Yearly Archives: 2012

CEO Preferences and Acquisitions

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Monday, June 25, 2012
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The following post comes to us from Dirk Jenter of the Department of Finance at Stanford University and Katharina Lewellen of the Tuck School of Business.

In our recent NBER working paper, CEO Preferences and Acquisitions, we test whether target CEOs’ retirement preferences affect the incidence, the pricing, and the outcomes of takeover bids. If mergers force target CEOs to retire early, then the CEOs’ private merger costs are the forgone benefits of staying employed until the planned retirement date. Though retirement plans differ across individuals, research in labor economics shows that a disproportional fraction of workers retires at the age of 65 (we observe the same phenomenon for CEOs). This age-65 effect cannot be fully explained by monetary incentives, including social security benefits or Medicare, which suggests behavioral explanations related to customs or social norms. If CEOs similarly favor 65 as retirement age, this preference should be reflected in their private merger costs, and – provided that these costs affect merger decisions – in the observed merger patterns. Specifically, one should observe an increase in merger activity as CEOs approach 65, or a discrete jump in this activity at the age-65 threshold.

We find strong evidence that target CEOs’ retirement preferences affect merger patterns. In data on U.S. public firms from 1992 to 2008, the likelihood of a takeover bid increases sharply when the target CEO reaches age 65. Controlling for CEO and firm characteristics, the implied probability that a firm receives a takeover bid is close to 4% per year for CEOs below the retirement age (e.g., in age groups 56-60 and 61-65), but it increases to 6% for the retirement-age group (above age 65). This corresponds to a 50% increase in the odds of receiving a bid, and the effect is statistically significant at the 1% level. The increase in takeover activity appears abruptly at the age-65 threshold, with no gradual increase as CEOs approach retirement age. The effect is similar whether all bids or only successful bids are included, and it remains economically large and significant even when CEO age and age squared are included separately as controls. These results show that bidders are more likely to target firms with retirement-age CEOs, possibly due to these CEOs’ weaker expected resistance against takeover bids.

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The Relevance of Audits and the Needs of Investors

Posted by the Harvard Law School Forum on Corporate Governance & Financial Regulation, on
Sunday, June 24, 2012
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Editor’s Note: James R. Doty is chairman of the Public Company Accounting Oversight Board. This post is based on Chairman Doty’s remarks before the USC Leventhal School of Accounting 31st Annual SEC and Financial Reporting Institute Conference, which are available (including footnotes) here. The views expressed in the post are those of Chairman Doty and should not be attributed to the PCAOB as a whole or any other members or staff.

This is a special year in many respects. We have our own concerns at home. But those of us who find our work on financial terrain have our sights trained east, toward Europe, and west, toward China, more than in past years.

In the broader population, there is new apprehension for effects we don’t know but must nevertheless judge. Will European states muster a defense to the behavioral contagion of financial panic? Will they find a way to use their inter-dependence to make Europe financially stronger? Or will they find that too many divergent interests must agree to save the European experiment? How will the U.S. be affected?

Looking toward China, many say that that nation’s economic growth cannot continue without structural changes. Can China instill its new, investing middle-class with confidence that financial markets will provide for its future? From our larger companies to our smaller entrepreneurs, we are doing business in China. Can we have confidence that China isn’t the latest iteration of — pick your era — the Tulip Scandal, the silver-mine frauds of the Old West, the S&L bust? And how should we deal with these risks in a global economy?

These are questions that require that admirable quality we often call vision. When we speak of vision, we speak of visionaries. That is, people who have stepped out from the crowd and revealed something that the rest of us could not see. There are false visionaries, who inspire us to act based on what we or they wish might be. But the true ones give us honesty, and invaluable leadership.

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Voting Decisions at US Mutual Funds: How Investors Really Use Proxy Advisers

Posted by Noam Noked, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Saturday, June 23, 2012
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The following post comes to us from Mark Watson, partner at Tapestry Networks, and is based on the executive summary of a Tapestry report by Robyn Bew and Richard Fields. The full report is available here.

The balance of power among shareholders, management, and boards of directors has been a subject of debate for many years. One area of intense focus has been how institutional shareholders exercise their proxy votes, which Mary Schapiro, Chairman of the US Securities and Exchange Commission (SEC), described as “often the principal means for shareholders and public companies to communicate with one another, and for shareholders to weigh in on issues of importance to the corporation.” [1]

There is clear consensus on the importance and benefits of having institutions vote their shares in a responsible, well-informed way, but much less clarity on how the voting process works in practice. A particularly active area of the debate is over how investors use proxy advisers’ research, recommendations, and other services – alone or in conjunction with other internal and external sources – in making decisions about tens of thousands of unique agenda items each year. Convictions are strong on both sides, with those in one camp charging that institutional investors vote “in a lock-step manner” [2] with proxy firm recommendations, and their opponents insisting that proxy advisers’ research and recommendations are used “solely as a supplement to [most investors’] own evaluation of agenda items.” [3]

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Lessons from the AOL Proxy Fight

Posted by Martin Lipton, Wachtell, Lipton, Rosen & Katz, on
Friday, June 22, 2012
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Martin Lipton is a founding partner of Wachtell, Lipton, Rosen & Katz, specializing in mergers and acquisitions and matters affecting corporate policy and strategy. This post is based on a Wachtell Lipton memorandum by Mr. Lipton, David E. Shapiro, Ronald C. Chen, and Lisa B. Schwartz.

AOL’s shareholders delivered a resounding victory recently to the Company’s management and board in re-electing the full slate of incumbent director nominees — over ISS recommended dissident directors nominated by activist hedge fund Starboard Value LP. The victory represents a clear and powerful message that a well-developed and well-articulated business strategy for long-term success will be supported by investors notwithstanding activist generated criticism and ISS support.

For several months, Starboard waged a damaging proxy fight to elect its own slate of three directors to the AOL board. The board and management of AOL countered Starboard’s destructive campaign by presenting, and continuing to execute on, their plan for long-term business value. AOL warned that Starboard had no viable business plan and was pursuing a short-term, value-destructive, and self-interested strategy. Nevertheless, ISS chose to cast its support with two of Starboard’s nominees, in part relying on the wrongheaded notion that the dissident nominations posed “little risk”. In doing so, ISS chose to support a dissident fund notwithstanding the fund’s lack of understanding of the Company’s fundamental business model.

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Conflicting Family Values in Mutual Fund Families

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Friday, June 22, 2012
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The following post comes to us from Utpal Bhattacharya and Veronika Krepely Pool, both of the Department of Finance at Indiana University Bloomington, and Jung Hoon Lee of the Department of Finance at Tulane University.

A major reason for the existence of conglomerates or business groups is to create internal capital markets to promote the efficiency of the group. One of many efficiency measures that internal capital markets can offer is an insurance pool, which provides temporary liquidity to the members of the group in the event of adverse shocks.  If mutual fund families, which are a collection of legally independent entities tied together by the sponsoring management company, are regarded as groups, it seems reasonable to assume that there would be a group interest. If so, it seems natural to ask whether insurance pools could exist in these families where cash-rich mutual funds direct capital to family funds that are facing large redemption requests, as these redemptions could lead to large fire sale losses. However, by law, they cannot. This is because, while the provision of such an insurance pool against temporary liquidity shocks benefits the family, the cost is borne by the shareholders of the fund providing this “free” insurance. A mutual fund owes a fiduciary responsibility only to its own shareholders, and not to its family.

In our paper, Conflicting Family Values in Mutual Fund Families, forthcoming in the Journal of Finance, we address whether such insurance pools exist in mutual fund families. We examine this by analyzing the investments of affiliated funds of mutual funds (AFoMFs). AFoMFs are mutual funds that only invest in other mutual funds within the family. Instead of the investors or their financial advisors choosing which mutual funds of the family to invest in, AFoMFs do that for the investors. Virtually non-existent in the 1990s, these funds have become very popular. In 2007, which is the last year of our sample.  Of the 30 large families that made up around 75% of the industry’s assets, 27 had AFoMFs.

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Enhancing Bank Supervision and Reducing Systemic Risk

Posted by the Harvard Law School Forum on Corporate Governance & Financial Regulation, on
Thursday, June 21, 2012
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Editor’s Note: Martin Gruenberg is acting chairman of the Federal Deposit Insurance Corporation. This post is based on Chairman Gruenberg’s testimony before the Senate Committee on Banking, Housing, and Urban Affairs, available here.

Implementation of the Dodd-Frank Act: Measures to Address Systemic Risk

The economic dislocations we have experienced in recent years, which have far exceeded those associated with any recession since the 1930s, were the direct result of the financial crisis of 2007-08. The reforms enacted under the Dodd-Frank Act were aimed at addressing the root causes of the crisis. Foremost among these reforms were measures to curb excessive risk-taking at large, complex banks and non-bank financial companies, where the crisis began. Title I of the Dodd-Frank Act includes new provisions that enhance prudential supervision and capital requirements for systemically-important financial institutions (SIFIs), while Title II authorizes a new orderly liquidation authority that significantly enhances the ability to resolve a failed SIFI without contributing to additional financial market distress.

SIFI Resolution Authorities

The most important new FDIC authorities under the Dodd-Frank Act are those that provide for enhanced resolution planning and, if needed, the orderly resolution of SIFIs. Prior to the recent crisis, the FDIC’s receivership authorities were limited to federally insured banks and thrift institutions. There was no authority to place the holding company or affiliates of an insured institution or any other non-bank financial company into an FDIC receivership to avoid systemic consequences. The lack of this authority severely constrained the ability of the government to resolve a SIFI and contributed to the excessive risk taking that led to the crisis.

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Standstills in Change of Control Transactions

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Wednesday, June 20, 2012
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The following post comes to us from Christina Sautter, Associate Professor of Law at Louisiana State University. This post is part of the Delaware law series, which is cosponsored by the Forum and Corporation Service Company; links to other posts in the series are available here.

Standstill agreements are ubiquitous in public company M&A deals. In fact, the execution of a standstill has been described as the “cost of entry” into negotiations and serves to indicate a bidder’s seriousness. Despite their ubiquity, there is surprisingly little Delaware case law on standstills and even less academic literature on the subject. In my paper, Promises Made to be Broken? Standstill Agreements in Change of Control Transactions, forthcoming in the Delaware Journal of Corporate Law, I attempt to begin to fill this gap in academic literature by examining and providing a blueprint for the resolution of various issues raised by the execution and enforcement of standstills in the context of sales resulting in a change of corporate control.

My paper concentrates on three issues the Delaware courts have yet to tackle: a target board’s ability to consider a third-party superior offer made in contravention of a standstill; a board’s promise not to waive a standstill; and a board’s ability to grant a “winning” bidder the right to enforce a previously executed standstill against a “losing” bidder. Each of these issues raises a conflict between two fundamental principles of Delaware M&A law: 1) a board’s Revlon duty to maximize stockholder value in a sale of corporate control; and 2) the sanctioning of certain deal protection provisions as permitted by the Delaware Supreme Court’s decision in Unocal Corp. v. Mesa Petroleum Co. and its progeny. As commonly argued, the availability of deal protection devices, including standstills and other promises made in relation to standstills, may assist a target board in extracting more value from bidders, thereby facilitating satisfaction of a board’s Revlon duties. Thus, at the pre-signing stage there may be good reason for a target board to agree to a standstill, and the provision may be permissible under Unocal but, pre-closing, the provision may inhibit the fulfillment of a board’s Revlon duties. Specifically, standstills may prevent a board from considering a third-party offer or deter a third party bound by a standstill from making an overbid in the first place.

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Secured Creditor’s Right to Credit Bid in Cramdown Plans

Posted by Noam Noked, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Wednesday, June 20, 2012
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The following post comes to us from Douglas P. Bartner, partner in the Bankruptcy & Reorganization Group at Shearman & Sterling LLP, and is based on a Shearman & Sterling client publication.

In a 8-0 decision resolving a split between the Third and Seventh Circuit Courts of Appeals, the United States Supreme Court recently affirmed a secured creditor’s right to credit bid in a sale of its collateral pursuant to a cramdown plan. In RadLAX Gateway Hotel, LLC v. Amalgamated Bank, [1] the Supreme Court upheld the Seventh Circuit’s ruling that section 1129(b)(2)(A)(iii) of the Bankruptcy Code, the so-called “indubitable equivalent prong” of the cramdown requirements for secured creditors, could not be used to justify confirming a plan which sold secured lenders’ collateral without allowing the lenders to credit bid.

The Court, in an opinion written by Justice Scalia, held that the canons of statutory construction did not permit the general “indubitable equivalent” option for cramdown of secured creditors to override the more specific option set forth in clause (ii) of section 1129(b)(2)(A). That cramdown option provides that a secured creditor can be crammed down if its collateral is sold, “subject to section 363(k),” and its security interest attaches to the proceeds of the sale. Section 363(k) allows a secured creditor to credit bid in a sale unless the court, for cause shown, rules otherwise. The Court would not permit confirmation of a plan that contemplated a sale of collateral free and clear of a security interest where the holder of that security interest could not credit bid.

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The Eurozone Crisis and Its Impact on the International Financial Markets

Posted by Noam Noked, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Tuesday, June 19, 2012
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The following post comes to us from Simon James, partner specializing in commercial dispute resolution at Clifford Chance, and is based on a Clifford Chance briefing from Mr. James, Marc Benzler, Michael Dakin, Kate Gibbons, and Deborah Zandstra, available here.

From the election of a French president who has openly expressed his opposition to austerity without a greater focus on stimulating economic growth to the struggles to form a new Greek government that may or may not agree to abide by the conditions set out in the existing bailout plan, recent elections have enveloped the Eurozone in yet more uncertainty. With the desire for an alternative to a programme of strict austerity gathering increasing popular support, balancing the challenges of the Eurozone’s rapidly escalating political crisis alongside the fiscal imperatives that need to be tackled has rarely been so difficult, or the path ahead for Europe’s leaders so unclear.

In these circumstances few would dare to predict the future. But the ability to assess and anticipate potential market risks – from the impact of sovereign debt issues on an already weakened banking sector to the prospect of a country, or even countries, leaving the Eurozone – is crucial. Also crucial is the need to prepare for a variety of eventualities, whether through more stringent credit assessment, tighter documentation, careful counterparty choice or other tactics.

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SEC Staff Guidance on Shareholder Proposals During 2012 Proxy Season

Posted by John F. Olson, Gibson, Dunn & Crutcher LLP and Georgetown Law Center, on
Monday, June 18, 2012
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John Olson is a founding partner of Gibson, Dunn & Crutcher’s Washington, D.C. office and a visiting professor at the Georgetown Law Center. This post is based on a Gibson Dunn alert, available (including footnotes) here.

There have been a number of significant shareholder proposals submitted during the 2012 proxy season to date. This alert summarizes notable responses by the Securities and Exchange Commission (the “SEC”) staff (the “Staff”) to no-action requests concerning many of these shareholder proposals. By way of background, according to Institutional Shareholder Services (“ISS”), 1,105 proposals have been submitted to companies to date for 2012 annual meetings. As of May 22, 2012, 303 no-action requests had been submitted to the SEC since October 1, 2011. This is comparable to the number of shareholder proposal no-action requests submitted during a similar period in 2011. Moreover, repeating the experience in 2011, the number of requests for reconsideration submitted by both companies and proponents was high. In addition, many companies successfully negotiated with proponents to withdraw shareholder proposals, illustrating that engagement with proponents can often eliminate the need to file a no-action request.

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