Monthly Archives: April 2012

Ten Additional Companies Disclose Management Declassification Proposals Made Pursuant to Agreements

Editor’s Note: 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. An earlier post about the SRP’s activities is available here, a critique of the SRP’s activities by Martin Lipton and Theodore Mirvis is available here, and a response to this critique by Jeffrey Gordon is available here.

Since the Harvard Law School Shareholder Rights Project (SRP) issued its March 19 News Alert (reprinted in a post here), ten additional companies have made filings disclosing management proposals to declassify their boards made pursuant to agreements that these companies entered with institutional investors represented and advised by the SRP. With these ten additional companies, the number of companies that have made filings disclosing such management proposals during this proxy season – all listed here – has increased to 31.

During the 2011-12 proxy season, the SRP has been representing and advising several institutional investors – the Illinois State Board of Investment (ISBI), the Los Angeles County Employees Retirement Association, the Nathan Cummings Foundation (NCF), the North Carolina State Treasurer (NCDST), and the Ohio Public Employees Retirement System – in connection with the submission of shareholder proposals to over eighty S&P 500 companies with a 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-three companies receiving such proposals (one additional company entered into an agreement since the March 19 News Alert). These forty-three companies have entered into agreements committing them to bring management proposals to declassify their boards.

The new companies disclosing management proposals made in accordance with such agreements (with the proponent submitting the shareholder proposal in parenthesis) are: C.H. Robinson Worldwide, Inc. (NCF); CenturyLink, Inc. (ISBI); Coventry Health Care, Inc. (ISBI); Flowserve Corporation (NCDST); FMC Technologies Inc (NCDST); Hudson City Bancorp, Inc. (NCF); Juniper Networks, Inc. (ISBI); O’Reilly Automotive, Inc. (NCF); Western Union (NCF); and Wyndham Worldwide Corporation (NCF). The full list of companies that have made filings disclosing management proposals made pursuant to agreements with institutional investors represented and advised by the SRP is available here. The list will be updated periodically as additional companies of those entering into agreements to bring management declassification proposals make such filings.

All of these companies, including the ten companies newly announcing management proposals, should be commended for their willingness to engage in a dialogue with shareholder proponents and their representatives and advisers – and for their responsiveness to shareholders’ preferences regarding classified boards.

Stock Options and Managerial Incentives for Risk Taking

The following post comes to us from Rachel Hayes, Professor of Accounting at the University of Utah; Michael Lemmon, Professor of Finance at the University of Utah; and Mingming Qiu of the Department of Finance at the University of Utah.

In our forthcoming Journal of Financial Economics paper, Stock Options and Managerial Incentives for Risk Taking, we exploit the change in the accounting treatment of stock-based compensation under FAS 123R, which was issued by the Financial Accounting Standards Board (FASB) and took effect in December 2005, to provide new evidence on the role that convexity in compensation contracts plays in providing incentives for risk taking by managers.  An additional rationale that is often stated for the dramatic rise in option-based compensation over time revolves around how stock options were treated for accounting purposes. Prior to the implementation of FAS 123R, firms were allowed to expense stock options at their intrinsic value. Because nearly all firms granted stock options at-the-money, no expenses for option-based compensation were generally reported on the income statement.

Hall and Murphy (2003) argue that, due to their favorable accounting treatment and the fact that there is no cash outlay at the time of the grant, firms act as though the perceived cost of options is lower than their true economic cost. If firms make decisions based on the perceived costs instead of the economic costs, they grant more options than they would otherwise, and options with their favorable accounting treatment are preferred to possibly better incentive plans with less favorable accounting treatment. Consistent with this view, Carter, Lynch, and Tuna (2007) provide evidence that the accounting treatment of stock options affected their use, showing that a comprehensive proxy for financial reporting concerns was positively related to the use of stock options prior to FAS 123R. The implementation of FAS 123R eliminated the ability to expense options at their intrinsic value and instead required firms to begin expensing stock-based compensation at its fair value, effectively eliminating any accounting advantages associated with stock options.

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Wachtell Lipton’s Critique of Harvard Law School

Editor’s Note: Jeffrey Gordon is the Richard Paul Richman Professor of Law at Columbia Law School. This post relates to an earlier post by Martin Lipton and Theodore Mirvis, which is available here. Both this post and the Lipton-Mirvis post relate to the 2011-2012 work of the Harvard Law School Shareholder Rights Project, which is described in a post here.

The HLS Forum recently published a post by Martin Lipton and Theodore Mirvis titled “Harvard Shareholder Rights Project is Wrong.” The post was based on a memorandum issued by their law firm, Wachtell, Lipton, Rozen & Katz (“Wachtell”), and signed by the authors of the post and two other top partners at the firm. The memo and post offer a strongly worded critique of Harvard Law School for permitting the operation of the Shareholder Rights Project (SRP) clinical program. The objections were twofold: First, the results achieved by the clinic – agreements by 42 large public companies to propose charter amendments declassifying their boards – are undesirable as a public policy matter. Second, the clinic was wrong to represent public pension funds and charitable endowments because this representation went beyond “provid[ing] educational opportunities while benefiting impoverished or underprivileged segments of society for which legal services are not readily available.”

I think the Wachtell memo-writers’ strongly held belief about the virtue of classified boards as a governance feature of large public firms has spilled over into an unfair attack on the Harvard SRP clinic based on a straitjacketed conception of clinical legal education not followed by leading American law schools. Wachtell has, of course, long been known for its invention of the poison pill and its expertise in takeover defenses. Because staggered boards make poison pills more powerful and fortify takeover defenses, it is understandable that Wachtell, and some of the clients it serves, do not welcome large-scale declassification of boards. Whether such declassification would benefit shareholders and the American economy is a legitimate question for debate. However, criticizing Harvard Law School for permitting the SRP to operate should not be part of this debate.

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Considering Causes and Remedies for Declining IPO Volume

The following post comes to us from Jay R. Ritter, Cordell Professor of Finance at the University of Florida’s Warrington College of Business Administration. This post is based on Professor Ritter’s testimony before the Senate Committee on Banking, Housing, and Urban Affairs, available here.

I will first give some general remarks on the reasons for the low level of U.S. IPO volume this decade and the implications for job creation and economic growth, and then make some suggestions on the specific bills that the Senate is considering.

First, there is no doubt that fewer American companies have been going public since the tech stock bubble burst in 2000, and the drop is particularly pronounced for small companies. During 1980-2000, an average of 165 companies with less than $50 million in inflation-adjusted annual sales went public each year, but in 2001-2011, the average has fallen by more than 80%, to only 29 small firm IPOs per year. The patterns are illustrated in Figure 1.

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Insider Trading in Takeover Targets

The following post comes to us from Anup Agrawal, Professor of Finance at the University of Alabama, and Tareque Nasser of the Department of Finance at Kansas State University.

In our paper, Insider Trading in Takeover Targets, forthcoming in the Journal of Corporate Finance, we provide systematic evidence on the level, pattern and prevalence of trading by registered insiders before announcements of takeovers during modern times. We examine insider trading in about 3,700 targets of takeovers announced during 1988-2006 and in a control sample of non-targets, both during an ‘informed’ and a control period. We analyze open-market stock transactions of five groups of corporate insiders: top management, top financial officers, all corporate officers, board members, and large blockholders. We separately examine their purchases, sales and net purchases in target and control firms during the one year period prior to takeover announcement (informed period) and the preceding one year (control) period, using a difference in differences (DID) approach. Using several measures of the level of insider trading, we estimate cross-sectional regressions that control for other determinants of the level of insider trading.

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SEC Enforcement to Focus on Private Equity Insider Trading and Conflicts of Interest

The following post comes to us from Howard Sobel, partner and co-head of the US Private Equity Practice at Latham & Watkins LLP, and is based on a Latham & Watkins Client Alert by Mr. Sobel and Robert Burwell.

The private equity industry should expect increased scrutiny by the Securities and Exchange Commission (SEC), particularly with respect to insider trading and how firms address conflicts of interest, according to recent speeches by representatives of the SEC Division of Enforcement’s new Asset Management Unit. Moreover, The Wall Street Journal has reported that the SEC has “launched a wide-ranging inquiry into the private equity industry.” [1]

The Enforcement Division’s increasing attention to private equity corresponds with the implementation of new rules under the Dodd-Frank Act that will significantly increase the number of private equity firms subject to SEC regulation as “investment advisers.” The Asset Management Unit, one of a number of specialized enforcement units formed by the Division of Enforcement in 2010 to focus on “priority areas,” [2] is staffed with 65 professionals, including private equity experts.

Once registered as investment advisers, private equity firms must appoint a chief compliance officer and maintain written policies and procedures reasonably designed to prevent violation of the federal securities laws, including laws prohibiting insider trading. According to the SEC Staff, these policies and procedures should also promote compliance with firms’ fiduciary duties and regulatory obligations, including identifying and addressing conflicts of interest.

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