Monthly Archives: October 2017

Why Does Fast Loan Growth Predict Poor Performance for Banks?

Rüdiger Fahlenbrach is Associate Professor at the Swiss Finance Institute at Ecole Polytechnique Fédérale de Lausanne (EPFL), Switzerland; Robert Prilmeier is Assistant Professor at Tulane University A.B. Freeman School of Business; and René M. Stulz is Everett D. Reese Chair of Banking and Monetary Economics at The Ohio State University Fisher College of Business. The post is based on their recent article, forthcoming in the Review of Financial Studies.

In our article, Why Does Fast Loan Growth Predict Poor Performance for Banks?, which was recently accepted for publication in the Review of Financial Studies, we show that the common stock of U.S. banks with loan growth in the top quartile of banks significantly underperforms the common stock of banks with loan growth in the bottom quartile.

Many recent papers find that credit booms generally end poorly and are followed by poor economic performance. A number of theories have been advanced to explain this phenomenon. Most of the empirical analyses examining these theories have focused on country-level evidence. We instead investigate bank-level credit growth and subsequent returns within a single country and ask what the results imply for these theories. We analyze a panel of U.S. publicly listed banks between 1972 and 2014. Such a long time series has the benefit of enabling us to show that the phenomenon we document is persistent and is not the result of changes in bank regulations or in bank governance.

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Shareholder-Manager Contracting in Public Companies

Jordan Schoenfeld is Assistant Professor of Accounting at the University of Utah Eccles School of Business. This post is based on his recent paper.

Activist investors often want managers to take specific actions, which they accomplish by methods such as installing their own person on the management team or the board or by writing explicit action-based contracts with management. These contracts have received far less research attention in the activist literature even though they are akin to the classical principal-agent model, where the principal knows exactly what actions the agent should take and will contract on those actions to the extent it is possible. This study examines binding bilateral contracts between shareholders and managers called shareholder agreements.

From 1996 to 2015, shareholders and managers executed over 4,400 binding bilateral shareholder agreement contracts. Using hand-collected data from 13D filings, I find that these contracts can specify rights and duties for both shareholders and managers, including director and management appointments, private information access, accounting procedures, dividends, capital structure, strategy, strategic alliances, private placements, and trading restrictions. I also find that these contracts are more prevalent in firms that are more volatile, less profitable, younger, and in firms with weaker information environments. Investors also react more positively to 13Ds that include these contracts, suggesting that these contracts do not arise at the expense of other shareholders.

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Index Investing Supports Vibrant Capital Markets

This post is based on a publication from BlackRock, Inc.

Index investing has profoundly changed the way investors seek returns, manage risk, and build portfolios. For nearly 50 years, index investment vehicles have lowered costs and simplified access to diversified investments for all investors, from sophisticated institutions to individuals. Technology and data have also transformed the range of investments that can be tracked by an index. Choice now extends beyond traditional equity indexes, which include stocks in proportion to their market-capitalization, to a whole array of more dynamic indexes compiled according to other methodologies. [1] These can be used to create investment products that serve a wide variety of needs—for example, products that track indexes with exposure to specific investment styles such as value or quality stocks.

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The Governance Implication of a Proposed Yates “Soft Repeal”

Michael W. Peregrine is a partner at McDermott Will & Emery LLP. This post is based on an article by Mr. Peregrine. Rebecca Martin and Joshua T. Buchman assisted in the preparation of this post. Their views do not necessarily represent the views of McDermott Will & Emery or its clients.

In an October 6, 2017 speech, Deputy U.S. Attorney General Rod J. Rosenstein offered further hints on the proposed “soft repeal” of the long-controversial “Yates Memorandum” on corporate liability and individual accountability.

Mr. Rosenstein had first raised the possibility of a change to Yates in a September 14, 2017 speech to the Heritage Foundation. In that speech, he stated that the policy set forth in that Memorandum was “under review”. In his October 6 speech, to the NYU program on Corporate Compliance and Enforcement, he elaborated on the pending change in policy.

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Busy Directors: Strategic Interaction and Monitoring Synergies

Alexander Ljungqvist is Ira Rennert Professor of Finance and Entrepreneurship at New York University Stern School of Business; Konrad Raff is Associate Professor of Finance at the Norwegian School of Economics. This post is based on their recent paper.

In our paper Busy Directors: Strategic Interaction and Monitoring Synergies, we examine when having a busy director on the board is harmful to shareholders and when it is beneficial. “Busy” directors—individuals who serve on multiple boards—continue to be the subject of debate among academics, practitioners, and policymakers. We develop and test the hypothesis that two factors jointly determine whether a busy board is beneficial or harmful to shareholders: (a) the existence of monitoring synergies across firms when directors serve on multiple boards, and (b) strategic interaction among directors on a firm’s board.

The policy debate implicitly assumes that busy directors experience negative monitoring synergies because time constraints prevent them from effectively monitoring all the firms on whose boards they serve. Our analysis nests this received wisdom but also allows for the possibility that a director with multiple board seats may experience positive monitoring synergies across firms. Positive synergies arise when the information or expertise acquired in monitoring one firm is transferable across firms.

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2017 Relative TSR Prevalence and Design of S&P 500 Companies

Ben Burney is Senior Advisor at Exequity LLP. This post is based on an Exequity publication by Mr. Burney. Related research from the Program on Corporate Governance includes: Paying for Long-Term Performance by Lucian Bebchuk and Jesse Fried (discussed on the Forum here).

Over the last several years as compensation committees and executives strive to align pay with shareholder returns, they have increasingly turned to market-based performance measures such as relative total shareholder return [1] (RTSR). Traditionally, RTSR was used primarily by Energy and Utilities companies, largely because these companies’ stock prices tend to be closely correlated, so TSR differences can more confidently be attributed to the success of management’s stewardship. Many companies outside of the Energy and Utilities arena have now adopted RTSR plans: 55% of S&P 500 companies use RTSR in their long-term incentive plans. While, adoption of new RTSR plans has slowed in recent years, it nonetheless continues to inch up in prevalence as companies and compensation committees seek to adjust compensation programs to comply with evolving expectation or respond to dissatisfied shareholders.

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Fire Sale Discount: Evidence from the Sale of Minority Equity Stakes

Isil Erel is Distinguished Professor of Finance at The Ohio State University Fisher College of Business; Serdar Dinc is Associate Professor of Finance & Economics at Rutgers Business School; and Rose Liao is Associate Professor of Finance at Rutgers Business School. This post is based on their recent paper.

Asset fire sales—namely, the forced sales by distressed sellers at prices lower than what the highest potential bidder could bid if it were not financially constrained as studied by Shleifer and Vishny (1992)—have attracted much attention. They have become important building blocks in much of recent theoretical work in finance and macroeconomics.

Empirical evidence on fire sales falls into two groups. In the first group are studies such as the analysis of aircraft sales by distressed airlines in Pulvino (1998) and that of fire sale discounts in bankruptcy auctions in Eckbo and Thorburn (2008). These studies observe the transaction prices on asset sales, but have to infer the fundamental values of the assets sold without the benefit of prices from a market with frequent trades. The second group includes studies such as Coval and Stafford (2007) who study the price impact of the sales of equity securities by mutual funds facing fund outflows. These studies have the benefit of asset prices from frequent trades, but they do not observe the transaction price received by the distressed sellers. They instead focus on the long run price impacts of the distressed sellers’ act of selling. There have been no empirical studies in a setting that provides both the transaction prices received by the distressed sellers and the pre-transaction prices given by frequent trades in an active market.

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Protecting Shareholder Ownership and Governance Rights

Sanford Lewis is Director at the Shareholder Rights Group. This post is based on a Shareholder Rights Group publication by Mr. Lewis, and was adapted from comments submitted by the Shareholder Rights Group to the Securities and Exchange Commission regarding the petition to alter resubmission thresholds for shareholder proposals.

Various efforts to reform the shareholder proposal process, SEC Rule 14a-8, ask the Securities and Exchange Commission to formally curb the ability of share owners to file proposals. The proposed reforms, including a 2014 petition by a consortium of corporate interest groups and a recent proposal by the US Department of Treasury [1], take a bigger-is-better approach. They seek both to require higher votes than currently required to resubmit proposals for the proxy subsequent to a vote, and to raise the filing threshold so that only larger share owners could file proposals.

These reform efforts fail to recognize and account for the high value of the services that the proposal process provides to corporations and investors in risk oversight, conflict resolution and governance. These services require that investors of all sizes, with diverse investment strategies, are able to bring forth issues relevant to the success of the corporation through the shareholder proposal process.

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Director Networks, Turnover, and Appointments

Luc Renneboog is Professor of Corporate Finance at Tilburg University and Yang Zhao is Lecturer in Banking and Finance at Newcastle University. This post is based on a recent paper by Professor Renneboog and Professor Zhao.

A company’s shareholders are to elect or approve the appointment of the non-executive (or supervisory) directors whose fiduciary duties include monitoring the CEO and the other executive directors. In case of continued poor corporate performance or natural retirement, one of the key responsibilities of the board is to contemplate the dismissal of the underperforming executives and to appoint successors. In this context, both networks of the executive and non-executive directors are likely to play an important role; the network of the former can facilitate the search for a new position in another firm, while the latter connections yield information on the pool of (external) successors. The role of social networks in job-searching has been well studied in sociology and labor economics for laborers and employees belonging to minorities, but has not been examined intensively for corporate top management. Given that close professional and social connections exist among the corporate elites, it may well be that executive and non-executive director networks are even more important in a labor market context than employees’ connections. Contrary to many existing studies that only focus on the CEO turnover, we evaluate the turnover and succession of all board members, comprising the CEO, executive directors, chairmen and non-executive directors.

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Securities Cases to Watch this Term at the Supreme Court

Brad S. Karp is Partner and Chairman at Paul, Weiss, Rifkind, Wharton & Garrison LLP. This post is based on a Paul, Weiss publication by Mr. Karp, Susanna Buergel, Chuck Davidow, Andrew Ehrlich, Roberto Gonzalez, and Audra Soloway.

Last Term, the Supreme Court continued its recent trend of taking up significant securities litigation enforcement matters. For the first time in many years, in Salman v. United States, the Court waded into the thorny question of the scope of insider trading liability. It took a strong stand on the statute of repose for private plaintiffs under the Securities Act of 1933 in CalPERS v. ANZ, and imposed limits on the SEC’s ability to obtain disgorgement in Kokesh v. SEC. It was, by any measure, as active a Term as the Court has had in this area in years.

In this respect, the Term beginning this week appears to be a continuation of the last. The Court has already granted certiorari in three significant cases affecting securities litigation and enforcement, and parties have filed numerous additional petitions for certiorari that await decision. In this post, we preview the three cases already granted, and highlight a petition for certiorari of note.

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