Monthly Archives: December 2011

Progress on International OTC Derivatives Reform

The following post comes to us from Jeremy Jennings-Mares, partner in the Capital Markets practice at Morrison & Foerster LLP, and is based on a Morrison & Foerster bulletin by Mr. Jennings-Mares, Peter Green, and Nimesh Christie.

On 11 October 2011, the Financial Stability Board (the “FSB”) published its second progress report (the “Report”) [1] and accompanying press release [2] on the implementation of reforms to the over-the-counter (“OTC”) derivatives market. This follows its initial progress report published on April 15, 2011, [3] in which it expressed concern regarding many jurisdictions’ likelihood of meeting the end of 2012 deadline set by the G-20 and warned that to achieve this target, jurisdictions needed to take “substantial, concrete steps” toward implementation urgently. The Report, which comes out merely one year before the end of 2012 deadline, contains a more detailed review of progress towards meeting the commitments reached at the G-20 Pittsburgh summit in September 2009, to be enforced by end of 2012, including:

  • all standardised OTC derivative contracts will be traded on exchanges or electronic trading platforms and cleared through central counterparties, where appropriate;
  • OTC derivative contracts will be reported to trade repositories (“TRs”); and
  • non-centrally-cleared contracts will be subject to higher capital requirements.


Say on Pay Leading to Better Communication About Compensation

Editor’s Note: Mary Schapiro is Chairman of the U.S. Securities and Exchange Commission. This post is based on Chairman Schapiro’s remarks to TheCorporateCounsel.Net “Say-on-Pay Workshop Conference”, which are available here. The views expressed in the post are those of Chairman Schapiro and do not necessarily reflect those of the Securities and Exchange Commission, the other Commissioners, or the Staff.

Executive compensation has long been an area of intense interest for shareholders, corporate boards, CEOs, senior executives – and to the SEC.

But, at the SEC, our interest is different from that of other stakeholders. It’s not rooted in any opinion regarding the level of compensation a corporate executive might receive. That is for companies and shareholders to discuss.

Rather, our interest is in ensuring that in this matter – as in other areas of corporate governance – the shareholders who own a company receive the information they need to make an informed judgment, and that they have a vehicle through which they can express that judgment to the board.

I believe that effective communication between shareholders and boards is a cornerstone of good governance.


Where Have All the IPOs Gone?

The following post comes to us from Xiaohui Gao of the Faculty of Business and Economics at the University of Hong Kong; Jay Ritter, Professor of Finance at the University of Florida; and  Zhongyan Zhu of the Department of Finance at the Chinese University of Hong Kong.

During 1980-2000, an average of 311 companies per year went public in the U.S. Since the technology bubble burst in 2000, the average has been only 102 initial public offerings (IPOs) per year, with the drop especially precipitous among small firms. Many have blamed the Sarbanes-Oxley Act of 2002 and the 2003 Global Settlement’s effects on analyst coverage for the decline in U.S. IPO activity. In our paper, Where Have All the IPOs Gone?, which was recently made publicly available on SSRN, we introduce a new explanation for the prolonged low level of U.S. IPO volume. We posit that there has been a structural change in the U.S. IPO market, driven by structural shifts in the economy that have reduced the profitability of small companies, whether public or private. Our analysis is based on the technological determinants of the optimal scale of the firm in a dynamic environment, where profitable growth opportunities may be lost if they are not quickly seized. We posit that many small firms can create greater operating profits by selling out in a trade sale (being acquired by a firm in the same or a related industry) rather than remaining as an independent firm. Earnings will be higher as part of a larger organization that can realize economies of scope and bring new technology to market faster.


Bridging the Pay Divide

The following post comes to us from Subodh Mishra, Head of Governance Exchange at Institutional Shareholder Services, and is based on an ISS white paper by Mr. Mishra, available, including appendix, here.


Investors have for a number of years expressed concerns over pay disparities between that of the chief executive officer and the next highest paid executive at U.S. corporations. The State of Connecticut pension system gave voice in 2008 to these concerns by filing shareholder proposals calling for enhanced disclosure of how internal pay equity factors into the pay-setting process. The targeted corporations were receptive to those concerns and agreed to implement the pension fund’s substantive demands.

Moreover, credit ratings agency Moody’s suggests pay gap multipliers in excess of three times the pay of the second highest paid officer can adversely affect a company’s cost of capital and debt rating. A high ratio between CEO pay and compensation for other named executives can indicate the company is CEO-centric, with associated CEO succession risk, according to Moody’s. [1] The ratings agency acknowledges that high internal pay equity can be a reflection of a CEO’s influence and centrality to a company, though argues “such a large disparity may indicate … concentration of power in the CEO.”


Forward-Looking Statements – Deal Market Trends for 2012

Editor’s Note: David Fox is a partner at Kirkland & Ellis LLP, focusing on complex mergers and acquisitions as a member of the firm’s Corporate Group. This post is based on a Kirkland & Ellis M&A Update.

With the M&A market recovery losing steam in the second half of 2011, dealmakers are faced with increased global macro-economic jitters, election year incertitude and tightened financing markets. But corporations and private funds still have capital to deploy, leading pundits and practitioners alike to be cautiously hopeful that the M&A market in 2012 may show signs of renewed vitality.

With that in mind, we look back at 2011 for lessons learned in the M&A space with implications for the coming year – from the birth of Airgas and further dismantling of staggered boards to the reported (but possibly not exaggerated) death of Omnicare and hyperbolized demise of proxy access.


The 2011 Corporate Contributions Report

Matteo Tonello is Managing Director of Corporate Leadership at The Conference Board, Inc. This post discusses a Conference Board report by Mr. Tonello and Judit Torok. For details regarding how to obtain a copy of the report, contact [email protected].

The 2011 Corporate Contributions Report, which was recently released by The Conference Board, discusses findings from a survey of 139 U.S.–based corporations conducted between April and July 2011. Participants in the survey (chief financial officers, corporate sustainability officers, heads of public affairs) were asked to provide information on the domestic and international (cash and non-cash) charitable contributions made directly by their companies or through their corporate foundations in FY2010.

To enable its practical use for peer-comparison purposes, the information in the report is organized by the size of contributions programs, ten industry groups and three business types (whether B2B, B2C or hybrid companies). The study also provides benchmarking ratios (such as contributions per employee, contributions as a percentage of pretax income and of annual sales), data on the geographic allocation of international charity and insight on program beneficiaries. The report contains data comparisons with FY2008.


Reputation Penalties for Option Backdating and the Role of Proxy Advisors

Fabrizio Ferri is an Assistant Professor of Accounting at Columbia University. Work from the Program on Corporate Governance about executive compensation includes the book Pay without Performance and the article Paying for Long-Term Performance, both by Bebchuk and Fried.

In the paper Reputation Penalties for Poor Monitoring of Executive Pay: Evidence from Option Backdating, forthcoming at the Journal of Financial Economics, my co-authors (Yonca Ertimur of Duke University and David Maber of the University of Southern California) and I examine whether directors are held accountable for poor monitoring of executive compensation.

Theoretical and empirical work suggests that outside directors incur reputation penalties in the director labor market for poor monitoring. However, it is unclear whether these penalties extend to poor monitoring of executive pay. A widely held view—articulated by Prof. Bebchuk and Prof. Fried in their book Pay without Performance—is that there is little or no accountability for excessive or abusive pay practices. Yet no study has empirically examined this question. Part of the reason is the difficulty of defining and identifying “poor monitoring” with respect to executive pay. In most cases, pay levels and structures can be justified on economic grounds (e.g. retention, incentives, attraction of talent) and with reference to the behavior of peer firms. Unless these practices are perceived as clearly “outrageous,” it is unlikely that directors will be concerned about reputation costs. Opacity in pay disclosures makes it even more difficult to assess the quality of pay practices.


Looking at the Effects of Securities Deregulation

Editor’s Note: John Coates is the John F. Cogan, Jr. Professor of Law and Economics at Harvard Law School. This post discusses Professor Coates’ testimony before the Subcommittee on Securities, Insurance, and Investment of the United States Senate Committee on Banking, Housing, and Urban Affairs, available in full here.

Amid an economic downturn caused in part by financial deregulation, it is odd to most people outside the Beltway that Congress should be actively considering (and indeed have passed in the House) a raft of proposals for more financial deregulation. Yet the politics of both parties require efforts to generate job growth, without spending or taxing, and some deregulatory proposals may plausibly do that. My testimony takes up three themes related to pending proposals to revise securities laws to (among other things) deregulate widely held but unlisted companies and banks, to permit unregistered “crowdfinancing,” and to loosen constraints on small public offerings:

  • (1) the proposals under review all raise the same general trade-off, which is best understood not as economic growth vs. investor protection, but as increasing economic growth by reducing the costs of capital-raising vs. reducing economic growth by raising the costs of capital;

Europe Restricts “Naked” Credit Default Swaps and Short Sales

The following post comes to us from Raphael M. Russo, partner in the Corporate Department at Paul, Weiss, Rifkind, Wharton & Garrison LLP, and is based on a Paul Weiss client memorandum by Mr. Russo, Manuel S. Frey, Udi Grofman, and Marco V. Masotti.

On November 15, 2011, the European Parliament adopted a regulation banning any person or legal entity in the European Union (“EU entities”) from entering into “naked,” or uncovered, credit default swaps (“CDS”) on sovereign debt and restricting uncovered short sales on shares and sovereign debt (the “Regulation”) after November 1, 2012. [1] The Regulation also bans such transactions from being effected on any trading venue in the European Union (the “EU”). CDS on sovereign debt that do not hedge exposure to the sovereign debt itself or to assets or liabilities whose value is correlated to the value of the sovereign debt will no longer be permitted. Short sales of shares and short sales of sovereign debt will be permitted only where the seller has “located” the share or debt instrument prior to entering into the agreement and has a “reasonable expectation” of being able to borrow the shares. The Regulation provides exemptions for market making activities and primary market operations and allows Member States of the EU (“Member States”) to temporarily suspend the ban on uncovered CDS on sovereign debt if the Member State determines that its sovereign debt market is not functioning properly as a result of the ban. The Regulation also introduces reporting requirements for significant net short positions.


A Theory of Income Smoothing When Insiders Know More Than Outsiders

The following post comes to us from Viral Acharya, Professor of Finance at New York University, and Bart Lambrecht, Professor of Finance at Lancaster University.

In our paper, A Theory of Income Smoothing When Insiders Know More Than Outsiders, we consider a setting in which insiders have information about income that outside shareholders do not, but property rights ensure that outside shareholders can enforce a fair payout. Insiders report income consistent with outsiders’ expectations based on publicly available information rather than true income, resulting in an observed income and payout process that adjust partially and over time towards a target. Insiders under-invest in production and effort so as not to unduly raise outsiders’ expectations about future income, a problem that is more severe the smaller is the inside ownership and results in an “outside equity Laffer curve.” A disclosure environment with adequate quality of independent auditing mitigates the problem, implying that accounting quality can enhance investments, size of public stock markets and economic growth.


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