Monthly Archives: July 2013

Corporate Governance in the Shadow of the State

The following post comes to us from Marc Moore, Deputy Director of the University College London Centre for Commercial Law.

Over recent decades, corporate governance has become an increasingly high profile aspect of legal scholarship and practice. But despite this widespread interest, there remains considerable uncertainty about how exactly corporate governance should be defined or understood. Of particular concern is whether corporate governance is most appropriately understood as an aspect of ‘private’ (facilitative) law, or else as a part of ‘public’ (regulatory) law. In my recent book, Corporate Governance in the Shadow of the State (2013, Hart Publishing), I demonstrate that this question is not just an academic one in the pejorative sense. On the contrary, it is arguably the most important issue confronting those who study or teach the subject of corporate governance in any level of depth or analytical rigour.


Delaware Court Allows Challenge to Venture Capital Preferred Financings

Editor’s Note: Allen M. Terrell, Jr. is a director at Richards, Layton & Finger. This post is based on a Richards, Layton & Finger publication, and is part of the Delaware law series, which is co-sponsored by the Forum and Corporation Service Company; links to other posts in the series are available here.

In Carsanaro v. Bloodhound Technologies, Inc., 2013 WL 1104901 (Del. Ch. Mar. 15, 2013), Vice Chancellor Laster of the Court of Chancery denied defendants’ motion to dismiss a complaint alleging breaches of fiduciary duties and statutory violations, among other things, in connection with several rounds of venture capital financings for a start-up healthcare technology company (“Bloodhound” or the “Company”).

In the late 1990s, Bloodhound began developing a web-based software application to monitor healthcare claims for fraud. From 1999 to 2002, the Company issued five series of preferred stock, designated Series A through Series E. Plaintiffs, former common stockholders of Bloodhound, alleged that in the Series D and Series E capital raises, the venture capital firms investing in the Company used their control over the Company’s board of directors to approve financings that unfairly diluted the common stock, undervalued the Company, and improperly benefited the venture capital firms and management. Plaintiffs also challenged a 1-for-10 reverse stock split of the common stock carried out in connection with the Series E refinancing in 2002. In addition to their challenges to transactions in 2001 and 2002, plaintiffs alleged that the board had acted wrongfully in 2011 when it agreed to sell the Company to a third party for $82.5 million, and approved a management incentive plan (“MIP”) that allocated $15 million, or about 19 percent of the merger proceeds, to the Company’s management. Plaintiffs alleged that, as a result of the dilutive financings and the MIP, they received only approximately $36,000 for their common shares in the merger.


Delaware Court Addresses Revlon Duties in Single-Bidder Sale-of-Control Transaction

The following post comes to us from C.N. Franklin Reddick III, partner and co-head of the corporate practice group at Akin Gump Strauss Hauer & Feld LLP. This post is based on an Akin Gump corporate alert, and 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 Court of Chancery recently addressed on two separate occasions—in In re Plains Exploration & Production Co. Stockholder Litigation [1] and Koehler v. NetSpend Holdings, Inc. [2]—whether a board of directors satisfied its Revlon duties in connection with a sale-of-control transaction involving negotiations with a single bidder. In both cases, the court found that the board’s initial decision to pursue a single-bidder process was reasonable. However, while the court in Plains found that the directors satisfied their fiduciary duties under the Revlon standard, the court in NetSpend, found that the directors would likely fail to meet their burden, under Revlon, of proving that they were fully informed and acted reasonably throughout the sale process. Specifically, in NetSpend, the court found that deficiencies in the fairness opinion and the combination of deal protection devices—which included a no-shop provision, a short preclosing period and a “don’t ask, don’t waive” provision that crystallized existing standstill agreements with parties that had previously expressed an interest in the company—did not pass muster under Revlon. These cases provide important lessons for companies considering whether to pursue, and how to conduct, a single-bidder sale-of-control transaction.


Tension in Directors’ Views of Corporate Board Diversity

The following post comes to us from Lissa L. Broome and John M. Conley, Wells Fargo Professor of Banking Law and William Rand Kenan Jr. Professor of Law, respectively, at University of North Carolina School of Law, and Kimberly D. Krawiec, Kathrine Robinson Everett Professor of Law at Duke Law School.

Corporate boards lack significant race and gender diversity. The numbers have improved over the years, but have moved relatively little in the last ten years. The percentage of board seats held by women in Fortune 100 companies increased from 14.9% in 2004 to 15.5% in 2010, while the percentage of board seats held by minorities (including female minorities) increased from 16.9% in 2004 to 18% in 2010. There is a great deal of discussion in the popular press about the lack of board diversity and the need for more diverse boards, with some European countries having mandated board gender diversity quotas. We began this project with these numbers as a backdrop and an interest in two related questions: Why do corporate boards pursue diversity (defined in terms of gender, race, and ethnicity)—even to the limited extent that they do—and what difference might diversity make to how boards work? There has been substantial quantitative research on the second of these questions, and the results can fairly be described as mixed.

Our research has employed a qualitative interview strategy to pursue both questions. We have interviewed fifty-seven people with direct experience with corporate boards, as directors, executives, consultants, regulators, or proxy advisors. Fifty of these serve or have served as directors of publicly traded corporations. Using a method rooted in anthropology and discourse analysis, we have worked from a general topic outline and conducted open-ended interviews in which we encouraged respondents to raise and develop issues of interest to them.


The New York Times on the Shareholder Rights Project

The New York Times published on Sunday an article on the work of the Shareholder Rights Project (SRP). The article, entitled New Momentum for Change in Corporate Board Elections, was written by New York Times columnist Gretchen Morgenson.

Based on a review of the SRP’s results and interviews with the SRP’s clients and the Director of the SRP, the article discusses the benefits produced by the SRP’s work. The article begins with the observation that “shareholder efforts that actually succeed in changing dubious corporate governance policies are so rare that when they happen, it makes you sit up and take notice;” and concludes that “[c]learly, the shareholder project is having a positive effect.” The article expresses the hope that “mutual funds would join this bandwagon or construct their own,” and suggests that “[t]he Shareholder Rights Project is a model they might want to emulate.”

The SRP is a clinical program operating at Harvard Law School. The SRP works on behalf of public pension funds and charitable organizations seeking to improve corporate governance at publicly traded companies, as well as on research and policy projects related to corporate governance.

The New York Times article stresses that the work of the SRP and its clients during the 2012 and 2013 proxy seasons has produced a large number of board declassifications at large publicly traded firms, moving these companies to annual elections for directors. The article further notes that “[a] far better approach for holding directors accountable, according to a significant body of academic research, is to make them stand for election annually.”


The Unintended Consequences of Say on Pay Votes

Editor’s Note: Ira Kay is a Managing Partner at Pay Governance LLC. This post is based on a Pay Governance memorandum by Mr. Kay and John Sinkular.

The confluence of Say on Pay (SOP) votes and heightened scrutiny plus the influence of proxy advisory firms (particularly ISS) are having a major unintended consequence—the movement to “one-size-fits-all” or homogenization of executive compensation programs. It is true that SOP votes have encouraged some valid governance enhancements, for example, significantly more shareholder outreach by many large companies. However, in order to minimize the potential for a negative SOP vote outcome, many companies are changing their pay practices based more on potential external views than business/talent needs. This is particularly apparent in the design of performance share plans with the increasing use of relative TSR (at nearly 50% prevalence). Below we summarize other areas of the executive compensation program that are exhibiting homogenization, the resulting risks and potential steps companies can take to preserve/maximize the linkage to a company’s business strategy and talent needs.


Evidence of CEO Adaptability to Industry Shocks

The following post comes to us from Wayne Guay, Daniel Taylor, and Jason Xiao, all of the Department of Accounting at the University of Pennsylvania.

Prior turnover literature documents various signals of poor performance, such as stock returns and earnings, that lead a board of directors to terminate the CEO, but does not explore the underlying causes of the CEO’s poor performance. In many cases, terminated CEOs have been successful earlier in their tenure as CEO. At some point, however, the board decides that the existing CEO’s skills do not fit with the current leadership needs of the firm, and so switches to a new CEO. The question of why these previously successful CEOs are released (apart from retirements or voluntary departures) remains largely unanswered.

In our paper, Adapt or Perish: Evidence of CEO Adaptability to Strategic Industry Shocks, which was recently made publicly available on SSRN, we conjecture that a previously successful CEO may not be able to adapt when the firms within her industry change their business strategy, or more precisely, that strategic shocks within the industry increase the probability that the CEO will suffer from an adaptability problem. If strategic industry shocks alter a firm’s leadership needs, and the board perceives the CEO cannot adapt their skills to fit those needs, then the CEO is more likely to be terminated. For example, assume a CEO has a set of skills that leads them to prefer to conduct manufacturing activities domestically. When faced with competitive forces that dictate a different strategy, some CEOs may be able to adapt successfully to manage foreign manufacturing operations. Other CEOs, however, may have difficulty adjusting their skills to fit the current strategic needs of the firm. If this is the case, the latter type of CEO will face a higher probability of being terminated when the firm’s industry competitors change their strategies. We note that it is certainly the case that all CEOs can adapt to some degree to changing business conditions. The interesting question then, is whether one can identify the types of shocks, if any, that cause CEO adaptability problems.


Determinants of Corporate Cash Policy

The following post comes to us from Huasheng Gao of the Division of Banking and Finance at Nanyang Business School; Jarrad Harford, Professor of Finance at the University of Washington; and Kai Li, Professor of Finance at the University of British Columbia.

In our paper, Determinants of Corporate Cash Policy: Insights from Private Firms, forthcoming in the Journal of Financial Economics, we exploit a database of private firms to help understand public firms’ cash policies. It is worth noting that the cash policy of private firms in itself is of great interest to financial economists due to a lack of data prior to our study. Further, the contrast between public and private firm behavior in cash management serves as cross-validation of prior research on cash policies using only public firms. We expect that the variation in agency conflicts across these two groups of firms is likely to be at least as substantial as the variation within public firms. Further, differences across these two groups of firms in financing frictions allow us to explore the relative importance of these two effects on cash levels, the speed of adjustment to target cash, and the dissipation of excess cash.


Delaware Court Ruling Raises Questions About Informal NYSE Interpretations

The following post comes to us from Robert Buckholz, partner and co-coordinator of the Corporate and Finance Group at Sullivan & Cromwell LLP. This post is based on a Sullivan & Cromwell publication, and 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.

Louisiana Municipal Police Employees Retirement System v. Bergstein [1] concerns a $120 million equity grant to the Chief Executive Officer of Simon Property Group, Inc. (“SPG”) and a related amendment to SPG’s stock incentive plan that was required to make the grant. The shareholder plaintiff alleges that the board of directors’ amendment of the plan was a breach of fiduciary duty because the plan mandated shareholder approval of amendments where required by law, regulation or applicable stock exchange rules. The defendants moved to dismiss, noting that SPG had received email confirmation from New York Stock Exchange staff that shareholder approval of the amendment was not required under NYSE rules. Ruling from the bench, Chancellor Leo E. Strine, Jr. denied SPG’s motion to dismiss, citing concerns that a staff email did not serve as a definitive interpretation of NYSE rules – particularly where, in Chancellor Stine’s view, the email to the NYSE did not adequately describe the broader circumstances.

The process SPG used is the customary one by which listed companies receive interpretations from the NYSE staff on governance matters, and Chancellor Strine’s ruling is at an early stage of the case. However, until there is more definitive guidance as to the weight that courts will give NYSE staff interpretations, listed companies should bear in mind the Chancery Court’s ruling when evaluating the weight that a court will give an NYSE email interpretation on a governance matter, particularly when evaluating whether a proposed change to an equity compensation plan would require shareholder


Piercing the Corporate Veil

Editor’s Note: The following post comes to us from Michael Hutchinson, partner at Mayer Brown LLP, and is based on a legal update by Mr. Hutchinson and Martin Mankabady.

The Supreme Court’s decision in the case of Petrodel v Prest, handed down June 12, 2013, marks a crucial shift in the extent to which the courts will allow the “piercing of the corporate veil”. Although the case revolved around a matrimonial dispute, it has profound implications for corporate governance.

The Facts

In October 2011, the High Court ruled that Mrs Prest (“W”) was entitled to a divorce settlement of £17.5 million from Mr Prest (“H”), a wealthy oil trader. Since H failed to comply with court orders by failing to give full and frank disclosure of his finances during proceedings, his appeal was dismissed at a preliminary stage. The award therefore stood regardless of later court decisions concerning enforcement.

In terms of enforcement of the award, Moylan J ordered that properties in London and overseas, owned by Petrodel Resources and two other companies (collectively “X”) were assets of H and formed part of the divorce settlement since they were beneficially owned by H as the sole shareholder. Whilst Moylan J found there had been no impropriety in relation to X, so as to permit the corporate veil to be pierced, he nevertheless held that H, exercising complete control over X both in terms of their operation and management, was ‘entitled’ to the relevant properties within the meaning of s24(1)(a) Matrimonial Causes Act 1973 (“MCA”), despite not personally owning the assets.

X appealed to the Court of Appeal, submitting that in order for company assets to become subject to s24(1)(a) MCA, the corporate veil would have to be pierced and this only occurred in exceptional circumstances, this not being one of them.


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