The analysis of corporate governance has been a strikingly one-sided affair. The focus has been almost exclusively on “internal” checks and balances, namely scrutiny of executives by the board of directors and by shareholders. In contrast, mechanisms that can operate as significant “external” checks on managerial discretion have been largely ignored. My recent paper, “Corporate Governance and Countervailing Power,” functions as a corrective to the prevailing trend. The paper focuses on three historically important examples of external constraints on managerial discretion, namely state regulation of corporate activity, competitive pressure from rival firms, and organized labor. A unifying feature … Read more
On September 13, the SEC’s Division of Investment Management withdrew two interpretive letters issued in 2004 to Egan-Jones Proxy Services (“Egan-Jones”) and Institutional Shareholder Services, Inc. (“ISS”). The letters described some of the guidelines under which an investment adviser could rely on a proxy advisory firm as an independent third party for purposes of making proxy voting recommendations. In particular, the letters focused on the steps an investment adviser should take to ensure that voting recommendations were made in an impartial manner and that the proxy advisory firm’s potential conflicts of interest were addressed. The SEC staff stated that it … Read more
Today the CLS Blue Sky Blog presents a debate about the role of deregulation in contributing to the financial crisis of 2007-2009. Our columnists are Professor Paul G. Mahoney at the University of Virginia School of Law, Professor Arthur E. Wilmarth, Jr., at The George Washington University Law School, and Professor Kathryn Judge at Columbia Law School. Their pieces are posted below.… Read more
From the New Deal until the 1970s, banks were on a tight leash. Regulators controlled the rate of interest they could pay on deposits. Banks could not underwrite or deal in corporate securities. With some exceptions, they could not expand geographically.
These restrictions were gradually eliminated beginning in the 1970s. Simultaneously, banking grew riskier. From the end of World War II to 1970, bank failures were virtually nonexistent. From that time on, the U.S. experienced waves of bank distress culminating in the financial crisis of 2007-09.
It is tempting to conclude that the deregulation caused the instability. I believe, however, … Read more
The financial crisis of 2007-09 caused the Great Recession, the most severe global economic downturn since the Great Depression. The financial crisis began with the collapse of the subprime mortgage market in the U.S. and spread to financial markets around the world. Similarly, the disastrous financial events of the Great Depression began with the Great Crash on Wall Street in October 1929 and spread throughout the U.S. and Europe during the early 1930s.
Congress responded to the Great Depression by passing the Glass-Steagall Banking Act of 1933. Two of Glass-Steagall’s key provisions – Sections 20 and 32 – separated … Read more
In their lively disagreement about the role of deregulation in contributing to the 2007-2009 financial crisis, professors Arthur Wilmarth and Paul Mahoney inadvertently illuminate why the processes through which finance is regulated are so ill-suited to that purpose. Finance is dynamic. Today’s financial system bears only a coarse resemblance to the financial system of the 1950s. Tomorrow, the system will evolve yet further and in ways we may not be able to imagine today. In contrast, the legal regime is designed to stagnate. Frictions make statutes and regulations difficult to change, even when market changes have already altered the substantive … Read more
Credit Default Swaps (CDSs) enable lenders to distribute credit risk to parties more willing and able to bear it, thereby enhancing the liquidity and flexibility of individual lenders and the financial system (Greenspan 2004). However, empirical evidence suggests that CDSs lead to a significant decline in the rigor and efficiency of monitoring by lenders (e.g., Ashcraft and Santos, 2009; Parlour and Winton 2013; Subrahmanyam, Tang, and Wang 2014). In our paper, “Credit Default Swaps and Managers’ Voluntary Disclosure,” we predict and find that CDS reference firms enhance their voluntary disclosure to offset the negative effect of reduced lender … Read more
M&A activity in August, like July, continued the recent downward trend in number of deals across most sectors while showing more mixed results as measured by total dollar value. The number of deals decreased in the U.S. by 39.4% to 274 and globally by 19.2% to 2,027 (the third consecutive month with the lowest levels since the beginning of this publication in 2012). However, deal volume by dollar value increased in the U.S. by 10.1% to $136.47 billion while it decreased globally by 6.6% to $275.93 billion.
Strategic vs. Sponsor Activity
The number of strategic deals decreased by 43.2% … Read more
Today, the Office of the Chairman and the Division of Investment Management at the Securities and Exchange Commission suddenly raised questions about long-resolved issues regarding shareholder voting. Because the Investor Advisory Committee’s critical work in this area is ongoing, it’s important to clarify the path ahead for those interested in giving shareholders real access to the levers of corporate democracy.
First, the law governing investor use of proxy advisors is no different today than it was yesterday. The Commission has long recognized that proxy advisors—the companies that develop recommendations regarding how investors should vote on corporate questions—serve an important … Read more
In 2008, the U.S. Department of the Treasury’s Advisory Committee on the Auditing Profession called for a “standard-setting initiative to consider mandating the engagement partner’s signature on the auditor’s report” as a way to increase audit transparency. The Public Company Accounting Oversight Board (PCAOB) considered this call, weighing investor benefits (e.g., increased transparency) against potential costs to the audit profession (e.g., increased litigation risk and administrative costs). After considerable discussion with registrants, investors, and audit firms, the PCAOB responded in December 2015 by enacting Rule 3211, Auditor Reporting of Certain Audit Participants.
The new rule mandates that auditors … Read more
Since the financial crisis, much of the business media have focused on the level of CEO compensation and how much it increases from the prior year, often calling out the CEOs with the highest pay. These articles in the New York Times and Fortune are good examples. Concerns about pay levels provided at least some of the impetus for the adoption of mandatory but non-binding say-on-pay voting in the United States, beginning at 2011 annual meetings for large public companies. These say-on-pay votes allow investors to express their opinions about a company’s executive compensation. Prior research supports the idea that … Read more
In this age of firebrand political rhetoric and sniping from the right and the left, Wall Street has taken more than its fair share of criticism. One of the most significantly misplaced criticisms, however, derives from a gross misunderstanding of how the invisible hand of the market works and how certain mechanisms improve the health of firms and the market overall, delivering value for a broad swath of stakeholders—managers, investors, and employees alike.
In his 1965 “Mergers and the Market for Corporate Control,” Henry Manne describes how market competition helps regulate the behavior of managers. Managers that pursue objectives counter … Read more
In the aftermath of the 2007—2009 financial crisis, policymakers around the globe responded to calls for greater transparency in the financial system by adopting new rules and institutions that required more and better information disclosure by financial institutions. For example, the Dodd-Frank Act required the Federal Reserve Board to publish the results of periodic stress tests administered to the largest financial institutions. In spite of the recent flurry of regulations, the jury is still out on whether they enhance the stability and development of the financial system.
The lack of consensus is largely based on conflicting predictions from the theoretical … Read more
On September 7, 2018, after considerable industry feedback and two issuances of temporary relief, the Financial Crimes Enforcement Network (FinCEN) issued permanent relief to the banking industry from the requirement to collect beneficial ownership information on certain accounts that automatically renew or rollover. Banks should incorporate these revised requirements into their anti-money laundering (AML) programs to ease their information collection efforts and avoid unnecessarily burdening customers.
The relief is provided in response to industry concerns that treatment of renewals and rollovers as “new accounts” was inconsistent with current industry practice and “[a]ny delay by the customer in providing the … Read more
As we approach the 10-year anniversary of the failure of Lehman Brothers, the news is again awash in a debate about whether policymakers could have saved the investment bank. That the issue remains so deeply contested reflects how fundamentally flawed the current legal regime is. Although embodying ideas that are sensible in the abstract, the regime makes the authority to act contingent on facts that policy makers cannot readily discern during periods of systemic distress. Making matters worse, subsequent events, including other actions by those same policy makers, can further skew the critical facts on which legal authority rests. This … Read more
Growing evidence that the personal characteristics of CEOs affect firm policy choices and performance prompts us to investigate the implications of CEO turnover for the value of a company. In a recent paper, we examine whether CEO succession gaps (i.e., the difference in characteristics between predecessor and successor CEO) have any influence on firm performance.
A change at the top is often considered good for a company, but evidence suggests that under certain conditions continuity is advisable. To address this, we seek to identify the characteristics of succession events involving CEOs with radically different personal traits that could harm firm … Read more
Issuers, investors, and regulators are paying increasing attention to corporate sustainability. Commentators have proffered a variety of explanations for this attention ranging from the argument that corporations are morally obligated to act in a socially responsible manner to the claim that sustainability is linked to economic performance. Responding to the demand for sustainability information, issuers are producing hundreds of pages of sustainability reports, and the number of intermediaries that have developed reporting standards and sustainability rating systems has proliferated. The range of approaches to disclosure, however, limit the comparability and reliability of the information disclosed, and investors repeatedly express dissatisfaction … Read more
The 10th anniversary of the harrowing financial events of September 2008 is nearly upon us. The anniversary will undoubtedly be marked by various retrospectives analyzing those events. For a longer-term perspective, though, it may be helpful to consider another anniversary that will be observed in September 2018: the near failure of Long-Term Capital Management, L.P. and its fund, Long-Term Capital Portfolio, L.P. (collectively “LTCM”) 20 years ago. LTCM was the largest hedge fund operating in the United States and its brush with death provided a preview of some of the forces that would contribute to the near collapse of the … Read more
Private firms can gain access to capital markets in several ways. The most well-known approach is through an initial public offering (IPO) of equity, and high-profile firms typically attract a large amount of attention from the popular press when they go public. However, a less publicized approach is going public through an initial public debt offering (IPDO), an alternative option for tapping public markets. One example of an IPDO firm that issued public debt (through a private subsidiary) before issuing public equity is United Parcel Service Inc. The company was founded in 1907, filed its IPO S-1 registration statement on … Read more
By adopting a systematic cross-national comparative approach, my recent study provides an overview of corporate governance (CG) around the world. It takes stock of what we know about the two main CG models, the variations within and across these models, as well as the worldwide diffusion and possible convergence of CG practices.
Although there is a range of different regimes of CG in advanced economies, the literature on comparative CG focuses on two: the shareholder-oriented model (prevailing in Anglo-Saxon countries) and the stakeholder-oriented model (prevailing in Germany, Japan, and continental Europe, Aguilera & Jackson, 2003). While the former prioritizes a … Read more
Hedge fund activists are technically just minority shareholders, yet they exert enormous influence, often forcing companies to undertake fundamental restructuring and substantially increase stock buybacks and dividends. For instance, Third Point Management and Trian Fund Management, holding only 2 percent of the outstanding stock of Dow Chemical and DuPont, respectively, engineered a merger-and-split of America’s top two chemical giants at the end of 2015 that resulted in massive layoffs and the closure of DuPont’s central research lab, one of the first industrial science labs in the United States. How did hedge-fund activists gain such power?
In the 1980s, predatory value … Read more
On August 24, 2018, the United States Court of Appeals for the Second Circuit issued its long-awaited decision in United States v. Hoskins, rebuffing an attempt by the US Department of Justice (the Department, or DOJ) to expand the jurisdiction of the anti-bribery provisions of the Foreign Corrupt Practices Act (FCPA) using the conspiracy and aiding-and-abetting statutes to reach individuals who otherwise cannot be prosecuted for violating the statute.
The government alleged that Lawrence Hoskins, a non-US citizen employed by Alstom S.A.’s UK subsidiary, was part of a scheme to bribe Indonesian government officials to secure a US$118 … Read more
The manner in which financial firms are governed directly affects the stability and sustainability of both the financial sector and the “real” economy, as the financial crisis and associated regulatory reform efforts have tragically demonstrated. However, two fundamental tensions continue to complicate efforts to reform corporate governance in post-crisis financial firms.
The first relates to reliance on increased equity capital as a buffer against shocks and a means of limiting leverage. The tension here arises from the fact that no corporate constituency desires risk more than equity does—and that risk preference only tends to be stronger in banks, and at … Read more
Pay disparity between executives and employees has been criticized as evidence of corporate greed. It can also create perceptions of unfairness and dissatisfaction among employees, weakening their commitment and performance. To provide more information about pay disparity, the U.S. Congress enacted Section 953 (b) of Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, which requires all publicly listed firms to disclose a Pay Ratio comparing annual CEO compensation with median annual employee compensation, excluding the CEO. Proponents of Section 953 (b) assert that the information helps investors understand and evaluate CEO compensation within a specific firm. However, critics … Read more
As of 2017, 172 of America’s 200 largest companies, ranked by revenue, were publicly traded. Public company dominance of the corporate economy of the United States has existed for decades. There has been much speculation recently that this era may be ending, reinforced by a marked decline in the number of public companies since 2000. My forthcoming article, “Rumours of the Death of the American Public Company are Greatly Exaggerated,” argues that this pessimistic take on the public company misses the mark in important respects.
Why might the American public company be in peril? Exit and entry to … Read more
On March 14, 2018, the Securities and Exchange Commission charged a former chief information officer of Equifax with insider trading. The complaint alleged that he profited from selling stock ahead of the September 2017 public announcement of a major cybersecurity breach at the company involving the data of 148 million customers. The high-profile nature of the incident prompted federal prosecutors to investigate how much of this sort of insider trading may be occurring.
In a recent Wall Street Journal Online article, William Hinman, a senior SEC official, states that the agency intends to clamp down on this practice. He suspects … Read more
In addition to providing legal protection, patents serve a disclosure function aimed chiefly at inventors and technology customers. However, the effect of this disclosure on capital markets has been left largely unexamined in the literature, creating a gap in understanding of how the capital markets digest the information in patents.
To understand the importance of the disclosure function, consider the challenge faced by firms that continuously invest in research and development. Research and development increase the information asymmetry between a firm and capital markets, leading to uncertainty about the firm’s value and future market position. This uncertainty can adversely affect … Read more
Market reactions to a company’s performance on environmental and other social issues are ambiguous, because it is difficult to measure social and financial performance and how they affect each other. We, however, create a virtual value-weighted portfolio based on the list of “100 Best CSR companies in the world” published by Reputation Institute and show that investing in this portfolio could provide investors annual abnormal returns of between 1.98 percent and 2.74 percent.
Corporate social responsibility (CSR) facilitates the integration of business operations with values so that the interests of all stakeholders—including customers, suppliers, employees, communities, governments, society, and the … Read more
The role of sell-side equity analysts in the capital markets has been researched extensively by academics over the past several decades. In contrast, due to data limitations, there has been little research on buy-side analysts. Buy-side analysts work for institutional investment firms and have different incentives and responsibilities than do their sell-side counterparts working at brokerage firms. That makes buy-side analysts not only worthy of study in their own right, but also makes it unclear whether the inferences and conclusions from the sell-side analyst literature also apply to buy-side analysts. While it is widely assumed that buy-side analysts conduct fundamental … Read more
The rapid proliferation of state statutes authorizing so-called “benefit” corporations—starting with Maryland in 2010 and spreading to over 30 states by 2018—has been premised in large part on the assertion that conventional corporate law mandates shareholder primacy. Under this legal mandate, the board of directors of a for-profit corporation must manage the business solely for the benefit of its shareholders. With the aim of maximizing shareholder wealth as a board’s singular focus, concerns for other, non-shareholding stakeholders, the public, and the environment are irrelevant except to the extent such concerns implicate the corporation’s profits.
Citing conventional corporate law’s mandate of … Read more
The CLS Blue Sky Blog seeks to focus on current events, and the president has given us an opportunity. He has suggested a shift from a quarterly to a six-month reporting cycle. How would this proposal affect the cost of capital, stock prices, liquidity, the bid/asked spread, and the asserted pressure on managers to sacrifice long term value for short term profit? Below are the views of our five columnists: John C. Coffee, Jr., James D. Cox, Donald C. Langevoort, Joshua R. Mitts, and Charles K. Whitehead.… Read more
Earlier this month, the CEO of Pepsi Co. suggested to President Trump that eliminating quarterly reporting (and shifting to biannual reporting) would reduce the pressure on managers to focus on the short-term. As impulsive as Elon Musk, the president bought this view hook, line, and sinker and tweeted his proposed shift to the world (and a probably startled SEC).
But what will be the actual impact? Those who have a law and economics orientation will predictably respond that widening reporting frames will present investors with greater uncertainty and risk, with the result that stock prices should decline (and the cost … Read more
Robust capital markets are widely believed to signal economic vitality, and a reliable barometer of such vitality was historically a rising number of IPOs and listings. Yet, as we are experiencing record setting economic expansion, that barometer has failed us. There has been a 20-year slide in the number of listed companies and the tepid-to-non-existent growth in IPOs. The number of listed companies peaked in 1997; listings today are below their level in the early 1970s. And the annual number of IPOs has never returned to their level in the 1990s. These developments have caused conservative politicians predictably to blame … Read more
I should be a prime candidate to support the lengthening of the financial reporting cycle from three to six months, as the White House—and many others—now say they want the SEC to do. I want public corporations to be more sustainable and managed for the long run and doubt that they currently are to a sufficient degree. America and the world need large firms willing and able to build for a shared future, not just deliver dividends and capital gains to investors in the here and now.
So if I thought that going to semi-annual reporting would move the markets … Read more
Trading in U.S. equity markets is fast and cheap. While proponents of ending quarterly reporting point to the dangers of short-termism, less frequent disclosure is also likely to lead to a decline in liquidity and to greater trading costs. The SEC should carefully consider the effect of increasing asymmetry on the flow of investment capital in secondary markets.
For decades, economists have pointed out that asymmetric information inhibits trade, beginning with George Akerlof’s famous observation that nobody will buy used cars if there is a high enough chance that some are lemons. In modern financial markets, the risk of … Read more
President Trump has directed the Securities and Exchange Commission to study whether a public company’s reporting requirements should shift from a quarterly to semi-annual schedule. Doing so, according to the president, “would make business (jobs) even better in the U.S.” and “allow greater flexibility & save money.”
The president’s views fit within the larger debate over whether public companies focus too much on short-term results. There can be little harm (or dissension) in studying the current reporting requirements. In fact, this may be one of those rare cases when Democrats and Republicans agree. Nevertheless, specifically directing the SEC to … Read more
Commercial real estate (CRE) lending is a risky activity that still dominates the business model of many modestly capitalized small and medium-sized banks. Bank supervisory and regulatory reforms recently enacted have reflected some of the lessons from the Great Financial Crisis of 2008 (GFC), but still underplay the importance of CRE lending and instead focus on bank size and nontraditional banking activities. My analysis (see Commercial Real Estate: How Vulnerable Are U.S. Banks?) shows that although banks have adapted their CRE lending practices, CRE loans have grown substantially among many small and medium-sized banks, defined here as those with … Read more
While “The Accountable Capitalism Act” introduced on August 15 by Senator Elizabeth Warren contains several very worthwhile provisions, it is premised on the federalization of all public corporations with revenues in excess of $1 billion. Mandatory federal incorporation and the creation of a federal office to make regulations and supervise compliance would be a major incursion into state corporation law. It is reminiscent of proposals by Ralph Nader some half-century ago to achieve control of major corporations by mandatory federal incorporation. Warren’s proposal should not receive any more support than Nader’s. However, like Nader’s proposal led to significant changes in … Read more
Legal academics and practitioners have long emphasized the important role that disclosure plays in the initial public offering (IPO) process. Issuers and their underwriters provide information via a prospectus and corresponding IPO roadshow to mitigate the information gap between the insiders of the firm and prospective investors. Evidence across a range of studies finds that the reduction in information asymmetry lowers firms’ issuance costs (cost of capital) and allows them to raise more equity in the offering. Studies are largely silent, though, on how investors learn of the IPO firm as a potential investment. Classic finance theory suggests that before … Read more
Did insider trading law almost devolve into an effort to define what kind of relationship a tipper and tippee must have for a defendant to be liable? And was any federal judge or jury qualified to say? Since the Second Circuit’s decisions in United States v. Newman and United States v. Martoma, courts, prosecutors, and regulators no longer need to figure out what a “meaningfully close personal relationship” is. Now, merely giving a tip to a complete stranger may actually violate Rule 10b-5.
Newman was the kind of case that my superiors at the Securities and Exchange … Read more
Amendments to the Delaware Limited Liability Company Act (the “DLLCA”) previously introduced in April 2018 were signed into law on July 24, 2018. The amendments enable a Delaware limited liability company (an “LLC”) to engage in several new forms of transactions including: the (1) division of an LLC into two or more separate LLCs, (2) formation of registered series of LLCs and statutory public benefit LLCs and (3) use of blockchain technology for maintenance of LLC records and for electronic transmissions.
I. Division of LLCs
Effective August 1, 2018, an LLC may divide itself, and its assets … Read more
What motivates a firm to disclose information rather than remain silent following a material, negative economic event? For example, why did oil companies issue multiple, detailed disclosures about oil spills caused by Hurricane Katrina and Hurricane Rita but not disclose information about oil spills of similar or even larger sizes caused by equipment failures and human error?
Our recent study, “Tip of the Iceberg? The Level of Blame and Disclosure Propensity,” examines whether firms are less likely to disclose information regarding material, negative economic events for which they are likely to be blamed. We define a “blamed event” as a … Read more
New legislation to reform review of foreign direct investment in the United States — the Foreign Investment Risk Review Modernization Act of 2018 (FIRRMA) — has just been signed into law. FIRRMA will bring significant changes to the framework according to which the Committee on Foreign Investment in the United States (CFIUS, or the Committee) conducts foreign investment review. This Client Alert briefly recaps the events leading up to FIRRMA’s passage and highlights several of the law’s most important provisions.
An appreciation of the events leading up to FIRRMA’s final form is necessary to understand the scope, significance, … Read more
The emergence of “activist” investors across a range of markets has been one of the most interesting phenomena of the past few decades (see here, here and here). These investment funds seek to capture rents from their investments by “actively” enforcing their rights. Activist investors pursue this strategy in markets in which the majority of investors are passive. Much of the discussion of this development in both the financial press and the academic literature has focused on activists acquiring equity positions in order to influence a firm’s management policies (see here and here). Our focus, however, is … Read more
On July 31, 2018 the Office of the Comptroller of the Currency (“OCC”) announced it will begin accepting applications from non-depository FinTech companies for a special purpose national bank charter.  This announcement caps a years-long and much anticipated initiative by the agency to make federal banking charters available to FinTech firms (see our prior analysis, here and here describing previous developments).
The OCC’s action came on the same day that the Treasury Department released the fourth report (the “Report”) mandated by Executive Order 13772, setting forth the Trump administration’s “core principles” for regulating the U.S. financial system. The … Read more