Yearly Archives: 2012

The Consequences of Private Meetings with Investors

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Monday, January 9, 2012
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The following post comes to us from David Solomon of the Department of Finance at the University of Southern California and Eugene Soltes of the Accounting and Management Unit at Harvard Business School.

Private meetings between executives and investors consume a significant amount of managerial time and offer investors a potentially unique window into a firm’s operations. In our paper, What Are We Meeting For? The Consequences of Private Meetings with Investors, which was recently made publicly available on SSRN, we investigate which funds meet privately with management and the consequences of these interactions.

We find that certain types of investors are more likely to privately meet with management including those with more assets, greater turnover, closer physical proximity to the firm, and greater holdings of the firm. We also find that hedge funds are also more likely to meet with management. These findings are consistent with the incentives of both sell‐side analysts (who arrange meetings for investors that offer the greatest revenue opportunities for the sell‐side analysts’ firm) and investors who have the most to gain from meetings with management.

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Auditing in the Decade Ahead: Challenge and Change

Posted by the Harvard Law School Forum on Corporate Governance & Financial Regulation, on
Sunday, January 8, 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 Canadian Public Accountability Board’s Audit Quality Symposium, which are available 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.

I will discuss some common themes pervading the regulation of audits, regardless of what country you are in. Certain structural challenges threaten the relevance of auditing. These threats rise at a time when confidence in business reporting is more important than ever. We are also affected by geopolitical forces that threaten both the regulation of audits as well as the audits themselves.

I do not believe any of these challenges, or the threats accompanying them, are insurmountable. But they must be confronted. I do believe overcoming them will require concerted, collective commitment and action.

I. Auditor Skepticism is the Foundation for Investor Confidence in Financial Reporting.

I want to begin with the motivating idea for this conference. A prolonged global financial crisis continues to jeopardize economies everywhere: in the Americas, in Europe, in Australia and Asia. Our people have a shared agenda to restore hope in their futures. Our families have shared agendas to be assured they have the resources to maintain their homes, rear their children with confidence in their ability to prosper, and provide for elders with dignity and respect for the achievements of their generations.

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Tough Dilemmas for Companies on Campaign Spending

Posted by the Harvard Law School Forum on Corporate Governance & Financial Regulation, on
Saturday, January 7, 2012
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Editor’s Note: Ben W. Heineman, Jr. is a former GE senior vice president for law and public affairs and a senior fellow at Harvard University’s schools of law and government. This post is based on an article that appeared in the online edition of the Harvard Business Review. Work from the Program on Corporate Governance about corporate political spending includes Corporate Political Speech: Who Decides? by Lucian Bebchuk and Robert Jackson, discussed on the Forum here. A committee of law professors co-chaired by Bebchuk and Jackson submitted a rulemaking petition to the SEC concerning corporate political spending; that petition is discussed here.

Should companies use funds from the corporate treasury to advocate directly for or against political candidates in contested elections?

This basic question — now made immediate with the opening of the election season in the Iowa caucuses — raises dilemmas for boards and business leaders:

  • Should we adopt detailed governance rules or keep decisions informal and in a small group?
  • Should we be passive and avoid such spending, or be active and get involved in partisan politics?
  • Should we voluntarily disclose all expenditures or keep expenditures hidden unless disclosure is required by law?
  • Should we support generally moderate candidates who can compromise on major structural issues facing the U.S., or narrow, even ideological candidates who will advocate for issues of immediate concern to the corporation?

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Say on Pay 2011: Proxy Advisors On Course for Hegemony

Posted by Charles M. Nathan, Latham & Watkins LLP, on
Friday, January 6, 2012
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Charles Nathan is Of Counsel at Latham & Watkins LLP and is co-chair of the firm’s Corporate Governance Task Force. This post discusses an article by Mr. Nathan, James D.C. Barrall, and Alice Chung that appeared in the New York Law Journal, available here.

My colleagues, Jim Barrall and Alice Chung, and I have co-authored an article titled Say on Pay 2011: Proxy Advisors on Course for Hegemony. The article analyzes the results of the first year of mandatory Say on Pay advisory votes and discusses the implications of these results for Say on Pay advisory voting during the 2012 proxy season. We begin by noting that based on the Say on Pay votes of a universe composed of the Russell 3000 companies that were subject to mandatory Say on Pay voting, recommendations by the two principal proxy advisory firms (ISS and Glass Lewis) appeared to have a significant effect, with a recommendation by ISS accounting, on average, for an approximately 25% vote swing, and one by Glass Lewis accounting, on average, for about a 5% vote swing. The data also indicates that companies receiving a negative SOP recommendation from ISS averaged less that a 70% favorable vote.

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IPO Pricing in Business Groups

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Friday, January 6, 2012
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The following post comes to us from Aharon Cohen Mohliver of the Department of Management at Columbia University, and Gitit Gur-Gershgoren, Chief Economist at the Israel Securities Authority.

In the paper Channeling Funds into the Group: IPO Pricing in Business Groups, which was recently made publicly available on SSRN, we demonstrate that business groups use financial intermediaries to boost the stock prices of affiliated firms in initial public offerings (IPO). This is done when mutual funds belonging to the group strategically participate in the IPO’s that originate from the group during the road show, and subsequently sell their holdings quickly after the IPO.

In the past decade there has been increasing interest in pyramidal business groups and in the ability of group owners to transfer assets from one firm in the pyramid to another. This phenomenon, dubbed “tunneling” by Kogut and Spicer (1998) and Johnson (2000), can take many forms such as transfer pricing, transfer of goods at nonmarket prices and inflated payments for intangibles. Much of the research examined the internal capital markets in these groups yet the theoretical possibility of transferring resources from external sources into the group’s internal capital markets, an activity we refer to in this paper as “channeling” was not previously addressed.

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The Corporate Capture of the United States

Posted by the Harvard Law School Forum on Corporate Governance & Financial Regulation, on
Thursday, January 5, 2012
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Editor’s Note: Robert Monks is the founder of Lens Governance Advisors, a law firm that advises on corporate governance in the settlement of shareholder litigation.

American corporations today are like the great European monarchies of yore: They have the power to control the rules under which they function and to direct the allocation of public resources. This is not a prediction of what’s to come; this is a simple statement of the present state of affairs. Corporations have effectively captured the United States: its judiciary, its political system, and its national wealth, without assuming any of the responsibilities of dominion. Evidence is everywhere.

The “smoking gun” is CEO pay. Compensation is an expression of concentrated power — of enterprise power concentrated in the chief executive officer and of national power concentrated in corporations. Median US CEO pay for 2010 was up 35 percent in the midst of a lingering recession, while CEO pay over the last decade has doubled as a percentage of pre-tax corporate income. Yet there has been no justification for current levels of CEO pay based on economic value added.

When Lee Raymond retired as CEO of ExxonMobil at the end of 2005, after six years at the helm of the merged firm and another six as head of Exxon before that, he walked away with more than a quarter billion dollars in realizable equity. In his final year alone, Raymond received in excess of $70 million in total compensation — an hourly wage of about $34,500 calculated at 40 hours a week for 50 weeks. No metric can justify such a raid on the corporate treasury and shareholder equity, but Raymond is only a particularly egregious and early example of what has since become common practice. Little wonder that the driving concern of banks receiving TARP “bailout” money was to pay it back so as to escape any restriction on executive pay.

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The Enforcement Regime of the UK Financial Services Authority

Posted by Noam Noked, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Thursday, January 5, 2012
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The following post comes to us from Jeffery Roberts, senior partner at Gibson, Dunn and Crutcher LLP, and is based on a Gibson Dunn alert by Mr. Roberts, Selina Sagayam, and James Barabas.

Overview

It’s not just a numbers game… Since overhauling its financial penalty framework in March 2010, the UK Financial Services Authority (FSA) has gone a long way to dispel views that it has a lacklustre approach towards levying market abuse fines. However, harsher fines are just one feature of its tougher enforcement regime. Recent cases show that the FSA has generally stepped up its enforcement activity, improving the range of resources and evidence available to successfully investigate market abuse. This will particularly be the case due to the introduction of the Zen monitoring system and requirement for firms to tap employee mobile phones.

Ready to take on the “tricky” cases: The regulator has also shown increased willingness to expunge novel/unusual forms of market abuse involving both non-equity securities, and instruments that do not in themselves fall squarely within the ambit of the Financial Services and Markets Act 2000 (the “Act”). The FSA has also levied fines in respect of individuals that live abroad, yet engage in abusive transactions in UK markets. Although in general, the harshest hitting penalties have been issued to high profile individuals, or those involved in very serious cases of market abuse, recent enforcement action has signaled that the FSA has the potential also to come down on firms that do not take appropriate steps to supervise and manage market abusers. It remains to be seen whether this tougher enforcement regime will transfer to the FSA successor agencies once the regulator is abolished.

This alert looks at a few examples of FSA enforcement action in 2011 in the market abuse area and considers how this heralds a more robust enforcement regime.

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European Regulation of Fund Managers

Posted by Barnabas Reynolds, Shearman & Sterling, on
Wednesday, January 4, 2012
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Barnabas Reynolds is head of the global Financial Institutions Advisory & Financial Regulatory Group at Shearman & Sterling LLP. This post is based on a Shearman & Sterling client publication by William Murdie and John Adams.

The EU Alternative Investment Fund Managers Directive (the “Directive”) came into force on 21 July 2011. The Directive promises to reshape the regulation of managers of alternative investment funds in the EU and beyond, and is required to be implemented across the EU by 22 July 2013. Yet the Directive requires significant rulemaking in the form of so-called Level 2 implementing measures in order to put flesh on its bones. The body tasked with bringing forth those implementing measures, the European Commission (the “Commission”), has now received final advice from the European Securities and Markets Authority (“ESMA”). That advice, upon which the Commission is expected to rely heavily in its own rulemaking, has been the subject of fierce debate during consultation. This note analyses ESMA’s Final Advice and the possible consequences for the fund management industry going forward.

Introduction

After two years of development, argument and fine-tuning, the Directive was finally published in the Official Journal of the European Union on 1 July 2011 and entered into force for European law purposes on 21 July 2011. EU Member States are required to implement the Directive by 22 July 2013.

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On the Importance of Internal Control Systems in the Capital Allocation Decision

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Wednesday, January 4, 2012
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The following post comes to us from David De Angelis of the Department of Finance at Cornell University.

In the paper, On the Importance of Internal Control Systems in the Capital Allocation Decision: Evidence from SOX, which was recently made publicly available on SSRN, I investigate the effects of information problems across corporate hierarchies on internal capital allocation decisions by using the Sarbanes-Oxley Act (SOX) as a quasi-natural experiment of a shock to the level of information frictions across corporate hierarchies. SOX requires firms to enhance their internal control systems in order to improve the reliability of financial reporting across corporate hierarchies.

I find that after SOX the capital allocation decision is more sensitive to performance as reported by the business segments. The changes in sensitivity of investment to performance are more pronounced for conglomerates that are more prone to information problems across corporate hierarchies, such as conglomerates with more segments and conglomerates that restated their earnings in the past. Moreover, in the post-SOX era, firms do not rely on past performance in their capital allocation decision when auditors report material weaknesses in their internal controls. The productivity advantage of conglomerates over stand-alone firms increases after SOX. In addition, conglomerates and segments that are more affected by SOX exhibit a larger increase in future profitability after SOX. Furthermore, the excess value of conglomerate firms relative to stand-alone firms increases (i.e., the conglomerate discount decreases). These changes in the internal capital allocation process are not associated with economic activities, financial constraints, or tensions between the management and shareholders.

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Risk Management and the Board of Directors – An Update for 2012

Posted by Martin Lipton, Wachtell, Lipton, Rosen & Katz, on
Tuesday, January 3, 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 firm memorandum by Mr. Lipton, Daniel A. Neff, Andrew R. Brownstein, Steven A. Rosenblum, Adam O. Emmerich, Sebastian L. Fain, and David J. Cohen.

I. Introduction

Overview

Corporate risk taking and the monitoring of risks have remained front and center in the minds of boards of directors, legislators and the media, fueled by the powerful mix of continuing worldwide financial instability; ever-increasing regulation; anger and resentment at the alleged power of business and financial executives and boards, including particularly as to compensation during a time of economic uncertainty, retrenchment, contraction, and changing dynamics between U.S., European and emerging market economies; and consistent media attention to corporations and economies in crisis. The reputational damage to boards of companies that fail to properly manage risk is a major threat, and Institutional Shareholder Services now includes specific reference to risk oversight as part of its criteria for choosing when to recommend withhold votes in uncontested director elections. This focus on the board’s role in risk management has also led to increased public and governmental scrutiny of compensation arrangements and their relationship to excessive risk taking and has brought added emphasis to the relationship between executive compensation and effective risk management. For the past few years, we have provided an annual overview of risk management and the board of directors. This overview highlights a number of issues that have remained critical over the years and provides an update to reflect emerging and recent developments.

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