Monthly Archives: November 2012

ISS Proposes 2013 Voting Policy Updates

Richard J. Sandler is a partner at Davis Polk & Wardwell LLP and co-head of the firm’s global corporate governance group. This post is based on a Davis Polk client memorandum.

On Tuesday, October 16, Institutional Shareholder Services (ISS) proposed updates to its proxy voting guidelines for the 2013 proxy season.

ISS’s proposed policy would:

  • Recommend voting against boards of directors who do not act on shareholder proposals that were approved by the vote of a majority of shares cast in the prior year;
  • Revise ISS’s say-on-pay criteria by refining the peer group selection methodology, incorporating “realizable pay” analysis into the qualitative evaluation of pay-for-performance and designating pledging shares as a problematic pay practice;
  • Extend the analysis of golden parachute arrangements to existing and legacy arrangements rather than just new or renewed arrangements; and
  • Provide for a case-by-case assessment of shareholder proposals to link executive compensation to environmental and social “sustainability metrics.”

The proposed updates were open to public comment until October 31, and the final policies are expected to be released in November. While these new policies have not yet been finalized and are subject to revision, it’s not too early for public companies to consider how these changes could affect their ISS profile in the upcoming proxy season.


The Relation between CEO Compensation and Past Performance

The following post comes to us from Rajiv Banker, Professor of Accounting at Temple University; Masako Darrough, Professor of Accountancy at City University of New York; Rong Huang, Assistant Professor of Accountancy at City University of New York; and Jose Plehn-Dujowich, Assistant Professor Accounting at Temple University.

Most of the empirical work on executive compensation investigates the role of contemporaneous performance measures in setting cash compensation, ignoring the relevance of past performance measures and the structure of cash compensation. In our paper, The Relation between CEO Compensation and Past Performance, forthcoming in The Accounting Review, we focus on the relation between cash compensation components (salary and bonus) and past performance measures as signals of a CEO’s ability.

We first develop a simple two-period principal-agent model with moral hazard and adverse selection. Our model suggests that salary is adjusted to meet the reservation utility and information rent, and is positively correlated over time to reflect ability. Bonus serves to address moral hazard and adverse selection problems by separating agents into contracts with different levels of risk. Agents are screened and receive different bonus arrangements according to their types. The higher an agent’s type, the more sensitive his bonus is to contemporaneous performance. A higher ability agent receives a larger portion of his compensation in the form of bonus and less as salary. For a given agent, salary increases with his past performance and higher current salary predicts higher future performance. Current bonus, however, is negatively correlated with both past and future performance.


Lucian Bebchuk and Martin Lipton to Debate Blockholder Regulation

Next Tuesday, November 13, the Conference Board will host a debate in New York City between Lucian Bebchuk, a professor of Law, Economics and Finance at Harvard Law School, and Martin Lipton, a founding partner of Wachtell, Lipton, Rozen & Katz (WLRK) on the regulation of outside blockholders. Those interested in attending the debate can do so by RSVP’ing at the Conference Board website here by Wednesday, November 7.

This debate will be the fourth time over the past decade that Bebchuk and Lipton will engage in an exchange:

The 2012 debate concerns an issue that became prominent last year when WLRK submitted a rulemaking petition (available here) to the SEC, advocating a tightening of the rules governing disclosure by outside blockholders under the Williams Act. In particular, the WLRK petition advocates reducing the period of time before the owner of 5% or more of a public company’s stock must disclose that position, from ten days to one day.


Istanbul Stock Exchange Moves First on Mandatory Electronic Voting

The following post comes to us from Melsa Ararat and Muzaffer Eroğlu, faculty at Sabancı University School of Management and University of Kocaeli Law School, respectively.


Turkey’s New Company Law paved the way for its national stock exchange to be the first in the world to require the issuers change their company statutes in order to allow electronic participation and voting at their general assemblies. A recent regulation mandated all listed companies to use a single electronic portal to allow shareholders to participate and vote electronically in general assemblies with immediate effect. The move is one in a series of reforms in support of Istanbul International Financial Center Project. The Financial Times refers to the new regulation as a coup for international institutional investors with Turkish holdings as it increases the transparency of ISE listed companies and empowers them to embrace an activist approach. This commentary discusses the possible consequences of the new regulation.


Fair Value Accounting for Financial Instruments

The following post comes to us from Elizabeth Blankespoor of the Graduate School of Business at Stanford University; Thomas Linsmeier of the Financial Accounting Standards Board; Kathy Petroni, Professor of Accounting at Michigan State University; and Catherine Shakespeare of the Ross School of Business at the University of Michigan.

In our paper, Fair Value Accounting for Financial Instruments: Does it improve the Association between Bank Leverage and Credit Risk?, which was recently made publicly available on SSRN, we contribute to the debate on whether financial instruments should be measured at fair value in financial statements. Accounting standard setters have been deliberating the role of fair values for financial instruments for decades. A fair value is the price at which two willing parties would exchange an asset or settle a liability. Starting after the savings and loan crisis in the late 1980s, the Financial Accounting Standards Board (FASB) has increased the extent to which financial instruments are recognized at fair value (see Godwin, Petroni, and Wahlen 1998). In 2010, the FASB proposed to require that all financial instruments be recognized at fair value, with limited exceptions for receivables and payables and some companies’ own debt (FASB 2010). The proposal was controversial, with over 2,800 comment letters submitted, the vast majority of which objected to the fair value measurement of loans, deposits, and financial liabilities. The FASB is redeliberating this project and has tentatively decided that all financial instruments should be measured at fair value except certain debt financial assets and most financial liabilities (including deposits), which would be measured at amortized cost (FASB 2011).

To empirically provide insight on the controversy, we assess whether a fair value leverage ratio can explain measures of a bank’s credit risk better than a leverage ratio based on a mixture of fair values and historical costs consistent with the mixed-attribute model of US Generally Accepted Accounting Principles (GAAP) and a leverage ratio based on even fewer fair values than GAAP, which is consistent with regulatory Tier 1 capital. We focus on balance sheet leverage because it is very commonly used for assessing firm risk. We define a bank’s credit risk as the risk that the bank defaults on its obligations, and we focus on credit risk because understanding a bank’s credit risk is essential to understanding its financial condition.


Citigroup: A Symbol of Board Resurgence?

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.

At the center of the corporate wreckage of the past fifteen years — the accounting scandals, the outright fraud, the environmental disasters, the financial meltdown — sits the boards of directors. Their failure to choose the right CEO and to provide appropriate oversight on core risks and opportunities has, in my view, reflected a broad failure of the corporate governance movement and its reliance on directors to effectively to oversee the corporation and its business leaders.

Yet, the recent fall of Vikram Pandit, Citigroup CEO, underscores a basic truth: Independent boards of directors are still the best mechanism — or the least worst one — for holding business leaders accountable, even if many boards have failed in their attempts to do this, often in spectacular fashion.

Much of the Citigroup commentary has focused on the behind-the-scenes campaign of Citigroup board chair William O’Neil to oust Pandit and his stark ultimatum during a one-on-one confrontation: resign now, resign at the end of the year, or be fired.

Many have criticized O’Neil for his ham-handedness, saying this was rude to Pandit, demoralizing to essential Citi leaders, lacking in clear public rationale. A minority, however, has said such CEO separations are invariably messy, bringing to mind Lady MacBeth’s advice to her husband about murdering the king: “If it were done when ’tis done, then ’twere well, It were done quickly.”

But the tactics surrounding the decision should not obscure the potential importance of the decision itself. Are boards of directors now more than in the past focusing on their fundamental task — critically evaluating the leadership and the management of the CEO? Are they now much less hesitant to force changes at the top of the corporation due to performance on fundamentals, not just scandal or stock price variation?


The New Era of Swaps Market Reform

Editor’s Note: Gary Gensler is chairman of the Commodity Futures Trading Commission. This post is based on Chairman Gensler’s remarks before the George Washington University Center for Law, Economics and Finance Conference, available here.

The days of the opaque swaps market are ending. On October 12, 2012, we are shifting to a new era of transparency and commonsense rules of the road for the swaps market.

New Era — Swaps Market Reform Becomes a Reality

During the Great Depression, President Roosevelt and Congress put in place similar rules to bring transparency to the securities and futures markets, and protect investors from fraud, manipulation and other abuses.

These critical reforms of the 1930s are at the foundation of our strong capital markets and many decades of economic growth.

Swaps emerged in the 1980s to provide producers and merchants a means to lock in the price of commodities, interest rates and currency rates. Our economy benefits from a well-functioning swaps market, as it’s essential that companies have the ability to manage their risks.

The swaps marketplace, however, has lacked the necessary transparency to best benefit Main Street businesses and common-sense rules to protect the public.


Mutual Fund Sales Notice Fees

The following post comes to us from David M. Geffen, counsel at Dechert LLP who specializes in working with investment companies and their investment advisers.

My recent article, Mutual Fund Sales Notice Fees: Are a Handful of States Unconstitutionally Exacting $200 Million Each Year?, forthcoming in the Hastings Constitutional Law Quarterly, describes the political compromise struck in 1996 between Congress and state securities regulators. That year, Congress enacted the National Securities Markets Improvement Act of 1996 (NSMIA), which effected multiple changes to the federal securities laws to promote efficiency and capital formation by eliminating overlapping federal and state securities regulations.

With respect to mutual funds, NSMIA resolved the problem of overlapping regulation by preempting state substantive regulation and registration requirements of mutual funds, thereby providing for exclusive federal jurisdiction over the contents of a mutual fund’s prospectus and operation of each fund. NSMIA was welcomed by the mutual fund industry because it eliminated the “crazy quilt” of regulation that had made registration of mutual fund shares unnecessarily cumbersome—in some cases leading mutual funds to restrict their fund offerings to residents of certain states.

However, in order to secure the acquiescence of the states and secure NSMIA’s enactment, NSMIA preserved state authority to require mutual funds to file sales reports and to pay state filing fees based on those sales in connection with the sales reports. A handful of states have taken unfair advantage of this fee loophole.


Middle Market Private Equity Buyer/Public Target M&A Deal Study

The following post comes to us from John Pollack and David Rosewater, partners focusing on mergers & acquisitions at Schulte Roth & Zabel LLP. This post is based on the Schulte Roth & Zabel Middle Market PE Buyer/Public Target M&A Deal Study; the full publication, including appendices, is available here.


We regularly conduct studies on private equity buyer acquisitions of U.S. public companies with equity values greater than $500 million (“large market” deals) to monitor market practice reflected by these high-profile transactions. Recognizing the importance of M&A activity in the $100 million to $500 million target equity value range (“middle market” deals), we are commencing a new deal study that identifies “market practice” involving private equity buyer acquisitions of U.S. public companies in the middle market. We also compare our findings for middle market deals to our findings for large market deals. During the period from January 2010 to June 30, 2012, there were a total of 36 middle market deals and 43 large market deals that met our parameters.

Part One

Key Observations: Market Practice and Trends in the Middle Market

  • 1. Activity in the middle market is down year over year. Only 5 deals were signed in 1H 2012 compared to 11 in 1H 2011, a decrease of 55%. Mean equity values of deals in 1H 2012 rose 21% when compared to 1H 2011. The year started with no activity — all of the 1H 2012 deals were signed in the second quarter. (See Chart 1.)


Deciphering Chaos

Editor’s Note: Bart Chilton is a Commissioner at the U.S. Commodity Futures Trading Commission. This post is based on Commissioner Chilton’s remarks before the High-Frequency Trading Leaders Forum in Chicago, IL, available here.

Wayne’s World

How many people here are not from Chicago or the Chicagoland area? It’s great to see you here. For those of you from the area, we all know the city of Aurora—the second largest city in Illinois. Most of you, and I’m sure a lot of others here, recall the movie Wayne’s World based upon the Saturday Night Live sketch? From a location near to us now, in that Aurora basement, long-haired Wayne Campbell and Garth Algar (played by the comedic masters Mike Myers and Dana Carvey) filmed their weekly low budget public-access Cable 10 television show, Wayne’s World. At the beginning and end of their show, and at various points Wayne plays a chord on his Fender Stratocaster and the duo sing, “Wayne’s World, Wayne’s World, party time, excellent.” That’s their “go to” when they get excited or there is a lull in conversation.

Well, there won’t be too many lulls in our conversation today, and I really am very excited to be with you—party time, excellent.

So, game on! Before we talk technology and about those wily high frequency cheetah traders—those fast, fast, fast speed traders out there nearly all of the time trying to scoop up micro dollars in milliseconds, I want to speak about Dodd-Frank.

The Status Gladys

It doesn’t matter if you’re an algo trader, a cheetah, a pit trader, an investor or a consumer—you want to know the rules of the road when it comes to financial reform.

It has been four years since the economy tanked and more than two years since Dodd-Frank became law. There are almost 400 rules to craft under Dodd-Frank. Overall, the regulators working to implement the new law have been slow. Most of the rules were to be completed within a year. That means the law called for almost everything to be completed by July of 2011. Of the 398 regulations that need to be finalized, only 131 are done. That’s a mere 33 percent. We’re not worthy. We’re not worthy.


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