The Law School’s Program on Corporate Governance has recently issued a discussion paper by Vice Chancellor Leo Strine, Toward Common Sense and Common Ground? Reflections on the Shared Interests of Managers and Labor in a More Rational System of Corporate Governance.  The paper presents the Vice Chancellor’s recent remarks at the Spring Banquet for the Journal of Corporation Law at the University of Iowa College of Law.  The Abstract is as follows:

In this essay, Vice Chancellor Strine reflects on the common interests of those who manage and those who labor for American corporations.  The first part of the essay examines aspects of the current corporate governance and economic environment that are putting management and labor under pressure.  The concluding section of the essay identifies possible corporate governance initiatives that might–by better focusing stockholder activism in particular and corporate governance more generally on long-term, rather than short-term, corporate performance–generate a more rational system of accountability, that focuses on the durable creation by corporations of wealth through fundamentally sound, long-term business plans.

The full essay is available for download here.  The essay will be appearing in the Journal of Corporation Law with responses by a number of prominent commentators.  In a subsequent post, Guest Contributor Hillary Sale will offer some background on that issue of the Journal and the responses to the Vice Chancellor’s remarks.

The Wall Street Journal carried a story yesterday on the pressure building on the SEC to file an amicus brief supporting the petition for certiorari filed by the plaintiffs in the Enron securities litigation against the firm’s former financial advisors.  In Regents of the University of California v. Credit Suisse, the Fifth Circuit reversed the certification of a class bringing securities claims against investment banking firms that worked with Enron, holding that Section 10(b) does not provide for primary liability for such advisors and deepening the split among the federal appellate courts on that issue. 

The Supreme Court has already agreed to decide whether financial advisors may be liable under Section 10(b) in Stoneridge Investment Partners v. Scientific Atlanta, an appeal from the Eighth Circuit, and The Race to the Bottom Blog will explore the issues raised by these cases next week.  But there is a crucial–and largely overlooked–difference between Stoneridge and the Enron litigation that may well affect the outcome.  It concerns the makeup of the justices who will be deciding the case.  If the Court grants review in the Enron litigation as well, it may well tell us something about the likely outcome in Stoneridge itself.

…continue reading: The SEC, the Supreme Court, and Enron

Michael Pittenger, Michael Reilly, and I have prepared an article, Buyer Beware: The Fiduciary Duties of a Buyer’s Board, on Vice Chancellor Parsons’s decision in Energy Partners, Ltd. v. Stone Energy Corp.  The article discusses the fiduciary duties of buyer boards and posits that buyer boards may, in the appropriate circumstances, need to bargain for contractual flexibility to deal with jumping bids for the buyer.  The article was published in the Spring 2007 issue of Deal Points, the official publication of the Negotiated Acquisition Committee of the American Bar Association.

The full article is available for download here.  In addition, the article may be found on the Potter Anderson & Corroon website in our publications collection.

I have recently prepared this M&A Deal Commentary, Appraisal Arbitrage: Will It Become a New Hedge Fund Strategy?, explaining that the recent decision in the Transkaryotic shareholder litigation may spawn a new “market” in appraisal rights that will allow purchasers of shares after the record date to bring appraisal actions.  As the Commentary notes, the decision raises, for the first time, the specter of arbitrage in appraisal rights.

Chief Justice Myron T. Steele of the Delaware Supreme Court offered his views on the duty of good faith on October 5, 2006, as part of the Delaware State Bar Association’s Third Annual Symposium on the Law of Delaware Business Entities, Good Faith After Disney: The Role of Good Faith in Organizational Relations in Delaware Business Entities. 

The transcript of Chief Justice Steele’s remarks, prepared for our readers with the generous assistance of his law clerks, is available here.

[Editor’s Note: We’re pleased to host the following dialogue between Mark Morton of Potter Anderson and Corroon and Larry Hamermesh of Widener Law School, precipitated by Mark’s ruminations about sellers’ insistence that a go-shop provision with a matching right in a merger agreement be accompanied by a right to reimburse the expenses of a topping bidder who is subsequently matched.  As always, we welcome reader comments on the discussion below.]

Mark Morton: In the typical M&A deal, there’s generally a match right.  As a result, the target can’t actually terminate the merger agreement for the superior proposal until the first bidder decides whether or not to match.  If the first bidder matches, he wins (unless he’s topped again).  In that case, the target will not have signed a merger agreement with the interloper, so the interloper doesn’t get a termination fee.  As a result, the interloper gets nothing for his superior bid–other than a large chunk of unreimbursed expenses.  I would argue, therefore, that the presence of a match right creates a significant disincentive to topping bids.

…continue reading: Go-Shops With Matching Rights: Reimbursing Topping Bidders

Sometimes good things happen to good people.  This Memorandum provides some lessons learned from the recent Motorola/Icahn proxy contest, where even the twinning of Icahn and ISS proved not invincible.

Robert K. Payson and Bradley W. Voss of Potter, Anderson & Corroon have released this Memorandum summarizing Vice Chancellor Strine’s recent decision in In re: The Topps Company Shareholders Litigation.  In Topps, the Court builds on the narrative Chancellor Chandler offered in Ryan v. Gifford, explaining why the Delaware courts will not stay a later-filed Delaware action in a shareholder derivative suit in favor of a first-filed action in another state if the Delaware courts are persuaded that the issues are important and novel under Delaware law.  Although the general rule favors deference to the speedier plaintiff in the first-filed action, since plaintiffs in derivative suits (in theory, at least) are not suing on their own behalf, Delaware courts have not hesitated to proceed with a later-filed Delaware action notwithstanding ongoing proceedings elsewhere.

The Ryan and Topps decisions represent an interesting nuance in the debate over competition among states with respect to corporate law.  Although that scholarship emphasizes where firms will choose to incorporate, there may be competition among courts over shareholder derivative suits as some plaintiffs file in Delaware and others in different jurisdictions (such as the venue where the company’s headquarters is located).  If some plaintiffs file suit outside of Delaware courts–believing, perhaps, that a foreign state’s court will apply Delaware law in a manner more favorable to shareholders–which court takes control of the case will be particularly important.  And, of course, the fact that dueling suits are proceeding side by side raises a host of interesting issues, including whether the courts or the parties will “race” to an outcome to gain collateral estoppel effect and whether having two costly suits proceeding simultaneously is an efficient use of judicial resources.

The John M. Olin Center has just posted a new paper by Michael Simkovic, an Olin Fellow in Law and Economics, entitled The Effect of Enhanced Disclosure on Stock Market Repurchases.  The paper studies the effect of the SEC’s rule requiring quarterly disclosure of shares purchased under share-repurchase programs on opportunistic use of share-repurchase announcements.  (Guest Contributor Jesse Fried also explored this issue in Informed Trading and False Signaling with Open Market Repurchases.)  The Abstract of Michael’s paper is as follows:

Publicly traded companies distribute cash to shareholders primarily in two ways–either through dividends or through anonymous repurchases of the company’s own stock on the open market.  Companies must announce a repurchase authorization, but do not actually have to repurchase any stock, and until recently did not have to disclose whether or not they were in fact repurchasing any stock.  Scholars and regulators noticed that companies frequently announced repurchases but then appeared not to complete them.  Scholars and regulators became concerned that such announcements might be used by insiders to exploit public investors.  To increase transparency and reduce opportunities for exploitative behavior, the SEC required that companies disclose their repurchase activity for the past quarter in the 10-Q and 10-K filings beginning in January 2004.  This paper tracks the 365 repurchase programs announced in 2004 and finds that since the SEC disclosure requirement went into effect, companies are more likely to complete their announced repurchases and do so within a shorter time period after the repurchase announcement.

Commentary is especially welcome on this fascinating new piece.  The full article can be downloaded here.

Last month I published this op-ed in the Financial Times questioning whether the push for greater “shareholder democracy” may end up harming public investors by driving companies into the arms of private equity firms.  After assessing the substantial increase in private equity activity in recent years, the piece concludes:

There is reason to suspect that the modern trend towards greater “shareholder power” has gone too far and is beginning to harm the very shareholders it was designed to protect.  A certain level of investor protection and power is, of course, essential to an honest and healthy public market.  But you can have too much of a good thing.  The buyout trend suggests we may already have too much “shareholder democracy”–at least, too much for shareholders’ own good.

My partner Arthur L. Dent has released this Memorandum on Chancellor Chandler’s recent decision in the Transkaryotic appraisal litigation.  The Memorandum provides a detailed analysis of the decision and its implications for appraisal proceedings.

Brian Broughman and I have written a paper, Deviations from Contractual Priority in the Sale of VC-Backed Firms, that examines how corporate governance arrangements in VC-backed firms that are sold affect the allocation of the sale proceeds between preferred shareholders (the VCs) and common shareholders (including the founders, employees, and angel investors).

It is often assumed that VC cash flow rights–including their right to liquidation preferences when the firm is sold–are fully respected.  However, we are unaware of any study that examines whether VCs’ contractual priority rights over common shareholders are, in fact, fully respected.  And there is reason to suspect that they may not be.  In other settings, such as bankruptcy, common shareholders are sometimes able to use holdup power to extract part of creditors’ cash flow rights, causing a deviation from contractual priority.  To the extent that common shareholders in a VC-backed firm have holdup power, they may similarly use that power to “renegotiate” the parties’ cash flow rights.

To investigate common shareholders’ ability to extract part of VCs’ liquidation preferences, we use a hand-collected database of 42 VC-backed Silicon Valley companies that were sold in 2003 or 2004 and, at the time of sale, had both preferred and common stock outstanding.  We find that in a majority of sales, VCs are able to receive the full amount of their cash flow rights.  However, they receive less than their contractual entitlement in over 25% of transactions.  The average carveout in these cases is approximately 11% of the VCs’ contractual payout rights.  In the aggregate, the VCs in our sample give up approximately 2-3% of their cash flow rights to common shareholders.

We also show that the likelihood and magnitude of deviations from contractual priority are larger when VCs have less power in comparison to common shareholders.  Deviations favoring common shareholders are more likely to occur and to be larger when VCs lack board control: When the selling CEO is not a professional hired by the VCs but rather a founder (and therefore more likely to use his positional power to assist common stockholders).  However, the finding that may be of particular interest to lawyers is that the expected carveout to common shareholders is higher when the firm is incorporated in California rather than Delaware.  While there is some evidence suggesting that, within the U.S., state corporate law affects the value of common stock in public companies, our study may be the first to demonstrate that the choice of corporate law affects financial outcomes in private firms.

Brian and I are continuing to work on this paper and a number of related projects, so any comments would be most welcome.

I recently submitted a new paper, Go-Shops: Market Check Magic or Mirage? for a panel entitled Selling to Private Equity at the 27th annual Ray Garrett Jr. Corporate and Securities Law Institute, hosted by the Northwestern University School of Law.  The article traces the evolution of “go-shops,” discusses the alleged advantages of using a “go-shop,” and suggests that there are a number of circumstances in which a “go-shop” will not materially improve the sales process.  In addition, the article includes a chart summarizing the material terms of every “go-shop” provision used in a public deal since the device first appeared.

In its annual meeting this month, the American Law and Economics Association elected Professor Lucian Bebchuk as its president.  He will serve in this role until the Association’s annual meeting next spring.

In accordance with the Association’s traditions, Bebchuk delivered a presidential address at the ALEA’s Annual Meeting last weekend entitled Self-Regulation and the Public Corporation.  The address reviewed and reflected on Bebchuk’s work on the subject over the years.  This work includes, among other pieces, Bebchuk’s articles The Debate on Contractual Freedom in Corporate Law; Limiting Contractual Freedom in Corporate Law: The Desirable Constraints on Charter Amendments; Federalism and the Corporation: The Desirable Limits on State Competition in Corporate Law; A New Approach to Takeover Law and Regulatory Competition; Federal Intervention to Enhance Shareholder Choice; Optimal Defaults for Corporate Law Evolution; Asymmetric Information and the Choice of Corporate Governance Arrangements; Why Firms Adopt Antitakeover Arrangements; Executive Compensation as an Agency Problem; and The Case for Increasing Shareholder Power.

This year’s round of proposed amendments to the Delaware General Corporation Law, introduced on May 8, unquestionably falls a little short in the excitement department, at least compared to last year’s amendments (particularly those relating to director elections and retirement policies).

In the current crop, the most notable changes are to the appraisal statute.  Under these proposed amendments:

–Petitions for appraisal can be filed by beneficial owners, rather than only by stockholders of record (although demands for appraisal must still be made by record owners).  The Depository Trust Company will surely be relieved not to have to serve as a nominal petitioner in every public company appraisal suit.

–Reference to a “national market system security on an interdealer quotation system by the National Association of Securities Dealers, Inc.” has been deleted from the so-called “market out,” in light of last year’s reorganization of the NASDAQ stock markets.

–Most notably, there is to be a presumptive approach to awarding interest in appraisal proceedings.  Ordinarily, interest is to “be compounded quarterly and shall accrue at 5% over the Federal Reserve discount rate (including any surcharge) as established from time to time during the period between the effective date of the merger and the date of payment of the judgment.”  This has been Delaware’s default legal rate of interest for some time, and has frequently been the basis for awards of interest in recent appraisal cases.  By making it the presumptive approach to awards of interest in such cases, however, it is hoped that unproductive litigation efforts on the interest issue can be avoided.  Under the proposal, however, the Court of Chancery still retains discretion, for “good cause,” to choose a different approach in awarding interest.

…continue reading: Proposed Amendments to the Delaware General Corporation Law

The Securities and Exchange Commission yesterday held its first roundtable on proxy access, and Chairman Cox told the press that the Commission will propose a rule in the early summer on shareholder rights in the proxy process.  We’re very pleased to host the following commentary on these events from J.W. Verret, a recent Harvard Law graduate and Olin Fellow in Law and Economics who has written extensively on corporate governance matters.  Jay (who can be reached at jayverret [at] gmail.com) and I welcome your comments on his analysis below.

The shareholder empowerment battle originated as a brief sortie to develop a withhold vote capability in the early 1990s, but has since become more of an unending campaign.  The academic community has debated shareholder empowerment for several years, and the fight has recently been given new life.  The SEC is convening a series of roundtable discussions on proxy access and the Commission’s role in protecting the state-law voting rights of shareholders.  And yes, that is deja vu you’re feeling: Lucian Bebchuk has studied, in depth, the justification for proxy access, and indeed can be credited for much of the momentum behind the movement.

But another movement is already afoot to empower shareholders: majority voting for uncontested elections, which will seriously affect the calculus of the proxy access debate.  In August of 2006, the Delaware Legislature passed an amendment to the General Corporation Law that renders shareholder-approved bylaws that set the minimum number of votes necessary for an election victory unalterable by the Board absent shareholder ratification.  This post summarizes my findings on that issue in my article Pandora’s Ballot Box, or a Proxy With Moxie? Majority Voting in Delaware Corporate Elections, forthcoming in the May edition of The Business Lawyer.

…continue reading: Pandora’s Ballot Box, or a Proxy with Moxie?

Last Tuesday, Chancellor William Chandler handed down a short but long-anticipated decision in the Transkaryotic (TKT) appraisal litigation.  TKT shareholders approved the deal by the requisite majority of the outstanding shares.  Cede & Co., holder of record and a DTCC intermediary, voted 12.8 million shares in favor of the merger and voted against or abstained with about 16.8 million shares. 

The opinion addresses the appraisal rights, under 8 Del. C. § 262, of shareholders who purchased some 8 million shares held by Cede & Co. after the record date for voting on the merger.  TKT sought summary judgment on the appraisal petition, arguing that the stockholders seeking the appraisal had the burden of proving that their shares were not among those voted by Cede in favor of the merger.  That sort of burden would have been impossible to satisfy, since market purchases after the record date can’t be traced to specific shares, and there is therefore no way to “tie” specific shares owned by those seeking the appraisal to shares that were voted for (or against) the merger. 

In an important ruling, Chancellor Chandler concludes that the traditional statutory reliance on record stockholder status in appraisal cases works in favor of the appraisal seekers: as long as the stockholder of record formally demands an appraisal in a timely fashion (i.e., before a vote on the merger), the law is indifferent as to whether a predecessor beneficial owner sought to vote the shares in favor of the merger.

…continue reading: Chancery Rules on Appraisal Rights for Shares Acquired After the Record Date for Merger Votes

This year’s meeting of the American Law and Economics Association, hosted here at Harvard Law, wrapped up today with three different panels featuring the latest scholarship on corporate governance.  Today’s panelists offered papers on hedge funds, stock market efficiency, and executive pay, all cutting-edge subjects for those interested in corporate governance.  For those of you who couldn’t join us here in Cambridge, I provide below a brief summary of the authors’ presentations as well as links to the excellent papers we discussed today.

…continue reading: ALEA Conference Goes Out In Style

This weekend the Law School plays host to the annual meeting of the American Law and Economics Association, which offers two days of presentations on the latest work in law and economics scholarship.  This afternoon’s panel on corporate governance reform, hosted by Paul Mahoney, featured papers from top scholars on the dismantling of staggered boards, the effect of Sarbanes-Oxley on the cross-listing premia available to foreign issuers, and the effects of the 2003 mutual fund voting disclosure regulation.  All three pieces are great reads for those interested in corporate governance reform.

…continue reading: Day One of the ALEA Conference: Debating Corporate Governance Reform

This year’s list of Ten Best Corporate and Securities Articles, selected by an annual poll of corporate and securities law academics, includes two selections from the Harvard Law faculty: Professors Lucian Bebchuk and Reinier Kraakman.  The articles were selected from a field of 450 pieces, and the selected articles will be reprinted in an upcoming issue of the Corporate Practice Commentator.  This is the seventh straight year that an article from an HLS professor has been honored, and the sixth year in a row that HLS has had multiple selections.

Bebchuk’s article, Letting Shareholders Set the Rules, was published in the April 2006 issue of the Harvard Law Review.  Kraakman’s article, Law and the Rise of the Firm, which he co-authored with Henry Hansmann and Richard C. Squire, was published in the March 2006 issue of the Harvard Law Review.

Classes may have ended here at Harvard, but the Law and Economics Seminar closed the Spring on a high note with a fascinating presentation by John Coffee of his new paper Law and the Market: The Impact of Enforcement.  The central thesis of the paper is that the intensity with which securities laws are enforced, rather than legal origin, explains differences in financial development across countries.

Professor Coffee’s paper contributes to a scholarly debate, now nearly a decade old, as to whether legal origin adequately explains differences in development.  The seminal paper on this subject concluded that common-law nations experienced faster growth than their civil-law counterparts, but the legal origins analysis has recently come under methodological and substantive criticism.  This paper argues that enforcement of securities law, rather than the source of the substantive law on the books, explains differences in financial development across countries.  Professor Coffee offers very persuasive evidence for that claim, although I’m less convinced that the evidence supports the policy implications offered in the piece.

…continue reading: Does Enforcement Intensity Explain Financial Development?

As the Securities and Exchange Commission prepares to hold roundtable discussions on the relationship between proxy rules and state corporation law, it might be worth considering the overall role of the Commission in the corporate governance process.  This is the subject of my recent essay, Corporate Governance, the Securities and Exchange Commission, and the Limits of Disclosure, and a topic that will be discussed at The Race to the Bottom blog.

The Commission has traditionally been viewed as responsible for disclosure, with the substance of corporate governance left to the states, as if the two were distinct.  In adopting the Exchange Act, however, Congress expected disclosure to help reduce certain abusive managerial practices, including self-perpetuation in office and excessive compensation.  (The legislative history, and especially the discussion of disclosure requirements at pages 12-14 of the House Report recommending passage of the Act, make clear that Congress expected disclosure to rein in managerial abuses.)  In other words, from the outset, Congress expected the Commission to be involved in the corporate governance process. 

…continue reading: Corporate Governance, the Securities and Exchange Commission, and the Limits of Disclosure