Monthly Archives: January 2012

Delaware Court Intervenes to Protect Shareholder Voting Rights

Eduardo Gallardo is a partner focusing on mergers and acquisitions at Gibson, Dunn & Crutcher LLP. This post is based on a Gibson Dunn Client Alert by Mr. Gallardo, Brian Lutz, and Aaron Holmes. Gibson Dunn represents Mr. Sherwood in the Delaware litigation discussed below. This post is part of the Delaware law series, which is co-sponsored by the Forum and Corporation Service Company; links to other posts in the series are available here.

On December 20, 2011, Vice Chancellor Parsons of the Delaware Court of Chancery issued an opinion and entered a temporary restraining order enjoining ChinaCast Education Corporation from holding its annual meeting, scheduled for later that day, until January 10, 2012. See Sherwood, et al. v. Chan Tze Ngon, et al., No. 7106-VCP (Delaware Court of Chancery). The Court found that ChinaCast’s actions, having removed incumbent director Ned Sherwood from its slate of nominees less than two weeks before the scheduled annual meeting, did not “comport with the ‘scrupulous fairness’ required of corporate elections.” The opinion serves as an important reminder for companies that while Delaware law provides significant latitude to create processes intended to facilitate the orderly conduct of annual stockholder meetings and election contests, actions that improperly infringe upon the shareholder franchise will be viewed skeptically by Delaware courts.

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Executive Stock Options, Differential Risk-Taking Incentives, and Firm Value

The following post comes to us from Christopher Armstrong and Rahul Vashishtha, both of the Accounting Department at the University of Pennsylvania.

In our paper, Executive Stock Options, Differential Risk-Taking Incentives, and Firm Value, forthcoming in the Journal of Financial Economics, we examine how executive stock options (ESOs) give chief executive officers (CEOs) differential incentives to alter their firms’ systematic and idiosyncratic risk. Since ESOs give CEOs incentives to alter their firms’ risk profile through both their sensitivity to stock return volatility, or vega, and their sensitivity to stock price, or delta, we examine both effects.

Theory suggests that vega gives risk-averse managers more of an incentive to increase total risk by increasing systematic rather than idiosyncratic risk, since, for a given level of vega, an increase in systematic risk always results in a greater increase in a CEO’s subjective value of his or her stock-option portfolio than does an equivalent increase in idiosyncratic risk. This differential risk-taking incentive manifests because a CEO who can trade the market portfolio can hedge any unwanted increase in the firm’s systematic risk. Consistent with this prediction, we provide evidence of a strong positive relationship between vega and the level of both total and systematic risk. However, we do not find vega and idiosyncratic risk to be significantly related.

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Reflections on Airgas and Long-term Value

Editor’s Note: Theodore Mirvis is a partner in the Litigation Department at Wachtell, Lipton, Rosen & Katz.

Here are slides on the Airgas case and slides on the underlying gating issue of long/short term perspective that drives much of the corporate governance debates and is rarely confronted by the “governistas” that advocate all sorts of standardized practices they consider to be value enhancing. I used these materials this month in a class co-taught by Lucian Bebchuk and Scott Hirst at Harvard Law School – hence, the reference to being “in the belly of the beast.” The slides are available here and here.

Rebuilding Trust: The Corporate Governance Opportunity for 2012

Ira Millstein is a senior partner, and Holly Gregory a corporate partner, at Weil, Gotshal & Manges LLP. This post is based on a Weil Alert by Mr. Millstein and Ms. Gregory.

Concerns about the responsible use of corporate power remain high in the wake of the financial crisis. Although these concerns have been focused primarily on the financial sector, there is spillover to corporations in every industry. Tough economic conditions, slow job growth, political dysfunction and general uncertainties about the future continue to undermine investor confidence and fuel public distrust (with Occupy Wall Street an example). This in turn intensifies the scrutiny of corporate actions and board decisions, and may skew the regulatory environment in which companies compete.

All corporate governance participants – boards, executive officers, shareholders, proxy advisors, regulators and politicians – have both an interest and a role to play in rebuilding trust in the corporations that are the engine of our economy. In our annual reflection, we offer thoughts on how, without the need for regulatory intervention, boards and shareholders can seize the opportunity to rebuild trust and, by doing so, help resolve some of the tensions that are stalling our economic recovery.

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Stephen Fraidin Joins PCG’s Advisory Board

The Forum is pleased to announce that Stephen Fraidin, a member of the law firm of Kirkland & Ellis, joined the Advisory Board of the Harvard Law School Program on Corporate Governance. He joins the existing members of the Board: William Ackman, Peter Atkins, Joseph Bachelder, Richard Breeden, Richard Climan, Isaac Corré, John Finley, Byron S. Georgiou, Larry Hamdan, Robert Mendelsohn, David Millstone, Theodore Mirvis, James Morphy, Toby Myerson, Eileen Nugent, Paul Rowe, and Rodman Ward.

For more than 30 years, Steve Fraidin’s practice has focused on the representation of major companies and investment groups in acquisitions and proxy contests, and special committees and boards of directors regarding mergers and acquisitions, corporate governance and other matters.  In 2003, he joined Kirkland & Ellis LLP as a senior partner in the M&A group. Major M&A representations most recently handled by Mr. Fraidin include the special committee of Expedia, Inc. in connection with the spinout of TripAdvisor, Inc., the representation of EMS Technologies in its sale to Honeywell, Inc. for approximately $600 million, and 3G Capital Management LLC in the $4.3 billion acquisition of Burger King. His work on behalf of 3G Capital was recognized by The American Lawyer in its annual “Dealmakers of the Year” edition and the transaction was recognized by Investment Dealers’ Digest in its annual “Deal of the Year Awards,” The Deal Magazine as one of the “Deals of the Year” and as the “Private Equity Deal of the Year” at the M&A Atlas and IFLR America’s awards ceremonies in New York. Mr. Fraidin also recently represented Pershing Square Capital Management LP, the New York hedge-fund firm led by activist investor William Ackman, in the acquisition of a 26.1% stake in retailer, J.C. Penney; Community Health Systems Inc. in the attempt to acquire Tenet Healthcare Corp.; and NRG Energy Inc. in successfully repelling Exelon Corp.’s  $7.45 billion hostile bid. His work in the NRG takeover attempt was recognized by The AmLaw Daily as “Dealmaker of the Week.”

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Measuring Continuity of Interest in Reorganizations

James Morphy is a partner at Sullivan & Cromwell LLP specializing in mergers & acquisitions and corporate governance. This post is based on a Sullivan & Cromwell publication by Avi S. Alter, Ronald E. Creamer, Jr., and David C. Spitzer.

On December 16, 2011, the Internal Revenue Service (the “IRS”) and Treasury Department issued final and proposed regulations (“the Final Regulations” and “the Proposed Regulations,” respectively) that generally provide rules for the proper timing of the valuation of consideration offered in respect of a reorganization, for purposes of satisfying the “continuity of interest” requirement for tax-free reorganizations. The Final Regulations issue in finalized form rules previously described in temporary regulations, which allow in certain circumstances for the valuation of consideration on the date prior to the signing of a merger agreement, known as the “signing date” rule, with some additional clarification.

The Proposed Regulations would expand the signing date rule and would allow for the use of an average share price under certain circumstances. Specifically, under the Proposed Regulations, for purposes of determining whether the “continuity of interest” requirement is satisfied:

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Regulation, Ownership, and Costs

The following post comes to us from Dan Bogart of the Department of Economics at the University of California, Irvine, and Latika Chaudhary of the Department of Economics at Scripps College.

In our paper, Regulation, Ownership, and Costs: A Historical Perspective from Indian Railways, forthcoming in the AEJ: Economic Policy, we provide an historical perspective by studying the transition from private to colonial state ownership of Indian railways from 1874 to 1912. In the mid-19th century prompted by British merchant houses and railway promoters, the British Government in London encouraged railway development in India. It opted for a system of private British owned and operated railways. However, the contracts stipulated a 5 percent dividend guarantee on share capital payable by the colonial Government of India. Such guarantees were common in other countries and were designed to compensate British investors for the risk involved in building railways in foreign places (Eichengreen 1995).

On account of conflicts and decades of disappointing performance, the Government of India began to construct and operate state lines in the 1870s. At the same time, they also began to takeover private companies. Because of a clause in the original concession contract, the Government could only takeover private companies on either the 25th or 50th anniversary of their contract. The Government exercised the takeover option in every case and by 1910 formed an extensive ownership stake in the railway sector. But, this process did not eliminate the private sector. Many companies were allowed to retain operations, but they faced more stringent Government control and supervision.

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French Thin Cap Reform

The following post comes to us from Jeffrey M. Trinklein, partner and member of the International Tax Practice Group at Gibson, Dunn & Crutcher LLP, and is based on a Gibson Dunn alert by Jérôme Delaurière.

According to a reform applicable as of January 1, 2012, the right to deduct interest due with respect to the purchase of shares in French target companies will be denied, unless the French acquiring company demonstrates — by any means — that (i) the decisions relating to such shares and (ii) the control over the target companies are effectively made by it or by a related party established in France.

For the purpose of this reform, a related party can be a controlling company or an entity controlled by or under common control with the acquiring company.

This new rule targets the purchase of shareholdings that are eligible for the French long-term participation exemption regime, i.e. mainly shares that represent at least 5% of the financial and voting rights of companies (other than certain real estate property companies).

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Disintermediating the Proxy Advisory Firms

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 and David C. Karp.

We have long eschewed the one-size-fits-all model of corporate governance advanced by many of the proxy advisory firms (see, for example, our memo of October 19, 2010). The formulaic voting policies sold by many of these proxy advisory firms represent a low-cost means by which many institutional shareholders seek to discharge their proxy voting responsibilities. Unfortunately the voting policies of the proxy advisory firms are usually derived from unsupported notions of what constitutes “good governance” and are often applied in ways that do not account for the specific circumstances at many companies. Accordingly, this approach often fails to advance the real interests of long-term investors. The Department of Labor and the Securities and Exchange Commission have raised questions regarding fiduciary responsibility in the context of the outsourcing of proxy voting decisions to proxy advisory firms, but no regulatory changes to address this issue have yet been adopted.

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Private Equity 2011: A Challenging Year, With Reasons For Optimism

Andrew J. Nussbaum is a partner in Wachtell, Lipton, Rosen & Katz’s Corporate Department. This post is based on a Wachtell Lipton firm memorandum by Mr. Nussbaum, Steven A. Cohen, and Amanda N. Persaud.

We will be neither the first nor, we suspect, the last industry participant to observe the challenges that financial sponsors, and private equity investors in particular, experienced in 2011. As we move into 2012, we do, however, find our glasses leaning more toward the full rather than empty side.

Limited Partners. The challenging fundraising environment has continued into 2011. Institutional investors, particularly public pension funds, are paring back the number of relationships, which bodes well for large established sponsors who are viewed as more stable and with deeper pockets to help buffer market volatility, In some cases, fund target sizes have been adjusted downwards, with economic and transparency concessions having become the new norm thanks in large part to ILPA. While concessions have varied among sponsors, what has become clear is that institutional investors remain committed to private equity and those capable of writing large checks are getting customized one-off arrangements with better economic terms. Whether through managed accounts, side-cars, direct investments, multi-strategy mandates or co-investments, institutional investors have taken advantage of the current fundraising cycle to actively partner with established sponsors in more creative ways, with the expectation of better returns in the long term.

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