April 20, 2012
Giving Shareholders a Voice
For those of us wrapped up in legal education, there has been a refocusing of attention in the way we envision the law school experience. More and more of what we do is thinking about how to fill the hole left by changing business models in legal practice. As firms become less interested in apprenticeship aspect of the first few years of legal practice by recent grads, the pressure is on law schools to make sure that grads come out of law school "practice ready." What does that mean? Who knows really, but that's the focus these days.
Clinics and the clinical experience plays a big part in creating client-based experiences for students. However, for all their usefulness, they remain heavily litigation oriented. That's fine for the students who see themselves practicing their craft in the courtroom. However, for many students they'll never be in a courtroom. Their transactionally oriented practice will benefit only modestly from traditional clinical experiences. To compensate, clinics have begun to add transactional clinical experiences for students. Now, Lucien Bebchuk has stepped into the clinical world. He recently posted an op-ed at the Dealbook about his new clinic, the Shareholder Rights Project, at Harvard Law School.
Post-Selectica and post-Airgas, "just say no" has more than solidified itself as legally viable defense against an unwanted tender offer. For those of us who believe having a robust market for corporate control is an important corporate governance backstop, this places the focus of the market for corporate control on the staggered board. The Shareholders Rights Project is focused on getting declassification proposals before shareholders at annual meetings and in that way taking some air out of the "just say no" defense. Although the clinic has attracted the ire of Martin Lipton, it's a creative way to generate real legal experiences for law students that don't involve litigation, but does engage a portion of the student body who have an active interest in corporate governance. It's a good addition to the mix.
April 19, 2012
Facebook's Billion Dollar Bet on Instagram
Facebook's billion dollar bet on Instagram is one of those deals that keeps me up at night. A billion dollars for a company with no revenues, hmmmm... I am even more worried now that reports indicate that the Facebook board was essentially absent in advising Zuckerberg on the decision to purchase Instagram.
Acquirer overpayment often occurs in these large transactions. While some papers connect these losses to classic agency cost problems, numerous finance scholars have studied the role that non-economic forces, such as ego and hubris, play in corporate transactions (for just some of these pieces, see here and here). Several of these studies find that empire-building preferences and overconfidence predict heightened managerial acquisitiveness, including acquisitions that result in losses in acquirer shareholder wealth. This is particularly true when managers have significant internal resources. Ulrike Malmendier and Geoffrey Tate demonstrate how CEOs can overestimate their abilities to generate returns and create value. In particular, they illustrate how overconfident CEOs are associated with an increased likelihood of conducting M&A transactions, and also poorer deals for their shareholders as measured by bid announcement returns. Simlilarly, Mathew Hayward and Donald Hambrick examined hubris as a determinant of the size of premiums that CEOs will pay for acquisitions. In their examination of 106 large acquisitions, Hayward and Hambrick find “losses in acquiring firms’ shareholder wealth following an acquisition, and the greater the CEO hubris and acquisition premiums, the greater the shareholder losses [following an acquisition].” Moreover, the study also indicates that the relationship between acquisition premiums and CEO hubris is stronger in cases where board vigilance is lacking, i.e. when the board has a high proportion of inside directors and a CEO who also serves as chair of the board. More recent papers build on these results. In an unpublished manuscript, John, Liu, and Taffler find that overconfident CEOs pay higher bid premiums and that this effect is reinforced when the target CEO is also overconfident. Similar findings are reported by Chatterjee and Hambrick who show that narcissistic CEOs in the computer industry carry out more and larger acquisitions.
None of this bodes well for Facebook's Instagram deal. It may be that at the end of the day the deal turns out ok. But I would be cautious when a young star CEO runs around spending the company's resources without any board involvment.
Congratulations to Afra! Her paper, Transforming the Allocation of Deal Risk Through Reverse Termination Fees was recently selected one of the Top 10 Corporate and Securities Articles of 2011 by the Corporate Practice Commentator. You're a star, Afra!
April 18, 2012
Is China's love affair with US capital markets over?
Not two years ago, reverse mergers with little known Chinese firms was all the rage. The reverse merger was a cheap way to get a private Chinese (or any other) company public. Chinese firms took a liking to this backdoor to the US capital markets more than anyone else. So much so that it caused the SEC to investigate the practice and toughen up some of the listing standards in this area.
Now, we are seeing more and more of the following:
Shengtai Pharmaceutical, Inc. (OTC Bulletin Board: SGTI) ("Shengtai" or "the Company" or "We" or "Us"), a manufacturer and distributor in China of glucose and starch as pharmaceutical raw materials and other starch and glucose products, today announced that its Board of Directors has received a preliminary, non-binding proposal from its Chairman and Chief Executive Officer, Mr. Qingtai Liu ("Mr. Liu"), which stated that Mr. Liu intends to acquire all of the outstanding shares of the Company's common stock not currently owned by him and his affiliates in a going private transaction at a proposed price of $1.65 per share in cash.
Of course, Shengtai wasn't always Shengtai Pharmaceuticals. In 2007, it was known as West Coast Car Company. Control was transferred to Shengtai when Chinese investors bought the majority of shares in West Coast Car in 2007.
In recent months there has been a growing string of Chinese firms listed in the US going private. Apparently, the US capital markets aren't laid with gold. Listing and disclosures standards make it expensive for a low quality company to stay public, so they go private. That should be a good thing. Of course, we now have the JOBS Act that will reduce the costs of staying public for so-called "emerging companies" so perhaps there will be an incentive for these Chinese rever merger companies to stay public if they can get themselves categorized as "emerging companies."
April 16, 2012
My colleague, Brian Galle, and his co-author Kelli Alces have just posted a paper, Is Inside Debt Efficient?. During the post-financial crisis there has been a lot of thought about executive compensation and the role that it might have played in encouraging excessive risk taking and what to do about it. One common suggestion is the use of inside debt to incentivize executives. Galle and Alces are less sanguine about the efficacy of inside debt to postively influence managers' behavior. Instead, inside debt may unnecessarily complicate manager incentives.
Abstract: The average publicly-traded firm pays its CEO millions of dollars in deferred compensation and defined-benefit pension commitments. Scholars debate whether firms use these payments to efficiently align managerial interests with those of creditors, or whether instead they represent “hidden” forms of rent extraction. Yet others recommend these forms of debt-like incentive compensation, sometimes called “inside debt,” as a way of controlling risk-taking in systemically important financial institutions.
We argue instead that inside debt is unlikely to be efficient in either setting. Inside debt is costlier and more complex than other tools for managing risk, such as covenants or simply cutting back on option pay, and gives managers opportunities to hedge their equity positions without revealing that fact to investors. Drawing on the behavioral literature, we also show that increasing pay complexity is likely to reduce the efficacy of all forms of manager incentives.
To test these hypotheses, we conduct a series of panel regressions utilizing matched CEO and firm data covering over 1300 firms during the period 2007 to 2009. Under most specifications, we find little evidence that current borrowing needs correspond with executive pay structures. We do find, however, significant relations between the use of pensions and markers of managerial power, markers of board risk aversion, and lagged firm debt levels.