Monthly Archives: April 2012

The Efficacy of Shareholder Voting

David Larcker is the James Irvin Miller Professor of Accounting at Stanford University.

In the paper, The Efficacy of Shareholder Voting: Evidence from Equity Compensation Plans, which was recently made publicly available on SSRN, my co-authors (Christopher Armstrong of the University of Pennsylvania and Ian Gow of Harvard Business School) and I examine the efficacy of shareholder voting in effecting changes in corporate policy. We focus on the effects of shareholder voting on equity-based compensation plans on firms’ executive compensation policies for two reasons. First, equity compensation plans are widespread and require shareholder approval, making votes on these plans the most common subject of shareholder voting after director elections and auditor ratification. Second, equity compensation proposals attract much higher levels of shareholder disapproval than most other company-sponsored proposals that are put to shareholder vote (e.g., director elections and auditor ratification nearly always receive in excess of 90% shareholder support), making them a more powerful setting for empirical analysis.

Of the 619 management-sponsored proposals rejected by shareholders between 2001 and 2010, 183 (30%) related to equity compensation plans. For the 2,659 management-sponsored proposals where Institutional Shareholder Services (ISS), a leading proxy advisory firm, recommended a vote against the proposal, 1,719 (65%) related to equity compensation plans. Moreover, ISS recommended against 27% of the 6,270 equity compensation plans considered between 2001 and 2010. Although only 2% of equity compensation proposals fail to receive the required level of shareholder support, this is substantially larger than the 0.07% failure rate for director elections, which have received considerably greater attention in recent research on shareholder voting and executive compensation.


Final Rule on Designation of Systemically Important Companies

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 Samuel Woodall.

Recently, the Financial Stability Oversight Council (“Council”) unanimously approved a final rule (the “Final Rule”) and related interpretive guidance (the “Final Guidance”) under the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”), [1] regarding the designation of systemically important nonbank financial companies (often referred to as nonbank “SIFIs”). The Final Rule and Final Guidance describe how the Council will apply the statutory designation standards and the procedures it intends to employ in exercising this authority. Designated companies are required to comply with enhanced prudential standards and are subject to consolidated supervision by the Board of Governors of the Federal Reserve System (the “Federal Reserve”). The Federal Reserve’s recent proposal regarding these enhanced standards suggests that this will be a comprehensive and rigorous regulatory regime. [2]

The Final Rule and Final Guidance, which are substantially similar to the Council’s October 2011 proposed rule and guidance (the “October 2011 Proposal”), [3] do not provide significant new insight as to which companies will ultimately be designated. Nonetheless, it is an important initial procedural step to enable the actual designation process to begin. Secretary of the Treasury Geithner, who chairs the Council, has indicated that the first of these designations will be made this year.


SEC Investigation Recognizes Individual’s Contribution

The following post comes to us from John H. Sturc, co-chair of the Securities Enforcement Practice Group at Gibson, Dunn & Crutcher LLP, and is based on a Gibson Dunn alert.

On March 19, 2012, the Securities and Exchange Commission (“SEC”) announced that it had credited the substantial cooperation of a former senior executive of an investment adviser in an investigation [1] by declining to take enforcement action against him. The SEC’s announcement can be found here. This is the first time the SEC has publicly recognized the cooperation of an individual since the announcement two years ago of its policy statement intended to incentivize individuals to cooperate in investigations, found here. [2] This announcement provides some much needed insight into the potential benefits of cooperating in an SEC investigation. However, the unique facts of the case mean that it will have limited application to other cases.

I. SEC’s Cooperative Initiative

As we have discussed in a prior alert, SEC’s Initiative to Foster Cooperation–Perspective and Analysis (Jan. 14, 2010), [3], the SEC announced a new policy under which individuals could cooperate in an enforcement investigation to avoid a civil enforcement action or receive a lesser sanction. Although the evaluation of cooperation requires a case-by-case analysis of the specific circumstances presented, the Cooperation Policy Statement explained that the SEC’s general approach would be to determine whether, how much, and in what manner to credit cooperation by individuals by evaluating four considerations: (1) the assistance provided by the cooperating individual in the SEC’s investigation or related enforcement actions; (2) the importance of the underlying matter in which the individual cooperated; (3) the societal interest in ensuring that the cooperating individual is held accountable for his or her misconduct; and (4) the appropriateness of cooperation credit based upon the profile of the cooperating individual.


The Revised EU and US Regulatory Frameworks for Commodity Derivatives

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 full publication, including footnotes, is available here.

Users of commodity derivatives markets are now facing major changes under proposed European and US legislation. Stronger supervision of the commodity derivatives market is one of the key areas of the G20 regulatory reform agenda. In Europe, the European Commission is proposing to regulate the activities of a wider range of commodity derivatives traders through amendments to MiFID. End-users will become subject to mandatory clearing requirements for OTC derivative transactions above certain thresholds once the recently agreed EMIR proposal comes into force. For the first time, the wholesale energy market and the commodity spot market will become subject to the market abuse regime. In the US, the Dodd-Frank Wall Street Reform and Consumer Protection Act brings in a comprehensive reform of the OTC derivatives market. This publication gives an overview of the impact of the various recent European and US regulatory changes from the perspective of non-financial businesses involved in commodity derivatives trading.


Various proposals have been introduced since the onset of the financial crisis to strengthen financial regulation across the full spectrum of financial services at international, EU and domestic levels. Previous client publications address many of these proposals. This publication draws together various threads of regulation in the context of their impact on commodity derivatives trading.


Endogeneity and the Dynamics of Internal Corporate Governance

The following post comes to us from M. Babajide Wintoki of the Department of Finance at the University of Kansas, and James Linck and Jeffry Netter, both of the Department of Banking and Finance at the University of Georgia.

In our forthcoming Journal of Financial Economics paper, Endogeneity and the Dynamics of Internal Corporate Governance, we use a well-developed dynamic panel generalized method of moments (GMM) estimator to alleviate endogeneity concerns in two aspects of corporate governance research: the effect of board structure on firm performance and the determinants of board structure. It is well known that theoretical and empirical research in corporate finance is complicated by the endogenous relation that exists between the control forces operating on a firm and its decisions. Jensen (1993) broadly classifies these control forces (i.e., governance in a broad sense) as capital markets, the regulatory system, product and factor markets, and internal governance. In much of the extant corporate finance research, researchers attempt to either explain the causes or examine the effects of corporate finance decisions as related to one or more of these control forces. Empirical research often involves determining the causal effect, if any, of a firm characteristic (X) on some measure of firm profits or value (Y). This is usually done using the inference from a regression of Y on X along with several control variables (Z). The question is often framed as: holding Z constant, does X have an economically and statistically significant causal effect on Y?


ISS Influence on 2012 Shareholder Voting

James R. Copland is director of the Manhattan Institute’s Center for Legal Policy. This post is based on a memorandum from the Proxy Monitor project; the memo is available here.

Corporate America’s proxy season—when companies hold annual meetings and shareholders vote on various proposals submitted to them on proxy statements—is now under way. As of March 15, 51 of the largest 200 companies by revenues, as ranked by Fortune magazine, had announced their annual meetings and mailed proxy materials to shareholders. Of those companies, 11 have already held meetings, with four more—Hewlett Packard on March 21, Exelon on April 2, Bank of New York Mellon on April 10, and United Technologies on April 11—scheduled to meet before the annual meeting cycle begins in earnest in mid-April.

In 2011, the Manhattan Institute launched its database, which catalogs shareholder proposals at America’s largest companies. Drawing upon information from the database, we have been examining a growing trend in shareholder activism wherein investors attempt to influence management and corporate practices through the shareholder voting process, sometimes in ways not directly related to maintaining or increasing shareholder value. [1]

This finding summarizes early trends in 2012 shareholder proposal findings and examines 2012 results to date in shareholder advisory votes on executive compensation—including the significant role played by the shareholder advisory firm Institutional Shareholder Services (ISS). This report also looks ahead to significant classes of shareholder proposals on the horizon that I have previously identified as items to watch for this year [2] — proposals relating to corporate campaign finance and political spending, proposals to separate the positions of corporate chairman and CEO, and proposals to grant shareholders proxy access for their director nominees. While votes on these issues have not occurred to date, several such proposals are on proxy ballots in the coming weeks, and we expect these to be major issues during this proxy season.


Proposals for Auditor Independence and Audit Firm Rotation

Richard Breeden is the founder and chairman of Breeden Capital Management LLC and former chairman of the U.S. Securities and Exchange Commission. This post is based on Mr. Breeden’s statement before the Public Company Accounting Oversight Board’s public meeting on firm independence and rotation, available here.

It is an honor for me to participate in the Public Company Oversight Board’s public meeting to discuss proposals to enhance auditor independence, objectivity and professional skepticism, including the potential of imposing rules setting a maximum term limit for audit relationships. Sadly, many people in official Washington seem prepared to jettison the interests of investors without reason as would occur in the proposed JOBS legislation, which as currently written would unnecessarily savage important barriers against fraud and manipulation of markets. We should never be afraid to experiment with opportunities for reducing unnecessary regulatory costs, particularly for smaller companies. At the same time, we shouldn’t let anyone’s financial agenda be a pretext for allowing the unscrupulous a free rein to abuse savers and investors. In its current form this legislation has too many elements that are simply fantasies, such as that a company with $1 billion in revenue is a “small business”, when that is 10-20X too high a threshold.

When Jim Doty and I were at the SEC, the Commission created an entire set of registration statements and ’34 Act filings (eg, Form 10-KSB) geared for small companies to lower their costs in raising capital or being public companies. Companies could elect the simpler forms if they wished, although they might pay a market penalty for providing less information. We allowed things like requiring two years of audited financials rather than 3 years, and three years rather than five years of selected financial data. We simplified disclosure requirements for smaller firms with less than $25mm in revenue (about $41mm in today’s dollars), but nobody got a free pass for fraud and there was still transparency for investors in current results.


Securities Class Action Settlements

The following post comes to us from Narayanan Subramanian, principal at Cornerstone Research. This post discusses a Cornerstone Research report by Ellen M. Ryan and Laura E. Simmons, available here.

There were 65 court-approved securities class action settlements involving $1.4 billion in total settlement funds in 2011—the lowest number of approved settlements and corresponding total settlement dollars in more than 10 years, according to Securities Class Action Settlements—2011 Review and Analysis, an annual report by Cornerstone Research. The number of settlements approved in 2011 decreased by almost 25 percent compared with 2010 and was more than 35 percent below the average for the preceding 10 years. Further, the total dollar value of settlements declined by 58 percent, from $3.2 billion in 2010 to $1.4 billion in 2011. The change in the number of settlements from 2010 to 2011 is one of the two largest year-over-year declines and, combined with a year-over-year decrease in settlements in 2010, the first time there has been a decline in the number of settled cases for two consecutive years.


Equity Risk Incentives and Corporate Tax Aggressiveness

The following post comes to us from Sonja Olhoft Rego of the Department of Accounting at Indiana University and Ryan Wilson of the Department of Accounting at the University of Iowa.

In our forthcoming Journal of Accounting Research paper, Equity Risk Incentives and Corporate Tax Aggressiveness, we examine equity risk incentives as one determinant of corporate tax aggressiveness. As noted by Shevlin [2007], we have an incomplete understanding of why some firms are more tax aggressive than others. Prior accounting research finds that corporate tax avoidance is systematically associated with certain firm attributes, including profitability, extent of foreign operations, intangible assets, research and development expenditures (R&D), leverage, and financial reporting aggressiveness. Dyreng, Hanlon, and Maydew [2010] conclude that individual managers influence their firms’ tax avoidance, even after controlling for numerous firm characteristics. Prior research also examines whether income tax avoidance is associated with corporate compensation practices, but finds mixed evidence. We argue that tax avoidance is a risky activity, which imposes costs on both firms and managers. As a result, managers must be incentivized to engage in tax avoidance that involves uncertain outcomes.

Equity risk incentives capture the convexity of the relation between a manager’s wealth and stock price, and are measured as the change in value of a manager’s stock option portfolio for a given change in stock return volatility (e.g., Guay [1999]). In short, equity risk incentives reflect how changes in stock return volatility affect managerial wealth. Prior research provides evidence that equity risk incentives motivate managers to make more risky – but positive net present value – investing and financing decisions. However, these studies do not examine the relation between equity risk incentives and risky tax planning, which we also refer to as “risky tax avoidance” and/or “aggressive tax positions.” We argue that just as equity risk incentives motivate managers to make more risky investing and financing decisions, they also motivate managers to undertake more aggressive (i.e., risky) tax positions, and thus account for some variation in tax aggressiveness across firms.


Giving Shareholders a Voice

Editor’s Note: Lucian Bebchuk is a Professor of Law, Economics, and Finance and Director of the Shareholder Rights Project (SRP) at Harvard Law School. This post is based on an op-ed article by Professor Bebchuk published today in the New York Times DealBook, available here. The post responds to a critique of the SRP’s activities in a memorandum issued by Wachtell, Lipton, Rosen & Katz, which appears in a post here. 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.

Staggered boards have long been a key mechanism for insulating boards of publicly traded firms from shareholders. This year, several institutional investors and a program working on their behalf have used shareholder proposals to move a large number of publicly traded firms away from such structures. Despite strong and expected criticism from the usual suspects, shareholders should welcome and support this work.

The Shareholder Rights Project, a clinical program that I run at Harvard Law School, assists public pension funds and charitable organizations in improving corporate governance at publicly traded companies. During this proxy season, we represented and advised five such clients – 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 – in connection with their submission of proposals for a vote at the annual meetings of more than 80 companies on the Standard & Poor’s 500-stock index.

The proposals urge companies with a staggered board, which allow shareholders to replace only a few directors each year, to place all board members up for election every year. Such a move to annual elections is viewed by investors as a best practice of corporate governance. By enabling shareholders to register their views on all directors each year, annual elections make boards more accountable to shareholders.


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