Yearly Archives: 2012

The Sensitivity of Corporate Cash Holdings to Corporate Governance

Posted by Katherine Schipper, Duke University,, on
Wednesday, November 28, 2012
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Katherine Schipper is a Professor of Accounting at Duke University.

In the paper, The Sensitivity of Corporate Cash Holdings to Corporate Governance, forthcoming in the Review of Financial Studies, my co-authors (Qi Chen, Xiao Chen, Yongxin Xu, and Jian Xue) and I analyze the change in cash holdings of a large sample of Chinese-listed firms associated with the split share structure reform that required nontradable shares held by controlling shareholders to be converted to tradable shares, subject to shareholder approval and adequate compensation to tradable shareholders. The reform removed a substantial market friction and gave controlling shareholders a clear incentive to care about share prices, because they could benefit from share value increases by selling some of their shares for cash.

We predict and find that this governance improvement led to reduced cash holdings of affected firms, and that the effect is more pronounced for private firms than for state-owned enterprises (SOEs), for firms with more agency conflicts, and for firms for which financial constraints are most binding. We interpret these results as consistent with both a direct free cash flow channel and an indirect financial constraint channel. These results are robust to several alternative specifications that address concerns about endogeneity and concomitant effects. They provide strong evidence that governance arrangements affect firms’ cash holdings and cash management behaviors. To the extent that cash management is a key operational decision that affects firm value, our findings suggest an important mechanism for corporate governance to affect firm value.

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Capital Plans and Stress Test Rules

Posted by H. Rodgin Cohen, Sullivan & Cromwell LLP, on
Tuesday, November 27, 2012
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H. Rodgin Cohen is a partner and senior chairman of Sullivan & Cromwell LLP focusing on acquisition, corporate governance, regulatory and securities law matters. This post is based on a Sullivan & Cromwell LLP publication by Joel Alfonso, Andrew R. Gladin and Mark J. Welshimer; the complete publication, including footnotes, is available here.

On November 9, 2012, the Board of Governors of the Federal Reserve System (the “Federal Reserve”) issued instructions and guidance for:

  • the Comprehensive Capital Analysis and Review program for 2013 (“CCAR 2013”) applicable to the 19 bank holding companies (“BHCs”) with total assets of $50 billion or more that were previously subject to CCAR and the Supervisory Capital Assessment Program (“SCAP”); and
  • the Capital Plan Review program for 2013 (“CapPR 2013”) applicable to an additional 11 BHCs with total assets of $50 billion or more that were not subject to prior CCARs or SCAP, but were subject to CapPR in 2012.

CCAR 2013 and CapPR 2013 are both being conducted under the Federal Reserve’s previously adopted Capital Plan Rule. In addition, elements of CCAR 2013 are being implemented in conjunction with the Federal Reserve’s newly finalized Stress Test Rules adopted pursuant to the separate stress test requirements of sections 165(i)(1) and (2) of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”). The following is an outline of certain notable aspects of the CCAR 2013, CapPR 2013 and their respective instructions.

In certain instances, the instructions and guidance for CCAR 2013 and CapPR 2013 contain new provisions, while in others, the new instructions are largely congruous with procedures for previous CCAR and CapPR iterations. Important aspects of CCAR 2013 instructions include:

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2012 Shareholder Activism Insight Report

Posted by Marc Weingarten, Schulte Roth & Zabel LLP, on
Monday, November 26, 2012
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Marc Weingarten is partner and chair of the Business Transactions Group at Schulte Roth & Zabel LLP. This post is based on a Schulte Roth & Zabel report by Mr. Weingarten and David Rosewater; the full publication, including charts and figures, is available here.

Schulte Roth & Zabel is pleased to present the 2012 edition of Shareholder Activism Insight, published in association with mergermarket. Based on a series of interviews with corporate executives and activist investors, this report highlights emerging trends in shareholder activism, as well as insights into the changing corporate landscape investors and executives will face in the coming years.

Corporate executives should expect to see increasing opposition from shareholders during next spring’s proxy season, according to the 78% majority of overall respondents. Using poor financial performance and the need for management or operational change as motivation, hedge funds, pensions and unions will continue the growth of shareholder activism. A significant increase in shareholder proposals will result, according to 84% of respondents.

The financial services sector is expected to see the greatest amount of shareholder activism as investors look to repair the still recovering industry after the crash of 2008. Distant runners-up, the industrials and chemicals, technology, and energy sectors are also expected to see more disputes with investors.

Half of respondents believe an active dialogue between shareholders and management can be the most effective defense tactic against activism. When a company prefers to be more active in preventing shareholder disputes, respondents cite offensive litigation, poison pills and staggered board elections as the likely defense tools.

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Accounting and Litigation Risk

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Monday, November 26, 2012
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The following post comes to us from Zhiyan Cao, Assistant Professor of Accountancy at the University of Washington Tacoma, and Ganapathi S. Narayanamoorthy, Assistant Professor of Accountancy at the University of Illinois at Urbana-Champaign.

In our paper, Accounting and Litigation Risk: Evidence from Directors’ & Officers’ Insurance Pricing, forthcoming in the Review of Accounting Studies, we study whether and how financial reporting concerns and traditional measures of corporate governance are priced by insurers that sell Directors’ and Officers’ (D&O) insurance to public firms. As D&O insurers typically assume the liabilities arising from shareholder litigation, the insurance premiums they charge for D&O coverage reflect their assessment of a company’s litigation risk.

Estimation of ex-ante litigation risk has always been a challenge for empirical research. Past studies employ ex-post lawsuits to derive an ex-ante measure of litigation risk. In such studies, a litigation risk prediction model is first estimated with the dependent variable being whether the firm got sued ex-post. The predicted values of the probability of getting sued are then used as ex-ante measures of litigation risk in an empirical model. Such measures ignore lawsuits filed in other jurisdictions and also cannot distinguish between frivolous and serious lawsuits. We employ a market-based measure of ex-ante litigation risk; that is, the D&O liability insurance premium, which incorporates the ex-ante expectation of both the likelihood of lawsuits and the magnitude of damages. In the U.S., public firms routinely purchase D&O insurance coverage for their directors and officers for reimbursement of defense costs and settlements arising from shareholder litigation. Most shareholder litigation is settled within policy limits, with the D&O insurers primarily footing the bill. Therefore, we expect the D&O insurers to price financial reporting risk and corporate governance risk efficiently in order to compensate for their expected payout obligations in the case of lawsuits.

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SEC Division of Investment Management Key Considerations

Posted by the Harvard Law School Forum on Corporate Governance & Financial Regulation, on
Sunday, November 25, 2012
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Editor’s Note: The following post comes to us from Norm Champ, director of the Division of Investment Management at the U.S. Securities and Exchange Commission. This post is based on Mr. Champ’s remarks at the ALI CLE 2012 Conference on Life Insurance Company Products, which are available here. The views expressed in this post are those of Mr. Champ and do not necessarily reflect those of the Securities and Exchange Commission, the Division of Investment Management, or the Staff.

I. Introduction

These are uncertain times for our nation’s investors and for those who issue and sell investment products, including variable insurance. A positive sign is that assets in variable annuities, at almost $1.6 trillion, remain near their all-time high. [1] In addition, the retirement income solutions offered by the industry are designed to address the needs of the many investors moving toward retirement in today’s uncertain market environment. However, there are significant challenges facing the business, particularly those presented by the persistent low interest rate environment and by volatile equity markets both here and abroad.

The Division has observed the industry undertaking several initiatives to address these challenges and curtail risk exposure in the contracts being offered. In addition, some insurers have chosen to exit the business. An industry on solid financial footing is important for investors, who rely on insurers’ ability to pay promised benefits. At the same time, some contract changes are not good for investors. For example, many recent changes have reduced benefits for new investors. Other changes have limited the ability of existing contract owners to make additional payments into their contracts in order to take advantage of the benefits of those contracts.

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Conflicts of Interest: Requiring a Closer Governance Focus

Posted by Noam Noked, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Saturday, November 24, 2012
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The following post comes to us from Michael W. Peregrine, partner at McDermott Will & Emery LLP. This post is based on an article by Mr. Peregrine.

A series of broad based developments over the last year combine to encourage governing boards to apply closer attention to conflicts of interest issues. These developments include several prominent judicial decisions; a series of focused articles in The New York Times; a highly public state attorney general investigation; the SEC internal investigation of its general counsel — and the subsequent investigation of its own Inspector General. Collectively, they draw new attention to the proper identification, disclosure and resolution of potential conflicts of interest. This new attention is consistent with an increasing lack of public, judicial and regulatory tolerance for perceived ethical lapses by corporate fiduciaries, their advisors, and others in a position of trust and confidence.

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Key Year-End Considerations for Public Companies

Posted by John F. Olson, Gibson, Dunn & Crutcher LLP and Georgetown Law Center, on
Friday, November 23, 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 by Amy Goodman, Elizabeth A. Ising, Gillian McPhee and Ronald O. Mueller.

With the arrival of fall, calendar-year companies are gearing up for what promises to be another busy proxy season, preparing for new rules that will impact their disclosures and governance practices, and planning their 2013 board and committee calendars. To assist public companies in these endeavors, we discuss below ten key items for corporate secretaries and in-house counsel to consider.

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It’s (Not) All About the Money

Posted by June Rhee, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Friday, November 23, 2012
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The following post comes to us from Nizan Geslevich Packin at the University of Pennsylvania Law School.

In the paper, It’s (Not) All About the Money: Using Behavioral Economics to Improve Regulation of Risk Management in Financial Institutions, forthcoming in the University of Pennsylvania Journal of Business Law, I focus on the Dodd-Frank Act’s risk management provisions, and specifically the requirement that financial institutions create separate risk committees. The goal of this regulation is to mitigate risks to the financial stability of the US, because despite media attention to financial institutions and great regulatory efforts, including the focus on risk management, little has changed in financial institutions’ business cultures. Indeed, excessive risk-taking by such institutions is still rampant. In the article, I argue that risk-related decision makers do not make decisions about risk-taking in a vacuum, but in an environment where multiple factors, noticed and unnoticed, can influence the decisions. Such factors include cognitive-related biases and group-related biases, and there are tools, which have not yet been analyzed in literature that regulators can use to reduce undesired or excessive risk-taking. Indeed, by shaping such environmental factors in which risk-related decisions in financial institutions are made, regulation can help actors make better, less pro-risk-taking, choices. With the goal of reducing excessive risk-taking by financial institutions, this article builds on an emerging focus in behavioral law and economics on prospects for “debiasing” actors through the structure of legal rules. Under this approach, legal policy may reduce biases’ effects and judgment errors by directly addressing them. Doing so will then help the relevant actors either to reduce or to eliminate these effects and errors. Accordingly, the article suggests using behavioral economic-based legal guidelines to supplement the Dodd-Frank Act‘s risk committee’s requirement. Such legal guidelines would help reduce the degree of biased behavior that risk committees exhibit.

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Oral Argument in Amgen: Will it Sway the Court?

Posted by Noam Noked, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Thursday, November 22, 2012
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The following post comes to us from Paul A. Ferrillo, litigation counsel at Weil, Gotshal & Manges LLP. This post is based on an article by Mr. Ferrillo, Robert F. Carangelo, David Schwartz and Matt Altemeier that first appeared in D&O Diary.

On November 5, 2012, the United States Supreme Court heard oral argument in Amgen Inc. v. Connecticut Retirement Plans & Trust Funds (No. 11-1085) (“Amgen”). In Amgen, Plaintiff/Respondent Connecticut Retirement Plans and Trust Funds (“Connecticut Retirement”) brought a putative class action under the Exchange Act of 1934, alleging that Defendant/Petitioner Amgen and several of its directors and officers misstated and failed to disclose safety information concerning two of its drugs. Amgen contends that it did not mislead investors and that the information it allegedly concealed was widely known.

Background of Amgen and Path to the Supreme Court

The issue in Amgen is the predominance requirement of Federal Rule of Civil Procedure (“Rule”) 23(b)(3), which states that a court may not certify a class for trial without determining that “questions of law or fact common to class members predominate over any questions affecting only individual members.” Because of the near-impossibility of establishing commonality of direct reliance on alleged misstatements in securities fraud litigations, plaintiffs typically rely on a rebuttable presumption of common indirect reliance on the integrity of the market price for the securities at issue. The Supreme Court first recognized this presumption in Basic Inc. v. Levinson, 485 U.S. 224, 241-47 (1988), relying in part on the “fraud-on-the-market” (“FOTM”) theory. The FOTM theory assumes that the market price of securities traded in an efficient market reflects all publicly-available material information, including any material misrepresentations.

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Limits of Disclosure

Posted by Steven Davidoff, Ohio State University College of Law, on
Wednesday, November 21, 2012
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Steven M. Davidoff is an Associate Professor of Law and Finance at Ohio State University College of Law.

In Limits of Disclosure recently posted to the SSRN we examine the shortcomings of disclosure. Claire Hill and I do so by exploring two areas where disclosure arguably failed, albeit for very different reasons: synthetic collateralized debt obligations (CDOs), such as Abacus and Timberwolf, sold in the years immediately leading up to the financial crisis, and executive compensation.

One big focus of attention, criticism, and proposals for reform in the aftermath of the 2008 financial crisis has been securities disclosure. Many commentators have emphasized the complexity of the securities being sold; some have noted that disclosures were sometimes false or incomplete. What follows, to some commentators, is that whatever other lessons we may learn from the crisis, we need to improve disclosure. How should it be improved? Commentators often lament the frailties of human understanding, notably including those of everyday (retail) investors: people do not understand or even read disclosure. This leads, naturally and unsurprisingly, to prescriptions for yet more disclosure, simpler disclosure, and financial literacy education.

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