Monthly Archives: October 2016

Selling Hope, Selling Risk

Donald Langevoort is a Professor of Law at the Georgetown University Law Center. This post relates to Professor Langevoort’s new book.

Most existing work in the fields of corporate governance and investor protection assumes that corporate managers (and bankers, analysts, brokers and the like) are smart—and selfish—utility maximizers, while many investors are not. That follows naturally from the assumption that the former got to where they are via success in competitive crucibles that reward rationality, and survive and thrive by continuing their savvy ways. Many of the legal strategies designed to discourage opportunism and promote honesty and fiduciary responsibility take that assessment of human nature for granted.

But what if that assessment is overly simple, or wrong? In a new book—Selling Hope, Selling Risk: Corporations, Wall Street and the Dilemmas of Investor Protection—I explore what it means for securities regulation if we take seriously ways that cultural and cognitive biases affect the behavior of more than just ordinary investors. A rapidly growing body of research in financial economics, psychology, and sociology paints a richer picture of how these biases, especially egocentric ones, can actually be survival traits in the Darwinian world of business and finance. Phenomena like overconfidence, excessive optimism, competitive arousal, self-serving inference and many others offer explanations for why illusions sometimes produce marketplace success, not prevent it.


It Pays to Set the Menu: Mutual Fund Investment Options in 401(k) Plans

Veronika Krepely Pool is an Associate Professor & the Gregg T. and Judith A. Summerville Chair of Finance at the Kelley School of Business at Indiana University. This post is based on a forthcoming article by Professor Pool; Irina Stefanescu, Economist at the Federal Reserve Board; and Clemens Sialm, Professor of Finance at the University of Texas at Austin.

401(k) plans have experienced significant growth in recent years, gradually replacing other pension arrangements. Many participants in these plans have no financial investments other than their retirement savings. Therefore, an important economic issue emerging from the growth of defined contributions is whether current employees can accumulate sufficient wealth for retirement in their 401(k) accounts. As investment decisions in these accounts are made by the participants who often lack financial expertise, the answer to this question is likely driven by the quality of the investment choices offered by the plans.

Most 401(k) plan sponsors hire service providers to help with plan design and administration. Mutual fund families play an important role in this market, most frequently undertaking the role of the trustee or recordkeeper. While typical 401(k) menus often offer investment options from several mutual funds companies, conflicts of interest may affect the set and quality of the investment opportunities offered to plan participants.


Navigating A New Management-Board Relationship

Mark B. Nadler is Principal and co-founder of Nadler Advisory Services. This post is based on a Nadler publication.

These can be difficult days for anyone in management who frequently deals with the company’s board of directors. That once-comfortable relationship between management and the board, particularly in public companies, is being strained by unprecedented change. It often plays out in ways that can feel intrusive and irritating—requests for more data, reports, presentations and meetings—all requiring more time, effort and attention. That can feel awfully frustrating when the new demands appear in a vacuum, without explanation.


The Fed’s Commodities Proposal: Safety and Soundness Regulation or Indirect Prohibition?

Arthur S. Long is a partner at Gibson, Dunn & Crutcher LLP. This post is based on a Gibson Dunn publication by Mr. Long, Michael D. BoppJeffrey L. Steiner, and Carl E. Kennedy.

On September 23, 2016, the Board of Governors of the Federal Reserve System (Federal Reserve) issued its long-expected proposed rule (Proposed Rule) relating to permissible financial holding company (FHC) commodities activities. [1] The Proposed Rule follows up on the Section 620 Study (Study) issued by the U.S. federal banking regulators two weeks earlier, in which the Federal Reserve recommended to Congress that it repeal Section 4(o) of the Bank Holding Company Act (BHC Act) and the Merchant Banking authority. [2]

In the Proposed Rule, the Federal Reserve suggested the following changes from current law:


Institutional Investor Cliques and Governance

Alan D. Crane is Assistant Professor of Finance at the Jesse H. Jones Graduate School of Business at Rice University. This post is based on a recent paper by Professor Crane; Andrew Koch, Assistant Professor of Business Administration at the University of Pittsburgh; and Sebastien Michenaud, Assistant Professor of Finance at Kellstadt Graduate School of Business.

Do institutional investors work together to influence firm policies and governance? Researchers often think of owners as independent actors. This leads to the common view that dispersed ownership will result in poorer governance, all else equal, because small owners will not have the incentive to monitor individually (the “free rider” problem). However, in recent years it has become widely acknowledged that some investors do not act independently, but instead share information about their investment decisions and even work together to influence corporate policies in the firms they own (see, for example, Top US financial groups hold secret summits on long-termism,, February 2016).

In our paper, we examine the relationship between ownership structure and firm governance, taking into account investor interactions. We empirically identify groups of investors that are likely to be working together to influence the firms they own. We then examine how the presence of these coordinating owners relates to governance. Our results support a more complex view of the relation between ownership structure, coordination, and governance. Shareholder coordination increases governance via “voice” by overcoming the free-riding problem, consistent with Shleifer and Vishny (1986). At the same time, coordination weakens governance via threat of exit as predicted in Edmans and Manso (2011).


Delaware Court’s Reliance on MFW to Dismiss Challenge to Going Private Transaction

Christopher E. Austin is a partner in the New York office of Cleary Gottlieb Steen & Hamilton LLP. This post is based on a Cleary Gottlieb publication, and is part of the Delaware law series; links to other posts in the series are available here.

In a recent decision, [1] Vice Chancellor Laster of the Delaware Court of Chancery clarified certain issues related to the obligations of a controlling stockholder that often arise in connection with going private and similar transactions. The case involved a relatively conventional proposal by a controlling stockholder (the Anderson family) to acquire the remaining shares of Books-A-Million, Inc. (“BAM”) from BAM’s minority stockholders. The family structured the proposal with the goal of satisfying the conditions of the MFW decision so that any challenge to the transaction would benefit from the favorable “business judgment” level of judicial review. [2]


Private Tech Growth as an Asset Class

Rohit Kulkarni is Managing Director of the Private Investment Research Group at SharesPost, Inc. This post is based on a SharesPost publication by Mr. Kulkarni and Jennifer Phillips.

Though everyone in the venture community is cognizant of the growth in the number and size of mega-private financings (i.e., $100MM+), we wanted to present our clients with a much clearer understanding of the trend and how it is impacting the capital markets for emerging growth technology companies.

To do that, we analyzed literally thousands of venture financings since the Great Recession (i.e., 2007-2008). In this post, we explore answers to a range of questions related to the private tech funding landscape, including: 1) How have VC investment dollar allocations trended across early-stage, mid-stage and late-stage private tech companies since the Great Recession? 2) How have the number of investments and pre-money valuations trended across early-stage, mid-stage, and late-stage private tech companies? 3) Which indicators suggest a change in sentiment among private tech investors? 4) Which early indicators presage the shape and direction of private tech investments over the next 12-24 months? Key highlights of our findings include:


Tournament Incentives and Firm Innovation

Carl Hsin-han Shen is Associate Professor of Finance at National Central University and Hao Zhang is Associate Professor at the Saunders College of Business at Rochester Institute of Technology. This post is based on a forthcoming article by Professor Shen and Professor Zhang.

A growing sentiment following the recent financial crisis is that CEOs are overpaid and that their large compensation dilutes shareholder value. This sentiment is partly rooted in the fact that the pay disparity between CEOs and other employees has rapidly grown over the last three decades. Recent evidence shows that non-CEO executives on average earn only approximately 40% of a CEO’s compensation, and the ratio between average CEO pay and worker pay is now around 300-to-1 (, 2015). To shed light on the pay disparity, the U.S. Securities and Exchange Commission (SEC) recently adopted the Pay Ratio Disclosure Rule that requires public companies to disclose the CEO-Employee pay ratios. Why is the large pay disparity in corporate America so prevalent? Is it only driven by the increased CEO power (Bebchuk et al., 2002)? Is it possible that such a large pay disparity may generate certain benefits to firms and shareholders? According to the classical tournament theory (Lazear and Rosen, 1981), pay gaps between hierarchy levels can encourage competition among employees and provide promotion-based incentives (also known as tournament incentives). In a CEO-promotion tournament, non-CEO senior executives compete with each other for the top position. These executives are evaluated relative to their peers (i.e., relative performance evaluation), and among them the best relative performer will be promoted to be the next CEO. Since a promotion to the CEO position is associated with higher pay, senior executives have strong incentives to expend great effort to enhance the corporate performance in order to increase their own chances of promotion. These discussions suggest that large pay gaps could be associated with better firm performance (including better innovation performance).


Protecting the Interests of Long-Term Shareholders In Activist Engagements

Rakhi Kumar is Head of Corporate Governance, and Ron O’Hanley is President and Chief Executive Officer of State Street Global Advisors (SSgA). This post is based on a SSgA publication. Related research from the Program on Corporate Governance includes The Long-Term Effects of Hedge Fund Activism by Lucian Bebchuk, Alon Brav, and Wei Jiang (discussed on the Forum here), and The Myth that Insulating Boards Serves Long-Term Value by Lucian Bebchuk (discussed on the Forum here).

Key Takeaways

  • State Street Global Advisors (SSgA) recognizes that activists can bring positive change to underperforming companies, especially when boards or management ignore investor concerns about poor corporate governance practices.
  • As near permanent capital, SSgA’s main goal is to ensure that activists are helping to promote long-term value creation in whatever way they choose to engage with companies.
  • However, a recent rise in settlement agreements entered into rapidly between boards and activists and without the voice of long-term shareholders concerns us, as we see evidence of short-term priorities compromising longer-term interests.
  • We believe boards should protect the interests of long-term shareholders in all activist situations, and carefully evaluate settlement agreements. In particular boards need to consider the interests of long-term shareholders as they assess: 1) duration of the agreements; 2) ownership thresholds and holding period requirements for continued board representation; and 3) risk to the company’s share
  • price posed by a lack of board oversight on significant pledging activities by activists serving on the board.
  • To help inform and explain our voting decisions on the election of directors in activist situations, we will assess settlement agreements according to how they address the concerns highlighted in this paper.


Responding to Concerns Regarding the Protection of the Interests of Long-Term Shareholders in Activist Engagements

Abe Friedman is Managing Partner at CamberView Partners. This post is based on a CamberView publication by Mr. Friedman, Pete Michelsen, Derek Zaba, and Sharo Atmeh and is a reply to a publication from State Street Global Advisors, discussed on the Forum here.

On October 10, 2016, State Street Global Advisors (SSGA) issued a press release and published an article (discussed on the Forum here) expressing wariness about rapid settlements with activists without the input of long-term shareholders, a view shared by other large institutional investors. To address this concern, SSGA CEO Ron O’Hanley requested that “corporate boards develop principles for engaging with activist investors to promote long-term value creation.” Specifically, SSGA calls for companies to:


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