How Banks with Leaders Experienced in Past Crises Fared in Global Financial Crisis

Regulators and policymakers have asserted that the public was “blindsided” by the “perfect storm” that caused the 2007-2009 global financial crisis (GFC, e.g., Financial Crisis Inquiry Commission [FCIC] 2011; Appelbaum 2015). Academic research has similarly found that market participants, including bank CEOs, generally did not recognize the severity of the crisis or respond effectively (e.g., Fahlenbrach and Stulz 2011; Desai, Rajgopal, and Yu 2016). As the FCIC concluded, “[the] greatest tragedy would be to accept the refrain that no one could have seen [the GFC] coming…If we accept this notion, it will happen again” (2011). These concerns are particularly salient … Read more

Corporate Governance and Crowdfunding

In a recent paper, we focus on the expected agency problems in equity crowdfunding markets and the governance mechanisms that might mitigate them.

In equity crowdfunding, there are two pronounced problems that result from significant information asymmetry associated with small firms and their investors. The first involves adverse selection, which posits that the pool of firms seeking to raise capital in equity crowdfunding may not have as high expected (risk-adjusted) returns as does the pool of firms trying to raise capital outside of equity crowdfunding. In the absence of prospectus requirements, it is very hard for a large number … Read more

Cleary Gottlieb Discusses FSOC Proposal to Change SIFI Designation Process

On March 6, 2019, the Financial Stability Oversight Council (“FSOC”) issued new proposed guidance (the “Proposal”) regarding the designation of nonbank financial companies as “systemically important financial institutions” (“SIFIs”).[1] The Proposal makes substantial changes to FSOC’s existing designation approach by shifting its focus away from an “entity‑based” approach towards an “activities‑based” approach. Designation of an individual firm would only occur if FSOC determined that efforts to address the financial stability risks of that firm’s activities by the primary federal and state regulators have been insufficient.

In summary, the Proposal:

  • Requires FSOC to focus

Read more

Debevoise & Plimpton Discusses the Rise of Secured Bonds in M&A Deals

Early 2019 has seen a wave of issuances of secured bonds to finance large acquisitions. The likelihood of slower rate increases by the Fed has led to an uptick in investor demand for secured bonds while making the pricing on such bonds more attractive for issuers. While issuers in recent years generally preferred term loans to bonds, last month, Dun & Bradstreet, TransDigm and CommScope increased the size of their secured bond tranches in response to investor demand. This update reviews some key considerations when issuing secured bonds in lieu of term loans or unsecured bonds.

Key Considerations

Call ProtectionRead more

Disruption and the Credit Markets

In the past 30 years, defaults on corporate bonds have been substantially higher than the historical average. Dividing the years from 1970 to 2016 into two equal periods, the default rate of U.S. corporate bonds rose from 0.12 percent to 0.46 percent, almost quadrupling. The figure below illustrates this development. In a recent working paper with Victoria Ivashina of Harvard, we investigate the role of corporate disruption in this trend.

If disruption is the process whereby new firms appear, using new technology and new business models, why would it affect default rates? Precisely because disruption involves new firms displacing old, … Read more

Billionaire Taxes

U.S. Senator Elizabeth Warren recently proposed an ultra-high-net worth tax that would raise hundreds of billions of dollars in revenue per year while taking no money from 99.9 percent of U.S. households.  Warren would annually tax household fortunes above $50 million at 2 percent of their value, and fortunes above $1 billion at 3 percent.  In the U.S., 99.5 percent of households have a net worth below $16.5 million, according to the Survey of Consumer Finance.  Even highly successful, hard-working, and well-educated people are extremely unlikely to pay a dime because of this proposed tax.

You do not have to … Read more

Debevoise & Plimpton Discusses Responsible Investment as an Opportunity for European Funds

European private equity fund managers are well aware that demonstrating a commitment to responsible investment is becoming an essential component of a smooth and successful fundraising. Regulation is only one of the drivers for that change, but it is an increasingly significant one, and two recent developments are characteristic of the changing regulatory landscape. They also highlight an opportunity for private equity fund managers – many of whom are already focused on ESG (“environmental, social and governance”) considerations when making and managing portfolio investments.

The first development comes from the UK’s Financial Reporting Council (FRC), a body that regulates accountants … Read more

Making Consumer Finance Work

In early 2009, with the financial crisis still raging, progressive policymakers  passed legislation upending the credit card industry. This legislation precluded card issuers from changing interest rates without sufficient warning or charging exorbitant late fees. Congresswoman Carolyn Maloney, who sponsored the legislation in the U.S. House, deemed it “historic” protection for consumers from deceptive bank practices. Conversely, Jamie Dimon, CEO of JPMorgan, postulated that restrictions on repricing would cause his bank to stop providing credit to 15 percent of its customers.

A few months later, the Federal Reserve amended its rules to disallow the levying of overdraft fees on consumers … Read more

Enforcing Preliminary Agreements

Contract formation in commercial transactions can be an expensive and intricate process involving multiple stages and players, as well as significant investments in expertise and information.  In complex asset purchases, leases, corporate acquisitions, or venture financing transactions, to name just a few types, it is practically impossible for the parties to execute a fully stipulated and binding contract in a single meeting or over a very short period of time.  Negotiations of these transactions are typically sequenced, with a subset of issues being addressed at each stage and by numerous agents with different expertise.  The parties frequently enter into preliminary … Read more

Double Trouble: An Analysis of IRS Attention and Financial Reporting

Existing research provides limited insight into what draws the attention of tax authorities to public information and how that information is used in the process of examining corporate tax positions.  For publicly traded firms in the U.S., the Internal Revenue Service (IRS) has access to both public and private information from the publicly mandated disclosures required by the Securities and Exchange Commission (SEC) and the IRS’ own private disclosures submitted via a corporate tax return.  The use of public information provides additional data to the IRS that can be used in the enforcement process to complement private information provided on … Read more

How the Tax Code Should Account for Automation

Bill Gates, founder of software giant Microsoft, has suggested that robots be taxed, with the revenue generated used to educate and train the U.S. labor force. While Amazon’s Alexa has her own opinion (more on that in a moment), commentators harbor mixed emotions regarding Gates’ suggestion. And for good reason.

If the economy stays on its current trajectory and automation continues unabated, the labor market risks contracting.  Said differently, while every day the so-called Technology Era ushers in new jobs, on balance, more may be lost than gained.

The current U.S Internal Revenue Code (“Tax Code”) exacerbates matters. It imposes … Read more

When Good Incentives Are Not Enough: The Quest for Financial Data Standardization

Data standardization – the process of developing and implementing rules for how data are described and recorded – offers significant benefits for financial firms and regulators.  Nonetheless, the topic has received only scant attention from academics, and regulatory efforts to promote standardization lag far behind the levels that would be optimal.  In a new paper, The Data Standardization Challenge, available here, we examine the myriad public and private benefits from standardization and the many frictions favoring the status quo.  We further use data standardization as a case study that illuminates the banal but meaningful forces that often lead … Read more

Auditing Is Too Important to Be Left to the Auditors!

Clemenceau was right.[1]  Reforming a profession cannot be left to the professionals. A cascade of auditing scandals — in the U.K., the U.S., Europe, and South Africa — has convinced many that reform is necessary. The political reaction has been the most intense in the U.K., where two governmental reports were released last month, each sharply critical of the auditing profession and its regulation. One has called for a new audit regulator that would be financially independent of the industry,[2] and the other by the U.K.’s Competition and Markets Authority (“CMA”) has proposed a number of measures to … Read more

How Investors React to Corporate Communications on Twitter, YouTube, and Instagram

Can social media help firms improve communication with investors? In a recent paper, I argue that social media communication can give a firm an advantage over competitors in attracting attention to earnings announcements and lead to stronger price reaction to news announcements. This is because investors have limited resources for acquiring and processing to information, and social media makes it easy for them—and particularly retail investors—to learn about company results.

To test the hypothesis, I look at FTSE100 companies that are active users of social media. For example, 64 percent of FTSE 100 companies used Twitter to communicate with investors … Read more

Wachtell Lipton Offers Acquisition Financing Year in Review: From Break-Neck to Brakes-On

The credit bull market finally exhibited signs of fragility in the fourth quarter of 2018, putting the brakes on what had seemed poised to be another banner year for corporate borrowers.  The skies may yet clear, but for savvy borrowers the New Year is a good time to prepare for turbulence.  Looking ahead to 2019, we contemplate strategies for M&A in choppy financing markets, the practical impact of credit rating downgrades, and the risks posed by the rise of “default activism” in the debt markets.

The Financing Markets in 2018: A Sharp Transition

A Hot Start… 

Through its first three … Read more

How Lenders React When Activists Target Borrowers

A number of recent news stories have recounted the quick and dramatic changes that activist hedge funds trigger in the companies they target. In the Atlantic magazine, for example, a 2016 article describes DuPont’s decision to cut 10 percent of its workforce in response to an activist campaign by investor Nelson Peltz and his company Trian Fund Management. The recent saga involving David Loeb’s Third Point hedge fund and Campbell Soup illustrates the typical pattern where activist investors take a small but meaningful stake in a target company and demand significant say over the strategic and financial policies of the … Read more

Is It Time to Get Rid of Earnings-per-Share?

Do U.S. companies focus too much on short-term profits at the expense of long-term investments, profits, and growth? There is considerable debate among academics, practitioners, and politicians about the relevance of short-termism, its possible sources, and potential mechanisms to mitigate it.

In a recent article, I propose that earnings-per-share (EPS) targets are a very likely driver of short-termism and discuss what we can do to break the link between EPS targets and short-termism. Earlier survey evidence shows that managers admit to short-termism driven by earnings management—they are willing to sacrifice positive net present value long-term investments to meet earnings goals.… Read more

Why Dismantling Nonbank SIFI Regulation Is a Serious Mistake

The unnerving events of fall 2008 removed all doubt that investment banks and other nonbank financial firms can propagate systemic risk and endanger the world’s financial system.  In response, Congress instituted a robust system for regulating systemic risk posed by nonbanks.  The Dodd-Frank Act created two approaches to nonbank systemic risk regulation.  The first, known as entity-based regulation, authorized the new Financial Stability Oversight Council (FSOC) to designate individual nonbank financial firms as systemically important financial institutions (SIFIs) for heightened regulation and oversight by the Federal Reserve.  The second, dubbed activities-based regulation, gave FSOC the power to make … Read more

Bitcoin Futures: From Self-Certification to Systemic Risk

December 2017 marked a milestone in the short history of virtual currency. On Friday, December 1, 2017, the Chicago Mercantile Exchange Inc. (CME) and the CBOE Futures Exchange (CFE) self-certified new contracts for cash-settled bitcoin futures products. The self-certification process allows designated contract markets (DCMs) to list new derivative products one day after submitting in writing to the Commodity Futures Trading Commission (CFTC) that the product complies with the Commodity Exchange Act (CEA) and CFTC regulations.

Prior to December 2017, there were limited options for investors that wanted access to bitcoin derivatives. In 2014, TeraExchange, LLC, a Swap Execution Facility … Read more

Skadden Discusses Proposed Updates to Banking Rules for Derivative-Contract Exposure

On October 30, 2018, the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency (collectively, the agencies) jointly invited comment on a proposed regulation that, if adopted, should provide regulatory capital relief for certain derivative exposures. If adopted, the regulation would amend the agencies’ risk-based and leverage capital requirements for banking organizations. The proposal is subject to public comment for 60 days following its publication in the Federal Register.

The proposal would implement a “standardized approach for counterparty credit risk” (SA-CCR) to replace the current exposure methodology … Read more