November 06, 2012
Disclosure and value creation ... or not
Two interesting papers that raise the question of the true value of disclosure. The first is by Steven Davidoff and Claire Hill, Limits of Disclosure. Disclosure has been a common regulatory device since it was by Louis Brandeis ("Sunlight is said to be the best of disinfectants", Other People's Money). Indeed, our system of securities regulation is built upon this premise. Davidoff and Hill look at just how effective disclosure was in the run up to the financial crisis with respect to retial investors and in regulation of executive compensation. They come away disappointed:
The two examples, taken together, serve to elucidate our broader point: underlying the rationale for disclosure are common sense views about how people make decisions — views that turn out to be importantly incomplete. This does not argue for making considerably less use of disclosure. But it does sound some cautionary notes. The strong allure of the disclosure solution is unfortunate, although perhaps unavoidable. The admittedly nebulous bottom line is this: disclosure is too often a convenient path for policymakers and many others looking to take action and hold onto comforting beliefs in the face of a bad outcome. Disclosure’s limits reveal yet again the need for a nuanced view of human nature that can better inform policy decisions.
In another paper, Jeffrey Manns and Robert Anderson, The Merger Agreement Myth, take on the question of whether M&A lawyers are really creating any value or if they are just haggling over nits that no one cares about. Manns and Anderson conduct an event study to figure out whether there is value to all that drafting. They take advantage of the fact that not all merger agreements are filed with the SEC on the same day they are announced. So, they look for stock price changes that they can attribute to the addition of new information after the market learns about the terms of the merger agreement. If lawyers add value, they hypothesize that prices should rise after the market has learned the terms of the agreement - that's the value attributable to lawyers. It's basically a disclosure argument. If disclosure works, then the market should be able to instantly - or reasonably quickly - absorb new information and have that information reflected in stock prices. Like Davidoff and Hill, Manns and Anderson come away disappointed:
Our analysis shows that there is no economically consequential market reaction to the disclosure of the acquisition agreement. Markets appear to recognize that parties publicly committed to a merger have strong incentives to complete the deal regardless of what legal contingencies are triggered. We argue that the results suggest that M&A lawyers are fixated on the wrong problems by focusing too much on negotiating “contingent closings” that allow clients to call off a deal, rather than “contingent consideration” that compensates clients for closing deals that are less advantageous than expected. This approach can enable M&A lawyers to protect clients against the effects of the clients’ own managerial hubris in pursuing mergers that may (and often do) fall short of expectations.
So, disclosure as a regulatory device, or as a determiner of value, is not that successful and suggests we start looking elsewhere.
August 07, 2012
Acquirer CEO incentives
Becher, Juergens, and Vogel have a paper, Do Acquirer CEO Incentives Impact Mergers?, examining the effect of CEO stock ownership and stock options on CEO acquisition decisions. One observation, stock ownership matters. CEOs with large amounts of stock are less likely to pursue value reducing acquisitions. Stock options, on the other hand, aren't as good at incentivizing value enhancing acquisitions. More and more the evidence continues to pile up across a number of governance areas - stock options aren't all they were hoped to be incentive-wise.
Abstract: This paper examines the mechanisms by which CEOs are incentivized and their impact on merger decisions. We argue that CEO ownership and incentive-based (option) holdings are not interchangeable and have differing effects on the choice to undertake a merger, the structure of mergers conditional on a firm undertaking a merger, and ultimately the performance of a deal. Results suggest that CEO ownership aligns incentives, enabling CEOs to make decisions around mergers that maximize shareholder value. CEOs with higher levels of ownership are less likely to take on mergers or hire advisors, more likely to use cash financing, pay lower premiums, and have better post-merger performance. CEO incentive-based holdings on the other hand are associated with higher incidence of undertaking a merger or hiring an advisor, lower probability of using cash financing, and pay higher premiums. In some tests, increased incentive-based wealth leads to lower post-merger performance. These results suggest that CEOs with high option holdings may be motivated more by agency conflicts than acting in shareholder interests.
June 20, 2011
Cleaning out the closets at Skype
So late last week, the FTC granted early termination to Microsoft and Skype for their announced deal. Early termination of the HSR waiting period means that Microsoft and Skype can move towards closing that deal. Now, comes the news from Bloomberg that Skype has fired a number of executives prior to closing:
Skype Technologies SA, the Internet- calling service being bought by Microsoft Corp. (MSFT), is firing senior executives before the deal closes, a move that reduces the value of their payout, according to three people familiar with the matter.
The reasons for the letting go this group of 8 high level Skype execs prior to closing aren't known, but the Skype Journal blog reinforces what is hinted at in the Bloomberg report - that the firings were done in order to reduce the number of stock options that are vested at closing and thus raises the payout to venture investors.
Now, I have no way of knowing if increasing the payout for investors is in fact true or if the execs that were let go didn't get an equivalent cash payout on their way out the door. My guess is that they did, but I don't know. If on the other hand it's true, then it's pretty cheesy.
The prospect of getting a large cash payout from valuable options after an IPO or a when unvested options are automatically vested coincident with sale is a huge part of the incentive package that keeps talented people working at start-ups. If it's true, and I guess everyone in the Valley will know the truth soon enough, then it means that executives with unvested options will be spending more time than one might like ensuring their positions in the event of a sale rather than risk getting let go just before their big payout.
July 22, 2010
Dodd-Frank and M&A
We at the M&A law prof blog haven’t spent much time addressing the new financial reform bill, but those who are interested should definitely read through the terrific masters forum on the Conglomerate addressing various aspects of the bill. There are also many other useful blogs addressing the bill, but it would take a whole page just to list all of them (although do keep up with the Harvard Corporate Governance Blog and the conglomerate for good links).
For day-to-day M&A deals, the most immediate relevant provision is “say on golden parachutes” which requires that in any proxy or consent solicitation for a meeting of shareholders occurring 6 months after the date of enactment of the Act (i.e. starting in January 2011) where shareholders are asked to approve an M&A transaction, companies must provide their shareholders with a non-binding shareholder vote on whether to approve payments to any named executive officer in connection with such M&A transaction. It’s worth taking a look at this Cleary Gottlieb client alert on what exactly this means for M&A deals and what isn’t clear (as you may guess, there is some lack of clarity!). For others who want more detail, Davis Polk (disclosure: my former employer) has a useful 130 page summary of the bill, plus a set of super nifty regulatory implementation slides which are pretty helpful in understanding what needs to be done next. Of course, you can also read all 2300 pages of the bill…
June 17, 2010
Bankers' Comp and Risk
Gillian Tett at the FT.com points to some early stage research by Hamid Mehran at the NY Fed that challenges whether it makes sense to compensate managers of banks/financial institutions with equity incentives. The problem stems from the typical capital structure of financial institutions vs other firms. Financial institutions tend to have 90-95% debt on their balance sheets while non-financial institutions have lower debt ratios - 60%. Given the high levels of leverage at financial institutions, Mehran and his co-authors argue that there is reason to believe that when bankers are compensated with equity they will chase riskier investments. All this suggests that equity-based compensation may not be a one-size-fits-all approach to inncentivizing managers. Mehran et al suggest tying compensation of banking executives to CDS spreads as a way of address the quality of their lending. Interesting. I'm looking forward to reading the paper.
December 02, 2009
Golden Parachute Waivers
You'll remember that early last month Burlington Northern announced that Buffet's Berkshire Hathaway would acquire the balance of BNSF's stock that it did not already own. Recently reported that the CEO of Burlington Northern Santa Fe waived his rights to compensation under the company's change of control agreement/golden parachute.
In general, seeing incumbent management waive their rights like this is a sign that the buyer and seller's management have a reasonably high level of confidence that the deal will work out well over the long term for both sides. Sometimes "working out well" involves a lucrative new contract for management. This case appears to be following Buffet's typical M.O. of buying strong management teams and leaving them in place to continue to run the business. So, it's not really a surprise that the CEO would waive his rights under the change of control agreement.
If (x) your Date of Termination (or the date of delivery of the applicable Notice of Termination) occurs during the Agreement Term and is coincident with or follows the occurrence of a Change in Control [ed: up to a period 24 months following a change in control] or (y) if you have a disability during the Agreement Term after the occurrence of a Change in Control, then you shall be eligible for payments and benefits in accordance with, and to the extent provided by, Section 4, with such eligibility determined on the basis for your termination of employment.
Payments are also due in the event the employee resigns for "good reason" following a change in control. Good reason includes the typical list of things like diminution of duties, salary, forced relocation beyond 50 miles, failure to pay salary and bonuses, failure to continue to provide benefits, etc.
The payments due under the contract are set equal to 2.5 times the highest 12 month salary over the previous 24 months (including deferred comp) and 2.5 times the targeted bonus for the current year. Of course, it goes without saying that the agreement provides for continuation of health insurance benefits for 24 months for the terminated employee under COBRA. Premiums to be paid by the company. To the extent there are tax implications - "parachute taxes" that are raised by payments under this agreement, the covered employee will be eligible for a tax gross-up payment as well.
What? Your employer doesn't pay your COBRA premiums and make gross-up payments to you?
Before I get too worked up, it's worth remembering the purpose of the Golden Parachute/Change of Control Agreement. In general, we want senior managers not to recoil in fear at the first sign of a takeover. Indeed, we'd like to create incentives for senior managers to be open to the possibility of being acquired. During the takeover boom of the 1980s that generated so much of the takeover case-law we now have, incumbent management fighting off potential acquirers was the constant theme. That particular theme has since receded from view, in part because the prevalence of change of control agreements has made senior managers more open to the prospect of losing their jobs.
The fact that Burlington Northern's CEO has waived his right to payments under the change of control agreement suggests that he is happy with the new boss and not likely going anywhere. That's a good thing.
November 10, 2009
Valero adopts Say-on-Pay Policy
It's officially a trend! In response to a say-on-pay campaign Valero announced yesterday that it was adopting a 'say-on-pay' policy joining Pfizer. Apparently shareholders at more than 110 companies are considering say-on-pay resolutions this proxy season.
The say on pay proposals, which have increased in number and support since they were first introduced in 2006, are fueled by public outrage over executives who got big bonuses “at the same time their companies were losing lots of money,” said Tim Brennan, chief financial officer of the Boston-based Unitarian Universalist Association, which sponsored the say on pay resolution that Valero shareholders approved in April.
“Valero wasn't selected because we thought there was something egregious about their structure,” Brennan said. “But as a big, visible company, it's a company that could set an example in best practices in corporate governance.”
October 30, 2009
Pfizer gives shareholders "say-on-pay"
Pfizer is kind of forward-looking when it comes to these kinds of governance issues. By that I mean - they get pushed, they resist, then they rethink their position. Last time around they adopted a majority-voting policy very early on. Now, it's say-on-pay. Here's the release:
“The Board’s action continues Pfizer’s long tradition of seeking and responding to shareholder input on compensation and other corporate governance topics,” said Matthew Lepore, Pfizer’s vice president and chief counsel for Corporate Governance. “The advisory vote is an additional means of obtaining feedback from our shareholders about executive compensation, which is set by the Compensation Committee of the Board and is designed to link pay with performance. This feedback will supplement our ongoing investor outreach activities on a broad range of corporate governance topics, which will not diminish with the adoption of this advisory vote.”
Timothy Smith, Senior Vice President Environment, Social and Governance Group for Walden Asset Management, and Stephen Viederman of The Christopher Reynolds Foundation said, “We commend Pfizer for taking this step. Once again, Pfizer has exhibited leadership in responding to investor concerns, a proactive approach to investor communications, and strong corporate governance.” The Christopher Reynolds Foundation sponsored a shareholder proposal regarding advisory votes on executive compensation at Pfizer’s 2009 Annual Meeting of Shareholders.
June 02, 2009
More Fuel for Shareholder Access Debate
The real question regarding the shareholder access debate is whether once shareholders have the power to nominate minority directors whether they will use it for good or ill, or at all. Yair Listokin has a paper, “If You Give Shareholders Power, Do They Use It? An Empirical Analysis,” in which suggests the answer might be that they won’t use it at all. Listokin looked at state antitakeover protection statutes that provide shareholders with the opportunity to opt-out through the adoption of shareholder initiated bylaw proposals. He finds that very few companies’ shareholders take advantage of the opportunity to opt-out of these statutes. This finding is consistent with earlier work from Rob Daines and Michael Klausner who looked at customization of incorporation documents and found very little opting out of default provisions (here).
Recently, we started to have experience with shareholder votes relating to ‘say-on-pay’ a hot-button issue (and here) it there ever was one. So far, shareholders who have had the opportunity to vote on pay packages appear reticent to say ‘no.’ The WSJ recently canvassed 15 companies large cap companies with say-on-pay policies that permit shareholders to review executive pay policies (here) and none of questions passed. Given the high degree of emotion that pay questions can generate, the vote results (or lack of them) are pretty amazing. All of this simply provides fuel for the shareholder access debate.