Monthly Archives: March 2012

Private Interaction Between Firm Management and Sell-Side Analysts

The following post comes to us from Eugene Soltes of the Accounting and Management Unit at Harvard Business School.

In the paper, Private Interaction Between Firm Management and Sell-Side Analysts, which was recently made publicly available on SSRN, I investigate private interaction between sell‐side analysts and senior management by examining a set of internal records compiled by a large‐cap NYSE traded firm. Thousands of hours of senior management time are consumed speaking with sell‐side analysts annually at publicly traded firms. Despite this significant use of time, there is little academic evidence that directly examines these interactions. The analysis in this paper seeks to begin a dialogue to fill this gap.

I find that analysts who privately meet with management cover fewer firms, have less experience, and cover the sample firm for a longer period of time. These individual analyst characteristics dominate attributes of the firms they work for in explaining which analysts privately interact with management.

Evidence indicates that analysts who interact privately are more likely to create reports. I do not find that private interaction significantly improves the accuracy of analysts’ earnings estimates. Evidence also suggests that private interaction with management largely complements, rather than substitutes for, other means of public interaction such as quarterly conference calls.


Investor Protection is Needed for True Capital Formation

Editor’s Note: Luis A. Aguilar is a Commissioner at the U.S. Securities and Exchange Commission. This post is based on a speech by Commissioner Aguilar; the full speech, 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. Last week the U.S. Senate passed the JOBS Act, with some amendments from the version passed by the U.S. House of Representatives on March 8, 2012.

Recently, the House of Representatives passed H.R. 3606, the “Jumpstart Our Business Startups Act.” It is clear to me that H.R. 3606 in its current form weakens or eliminates many regulations designed to safeguard investors. I must voice my concerns because as an SEC Commissioner, I cannot sit idly by when I see potential legislation that could harm investors. This bill seems to impose tremendous costs and potential harm on investors with little to no corresponding benefit.

H.R. 3606 concerns me for two important reasons. First, the bill would seriously hurt investors by reducing transparency and investor protection and, in turn, make securities law enforcement more difficult. That is bad for ordinary Americans and bad for the American economy. Investors are the source of capital needed to create jobs and expand businesses. True capital formation and economic growth require investors to have both confidence in the capital markets and access to the information needed to make good investment decisions.


Top Concerns for Directors in 2012

The following post comes to us from John J. Barry, leader, Center for Board Governance at PricewaterhouseCoopers LLP, and is based on a PwC publication, available here.

The SEC enforcement agenda and whistleblower bounty program, CEO succession, executive compensation, and IT risk were among the issues on audit committee members’ minds as they met in December and January at three audit committee peer exchanges hosted by the PwC Center for Board Governance. The exchanges were part of the 2011 Year-end considerations for audit committees seminar held in Arizona, New York and Florida.

PwC Vice Chair, Assurance, Tim Ryan facilitated the exchanges, which included over 200 audit committee members. Following are the major recurring themes at each of the venues.


Among all the rulemaking and enforcement actions that have taken place over the past year, one that caused significant consternation among the audit committee members is the new SEC whistleblower bounty program. Many are concerned about the program undercutting existing company whistleblower programs that came into existence following the passage of the Sarbanes-Oxley Act in 2002. That law calls for public company audit committees to oversee whistleblower hotlines.


Harvard’s Shareholder Rights Project is Wrong

Martin Lipton is a founding partner of Wachtell, Lipton, Rosen & Katz, specializing in mergers and acquisitions and matters affecting corporate policy and strategy. Theodore Mirvis is a partner in the Litigation Department at Wachtell Lipton. This post is based on a Wachtell Lipton memorandum by Mr. Lipton, Mr. Mirvis, Daniel A. Neff, and David A. Katz. This post discusses the 2011/2012 activities of the Harvard Law School Shareholder Rights Project, which are described in an earlier post here.

The Harvard Law School Shareholders Rights Project (SRP) recently issued joint press releases with five institutional investors, principally state and municipal pension funds, trumpeting SRP’s representation of and advice to these investors during the 2012 proxy season in submitting proposals to more than 80 S&P 500 companies with staggered boards, urging that their boards be declassified. The SRP’s “News Alert” issued concurrently reported that 42 of the companies targeted had agreed to include management proposals in their proxy statements to declassify their boards – which reportedly represented one-third of all S&P 500 companies with staggered boards. The SRP statement “commended” those companies for what it called “their responsiveness to shareholder concerns.”

This is wrong. According to the Harvard Law School online catalog, the SRP is “a newly established clinical program” that “will provide students with the opportunity to obtain hands-on experience with shareholder rights work by assisting public pension funds in improving governance arrangements at publicly traded firms.” Students receive law school credits for involvement in the SRP. The SRP’s instructors are two members of the Law School faculty, one of whom (Professor Lucian Bebchuk) has been outspoken in pressing one point of view in the larger corporate governance debate. The SRP’s “Template Board Declassification Proposal” cites two of Professor Bebchuk’s writings, among others, in making the claim that staggered boards “could be associated with lower firm valuation and/or worse corporate decision-making.”


Repealing Classified Boards in S&P 500 Companies

Professor Lucian Bebchuk is the Director of the Harvard Law School Shareholder Rights Project (SRP), and Scott Hirst is the SRP’s Associate Director. Any views expressed and positions taken by the SRP and its representatives should be attributed solely to the SRP and not to Harvard Law School or Harvard University.

The Harvard Law School Shareholder Rights Project (SRP) is a clinical program at Harvard Law School through which faculty, staff and students assist public pension funds and charitable organizations to improve corporate governance at publicly traded companies in which they are shareowners. Below are links to joint press releases issued earlier this week by the SRP with each of five institutional investors – the Illinois State Board of Investment, the Los Angeles County Employees Retirement Association, the Nathan Cummings Foundation, the North Carolina State Treasurer, and the Ohio Public Employees Retirement System.

During the 2011-2012 proxy season, the SRP has been representing and advising these institutional investors in connection with the submission of shareholder proposals to more than eighty S&P 500 companies that have staggered boards. The proposals urge a move to annual elections, which are widely viewed as corporate governance best practice.

Through active engagement with companies receiving declassification proposals, the SRP and the institutional investors working with the SRP have been able to reach negotiated outcomes with forty-two of the companies receiving such proposals. These forty-two companies have entered into agreements committing them to bring management proposals to declassify their boards of directors.

The forty-two companies that have entered into agreements to bring management declassification proposals represent about one-third of the S&P 500 companies that had staggered boards at the beginning of this proxy season. A list of twenty-five companies that have entered into such agreements is available here. The list includes only companies that, after they entered into such agreements, issued a public filing disclosing the planned management proposal. The list will be updated periodically as more companies disclose management proposals brought pursuant to such agreements.

The press releases providing more information about the work described above are available at the following links:


Greek Restructuring: Why Isn’t It (Yet) a Credit Event?

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.

Recent developments arising out of the Greek sovereign debt crisis have required the ISDA Determinations Committee to determine whether a “Credit Event” has occurred under credit default swaps (“CDS”) referencing Greek sovereign debt. The Determinations Committee concluded on 1 March 2012 that a Credit Event has not yet occurred. We explain below why this is the case.

Standard Sovereign CDS incorporates the 2003 ISDA Credit Derivatives Definitions (as amended). These definitions set out what will constitute Credit Events and the Determinations Committee will then decide (on request) whether a relevant Credit Event has occurred and, broadly, the market has agreed to live with the result.

The Credit Event in question is “Restructuring”. Many different things might constitute “Restructuring”, but those in play at the moment are: (1) reduction in principal or interest, and (2) change in ranking in priority of payment, causing Subordination. These must occur in a form that binds all holders of the relevant Obligation and must result from deterioration in creditworthiness or financial condition of the debtor.


Detecting Deceptive Discussions in Conference Calls

The following post comes to us from David Larcker, Professor of Accounting at Stanford University, and Anastasia Zakolyukina of the Department of Accounting at Stanford University.

Considerable accounting and finance research has attempted to identify whether reported financial statements have been manipulated by executives. Most of these classification models are developed using accounting and financial market explanatory variables. Despite extensive prior work, the ability of these models to identify accounting manipulations is modest. In the paper, Detecting Deceptive Discussions in Conference Calls, forthcoming in the Journal of Accounting Research, we take a different approach to detecting financial statement manipulations by analyzing linguistic features present in CEO and CFO narratives during quarterly earnings conference calls. Based on prior theoretical and empirical research from psychology and linguistics on deception detection, we select the word categories that theoretically should be able to detect deceptive behavior by executives. We use these linguistic features to develop classification models for a very large sample of quarterly conference call transcripts.

A novel feature of our methodology is that we know whether the financial statements related to each conference call were restated in subsequent time periods. Because the CEO and CFO are likely to know that financial statements have been manipulated, we are able to reasonably identify which executive discussions are actually “deceptive”. Thus, we can estimate a linguistic-based model for detecting deception and test the out-of-sample performance of this classification method.


Delaware Court Reaffirms Revlon Duties and Fiduciary Duty of Disclosure

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. 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.

In its recent Micromet [1] preliminary injunction decision, the Delaware Chancery Court reaffirmed that (i) Revlon’s enhanced scrutiny is a reasonableness standard based on the particular circumstances of the target company and (ii) Delaware’s fiduciary duty of disclosure only requires that the information provided to shareholders for purposes of their vote on a merger be sufficiently robust in its entirety so that the information omitted would not significantly alter the total mix of information available to shareholders. Specifically, the Micromet court found adequate (because of the nature of Micromet’s fledgling pharmaceutical company’s business that involved partnering with strategics and its Board’s understanding of the Company and its needs) a pre-signing market check that was limited to strategic buyers with which Micromet previously had a commercial relationship, and to one week of diligence. In addition, the Micromet court was not persuaded that the following omissions from the 14D-9 disclosure statement sent to shareholders were sufficient to show a reasonable probability of success on a breach of fiduciary duty of disclosure claim: (i) the specific fees paid by Micromet to Goldman Sachs, its financial advisor, for unrelated work for the previous two years, (ii) the amount of Goldman’s ownership of the buyer’s stock, (iii) the basis for Micromet management’s probability of success rates for trial drugs, (iv) management’s projections regarding the use of net operating loss carry-forwards, (v) Goldman’s sum of the parts DCF analysis (that was not significantly different than Goldman’s DCF analysis) and (vi) management’s “upside case” projections provided to Goldman but described by the CEO as “highly optimistic and, in fact, not realistic” and that were not relied upon by Goldman in its analysis. The Micromet court, citing precedent, noted that “Delaware courts have repeatedly held that a board need not disclose specific details of the analysis underlying a financial advisor’s opinion” in satisfying the fiduciary duty of disclosure.


UK Supreme Court on Protection of Client Monies

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.

The Lehman Brothers International (Europe) (In Administration) (“LBIE”) client money litigation has generated significant interest. It deals with fundamental issues concerning the protections given by financial institutions to their clients. The decisions of the High Court and Court of Appeal on LBIE were keenly followed by the market. [1] Certain key points were appealed to the UK’s highest court, the Supreme Court (previously the House of Lords), which handed down its judgment this week. [2] The case is of great interest not only for the Lehman creditors but also for those with interests in the MF Global administration, and more generally for customers who are concerned about assets that they place with financial institutions.

What did the Supreme Court ruling address?

The Supreme Court ruled on the following three issues:

  • When does the statutory trust in relation to client money arise – upon receipt by a firm or when the firm segregates it?
  • Do the client money distribution rules apply to all identifiable client money, including client money held in house accounts?
  • Is participation in the notional client money pool (“CMP”) dependent on actual segregation of client money, or do clients for whom client money was not segregated, but who were entitled to have it segregated, share in the CMP?


Transparency, Liquidity, and Valuation

The following post comes to us from Mark Lang, Professor of Accounting at the University of North Carolina at Chapel Hill; Karl Lins, Professor of Finance at the University of Utah; and Mark Maffett of the Department of Accounting at the University of North Carolina at Chapel Hill.

Reductions in the liquidity and valuation of securities traded in global capital markets during the recent financial crisis have demonstrated the importance of understanding more fully the drivers of a firm’s stock market liquidity and associated linkages to valuation. In the paper, Transparency, Liquidity, and Valuation: International Evidence on When Transparency Matters Most, forthcoming in the Journal of Accounting Research,” we examine whether reduced transparency is associated with increased transaction costs and lower liquidity in a firm’s shares and, therefore, increased cost of capital and reduced valuation. We also investigate the extent to which the relation between transparency and liquidity is influenced by institutional and firm-level factors and by time series variation in uncertainty.

Our sample includes 97,799 firm-year observations across 46 countries over the period 1994–2007. In our first set of tests, we relate transparency to transaction costs and stock market liquidity. To measure transparency, we employ several firm-choice variables from prior cross-country research including earnings management (Fan and Wong (2002) and Leuz, Nanda, and Wysocki (2003)), auditor quality (Fan and Wong (2005)), and adoption of global accounting standards (Daske, Hail, Leuz and Verdi (2008, 2009)). We also employ two transparency variables that capture external information gathering by intermediaries: the number of analysts who cover a firm and the accuracy of analyst forecasts.


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