Monthly Archives: December 2017

Globalization and Executive Compensation

Wolfgang Keller is Professor of Economics at the University of Colorado-Boulder and Director of the McGuire Center for International Economics; William Olney is Associate Professor of Economics at Williams College. This post is based on their recent paper. 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) and The Growth of Executive Pay by Lucian Bebchuk and Yaniv Grinstein.

Inequality

Growing inequality has been one of the most salient features of the U.S. economy over the last forty years. As depicted in Figure 1, nearly all of this growth in inequality is driven by the rapid increase in top incomes (Piketty and Saez 2003; WID). The share of income accruing to the top one percent of earners has risen from less than 10% in the 1970s to over 20% today. Despite important policy implications, the causes of this growth in top incomes remains an open question.

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Why Do Some Companies Leave? Evidence on the Factors that Drive Inversions

Douglas O. Cook is the Ehney A. Camp, Jr. Endowed Chair of Finance and Investments at the University of Alabama. Joseph Stover is a Visiting Assistant Professor of Finance at Trinity University. This post is based on their recent paper.

On November 23rd, 2015, pharmaceutical giant, Pfizer, officially announced that it had reached an agreement with its competitor, Allergan, to merge the two companies in a deal that would have created the largest pharmaceutical company in the world. The combined company would have been called Pfizer and would have been led by Pfizer’s current CEO, Ian Read, but the deal was being structured so that, at least on paper, Allergan would have been the buyer. By making Allergan the purchaser, Pfizer would be able to change its country of incorporation from the U.S. to Ireland (where Allergan is currently incorporated) and reduce its tax bill in the process.

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Credit Default Swaps, Agency Problems, and Management Incentives

David Yermack is Albert Fingerhut Professor of Finance and Business Transformation and Chair of Department of Finance at New York University Stern School of Business and Faculty Research Associate at the National Bureau of Economic Research; Jongsub Lee is University Term Assistant Professor of Finance at University of Florida Warrington College of Business; and Junho Oh is a Ph.D. candidate at University of Florida Warrington College of Business. This post is based on their recent paper.

Recent literature has focused on conflicts between shareholders and creditors in the presence of Credit Default Swaps (CDS), but these papers have generally overlooked potential agency problems arising between shareholders and managers.

CDS are insurance contracts between two parties with contingent payoffs referenced to future credit events of the underlying entity. Credit events that trigger CDS payments are potentially endogenous, since they may occur as outcomes of unobserved interactions between shareholders and creditors. Several studies recently demonstrate that CDS, once issued, may affect bargaining between shareholders and creditors on an ongoing basis. Since CDS provide creditors with a form of default insurance, they could strengthen their bargaining power in debt negotiations, which in turn could generate significant feedback effects on corporate financial policies. Lenders who heavily hedge their debt exposure with CDS become “empty creditors” (Hu and Black, 2008; Bolton and Oehmke, 2011), who may frequently reject debt exchange offers from shareholders in order to avail themselves of voting rights that may attach during bankruptcy. Such feedback effects of CDS on various corporate policies have been extensively documented, including increasing corporate leverage (Saretto and Tookes, 2013), more frequent outright liquidations (Subrahmanyam, Tang, and Wang, 2014), and precautionary corporate liquidity management (Subrahmanyam, Tang, and Wang, 2017) following the onset of CDS trading for the debt of a specific firm. Importantly, these studies rely on the inception of CDS trading as an identification strategy, since the listing of a new CDS contract occurs as a result of decisions taken by third-party market makers who typically have no connection with the firm’s managers.

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Global and Regional Trends in Corporate Governance for 2018

Rusty O’Kelley III is the Global Head of the Board Consulting and Effectiveness Practice, Anthony Goodman is a member of the Board Consulting and Effectiveness Practice, and Melissa Martin is a Board and CEO Advisory Group Specialist in the Washington, D.C. office of Russell Reynolds Associates. This post is based on a Russell Reynolds publication by Mr. O’Kelley, Mr. Goodman, and Ms. Martin.

At the end of each year, Russell Reynolds Associates interviews over 30 institutional and activist investors, pension fund managers, public company directors, proxy advisors, and other corporate governance professionals in five key markets regarding the trends and challenges that public company boards will face in the following year.

Across all of our interviews this year, an overriding theme was the importance of board quality and composition—and the components that go into both. Investors of all types (including institutional and activist) are continuing to ratchet up their focus on the quality of a company’s board of directors, both collectively and individually. The focus on quality and composition is even greater than in previous years. Investors are motivated to hold boards accountable for company performance and are willing to take action to ensure that boards are meeting governance standards. Governance expectations continue to rise across markets and industries. Investors and proxy advisors are relying on traditional metrics (e.g., tenure, overboarding) to assess board quality, but a number of investors have talked about needing to have greater insights into the board to assess quality.

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Venture Capital Investments and Merger and Acquisition Activity around the World

Gordon Phillips is C.V. Starr Foundation Professor of Finance and faculty director of the Center for Private Equity and Entrepreneurship at Dartmouth College Tuck School of Business; Alexei Zhdanov is Assistant Professor of Finance at Penn State University Smeal College of Business. This post is based on their recent paper. Related research from the Program on Corporate Governance includes: Carrots & Sticks: How VCs Induce Entrepreneurial Teams to Sell Startups by Jessie Fired and Brian Broughman (discussed on the Forum here).

In this paper, we investigate what happens to venture capital investments when M&A activity is regulated. The paper studies the interaction between venture capital (VC) activity and M&A activity in 40 different countries around the world. Venture capital funding is important to many small innovative firms, allowing them to survive and prosper. In this paper, we study the interaction of the merger market with venture capital in a sample of 48 countries around the world. We argue that active M&A markets promote innovation investments and make it easier for venture capitalists to monetize their investment by selling their portfolio companies to potential acquirers. We examine VC investments following M&A activity and also VC investments subsequent to passage of pro-takeover and anti-takeover legislation. While mergers of firms that are horizontally competing may indeed reduce innovation, general policies where a large firm is prevented from buying a smaller firm may have deleterious effects on the ex ante incentives to conduct R&D by the smaller firm, as has been emphasized by Phillips and Zhdanov (2013). This argument is further supported by Bena and Li (2014), who show that large companies with low R&D expenditures are more likely to be acquirers, and argue that synergies obtained from combining innovation capabilities are important drivers of acquisitions.

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Weekly Roundup: December 22-28, 2017


More from:

This roundup contains a collection of the posts published on the Forum during the week of December 22-28, 2017.

Top 5 Things Shareholder Activists Need to Know


Analysis of Final Tax Reform Legislation



The Information Content of Dividends: Safer Profits, Not Higher Profits


Advising Shareholders in Takeovers


SEC Cyber Unit and Allegedly Fraudulent ICO


Board Composition: A Slow Evolution


The Impact of Pending Tax Reform on Executive Compensation: The Need for Deductive Reasoning


Do Activists Turn Bad Bidders into Good Acquirers?


Appraisal Litigation Update


Shareholder-Creditor Conflict and Payout Policy



The Legal Validity of Oral Agreements with Activist Investors

The Legal Validity of Oral Agreements with Activist Investors

Scott A. Barshay is a partner at Paul, Weiss, Rifkind, Wharton & Garrison LLP. This post is based on a Paul, Weiss publication by Mr. Barshay, Ariel Deckelbaum, Ross Fieldston, Justin Hamill, Stephen Lamb, and Jeffrey Marell, and is part of the Delaware law series; links to other posts in the series are available here. includes The Long-Term Effects of Hedge Fund Activism by Bebchuk, Brav and Jiang (discussed on the Forum here); and Dancing With Activists by Lucian Bebchuk, Alon Brav, Wei Jang, and Thomas Keusch (discussed on the Forum here).

Recently in Sarissa Capital Domestic Fund LP v. Innoviva, Inc., the Delaware Court of Chancery specifically enforced a disputed oral settlement agreement in a proxy contest between Innoviva, Inc. and Sarissa Capital Management resulting in two dissident directors being seated on the Innoviva board. The court held that the principals of Innoviva and Sarissa had entered into a valid, binding (albeit oral) agreement that required, among other things, Sarissa to cease its proxy solicitation in exchange for two seats on the Innoviva board. Due in part to what the court referred to as Innoviva’s “opportunistic maneuvers” of reneging on the agreement only after it became clear that it would win the proxy contest despite early predictions of a loss, the court used its equitable powers to award Sarissa specific performance of the settlement agreement.

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Can Taxes Mitigate Corporate Governance Inefficiencies?

Noam Noked is assistant professor of law at The Chinese University of Hong Kong. This post is based on his recent article, published in the William & Mary Business Law Review.

Policymakers have long viewed tax policy as an instrument to influence and change corporate governance practices. Certain tax rules were enacted to discourage pyramidal business structures and large golden parachutes, and to encourage performance-based compensation. Other proposals, such as imposing higher taxes on excessive executive compensation, have also attracted increasing attention. Contrary to that view, this article contends that the ability to effectively mitigate corporate governance problems and increase efficiency through the use of corrective taxes is very limited. The existing corrective taxes should be reconsidered, and in certain cases revoked and replaced with other more efficient forms of regulation.

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Shareholder-Creditor Conflict and Payout Policy

Yongqiang Chu is Associate Professor of Finance at University of South Carolina Darla Moore School of Business. This post is based on his recent article, forthcoming in the Review of Financial Studies.

In my article, Shareholder-Creditor Conflict and Payout Policy: Evidence from Mergers between Lenders and Shareholders, which is available on SSRN and is also forthcoming at the Review of Financial Studies, I show that the conflict of interests between shareholders and creditors induces corporations to pay excessive dividends at the expense of debt holders.

The classical agency theory (e.g. Jensen and Meckling, 1976, and Smith and Warner, 1979) posits that the conflict of interest between shareholders and creditors can induce agency costs in the form of excessive dividend payments, claim dilution, asset substitution, and underinvestment. Excessive dividend payments, in particular, may lead to significant wealth transfers from creditors to shareholders. Black (1976) points out that “there is no easier way for a company to escape the burden of a debt than to pay out all of its assets in the form of a dividend, and leave the creditors holding an empty shell.” In this sense, dividend policy can reflect the extreme effect of shareholder-creditor conflict.

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Appraisal Litigation Update

William Mills, Joshua Apfelroth, and Jason Halper are partners at Cadwalader, Wickersham & Taft LLP. This post is based on a Cadwalader publication by Mr. Mills, Mr. Apfelroth, Mr. Halper, Nathan Bull, Marianna Wonder, and William Simpson, and is part of the Delaware law series; links to other posts in the series are available here.

On December 14, the Delaware Supreme Court released a long-awaited opinion in Dell Inc. v. Magnetar Global Event Driven Master Fund Ltd. that reversed and remanded a high-profile appraisal case decided by the Delaware Court of Chancery in 2016. The Delaware Supreme Court built on its recent opinion in DFC Global Corporation v. Muirfield Value Partners L.P. to reiterate the potential for negotiated merger consideration to constitute the most important evidence of fair value in appraisal actions. While refusing to establish a presumption equating fair value to the deal price, taken together DFC and Dell suggest that strong evidence in the factual record undermining the reliability of the deal price—such as the existence of material flaws in the sales process or an inefficient public market for the target’s stock—will be necessary for petitioners to demonstrate that they are entitled to a higher price.

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