As we enter 2012 and as the U.S. economy continues to stabilize, there appears to be a growing sense of optimism about further recovery in the M&A market. During the first half of 2011, the M&A market continued a resurgence that began in the latter part of 2010, with higher aggregate deal value than had been seen since before the financial crisis. Though worldwide M&A activity declined in the second half of 2011, reflecting uncertainties regarding the volatile global financial climate, it has continued at a relatively strong pace, and a number of significant transactions have recently been announced, including Kinder Morgan’s $38 billion acquisition of El Paso, United Technologies’ $18 billion acquisition of Goodrich, and Gilead’s $11 billion acquisition of Pharmasset.

…continue reading: Mergers and Acquisitions in 2012

In our paper Why Do CEOs Survive Corporate Storms? Collusive Directors, Costly Replacement, and Legal Jeopardy, which was recently made publicly available on SSRN, we consider new explanations for the puzzling result that a majority of misreporting CEOs retain their jobs.  We extend the literature by investigating the role of directors’ both personal and reputational incentives in the CEO retention decision.  Overall, our analysis improves our understanding of the CEO retention decision by 30 to 40% relative to a benchmark model based on the severity of the misreporting, the firm’s performance and risk characteristics, and traditional measures of the strength of corporate governance.

We show that two types of personal benefits make conventionally independent directors less likely to remove CEOs: loss avoidance on equity-contingent wealth and increased compensation. First, we find that in firms where independent directors emulate CEOs’ trading behavior and also engage in abnormal insider selling over the misreporting period, CEOs are 13.6% more likely to be retained.  We view independent directors’ trading as suggestive of collusion because, like CEOs and other executive directors, they personally benefit by selling their equity at inflated prices during the period over which earnings are misreported.  To the extent that the misreporting sustains the firm’s overvaluation, the fact that directors engage in abnormal selling suggests they have access to negative information about the firm that they do not reveal to shareholders.  We posit that independent directors prefer not to attract attention to their own abnormal selling.  Thus, even though dismissing the CEO could enhance shareholder value by restoring credibility, directors whose trading actions align with those of CEOs have weaker incentives to replace the CEO.

…continue reading: Why Do CEOs Survive Corporate Storms?

The past year has been one of change and challenge for public companies and their boards, as companies have moved to implement “say-on-pay” and other provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”). With the 2012 proxy season on the horizon, public companies and their directors will continue to feel the impact of Dodd-Frank as the Securities and Exchange Commission (“SEC”) proceeds with its ongoing efforts to implement the law. At the same time, public companies and their boards are operating in an environment where the balance of power between boards and shareholders continues to shift. The traditional, board-centric model of corporate governance continues to gravitate toward a paradigm that includes an increased role for shareholders. Activist shareholders are seeking greater participation in companies’ governance and operations, and they are exerting increased pressure on companies to adopt so-called corporate governance “best practices.”

…continue reading: Considerations for Public Company Directors in the 2012 Proxy Season

With the phase out of Tier 1 capital treatment for trust preferred securities (TruPS) mandated by Dodd Frank slated to begin January 1, 2013, financial institutions have been active in considering potential strategies to replace outstanding TruPS with other forms of regulatory capital. Last week, Huntington Bancshares completed a novel exchange offer for several specified series of outstanding TruPS. In the offer, Huntington exchanged outstanding floating-rate TruPS for a new series of floating-rate non-cumulative perpetual preferred stock, which – unlike the TruPS – will not lose Tier 1 treatment under Dodd Frank and will also continue to be recognized as a Tier 1 instrument under Basel III.

Huntington’s exchange offer involved four different series of TruPS and the offer was tailored to each series, including through the use of additional cash consideration for two of the series and by employing a waterfall of acceptance priority levels among the four series in the event that the offering was oversubscribed. By conducting the exchange as a registered offering rather than relying on the exchange provisions under Section 3(a)(9) of the Securities Act of 1933, Huntington was able to employ a dealer manager to solicit TruPS holders in an effort to maximize participation. Note, however, that while Huntington’s exchange offer was completed in the scheduled time frame, the SEC must declare an exchange offer registration statement effective prior to closing, and the SEC review process can risk a delayed closing. Under the securities laws, the offer must be open to all holders and must remain open for at least 20 business days.

…continue reading: Creative TruPS Capital Restructurings

On December 20, 2011, Vice Chancellor Parsons of the Delaware Court of Chancery issued an opinion and entered a temporary restraining order enjoining ChinaCast Education Corporation from holding its annual meeting, scheduled for later that day, until January 10, 2012. See Sherwood, et al. v. Chan Tze Ngon, et al., No. 7106-VCP (Delaware Court of Chancery). The Court found that ChinaCast’s actions, having removed incumbent director Ned Sherwood from its slate of nominees less than two weeks before the scheduled annual meeting, did not “comport with the ‘scrupulous fairness’ required of corporate elections.” The opinion serves as an important reminder for companies that while Delaware law provides significant latitude to create processes intended to facilitate the orderly conduct of annual stockholder meetings and election contests, actions that improperly infringe upon the shareholder franchise will be viewed skeptically by Delaware courts.

…continue reading: Delaware Court Intervenes to Protect Shareholder Voting Rights

In our paper, Executive Stock Options, Differential Risk-Taking Incentives, and Firm Value, forthcoming in the Journal of Financial Economics, we examine how executive stock options (ESOs) give chief executive officers (CEOs) differential incentives to alter their firms’ systematic and idiosyncratic risk. Since ESOs give CEOs incentives to alter their firms’ risk profile through both their sensitivity to stock return volatility, or vega, and their sensitivity to stock price, or delta, we examine both effects.

Theory suggests that vega gives risk-averse managers more of an incentive to increase total risk by increasing systematic rather than idiosyncratic risk, since, for a given level of vega, an increase in systematic risk always results in a greater increase in a CEO’s subjective value of his or her stock-option portfolio than does an equivalent increase in idiosyncratic risk. This differential risk-taking incentive manifests because a CEO who can trade the market portfolio can hedge any unwanted increase in the firm’s systematic risk. Consistent with this prediction, we provide evidence of a strong positive relationship between vega and the level of both total and systematic risk. However, we do not find vega and idiosyncratic risk to be significantly related.

…continue reading: Executive Stock Options, Differential Risk-Taking Incentives, and Firm Value

Here are slides on the Airgas case and slides on the underlying gating issue of long/short term perspective that drives much of the corporate governance debates and is rarely confronted by the “governistas” that advocate all sorts of standardized practices they consider to be value enhancing. I used these materials this month in a class co-taught by Lucian Bebchuk and Scott Hirst at Harvard Law School – hence, the reference to being “in the belly of the beast.” The slides are available here and here.

Concerns about the responsible use of corporate power remain high in the wake of the financial crisis. Although these concerns have been focused primarily on the financial sector, there is spillover to corporations in every industry. Tough economic conditions, slow job growth, political dysfunction and general uncertainties about the future continue to undermine investor confidence and fuel public distrust (with Occupy Wall Street an example). This in turn intensifies the scrutiny of corporate actions and board decisions, and may skew the regulatory environment in which companies compete.

All corporate governance participants – boards, executive officers, shareholders, proxy advisors, regulators and politicians – have both an interest and a role to play in rebuilding trust in the corporations that are the engine of our economy. In our annual reflection, we offer thoughts on how, without the need for regulatory intervention, boards and shareholders can seize the opportunity to rebuild trust and, by doing so, help resolve some of the tensions that are stalling our economic recovery.

…continue reading: Rebuilding Trust: The Corporate Governance Opportunity for 2012

The Forum is pleased to announce that Stephen Fraidin, a member of the law firm of Kirkland & Ellis, joined the Advisory Board of the Harvard Law School Program on Corporate Governance. He joins the existing members of the Board: William Ackman, Peter Atkins, Joseph Bachelder, Richard Breeden, Richard Climan, Isaac Corré, John Finley, Byron S. Georgiou, Larry Hamdan, Robert Mendelsohn, David Millstone, Theodore Mirvis, James Morphy, Toby Myerson, Eileen Nugent, Paul Rowe, and Rodman Ward.

For more than 30 years, Steve Fraidin’s practice has focused on the representation of major companies and investment groups in acquisitions and proxy contests, and special committees and boards of directors regarding mergers and acquisitions, corporate governance and other matters.  In 2003, he joined Kirkland & Ellis LLP as a senior partner in the M&A group. Major M&A representations most recently handled by Mr. Fraidin include the special committee of Expedia, Inc. in connection with the spinout of TripAdvisor, Inc., the representation of EMS Technologies in its sale to Honeywell, Inc. for approximately $600 million, and 3G Capital Management LLC in the $4.3 billion acquisition of Burger King. His work on behalf of 3G Capital was recognized by The American Lawyer in its annual “Dealmakers of the Year” edition and the transaction was recognized by Investment Dealers’ Digest in its annual “Deal of the Year Awards,” The Deal Magazine as one of the “Deals of the Year” and as the “Private Equity Deal of the Year” at the M&A Atlas and IFLR America’s awards ceremonies in New York. Mr. Fraidin also recently represented Pershing Square Capital Management LP, the New York hedge-fund firm led by activist investor William Ackman, in the acquisition of a 26.1% stake in retailer, J.C. Penney; Community Health Systems Inc. in the attempt to acquire Tenet Healthcare Corp.; and NRG Energy Inc. in successfully repelling Exelon Corp.’s  $7.45 billion hostile bid. His work in the NRG takeover attempt was recognized by The AmLaw Daily as “Dealmaker of the Week.”

…continue reading: Stephen Fraidin Joins PCG’s Advisory Board

On December 16, 2011, the Internal Revenue Service (the “IRS”) and Treasury Department issued final and proposed regulations (“the Final Regulations” and “the Proposed Regulations,” respectively) that generally provide rules for the proper timing of the valuation of consideration offered in respect of a reorganization, for purposes of satisfying the “continuity of interest” requirement for tax-free reorganizations. The Final Regulations issue in finalized form rules previously described in temporary regulations, which allow in certain circumstances for the valuation of consideration on the date prior to the signing of a merger agreement, known as the “signing date” rule, with some additional clarification.

The Proposed Regulations would expand the signing date rule and would allow for the use of an average share price under certain circumstances. Specifically, under the Proposed Regulations, for purposes of determining whether the “continuity of interest” requirement is satisfied:

…continue reading: Measuring Continuity of Interest in Reorganizations