Monthly Archives: August 2017

Governance through Shame and Aspiration: Index Creation and Corporate Behavior in Japan

Charles C.Y. Wang is the Glenn and Mary Jane Creamer Associate Professor of Business Administration at Harvard Business School; Akash Chattopadhyay is an Assistant Professor of Accounting at University of Toronto Mississauga and the Rotman School of Management; and Matthew Shaffer is a doctoral student at Harvard Business School. This post is based on a recent paper by Professor Chattopadhyay, Mr. Shaffer, and Professor Wang.

There is growing interest in using stock indexes to shape corporate behavior and the standards of corporate governance. Over the past weeks, two of the largest index providers—S&P Dow Jones and FTSE Russell—announced their decisions to exclude certain firms with multiple share-class structures from their indexes. Despite these significant moves, empirical research has not established whether and how stock indexes can be effective in shaping standards of corporate behavior.

In a new working paper recently posted on SSRN, Governance through Shame and Aspiration: Index Creation and Corporate Behavior in Japan, we examine the governance role of stock indexes by exploiting the unique features of Japan’s JPX-Nikkei 400 index (JPX400). Launched in 2014, the JPX400 consists of the 400 best performing firms in terms of profitability among Japan’s largest and most liquid firms. Our analysis shows that the index had profound effects on Japanese firms and the overall stock market, and that these effects were predominantly driven by managers’ prestige concerns—the aspiration to acquire prestige or the desire to avoid shame—rather than the financial benefits of index inclusion.

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2017 Securities and M&A Litigation Mid-Year Review

Roger Cooper and Jared Gerber are partners at Cleary Gottlieb Steen & Hamilton LLP. This post is based on a Cleary Gottlieb publication by Mr. Cooper, Mr. Gerber, Abena Mainoo, Vanessa Richardson and Amanda Ravich.

As we previewed in our 2016 Year in Review, several significant developments in the federal securities laws occurred during the first half of 2017. The U.S. Supreme Court ruled that the Securities Act’s repose period is not subject to class-action tolling, in California Public Employees’ Retirement System v. ANZ Securities, Inc. In another case addressing the application of statutory time-bars to securities law violations, the Court held in Kokesh v. Securities and Exchange Commission that disgorgement in SEC proceedings is subject to the five-year statute of limitations for penalties. The Court also granted petitions for certiorari in two securities cases it will consider next term. One petition concerns liability under Section 10(b) and Rule 10b-5 based on a failure to make disclosures required by SEC regulation. The other petition relates to the appropriate forum for class actions asserting Securities Act claims.

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Activist Investors’ Approaches to Targeting Boards

Jack “Rusty” O’Kelley III is a Managing Director at Russell Reynolds Associates. This post is based on a Russell Reynolds publication by Mr. O’Kelley. 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); The Myth that Insulating Boards Serves Long-Term Value by Lucian Bebchuk (discussed on the Forum here); and Who Bleeds When the Wolves Bite? A Flesh-and-Blood Perspective on Hedge Fund Activism and Our Strange Corporate Governance System by Leo E. Strine, Jr. (discussed on the Forum here).

Clients who are anticipating or early in the process of an activist situation, and a potential proxy contest, often ask us two questions:

  1. How do you know if an activist is going to seek to expand the board or target specific directors for replacement (and potentially escalate the situation to a proxy contest)?
  2. If an activist chooses a board member replacement strategy, how can you predict which directors an activist may target?

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Private Equity and Financial Fragility During the Crisis

Shai Bernstein is Assistant Professor of Finance at Stanford Graduate School of Business. This post is based on a recent paper by Professor Bernstein; Josh LernerJacob H. Schiff Professor of Investment Banking at Harvard Business School; and Filippo Mezzanotti, Assistant Professor of Finance and Donald P. Jacobs Scholar at the Kellogg School of Management. 

The recent global financial crisis increased the attention paid by policy makers, regulators, and academics to financial stability. While much attention has been devoted to deficiencies in the banking system, high levels of corporate debt have also triggered concerns. Highly leveraged firms may enter financial distress during a crisis, exacerbating cutbacks in investment and employment and contributing to the persistence of the downturn. As such, the practices of the private equity (PE) industry, which raised close to $2 trillion in equity before the crisis, raised significant concerns.

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Sales Practices: Third-Party Risk Management Matters Too

Dan Ryan is Banking and Capital Markets Leader at PricewaterhouseCoopers LLP. This post is based on a PwC publication by Mr. Ryan, Roberto Rodriguez, Mike Alix, Adam Gilbert, and Julien Courbe.

Sales practices in the financial services industry have come under increased scrutiny from both regulators and financial institutions since last year. The attention so far has been largely on the financial institutions’ sales practices, which include activities throughout the customer relationship lifecycle from marketing to sales, servicing, and collection. However, the scope is broadening to include third parties, which have been used over the last decade to help institutions grow revenues, cut costs, and improve the customer experience. [1]

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Information Asymmetries Conceal Fraud and Systemic Risks in the U.S. Banking Industry

Beckwith B. Miller is a Managing Member, Gary F. Henry is Chief Executive Officer and Howard R. Sutherland is a Member of the Advisory Board at Ethics Metrics LLC. This post is based on an Ethics Metrics Publication by Mr. Miller, Mr. Henry and Mr. Sutherland.

U.S. Government Initiatives (USGIs) to “foster economic growth and vibrant financial markets through more rigorous regulatory impact analysis that addresses systemic risk and market failures, such as moral hazard and information asymmetry[1] are failing because of a deeply ingrained industry practice and bias. Bank regulatory oversight protects the FDIC’s Deposit Insurance Fund and the stability of the financial markets, but not investors.

This practice centers on information asymmetries permitted by federal bank regulators that classify material information, including formal enforcement actions (FEAs), internal fraud and external fraud, as confidential for regulated depository institution holding companies (DIHCs). As a result, many of the 100 largest (assets +$10 billion) DIHCs, from 2002 to the present, are able intentionally to withhold material information, including negative events that ordinarily require disclosure, from investors and the public. Disclosure of 565 FEAs, reflecting events of default in credit agreements and material contracts required to be disclosed by the SEC, led to default for 39% of these 565 DIHCs. Only 11 FEAs were issued for largest DIHCs but the default rate was 55%. The risk profiles for many of the current 100 largest DIHCs, that did not disclose a FEA, match the risk profiles of the 112 DIHCs with assets between $1 billion and $32 billion that did disclose a FEA. This information concerning the largest DIHCs was suppressed because the government could not afford the failure of any one of the largest DIHCs with the limited financial resources of the FDIC. This undisclosed material information, however, is directly relevant for evaluating the risk of default and actual defaults of large, systemically interconnected DIHCs and overall systemic risk as defined in the Dodd Frank Act, Sec 203(b) and Sec. 203(c)(4)(D): “the financial company is, or is likely to be, unable to pay its obligations (other than those subject to a bona fide dispute) in the normal course of business.”

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Regulating Motivation: A New Perspective on the Volcker Rule

Marcel Kahan is the George T. Lowy Professor of Law and Ryan Bubb is Professor of Law at New York University School of Law. This post is based on their recent paper. Related research from the Program on Corporate Governance includes Regulating Bankers’ Pay by Lucian Bebchuk and Holger Spamann (discussed on the Forum here); The Wages of Failure: Executive Compensation at Bear Stearns and Lehman 2000-2008 by Lucian Bebchuk, Alma Cohen, and Holger Spamann (discussed on the Forum here); and How to Fix Bankers’ Pay by Lucian Bebchuk (discussed on the Forum here).

The myriad problems with the Dodd-Frank Act’s ban on proprietary trading by banks have led to a rare bipartisan consensus: the Volcker Rule must be pared back or even repealed. At the root of the Rule’s problems is a fundamental definitional challenge. Whether a particular trade is banned turns on its motivation—is the trade intended to profit from short-term price movements or is it incidental to core financial intermediation functions such as market marking and underwriting—which is difficult for regulators to determine.

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Losing Stockholder Standing to Assert and Enforce Corporate Inspection Rights

Jacqueline P. Rubin is a partner and Matthew D. Stachel is an associate in the litigation department at Paul, Weiss, Rifkind, Wharton & Garrison LLP. This post is based on a Paul Weiss publication by Ms. Rubin and Mr. Stachel and is reprinted with permission from Delaware Business Court Insider. This post is part of the Delaware law series; links to other posts in the series are available here.

The rights of stockholders to demand to inspect a corporation’s books and records under state corporation laws are a powerful method of ensuring the stockholders’ rights and interests are safeguarded. Such inspection rights are not, however, unfettered. Exercising them involves balancing the inspection rights with the rights of corporations “to be free of frivolous or vexatious demands to examine records, and to avoid production of records to individuals pursuing interests other than those relating to stock ownership.” To strike an appropriate balance, stockholders must first comply with certain requirements. Among these are requirements governing the making of an inspection demand on the corporation and the requirement of articulating a proper purpose for the demanded inspection.

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Weekly Roundup: August 11–17, 2017


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This roundup contains a collection of the posts published on the Forum during the week of August 11–17, 2017.




Brexit: The Great Repeal Bill










Delaware’s Most Recent Thinking on the Preferred-Common Conflict

John L. Hardiman and Melissa Sawyer are partners at Sullivan & Cromwell LLP. This post is based on a Sullivan & Cromwell publication by Mr. Hardiman and Ms. Sawyer, and is part of the Delaware law series; links to other posts in the series are available here. Related research from the Program on Corporate Governance includes: Agency Costs of Venture Capitalist Control in Startups by Jesse M. Fried and Mira Ganor.

In two recent decisions, the Delaware Court of Chancery addressed the differing rights of preferred and common stockholders in the M&A context. On April 14, 2017, in Frederic Hsu Living Trust v. ODN Holding Corp., [1] the Court refused to dismiss claims that a private equity fund and the directors of one of its portfolio companies breached their fiduciary duties to common stockholders by selling certain of the company’s business lines and assets in order to fund a mandatory redemption of preferred stock. The case, while decided on a limited record in the context of a motion to dismiss, illustrates the primacy—and power—of director duties to holders of common stock as compared to the contractual obligations owed to holders of preferred stock. Separately, on June 7, 2017, in In re Appraisal of GoodCents Holdings, Inc., [2] the Court determined that common stockholders who had received no consideration in a 2015 merger were entitled to a pro rata share of the merger proceeds; in reaching that conclusion, the Court interpreted the company’s certificate of incorporation—which established a liquidation preference for the company’s preferred stockholders—as guaranteeing only a voting right, not a liquidation preference, in the event of a merger. Though the case centered on an issue of contractual interpretation—and its implications are therefore limited—the outcome favored the holders of common stock over the holders of preferred stock.

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