Monthly Archives: August 2016

DOJ Acts on Interlock Concern in Transaction Involving Foreign Entities

Brad S. Karp is chairman and partner at Paul, Weiss, Rifkind, Wharton & Garrison LLP. This post is based on a Paul Weiss memorandum by Mr. Karp, Robert A. AtkinsAndrew C. Finch, Jacqueline P. Rubin, and Aidan Synnott.

On July 14, 2016, the United States Department of Justice announced that it had concerns that a transaction involving two foreign electronic trading platforms would have, as originally structured, violated Section 8 of the Clayton Act. The parties restructured the transaction to address those concerns. [1] Section 8 of the Clayton Act generally prohibits the same “person” from simultaneously serving “as a director or [board-appointed] officer in any two corporations … that are … competitors” unless certain highly technical safe-harbor criteria are met. [2]

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Director Networks and Informed Traders

Felix Meschke is Associate Professor of Finance at the University of Kansas. This post is based on an article authored by Professor Meschke; Ferhat Akbas, Assistant Professor of Finance at the University of Kansas; and Jide Wintoki, Associate Professor of Finance at the University of Kansas.

Sophisticated traders can profit from material information by trading on it ahead of public releases. This makes corporate directors, who frequently have access to this kind of knowledge, a potential information source for professional traders. And though federal law forbids directors’ sharing of insider information with traders, that information can and does leak out. In our article, Director Networks and Informed Traders, forthcoming in the Journal of Accounting and Economics, we document that these traders generate greater profits when trading stocks of firms with more connected boards.

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Director Tenure Remains a Focus of Investors and Activists

David A. Katz is a partner and Laura A. McIntosh is a consulting attorney at Wachtell, Lipton, Rosen & Katz. The following post is based on an article by Mr. Katz and Ms. McIntosh that first appeared in the New York Law Journal. The views expressed are the authors’ and do not necessarily represent the views of the partners of Wachtell, Lipton, Rosen & Katz or the firm as a whole. Related research from the Program on Corporate Governance includes The “New Insiders”: Rethinking Independent Directors’ Tenure by Yaron Nili (discussed on the Forum here).

Director tenure, or “board refreshment,” is a corporate governance flashpoint at the moment for institutional investors, boards of directors and proxy advisory firms. One of the top takeaways from the 2016 proxy season, according to EY, is that “board composition remains a key focus—with director tenure and board leadership coming under increased investor scrutiny.” [1] Many investors and shareholder activists view director tenure as integral to issues of board composition, succession planning, diversity, and, most of all, independence.

Fortunately, term limits for directors is an idea that, in the United States, appears to have more appeal in theory than in practice. Term limits are in place at only three percent of S&P 500 companies—a decrease from five percent in 2010. Although the sample size is small, term limits in this group range from 10 to 20 years. [2] And, despite the seeming popularity of term limits among investors, during the 2016 proxy season, there were no shareholder proposals regarding director term limits, and during the 2015 proxy season, there were only two. [3] The small number of boards that have mandatory term limits indicates that the vast majority of directors—though they may appreciate the arguments in favor of term limits—determine, as a practical matter, that director tenure is best evaluated on a case-by-case basis, both at the company level and at the level of individual directors. The best way to achieve healthy board turnover is not term limits or retirement ages but a robust director evaluation process combined with an ongoing director succession process.
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Pre-Market Trading and IPO Pricing

Jay R. Ritter is Joe B. Cordell Eminent Scholar at the University of Florida. This post is based on a recent article by Professor Ritter; Chun Chang, Executive Dean and Professor of Finance at Shanghai Advanced Institute of Finance, Shanghai Jiao Tong University; Yao-Min Chiang, Professor of Finance at National Taiwan University; and Yiming Qian, Associate Professor of Finance at the University of Iowa.

The underpricing of initial public offerings (IPOs), with stocks going public having an offer price that is on average below the market price once the stock starts trading, is a worldwide phenomenon. Explanations for the positive first day returns, which average 10-30% in most countries, largely fall into two categories: 1) compensating investors for the uncertainties, including adverse selection risk, associated with buying newly issued stock of unknown value, and 2) agency problems between issuers and underwriters that result in excessive underpricing.

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The Granular Nature of Large Institutional Investors

Itzhak Ben-David is Associate Professor of Finance at The Ohio State University. This post is based on a recent paper authored by Professor Ben-David; Francesco Franzoni, Professor of Finance at the University of Lugano; Rabih Moussawi, Assistant Professor of Finance at Villanova University; and John Sedunov, Assistant Professor of Finance at Villanova University.

The U.S. asset management industry has become increasingly concentrated in recent times. Over the last 35 years, the largest institutional investors have quadrupled their holdings in the equity market. As of September 2015, the largest asset manager oversaw 5.1% of the total equity assets in SEC 13F filings, and the largest 10 managers managed 23.4% of these assets, which represents about 35% of overall institution ownership.

Such concentration of assets held by the largest asset managers is arguably associated with increased risk concentration, which can have a systematic impact. In other words, the risk that the largest institutions pose is that idiosyncratic shocks to any large individual player in an economy is hardly diversifiable, due to their sheer size (Gabaix, Gopikrishnan, Plerou, and Stanley, 2006; Gabaix, 2011). In this vein, large institutional investors are not equivalent to a collection of smaller independent entities; rather, they have an incompressible institutional identity that leaves a large footprint in the market. That is, they are “granular,” and idiosyncratic shocks to those large institutions are also “granular” in that they cannot be diversified away or absorbed by the market. The asset management space indeed has experienced many examples of idiosyncratic events at the institutional investor level that have had widespread repercussions in the financial system. Recent examples include the bankruptcy of Lehman Brothers in 2008, JP Morgan’s trader (the “London Whale”) who built a large short position in credit default swaps that led to trading losses exceeding $6 billion within weeks, and the sudden departure of co-founder Bill Gross from Pimco in September 2014 which caused unprecedented large withdrawals and consequent drastic liquidations. It is important to note that idiosyncratic events need not be rare or extreme to have an impact on asset prices. A large institution that initiates trades to accommodate investor flows, or for portfolio rebalancing, or for risk-management reasons may cause price dislocations. Regulators have expressed similar concerns about systemic risks that could result from the high concentration of assets under a single large manager.

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