Sunday, December 5, 2010
Golden Parachutes and the Wealth of Shareholders, by Lucian A. Bebchuk, Harvard University - Harvard Law School; National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI); Alma Cohen, Tel Aviv University - Eitan Berglas School of Economics; Harvard Law School; National Bureau of Economic Research (NBER); and Charles C. Y. Wang, Stanford University; Harvard University - Harvard Law School, was recently posted on SSRN. Here is the abstract:
Golden parachutes have attracted much debate and substantial attention from investors and public officials for more than two decades, and the Dodd-Frank Act recently mandated a shareholder vote on any future adoption of a golden parachute by public firms. We use IRRC data for the period 1990-2006 to provide a comprehensive analysis of the relationship that golden parachutes have both with the evolution of firm value over time and with shareholder opportunities to obtain acquisition premiums. We find that golden parachutes are associated with increased likelihood of either receiving an acquisition offer or being acquired, a lower premium in the event of an acquisition, and higher (unconditional) expected acquisition premiums. Tracking the evolution of firm value over time in firms adopting GPs, we find that firms adopting a GP have a lower industry-adjusted Tobin’s Q already in the IRRC volume preceding the adoption, but that their value continues to decline during the inter-volume period of adoption and continues to erode subsequently. A similar pattern is displayed by an analysis of abnormal stock returns prior to the adoption of GPs, during the inter-volume period of adoption, and subsequently.
A New Discourse Theory of the Firm After Citizens United, by Michael R. Siebecker, University of Florida - Fredric G. Levin College of Law, was recently posted on SSRN. Here is the abstract:
Could a new “discourse theory” of the firm provide a better way than existing corporate law principles to understand the evolving nature of the firm and the role shareholders should play in corporate governance? Two recent developments provide a special urgency for considering the question. First, the Supreme Court’s decision in Citizens United v. FEC, which grants to corporations essentially the same political speech rights as individuals, will affect democracy at its core by allowing corporations to dominate the political agenda and public opinion. Second, the Securities and Exchange Commission’s adoption of a new Rule 14a-11, which grants to certain shareholders the right to nominate directors using the corporation’s own proxy, could effectively serve as a check on creeping corporate influence in all realms of society. Those two developments combine to signal a potentially tectonic shift in the nature of the corporation and to beckon for a more descriptively accurate theory of the corporation capable of accommodating such a change.
But why is a new discourse theory necessary to answer effectively questions about the nature of the firm and expansion of shareholder rights? Quite simply, the corporation has evolved from a simple investment vehicle for generating wealth. Accordingly, the underlying theories governing corporate behavior should evolve as well. The decisions affecting some of the most important aspects of our individual and communal lives now get made inside the boardroom rather than in the public eye. And, in the wake of Citizens United, corporate actors may likely dominate the political agenda and public opinion on any matters that remain open for discussion in the public realm. In some real sense, the ability to direct corporate decisions represents the ability to control political life. Not only does a new discourse theory of the firm accurately attend to the evolving nature of the corporation, but it provides rather clear guidance on whether the SEC should promote enhanced shareholder suffrage through director nomination rights. Within a new discourse theory of the firm, providing shareholders the right to nominate directors represents a clear first step in enhancing a continual engagement between corporate managers and the shareholders they serve. Moreover, enhanced discourse necessarily promotes a more efficient level of shareholder suffrage than current corporate law provides.
Lucky CEOs and Lucky Directors, by Lucian A. Bebchuk, Harvard University - Harvard Law School; National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI); Yaniv Grinstein, Cornell University - Samuel Curtis Johnson Graduate School of Management; and Urs Peyer,
INSEAD - Finance, was recently posted on SSRN. Here is the abstract:
This paper integrates and further develops the analysis of two discussion papers we circulated earlier, “Lucky CEOs” and “Lucky Directors.” We study the relation between opportunistic timing of option grants and corporate governance, focusing on at-the-money “lucky” grants awarded at the lowest price of the grant month. We find that both CEO and independent directors received an abnormally high number of lucky grants, and that opportunistic timing of director grants was not merely a by-product of their coinciding with executive grants or of firms’ routinely timing all grants. Lucky grants to CEOs and directors are associated with higher CEO compensation from other sources, and are correlated with a lack of majority of independent directors on the board, no independent compensation committee with an outside blockholder, or a long-serving CEO. For any given firm, the odds of a lucky grant increased when the payoffs from luck were high and when a preceding grant was lucky.
The Dodd-Frank Act: A Flawed and Inadequate Response to the Too-Big-To-Fail Problem, by Arthur E. Wilmarth Jr., George Washington University Law School, was recently posted on SSRN. Here is the abstract:
The Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank") was enacted in July 2010. Dodd-Frank's preamble proclaims that one of the statute's primary purposes is to "end 'too big to fail' [and] to protect the American taxpayer by ending bailouts." Dodd-Frank does contain useful reforms, including potentially favorable alterations to the supervisory and resolution regimes for systemically important financial institutions ("SIFIs"). However, Dodd-Frank falls far short of the fundamental reforms that would be needed to eliminate (or at least greatly reduce) the public subsidies that are currently exploited by "too big to fail" ("TBTF") financial institutions.
After briefly describing the financial crisis that led to the enactment of Dodd-Frank, this article evaluates whether the new statute is likely to solve the TBTF problem. Dodd-Frank establishes a new umbrella oversight body – the Financial Stability Oversight Council – that will designate SIFIs and make recommendations for their regulation. The statute also authorizes the Federal Reserve Board ("FRB") to apply enhanced supervisory requirements to SIFIs. Most importantly, Dodd-Frank establishes a new systemic resolution regime – the Orderly Liquidation Authority ("OLA") – that should provide a superior alternative to the "bailout or bankruptcy" choice that federal regulators confronted when they dealt with failing SIFIs during the financial crisis.
Nevertheless, Dodd-Frank does not solve the TBTF problem. Congress did not adequately strengthen statutory limits on the ability of large complex financial institutions ("LCFIs") to grow through mergers and acquisitions. The enhanced prudential standards to be imposed on SIFIs under Dodd-Frank rely heavily on capital-based regulation, which has repeatedly failed to prevent financial crises in the past. Moreover, the success of Dodd-Frank's supervisory reforms will depend heavily on many of the same federal agencies that failed to stop excessive risk-taking by LCFIs in the past and, in the process, showed their vulnerability to political influence wielded by LCFIs and their trade associations.
Dodd-Frank's most promising reform – the OLA – does not completely close the door to future transactions that protect creditors of failing LCFIs. The FRB and the Federal Home Loan Banks retain authority to provide emergency liquidity assistance to troubled LCFIs. The FDIC can borrow from the Treasury and can also use the "systemic risk exception" to the Federal Deposit Insurance Act in order to generate funding to protect creditors of failed SIFIs and their subsidiary banks. While Dodd-Frank has made bailouts more difficult, the continued existence of these additional sources of financial assistance indicates that Dodd-Frank probably will not prevent TBTF rescues during future episodes of systemic financial distress.
Contrary to my earlier recommendation, Dodd-Frank does not require SIFIs to pay risk-based assessments to pre-fund the Orderly Liquidation Fund ("OLF"), which will cover the costs of resolving failed SIFIs. Instead, the OLF will be forced to borrow the necessary funds in the first instance from the Treasury (i.e., the taxpayers). Dodd-Frank also does not include my previous proposal for a strict regime of structural separation between SIFI-owned banks and their nonbank affiliates. Thus, unlike Dodd-Frank, my earlier proposals would (i) require SIFIs to internalize the potential costs of their activities by paying risk-based premiums to pre-fund the OLF, and (ii) prevent SIFI-owned banks from transferring their safety net subsidies to their nonbank affiliates.
In combination, my proposals would strip away many of the public subsidies currently exploited by financial conglomerates and would subject them to the same type of market discipline that investors have applied over the past three decades in breaking up inefficient commercial and industrial conglomerates. Financial conglomerates have never demonstrated their ability to provide beneficial services to customers and attractive returns to investors without relying on federal safety net subsidies during good times and taxpayer-financed bailouts during crises. Congress must remove those subsidies and create a true “market test” for LCFIs, in which case market forces would probably compel many LCFIs to break up voluntarily.
For those looking for a good read over the holiday season, I recommend The Hellhound of Wall Street: How Ferdinand Pecora's Investigation of the Great Crash Forever Changed American Finance, by Michael Perino (St. Johns). Here is a brief description:
A gripping account of the underdog Senate lawyer who unmasked the financial wrongdoing that led to the Crash of 1929 and forever changed the relationship between Washington and Wall Street.
In The Hellhound of Wall Street, Michael Perino recounts in riveting detail the 1933 hearings that put Wall Street on trial for the Great Crash. Never before in American history had so many financial titans been called to account before the public, and they had come within a few weeks of emerging unscathed. By the time Ferdinand Pecora, a Sicilian immigrant and former New York prosecutor, took over as chief counsel, the investigation had dragged on ineffectively for nearly a year and was universally written off as dead.
The Hellhound of Wall Street provides a minute-by-minute account of the ten dramatic days when Pecora turned the hearings around, cross- examining the officers of National City Bank (today's Citigroup), particularly its chairman, Charles Mitchell, one of the best known bankers of his day. Mitchell strode into the hearing room in obvious disdain for the proceedings, but he left utterly disgraced. Pecora's rigorous questioning revealed that City Bank was guilty of shocking financial abuses, from selling worthless bonds to manipulating its stock price. Most offensive of all was the excessive compensation and bonuses awarded to its executives for peddling shoddy securities to the American public.
Pecora became an unlikely hero to a beleaguered nation. The man whom the press called "the hellhound of Wall Street" was the son of a struggling factory worker. Precocious and determined, he became one of New York's few Italian American lawyers at a time when Italians were frequently stereotyped as anarchic criminals. The image of an immigrant lawyer challenging a blue-blooded Wall Street tycoon was just one more sign that a fundamental shift was taking place in America.
By creating the sensational headlines needed to galvanize public opinion for reform, the Pecora hearings spurred Congress to take unprecedented steps to rein in the freewheeling banking industry and led directly to the New Deal's landmark economic reforms. A gripping courtroom drama with remarkable contemporary relevance, The Hellhound of Wall Street brings to life a crucial turning point in American financial history.