Monthly Archives: May 2013

How Do Investors Interpret Announcements of Earnings Delays?

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Monday, May 13, 2013
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The following post comes to us from Tiago Duarte-Silva of Charles River Associates, Huijing Fu of the Shanghai Advanced Institute of Finance, Christopher Noe of MIT Sloan School of Management, and K. Ramesh, Professor of Accounting at Rice University.

Companies that fail to file a 10-K or 10-Q on time are required by SEC Rule 12b-25 to file a Form NT (NT for non-timely), which provides a narrative explanation for the late filing. No analogous rule exists for earnings announcements, which often precede 10-K or 10-Q filings. For companies that are unable to report earnings by their expected date, therefore, managers face a decision – to keep silent or announce the delay. The SEC has also manifested interest in earnings delays: it recently announced a quantitative model that is expected to supply potential leads to its Division of Enforcement and lists earnings delays as a signal of earnings management.

In our paper, How Do Investors Interpret Announcements of Earnings Delays?, which was recently accepted for publication in the Journal of Applied Corporate Finance, we show that announcements of a delay in the reporting of earnings produce an average one-day abnormal stock return of approximately -6%. So, although announcements of a delay in the reporting of earnings are infrequent, they tend to be associated with a considerable reduction in firm value. In addition, delays precipitated by accounting issues or lacking an explanation result in more negative market reactions than delays related to business events, implementation of new accounting standards, or non-business reasons such as bad weather.

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European Compensation Developments: Financial Institutions and Beyond

Posted by Kobi Kastiel, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Sunday, May 12, 2013
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The following post comes to us from Simon Witty and Kyoko Takahashi Lin, both partners in the corporate department at Davis Polk & Wardwell LLP, and is based on a Davis Polk client memorandum.

Almost half a decade after the onset of the financial crisis, populist sentiment and the resulting political environment continue to fuel stricter regulation of executive and director compensation, with the latest wave in Europe including substantive restrictions on compensation in the financial services industry and “say-on-pay” initiatives (i.e., initiatives providing for shareholder approval of compensation). This post describes these recent European compensation developments, namely:

  • The so-called “banker bonus cap” – substantive limits on the amount of variable compensation that can be paid to certain employees at financial institutions; and
  • Say-on-pay developments in the E.U. and Switzerland.

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SEC Announces First Non-Prosecution Agreement in an FCPA Matter

Posted by Noam Noked, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Saturday, May 11, 2013
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The following post comes to us from Colleen P. Mahoney, partner and head of the Securities Enforcement and Compliance practice at Skadden, Arps, Slate, Meagher & Flom, and is based on a Skadden Arps client alert by Ms. Mahoney, Charles F. Walker, and Erich T. Schwartz.

On April 22, the U.S. Securities and Exchange Commission (SEC) announced its first non-prosecution agreement (NPA) with a company in a matter involving alleged violations of the U.S. Foreign Corrupt Practices Act (FCPA). [1] The SEC entered into the agreement with Ralph Lauren Corporation (Lauren), resolving allegations that Lauren violated the FCPA when its Argentine subsidiary allegedly paid bribes to government and customs officials to improperly secure the importation of Lauren’s products into Argentina. The NPA in this case resulted from Lauren’s prompt self-reporting and extensive cooperation. Prior to the Lauren NPA, the SEC seemed to provide limited credit to public companies for cooperation in FCPA investigations.
Time will tell whether the Lauren NPA is a harbinger of a new approach.

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Bylaw Protection against Dissident Director Conflict/Enrichment Schemes

Posted by Martin Lipton, Wachtell, Lipton, Rosen & Katz, on
Friday, May 10, 2013
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Martin Lipton is a founding partner of Wachtell, Lipton, Rosen & Katz, specializing in mergers and acquisitions and matters affecting corporate policy and strategy. This post is based on a Wachtell Lipton memorandum by Mr. Lipton, Theodore N. Mirvis, Andrew R. Brownstein, and Steven A. Rosenblum.

This year, the practice of activist hedge funds engaged in proxy contests offering special compensation schemes to their dissident director nominees has increased and become even more egregious. While the terms of these schemes vary, the general thrust is that, if elected, the dissident directors would receive large payments, in some cases in the millions of dollars, if the activist’s desired goals are met within the specified near-term deadlines.

These special compensation arrangements pose a number of threats, including:

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Regulation in a Global Financial System

Posted by Mary Jo White, Chair, U.S. Securities and Exchange Commission, on
Friday, May 10, 2013
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Mary Jo White is Chair of the U.S. Securities and Exchange Commission. This post is based on Chair White’s remarks at the Investment Company Institute (ICI) General Membership Meeting, which are available here. The views expressed in this post are those of Chair White and do not necessarily reflect those of the Securities and Exchange Commission, the other Commissioners, or the Staff.

It should rapidly become clear that my remarks belong only to me because I will be talking about the role of the SEC in an increasingly global financial and regulatory system from the viewpoint of a Chair on Day 18 of her tenure. Already, I find myself emphasizing to some outside the agency that the international aspect of the SEC’s role is not a distraction from our important core domestic duties. Rather, that role must be understood in order to fully appreciate the agency’s whole mission – to protect investors, maintain fair, orderly and efficient markets, and facilitate capital formation.

And it’s how we’re furthering that mission through our international efforts that I will speak about today.

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Passive Investors, Not Passive Owners

Posted by Noam Noked, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Friday, May 10, 2013
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The following post comes to us from Glenn Booraem, Principal and Fund Controller at Vanguard Fund Financial Services, and is based on a Vanguard publication by Mr. Booraem.

About a year ago we restated Vanguard’s mission to read: “To take a stand for all investors, treat them fairly, and give them the best chance for investment success.” While the words were new, the ideals were not; they’ve been the consistent principles by which we’ve managed our enterprise since our founding.

As we stand on the cusp of “proxy season”—when investors in most U.S. companies will vote at shareholder meetings on matters including the election of directors and the approval of compensation plans—it strikes me that nothing better exemplifies our mission in action than our efforts to ensure that the companies in which our funds invest are subject to the highest standards of corporate governance.

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Do Investors Understand ‘Operational Engineering’ before Management Buyouts?

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Friday, May 10, 2013
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The following post comes to us from Xi Li of the Department of Accounting at Hong Kong University of Science and Technology, Jun Qian of the Department of Finance at Boston College, and Julie Lei Zhu of the School of Management at Boston University.

In our paper, Do Investors Understand ‘Operational Engineering’ before Management Buyouts?, which was recently made publicly available on SSRN, we use a sample of management buyouts (MBOs) from 1985-2005 and a matched subsample of post-MBO firms to examine three questions. First, we examine whether firms undertake different types of activities to lower earnings before MBOs. Second, to see whether outside investors and the market understand such ‘operational engineering’ activities, we study the impact of these activities on target firms’ stock returns and MBO deal characteristics including deal premium and likelihood of deal completion. Third, we examine the relation between pre-MBO earnings-reducing activities and the post-MBO operating performance.

With the Great Recession of 2007-2009 exposing deficiencies of the world’s most advanced financial markets, leveraged buyouts (LBOs) have ‘reemerged’ as a solution to the many challenges facing corporate sectors. Unlike publicly listed firms, LBO firms are characterized by concentrated ownership, active monitoring and high leverage. A growing strand of literature shows that LBO firms can create value through ‘financial, operational and governance engineering’ (Kaplan and Stromberg, 2009). In fact, Jensen (1989) argues that LBOs should replace publicly held corporations as the dominant corporate organizational form.

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Exchange Rules on Independence of Compensation Committee Members

Posted by Joseph E. Bachelder III, McCarter & English, LLP, on
Thursday, May 9, 2013
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Joseph Bachelder is special counsel in the Tax, Employee Benefits & Private Clients practice group at McCarter & English, LLP. This post is based on an article by Mr. Bachelder, which first appeared in the New York Law Journal.

Today’s column focuses on new rules of the New York Stock Exchange (NYSE) and the NASDAQ Stock Market (NASDAQ) concerning independence requirements for directors who are members of compensation committees. The new rules must be complied with by listed companies by the earlier of the first annual meeting of shareholders after Jan. 15, 2014, or Oct. 31, 2014. [1]

NYSE Section

NYSE Listed Company Manual Section 303A.02(a)(ii) contains the following requirements regarding compensation committee member independence (references to an NYSE Listed Company Manual Section hereinafter will be referred to as NYSE Section):

[I]n affirmatively determining the independence of any director who will serve on the compensation committee of the listed company’s board of directors, the board of directors must consider all factors specifically relevant to determining whether a director has a relationship to the listed company which is material to that director’s ability to be independent from management in connection with the duties of a compensation committee member, including, but not limited to:

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The Need for Robust SEC Oversight of SROs

Posted by Luis A. Aguilar, Commissioner, U.S. Securities and Exchange Commission, on
Thursday, May 9, 2013
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Luis A. Aguilar is a Commissioner at the U.S. Securities and Exchange Commission. This post is based on a statement by Commissioner Aguilar; the full text, 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.

The staff of the U.S. Securities and Exchange Commission (“Commission” or “SEC”) is planning to hold an SRO Outreach Conference (the “Conference”) this month. In anticipation of the Conference, I would like to address the challenges faced by self-regulatory organizations (“SROs”) as a result of the significant changes that the securities markets have undergone in the last decade, and the need for robust Commission oversight of SRO activities to enhance investor protection, maintain fair, orderly, and efficient markets, and facilitate capital formation.

The roles of SROs have a long tradition in our securities markets. As a practitioner in the securities industry for over 30 years, I’ve interacted with SROs as a member of the private sector as well as a Commissioner. I fully appreciate their role in the regulation of our marketplace by setting standards, conducting examinations, and enforcing rules among their members.

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Short-Termism of Institutional Investors and the Double Agency Problem

Posted by June Rhee, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Thursday, May 9, 2013
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The following post comes to us from Paul Frentrop and Daniëlle Melis, a Professor and an Associate Professor, respectively, at Nyenrode Business Universiteit. The following post is based on an inaugural lecture by Professor Frentrop.

Complaints that investors only look for short-term gains are nothing new. As early as 1990 an Economist article proclaimed: “The old bugbear of businessmen — that fund managers are too obsessed with the short term, and unwilling to buy shares in companies with ambitious research projects — is back on the prowl.”

Recently, the turnover of shares in listed companies has grown to numbers far exceeding those of 1990. Does this change in investor behavior influence the behavior of managers in listed firms?

The institutional innovation of freely tradable shares, traceable to Holland in the 17th century, made it possible for companies such as the Dutch East India Company to have longer investment horizons than individual investors. Listing shares ensured that an investor could recoup his money from other investors and that, as a result, companies didn’t have to repay individual investors. Seen in this light, one might assume that investor short-termism would have little influence on board decisions at listed companies and much more influence on board decisions at privately held companies. General opinion, however, disagrees.

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