Yearly Archives: 2013

2013 Annual Corporate Governance Review

Posted by Noam Noked, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Tuesday, November 12, 2013
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The following post comes to us from David Drake, President of Georgeson Inc., and is based on the Executive Summary of a Georgeson report. The complete publication is available here.

For many years, the proactive engagement of shareholders on corporate governance matters has been limited to just a handful of companies. However, over the past few years companies have shown a greater willingness to engage, particularly after the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) made advisory votes on executive compensation (commonly referred to as “say-on-pay”) a mandatory voting item for most publicly traded U.S. companies. Last year we reported on the explosive growth in the level of engagement between public companies and investors on corporate governance matters, with both sides lauding the benefits of such engagement. Investors’ proxy departments have reported the benefits of gaining an early understanding of the issues a company is facing and the rationale behind decisions the company made beyond what is disclosed in the proxy statement. Meanwhile, issuers have found value in gaining firsthand knowledge of the nuances of investors’ proxy voting guidelines.

Given that both sides have seen the benefits of such an exchange, there has again been a significant rise in the number of engagement programs initiated by companies this year. As one would expect, there were a variety of reasons that companies sought to engage in outreach campaigns. While most companies engaged in order to improve on their past voting results, many others have aimed to establish a dialogue in order to maintain positive results. The scope of programs also tended to vary with many being quite expansive. These included lengthy off-season engagements with institutions, multiple contacts with the same institution during the year, in-person visits with investors and inclusion of members of the board of directors in the discussion. Some companies went so far as to proactively reach out to their top 100, 150 and even 200 institutional investors.

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The Autonomous Board

Posted by John Wilcox, Sodali, on
Monday, November 11, 2013
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John Wilcox is chairman of Sodali, a co-chair of ShareOwners.org, and former Head of Corporate Governance at TIAA-CREF. This post is based on a Sodali publication by Mr. Wilcox.

“Can we end the long tradition of the boardroom as a sealed chamber…? Can we move toward more transparency about the boardroom process…?”
—Leon Panetta [1]

Companies preparing for their annual shareholder meetings in 2014 should be aware of a new governance challenge: opposition to the election of individual directors is becoming a strategy of choice not only for activists but for “responsible” investors seeking change at portfolio companies. Withholding (or threatening to withhold) votes for incumbent directors, supporting short slate campaigns, or voting for dissident candidates in proxy contests are no longer considered hardball tactics for use only in extreme cases. Institutional investors who in the past would routinely support incumbent directors have learned an important lesson from the success of hedge funds and activists: targeting directors gets the immediate attention of companies, promotes dialogue, attracts media coverage and increases pressure on other investors to support shareholder initiatives.

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FINRA Issues Report on Broker-Dealer Conflicts of Interest

Posted by Annette L. Nazareth, Davis Polk & Wardwell LLP, on
Sunday, November 10, 2013
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Annette Nazareth is a partner in the Financial Institutions Group at Davis Polk & Wardwell LLP, and a former commissioner at the U.S. Securities and Exchange Commission. The following post is based on a Davis Polk client memorandum.

On October 14, 2013, FINRA issued a Report on Conflicts of Interest. The report summarizes FINRA’s observations following an initiative, launched in July 2012, to review conflict management policies and procedures at a number of broker-dealer firms. The report focuses on approaches to identifying and managing conflicts of interest in three broad areas: enterprise-level conflicts governance frameworks; new product conflicts reviews; and compensation practices.

While the report does not break new ground or create or alter legal or regulatory requirements, it offers insight into the approach that FINRA expects firms to take in implementing a robust conflict management framework. In particular, the report identifies effective practices that FINRA observed at various firms. Broker-dealers should use this report as a basis for reviewing and potentially strengthening their policies and procedures relating to managing conflicts of interests.

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FDIC Cautions Financial Institutions Regarding Increase in D&O Insurance Exclusions

Posted by Noam Noked, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Saturday, November 9, 2013
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The following post comes to us from John Dugan, partner and chair of the Financial Institutions Group at Covington & Burling LLP, and is based on a Covington & Burling E-Alert.

The FDIC last week issued a Financial Institution Letter advising financial institutions and their directors and officers of the increased use of exclusionary terms or provisions in D&O policies, and the resulting increased risk of uninsured personal civil liability for directors and officers. (FIL-47-2013, October 10, 2013).

The FDIC Letter urges the directors of financial institutions to make well-informed choices about D&O coverage, including consideration of costs and benefits, exclusions and other restrictive terms in proposed policies, and the implications for personal financial liability for directors and officers.

D&O insurance is a critical asset for financial institutions and their directors and officers, and the FDIC Letter expressly affirms that the purchase of D&O insurance serves a valid business purpose. The FDIC’s Letter is also a timely reminder that the D&O insurance market is in constant flux and that—in addition to seeking advice from insurance brokers—directors should consider seeking advice from experienced coverage counsel to gain a better understanding of the potential impact of restrictive provisions in proposed policies.

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Creeping Takeovers and Fiduciary Duties—A Recap

Posted by Noam Noked, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Friday, November 8, 2013
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The following post comes to us from Spencer D. Klein, partner in the Corporate Department and co-chair of the global Mergers & Acquisitions Group at Morrison & Foerster LLP, and is based on a Morrison & Foerster publication. 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 Sirius XM Shareholder Litigation, [1] Delaware Chancellor Strine dismissed a complaint that the Sirius board had breached its fiduciary duties by adhering to the provisions of an investment agreement with Liberty Media that precluded the Sirius board from blocking Liberty Media’s acquisition of majority control of Sirius through open-market purchases made by Liberty Media following a three-year standstill period. By holding the complaint to be time-barred under the equitable doctrine of laches the Delaware court did not address the merits of whether the Sirius board breached its fiduciary duties. However, In re Sirius still offers the opportunity to recap the guidance on “creeping takeovers” that can be derived from existing Delaware case law:

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Third Circuit Panel Strikes Down Court of Chancery’s Confidential Arbitrations

Posted by Noam Noked, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Friday, November 8, 2013
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The following post comes to us from Frederick H. Alexander, Chair of the Executive Committee and partner in the Delaware Corporate Law Counseling Group at Morris, Nichols, Arsht & Tunnell LLP. The following post is based on a Morris Nichols publication by Mark Hurd and John DiTomo. 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.

A three-judge panel of the U.S. Court of Appeals for the Third Circuit—issuing three opinions, a majority, concurrence, and dissent—today [Oct. 23, 2013] affirmed a district court ruling enjoining the Delaware Court of Chancery’s arbitration program. Click here to download a copy of the Court’s opinion.

In 2009, the Delaware General Assembly enacted legislation empowering sitting judges of the Court of Chancery to arbitrate private business disputes so long as one party is a Delaware entity, neither party is a consumer, and the amount in controversy exceeds $1 million (“Chancery Arbitrations”). Like most private arbitrations, Chancery Arbitrations are conducted confidentially. In 2011, the Delaware Coalition for Open Government challenged the constitutionality of Chancery Arbitrations, arguing that because the proceedings are conducted in private, the program violated the First and Fourteenth Amendments of the U.S. Constitution, which guarantee a right of public access to certain government proceedings. In 2012, the district court enjoined the members of the Court of Chancery from conducting Chancery Arbitrations, concluding that the proceedings were no different than civil trials to which a right of public access extended. The Chancellor and Vice Chancellors appealed the decision.

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Exclusive Forum Provisions: Is Now the Time to Act?

Posted by Richard J. Sandler, Davis Polk & Wardwell LLP, on
Thursday, November 7, 2013
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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

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Thursday, November 7, 2013
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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

Posted by Martin Lipton, Wachtell, Lipton, Rosen & Katz, on
Wednesday, November 6, 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.

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

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Wednesday, November 6, 2013
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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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