Monthly Archives: May 2012

Can JP Morgan Transparently Police Itself?

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 Harvard Business Review online.

In the wake of its significant trading losses (now reportedly rising from $2 to $3 billion or more), JP Morgan can win back some of its lost reputation by transparently holding those responsible to account.

These individuals could include (but not be limited to) the London trader, Bruno Iksil (“The London Whale”); his London boss, Achilles Macris; their U.S. boss, Ina Drew, the former head of the bank’s Chief Investment Office (CIO); and CEO Jamie Dimon, who oversaw the CIO. Drew quickly retired after the losses, and Iksil and Macris are, according to news reports, leaving the bank.

Although the media has spoken loosely about a company “clawing back” pay, there are, in fact, different ways to hold responsible individuals to financial account. A “claw-back” seeks cash or equity already transferred to an individual. A “hold-back” cancels financial benefits which have been awarded but have not yet vested. A future compensation action would reduce 2012 variable benefits (bonus or equity awards) in absolute terms (or through a much slower rate of increase). Claw-backs or hold-backs of past awards could be appropriate for the departed employees. They could be appropriate for Dimon, but so could a compensation action about future variable comp.


Delaware Decisions: Data Points, Not Doctrine

David Fox is a partner at Kirkland & Ellis LLP, focusing on complex mergers and acquisitions as a member of the firm’s Corporate Practice Group. This post is based on a Kirkland & Ellis M&A Update by Mr. Fox, Yosef J. Riemer, and Daniel E. Wolf. 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.

Delaware courts often take an expansive approach to decision-making, offering detailed commentary on the facts and the underlying law in many key M&A cases. While these lengthy opinions can offer market participants useful insights into best practices for future deals, it is equally important that dealmakers not overreact to observations that should, and no doubt are intended to, be read within the context of the specific circumstances before the court. In seeking guidance from court decisions, readers should be mindful that, more often than not, it is only the cases with the worst, or at least most complicated, facts that make it to a final court decision, exacerbating the risk reflected in the old legal adage that “hard cases make bad law”. A few examples may be useful.

Stapled Financing In his 2005 Toys “R” Us, Inc. decision, then VC Strine was critical of the decision to allow one of the target board’s financial advisers to offer financing to the winning bidder after the merger agreement was signed. Some commentators interpreted the court’s comments as blanket discouragement of the practice of “stapled financing” being offered to bidders by a target adviser. However, VC Strine himself later publicly commented that such a reading “misconstrued” his opinion and that there were situations where it would be appropriate for a seller, through its banker, to offer financing to potential bidders (for example, in order to stimulate interest among buyers, to reduce the risk of leaks or to set a valuation floor for an auction). His criticism in Toys was directed at the risk of appearance of conflict generated by the request of the adviser (and agreement by the board) to offer financing once the deal was already signed, meaning the financing role served to only generate fees for the lending bank as opposed to any useful function for the target. A similar nuanced reading is required of VC Laster’s recent commentary on stapled financing that played a significant role in the fairly scathing Del Monte decision. Rather than suggesting that stapled financing is per se problematic, VC Laster implied that the court will seek evidence that allowing a sell-side adviser to offer a buyer financing had “some justification reasonably relating to advancing stockholder interests”. Instead of the reflexive avoidance of stapled financing that occurred in the aftermath of each of these two decisions, a more refined reaction requires principals and their advisers to critically assess whether such financing could in fact advance the target’s interests and, if such financing is in fact offered, to ensure that it is done with the full knowledge of the board with appropriate protections in place to address any resulting potential conflicts (e.g., by early engagement of a second, non-financing adviser).


A Proposal to Repeal Exclusive Forum at Chevron

Editor’s Note: The following post comes to us from Richard H. Koppes, administrative officer at the National Association of Public Pension Attorneys and former general counsel of the California Public Employees’ Retirement System. This post is based on an article by Mr. Koppes in the NAPPA Report.

When I left CalPERS in 1996 after ten years (having founded and run their corporate governance program for all ten years), I bought shares in ten companies that I felt listen to shareowners, had or were developing good corporate governance, and would be (hopefully!) a good economic investment. Of those ten companies, eight have done very well, with one doing so-so, and one not doing so good. Chevron, a Fortune Ten Company, was one of those ten companies. I have held Chevron stock for 16 years now, and it has done quite well.

Spring is proxy season and my mailbox, both postal and electronic, has filled with proxy materials and annual reports. I try to read/look over all these materials and to carefully vote my proxies. Recently, I turned to my Chevron proxy and noted item No. 4, entitled: “Shareholder Proposal Regarding Exclusive Forum Provisions.” This proposal states: “RESOLVED: The shareholders of Chevron Corporation (the “Company”) hereby ask the board of directors to repeal the Company’s “exclusive forum” bylaw which was unilaterally adopted by the board of directors and which generally requires shareholders to bring certain types of legal actions only in Delaware, the state where the Company is incorporated.”

I have fought for good corporate governance for over 26 years, first as a CalPERS “shareowner activist,” and then as a counselor to corporate boards for the last 15+ years, and as a corporate board member of various public companies for the last 13 years.


Global Financial Inclusion Indicators

The following post comes to us from Asli Demirguc-Kunt, Director of Development Policy in the World Bank’s Development Economics Vice Presidency and Chief Economist of the Financial and Private Sector Network, and Leora Klapper, Lead Economist in the Finance and Private Sector Research Team of the Development Research Group at the World Bank.

In a recent World Bank working paper, Measuring Financial Inclusion: The Global Findex Database, we provide the first analysis of the Global Financial Inclusion (Global Findex) Database, a new set of indicators that measure how adults in 148 economies save, borrow, make payments, and manage risk. Well-functioning financial systems serve a vital purpose, offering savings, credit, payment, and risk management products to people with a wide range of needs. Inclusive financial systems—allowing broad access to financial services, without price or nonprice barriers to their use—are especially likely to benefit poor people and other disadvantaged groups. Without inclusive financial systems, poor people must rely on their own limited savings to invest in their education or become entrepreneurs—and small enterprises on their limited earnings to take advantage of promising growth opportunities. This can contribute to persistent income inequality and slower economic growth.

Until now, little had been known about the global reach of the financial sector—the extent of financial inclusion and the degree to which such groups as the poor, women, and youth are excluded from formal financial systems. Systematic indicators of the use of different financial services had been lacking for most economies.

The Global Financial Inclusion (Global Findex) database provides such indicators, measuring how people in 148 economies save, borrow, make payments, and manage risk. These new indicators are constructed with survey data from interviews with more than 150,000 nationally representative and randomly selected adults age 15 and above. The survey was carried out over the 2011 calendar year by Gallup, Inc. as part of its Gallup World Poll.


Give Credit Where Credit Is Due

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 Corporate Counsel.

Federal enforcement authorities should give much more systematic credit to effective corporate compliance programs when making decisions about criminal prosecutions, including nonprosecution or deferred prosecution agreements, and when deciding the scope of civil and administrative settlements.

That is the fundamental conclusion of a recent report from an advisory group constituted in November 2011 to assess the effectiveness of the Federal Sentencing Guidelines for Organizations (FSGO) 20 years after publication by the U.S. Sentencing Commission. Organized by the Ethics Resource Center, the advisory group was composed of law enforcement officials, judges, prosecutors, academics, and compliance experts from companies and law firms. It focused on corporations, not other entities covered by the FSGO (such as unions or pension funds). (Disclosure: I was on the advisory group and approved the final report but was not involved in decisions about scope or in drafting.)

The advisory group faced a fundamental paradox at the outset. In response to the elements of a good compliance program outlined in the FSGO (and elements drawn from numerous other sources), many corporations have established strong compliance and ethics programs during the past 20 years. Yet few corporations received credit under the Sentencing Guidelines because there were so few corporate convictions as more and more corporate criminal investigations were settled outright or resolved with nonprosecution or deferred prosecution agreements (NPAs and DPAs).


Developing Insightful Oversight

Robert Kirchstein is director of CSCPublishing at the Corporation Service Company. This post is an excerpt from the 2012 edition of The Directors’ Handbook, by Thomas J. Dougherty of Skadden, Arps.

So much of the architecture of corporate governance has been the subject of recent federal reforms (SOX, Dodd-Frank, FCPA expansion, etc.) that it is easy to forget that those enactments leave a lot of the governance landscape unaddressed. Clearly, federal requirements for compulsory CEO and CFO financial statement certifications, automatic clawback of senior executive stock option grants following restatement of financials, expanded MD&A and CD&A disclosures, say-on-pay voting requirements, board committee charter mandates, federal one-size-fits-all proxy access rules (that have been blocked in court from implementation), new federal whistleblowing protection schemes, and other federal reforms have reshaped many of the peaks and valleys of corporate governance and are covered at length in this handbook.

However, directors’ robust exercise of their oversight responsibilities depends on much more than taking into account those federal promontories and gullies. Arguably, some of the most important director oversight functions, such as CEO succession, conflict of interest avoidance, strategic risk assessment, capital allocation and employee retention occupy large spaces in the governance landscape that are only indirectly touched by headline-fetching federal reforms. Yet those other key oversight responsibilities might easily become neglected lacunae in the landscape if they are overshadowed by the burden and time devoted to regulators’ mandates.

Consequently, well apart from regulatory guidelines and headline pressures that structure many board tasks, directors also need to devote the self-disciplined effort requisite to fulfilling those fundamental oversight duties.


The Impact of Regulatory Governance Mandates on Poorly Governed Firms

The following post comes to us from Reena Aggarwal, Robert E. McDonough Professor of Business Administration at Georgetown University; Jason Schloetzer of the Department of Accounting at Georgetown University; and Rohan Williamson, Professor of Finance and Stallkamp Research Fellow at Georgetown University.

In our paper, The Impact of Regulatory Governance Mandates on Poorly Governed Firms, which was recently made publicly available on SSRN, we investigate the relation between regulatory governance mandates and firm value by assessing the impact of recent governance mandates on the firms that were most affected by changes in governance regulation. We exploit the cross-sectional variation in compliance with governance mandates in the pre-regulatory period to identify firms that were most affected by the governance mandates promulgated by congressional action and the associated changes to NYSE and Nasdaq listing requirements (“affected firms”) and firms that were less affected by such mandates (“control firms”). We use propensity score trimming (Crump et al. 2009; Imbens and Wooldridge 2009) to form a sample of affected and control firms that display covariate balance, facilitating comparisons across the pre- (1996 through 2004) and post-regulatory (2005 through 2009) periods. An important objective of recent governance mandates was to improve board monitoring. Hence, we identify affected and control firms using the governance mandates most closely related to board monitoring (please see our paper for more details). Our research design helps to mitigate endogeneity concerns by combining a quasi-natural experiment with the identification of firms differentially affected by the regulatory governance mandates.


Corporate Philanthropy as Signaling and Co-optation

The following post comes to us from Roy Shapira, fellow of the Program on Corporate Governance.

In a paper recently published in Fordham Law Review, Corporate Philanthropy as Signaling and Co-optation, I examine a previously unnoticed mechanism through which corporate philanthropy (CP) can enhance company value: signaling.

Current value-enhancing accounts rest on the premise that CP “buys goodwill” for the company: companies, by acting nicely, can increase consumers’ or employees’ willingness to pay. But the necessary conditions underlying this theory are simply too unrealistic. For one, consumers have to be aware of companies’ CP policies and be willing to pay to delegate their philanthropy (that is, pay for someone else’s charitable preferences). We should focus less on charitable preferences and warm-glow concepts, and more on the potential of pro-social sacrifices to convey messages about a firm’s fundamentals. Explicit sacrifices of profits can serve as costly signals. They reliably convey messages about attributes that are important to shareholders, consumers, and employees – who are evaluating whether to invest in, buy products from, or work for those companies (that is, important even to those stakeholders who are strictly profit-minded).

To illustrate, the paper elaborates on the option of CP as a costly signal to investors. An increase in the level of donations could convey messages about financial strength to potential investors, who could infer that future free cash flows are perceived by insiders to be relatively high, that the company is now less financially constrained, or that the riskiness of future cash flows has decreased. Pro-sociality could also bridge asymmetric information between insiders and non-financial stakeholders, such as employees and consumers, by conveying messages about the styles and characteristics of top management and the extent to which they are subject to short-termism.


Dim the Spotlight: De-emphasizing Pay for Performance

Editor’s Note: Simon Wong is a partner at Governance for Owners, an adjunct professor of law at the Northwestern University School of Law, and a visiting fellow at the London School of Economics and Political Science. This post is based on an article by Mr. Wong that appeared The Conference Board Review. Work from the Program on Corporate Governance on executive compensation includes the paper Paying for Long-Term Performance, and the book Pay without Performance, both by Bebchuk and Fried.

It is common knowledge that people are not driven solely by the prospect of financial rewards. Yet, in business, motivational tools for top executives—particularly the CEO—almost singularly comprise financial incentives. In 1980, only 10 percent of the UK’s largest FTSE100 companies utilized incentive arrangements (in the form of cash and stock-based variable pay). Today, they are universally employed as a matter of best practice and variable pay accounts for approximately two-thirds of total compensation.

Widespread adoption of financial incentives has contributed to substantial pay increases, in absolute and relative terms. In the United Kingdom, the average compensation of FTSE100 CEOs climbed from £1 million in 1998 to £4 million a decade later, with the ratio of CEO pay to average employee pay nearly tripling. (The figures are, of course, higher for American executives.) The rise in top executive pay has far outstripped growth in share price and other indicators of company performance, with certain incentive arrangements proving counterproductive by encouraging excessive risk-taking and accounting manipulation.

Amid growing sensitivity to widening income inequality in many countries, it is no wonder that executive pay has remained a visible target.


Private Equity Buyer/Public Target M&A Deal Study

The following post comes to us from John Pollack and David Rosewater, partners focusing mergers & acquisitions at Schulte Roth & Zabel LLP. This post discusses the Schulte Roth & Zabel Private Equity Buyer/Public Target M&A Deal Study 2011 Year-End Review, which is available here. Posts about previous versions of the study are available here and here.

Survey Methodology

We conducted our survey as follows:

  • We reviewed the treatment of certain key deal terms in all private equity buyer/public company target cash merger transactions involving consideration of at least $500 million in enterprise value [1] entered into during 2010 and 2011, which totaled 37 transactions.
  • We then compared the treatment of such deal terms in the 20 transactions entered into between Jan. 1, 2010 and Dec. 31, 2010, which we refer to as the “2010 Transactions,” with the treatment of the same key deal terms in the 17 transactions entered into between Jan. 1, 2011 and Dec. 31, 2011, which we refer to as the “2011 Transactions.”

Key Observations

As widely reported, 2011 was a tumultuous year characterized by economic uncertainty. The European sovereign debt crisis and the downgrade to the U.S. credit rating caused significant volatility in the U.S. debt and equity markets. The large private equity buyer/public company segment of the U.S. M&A market was not immune to these factors. Deal activity was down overall relative to 2010 and the deals that were completed in 2011 took longer to complete.


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