Yearly Archives: 2012

The Costs of a Combined Chair/CEO

Posted by Noam Noked, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Friday, July 13, 2012
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The following post comes to us from Paul Hodgson, Chief Communications Officer and Senior Research Associate at GovernanceMetrics International, and is based on a GMI report by Mr. Hodgson and Greg Ruel.

The two most authoritative positions in a boardroom are the CEO and the chairman. However, when these roles are combined, all the authority is vested in one individual; there are no checks and balances, and no balance of power. The CEO is charged with monitoring him or herself, presenting an obvious conflict of interest. Indeed, if the CEO is responsible for running the company, and the board is tasked with overseeing the CEO’s decisions in the interests of shareholders, how can the board properly monitor the CEO’s conduct if he or she is also serving as board chair?

While the theory behind separating the two roles has been the subject of much shareholder and governance activist protest and commentary, an analysis of GMI Ratings’ data suggests that other, more practical considerations would support the separation of the two roles. In addition to the inherent conflict of interest already discussed, CEOs who also command the title of chairman are more expensive than their counterparts serving solely as CEO. In fact, executives with a joint role of chairman and CEO are paid more than even the combined cost of a CEO and a separate chairman. Also, companies with a combined CEO and chairman appear to present a greater risk of ESG (environmental, social and governance) and accounting risk than companies that separate the roles. Furthermore, companies with combined CEOs and chairmen also appear to present a greater risk for investors and provide lower stock returns over the longer term than companies that have separated the roles. Thus having a separate chairman and CEO costs less, is less risky and is a better investment. This report focuses on 180 North American mega-caps, those with a market capitalization of $20 billion or more. This group was chosen because, given the relative complexity of running the companies, it might be expected that the resulting differentials between leadership structures in cost structure, performance and risk exposure would be more marked. Here are some of the main findings of the report:

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Pension Funds as Owners and Investors

Posted by Luis A. Aguilar, Commissioner, U.S. Securities and Exchange Commission, on
Friday, July 13, 2012
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Editor’s Note: Luis A. Aguilar is a commissioner at the U.S. Securities and Exchange Commission. This post is based on a Commissioner Aguilar’s keynote address before the NAPPA 2012 Legal Education Conference; the full address, including footnotes, is available here. The views expressed in the post are those of Commissioner Aguilar and do not necessarily reflect those of the Securities and Exchange Commission, the other Commissioners, or the Staff.

As an SEC Commissioner focused on investor protection, I’d like to talk to you today about some issues important to investors in the current capital market environment, and how public pension funds, in their capacity as shareowners and investors, can be a more effective voice for America’s working families.

Investors are the Capital Providers — The Economic Impact of Public Pension Funds

First, I want to quickly highlight the critical role public pension plans have in our economy. As they often do, the statistics tell the story: State and local pension plans serve about 14.4 million active employees, and pay benefits to about 7.5 million current beneficiaries. In 2010, public pensions paid an average benefit of just under $26,000 per year. That regular income provides security, stability and peace of mind that individual savings and defined contribution plans alone cannot ensure for most workers.

Pension plans may also help reduce the disparity in retirement incomes between men and women, as well as the wide income gulf between white and non-white households in retirement. A 2009 report by the National Institute on Retirement Security found that, while older households headed by women, and those headed by people of color, were significantly more likely to be classified as poor than their male and/or white counterparts, that disparity is substantially reduced among households receiving pension income.

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Multinationals and the High Cash Holdings Puzzle

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Friday, July 13, 2012
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The following post comes to us from Lee Pinkowitz of the Department of Finance at Georgetown University; René Stulz, Professor of Finance at Ohio State University; and Rohan Williamson, Professor of Finance at Georgetown University.

In the paper, Multinationals and the High Cash Holdings Puzzle, which was recently made publicly available on SSRN, we investigate whether the cash holdings of American companies are abnormally high after the financial crisis and whether these cash holdings can be explained by the theories summarized in the previous paragraph. We show that the extent to which cash holdings are unusually high after the crisis depends critically on the measure used. We would expect larger firms to hold more cash. Since corporate assets tend to grow over time, the dollar amount of cash holdings would grow even if the ratio of cash to assets stays constant. Consequently, at the very least, cash holdings should be measured relative to a firm’s assets. Using all non-financial and non-regulated public firms with assets and market capitalization greater than $5 million per year, the average cash/assets ratio is 20.18% in 2009-2010 compared to 20.50% in the 2004-2006 pre-crisis period. However, when we consider the median ratio, it is higher by 0.87% in 2009-2010 than in 2004-2006. Similarly, the asset-weighted ratio is higher by 0.74% in the recent period. The larger increase in the asset-weighted ratio than in the equally-weighted ratio suggests that large firms increased their holdings more and we show that this is the case. However, the changes in cash holdings from 2004-2006 to 2009-2010 are dwarfed by the changes in cash holdings from 1998-2000 to 2004-2006. Over that latter period, the average cash/assets ratio increases by 3.77%, the median by 6.39%, and the asset-weighted average by 3.62%. When we distinguish between private and public firms, we show that there is no evidence of an increase in the cash/assets ratio for private firms.

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Hedging Under the Volcker Rule

Posted by Hal Scott, Harvard Law School, on
Thursday, July 12, 2012
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Hal Scott is the director of the Program on International Financial Systems at Harvard Law School and the director of the Committee on Capital Markets Regulation. This post is based on a statement from the committee, available here.

Debate continues around the proposed regulations to implement the Volcker Rule, most lately around its provisions related to permitted hedging activities. As the Committee on Capital Markets Regulation (CCMR) has commented in the past, the proposed regulations should be appropriately constructed to address activities that are specifically permitted under Dodd-Frank, including market-making, underwriting and hedging.

Following the recent JPMorgan (JPM) trading losses, some have called for tightening or even removing the provisions for portfolio hedging that are incorporated in the proposed regulations. Dodd-Frank permits hedging on aggregated positions but critics suggest this should not be interpreted to allow hedging on a portfolio basis. Despite the JPM losses, however, CCMR believes that portfolio hedging should in general be permitted.

Portfolio hedges are crucial for banks to reduce overall volatility and risk. Overly restricting hedging would actually increase bank risk, the very outcome the critics themselves seek to avoid. Suggestions that portfolio hedges need to be correlated to individual underlying positions are both unworkable and overlook the reality that banks seek to hedge their overall mix of assets, and potential movements across an entire portfolio, rather than single movements of individual assets. Furthermore, correlations evolve over time and hedging is a dynamic process.

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Lessons Learned So Far During the 2012 Proxy Season

Posted by Noam Noked, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Thursday, July 12, 2012
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The following post comes to us from Regina Olshan, partner in the executive compensation and benefits practice at Skadden, Arps, Slate, Meagher & Flom LLP, and is based on a Skadden alert by Ms. Olshan, Stuart N. Alperin, Neil M. Leff, Erica Schohn, Joseph M. Yaffe, and Barbara R. Mirza.

As we reach the peak of the 2012 proxy filing season, we are continuing to monitor the following developments:

What are the overall vote results?

Of the first 1,656 companies to report the results of say-on-pay proposals, approximately:

  • 70 percent have passed with more than 90 percent support;
  • 21 percent have passed with between 70 percent and 90 percent
    support;
  • 7 percent have passed with between 50 percent and 70 percent
    support; and
  • 3 percent (45 companies) obtained less than 50 percent support.

While the overall proportions are generally not dissimilar to 2011 results, we have already seen more companies fail their say-on-pay votes this year than in the entire season last year. Four companies have seen failed votes in both 2011 and 2012.

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Large Trader Reporting Rule

Posted by Noam Noked, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Wednesday, July 11, 2012
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The following post comes to us from Russell D. Sacks, partner at Shearman & Sterling LLP, and is based on a Shearman client publication by Mr. Sacks, Charles S. Gittleman, Shriram Bhashyam, Michael J. Blankenship, and Bradford B. Rossi.

On April 23, 2012, the US Securities and Exchange Commission (“SEC”) issued an order temporarily exempting registered broker-dealers from the Large Trader Identification requirements under Rule 13h-1 (the “Rule”). [1] This temporary exemption was issued in anticipation of the Rule’s original effective date of April 30, 2012, providing covered broker-dealers with additional time to ensure compliance with the recordkeeping, reporting, and monitoring requirements under the Rule. In addition, the SEC granted a permanent exemption for certain capital market transactions for the purposes of the large trader identification requirements.

Introduction and Overview

Rule 13h-1 will require a “large trader,” defined as a person whose transactions in NMS securities equal or exceed 2 million shares or $20 million during any calendar day, or 20 million shares or $200 million during any calendar month, to identify itself to the SEC and make certain disclosures to the SEC on Form 13H. Upon receipt of Form 13H, the SEC will assign to each large trader an identification number that will identify the trader, which the large trader must then provide to registered broker-dealers with which it conducts business. Such registered broker-dealers will then be required to maintain records relating to transactions effected through large traders’ accounts and to report large trader transaction information to the SEC upon request. The large trader reporting requirements are designed to provide the SEC with data to support its investigative and enforcement activities, as well as to facilitate the SEC’s ability to assess the impact of large trader activity on the securities markets including reconstructuring trading activity following periods of unusual market volatility, and analyzing significant market events for regulatory purposes.

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CEO Characteristics and Firm Responses to Pressures for Disclosure

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Wednesday, July 11, 2012
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The following post comes to us from Glen Dowell and Ben Lewis, both of the Department of Management at Cornell University, and Judith Walls of the Department of Management at Concordia University, Quebec.

In the paper, Difference in Degrees: CEO Characteristics and Firm Responses to Pressures for Disclosure, which was recently made publicly available on SSRN, we extend existing theory by examining how managerial attributes influence firm’s strategic responses to environmental issues. We argue that the characteristics of the CEO play an important role in the extent to which external environmental pressures are attended to and how they are interpreted and acted upon (Hoffman, 2001). As top managers, CEOs strongly influence whether stakeholder groups are considered salient (Delmas & Toffel, 2008; Eesley & Lenox, 2006) and how environmental issues should be addressed (Sharma, 2000).

Specifically, our research examines how firms respond to requests to disclose their environmental performance. Because the costs and benefits of disclosure are often uncertain, decisions about firm response may be subject to managerial interpretation. We therefore argue that CEO characteristics play an important role in determining whether the disclosure of environmental information is perceived as an opportunity or a threat (Sharma et al., 1999).

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A Growing Divide Between Compliance Have’s and Have-Not’s

Posted by Scott Hirst, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Tuesday, July 10, 2012
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The following post comes to us from Jeffrey M. Kaplan, partner at Kaplan & Walker LLP.

In Semi-Tough: A Short History of Compliance and Ethics Program Law, presented at a May 2012 RAND Symposium on Corporate Culture and Ethical Leadership Under the Federal Sentencing Guidelines: What Should Boards, Management and Policymakers Do Now, I explore the legacy of the Federal Sentencing Guidelines for Organizations (“FSGO”) with respect to compliance and ethics (“C&E”) programs.

Since the advent of the FSGO in November 1991, the legal drivers for corporations to implement strong C&E programs have seemed to be ever on the increase, at least in the U.S. Indeed, the past few years alone have seen:

  • Rigorous enforcement, to an unprecedented extent, of the Foreign Corruption Practices Act (“FCPA”) – a law which, because of its internal controls provisions, strongly encourages companies to have effective C&E programs.
  • The imposition, also to an extent never before seen, of very large federal criminal fines, including but by no means limited to those meted out in FCPA cases.
  • The initiation of a significant number of “Caremark” claims alleging failures by directors to oversee sufficiently their respective companies’ C&E programs.
  • Revisions in 2010 to the FSGO to encourage independent C&E officer functions.
  • Numerous other subject-matter-specific legal developments including (but by no means limited to) those regarding government contracting and energy utilities.

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Binding Say on Pay in the UK

Posted by Amy L. Goodman, Gibson, Dunn & Crutcher LLP, on
Monday, July 9, 2012
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Amy Goodman is a partner and co-chair of the Securities Regulation and Corporate Governance practice group at Gibson, Dunn & Crutcher LLP. This post is based on a Gibson Dunn memo by Ms. Goodman, James Barabas, James A. Cox, Jeffery Roberts, and Elizabeth A. Ising.

Earlier this year we reported on the UK Government’s proposals to give shareholders of companies greater influence over executive pay through the use of binding votes.

Since the draft proposals were announced the UK has seen the so-called “Shareholder Spring” with majority votes against remuneration reports under the current ‘advisory’ (non-binding) regime at Aviva, Cairn Energy, Pendragon, and WPP; and sizeable votes against the reports at Xstrata (40% against), Barclays, Cookson and UBM (approx. 25% or more against) amongst others.

Building on the momentum created by shareholders on June 20, 2012, the UK Government announced its detailed proposals for a far-reaching reform of the approval mechanism for executive pay, including the use of binding votes. The proposals will likely apply (we await detail) to so-called ‘quoted companies’ (see further below).

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The End of the Era of the Corporate Interlock Network

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Monday, July 9, 2012
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The following post comes to us from Johan Chu of the Department of Management and Organizations at the University of Michigan Ross School of Business.

In the paper, Who Killed the Inner Circle? The End of the Era of the Corporate Interlock Network, which was recently made publicly available on SSRN, I show that the American board interlock network has changed in fundamental ways.

Throughout the 20th century, the American board interlock network—in which companies are linked by shared board directors—exhibited a stable cohesiveness, characterized by short path lengths between companies and the existence of an “inner circle” of well-connected directors. This enduring cohesiveness of the interlock network was both the result of elite social cohesion and a key mechanism for maintaining this elite cohesion (e.g., Mills, 1956; Useem, 1984). The characteristics of the interlock network were so stable that Davis, Yoo, and Baker (2003) asserted that short path lengths and an inner circle were inevitable properties of “networks qua networks”.

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