Monthly Archives: August 2016

The Lifecycle of Firm Takeover Defenses

Jonathan M. Karpoff is Professor of Finance at University of Washington Foster School of Business. This post is based on a recent paper authored by Professor Karpoff; William C. Johnson, Assistant Professor of Finance at Suffolk University Sawyer Business School; and Sangho Yi, Sogang University. Related research from the Program on Corporate Governance includes What Matters in Corporate Governance? by Lucian Bebchuk, Alma Cohen and Allen Ferrell (discussed on the Forum here); The Costs of Entrenched Boards by Lucian Bebchuk and Alma Cohen; and How Do Staggered Boards Affect Shareholder Value? Evidence from a Natural Experiment by Alma Cohen and Charles C. Y. Wang.

Are takeover defenses good or bad for shareholders? The answer depends on whom you ask. Many researchers find support for the view that takeover defenses entrench managers and decrease firm value (e.g., Gompers, Ishii and Metrick (2003), Masulis, Wang, and Xie (2007), Bebchuk, Cohen and Ferrell (2009)). But others find that takeover defenses are associated with improved value and performance (e.g., Linn and McConnell, 1983; Caton and Goh, 2008; Chemmanur and Tian, 2013; Smith 2013). In this paper, we propose that takeover defenses confer costs and benefits to a firm’s shareholders that change in systematic ways as the firm ages. Previous findings are mixed because they do not account for this lifecycle effect in takeover defenses.

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Do Creditor Rights Increase Employment Risk? Evidence from Loan Covenants

Antonio Falato is an economist and Nellie Liang is a director at the Federal Reserve Board. This post is based on a recent article by Mr. Falato and Ms. Liang.

In our article, Do Creditor Rights Increase Employment Risk? Evidence from Loan Covenants, which was recently accepted for publication in the Journal of Finance, we provide evidence that binding financial contracts have a large impact on employees and are an amplification mechanism of economic downturns.

A fundamental question in both finance and macroeconomics is whether financing frictions and, more broadly, firm financial conditions, have real effects. Existing empirical research on this question focuses primarily on corporate investment (e.g., Whited (1992), Rauh (2006), and Chava and Roberts (2008); Benmelech, Bergman, and Seru (2011) is a recent exception that instead focuses on employment). However, a long tradition of theoretical research in both macro (e.g., Bernanke and Gertler (1989)) and corporate finance (e.g., Berk, Stanton, and Zechner (2010)) as well as the exceptional job losses in the aftermath of the financial crisis and in the Great Recession of 2008 and 2009 highlight the potential importance of financing effects on employment, which raises two important empirical questions: Are corporate financing and labor policies related, and how? The goal of our paper is to make progress on these questions by examining the response of corporate labor policies to loan covenant violations.

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Corporate Culture and the Role of Boards

This post is based on a report produced by the United Kingdom’s Financial Reporting Council.

The FRC’s mission is to promote high quality corporate governance and reporting to foster investment. The UK has a good reputation in this field which has underpinned a substantial amount of business success, but it is by no means perfect.

There are valid questions about how effectively existing corporate governance arrangements address the board’s responsibilities to stakeholders other than shareholders, as envisaged in the Companies Act 2006. The framework of corporate governance in the UK is based on a shareholder primacy and value model of equity capitalism. There is a continuing debate about what this means. One view is that it necessarily involves a short-term focus since shareholders are most interested in the certainty of more immediate financial returns. This inevitably has consequences in terms of the decisions and actions which companies and investors take. Short-termism can drive poor business behaviours and conduct, for example: inappropriate incentives, market-rigging, poor customer service, low levels of investment and opaque financial structures and arrangements.

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Stakes Go Up In SEC Administrative Proceedings

Wayne M. Carlin is a partner in the Litigation Department at Wachtell, Lipton, Rosen & Katz. This post is based on a Wachtell Lipton firm memorandum by Mr. Carlin and David B. Anders.

The U.S. Court of Appeals for the D.C. Circuit [on August 9, 2016] upheld the constitutionality of SEC administrative proceedings in Raymond J. Lucia Cos. v. Securities and Exchange Commission . This is a significant victory for the SEC. In recent years, the SEC has brought increasing numbers of enforcement actions as administrative proceedings, rather than in federal court. A number of litigants have fought back and attempted to challenge the SEC’s choice of forum, in part because the administrative process affords much more limited opportunities to conduct discovery and lacks other protections that exist in federal court.

The pivotal issue presented is whether administrative law judges are “officers of the United States” within the meaning of the Appointments Clause of Article II of the Constitution, or whether they are “lesser functionaries.” Officers of the United States must be appointed by one of the methods specified in the Appointments Clause, which is not the procedure followed for the SEC’s ALJs. The Lucia court was the first court of appeals to consider this issue on the merits, and it concluded that the ALJs are not officers of the United States, thereby rejecting the argument that they are improperly appointed. While other parties may continue to litigate this issue in other circuits, the Lucia decision will likely be influential and will be viewed by the SEC as a vindication of its increased use of the administrative forum.
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Will I Get Paid? Employee Stock Options and Mergers and Acquisitions

Ilona Babenko is Associate Professor of Finance at Arizona State University W. P. Carey School of Business. This post is based on a recent paper authored by Professor Babenko, Yuri Tserlukevich, and Fangfang Du.

Employee stock options (ESOs) represent an integral component of modern employee compensation packages, particularly for highly innovative firms and those that operate in the high-tech industry (see e.g., Core and Guay (2001), Ittner et al. (2003), and Chang et al. (2015)). However, these types of firms also make attractive acquisition targets, and the natural question arises as to what happens to ESOs held by rank-and-file employees once their firms get acquired.

Using data from merger agreements on 1,178 deals announced during 2006-2014, we find that ESOs compensation is modified by acquirers in a way that does not benefit employees. In more than 80% of all completed M&A deals, some of the target’s outstanding employee stock options are simply terminated by the acquirer. While the most common scenario is cancelling all out-of-the-money stock options of the target firm, even in-the-money stock options can sometimes be terminated without any compensating payment to employees, and vested and unvested stock options can all be fair game. For example, when Microsoft was buying Skype in 2011, employees were not even able to keep the vested portion of their stock options.

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Weekly Roundup: August 5–August 11, 2016


More from:

This roundup contains a collection of the posts published on the Forum during the week of August 5–August 11, 2016.





Form 13f (Mis) Filings


Interest in Appraisal










2016 Proxy Season Review

Shirley Westcott is a Senior Vice President at Alliance Advisors LLC. This post is based on an Alliance Advisors publication.

For a second year, proxy access was the preeminent theme during proxy season, with over 200 resolutions filed—reportedly the most ever seen in any shareholder proposal category in a given year. As a result of negotiated withdrawals and voluntary adoptions, over 250 companies had established access rights by the end of June—seven times as many as a year ago—setting the stage for a continuation of private ordering in the years to come.

After proxy access, environmental issues and campaign finance were the second and third most frequent ballot items raised by shareholder proponents (see Table 1 of the complete publication). Chief among the targets was Exxon Mobil, which has faced a 25-year campaign to address the threat of climate change. Although all of the climate-related resolutions at Exxon were defeated, a watershed majority vote on proxy access could give activists more leverage in advancing their agenda.

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Government Pushes to Expand Insider Trading Liability

Jonathan N. Eisenberg is partner in the Government Enforcement practice at K&L Gates LLP. This post is based on a K&L Gates publication by Mr. Eisenberg, Shanda N. Hastings, and Andrew Edwin Porter.

Two years ago, the Second Circuit Court of Appeals dealt the government a stinging defeat in United States v. Newman, an insider trading case that the government stated “will dramatically limit the Government’s ability to prosecute some of the most common, culpable, and market-threatening forms of insider trading,” and that “arguably represents one of the most significant developments in insider trading law in a generation.” After the government failed to persuade the Supreme Court to grant its petition for certiorari, it appeared that Newman, decided by a court that has been described as the “Mother Court” for securities cases, would become the law of the land.

In an odd turn of events, however, this week the government filed a brief in another insider trading case, Salman v. United States—a case now before the Supreme Court despite the government’s opposition to granting certiorari. The government’s brief asks the Court to adopt a standard that, as we explain below, would effectively reverse the Newman standard for insider trading liability and create a bar so low that it is without precedent. We provide the relevant background below and discuss the difficulty of reconciling the government’s position with the Supreme Court’s decision in Dirks v. SEC, 463 U.S. 646 (1983).

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Are Foreign Investors Locusts? The Long-Term Effects of Foreign Institutional Ownership

Pedro Matos is Associate Professor of Business Administration at the University of Virginia Darden School of Business. This post is based on a recent paper by Professor Matos; Jan Bena, Assistant Professor at the University of British Columbia Sauder School of Business; Miguel Ferreira, Banco BPI Chair in Finance at Nova School of Business and Economics; and Pedro Pires, Nova School of Business and Economics.

In an era of increasing financial globalization, many analysts have expressed fears that a dispersed and globalized shareholder structure may be harmful to corporate investment, undermining firms’ future growth and performance. In fact, many policy makers have voiced protectionist sentiments with regard to foreign capital flows which might represent “hot money” in search of short-term profits, with little regard for firms’ long-term prospects. These views were famously vocalized over a decade ago by Franz Müntefering, the then chairman of the German Social Democratic Party (SPD), when he compared foreign investors to an invasion of “locusts” stripping companies bare. At SPD’s convention he stated that “(…) we support those companies, who act in interest of their future and in interest of their employees against irresponsible locust swarms, who measure success in quarterly intervals, suck off substance and let companies die once they have eaten them away.” The concern regarding “locust” foreign capital is that it might lead to asset stripping to boost short-term profits, delocalization of production, and adoption of unfriendly labor policies.

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The Impact of ISS’ New Policy on IPO Company Director Elections

Joseph A. Hall is a partner and head of the corporate governance practice at Davis Polk & Wardwell LLP. This post is based on a Davis Polk memorandum authored by Mr. Hall.

We recently published a survey of corporate governance practices adopted by companies in their IPOs. Our survey concluded that IPO companies continue to adopt charter provisions such as a classified board or dual class stock that can be viewed as having an anti-takeover impact, without any noticeable impact on valuation or marketing.

While we continue to believe that such provisions are appropriate in many instances, companies preparing for an IPO should be aware of the consequences for director elections of a recent policy change implemented by Institutional Shareholder Services (ISS), the influential proxy advisory firm. For newly public companies, ISS now will generally recommend “vote against” or “withhold” for directors of a company that, prior to or in connection with its IPO, adopted bylaw or charter provisions that ISS considers adverse to shareholders’ rights. These include common anti-takeover protections, such as a classified board, supermajority thresholds to amend the charter or bylaws, limitations on shareholders’ right to amend the charter or bylaws and dual-class shares. The policy was announced in November 2015, so the recently completed 2016 annual meeting season was the first time that the policy was applied to newly public companies.

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