. Garfinkel, Associate Professor of Finance at the University of Iowa; and Yi Jiang, Assistant Professor of Finance at California State University.

The governance structure of a firm can influence any number of its policies and actions, sometimes to the benefit and sometimes to the detriment of shareholders. Among the many studies of these relationships, numerous ones investigate the link between firm governance and corporate investment; however, the findings are inconclusive. Some studies report results suggesting poor governance associates with excessive investment (over-investment or empire-building), while others suggest the opposite (poorly governed managers may prefer the “quiet life”).

In our paper, The Influence of Governance on Investment: Evidence from a Hazard Model, forthcoming in the Journal of Financial Economics, we revisit the question of how governance affects corporate investment behavior in an attempt to reconcile these conflicting findings. Unlike prior studies we use a hazard framework, wherein we study how governance influences the time between large investment expenditures. This empirical approach helps alleviate some of the concerns with the methods of prior studies and also provides an unexplored perspective. In this framework, we find that governance does influence the time between major investments (investment spikes). Poor governance associates with shorter periods between spikes than that for firms with stronger governance. We further show that this relation is due to poorly governed firms over-investing, rather than stronger governance firms under-investing.


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