Monthly Archives: November 2013

Exclusive Forum Provisions: Is Now the Time to Act?

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 by Mr. Sandler, Arthur F. Golden, and William M. Kelly. 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.

Exclusive forum provisions in corporate bylaws and certificates of incorporation are back on the agenda for many companies. We reviewed the trend data in a June 2012 briefing and predicted that few companies would adopt exclusive forum provisions until there was guidance from then-pending litigation in the Delaware Court of Chancery. That guidance came this past June in the form of Chancellor Strine’s decision upholding the validity of board-adopted exclusive forum bylaw provisions at Chevron and FedEx. Most recently the plaintiffs in that litigation dropped their appeal, so for now Chancellor Strine’s decision stands in support of the proposition that, unsurprisingly, Delaware views the selection of a Delaware forum as at least facially valid.

In the wake of these developments the adoption of exclusive forum provisions has resumed, and by our count there are now about 120 companies, largely but not exclusively Delaware corporations, that have gotten on board since the Chevron decision. While these are still small numbers in the context of several thousand U.S. public companies, we expect the number to continue to grow in the coming months.

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CEO Compensation and Corporate Risk

The following post comes to us from Todd Gormley of the Department of Finance at the University of Pennsylvania, David Matsa of the Department of Finance at Northwestern University, and Todd Milbourn, Professor of Finance at Washington University in St. Louis.

Every firm is exposed to business risks, including the possibilities of large, adverse shocks to cash flows. Potential sources for such shocks abound—examples include disruptive product innovations, the relaxation of international trade barriers, and changes in government regulations. In our paper, CEO Compensation and Corporate Risk: Evidence from a Natural Experiment, forthcoming in the Journal of Accounting and Economics, we examine (1) how boards adjust CEOs’ exposure to their firms’ risk after the risk of such shocks increase and (2) how incentives given by the CEOs’ pre-existing portfolios of stock and options affect their firms’ response to this risk. Specifically, we study what happens when a firm learns that it is exposing workers to carcinogens, which increase the risks of significant corporate legal liability and costly workplace regulations.

The results presented in this paper suggest that corporate boards respond quickly to changes in their firms’ business risk by adjusting the structure of CEOs’ compensation, but that the changes only slowly impact the overall portfolio incentives CEOs face. After the unexpected increase in left-tail risk, corporate boards reduce CEOs exposure to their firms’ risk; the sensitivities of the flow of managers’ annual compensation to stock price movements and to return volatility decrease. Various factors likely contribute to the board’s decision, including CEOs’ reduced willingness to accept a large exposure to their firms’ risk and the decline in shareholders’ desired investment after left-tail risk increases. Indeed, managers act to further reduce their exposure to the firm’s risk by exercising more options than do managers of unexposed firms. These changes, however, only slowly move CEOs’ overall exposure to their firm’s risk because the magnitude of their pre-existing portfolios continues to influence their financial exposure to the firm.

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Predicting Future Merger Activity

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.

The October 29, 2013 New York Times Deal Book article, “Frenzy of Deals, Once Expected, Seems to Fizzle,” has resulted in a number of requests for me to discuss merger activity and predict the level of future merger activity. In the course of a long career of advising on mergers, I’ve identified many of the factors that determine merger activity, but a complete catalog is beyond me and I am not able to predict even near-term levels of merger activity. Since the 1980s, I’ve written and lectured extensively on this and the history of merger waves, and I regularly revise an outline of the factors that I believe are the most significant that influence mergers. This is a condensed version of the outline:

First, it is recognized that mergers are an integral part of market capitalism, including the types that are practiced in Brazil, China, India and Russia. Mergers are an element in the Schumpeterian theory of creation and destruction of companies that characterizes market capitalism.

Second, the autogenous factors, not in the order of importance, are relatively few and straight forward:

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The Real Costs of Disclosure

The following post comes to us from Alex Edmans, Professor of Finance at the London Business School; Mirko Heinle of the Department of Accounting at the University of Pennsylvania; and Chong Huang of the UC Irvine Paul Merage School of Business.

In our paper, The Real Costs of Disclosure, which was recently made publicly available on SSRN, we analyze the effect of a firm’s disclosure policy on real investment. An extensive literature highlights numerous benefits of disclosure. Diamond (1985) shows that disclosing information reduces the need for each individual shareholder to bear the cost of gathering it. In Diamond and Verrecchia (1991), disclosure reduces the cost of capital by lowering the information asymmetry that shareholders suffer if they subsequently need to sell due to a liquidity shock. Kanodia (1980) and Fishman and Hagerty (1989) show that disclosure increases price efficiency and thus the manager’s investment incentives.

However, the costs of disclosure have been more difficult to pin down. Standard models (e.g. Verrecchia (1983)) typically assume an exogenous cost of disclosure, justified by several motivations. First, the actual act of communicating information may be costly. While such costs were likely significant at the time of writing, when information had to be mailed to shareholders, nowadays these costs are likely much smaller due to electronic communication. Second, there may be costs of producing information. However, firms already produce copious information for internal or tax purposes. Third, the information may be proprietary (i.e., business sensitive) and disclosing it will benefit competitors (e.g., Verrecchia (1983) and Dye (1986)). However, while likely important for some types of disclosure (e.g., the stage of a patent application), proprietary considerations are unlikely to be for others (e.g., earnings). Perhaps motivated by the view that, nowadays, the costs of disclosure are small relative to the benefits, recent government policies have increased disclosure requirements, such as Sarbanes-Oxley, Regulation FD, and Dodd-Frank.

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Court Holds Merger Price Is Reliable Indicator of Fair Value

William Savitt is a partner in the Litigation Department of Wachtell, Lipton, Rosen & Katz. This post is based on a Wachtell Lipton firm memorandum by Mr. Savitt and David E. Shapiro. 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.

In a thoughtful and well-reasoned decision, the Delaware Court of Chancery held last week that the merger price produced by a “throrough, effective” sales process, “free from any spectre of self-interest or disloyalty,” can be the most reliable indicator of the value of shares in an appraisal proceeding. Huff Fund Investment Partnership v. CKx, Inc., No. 6844-VCG (Del. Ch. Nov 1, 2013).

CKx was a publicly traded corporation with interests in iconic entertainment properties, including the American Idol television show, Elvis Presley Enterprises, and Muhammad Ali Enterprises. In 2011, following an attempted go-private transaction and faced with uncertainty related to the network renewal of American Idol, CKx received several unsolicited bids to purchase the Company for cash. The CKx board retained an independent financial advisor and conducted an expedited process to explore a sale of the Company. Interested bidders were given three weeks to conduct diligence and negotiate a transaction. The Company ultimately received an offer of $5.50 per share from Apollo and an offer of $5.60 from a competing private equity firm. The $5.60 bid, while nominally higher, was not supported by financing commitments and the bidder refused to provide documentation that would have allowed CKx to verify its representations as to financing. In light of the uncertainty surrounding the $5.60 bid, CKx accepted the offer from Apollo notwithstanding its nominally lower purchase price.

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Delaware Court Addresses Post-Merger Breach of Fiduciary Duty Claims

The following post comes to us from Robert B. Schumer, chair of the Corporate Department at Paul, Weiss, Rifkind, Wharton & Garrison LLP, and is based on a Paul Weiss client memorandum. 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.

In In re Bioclinica, Inc. Shareholder Litigation, the Delaware Court of Chancery (VC Glasscock) dismissed a stockholder suit alleging that the members of a board of directors breached their fiduciary duty of loyalty in a sale process for a transaction that had since closed, and where plaintiffs’ allegations previously had been found insufficient to support a pre-closing motion to expedite. Under those circumstances, the court found the chances of those same allegations surviving a post-closing motion to dismiss to be “vanishingly small.” Moreover, the court reaffirmed that reasonable deal protections, such as no-solicitation provisions, termination fees, information rights, top-up options, and stockholder rights plans, in the context of an otherwise reasonable sales process, are not preclusive and do not, in and of themselves, demonstrate a breach of the duty of care or loyalty. Finally, the court dismissed claims against the acquirer that it aided and abetted the directors’ breach of fiduciary duties because no breach of such duties was found.

As we previously detailed here, BioClinica engaged in an eight-month sale process, which led to a two step tender offer acquisition that closed on March 13, 2013. Before the closing of the tender offer, the court found that plaintiffs’ allegations that the board members had breached their fiduciary duties were not colorable, and the court declined to expedite the litigation (or enjoin the transaction). Such a finding typically leads to a voluntary dismissal by plaintiffs. Here, however, plaintiffs nonetheless chose to pursue this action, and, because the exculpation provisions in the company’s certificate of incorporation absolved the directors from monetary damages arising out of breaches of the duty of care, plaintiffs were forced to allege that the directors breached their duty of loyalty or acted in bad faith.

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Must Salmon Love Meinhard? Agape and Partnership Fiduciary Duties

The following post comes to us from Stephen M. Bainbridge, Professor of Law at the UCLA School of Law.

In a 2004 lecture, Jeffrie Murphy noted that “John Rawls claimed that justice is the first virtue of social institutions,” but Murphy went on to ask “what if we considered agape to be the first virtue? What would law then be like?” A variant on Murphy’s question has been chosen as the motivating question for the Law and Love Conference, to be held at Pepperdine University School of Law, on February 7-8, 2014, at which this article will be presented. As propounded by the convokers, the question read “What would law be like if we organized it around the value of Christian love [agape]? What would be the implications for the substance and the practice of law?” This article poses those questions with respect to partnership law.

When I was asked to contribute a paper on business organization law to the Pepperdine conference, the conference call immediately brought to mind Benjamin Cardozo’s opinion in Meinhard v. Salmon, [1] which famously held that a managing partner “put himself in a position in which thought of self was to be renounced, however hard the abnegation.” [2] The parallels between Cardozo’s framing of the partner’s duties and, to cite but one example, Kierkegaard’s formulation of agape, which avers that “[l]ove of one’s neighbor … is self-renouncing love,” [3] are obvious and striking. What then would partnership fiduciary duty law be like if it were organized around the value of agape?

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The (Advisory) Ties That Bind Executive Pay

Editor’s Note: Robert Pozen is a senior lecturer at Harvard Business School and a senior fellow at the Brookings Institution. This post is based on an article by Mr. Pozen and Theresa Hamacher that originally appeared in the Financial Times.

While shareholders of public companies in the UK and US have been voting on advisory (non-binding) resolutions about executive compensation, those in the Netherlands, Norway and Sweden have been voting on binding resolutions.

This might change. The UK government has proposed moving from advisory to compulsory resolutions on executive pay and, recently, the Swiss approved a referendum directing its parliament to require public companies to hold binding shareholder resolutions over pay.

Based on the available data, however, we do not support a general requirement for all public companies to hold a binding shareholder vote on executive compensation. But if less than a majority of the shares voted at one annual meeting favour a company’s executive compensation plan, then at the next annual meeting, the shareholder vote on that company’s executive compensation plan should be binding.

Let us begin by reviewing the data on advisory resolutions in the US and UK. In the first half of 2012, only 53 US public companies received less than a majority vote on their executive compensation plan. Of these 53, however, 45 gained majority support for their say on pay resolutions in 2013, according to Institutional Shareholder Services.

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SEC Hits ‘Reset’ on Failure to Supervise Liability

The following post comes to us from Ivan B. Knauer, co-chair of the Securities and Financial Services Enforcement Group and partner in the White Collar Litigation and Investigations Practice Group of Pepper Hamilton LLP, and is based on a Pepper Hamilton Client Alert by Mr. Knauer and Min Choi.

On September 30, 2013, the U.S. Securities and Exchange Commission (SEC)—quietly, and with little fanfare—released an informal statement of policy in the form of frequently asked questions (FAQ), in which it addressed its recent case against Ted Urban. [1] In doing so, the SEC shed light on when and how the agency will seek to hold legal and compliance personnel responsible for failing to supervise employees on the business side.

As many will recall, the Urban case was closely watched by securities legal and compliance professionals, who worried that a decision by the commissioners could be used by enforcement staff to make such professionals easier targets in future enforcement actions. Ultimately, the commissioners dismissed the case. That said, given the circumstances surrounding the case’s dismissal, legal and compliance officers were left with little guidance as to whether the case against Urban could be used against them to establish supervisor liability.

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Executive Compensation—It Just Won’t Go Away

The following post comes to us from William J. Catacosinos, Senior Partner and Principal at Laurel Hill Advisory Group, and is based on a Laurel Hill publication by Mr. Catacosinos.

Over the last several years executive compensation has been an issue that has received a lot of attention from Wall Street, union pension funds, activists, and others. The Dodd-Frank Say-on-Pay mandate was put in place and early on there was surprising push back from shareholders. There were results that have been tracked about the impact of Say-on-Pay and the support from shareholders over several years that are as follows:

Based on the recent Towers Watson Research of approximately 13,050, roughly 3,000 companies show their positive results on Say-on-Pay in 2013 are up to 90% from 89% in 2012. The percentage of those companies receiving negative ISS board recommendations drop from 13 to 11 percent.

It is clear that company disclosures are better focused on explaining executive compensation generally. This is a result of a conclusion reached by Ning Chiu of Davis Polk, LLP. Companies are also more sensitive about those issues that will raise questions and possibly trigger negative proxy advisory firm recommendations. Clearly, the large companies are responding to shareholder Say-on-Pay concerns and are being advised by their outside counsels on the proper manner of preparing detailed compensation disclosure in their proxy statements. Further, we believe that many of these companies are reaching out to their large institutional investors and having a dialogue with them concerning compensation, getting feedback, and responding appropriately—so progress has been made.

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