Monthly Archives: November 2014

A Closer Look at US Credit Risk Retention Rules

David M. Lynn is a partner and co-chair of the Corporate Finance practice at Morrison & Foerster LLP. The following post is based on a Morrison & Foerster publication by Jerry Marlatt, Melissa Beck, and Kenneth Kohler.

In a flurry of regulatory actions on October 21 and 22, 2014, the Federal Deposit Insurance Corporation (the “FDIC”), the Office of the Comptroller of the Currency, the Federal Reserve Board, the Securities and Exchange Commission, the Federal Housing Finance Agency (the “FHFA”), and the Department of Housing and Urban Development (collectively, the “Joint Regulators”) each adopted a final rule (the “Final Rule”) implementing the credit risk retention requirements of section 941 of the Dodd-Frank Act for asset-backed securities (“ABS”). The section 941 requirements were intended to ensure that securitizers generally have “skin in the game” with respect to securitized loans and other assets.

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ISS Details Governance QuickScore 3.0 Updates

The following post comes to us from Yafit Cohn, Associate at Simpson Thacher & Bartlett LLP, and is based on a Simpson Thacher memorandum.

Institutional Shareholder Services Inc. (“ISS”) has released a technical document detailing the factors and scoring methodology of Governance QuickScore 3.0, which ISS plans to launch on November 24, 2014. [1] Corporate issuers may verify, update or correct the data used to calculate their scores, via ISS’s data verification site, through 8:00 p.m. EST on November 14.

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Relative Total Shareholder Return Performance Awards

The following post comes to us from Frederic W. Cook & Co., Inc., and is based on the Executive Summary of a FW Cook publication by David Cole and Jin Fu. The complete publication is available here.

Since 2010, performance-contingent awards have been the most widely used long-term incentive (LTI) grant type among the Top 250 companies [1] and are now in use by 89% of the sample. The prevalence of performance awards and investor preferences have spurred considerable interest in relative total shareholder return (TSR) as a performance metric. Relative TSR measures a company’s shareholder returns [2] against an external comparator group and eliminates the need to set multi-year goals. Use of relative TSR performance awards among the Top 250 companies has increased from 29% in 2010 to 49% in 2014, and relative TSR is now the most prevalent measure used to evaluate company performance for performance awards.

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Executive Compensation in Controlled Companies

Kobi Kastiel is a fellow at the Harvard Law School Program on Corporate Governance. His article, Executive Compensation in Controlled Companies, is forthcoming in the January 2015 issue of Indiana Law Journal and available here. Additional work from the Program on Corporate Governance on executive compensation includes Paying for Long-Term Performance by Lucian Bebchuk and Jesse Fried, discussed on the Forum here.

More than a decade ago, Professors Lucian Bebchuk and Jesse Fried published the seminal work on the role and significance of managerial power theory in executive compensation. Their work cultivated a vivid debate on executive compensation in companies with dispersed ownership. The discourse on the optimality of executive pay in controlled companies, however, has been more monolithic. Conventional wisdom among corporate law theorists has long suggested that the presence of a controlling shareholder should alleviate the problem of managerial opportunism because such a controller has both the power and incentives to curb excessive executive pay.

My Article, Executive Compensation in Controlled Companies, forthcoming in the Indiana Law Journal, challenges that common understanding by proposing a different view that is based on an agency problem paradigm, and by presenting a comprehensive framework for understanding the relationship between concentrated ownership and executive pay. On the theoretical level, the Article shows that controlling shareholders often have incentives to overpay professional managers instead of having an arm’s-length contract with them, and therefore it suggests that compensation practices in a large number of controlled companies may have their own pathologies.

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Cyber Security, Cyber Governance, and Cyber Insurance

Paul A. Ferrillo is counsel at Weil, Gotshal & Manges LLP specializing in complex securities and business litigation. This post is based on an article authored by Mr. Ferrillo and Christine Marciano, President of Cyber Data Risk Managers.

JP Morgan Chase. Community Health Systems. The Home Depot. Kmart. There has been no shortage of data breaches in recent weeks—with new developments on an almost daily basis. The age of cyber hactivisim, cyber extortion, and cyber terrorism is here, and it is not going away any time soon.

Data security issues are no longer just an IT Department concern. Indeed, they have become a matter of corporate survival, and therefore companies should incorporate them into enterprise risk management and insurance risk transfer mechanisms, just as they regularly insure other hazards of doing business. As the number of data breaches has increased, the demand for cyber insurance has likewise dramatically increased more than that for any other insurance product in recent years. Every board of directors should be questioning its officers and management as to “whether or not its company should be purchasing cyber insurance to mitigate its cyber risk.” If management answers, “Oh, it costs too much,” or “Oh, it will never pay off,” second opinions should be obtained. Rapidly. Because neither answer is correct.

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Controlling Stockholders in Delaware—More Than a Number

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 and David B. Feirstein. 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.

Two recent Chancery Court decisions, Crimson Exploration and KKR Financial, confirm that Delaware takes a flexible and fact-specific approach to determining whether a stockholder is deemed to be “controlling” for purposes of judicial review of a transaction. It is important for dealmakers to understand when the courts may make a determination of control, both to properly craft a defensible process and to understand the prospects for resulting deal litigation.

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Governance and Comovement Under Common Ownership

The following post comes to us from Alex Edmans, Professor of Finance at London Business School; Doron Levit of the Finance Department at the University of Pennsylvania; and Devin Reilly of the Department of Economics at the University of Pennsylvania.

Most existing theories of blockholder governance consider a single firm. However, in reality, many institutional investors hold blocks in multiple firms. In our paper, Governance and Comovement Under Common Ownership, which was recently made publicly available on SSRN, we study the implications of common ownership for corporate governance and asset pricing. In particular, we address two broad questions. First, does holding multiple blocks weaken governance by spreading a blockholder too thinly, as commonly believed? If not, under what conditions can multi-firm ownership improve governance? Second, can common ownership lead to correlation between stocks with independent fundamentals, and if so, in which direction?

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Harvard Convenes the Executive Compensation Roundtable

The Harvard Law School Program on Corporate Governance and the Harvard Law School Program on Institutional Investors convened the Harvard Roundtable on Executive Compensation last Thursday, November 6. The event brought together for a roundtable discussion prominent representatives of the investor, issuer, advisor, and academic communities. Participants in the event, and the topics of discussion, are set out below.

The Roundtable, which was co-organized by Lucian Bebchuk, Stephen Davis, and Scott Hirst, was sponsored by Pearl Meyer & Partners. In addition to Pearl Meyer & Partners, the Roundtable was supported by a number of co-sponsors (listed here), the supporting organizations of the Program on Corporate Governance (listed on the program site here), and the institutional members of the Harvard Institutional Investor Forum (listed here).

The Roundtable sessions focused on both the process for determining executive compensation, and on substantive pay arrangements. The Roundtable discussion on issues relating to the process of determining executive compensation included discussion of the work of proxy advisors and their interaction with investors and issuers, engagement between issuers and investors themselves and compensation disclosure issues. The Roundtable then moved to a discussion of the substantive terms of compensation arrangements, including compensation levels, composition, and structures. Issues that were considered included the choice of peer groups, the composition of long-term and short-term incentive pay and contractual provisions such as claw-backs and golden parachutes.

The participants in the Harvard Roundtable on Executive Compensation included:

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Strategic News Releases in Equity Vesting Months

The following post comes to us from Alex Edmans, Professor of Finance at London Business School; Luis Goncalves-Pinto of the Department of Finance at the National University of Singapore; Yanbo Wang of the Finance Area at INSEAD; and Moqi Xu of the Department of Finance at the London School of Economics.

In our paper, Strategic News Releases in Equity Vesting Months, which was recently made publicly available on SSRN, we study the link between the equity vesting schedules of CEOs and the timing of corporate news releases. We show that, in months in which the CEO has equity vesting, the firm releases more news. This is an easy way to pump up the short-term stock price, as news attracts attention to the stock. This attention also increases trading volume, which allows the CEO to cash out his equity in a more liquid market. Indeed, we find that these news releases lead to significant increases in the stock price and trading volume in a 16-day window, but the effect dies down over 31 days, consistent with a temporary attention boost. The median CEO cashes out all of his vesting equity within seven days—within the window of price and volume inflation.

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Why Commissioner Gallagher is Mistaken about Disclosure of Political Spending

Lucian Bebchuk is Professor of Law, Economics, and Finance at Harvard Law School. Robert J. Jackson, Jr. is Professor of Law 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 all 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 last year in the Georgetown Law Journal. A series of posts in which Bebchuk and Jackson respond to objections to an SEC rule requiring disclosure of corporate political spending is available here.

Last week, Securities and Exchange Commissioner Daniel Gallagher took the unusual step of publishing a letter to the editor of the New York Times expressing his opposition to the SEC even considering companies’ disclosure of political spending. In his letter, the Commissioner vows “to fight to keep” the subject off the SEC’s agenda. As explained below, however, his letter fails to provide a substantive basis for his vehement opposition to transparency in corporate spending on politics.

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