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Abstract:
Using a large hand-collected dataset from 2001 to 2006, we find that activist hedge funds in the U.S. propose strategic, operational, and financial remedies and attain success or partial success in two thirds of the cases. Hedge funds seldom seek control and in most cases are nonconfrontational. The abnormal return around the announcement of activism is approximately 7%, with no reversal during the subsequent year. Target firms experience increases in payout, operating performance, and higher CEO turnover after activism. Our analysis provides important new evidence on the mechanisms and effects of informed shareholder monitoring.

Hedge Fund, Activism, Governance

Abstract:
In this paper, we review Pay Without Performance by Professors Lucian Bebchuk and Jesse Fried. The book develops and summarizes the leading critiques of current executive compensation practices in the U.S., and offers a negative, if mainstream, assessment of the state of U.S. executive compensation: U.S. executive compensation practices are failing, and systemic reform is needed. This review summarizes the book in some detail and offers some counter-arguments.

The book's thesis is that executive compensation practices are bad for shareholders (not "optimal") because they are the product of "managerial power." Managerial power arises because boards of directors at public companies are not independent of executives. Weak compensation committees thus do little to protect the firm in its pay negotiations with the CEO, leading to levels of executive pay that are both inappropriately high and have inappropriately low levels of incentives.

The authors offer a four part analysis of CEO pay. First, they describe and critique optimal contracting theory, which posits that executive compensation arrangements are designed to benefit shareholders. Second, they explain managerial power theory, in part through an in-depth analysis of current executive compensation practices. They assert the managerial power theory provides a superior explanation of current practices to the optimal contracting perspective. They also draw the strong implication that if managerial power exists, it means that something is wrong with the contracting process. Third, they claim that CEO compensation does not vary sufficiently with firm performance. They conclude with policy recommendations for changing compensation plans and improving corporate governance, for example by requiring that directors be more independent.

We agree that it is useful to consider the effect of managerial power on compensation, but we disagree with their interpretation of the consequences of this power. It is true that contract structures reflect CEO power, and that CEOs with more power get more pay, but this does not necessarily lead to the conclusion that CEO pay is not optimized for shareholders, nor does it imply that CEO pay needs reform. We show that in many settings where managerial power exists, observed contracts anticipate and try to minimize the costs of this power, and therefore may in fact be written optimally. As a result, the optimal contracting and managerial power perspectives are complementary, and not competing, explanations.

We next examine Bebchuk and Fried's claim that U.S. compensation is inefficient "pay without performance." Their analysis focuses on whether CEO annual pay varies with firm performance. While the book conducts an extensive analysis of the incentives provided by annual grants of stock options and equity it largely ignores the main source of CEO incentives: Large holdings of stock and options. These large equity holdings provide powerful performance incentives and ensure that the wealth of most CEOs varies strongly with their firm's stock price. The books' claim that CEO compensation is "pay without performance" does not appear correct once one considers this main source of CEO incentives. U.S. executives have very large pay-performance incentives, and their overall pay levels do not seem inappropriate.

We conclude by examining some of Bebchuk and Fried's policy recommendations. Bebchuk and Fried have missed some important aspects of executive pay and incentives. They have not shown that there are systematic failures with U.S. CEO compensation, and therefore have not shown that reform is needed.

CEO compensation, stock options, equity incentives, corporate governance

Abstract:
Hedge fund activism is a new form of arbitrage. Using a large hand-collected data set from 2001 to 2006 we find that activist hedge funds in the U.S. propose strategic, operational, and financial remedies and attain success or partial success in two-thirds of the cases. The abnormal stock return upon announcement of activism is approximately seven percent, with no reversal during the subsequent year. Target firms experience increases in payout, operating performance, and higher CEO turnover after activism. We also find large positive abnormal return to the self-reported hedge fund activists during our sample period. The abnormal return significantly exceeds the returns to all hedge funds, the returns to equity-oriented hedge funds and is robust to alternative risk adjustments and selection biases.

Hedge Fund, Activism, Governance

Abstract:
In this paper, we examine the key legal characteristics of 375 employment contracts between some of the largest 1500 public corporations and their Chief Executive Officers. We look at the actual language of these contracts, asking whether and in what ways CEO contracts differ from what are thought of as standard employment contract features for other workers. Our data provide some empirical answers to several common assertions or speculations about CEO contracts, and shed light on whether these contracts are negotiated solely to suit the preferences of CEOs or have provisions that insure that the employers' interests are also safeguarded.

After giving an overview of the general characteristics of a CEO employment contract, and the process by which they are negotiated, we focus on five contracting issues: (1) the term just cause that defines when an executive can be terminated involuntarily with penalties; (2) the good reason termination clauses in the contract that permit an executive to leave voluntarily without financial penalties; (3) the non-competition clauses in the contract; (4) the use of arbitration clauses as a method of resolving contractual disputes; and (5) the contractual restrictions, if any, on the CEO selling stock options. We also discuss some of the less-well known economic terms of these contracts, including their length and the level of perquisites given to CEOs.

CEO, Employment Contracts

Abstract:
One of the most puzzling aspects of executive compensation is the pay gap that exists between American and foreign Chief Executive Officers (CEOs). Commentators and the financial press have been quick to argue that such differences are the result of high agency costs, or "board capture," a theory that claims powerful American executives take advantage of weak domestic boards of directors and passive, dispersed shareholders to overpay themselves exorbitantly. According to these theorists, American CEOs orchestrate the appointments of friendly, passive outside directors, and their obedient subordinates as inside directors. The net result is a board comprised of compliant directors and a Compensation Committee that lacks the aggressive hard-nosed negotiators needed to keep executive pay in check.

The international pay gap arises, under this theory, because foreign CEOs don't have the same power over their boards. In most foreign corporations, control shareholders act as strong checks on executive pay. Control shareholders will recoup most of the firm's surplus that is not paid out to the factors of production, such as CEOs, and therefore have strong financial incentives to keep executive pay abroad low. Thus, by comparison to U.S. levels, foreign CEOs are paid less.

In this article, I am critical of the board capture explanation and offer several more plausible, market-based explanations. Board capture, while it may lead to some inflation in U.S. CEO pay levels, it does not fully explain CEO pay levels. For example, it does not tell us why executive pay in the U.S. grew so rapidly after the early 1980's. There is no evidence that CEOs' power over their boards grew during this time period; in fact, most evidence is to the contrary. Nor does this theory offer a persuasive explanation of why bigger firms pay their executives more than smaller ones, or why the supply of executives has not dramatically increased in response to the alleged huge rents that CEOs have been receiving for the last twenty years. Furthermore, board capture does not explain why boards pay incoming CEOs so much where they have no prior relationship with the directors. Finally, even if we accept the theory, we still will need a mechanism to set executive pay. Market-driven forces seem necessary to accomplish this result.

I offer four alternative market-based justifications for higher pay for American CEOs. The first rests on the marginal revenue product of executive labor. American CEOs should be paid more, on average, than foreign CEOs because American CEOs contribute more to their firms' value. American firms have greater growth opportunities, have greater resources to be deployed because they are bigger, and American CEOs play a much larger role in the decision-making process at their firms than CEOs at foreign firms. Furthermore, American CEOs receive more of their pay in the form of stock options, and may hold more of their wealth in company stock, than foreign CEOs and therefore their pay will reflect a risk premium.

Next, I examine the international pay gap by examining the workings of corporations' internal labor markets and tournament theory. The tournament to become the CEO is, under this theory, a much bigger one at American firms because these CEOs have so much more power than their foreign counterparts. After all, in the U.S., the CEO is normally also the Chairman of the Board, whereas in foreign countries this is rarely the case. American CEOs' power is further enhanced compared to those of their biggest foreign rivals, Japan and Germany, because boards of directors are smaller in the U.S. than in Japan, and have only one tier, instead of the two tier structure in Germany. Furthermore, the "winner take all" culture in the U.S. may condone bigger prizes in these tournaments than are socially acceptable abroad.

Third, I show that there are differences in the opportunity costs for American and foreign CEOs. The opening up of financial markets since the early 1980s has given U.S. CEOs better access to capital markets for financing their own start-up businesses, raising the value of their alternative opportunities. This occurred first through the use of the leveraged buyout (LBO) as a method of financing a new firm, then with the tremendous growth in venture capital financing, and later on (at least for a period of years) when the technology boom made available massive amounts of capital to finance start-ups. Established American businesses that wished to compete for managerial talent were thereby forced to offer executives larger pay packages.

By comparison, foreign CEOs have not had nearly the same access to financial markets to launch their own businesses. Foreign financial markets are more fragmented, more regulated, offer less venture capital financing and experience fewer MBOs. Only recently has there been an expansion of executive job opportunities with the deregulation of some capital markets and increased managerial migration. These changes have increased pressure on foreign companies to pay their executives more like Americans, but they have yet to catch up.

Finally, there are big differences in the amount of bargaining power that American CEOs have compared to that of foreign CEOs. These differences derive from two important forces at work in the U.S.: first, the shift in the 1980's in the relative bargaining strength of American CEOs in vetoing takeovers of their corporations; and second, the concurrent acceptance of the idea of pay-for-performance by domestic institutional investors. These changes gave American CEOs tremendous power to stop a hostile takeover unless the sale of the firm was perceived as in that executive's personal best interests.

Top managers of foreign firms have not enjoyed the same increase in bargaining power because, while hostile takeovers in most foreign countries continue to be almost impossible to pull off, these firms generally have control shareholder ownership structures. Thus, in foreign firms control shareholders make the decision whether or not to sell the company. There is no reason for the dominant shareholder to offer the firm's CEO more money for agreeing to a sale, unless the CEO happens to be the control shareholder himself.

Abstract:
The large gap between American CEO pay and foreign CEO pay is one of the biggest puzzles in executive compensation. Recent scholarship has suggested that it is the result of board capture. This theory claims that the pay gap arises because in the U.S. passive friendly directors award their CEOs huge pay increases, while in other countries tight-fisted control shareholders suppress CEO pay levels.

This paper criticizes board capture theory and then develops four market-based theories that offer persuasive alternative explanations for the international CEO pay gap. It argues that market forces will determine whether the pay gap will disappear and that current proposals for government intervention will be at best ineffective, and more likely counterproductive.

Abstract:
In this paper, we examine changes in financial instruments and institutions by contrasting the successes and failures of institutional shareholder activism during the 1990s with more recent developments in hedge fund activism and the use of financial innovation. We find that although institutional investor activism was the watch word of the 1990's, overall traditional institutional activism has been of marginal importance at targeted firms. In contrast, there is evidence of real monitoring in the more aggressive recent activism of hedge fund managers, in part because financial innovation has generated a host of new opportunities that did not exist a decade ago.

To illustrate these points, we compare institutional activism and hedge fund activism with respect to voting, litigation, and change of control contests. We also categorize the costs and benefits of four major types of strategies activist hedge funds recently have pursued: information asymmetry and convergence trades; capital structure motivated trades; merger and risk arbitrage; and, most controversially, governance and strategy. We conclude with a discussion of the policy implications of our work, pointing out some of the regulatory challenges created by this new wave of investor activism.

hedge funds, activism, corporate governance, risks, derivatives, institutional investors

Abstract:
Private equity has reaped large rewards in recent years. We claim that one major reason for this success is due to the corporate governance advantages of private equity over the public corporation. We argue that the development of substantial derivative contracts and trading has significantly weakened the governance of public corporations and has created a need for financially sophisticated directors and much closer supervision of management. The private equity model delivers these benefits and allows corporations to be better governed, creating wealth gains for investors.

private equity, corporate governance, contracts, trading, public corporations, subprime

Abstract:
Executive pay arrangements in Britain's publicly quoted companies have been subjected to much criticism in recent years. Proposals that shareholders should have a greater direct say over managerial remuneration have been a by-product of the concerns expressed. Debate on this point, however, has been largely speculative. This is because there is little evidence available in the United Kingdom indicating how shareholders would exercise any new powers they might be given. This paper addresses the evidentiary gap by drawing upon the experience in the United States, where empirical work indicates that shareholder voting only operates as a potential check when pay arrangements deviate far from the norm. In a British context, these findings imply that implementing the shareholder-oriented reforms that have been canvassed recently would fail to address fully the concerns raised by critics of executive pay.

Abstract:
Executive pay arrangements in Britain's publicly quoted companies have been subjected to much criticism in recent years. Proposals that shareholders should have a greater direct say over managerial remuneration have been a byproduct of the concerns expressed. Debate on this point, however, has been largely speculative. This is because there is little evidence available in the UK indicating how shareholders would exercise any new powers they might be given. This paper addresses the evidentiary gap by drawing upon the experience in the United States, which offers much potentially valuable data.

In the United States, the two primary circumstances where shareholders vote on executive pay issues are where a stock option plan is put forward for approval and where a shareholder proposal has been made pursuant to US securities laws. Empirical studies reveal that American investors use the powers they have in a discerning fashion. At the same time, though, shareholder voting probably only operates as a potential check when pay arrangements deviate far from the norm. With respect to Britain, these findings imply that implementing the shareholder-oriented reforms that have been canvassed recently would fail to address fully the concerns raised by critics of executive pay.

Abstract:
This paper examines the overlap between SEC securities enforcement actions and private securities fraud class actions. We begin with an overview of data concerning all SEC enforcement actions from 1997 to 2002. We find that the volume of SEC enforcement proceedings is relatively modest. We next examine the scope of the recently enacted "Fair Fund" provision that authorizes the SEC to designate civil penalties it recovers from defendants to benefit defrauded private investors. We conclude that this provision offers only limited potential relief for private investors. We complete this part of the paper with an analysis of the serious resource limitations faced by the SEC.

The second portion of the paper contains an empirical analysis of the determinants of SEC enforcement actions and the overlap of private fraud suits and SEC enforcement proceedings. In bi-variate analysis, we find that: private suits with parallel SEC actions settle for significantly more than private suits without such proceedings; SEC enforcement actions target significantly smaller companies than private actions alone; private cases with parallel SEC actions take substantially less time to settle than other private cases; and private cases with parallel SEC actions have significantly longer class periods than other private actions. Finally, we create a model for estimating damages to compare settlement ratios in cases with parallel SEC actions to those in private actions. We find that one-fourth of all the private class action settlements occurring in suits that yield less than 10% of provable losses are settled for less than .02 percent of provable losses, but that there are no private actions with parallel SEC suits with such small settlements.

In the final part of the paper, we conduct a multivariate regression analysis of the determinants of when SEC enforcement actions are filed. We find that the most highly significant determinant of SEC actions is financial distress. Estimated losses do not appear to be a statistically significant factor in the SEC's decision to file these suits.

Abstract:
This article presents the results of an empirical investigation of the frequency with which financial institutions submit claims in settled securities class actions. We combine an empirical study of a large set of settlements with the results of a survey of institutional investors about their claims filing practices. Our sample for the first part of the analysis contains 118 settlements that were not included in our earlier study. We find that less than 30% of institutional investors with provable losses perfect their claims in these settlements.

We then explore the possible explanations for this widespread failure. We suggest a wide range of potential problems from mechanical failures in the notification and recordkeeping processes to more subtle issues such as portfolio managers' beliefs that only investment activities produce significant returns for their clients.

In order to determine which of these problems were the main culprits, we surveyed institutional investors about their claims filing practices, asking them who was responsible for this task, how they performed it, and what, if any, performance monitoring was done. We learned that most institutions relied on their custodian banks to file claims for them in securities fraud class action settlements, that many of these institutions did little monitoring of whether the custodian actually performed these services, and that custodians had financial disincentives to file claims on behalf of their clients.

We argue that any such failures should be evaluated as potential breaches of the duty of care consistent with the monitoring obligations embraced in Delaware's Caremark decision. Applying this standard to our problem, we believe that the trustees of institutional investors must, in good faith, insure that their fund has an adequate system in place to identify and process the fund's claims. Furthermore, they should create a monitoring mechanism to insure that this system is adequate, and if they learn it is inadequate they should take measures to fix the problem. Custodians that file claims on behalf of their institutional clients should perform the various aspects of this job with due care, too, or face potential liability for negligence. We then identify several discrete problems with the claims filing system that can be addressed to help remedy the current situation.

We conclude our article with two observations about the implications of our results for the goals of securities fraud litigation. Our survey results show a serious mismatch between the beneficiaries of the settlement and those that have been harmed by the securities violation that gave rise to the settlement. Simply stated, many defrauded beneficiaries are not compensated for their losses, while others are unjustly enriched. Given the enormous importance of institutional investors in the market, this mismatch raises serious doubts about whether securities fraud class actions can be justified as compensatory mechanisms. Moreover, the poor claims filing records of institutional investors exacerbates this mismatch, as many investors are systematically deprived of any benefits from these settlements. This raises more doubts about the compensatory function of securities fraud cases.

Rather we believe the more persuasive rational for these cases is the deterrence of fraud. But in order to accomplish that purpose, we think that the current process needs to undergo some changes. We therefore suggest targeting securities fraud litigation at the individual wrongdoers, and invoking vicarious liability only when the company benefits from the fraud.

Institutional Investors, securities class action settlements, Caremark decision

Abstract:
We examine the various methods by which shareholders have tried to influence executive compensation. We then attempt to determine whether one of the most popular methods for individual investors, shareholder proposals using Rule 14a-8, has had any impact on the level and composition of CEO's compensation at target companies. We use data for the 1993-1997 proxy seasons on 168 executive compensation proposals submitted to 145 different companies to determine how shareholders have chosen their target companies and whether these companies' boards have responded to investors' proposals by reducing CEO pay levels or shifting the composition of their pay packages.

Our analysis yields several interesting results. We find that shareholders generally target their proposals at relatively poorly performing companies exhibiting higher levels of executive compensation than other similar-sized firms in their industry. This is consistent with the claim that shareholder proposals are being used in an attempt to monitor excessive levels of executive compensation. We also find that shareholders are statistically more likely to support executive compensation proposals that attempt to restrict executive compensation than they are proposals that simply ask for more disclosure about executive compensation. Similarly, we find that shareholders are statistically more likely to support executive compensation proposals that raise corporate governance issues rather than those that raise social responsibility issues.

Shareholder proposals concerning executive compensation may affect the level and composition of CEO compensation. We find that target companies do not increase average total CEO compensation levels as rapidly in the year after receiving a shareholder proposal as firms not receiving such proposals. In addition, we employ regression analysis to determine whether executive compensation levels at companies receiving shareholder proposals are affected by factors such as the level of voting support for the initiative, the type of sponsor of the proposal, and the nature of the proposal related to the proposal. We find some support for the hypothesis that higher levels of voting support for proposals are associated with smaller increases in CEO compensation at companies receiving proposals when compared to CEO pay levels at similar-sized companies in the same industry. These results are consistent with the hypothesis that boards of directors are responsive to shareholders' expressions of dissatisfaction with their firms' executive compensation pay packages, especially when they are raised as corporate governance issues.

Abstract:
We examine the various methods by which shareholders have tried to influence executive compensation. We then attempt to determine whether one of the most popular methods for individual investors, shareholder proposals using Rule 14a-8, has had any impact on the level and composition of CEO's compensation at target companies. We use data for the 1993-1997 proxy seasons on 168 executive compensation proposals submitted to 145 different companies to determine how shareholders have chosen their target companies and whether these companies' boards have responded to investors' proposals by reducing CEO pay levels or shifting the composition of their pay packages.

Our analysis yields several interesting results. We find that shareholders generally target their proposals at relatively poorly performing companies exhibiting higher levels of executive compensation than other similar-sized firms in their industry. This is consistent with the claim that shareholder proposals are being used in an attempt to monitor excessive levels of executive compensation. We also find that shareholders are statistically more likely to support executive compensation proposals that attempt to restrict executive compensation than they are proposals that simply ask for more disclosure about executive compensation. Similarly, we find that shareholders are statistically more likely to support executive compensation proposals that raise corporate governance issues rather than those that raise social responsibility issues.

Shareholder proposals concerning executive compensation may affect the level and composition of CEO compensation. We find that target companies do not increase average total CEO compensation levels as rapidly in the year after receiving a shareholder proposal as firms not receiving such proposals. In addition, we employ regression analysis to determine whether executive compensation levels at companies receiving shareholder proposals are affected by factors such as the level of voting support for the initiative, the type of sponsor of the proposal, and the nature of the proposal related to the proposal. We find some support for the hypothesis that higher levels of voting support for proposals are associated with smaller increases in CEO compensation at companies receiving proposals when compared to CEO pay levels at similar-sized companies in the same industry. These results are consistent with the hypothesis that boards of directors are responsive to shareholders' expressions of dissatisfaction with their firms' executive compensation pay packages, especially when they are raised as corporate governance issues.

Abstract:
Early studies of market reaction to stock option plans have found positive increases in stock prices upon the announcement of these plans. However, since in the mid-1990's, shareholders have become increasingly critical of stock option plans, and voted against them in growing numbers. Are shareholders fed up with the continued growth in option compensation, and if so, what are boards of directors doing in response to these concerns?

In this paper, we use data from the 1998 proxy season to reevaluate market reaction to management-sponsored proposals for stock option plans, the level of shareholder opposition to these plans, and the effect of this opposition on corporate boards' awards of CEO compensation in subsequent years. In the first half of the paper, we conduct an event study similar to those done for early stock option plans from the 1980's and early 1990's. However, we expect to find that the market will react differently to plans that exhibit the high levels of potential dilution of shareholder ownership and certain "shareholder unfriendly" aspects of the plans that make shareholders more likely to vote against such plans. Our findings support part of our hypothesis: we find that higher levels of potential dilution in executive-only plans result in significantly negative cumulative market adjusted returns in the 3-day period surrounding the proxy date, but that plans that include repricing provisions, permit executives to borrow money from the firm in order to exercise options, or that allow the issuance of restricted stock, do not experience significantly negative returns.

In the second part of the paper, we present evidence regarding the factors that affect shareholder voting opposition to stock option plans and the impact of this opposition on subsequent CEO compensation. In cross-sectional regressions, we find a significantly negative relationship between the percentage vote against the option proposal and the percentage change in salary and in total pay from the 1999 to 1998 compensation years. We interpret this finding to support the idea that boards of directors respond to shareholder concerns about CEO option awards by reducing executive pay in the year after a high level of shareholder opposition.

Abstract:
Over the past decade, executive compensation has become a controversial topic. Increasingly, corporate boards of directors are confronted by angry shareholder groups over the size and composition of executive pay packages. One of the most important focal points for these tensions arises when shareholders are asked by the board to approve the creation of new stock option plans, or the amendment of existing plans. This article seeks to identify the factors that lead shareholders to support or oppose stock option plans. We examine the justifications for the widespread use of stock options and identify several benefits from stock option plans as well as some of the criticisms leveled against the methods that boards have used to implement the plans.

In addition, we conduct an empirical analysis of the determinants of shareholder voting on stock option plans in the 1998 proxy season. We examine the four companies in our sample in which shareholders defeated the plans and then perform a cross-sectional analysis of voting results on the entire sample of 637 proposals. Our principal finding is that while shareholders generally vote to approve stock option plans, shareholders are particularly sensitive to the potential dilution caused by the plans, whether that dilution is in terms of total company dilution or individual plan dilution. In addition, we find that several characteristics of the plans, such as option repricing, payments in restricted stock, and the provision of loans to executives for the purchase of shares appear to be the most significant factors leading to increased shareholder opposition.

Abstract:
Shareholder lawsuits are a principal legal means to control management agency costs in corporations, yet they generate their own agency costs from the attorneys who bring representative litigation. The key policy question, and one that is central to good corporate governance, has long been how to properly balance the positive management agency reductions from shareholder litigation against the often-maligned litigation agency costs.
We address the tradeoff inherent in this debate using our empirical study of shareholder litigation in Delaware. Our data set of all 1000 corporate fiduciary duty cases filed in Delaware in 1999 and 2000 is the largest empirical study of shareholder litigation. We find that more than 80% of these cases are class actions against public companies challenging one type of director decision - whether or not to participate in a corporate acquisition. By contrast, derivative suits, the traditional shareholder litigation that is the staple of corporate law casebooks, make up only about 14% of all fiduciary duty suits.

The acquisition-oriented class actions are a new, previously unstudied category of representative litigation, an area long dominated by studies of state derivative suits and federal securities fraud class actions. We find these suits do provide some management agency costs reductions, but these are concentrated in only one subset of the suits that are brought. Settlements leading to relief in an acquisition setting are not spread across all acquisitions complaints (including hostile, second bidder acquisitions etc.), but rather concentrated where there is a majority shareholder who is attempting to cash-out the minority interest held by public shareholders on terms that have been picked by the majority.

On the opposite side of the equation - whether these suits possess high litigation agency costs - we find conflicting evidence. The acquisition oriented class action suits have many characteristics that have been identified in other contexts as indicators of agency costs (e.g., suits filed quickly, many suits per transaction). Yet, these litigation agency costs are below the level of perceived costs that spurred securities fraud legislation, for example.

We suggest that Delaware could reduce the litigation agency costs associated with class actions without increasing management agency costs by instituting two procedural reforms. First, Delaware should enact a lead plaintiff provision, similar to that adopted for federal securities fraud class actions in PSLRA, to encourage larger investors to become more active monitors of fiduciary duty litigation. Second, we suggest that Delaware should put in limitations on professional plaintiffs as in PSLRA in order to reduce litigation agency costs further.
Our article also examines derivative lawsuits from the two-year period, but we find that they do not look much like our acquisition cases (e.g., longer time to file and to settle, fewer suits per transaction and more motions). Derivative cases in our database are concentrated in areas where management agency costs seem likely to be high and produce a number of beneficial settlements that are concentrated in duty of loyalty contexts. Given these characteristics and the current balance between reducing management agency costs and increasing litigation agency costs in derivative litigation, we suggest that Delaware could loosen some of the restrictions that it has placed on shareholder plaintiffs in derivative cases.

Abstract:
Shareholder litigation is the most frequently maligned legal check on managerial misconduct within corporations. Derivative lawsuits and federal securities class actions are portrayed as slackers in debates over how best to control the managerial agency costs created by the separation of ownership and control in the modern corporation. In each instance, early hopes these suits would effectively monitor managerial misconduct have been replaced with concerns about the size of the litigation agency costs of such representative litigation, which can arise when a self-selected plaintiff's attorney and her client that are appointed to pursue the claims of an entire class of shareholders have interests that may differ from those of the class.

Now, however, a new form of shareholder litigation has emerged that is distinct from derivative or securities fraud claims: class action lawsuits filed under state law challenging director conduct in mergers and acquisitions. The empirical data reported in this article show that these acquisition-oriented suits are now the dominant form of corporate litigation, outnumbering derivative suits by a wide margin.

Are these acquisition-oriented class actions just another deadbeat in the corporate governance debate? Should policymakers take action to cut back on the development of this new form of shareholder litigation? In this paper, we argue that, just as with derivative suits and securities fraud class actions, good policy must balance the positive management agency cost reducing effects of these acquisition-oriented shareholder suits against their litigation agency costs. This new breed of suits has positive management agency cost reducing effects that may offset the litigation agency costs that accompany them.

Our data set of all 1000 corporate fiduciary duty cases filed in Delaware in 1999 and 2000 is the largest empirical study of shareholder litigation. We find that more than 80% of these cases are class actions against public companies challenging one type of director decision - whether or not to participate in a corporate acquisition. By contrast, derivative suits, the traditional shareholder litigation that is the staple of corporate law casebooks, make up only about 14% of all fiduciary duty suits.

The acquisition-oriented class actions are a new, previously unstudied category of representative litigation, an area long dominated by studies of state derivative suits and federal securities fraud class actions. We find these suits do provide some management agency costs reductions, but these are concentrated in only one subset of the suits that are brought. Settlements leading to relief in an acquisition setting are not spread across all acquisitions complaints (including hostile, second bidder acquisitions, etc.), but rather concentrated where there is a majority shareholder who is attempting to cash-out the minority interest held by public shareholders on terms that have been picked by the majority.

On the opposite side of the equation - whether these suits possess high litigation agency costs - we find conflicting evidence. The acquisition-oriented class action suits have many characteristics that have been identified in other contexts as indicators of agency costs (e.g., suits filed quickly, many suits per transaction). Yet, these litigation agency costs are below the level of perceived costs that spurred securities fraud legislation.

Placing our findings in the historical context of the debate over the value of representative shareholder litigation, we believe that the positive management agency cost reducing effects of acquisition-oriented class actions are substantial, while the litigation agency costs they create do not appear excessive. For these suits, we therefore disagree with earlier studies that have claimed that all representative shareholder litigation has little, if any, effect in reducing management agency costs and should be evaluated solely in terms of its litigation agency costs.

Abstract:
Critics of U.S. executive pay practices have raised four major concerns: (1) executive pay is too high; (2) CEO contracts do not provide strong enough incentives to increase value (i.e., there is too little pay-for-performance); (3) options and other equity-based pay provide windfalls, large payoffs that reflect good luck more than good performance; and (4) CEOs have too much freedom to unwind their incentives. This negative, and increasingly mainstream, assessment of the state of U.S. executive compensation has led many observers to conclude that executive pay practices are fundamentally flawed and that systemic reform is needed. We shed light on these perceived problems with executive pay and, in so doing, provide some balance to what we find to be an increasingly one-sided debate. Our key points are that: (1) CEOs' stock and option holdings provide powerful incentives to increase value, and this is true regardless of whether or not annual pay varies with firm performance; (2) recent growth in annual pay may well be appropriate to compensate CEOs for recent growth in incentive risk borne through their stock and option holdings, and due to the increasing size and complexity of U.S. firms; (3) when viewed as a combination of market risk and firm-specific risk, conventional (that is, unindexed) stock and options may provide a simultaneous solution to shareholders' demand for executive rewards tied to company performance, and executives' preference to diversify their wealth; (4) U.S. CEOs show little evidence of widespread unwinding of incentives, and in cases where CEOs have too much incentives, it is appropriate to allow and encourage the CEO to exercise options and sell stock to rebalance her portfolio.

CEO, compensation, corporate governance, incentives

Abstract:
Derivative suits, long the principal vehicle for discussions about representative litigation in corporate and securities law, now share the stage with younger cousins - securities fraud class actions and state law fiduciary duty class actions. At the same time alternative governance vehicles - independent directors, auditors and other reforms that have followed in the wake of Enron - potentially diminish the relative place of litigation such as derivative suits. This article presents data from all derivative suits filed in Delaware over a two-year period. We find a relatively small number, certainly as compared to fiduciary class action and securities fraud class actions. Unlike these other representative suits, derivative suits are used for both public and close corporations. They arise usually in a duty of loyalty context. Contrary to earlier studies, we do not find evidence that these cases are strike suits yielding little benefit. Instead, roughly 30% of the derivative suits provide relief to the corporation or the shareholders, while the others are usually dismissed quickly with little apparent litigation activity. In cases producing a recovery to shareholders, those amounts typically exceed the amount of attorneys' fees awarded by a significant margin. They do demonstrate some indicia of litigation agency costs (for example suits being filed quickly, multiple suits per controversy, and repeat plaintiffs' law firms), but each of these is much less pronounced for derivative suits than for other forms of representative litigations. Overall, the claim that derivative suits are strike suits is much weaker than in earlier periods. The Delaware judiciary, which hears most public company corporate litigation in America, has effectively monitored these cases. There is room to open the door for larger shareholders to utilize these suits to police corporate misconduct. Institutional shareholders, while not willing to take on as large a role in governance as many have suggested in terms of naming directors and the like, may be willing to take a larger role in derivative litigation. Thus we see potential for derivative litigation to play a more important role in the future. We therefore suggest that suits brought by a one percent or larger shareholder should be excused from the demand requirement currently applied in derivative suits.

Private law, compliance law, corporate & securities law, finance & corporate governance

Abstract:
This paper analyzes the question of whether there is a U.S.-oriented convergence trend in international executive pay. After surveying the essential elements of the American pay paradigm, we consider market-oriented dynamics that could constitute a global compensation imperative. We find that it is difficult to predict how decisive these forces will be, in part because market factors do not tell the whole story. Rather, it is necessary to take into account several other variables, such as legal regulation and business culture. These may stop convergence from occurring at any point in the near future.
The primary purpose of this paper is to identify and analyze the variables that will determine whether executive pay convergence will occur along American lines; therefore, we do not assess in detail whether such a shift would be a "good thing." However, we do recognize the tension between the useful function of U.S.-style pay packages in aligning the interests of shareholders and executives, while also acknowledging that they can in certain circumstances constitute self-serving managerial "rent extraction." Also, the paper makes a significant normative contribution by identifying obstacles regulators will need to address if they want to promote convergence and by drawing attention to rules that could be invoked to hinder the Americanization of executive pay if this was thought to be the better way to proceed.

Abstract:
This paper examines corporate voting contests experimentally using a weighted voting model. We begin by providing a systematic treatment of weighted voting models as an analytical tool for legal policy. After this short intuitive guide to the basic concepts and techniques employed in these models, we then explore their use (and misuse) by the courts in the political arena. We continue this introduction by examining prior work using weighted voting models in the corporate setting. Here the literature has focused on two different aspects of corporate voting: the analysis of voting concentration and corporate control and, more recently, proxy contests for corporate control.

In the next section, we engage in an in-depth analysis of the new models of corporate elections developed by Gilson & Schwartz and Bebchuk & Hart. In our critique, we show that both the Gilson & Schwartz approach and the Bebchuk & Hart paper are flawed. In particular, we find that the models used in Gilson & Schwartz employ unreasonable hypotheses and reach questionable conclusions, whereas we argue that the Bebchuk & Hart effort requires exceptionally strong hypotheses and very stringent mathematical assumptions to reach its conclusions.

To develop a more realistic approach to these questions, we employ a probabilistic version of a standard weighted voting model that explicitly incorporates two critical features of corporate voting: first, that shares are normally voted in large blocks rather than in single shares; and second, that independent third party proxy voting advisors play an important, and often pivotal, role in determining the outcome of corporate elections. In addition, we explicitly incorporate information about the size of different corporate constituencies and their voting preferences. Using our model, we show experimentally how the distribution of shares among various investor constituencies will affect the outcome of different types of voting contests.

Initially, we assume that the current legal regime applies so that corporate management determines whether to accept an unsolicited bid and can use a wide variety of anti-takeover defenses to forestall hostile bidders. We find that neither proxy contests, tender offers, nor combined proxy contests and tender offers will always lead to the desirable outcome for target company shareholders in any scenario. With each type of acquisition technique, bidders succeed in obtaining control of the target company in some value decreasing transactions, and are defeated in their acquisition efforts in some value increasing transactions. The implication is that, under current law, there will generally be some plausible basis for target company management to argue that it is value increasing to use defensive measures to preclude shareholder acceptance of a takeover bid.

Finally, we study the effect on our results of adopting different theoretical perspectives on the proper role for shareholder voting. One alternative theory we examine is that target management should be barred from using defensive measures to stop an unsolicited takeover bid. Our model shows that if we adopt this theory, a change of control will occur in any case where the bid's value significantly exceeds the target's prior stock price. However, we are unable to accurately measure how this change will affect the size of premium offered in all bids, or the frequency of takeover bids, so that we cannot make social welfare comparisons between this regime and the current one.

We then examine a second alternative theory that proposes shareholders should be able to vote within a reasonable period of time to remove any defensive tactic that impedes their ability to accept a takeover bid. This approach reduces all takeover battles to proxy contests occurring within at most thirteen months, the maximum length of time most states permit to elapse between annual meetings from the time of the announcement of the bid. In this situation, the shareholder vote will, in most circumstances, lead to an acceptance of value maximizing bids and a rejection of value decreasing offers. We endorse this position because it is at least as good as the current legal regime in insuring the maximization of shareholder vote, and better in that it permits shareholders to decide their own fate in more circumstances.

Abstract:
In the "Aircraft Carrier," the Securities and Exchange Commission (SEC) proposed changes in federal securities disclosure requirements in an attempt to enhance and facilitate the process of issuing new securities. Under the proposed regulatory regime, the registration process would be simplified so that many larger, more experienced issuers would be able to use a new, shorter registration statement called Form B (as opposed to the more extensive Form A) whenever they sell securities to the public. To qualify to use Form B, a company with at least twelve months reporting history under the Exchange Act must either have a public float of $75 million or more and an average daily trading volume (ADTV) of $1 million or more, or have a public float of $250 million or more.

In this paper, we argue that the SEC's study of capital market efficiency employs too broad a definition of what constitutes "an analyst" who represents an important conduit for information between a company and its investors. We adjust the definition of an analyst to more accurately reflect only those analysts whose research effectively disseminates information to investors in the market (sell-side analysts) and find that the proposed numerical cutoffs for the use of Form B are set much too low to insure adequate analyst following. This finding is consistent with evidence we present that a substantial percentage of companies eligible to use Form B have low levels of institutional investor shareholdings.

Based on a sample of companies whose stock price was greater than $1.00 on 12/31/99, we find that 3,413 (43.3%) of firms in the sample qualify to file Form B using the SEC's proposed numerical cutoffs. Using First Call's consensus earnings estimate service, we examine the analyst following of firms that have a market capitalization greater than $250 million and find that 26.1% of these firms have less than three analysts compared to the 5.0% reported by the SEC. We also examine the SEC's second criteria (market capitalization greater than $75 million and average daily trading volume (ADTV) of $1 million) and find that 38.1% of companies have less than three analysts compared to the 14.0% reported by the SEC. We argue that equity or sell-side analyst following represents an important source of information to investors and should be considered when establishing criteria for relaxed reporting requirements when companies issue securities.

Abstract:
Although the owners of publicly traded companies have had the right to offer shareholder proposals using Rule 14a-8 for several decades, the effectiveness of the rule has been frequently questioned because few of these proposals received substantial support from other shareholders and even fewer have been implemented by boards. Using new data from the 2002-2004 proxy seasons, we analyze shareholder voting patterns on these proposals, board reactions to them, and market responses. We find some big changes from earlier periods: many more proposals are receiving majority shareholder support during our sample period relative to earlier studies, and this support has translated into directors implementing more of the actions called for by shareholders. In particular, boards are increasingly willing to remove important anti-takeover defenses, such as the classified board and poison pill, in response to shareholders' requests, something rarely seen in the past. Despite the increase in support for shareholder proposals and board action in response, we find small and insignificant stock market reaction. We conclude that shareholder proposals under Rule 14a-8 have an emerging role in reducing agency costs by increasing director responsiveness to shareholder concerns to open the market more fully to corporate control.

shareholder, corporate governance, investors, market performance

Abstract:
In this paper, we examine the role of institutional investors in securities fraud class actions. We begin by surveying the first five years of experience with the Lead Plaintiff provision of the Private Securities Litigation Reform Act (PSLRA). In particular, we look at those cases where the lead plaintiff position has been contested and the outcome of those disputes. We find that institutional investors have been very successful in obtaining the position of lead plaintiff where they have sought it, but that there are a number of cases where they were unsuccessful.

In part two of the paper, we dissect institutional investors' fiduciary obligations in petitioning to become lead plaintiffs and in filing claims in securities fraud settlements. For each major type of institution, we analyze their legal obligations under different legal standards in an effort to answer the question what obligation do they have to act in these areas. We conclude that institutional investors have a duty to file claims in settlements, except what we believe are rare instances where their cost-benefit calculations show filing to be unjustified. The case for becoming lead plaintiffs in securities fraud class actions is much more tenuous, though, as the costs of such a course of action may be substantial and the benefits are less certain.

The remainder of the paper focuses on the question of filing claims in settled securities fraud cases. Beginning with a discussion of the process of notifying claimants, we move to an empirical analysis of whether institutions actually file claims in these cases. We use a sample of 53 settlements. Our tentative findings are that only 25-33% of institutions that we can identify as having claims to file in these settlements are actually filing claims.The last section of the paper offers several theories as to why institutions are not filing claims. Among the theories proposed, we focus on three as the most likely candidates: first, that the institutions are making cost-benefit analyses of whether to file such claims, and concluding that they are not worth filing; second, that there are no internal personnel at the institutions that are responsible for filing the claims, and thus they never get made; and third, that the institutions may not be receiving notice of the settlements and claims forms from the banks and brokers that hold their shares for them. Each of these theories may explain some portion of the institutions' failure to file claims in securities fraud cases.

Abstract:
In this paper, we examine how those corporations that have been the targets of SEC enforcement efforts compare in terms of their size and financial health vis-a-vis firms that are targeted only by the private securities class action. We also ask whether the SEC or the private bar systematically proceeds against violators that cause the greatest loss to investors. In this regard, we are intrigued by the most basic question posed by private suits, whether settlements bear any relationship to the losses suffered by the class and whether those losses bear any relationship to the size of either the firm itself or the duration of the class action. Our data set consists of 389 securities class action settlements that occurred between 1990 and 2003.

Using multivariate regression analysis to examine the determinants of government litigation, we find a sharp change in the pattern of SEC enforcement actions after the end of 2001. We find that the SEC seems to have shifted its enforcement focus away from targeting frauds at firms in financial distress to seeking out frauds at companies where investors may have suffered larger losses, especially if they are smaller firms.

Again applying multivariate regression analysis, we look at settlement sizes in private class actions. We find that provable losses, total assets, class period and the presence of an SEC enforcement action, are all positively and significantly related to the dollar amount of the settlement obtained in a private action. These effects do not change over the time period of our sample. The fact that provable losses are such an important determinant of the size of actual recoveries supports the view that the "merits do matter."

SEC, Securities Laws, Enron6

Abstract:
In this paper, we examine the impact of the PSLRA and more particularly the impact the type of lead plaintiff on the size of settlements in securities fraud class actions. We thus provide insight into whether the type of plaintiff that heads the class action impacts the overall outcome of the case. Furthermore, we explore possible indicia that may explain why some suits settle for extremely small sums - small relative to the "provable losses" suffered by the class, small relative to the asset size of the defendant-company, and small relative to other settlements in our sample. This evidence bears heavily on the debate over "strike suits." Part I of this paper sets forth the contemporary debate surrounding the need for further reforms of securities class actions. In this section, we set forth the insights advanced in three prominent reports focused on the competitiveness of U.S. capital markets. In Part II we first provide descriptive statistics of our extensive data set, and then use multivariate regression analysis to explore the underlying relationships. In Part III, we closely examine small settlements for clues to whether they reflect evidence of strike suits. We conclude in Part IV with a set of policy recommendations based on our analysis of the data.

plaintiffs, securities, empirical class actions

Abstract:
This article compares executive pay practices in the U.S. with those employed elsewhere in the world. After providing an overview of current practices, it goes on to analyze whether there is likely to be a convergence of these practices. It first examines the influence of market based factors, such as evolving share ownership patterns, cross-border hiring, transnational mergers and acquisitions, and the growth of multinational enterprises, on the likelihood of convergence occurring. It concludes that these factors point in the direction of increasing convergence in executive pay. Next, the paper discusses the influence of legal regulations, including corporate law, judicial interpretations of fiduciary principles, shareholder voting requirements, restrictions on stock option plans and disclosure rules on comparative executive pay practices. Other legal regimes, such as, tax law, labor law, and "soft" law that might also influence executive compensation are also scrutinized to see how they will affect pay convergence. In its final section, the article considers the effects of culture in several countries and how it impacts compensation levels and practices.

shareholders, executive compensation, CEO pay, benefits, cross border hiring, transnational mergers and acquisitions, judicial interpretations of fiduciary principles

Abstract:
This paper is an empirical analysis of plaintiffs' success rates in executive compensation litigation. Using data from publicly available files, this study examines a sample of 124 cases where shareholders have challenged executive compensation levels and practices at public and closely held corporations. This data set shows that shareholders are successful in at least some stage of this litigation in a significant percentage of these cases.

Our most robust result is that plaintiffs win a greater percentage of the time in compensation cases against closely held companies than against publicly held companies. This result is consistent for every stage of these cases - motions to dismiss, motions for summary judgment, trial and appeal. We also find that, on average, plaintiffs fare better in compensation cases in courtrooms outside of Delaware than in Delaware. However, once we control for the different composition of the Delaware Courts' caseload, these differences disappear and the overall success rates in executive compensation litigation are surprisingly similar.

When we look at the procedural and substantive claims being made in the cases, we find some other interesting results. Demand futility is a significant barrier to getting such suits off the ground. Plaintiffs lose on a motion to dismiss for failure to make demand about half the time. In Delaware, motions to dismiss for failure to make demand are much more frequently raised since the Delaware Supreme Court's decisions in Aronson v. Lewis, although plaintiffs today seem to succeed in overcoming them a greater percentage of the time.

The picture is more complicated with respect to the substantive claims made in these cases. Plaintiffs average about 30% success in maintaining duty of care claims at the various stages of these suits with slightly higher success rates in non-Delaware cases. However, since the Delaware Supreme Court's decision in Smith v. Van Gorkom, the number of these claims has increased and their likelihood of success at least at some stage of the litigation appears to have increased. With waste claims, plaintiffs succeed about 40% of the time, while for duty of loyalty claims, they win about 35% of the time. Plaintiffs are consistently more successful at close corporations than at public corporations for both types of claims.

Abstract:
For many years academics have debated whether it is better to permit hostile acquirers to use tender offers to gain control over unwilling target companies, or to force them to use corporate elections of boards of directors in these efforts. The Delaware courts have expressed a strong preference for shareholder voting as a change of control device in hostile acquisitions. To force acquirers to accept their preferences, the Delaware courts have developed a jurisprudence permitting the effective classified board (ECB), a poison pill combined with a classified board, to protect target company management from removal by a hostile tender offer alone, or through a single corporate election. For companies with ECB's, this means that a determined acquirer must engage in two corporate elections over a period of two years to force entrenched managers to give up power.

In this paper, we examine whether proxy contests, tender offers or combined proxy contest/tender offers are more likely to result in value maximizing outcomes for shareholders when target companies are able to deploy defensive tactics. We begin by showing that prior work suffers from serious flaws involving the use of voting models that are inappropriate for analyzing proxy contests.

To develop a more realistic approach to these questions, we employ a probabilistic version of a standard weighted voting model that explicitly incorporates two critical features of corporate voting: first, that shares are normally voted in large blocks rather than in single shares; and second, that independent third party proxy voting advisors play an important, and often pivotal, role in determining the outcome of corporate elections. In addition, we explicitly incorporate information about the size of different corporate constituencies and their voting preferences. Using our model, we show experimentally how the distribution of shares among various investor constituencies will affect the outcome of different types of voting contests.

Using this model, and these different sets of assumptions, we find that neither proxy contests, tender offers, nor combined proxy contests and tender offers will always lead to the desirable outcome for target company shareholders in any scenario. With each type of acquisition technique, bidders succeed in obtaining control of the target company in some value decreasing transactions, and are defeated in their acquisition efforts in some value increasing transactions. These results hold whether we permit existing defensive tactics or eliminate them.

We conclude that in order to properly analyze the role of defensive tactics, courts must take into account the underlying shareholder ownership patterns. This requires them to engage in a fact sensitive analysis of whether defensive tactics are impeding or facilitating the maximization of shareholder value. When we examine the Delaware Chancery Court's decisions, the reasonableness analysis that they have employed to decide whether to overturn defensive tactics permits them to do so. We recommend that the courts continue to apply this type of analysis in the future with more direct consideration of the impact of the underlying ownership structure in determining whether the defenses are being used to maximize shareholder value.

Abstract:
This paper documents and explains the amazing growth of the largest firms in law, accounting, and investment banking. Scholars to date have used various supply-side theories to explain the growth, and have generally examined only one industry at a time. We give the first demand-side explanation of firm growth, and show how the explanation is similar for firms in all "project" industries. We show that law plays an important role in determining industry structure.

Among the areas we cover are the growth of Multi-Disciplinary Practice firms. We argue that the issues surrounding MDPs can best be understood by looking more broadly at the forces driving project industries. We also explain the driving forces behind the breakup of the Big Five accounting firms, the consolidation of the investment banking industry and the heretofore unexamined divergent growth patterns of the law firms in the plaintiffs' securities litigation field.

Abstract:
This paper examines internal pay disparities in American public corporations and argues that wide gaps between the top and bottom of the pay scale can, in certain circumstances, directly and adversely affect firm value, that corporate boards should be informed about these effects, and that they should, in some cases, reduce internal pay differentials to address them. In support of this thesis, it analyzes numerous empirical studies that have shown that wide disparities in corporate pay scales can adversely affect firm value. These studies demonstrate that, at many types of organizations, as internal pay differentials grow, employees and lower level managers increasingly view themselves as being unfairly compensated in comparison to more highly paid top management. This perception adversely affects employee performance, productivity and willingness to work, and thereby reduces firm value. Directors' duty of care requires that they consider the spread between the high and low end of the corporate pay scale in setting firm compensation levels and act in the corporation's best interests to reduce it if necessary to maximize firm value.

Moreover, mega-grants of stock options are primarily responsible for these growing pay differentials. Corporate directors are uninformed about the real costs and benefits of these huge awards. Mega-grants of stock options to corporate managers are unjustified if their uncertain benefits are exceeded by their costs. As virtually no research has shown that mega-grants of stock options' costs exceed their benefits, directors need to more carefully determine if these programs maximize firm value. Once again, directors' duty of care obligates them to be reasonably informed about the value of these plans as that constitutes material information about their firm.

Abstract:
This is a review of Professor Mark Roe's book, The Political Determinants of Corporate Governance. It seeks to accomplish two goals. First, in Part I, it summarizes the theoretical arguments made in Political Determinants and critiques the empirical support marshaled by Professor Roe in support of them. Then, in Part II, it develops an alternative model that could be used to test jointly Professor Roe's and LLSV's theory about the determinants of corporate governance. Finally, it offers a few concluding remarks about the future of empirical legal scholarship.

Corporate Governance, Empirical Research, Political Determinants

Abstract:
Most commentators decry forum shopping. This general hostility extends to forum shopping by firms filing for bankruptcy. Indeed, Congress is considering legislation designed to reduce forum shopping by companies filing for bankruptcy. This article makes two contributions to this debate. First, we show that the current debate is driven almost exclusively by attorneys trying to protect fees rather than by any principled objection to forum shopping. Second, on the merits, we argue that the hostility to forum shopping is misplaced. The near universal condemnation of forum shopping rests on the premise that, at the time the plaintiff selects a forum, there is a zero-sum game between the plaintiff and defendant - every advantage that a plaintiff secures comes at a cost to the defendant. We demonstrate that, in the bankruptcy context, this zero-sum game disappears if one forces a firm to commit to a specific venue before its seeks funds in the capital markets. Drawing on the "race to the top" literature in corporate law, we show that markets will discipline managers who act opportunistically. The threat of this discipline will lead managers to commit to the venue most likely to maximize firm value. Moreover, our proposal will create incentives for judges to exercise the vast discretion that the Bankruptcy Code gives them in a way which promotes efficiency.

Abstract:
In this paper, we provide an overview of the most significant empirical research that has been conducted in recent years on the public and private enforcement of the federal securities laws. The existing studies of the U.S. enforcement system provide a rich tapestry for assessing the value of enforcement, both private and public, as well as market penalties for fraudulent financial reporting practices. The relevance of the U.S. experience is made broader by the introduction through the PSLRA in late 1995 of new procedures for the conduct of private suits and the numerous efforts to evaluate the effects of those provisions.

We believe that the evidence reviewed here shows that the PSLRA's provisions have largely achieved their intended purposes. For example, many more private suits are headed by an institutional lead plaintiff, such plaintiffs appear to fulfill the desired role of monitoring the suit's prosecution and their presence is associated with suits yielding better settlements and lower attorneys' fees awards. SEC enforcement efforts, while significant, have tended to focus on weaker targets, suggesting that the big fish get away. Equally importantly, markets impose their own discipline on companies whose managers release false financial reports and, in turn, firms discipline the managers who are responsible for false misleading reporting, perhaps because of the presence of, or potential for, private enforcement actions.

Empirical Studies, Shareholder Litigation, PSLRA Provision, U.S. Securities Law

Abstract:
For many years academics have debated whether it is better to permit hostile acquirers to use tender offers to gain control over unwilling target companies, or to force them to use corporate elections of boards of directors in these efforts. The Delaware courts have expressed a strong preference for shareholder voting as a change of control device in hostile acquisitions. To force acquirers to accept their preferences, the Delaware courts have developed a jurisprudence permitting the effective classified board (ECB), a poison pill combined with a classified board, to protect target company management from removal by a hostile tender offer alone, or through a single corporate election. For companies with ECBs, this means that a determined acquirer must engage in two corporate elections over a period of two years to force entrenched managers to give up power.

In this Article, Professors Edelman and Thomas examine whether proxy contests, tender offers, or combined proxy contest/tender offers are more likely to result in value maximizing outcomes for shareholders when target companies are able to deploy defensive tactics. The authors begin by showing that prior work suffers from serious flaws involving the use of voting models that are inappropriate for analyzing proxy contests. To develop a more realistic approach to these questions, the authors employ a probabilistic version of a standard weighted voting model that explicitly incorporates two critical features of corporate voting: first, that shares are normally voted in large blocks rather than in single shares; and second, that independent third party proxy voting advisors play an important, and often pivotal, role in determining the outcome of corporate elections. In addition, the authors explicitly incorporate information about the size of different corporate constituencies and their voting preferences. Using their model, Professors Edelman and Thomas show experimentally how the distribution of shares among various investor constituencies will affect the outcome of different types of voting contests.

Using this model, and these different sets of assumptions, the authors find that neither proxy contests, tender offers, nor combined proxy contests and tender offers will always lead to the desirable outcome for target company shareholders in any scenario. With each type of acquisition technique, bidders succeed in obtaining control of the target company in some value decreasing transactions, and are defeated in their acquisition efforts in some value increasing transactions. These results hold whether the authors permit existing defensive tactics or eliminate them.

Professors Edelman and Thomas conclude that in order to properly analyze the role of defensive tactics, courts must take into account the underlying shareholder ownership patterns. This requires them to engage in a fact sensitive analysis of whether defensive tactics are impeding or facilitating the maximization of shareholder value. When the authors examine the Delaware Chancery Court's decisions, the reasonableness analysis that the courts have employed to decide whether to overturn defensive tactics permits them to do so. The authors recommend that the courts continue to apply this type of analysis in the future with more direct consideration of the impact of the underlying ownership structure in determining whether the defenses are being used to maximize shareholder value.

takeover, proxy contest, corporate voting, weighted voting

Abstract:
The PSLRA's lead plaintiff provision was adopted in order to encourage large shareholders with claims in a securities fraud class action to step forward to become the class' representative. Congress' expectation was that these investors would actively monitor the conduct of a securities fraud class action so as to reduce the litigation agency costs that may arise when class counsel's interests diverge from those of the shareholder class. Proponents of the provision claimed that there would be substantial benefits from having institutional investors serve as lead plaintiffs. Now, ten years later, the claim that the lead plaintiff is a more effective monitor of class counsel in securities fraud class actions continues to be intuitively appealing, but remains unproven.

In this paper, we inquire empirically whether the lead plaintiff provision has performed as projected. We break the lead plaintiffs into five categories: public pension funds; other institutional investors; single individual lead plaintiffs; aggregate groups of individual lead plaintiffs and groups containing both individuals and entities. Our data shows that courts fairly consistently favor financial institutions over other types of investors when there is a contest among them to be appointed lead plaintiff. We find that the public pension funds have much larger dollar claims than any of the other groups, and have the largest, or close to the largest, claims of any investors in the case in which they appear as lead plaintiffs.

We then analyze a sample of 388 securities fraud class action settlements to further investigate the effect of the lead plaintiff provision. Our first hypothesis is that PSLRA and the lead plaintiff provision have increased the dollar amount of settlements in securities fraud class actions. Our results show that after controlling for estimated losses, market capitalization of defendant firms, the length of class period and the presence of parallel SEC actions, the dollar amount of post-PSLRA settlements are not statistically significantly different from those in the pre-PSLRA cases in our sample. We also find that the ratio of settlement amounts to estimated provable losses - which is the most important indicator of whether investors are being compensated for their damages - was statistically significantly lower in the post-PSLRA period. In other words, the lead plaintiff provision and the PSLRA may have made investors worse off.

We next analyze the determinants of institutional investors' decision to become lead plaintiffs in the cases in our sample. Using a logit regression analysis, we find that institutions are more likely to become lead plaintiffs in cases involving larger provable losses, with longer class periods, with larger defendant firms, and when there is a parallel SEC enforcement action. Importantly, we find that the presence of an institutional lead plaintiff improves the securities fraud settlement, even holding constant estimated provable losses, firm market capitalization, the length of class period, and the presence of an SEC enforcement action.

Third, we examine whether recoveries are significantly different among settlements when a single (non-institutional) plaintiff represents the class compared with the lead plaintiff being either an aggregation of individuals or a group comprised of individuals and a non-institutional entity. We find that the single individual lead plaintiff does best in the smallest cases, and performs worst in the larger cases. Groups perform relatively better than individuals in larger cases.

Finally, we investigate press reports that institutions are aggressively lobbied by plaintiffs' law firms to appear as lead plaintiffs in "pay to play" schemes, with political contributions being made in exchange for institutional investors' agreement to become a lead plaintiff and select a preferred law firm as class counsel.

Lead Plaintiff, PSLRA

Abstract:
Federal appellate courts have promulgated divergent legal standards for pleading fraud in securities fraud class actions after the Private Securities Litigation Reform Act (PSLRA). Recently, the U.S. Supreme Court issued a decision in Tellabs v. Makor Issues & Rights that could have resolved these differences, but did not do so. This article provides two significant contributions. We first show that Tellabs avoids deciding the hard issues that confront courts and litigants daily in the wake of the PSLRA's heightened pleading standard. As a consequence, the opinion keeps very much alive the circuits' disparate interpretations of the PSLRA's fraud pleading standard. To be sure, Tellabs might ultimately be applied by lower courts to narrow the range of permissible approaches to satisfying the strong inference standard, but leaves a good deal of room within which wide variations in approach will continue.

Our second contribution is empirical in that we seek to answer the question: do plaintiffs' attorneys take advantage of the differences among the circuits' interpretation of the pleading standard to select more favorable venues to file their cases as some scholars have claimed? We find that 85% of the securities fraud class actions in our sample are filed in the home circuit of the defendant corporation. In the remainder of cases, those that are filed outside the defendant's home jurisdiction, our analysis shows that differences in the pleading standards do not explain a statistically significant amount of the reason for that decision.

While the differences in the circuits' pleading standards do not have a statistically significant impact on the plaintiffs' choice of venue, we find that plaintiffs are more likely to file low value cases in jurisdictions other than the one in which the defendants' headquarters is located. In particular, we find that cases with smaller provable losses and without an accompanying SEC investigation are statistically significantly more likely to be filed in circuits other than where the defendant's principal place of business is located. We interpret the former result as consistent with the hypothesis that in lower value cases, plaintiffs' counsel is more likely to select jurisdictions that are convenient to themselves rather than to the defendant. Conversely, when an SEC investigation is proceeding on the basis of the same operative facts, our results are consistent with the claim that plaintiffs' counsel will avoid filing outside of the defendant corporation's home jurisdiction to avoid procedural delays.

Securities, class actions, Tellabs, fraud, PSLRA

Abstract:
This is a short essay on what should be the fundamental criterion used to evaluate corporate law. I argue that the overall goal of good corporate law should be to assist private parties to create wealth for themselves and the economy in a manner that does not inflict uncompensated negative externalities upon third parties. Private businesses that produce goods and services should be encouraged by the state because creating greater wealth is generally beneficial to society. Corporate law can act as a helpful precondition for faster economic growth by protecting the parties' expectations, encouraging savings and investment, reducing transaction costs, minimizing agency costs, and compensating third parties for any harm that they may suffer from this business activity.

Corporate Law, Societal Welfare

Abstract:
Recent empirical work has demonstrated that large, publicly held firms tend to file for bankruptcy in Delaware. In our previous work, we have documented this trend, and argued that it may be efficient for prepackaged bankruptcies, while it unclear if it is efficient for traditional Chapter 11 cases. In this piece, we respond to LoPucki and Kalin's assertion that Delaware bankruptcy court performs worse than others. They base this claim on the observation that firms that file for bankruptcy in Delaware are more likely to file for bankruptcy a second time than are firms that file in another jurisdiction.

We demonstrate a number of problems with their analysis. These include that: they have failed to offer a robust definition of what constitutes a successful reorganization; they do not adequately justify focusing narrowly on refiling rates; and that a substantial number of firms drop out of their sample which may adversely affect their results. Moreover, contrary to their assumption, we also show that there may be an optimal refiling rate that is above zero. In any given case, there may be a trade off between resolving the case quickly and the risk of a subsequent filing. We conclude that, while their results are provocative, there remains much more work to be done before strong implications can be drawn from them.

Abstract:
In this paper, we ask whether CEOs bargain to include binding arbitration provisions in their employment contracts. After exploring the theoretical arguments for and against including such provisions in these agreements, we use a large sample of CEO employment contracts to test the several different hypotheses for including such provisions. We find that only about one half of CEO employment contracts in our sample include such provisions. We further find that CEOs that receive a higher percentage of long term incentive pay as a fraction of their total pay, that work in industry sectors that are undergoing greater amounts of change, and that have lower long term profitability are statistically significantly more likely to have arbitration provisions in their employment contracts.

CEO, arbitration, employment contracts

Abstract:
We analyze voting data from five proxy seasons (2003-2008) to identify the extent to which shareholders generally, and mutual funds in particular, vote in accordance with the voting recommendations of RiskMetrics’ ISS Corporate Governance Services. We look at voting by all shareholders and voting decisions by mutual funds on non-election and non-routine proxy proposals - both those submitted by management and those submitted by shareholders. We find that shareholders generally tended to vote more consistently with ISS voting recommendations than management recommendations during this period, with more consistency among mutual funds than all shareholders. We also find that independent voting is unusual: Shareholder voting and, even more so, mutual fund voting decisions generally follow either the recommendations of management or of the ISS. Mutual fund voting decisions are consistent with ISS recommendations more frequently than management recommendations, whether the proposal is submitted by management or by shareholders, and whether relating to anti-takeover issues or corporate governance issues. Our univariate results are confirmed by multivariate regressions that examine the weight mutual funds give to ISS recommendations. In short, ISS has an impact on voting by shareholders generally and, across the board, an even greater impact on voting by mutual funds.

mutual fund voting, ISS, corporate governance, shareholders

Abstract:
Hedge fund activism is a new form of investment strategy. Using a large hand-collected dataset from 2001 to 2006, we find that activist hedge funds in the United States propose strategic, operational, and financial remedies and attain success or partial success in two-thirds of the cases. The abnormal stock return upon announcement of activism is approximately 7 percent, with no reversal during the subsequent year. Target firms experience increases in payout and operating performance and higher CEO turnover after activism. We find large positive abnormal return to hedge fund activists, which is higher than the return to other equity-oriented hedge funds.

Alternative Investments - Hedge Fund Strategies, Portfolio Management - Hedge Fund Strategies, Corporate Governance

Abstract:
This article examines firm-commitment initial public offerings, exploring the ways underwriters use and abuse the over-allotment option to affect legal price stabilization in after-market trading. After illustrating that underwriters always profit when they make full use of the over-allotment option, the authors suggest that the NASD reexamine the size of the over-allotment option and require disclosures concerning the use of the option be included in the prospectus distributed to potential buyers of newly issued securities.

Abstract:
In this paper we address underwriters' use of the over-allotment option (OAO) as a means of reducing the risks associated with a firm commitment underwriting. We argue that the OAO is an effective device for reducing the risk of adverse market changes in a firm commitment underwriting. We conduct an empirical analysis to test whether underwriters exercise the OAO strategically to reduce these risks.

The over-allotment option allows the underwriter to sell additional shares, up to 15% of the number of shares registered in the "official" offering. If the underwriter sells the shares covered by the over-allotment option when the offer commences, this establishes a short position in the stock that can be covered with stock repurchases in the open market if the stock price does not increase, or by exercising the OAO if it does.

If the price of the newly issued shares drops, the underwriter places a bid to purchase shares in the market at or below the offering price to cover its short position without exercising the over-allotment option. By contrast, if the price increases, the underwriter exercises the over-allotment option and collects the commission or gross spread for these shares. Thus no matter which direction the stock price moves after issuance, the underwriter eliminates much of the market risk associated with any potential change in the market's condition and makes money on the over-allotted stock, so long as it can sell the additional securities at issuance.

Our results suggest that underwriters use the OAO in different ways depending on market conditions after the issuance of the new stock, and that their actions are consistent with our hypothesis that the OAO acts to decrease the risks associated with unsuccessful IPOs. In particular, we find that the extent to which the OAO is exercised is positively related to both the initial return on securities sold in a public offering and the return on the newly issued shares during the first four weeks after issuance.

Our estimates of underwriter profitability are almost always positive and are always positive when at least some of the OAO is exercised. This suggests that underwriters of IPOs are not subjected to significant financial risks, in part due to their use of the OAO. Finally, we show that the number of shares exercised of the OAO is negatively related to the number of shares repurchased through underwriter stabilization activities in the secondary market after issuance, even after controlling for other characteristics of the offer.

Overall, these results suggest that the extent of the OAO exercise is related to the after-issuance performance of an issuing firm's stock price, and that the underwriter can strategically exercise the OAO to greatly reduce the risks from underwriting an IPO.

Abstract:
This paper investigates the increased shareholder activism by labor unions and their pension funds, who are now the most aggressive institutional shareholders. Sometimes unions propose traditional corporate-governance measures through procedures familiar to shareholders. Only the union sponsor is novel. But recently unions have pushed innovative methods to get corporations to listen to shareholder complaints. These methods include mandatory amendment of corporate by-laws by shareholders and floor proposals submitted for a shareholder vote at the annual meeting.

Unions as shareholders have conflicting roles. We distinguish union-shareholder initiatives designed to further unions' traditional organizing and collective bargaining goals from those that enhance unions' role as a participant in strategic corporate decisions, a newer vision of the union role. With either the traditional or new role, the union shareholder can fight management in ways that benefit other shareholders, or can benefit workers at the expense of other shareholders.

We use this framework to describe labor unions' current voting initiatives. From the labor perspective, unions themselves recognize the need for new approaches - including approaches that do not reflexively regard efficiency and profitability as goals of "enemy" shareholders. From the corporate perspective, unions need new approaches because they have remained peripheral players in the boardroom despite their vast stock holdings.

We find legal reform to be unnecessary, because existing legal and market checks adequately constrain potential opportunistic union behavior. These checks include the fiduciary structure of Taft-Hartley union pension funds; the need to persuade other self-interested shareholders to vote for union initiatives; and the disciplinary power of capital markets, product markets, and the market for corporate control. These forces adequately limit labor unions' ability to expropriate more corporate value for their members, if they would choose to pursue that course of action.

Finally, we suggest that union-shareholder activism may have long-lasting effects on unions' role in corporate governance, but only if unions focus their shareholder voting initiatives in areas where they have special advantages in monitoring management. If unions can package their proposals in ways that emphasize to other shareholders ways in which the two groups' interests are aligned, then union-shareholder activism may become an important force in corporate governance.

Abstract:
In this paper, we examine whether labor groups should be allowed to use Rule 14a-8 as a mechanism for pursuing their interests as shareholders. We focus on the questions raised by corporate management about labor's potential conflicting roles as shareholders and workers. Using data from the 1994 proxy season, we conduct an empirical examination of the differences between shareholder resolutions proposed by labor groups and those sponsored by other investors. Our analysis focuses on shareholders' perceptions of these proposals and in particular the proposals' success in the ballot box. Our data set contains 192 shareholder proposals submitted by labor groups, public institutions, private institutions, and individuals. We include proposals covering internal and external corporate governance, compensation-related, and miscellaneous issues. We estimate regressions for the fraction of votes cast for a shareholder-sponsored corporate governance proposal including independent variables for sponsor, proposal type and ownership variables. We find that, controlling for the type of proposal and ownership structure: (1) labor-sponsored proposals receive a statistically significant higher percentage of favorable votes than do similar proposals sponsored by private institutions and individuals; and (2) labor-sponsored proposals obtain approximately the same percentage of votes as proposals sponsored by public institutions. To further explore these findings, we focus on a subsample of proposals identified by the ATA as specific instances where labor has used the proposal mechanism as part of a "corporate campaign." We find no significance difference between the average percentage votes cast for these allegedly "abusive" proposals and the average votes cast for all other corporate governance proposals. We do find that these proposals receive a slightly lower percentage of favorable votes than other labor proposals, but the difference is not statistically significant. We interpret these results to suggest that shareholders view labor proposals under Rule 14a-8 as favorably, or more favorably, than proposals made by other shareholders. Even in situations where labor is battling management over other issues, such as collective bargaining negotiations, shareholders continue to treat labor proposals as no different from those submitted by others. These results suggest that management's concerns with labor's use of the shareholder proposal mechanism are overstated and that regulatory reform is unnecessary.

Abstract:
This article examines whether corporate inspection statutes facilitate shareholder communication and information collection. Using an empirical analysis of the Delaware inspection statute from a companion article, it shows that while shareholders almost always obtain stock lists and frequently get books and records, there are substantial delays and significant costs to them from using inspection statutes. It argues that the Delaware statute must be substantially streamlined to improve shareholders' access to information. In particular, it recommends granting automatic access to stock lists in most circumstances and greater access to the corporation's books and records provided certain conditions are satisfied. Finally, the article urges revision of Rule 14a-7 of the 1934 Exchange Act if Delaware does not act to revise its inspection statute. This paper is copyright Arizona Board of Regents, 1996.

Abstract:
This article analyzes the current controversy over whether a company's state of incorporation should remain an appropriate venue for firms filing for corporate reorganization under Chapter 11 of the Bankruptcy Code. The article examines the recent developments involving the Delaware bankruptcy court, and concludes that the state of incorporation should remain as an acceptable venue in bankruptcy cases. The article then, drawing on the general corporate law literature, argues that firms should be required to precommit to filing in a particular venue well before the onset of financial distress. The firms managers will then have the incentive to choose the venue which promises to maximize firm value. Bankruptcy courts, which compete amongst themselves for Chapter 11 cases, will then have the incentive to interpret and implement the Bankruptcy Code so as to maximize firm value.

The article makes three substantial contributions to the extant bankruptcy literature. First, it details the rise in importance of Delaware as a venue for Chapter 11 cases, shows how this is related to Delaware?s handling of prepackaged bankruptcies, and demonstrates that there should be a single forum for such bankruptcies and that Delaware is the logical choice. Second, the article draws on the ?race to the top? literature to show how a change in the Bankruptcy Code?s venue provisions can lead to more efficient interpretations and applications of the Bankruptcy Code. Finally, the article takes issue with the suggestion that all of corporate bankruptcy law should be returned to the states. It does this by undertaking a comparative analysis of the political economy of state and federal lawmaking.

Abstract:
This paper investigates the increased shareholder activism by labor unions and their pension funds, who are now the most aggressive institutional shareholders. Sometimes unions propose traditional corporate-governance measures through procedures familiar to shareholders. Only the union sponsor is novel. But recently unions have pushed innovative methods to get corporations to listen to shareholder complaints. These methods include proposing by-law amendments that would be adopted by shareholders and then bind the corporation and floor proposals submitted for a shareholder vote at the annual meeting. We describe recent developments in the law surrounding these new shareholder tactics, including the Fleming Companies case and the Idaho Power no-action letter. Unions as shareholders have conflicting roles. We distinguish union-shareholder initiatives designed to further unions' traditional organizing and collective-bargaining goals from those that enhance unions' role as a participant in strategic corporate decisions, a newer vision of the union role. With either the traditional or new role, the union shareholder can fight management in ways that benefit other shareholders, or can benefit workers at the expense of other shareholders. We use this framework to describe labor unions' current voting initiatives. From the labor perspective, unions themselves recognize the need for new approaches -- including approaches that do not reflexively regard efficiency and profitability as goals of "enemy" shareholders. From the corporate perspective, unions need new approaches because they have remained peripheral players in the boardroom despite their vast stock holdings. We find legal reform to be unnecessary, because existing legal and market checks adequately constrain potential opportunistic union behavior. These checks include the fiduciary structure of Taft-Hartley union pension funds; the need to persuade other self-interested shareholders to vote for union initiatives; and the disciplinary power of capital markets, product markets, and the market for corporate control. These forces adequately limit labor unions# ability to expropriate more corporate value for their members, if they would choose to pursue that course of action. Finally, we suggest that union-shareholder activism may have long-lasting effects only if unions focus their shareholder initiatives in areas where they have special advantages in monitoring management.

Abstract:
We propose that plaintiffs in securities fraud actions should use state inspection statutes to obtain discovery about potential securities fraud cases. First, we argue that the effect of the Private Securities Law Reform Act (PSLRA) has been to substantially increase the difficulty of uncovering securities fraud. We show that shareholders have an alternative method of investigating fraud using state inspection statutes. We then analyze cases filed under the Delaware inspection statute to examine the costs to plaintiffs of pursuing claims under this statute. We find that the statutory inspection process is a largely successful, expensive and time-consuming process. Nevertheless, potential plaintiffs could realize substantial benefits from utilizing inspection statutes in this manner.