Monthly Archives: June 2013

Innovation, Reallocation, and Growth

The following post comes to us from Daron Acemoglu, Professor of Economics at MIT; Ufuk Akcigit of the Department of Economics at the University of Pennsylvania; Nicholas Bloom, Professor of Economics at Stanford University; and William Kerr of the Entrepreneurial Management Unit at Harvard Business School.

In our paper, Innovation, Reallocation, and Growth, which was recently made publicly available on SSRN, we build a micro-founded model of firm innovation and growth, enabling us an examination of the forces jointly driving innovation, productivity growth and reallocation. In the second part of our paper, we estimate the parameters of the model using simulated method of moments on detailed U.S. Census Bureau micro data on employment, output, R&D, and patenting during the 1987-1997 period.

Our model builds on the endogenous technological change literature. Incumbents and entrants invest in R&D in order to improve over (one of) a continuum of products. Successful innovation adds to the number of product lines in which the firm has the best-practice technology (and “creatively” destroys the lead of another firm in this product line). Incumbents also increase their productivity for non-R&D related reasons (i.e., without investing in R&D). Because operating a product line entails a fixed cost, firms may also decide to exit some of the product lines in which they have the best-practice technology if this technology has sufficiently low productivity relative to the equilibrium wage. Finally, firms have heterogeneous (high and low) types affecting their innovative capacity—their productivity in innovation. This heterogeneity introduces a selection effect as the composition of firms is endogenous, which will be both important in our estimation and central for understanding the implications of different policies. We assume that firm type changes over time and that low-type is an absorbing state (i.e., high-type firms can transition to low-type but not vice versa), which is important for accommodating the possibility of firms that have grown large over time but are no longer innovative.

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CEO-Board Chair Separation: If It Ain’t Broke, Don’t Fix It

The following post comes to us from Matthew Semadeni, Associate Professor of Strategy at Indiana University. This post relates to an issue of The Conference Board’s Director Notes series authored by Mr. Semadeni and Ryan Krause; the full publication, including footnotes, is available here.

One of the most contentious corporate governance issues for boards of directors is board leadership, and specifically whether sitting CEOs should also serve as board chairs. This report examines three types of CEO-board chair separation and their consequences on company performance.

To date, research on CEO-chair separation has yielded only one overarching conclusion: a CEO who also serves as board chair is no better or worse for company performance than an independent director serving as board chair. Nevertheless, many in the corporate governance field advocate for separation of the CEO and board chair roles. Here, we examine three possible types of CEO-board chair separation and their performance consequences. Our results suggest that if a company chooses to separate the CEO and board chair positions, particularly by demoting the CEO, the reason for the separation should extend beyond the conventional wisdom that doing so is “best practice.”

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Responding to Objections to Shining Light on Corporate Political Spending (7): Claims About the Costs of Disclosure

Lucian Bebchuk is Professor of Law, Economics, and Finance at Harvard Law School. Robert J. Jackson, Jr. is Associate Professor of Law, Milton Handler Fellow, and Co-Director of the Millstein Center at Columbia Law School. Bebchuk and Jackson served as co-chairs of the Committee on Disclosure of Corporate Political Spending, which filed a rulemaking petition requesting that the SEC require public companies to disclose their political spending, discussed on the Forum here. Bebchuk and Jackson are also co-authors of Shining Light on Corporate Political Spending, published in the April issue of the Georgetown Law Journal. This post is the seventh in a series of posts, based on the Shining Light article, in which Bebchuk and Jackson respond to objections to an SEC rule requiring disclosure of corporate political spending; the full series of posts is available here.

The Securities and Exchange Commission is currently considering a rulemaking petition urging the Commission to develop rules requiring public companies to disclose their political spending. In our first six posts in this series (collected here), we examined six objections raised by opponents of such rules and explained why these objections provide no basis for opposing rules requiring public companies to disclose their spending on politics. In this post, we consider a seventh objection: the claim that disclosure rules in this area would impose substantial costs on public companies—and that the SEC lacks the authority to develop such rules because these costs would exceed any benefits that the rules would confer upon investors.

Several opponents of the petition have argued that the SEC may not require public companies to disclose their spending on politics because the costs of such rules would exceed their benefits. For example, the American Petroleum Institute and the U.S. Chamber of Commerce, which are both significant intermediaries through which undisclosed corporate political spending is currently channeled, recently argued in letters to the SEC that the “Commission could not rationally find that the benefits of such a rule” “could outweigh the huge costs.” There is currently considerable debate over the precise weight that cost-benefit analysis should be given in the SEC rulemaking process generally. Whatever position one takes on that general issue, however, cost-benefit analysis does not preclude the SEC from adopting rules requiring public companies to disclose their spending on politics.

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Is Your Board Governing Itself Effectively?

The following post comes to us from Maureen Errity, Director, Center for Corporate Governance at Deloitte LLP, and is based on an article featured in a Center for Corporate Governance newsletter.

Never before has the role of board members been so important to organizations and investors. With many boards stretched beyond capacity trying to meet stakeholder needs and compliance requirements, board members must provide strategic leadership, stewardship, and governance.

Effective governance requires a proactive, focused state of mind on the part of directors, the CEO, and management, all of whom must be committed to business success through maintenance of the highest standards of responsibility and ethics. Recent studies, such as the 2012 Board Practices Report: Providing Insight into the Shape of Things to Come (previously discussed here), a publication from the Deloitte Center for Corporate Governance and the Society of Corporate Secretaries and Governance Professionals, suggest that there has been progress in revamping governance practices and establishing board infrastructure, effectiveness, and engagement.

The Deloitte Governance Framework, as outlined in Framing the Future of Corporate Governance: Deloitte Governance Framework, helps organizations form the basis for the tools that help boards and executives quickly identify potential opportunities to improve both effectiveness and efficiency and provide an end-to-end view of corporate governance. Within the framework, the board can develop a set of key objectives for each of the six elements (see Figure 1).

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Trading Plan Storm Clouds Move to the Boardroom

The following post comes to us from William H. Hinman, Jr. and Daniel N. Webb, partners in the Corporate Department at Simpson Thacher & Bartlett LLP. This post is based on a Simpson Thacher memorandum by Mr. Hinman and Mr. Webb.

The revived scrutiny of Rule 10b5-1 trading plans that began late last year has now expanded to the trading activities of corporate board members and affiliated large investors. Some recent press coverage has asserted that directors’ and investors’ use of 10b5-1 trading plans is “exotic” or beyond the intended scope of the rule—despite the fact that Rule 10b5-1 does not limit its use to corporate executives. Indeed, Rule 10b5-1 has consistently been used by directors and institutional investors since its adoption over a decade ago.

Nevertheless, with regulators and prosecutors continuing to take interest, corporate directors, investment funds and other insiders should consider best practices, such as those discussed below and previously here, in order to reduce the risk that scrutiny will result in liability or reputational damage.

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SEC Unanimously Votes to Propose Money Market Funds Reforms

The following post comes to us from Frederick Wertheim, partner focusing on investment management and broker-dealer regulation at Sullivan & Cromwell LLP, and is based on a Sullivan & Cromwell publication.

On June 5, 2013, the SEC voted unanimously to propose alternatives for amending rules that govern money market mutual funds under the Investment Company Act of 1940. Two alternative reforms to rule 2a-7 under the Investment Company Act of 1940 could be adopted separately or combined into a single reform package:

  • Alternative One: Floating Net Asset Value (“NAV”): The proposal would require all institutional prime money market funds to sell and redeem shares based on the current market value of the fund’s portfolio securities, rounded to the fourth decimal place, rather than at a $1.00 stable share price. Retail and government money market funds would be exempt from the floating net asset value requirement and would be allowed to continue using the penny-rounding method of pricing to maintain a stable share price but would not be allowed to use the amortized cost method to value securities.
  • Alternative Two: Liquidity Fees and Redemption Gates: Money market funds, other than government money market funds, would be required to impose a 2% liquidity fee if the fund’s level of weekly liquid assets fell below 15% of its total assets, unless the fund’s board of directors (a “Board”) determined that it was not in the best interest of the fund or that a lesser liquidity fee was in the best interests of the fund. After a fund has fallen below the 15% weekly liquid assets threshold, the Board would also be able to temporarily suspend redemptions in the fund for no more than 30 days in any 90-day period.

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Custom (Go-)Shopping

Daniel Wolf is a partner at Kirkland & Ellis focusing on mergers and acquisitions. The following post is based on a Kirkland memorandum by Mr. Wolf, David B. Feirstein, Sarkis Jebejian, and Joshua M. Zachariah. 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.

The Delaware courts have often repeated the bedrock principle that there is no one path or blueprint for the board of a target company to fulfill its Revlon duties of seeking the highest value reasonably available in a sale transaction. The courts have usually deferred to the judgment of the directors as to whether the requisite market-check is best achieved by a limited pre-signing process, a full-blown pre-signing auction or a post-signing fiduciary out. However, as evidenced in the recent decision by VC Glasscock in NetSpend, it is equally true that the courts will also not automatically bless a sale process simply because the deal protection provisions fall with- in the range of “market” terms. Especially in a single-bidder sale process, the courts will continue to seek evidence of a fully informed and thoughtful approach by the target board to the sale process and deal protection terms with the goal of maximizing value for shareholders.

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Impact Investment: Sovereign Wealth Funds, Corporate Governance and Stock Markets

The following post comes to us from Dimitrij Euler, a Visiting Scholar at the Lauterpacht Centre for International Law at the University of Cambridge.

In the light of the ever-dwindling resources that will be addressed by our future generation, impact investors invest in accordance with ethical and environmental principles, going beyond financial performance. In particular, Sovereign Wealth Funds invest in assets worldwide in accordance with ethical and environmental principles and significantly influence the investment sphere and how enterprises are managed. In the last decades, corporate governance and stock market rules require information beyond financial performance and have changed the information requirement of how listed enterprises have to inform. Although this had an impact towards a more transparent market, the law has to establish obligations broadly reflecting the needs of impact investors and thereby taking the chance of contributing more significantly to development. The SSRN Working Paper “Impact Investment: Sovereign Wealth Funds, Corporate Governance and Stock Markets” recalls that some soft law standards of the OECD favour disclosure and some Stock Market rules require disclosure of information that help an impact investor to justify the investment.

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Reporting, Accounting, and Auditing in Financial Markets

Elisse B. Walter is a Commissioner at the U.S. Securities and Exchange Commission and was the Chairman of the SEC from December 2012 to April 2013. This post is based on Commissioner Walter’s recent remarks at the SEC and Financial Reporting Institute Conference, available here. The views expressed in this post are those of Commissioner Walter and do not necessarily reflect those of the Securities and Exchange Commission, the other Commissioners, or the Staff.

You may not hear this too often from people outside your profession, but I have always had a passion for accounting and auditing. I think this has its roots in the time I spent with my father, who was a CPA and the CFO of a publicly-held company; he helped me begin to understand just how important accounting is to business and the financial system. Of course, in my more than two decades with the SEC, which included close to a decade in the Division of Corporation Finance, I have developed a deeper and more complete understanding of the critical role accounting and auditing professionals play in our capital markets.

And today, I am pleased to see that we are working to adapt and expand that role to serve investors and other stakeholders even more effectively in the years ahead, by addressing critical issues at a moment of great change and important progress in the worlds of finance and accounting.

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Corporate Governance, Incentives, and Tax Avoidance

The following post comes to us from Christopher Armstrong and Jennifer Blouin, both of the Department of Accounting at the University of Pennsylvania; Alan Jagolinzer of the Division of Accounting at the University of Colorado; and David Larcker, Professor of Accounting at Stanford University.

There has been a recent surge in research that seeks to understand the sources of variation in tax avoidance (e.g., Shevlin and Shackelford, 2001; Shevlin, 2007; Hanlon and Heitzman, 2010). The benefits of tax avoidance can be economically large (e.g., Scholes et al., 2009) and tax avoidance can be a relatively inexpensive source of financing (e.g., Armstrong et al., 2012). However, aggressive tax avoidance may be accompanied by substantial observable (e.g., fines and legal fees) and unobservable (e.g., excess risk and loss of corporate reputation) costs. Although understanding the factors that influence managers’ tax avoidance decisions is an important research question that has broad public policy implications, relatively little is known about why some firms appear to be more tax aggressive than others.

In our paper, Corporate Governance, Incentives, and Tax Avoidance, which was recently made publicly available on SSRN, we examine whether variation in firms’ corporate governance mechanisms explains differences in their level of tax avoidance. We view tax avoidance as one of many investment opportunities that is available to managers. Similar to other investment decisions, managers have personal incentives to engage in a certain amount of tax avoidance that may not be in the best interest of shareholders, thereby giving rise to an agency problem. From the perspective of the firm’s shareholders, unresolved agency problems with respect to tax avoidance can manifest as either “too little” or “too much” tax avoidance. As with other agency problems, certain corporate governance mechanisms can mitigate agency problems with respect to tax avoidance.

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