It is well known that firms contribute money to politicians. It is also widely held that such money, in the form of campaign contributions and lobbying expenditures, is used to buy access to and/or favors from politicians. Firms and politicians establish relationships with one another and the value to firms of such relationships likely increases over time. When a politician with a well-established relationship to a firm faces a tough election prospect, it is in the firm’s interest to secure that politician’s future. One obvious way to do so is to make further monetary contributions directly to the politician’s campaign. A priori, direct monetary contributions are not the only channel through which firms can deliver benefits to candidates during political campaigns. In a recent working paper, Sugata Roychowdhury of MIT and I investigate whether political contributions can take a non-cash form, specifically (accounting) information. In other words, we investigate whether (accounting) information can be used as political currency?

Our setting is the US congressional election of 2004, where outsourcing of US jobs was a campaign issue. Firms engaged in outsourcing activities had incentives to ensure that political candidates they were affiliated with did not suffer from negative media due to the outsourcing. These incentives were likely to be strongest when the candidates were in competitive races. We test whether outsourcing firms understated profits in the period leading up to the 2004 election, in circumstances where the firms’ affiliated candidates were in competitive races. Understating profits can help deflect attention away from the firms’ outsourcing activities, and thus spare the candidates considerable embarrassment. We find that outsourcing firms donating to congressional candidates in closely watched races managed their earnings downwards in the two quarters immediately preceding the 2004 election. We find no evidence of downward earnings management among outsourcing corporations donating to congressional candidates not in closely watched races.

Ceteris paribus, if donors’ downward earnings management is effective in deflecting attention away from outsourcing, thus sparing candidates from negative media, we expect such candidates to do better in the election (than the average candidate). In regression tests that control for likely determinants of election outcomes, we find vote shares for candidates are increasing in the extent of their corporate donors’ downward earnings management. Overall, our findings are consistent with firms managing accounting information in circumstances where this is likely to benefit allied politicians. The evidence is consistent the hypothesis that accounting information can be used as political currency.

You can read the entire paper here and an interview with me over the paper here.

My paper entitled “Entrepreneurial Shareholder Activism: Hedge Funds and Other Private Investors”, which I co-wrote with Emanuel Zur and which was recently accepted for publication in the Journal of Finance, examines recent aggressive campaigns by entrepreneurial shareholder activists, which we define as an investor who buys a large stake in a publicly held corporation with the intention to bring about change and thereby realize a profit on the investment.

We conduct our analyses on two samples of entrepreneurial activists. The first sample consists of 151 hedge fund activist campaigns conducted primarily between 2003 and 2005. The second sample contains 154 other entrepreneurial confrontational activist campaigns over the same time period. These activists are composed primarily of individuals, private equity funds, venture capital firms, and asset management groups for wealthy investors. The common feature of each group is that the investor is relatively free from the regulatory controls of the Securities Act of 1933, the Securities Exchange Act of 1934, and most notably the Investment Company Act of 1940.

We find similarities and disparities between our samples of hedge fund and other entrepreneurial activists.

The three main parallels are market reaction to the activism, a further significant increase in share price for the subsequent year, and the activist’s success in gaining its original objective. These findings suggest that the market, on average, believes activism creates shareholder value. Moreover, ex ante, the market is able to differentiate between overall successful and non-successful campaigns. For both groups of activists, the abnormal return surrounding the initial Schedule 13D filing is significantly higher for firms in which the activist gains its objective within one year, when compared to those firms in which the activist is unsuccessful.

The two main differences between the two categories of entrepreneurial shareholder activists are the types of companies each group targets and the activists’ post-13D filing strategies. Hedge fund activists target more profitable and financially healthy firms than other entrepreneurial activists. Hedge funds appear to address the free cash flow problem, since hedge fund activists frequently demand the target firm to buy back its own shares, cut the CEO’s salary, or initiate dividends, whereas other activists do not make these demands. In contrast, other entrepreneurial activists appear to redirect the investment strategies of their targeted firms.

The full paper is available for download here.

(Editor’s note: A post on April 30 by Brian Cadman also analyzed the role of compensation consultants in setting pay, and is available here.)

My paper, Executive Pay and “Independent” Compensation Consultants, which I co-wrote with Kevin J. Murphy, analyzes two primary sources of conflicts of interest between consultants and their client firms. First, consultants have a conflict of interest whenever they design the pay packages of the same executives that have the power to reappoint them. Consultants who are hired by, or who work for, top management (rather than the board) have clear incentives to please the firm’s top executives by recommending generous pay packages. Second, while some consultants are “boutique” firms focused exclusively on executive compensation, many are large integrated corporations offering a full-range of compensation, benefits, and actuarial services, and therefore there is an incentive to cross-sell additional services. Consultants recommending a lower-than-expected level of CEO pay can jeopardize the opportunities to cross-sell other more lucrative services to the firm.

We use newly disclosed SEC data for 938 firms to investigate whether these conflicts of interest between consultants and their client firms lead to higher pay for CEOs, other top executives, and outside directors. We test the “repeat business” effect (i.e., the consultants’ concern with being reappointed) by examining whether pay is related to proxies for managerial influence over the decision to appoint (or reappoint) consultants, including whether the consultant is retained by the compensation committee or by management, whether the consultant works exclusively for the committee or also works for management, and whether the consult is described as “independent” in the company proxy statement. We test the “other services” effect by examining voluntary disclosures related to such services in the proxy statements, and by merging our data with 5500 filings with the IRS and Department of Labor that identify which of the consultants used by each of our sample companies also provide actuarial services to those firms.

We find that executive and director pay is higher in companies retaining consultants for pay advice than in companies not seeking advice, even after controlling for size, industry, and the mix of pay. However, we find no evidence that the higher pay is related to conflicts of interest: CEO pay is higher (and not lower) in companies where the consultant works exclusively for the compensation committee rather than management, and CEO pay does not increase when the consultant provides actuarial or other services to their client firms. Interestingly, we do find that pay is higher when the companies retain more than two consultants, suggesting perhaps that companies “shop around” until they get the answer they like!

The full paper is available for download here.

(Editor’s note: This post comes to us from Glenn Curtis, Director, Strategic Research of Thomson Reuters)

As part of an effort to provide insight into what types of companies activist hedge funds and private equity firms are targeting, Thomson Reuters tracks proxy battles on a quarterly basis. To that end, we recently released a report, entitled 2007 Shareholder Activism, for the fourth quarter of 2007. The purpose of our research is to shed some light on the types of companies activists are targeting in terms of sector, and market cap. Our goal is to also provide some color on the success rates of activists and the most common demands they are making of boards. Our reported findings include the following:

• Throughout 2007 activists attempted to exert their influence at 61 public companies. That is, they either sought to make changes to the target’s board of directors, or to effectuate some other sort of value enhancing action or transaction.

• Between October and December 2007 (Q4) activists attempted to exert their influence at eight public companies. While it is impossible to definitively determine which party (the activist or the target) will prevail in each of these instances, there are two instances where it appears as though the activist will secure a victory.

• The most common demand made by activist firms was for board seats. This is consistent with two studies that we have completed in the past.

• The average target size in terms of market capitalization during Q4 was about $1.22 billion - well below the roughly $8.49 billion average for the first three quarters of 2007.

• Consumer Discretionary companies were the most frequent targets in the fourth quarter. This too is consistent with studies that we have completed in the past.

• Companies within the financial industry were not targeted in the fourth quarter. This is somewhat surprising given the large decline in equity prices in this group and given that many of these firms continue to maintain valuable and tangible assets on their balance sheets.

• While Carl Icahn and entities controlled by Icahn appeared to be the most active for all of 2007, Ramius Capital was a close second, recording three cases of activism in Q4 and five for the full year.

• Private equity firms and hedge funds remained the most common activists. Q4 did not see major mutual funds or individual investors lead any charges for corporate change as they did in the Q1 to Q3 time frame.

• Perhaps not surprisingly, cash-strapped construction companies and builders were targeted the least by activist shareholders throughout 2007. There was no change from the first three quarters of the year.

To obtain a full copy of the report, please contact its author, Glenn Curtis, at glenn.curtis[at]thomsonreuters.com.

(Editor’s note: This post comes to us from Vidhi Chhaochharia of the University of Miami and Yaniv Grinstein of Cornell University. Their article was recently accepted for publication in the Journal of Finance.)

The purpose of this article is to examine how the new board requirements that were enacted in response to corporate scandals in 2001 and 2002 affected compensation decisions. We use the difference-in-difference approach to compare changes in compensation between firms that were already complying with these requirements and firms that were not complying with them. Our sample consists of 865 firms that belong to the S&P 1500 index for the period 2000 to 2005. To measure level of compliance, we focus on three board structure variables that were required by the rules: the requirement for a majority of independent directors on a single board, the requirement for an independent nominating committee, and the requirement for an independent compensation committee.

We find that firms that did not comply with these requirements significantly decreased CEO compensation in the period after the rules went into effect, compared to the complying firms. The decrease is on the order of 17%, after taking into account performance, size, time varying shocks to different industries during that period, firm fixed effects, and other variables affecting compensation that changed during that time. We also find that the one requirement that is strongly associated with a drop in compensation is the requirement that the majority of board members be independent, and that the significant relative drop in compensation comes from the decrease in the bonus and the stock based compensation. We also find that the decrease in compensation is particularly pronounced in the subset of affected firms with no outside block holder on the board and in affected firms with low concentration of institutional investors. In short, our results suggest that the new board requirements affected CEO compensation decisions.

The full paper is available for download here.

My paper, co-authored with Julian Atanassov of the University of Oregon, was recently accepted for publication in the Journal of Finance. This paper investigates how labor and investors’ relative influence and firm level variables interact to affect corporate governance. A key conclusion is that weak investor protection combined with strong union laws are conducive to worker-management collusion harmful to investors.

Specifically, we analyze restructuring decisions when firms suffer a sudden, sharp deterioration in operating performance. We proxy for stakeholders’ relative influence at the country level by the strength of legal protection of investors and labor. We consider three types of restructuring measures: large scale employee layoffs, top management turnover, and major asset sales. Our sample consists of 9,923 firms (10,947 firm-years) at the onset of sharply declining operating performance in 41 developed and emerging economies over the period 1993 to 2004.

We find that poorly performing firms in stronger investor protection countries are more likely to undertake large-scale worker layoffs and replace top management than those in weaker investor protection countries. These restructuring actions are followed by superior operating performance in all legal environments. Major asset sales are different, however. We observe more asset sales when investor protection is either very strong or very weak. Asset sales in strong investor protection countries are followed by superior operating performance, whereas asset sales in weak investor protection countries are followed by inferior subsequent operating performance.

The likelihood of value-reducing asset sales increases as collective bargaining and labor relations laws grant more power to labor unions, suggesting that these asset sales are countenanced by workers. In addition, underperforming top managers in low investor protection countries are more likely to retain their jobs as union power increases. These results point toward management-worker alliances motivated by a mutual desire to retain jobs. For such an alliance to work, management needs funds to minimize layoffs and wage cuts. Lacking other means to raise the necessary funds, poorly performing firms sell assets to forestall layoffs even when doing so hurts subsequent operating performance. Indeed, asset sales in weak investor protection countries do not lead to layoffs, whereas in strong investor protection countries asset sales predict layoffs.

We also find that strong union laws are less effective in preventing layoffs when financial leverage is high, indicating that financial leverage is an effective instrument with which investors counter the power of workers.

Overall, our results highlight the importance of interaction among management, labor, and investors in shaping corporate governance.

The full paper is available for download here.

The UK has, similarly to the US, deep and liquid securities markets and widely-dispersed ownership of publicly-traded firms. The central problem of corporate governance for publicly-traded firms in the UK is rendering managers accountable to shareholders. My recent paper, entitled Enforcement Strategies in UK Corporate Governance: A Roadmap and Empirical Assessment, provides a roadmap of the enforcement strategies employed in UK corporate governance, and a first approximation of their empirical significance.

Enforcement strategies affect agents’ incentives to comply with substantive rules, and so the effectiveness of a regulatory regime is a function of both substantive rules and the strategies by which they are enforced. While recent scholarship has begun to address enforcement-related issues, no clear consensus has yet emerged, as the results seem sensitive to the way in which ‘enforcement’ is measured. Moreover, those studies that have been done have focused on formal (court-based) mechanisms of enforcement. There are, of course, a variety of other ways in which the agency problems at the centre of corporate governance can be kept in check—from quiet intervention by a regulator to the threat of a shareholder revolt. The impact in practice of a corporate governance regime on agents’ incentives is therefore the sum of all institutions—formal and informal—that may impose a sanction on agents for inappropriate performance. Such institutions vary across countries, and so studies that focus solely on court-based enforcement risk misleading comparisons. Of course, this point isn’t new. The challenge is how to identify these modalities and measure their intensity in a meaningful way. This paper offers a first cut at the problem in the context of the UK.

The results suggest three stylised facts about the UK corporate governance system. First, shareholder lawsuits are conspicuous by their absence. Formal private enforcement appears to play little or no role in controlling managers. Secondly, it is public, rather than private, enforcement which dominates in relation to listed companies. However, the lion’s share of the interventions by the relevant agencies—the Takeover Panel, the Financial Reporting Review Panel, and the Financial Services Authority—is of an informal character, not resulting in any legal action. Suasion, rather than sanction, is the order of the day. Thirdly, a simple divide between public and private enforcement fails fully to take account of the role played by institutional investors in the UK, who have engaged systematically in informal private enforcement activity. Strong informal private enforcement has historically therefore been the flipside, in the UK, of weak formal private enforcement.

The paper is available here.

(Editor’s note: This post comes to us from Jonathan Rogers and Andrew Van Buskirk at the University of Chicago Graduate School of Business. Their paper was recently accepted for publication in the Journal of Accounting and Economics)

While the deterrent function of private litigation has been studied in some detail, we investigate the existence of another potential benefit of securities litigation: a change in the conduct of the firms involved in private litigation. Specifically, we examine changes in the disclosure behavior of firms involved in 827 disclosure-related class-action securities litigation cases filed between 1996 and 2005. Prior studies have investigated how proxies for the threat of private securities litigation affect corporate disclosure behavior, but little is known about the behavioral changes of companies that are actually sued.

We find no evidence that the firms in our sample respond to the litigation event by increasing or improving their disclosures to investors. Rather, we find consistent evidence that firms reduce the level of information provided post-litigation. This reduction takes many forms. The probability of a firm hosting an earnings-related conference call or issuing an earnings forecast is lower following litigation. When firms choose to issue earnings forecasts, those forecasts are issued for shorter horizons and are less likely to be quantitative. When quantitative forecasts are issued, these forecasts are less specific (i.e., wider range estimates). We also find an increase in the magnitude of future earnings surprises and an increase in the absolute value of earnings announcement excess returns. We find no evidence that this reduction in disclosure is driven by a decrease in the firm’s forecasting ability; management forecast accuracy is indistinguishable post-litigation compared to a twelve-month window prior to the damage period. Our results hold after controlling for other potential determinants of disclosure choices such as CEO turnover, demand for disclosure, and economy-wide trends in disclosure.

Our evidence suggests that the litigation process encourages firms to decrease the provision of disclosures for which they may later be held accountable, despite the increased protections afforded by the Private Securities Litigation Reform Act of 1995. Our results seem inconsistent with the intentions of regulators and private litigants who seek enhanced corporate transparency.

The full paper is available for download here.

One of the major findings of the law and finance literature comparing corporate governance across countries is that large-percentage shareholders in public corporations are a response to weak legal protections for investors. Thus, it is reported that common law countries have less concentrated ownership than civil law countries because they afford stronger legal protections for investors. Similarly, it is reported that ownership is less concentrated in countries with strong investor protection laws.

The papers that reach these conclusions analyze country averages of ownership concentration instead of firm-level data. I just released a paper in which I show that this creates omitted-variable and aggregation biases. Aggregation, in particular, eliminates all within-group (country) variation, leading to artificial clustering. Most papers also use small samples of large firms. This makes inferences to country populations problematic because ownership concentration is inversely related to firm size and firm size varies across countries.

I correct for these limitations by analyzing firm-level observations; control for firm-level determinants of ownership concentration, including size; and use a broad sample of firms from 32 countries. When I take these steps there is no support for the widely held theory that large shareholders are a response to weak legal protections for investors. In particular, there is no relation between ownership concentration and whether a firm comes from a common law country. Similarly, there is no systematic relation between ownership concentration and 14 broad indices of investor protection laws. An index is as likely to be positively associated with ownership concentration as it is to be negatively associated with ownership concentration.

Given these findings, I re-examine the theoretical literature that predicts a negative relation between investors’ legal protections and ownership concentration. There are two branches to this literature, and they have diametrically opposed views on the role of large shareholders in public corporations. One branch models external blockholders who monitor management to stop the appropriation of corporate resources. The problem is that around the world blockholders typically are managers. The other branch, in contrast, models internal blockholders who appropriate corporate resources. Although this comports with the reality that most blockholders are insiders, it is inconsistent with evidence showing that in most countries firm value increases with ownership concentration. Both branches of the literature ignore the effects of large shareholders on management decisions. Given how broadly large shareholders can impact management and given that management decisions are not subject to judicial review, even in countries with strong legal systems, there is no reason to expect ownership concentration to vary with investors’ legal protections.

The full paper is available here.

(Editor’s note: This post comes to us from Brian Cadman at the Kellogg School of Management at Northwestern University)

I, along with my co-authors Mary Ellen Carter and Stephen Hillegeist, have recently posted a new working paper entitled The Role and Effect of Compensation Consultants on CEO Pay.

The paper examines how compensation consultants influence the level, form and pay-performance sensitivity of CEO pay for a sample of 880 firms from the S&P 1500 for fiscal year 2006. The sample was collected by looking at the Compensation Disclosure and Analysis (CD&A) report in the annual proxy statement, which is required for filings on or after December 15, 2006. Our final sample of 880 firms all have December fiscal year ends. In addition, 86% of the firms in our sample disclosed that they retained a compensation consultant, suggesting that the use of consultants is widespread.

We find evidence of greater compensation in the presence of a compensation consultant, consistent with theory that these consultants facilitate rent extraction. However, we find no evidence of less pay-performance sensitivity when compensation consultants are hired. Among firms that retain consultants, we also examine whether there is greater rent extraction for clients of consultants with potentially greater conflicts of interest. Using a variety of specifications, we are unable to find widespread evidence of more lucrative CEO pay packages for clients of conflicted consultants despite anecdotal evidence to the contrary. Overall, we conclude from our findings that the potential conflict of interest between the firm and consultant is not a primary driver of excessive CEO pay.

The full paper is available for download here.

(Editor’s note: The blog featured earlier posts on the option backdating and its corporate governance implications by Larry Ribstein here, by Ted Mirvis and Paul Rowe here, and by Lucian Bebchuk here, here, here, here, and here.)

I have just posted on SSRN a paper that analyzes three forms of secret option backdating used by public firms and their significance for various corporate governance debates: Option Backdating and Its Implications. The current draft is available on SSRN here.

The three forms of option backdating analyzed are: (1) the backdating of executives’ option grants; (2) the backdating of non-executive employees’ option grants; and (3) the backdating of executives’ option exercises. The paper shows that each type of backdating less likely reflects arm’s-length contracting than a desire to inflate and camouflage executive pay. Secret backdating thus provides further evidence that pay arrangements have been shaped by executives’ influence over their boards. The fact that thousands of firms continued to secretly backdate after the Sarbanes Oxley Act, in blatant violation of its reporting requirements, suggests recent reforms may have failed to adequately curb such managerial power.

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

(Editor’s note: The Agrawal study is described on our blog here; the initial AFL-CIO response is available on our blog here; two reactions to that AFL-CIO response - from Ashwini Agrawal and from Steven Kaplan - are available here; the subsequent AFL-CIO response is available here).

I am writing to respond to the recent post by Daniel Pedrotty, director of the AFL-CIO Office of Investment, critiquing my study on AFL-CIO proxy voting.

First, in contrast to Pedrotty’s claim that I was never in contact with the AFL-CIO Office of Investment, I contacted Michele Evans, office administrator of the AFL-CIO Office of Investment by email on May 22, 2007, and received a reply from her by email on June 1, 2007. The email exchange is available here.

Second, I would like to respond to Pedrotty’s request that I share my data with the AFL-CIO on a confidential basis with the AFL-CIO committing not to share it with any rival researcher and to use it solely to “check the accuracy” of my findings. Given that the AFL-CIO has not provided me data and information when I have requested it and has made what I consider false and misleading statements about my research, I have serious concerns, as do my advisors, that the AFL-CIO will misuse and mischaracterize any data I send them prior to publication. I therefore will not enter into the requested confidentiality agreement with them. Instead, I suggest they consult the public sources of data I use in writing my paper and replicate the findings themselves.

Third, I would like to respond to Pedrotty’s claim that the study is not possible to replicate using public information. Pedrotty makes a useful point that I did not fully describe the information I obtained from Investor Relations departments, however, as I will make clear in the next version of the paper, the findings in the paper are the same if one relies on the public data sources described in the paper. The next draft will explain that I contacted four companies whose investor relations departments confirmed, consistent with the lack of discussion of unionized workers in their 10-K’s, that they did not have union workers (an assumption I discuss in the paper). I will also make sure to fully describe any information I get from additional investor relations departments or other sources that I may choose to contact while revising my study.

As for other claims raised by Pedrotty, I have addressed them already in my earlier post, available here.

(Editor’s note: This post by Jun-Koo Kang and Jin-Mo Kim is part of the series of posts on corporate governance articles accepted for publication in prominent Finance Journals.)

Our forthcoming article in the Journal of Finance entitled The Geography of Block Acquisitions, extends the literature on geographic proximity by studying how corporate governance activities of block acquirers in targets and target announcement returns are affected when the acquirers are located near the targets.

Using a sample of 799 partial acquisitions in the U.S. during the 1990 to 1999 period, we find that:

The full paper is available for download here.

(Editor’s note: The Agrawal study is described on our blog here; the initial AFL-CIO response is available on our blog here; two reactions to that AFL-CIO response - from Ashwini Agrawal and from Steven Kaplan - are available here).

Regarding the recent posting by Mr. Agrawal and Professor Kaplan,

Ashwini Agrawal, a graduate student at the University of Chicago, posted a paper on this blog that used a statistical model whose key variables were custom built by him to assert that the AFL-CIO votes its public company proxies based not on proxy voting guidelines, but on the union affiliation of public company employees. Through a series of e-mails (he has refused to meet in person or communicate over the phone) we told him he was completely and utterly wrong and asked him to release his data set. Mr. Agrawal accused the AFL-CIO of not responding to his questions after refusing to meet or release his data. University of Chicago Professor Steven Kaplan, who is advising Mr. Agrawal on this project, wrote a lengthy post defending these opaque methods.

Mr. Agrawal’s claim that he contacted the AFL-CIO and was denied information is false. Mr. Agrawal has never contacted a member of the AFL-CIO program staff to discuss his paper or ask for any data, and has refused every opportunity to meet and ask us questions.

Both posts also contain a series of important contradictions. Professor Kaplan and Mr. Agrawal repeatedly assert that the study can be easily replicated using publicly available sources of data. Kaplan emphasizes that this is “an important point. It does not rely on data that can be shaded by an interested party.”

Despite this, Kaplan later asserts that “in putting together a data set, a researcher spends a great deal of time and effort.” Which is it then? Is it a lengthy endeavor worthy of “great time and effort,” or something that’s “easily replicated?”

We continue to demand access to Agrawal’s data because it cannot be replicated. His data collection efforts were more subjective than mechanical. For example, when data on company unionization was incomplete Mr. Agrawal relied on information “from the Investor Relations departments of firms themselves.” [Appendix A, pg. 29]

The difficulty of replicating this skewed effort at data collection is obvious. How would the AFL-CIO go about determining which companies he contacted directly? Should we selectively call random Investor Relations departments and ask for the individual who spoke with Mr. Agrawal two years ago? What if the person he spoke with no longer works at the company? How do we know what source the Investor Relations Department used, and was it the same across all companies? Was a record of his phone conversations kept to back up his methodology?

Mr. Agrawal and Professor Kaplan assert that his paper has not been published, and that because it is not published they should be able to keep their data secret. It’s true that it hasn’t appeared in any peer reviewed setting–but it has been twice cited on the editorial page of the Wall Street Journal as evidence for repeated false accusations against the AFL-CIO, as well as being posted on this blog and widely circulated in academic and business circles.

Professor Kaplan’s defense that they won’t release data to a competing researcher is misplaced. We are the subject of a widely published study which makes false accusations based on unreproduceable statistical models. We are not seeking to complete a research project for a rival journal, but instead correct the record.

We would be happy to receive Mr. Agrawal’s data on the strict condition that we won’t turn it over to competing researchers or publish it in a competing paper. As outlined above, we need to review the accuracy of Mr. Agrawal’s data and statistical model, and when given the opportunity to talk to him, inform him of the serious flaws in his research.

A copy of the AFL-CIO’s recent report, Facts About the AFL-CIO’s Proxy Votes, is available here. We repeat our request that Mr. Agrawal release his data set or withdraw his paper.

(Editor’s note: We received two responses - from Ashwini Agrawal and from Steven Kaplan - to the AFL-CIO post responding to the study by Mr Agrawal of the AFL-CIO’s proxy-voting record. The Agrawal study is described on our blog here, and the AFL-CIO response is available on our blog here.)

Ashwini Agrawal wrote to us:

In my study, Corporate Governance Objectives of Labor Union Shareholders, I examine the proxy votes of the AFL-CIO Reserve Fund and Staff Retirement Fund. I compare the votes before and after the AFL-CIO split into two groups: the AFL-CIO and the Change to Win Coalition. After the breakup, the funds become relatively more supportive of directors of firms in which workers become primarily affiliated with the Change to Win Coalition.

In his blog post and letter, Daniel Pedrotty makes a number of mischaracterizations regarding my study.

For example, in the paper I note that the AFL-CIO proxy votes are cast by a third party fiduciary in accordance with AFL-CIO proxy voting guidelines; I do not argue otherwise, as Pedrotty claims. AFL-CIO proxy voting guidelines can be found here.

In another example, Pedrotty states that changes in AFL-CIO voting patterns solely reflect changes in governance characteristics. To investigate this, I look at the votes of other institutional investors who take governance characteristics into account, such as mutual funds Fidelity, Vanguard, TIAA-CREF and union pension funds associated with the Brotherhood of Carpenters (UBCJA). I find that these other investors do not change their voting patterns in the same ways as AFL-CIO funds, suggesting the AFL-CIO votes are not solely based on governance characteristics.

Pedrotty also erroneously claims I treat all firms with mixed union representation as though they are affiliated with the AFL-CIO only. Based on publicly available data, I distinctly categorize a company based on whether a significant fraction (at least 90%) of the unionized workers at the firm switches affiliation from the AFL-CIO to the Change to Win Coalition. This is meant to capture significant decreases in the AFL-CIO’s labor representation across firms. For example, if 50% of a firm’s unionized workers remain part of the AFL-CIO, while the other 50% switch to the Change to Win coalition, then I assume the AFL-CIO still has substantial labor representation in this firm. If labor interests do not influence proxy votes, this categorization should not impact the findings in the paper.

Pedrotty asserts I gather data on certain Change to Win funds but that I do not compare their voting behavior with the AFL-CIO. This is incorrect; I compare the UBCJA pension fund votes (a Change to Win affiliate) with those of the AFL-CIO funds. Upon joining the Change to Win Coalition, the UBCJA funds become relatively more opposed to directors of firms in which workers are primarily affiliated with the Change to Win Coalition.

Pedrotty also claims that I made no effort to inquire into the methods by which AFL-CIO proxies are voted. When I requested this information from the AFL-CIO Office of Investment (in May, 2007), I was told by the AFL-CIO Office of Investment that this information would not be disclosed to me (in June, 2007).

The AFL-CIO’s claim that their voting fiduciary cast votes the same way for certain CTW funds does not change the findings as they pertain to AFL-CIO affiliated funds. In addition to the AFL-CIO not disclosing the sizes of these CTW funds and the extent to which AFL-CIO proxy voting guidelines are applied to them, the AFL-CIO’s claim could reflect agency issues within the voting structure of union pension funds. However, making any such assessment is beyond the scope of my paper.

This study can be easily replicated using publicly available sources of data. Both the sources and methodologies are described in the paper, available online here. It should also be noted that I use publicly available data because it is verifiable by other researchers and because my requests to the AFL-CIO for access to their own database on union membership were denied. I am happy to incorporate the AFL-CIO’s internal data into my study, however this data has still not been given to me.

I encourage blog readers to read both my study and the AFL-CIO’s report to reach their own conclusions. Peer review, comments, and criticisms are welcome.

Steven Kaplan wrote to us:

I would like to respond to Daniel Pedrotty’s post on Ashwini Agrawal’s work. I am a member (but not the chairman) of Mr. Agrawal’s dissertation committee so I know his work well. His committee consists of four professors at the University of Chicago Graduate School of Business.

Daniel Pedrotty’s post (criticizing Ashwini Agrawal’s study) does not in any way contradict Mr. Agrawal’s study. Mr. Pedrotty claims the paper makes a “serious and completely false accusation of voting behavior.” That is not true. Mr. Agrawal’s paper reports the results of his data collection and analysis. Mr. Agrawal’s results use publicly available data and are replicable. Using data on AFL-CIO votes and data from public sources regarding AFL-CIO union representation, Mr. Agrawal finds significant changes in AFL-CIO votes. After the split of the AFL-CIO and CtW, the AFL-CIO pension fund was much more likely to vote for management and directors of companies with unions primarily represented by the CtW than before the split. At the same time, the AFL-CIO pension fund remained less likely to vote for management and directors of companies still mainly represented by the AFL-CIO. The union voting behavior that Mr. Agrawal’s analysis reports is more consistent with union self-interest than with shareholder value maximization. While any such behavior cannot be proved beyond a shadow of a doubt, the results are very statistically significant.

Mr. Pedrotty has not attempted to replicate Mr. Agrawal’s methodology or tests. He presents some other data and claims that are irrelevant to Mr. Agrawal’s analysis. And, therefore, Mr. Pedrotty’s post does not have anything substantive to say about Mr. Agrawal’s results. Given this, it is extraordinary that Mr. Pedrotty request Mr. Agrawal to withdraw or revise his paper.

Let me examine Mr. Agrawal’s paper and Mr. Pedrotty’s post in more detail.

…continue reading: Responses to AFL-CIO’s Critique of the Agrawal Study

(Editor’s note: This post by Luigi Zingales is part of the series of posts on corporate governance articles accepted for publication in prominent Finance Journals.)

A forthcoming article in the Journal of Finance titled “The Corporate Governance Role of the Media: Evidence from Russia”, which is co-written by Alexander Dyck, Natalya Volchkova, and myself studies the effect of media coverage on corporate governance. The article focuses on Russia during the period 1999 to 2002 to answer two main questions: Can hedge funds (or shareholders in general) increase the level of coverage received by certain companies? And if so, does this coverage have any effect on corporate governance outcomes? The article develops four main conclusions:

The article notes that an egregious corporate governance violation is more likely to be covered by newspapers regardless of any effort by hedge fund managers, and it is also more likely to generate a reaction. To attempt to disentangle these effects, we employ an instrument—the portfolio composition of the Hermitage Fund, an investment fund that consciously played a media strategy in post-1998 Russia—to provide further evidence that there is a causal link from press coverage to the governance outcome.

The full article is available here.

I have recently finished a paper, with two co-authors, Jennifer Bethel and Gang Hu, titled “Law and Economic Issues in Subprime Litigation”.

The losses suffered by mortgaged-backed security (MBS) holders, collateralized debt obligations (CDOs) holders and security holders in investment banks, mortgage originators, bond insurers and credit rating agencies is generating, and will continue to generate, an enormous wave of litigation. In the paper we provide some basic descriptive statistics and institutional details on the mortgage origination process, MBS and CDOs, including the evolution of MBS tranche structure over time, the underwriting quality of mortgage originations, CDO trustees and liquidations, and the identity of MBS and CDO sponsors. In addition the paper also discusses some of the main issues that will likely be critical in much of this subprime litigation; issues such as whether the subprime crisis was foreseeable; the distinction between ex ante expectations and ex post losses; the distinction between the transparency of the quality of the underlying assets being securitized and the transparency as to which market participants are exposed to subprime losses; and the distinction between what investors and the market generally knew and what individual entities in the structured finance process knew.

The paper can be found here.

The Program on Corporate Governance has recently released a new discussion paper entitled Perpetuities, Taxes, and Asset Protection: An Empirical Assessment of the Jurisdictional Competition for Trust Funds, which I co-wrote with Max Schanzenbach. The paper abstract is as follows:

This chapter provides an accessible overview of our previous work on the impact of the abolition of the Rule Against Perpetuities (RAP) on trust fund situs. The implementation of the Generation Skipping Transfer (GST) Tax by the Tax Reform Act of 1986 sparked a movement to repeal the RAP. Since 1986, nearly half the states have abolished or effectively abolished the RAP as applied to interests in trust. Prior to 1986, only three states had abolished the RAP. We find no evidence that abolishing the RAP prior to the 1986 GST tax attracted trust business. By contrast, between 1986 and 2003, abolishing states reported an average increase in trust assets of $6 billion (a 20 percent increase). In addition, average account size in abolishing states increased by $200,000, implying that abolishing the rule attracted relatively larger trusts. Our findings imply that roughly $100 billion in trust funds have moved to take advantage of the abolition of the RAP. Further, we can trace these results to the subset of abolishing states that did not levy a tax on income accumulated in trusts attracted from out of state. This finding, which implies that abolishing the RAP does not directly increase state tax revenue, bears on the scholarly debate over the mechanisms of jurisdictional competition. Our analysis also controls for whether a state validated the so-called self-settled asset protection trust (APT). We did not find consistent evidence that validating APTs increases a state’s reported trust business, but in the period studied few states had validated APTs, so we draw no firm conclusions.

We conclude that the jurisdictional competition for trust funds is real and intense, with the primary margin of competition being the rules that bear on trust duration, and that the enactment of the GST tax sparked the rise of the perpetual trust. In future work using more refined data, we intend to revisit the jurisdictional competition for trust funds and to expand our inquiry to include directed trustee statutes and the recent reforms to trust-investment laws.

Alon Brav, Wei Jiang and Frank Partnoy and I have recently released a paper, entitled Hedge Fund Activism, Corporate Governance, and Firm Performance. The abstract is as follows:

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. 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.

(Editor’s note: The post below comes to us from Andriy Bodnaruk of the University of Maastricht, Massimo Massa of INSEAD, and Andrei Simonov of the Stockholm School of Economics and CEPR).

We have recently released a paper, entitled The Dark Role of Investment Banks in the Market for Corporate Control. Our paper studies M&A transactions in the US in the 20 year-period 1984 to 2003. Its focus is on transactions in which the investment bank advising the bidder in an M&A transaction also holds a stake in the shares of the target company at the time the deal was announced. In broad terms, the paper provides evidence as to (1) the extent to which investment banks advising bidders took advantage of confidential information garnered from their advisory assignments to acquire stakes in the target prior to the deal’s announcement; and (2) the extent to which the investment bank’s stake in the target compromised the financial interests of the bank’s bidder client.

We show that the presence of advisors helps to predict if a firm will be a takeover target. Conditioning on firms with similar industry and size characteristics, firms in which the advisors to the bidder hold a stake are 45 percentage points more likely to become targets, with the probability of becoming a target increasing from the unconditional sample mean of 4.2% to 6.1%. When we build the trading strategy long in the actual positions of the advising investment banks and short in the positions of the non-advisory banks, we find the strategy delivers 1.40% per month (adjusted for risk). This provides a lower bound estimate of the informational advantage that the advisory bank has relative to other sophisticated market players.

We further show that where an investment bank advising the bidder holds a stake in the target, the bidder will pay a higher premium for the target relative to deals in which the advisor holds no target stake. The target’s premium increases by 590 basis points from 30.6% to 36.5% relative to non-conflicted deals. An increase of one standard deviation in the (dollar value of the) average fraction of the target firm held by the advisor to the bidder implies a premium 310 (290) basis points higher than average. Deals involving the bidder’s advisor holding a stake in the target are more likely to succeed than other deals. Moreover, targets in these deals tend to be overvalued by more than 10% compared to deals in which the bidder’s advisor holds no target stake.

These findings suggest that advisors do take advantage of their privileged position, not only by acquiring positions in the deals on which they advise, but also by directly affecting the outcome of the deal in order to realize higher capital gains from their positions. These results provide important insights into the conflicts of interest affecting financial intermediaries that can both advise on corporate events and invest in the equity market.

The paper is available here.

We have just posted a paper on SSRN, Opting Only In: Contractarians, Waiver of Liability Provisions, and the Race to the Bottom, challenging one of the core positions of the contractarian approach to corporate law. Contractarians espouse an enabling approach to regulation allowing corporations to opt in or opt out and oppose a mandatory approach based on categorical rules. In their view, an enabling approach allows private ordering and enables owners and managers to derive the most efficient set of provisions, tailored to each company’s specific circumstances. This position has been reflected in attacks on legislations like SOX. Many commentators objected to its provisions because they were categorical and did not allow for private ordering.

Our study seeks to test this theory’s explanatory power in one area of corporate law. We chose a recent example of states replacing a categorical requirement with an enabling provision - waiver of liability provisions – for examination. These provisions allow companies to “opt out” of a rule that imposes liability on directors for breach of the duty of care. They may do so through the mechanism of an amendment to the articles. The amendment process requires the consent of both owners and managers, presenting conditions ripe, at least in theory, for the two groups to “bargain.”

We note first that waiver of liability provisions were authorized not in response to Van Gorkom, as is typically represented, but in response to the D&O insurance crisis occurring in the 1980s. In other words, the provisions were designed to interfere in the market for insurance. No evidence was offered, nor could we find any, indicating that this was a more efficient way of dealing with the economic uncertainties that existed at the time.

Second, we examined the waiver of liability provisions implemented by the Fortune 100 (data that we will eventually expand to the Fortune 500). Our analysis does not offer any evidence of private ordering. With one exception, all non-mutual companies in the Fortune 100 have eliminated liability for breach of the duty of care (in some states, this was done statutorily, with no company “opting out” of the no liability regime). Moreover, none of the waiver provisions reflected bargaining, with the wording of the provisions being remarkably similar. The companies in our sample waived liability to the fullest extent permitted by law.

Our analysis shows that one categorical rule favoring shareholders (liability for the breach of the duty of care) was replaced by another categorical rule favoring management (no liability for breach of the duty of care). While we do not rule out the possibility, we are not persuaded that any significant evidence demonstrating that one was more efficient than the other exists.

Our conclusion is supported by the fact that no actual bargaining occurs. Particularly where provisions are implemented by an amendment to the articles, it is management that drafts the language and only management that can initiate adoption or repeal. In other words, whatever theoretical benefit can result from the contractarian view of private ordering, it can only arise in practice if shareholders have the ability to meaningfully participate in the bargaining process. Our evidence suggests that they do not.

I have just released a working paper on the measurement of shareholder protection around the world, entitled “’Law and Finance’ Revisited” and available on SSRN here. The abstract is as follows:

The “Antidirector Rights Index” from La Porta et al.’s “Law and Finance” (1998) has been used as a measure of shareholder protection in almost 100 published studies. With articles by legal scholars questioning the accuracy of index values for several countries, I undertake a systematic study to verify these values for 46 countries with the help of local lawyers. My emphasis is on accuracy of the data; I do not change the original variable definitions. The study leads to a substantial revision: 33 of the 46 observations need to be corrected, and the correlation of corrected and original values is only .53. With accurate values, the well-known results of La Porta et al. (1997, 1998) no longer hold: accurate index values are neither distributed with significant differences between Common and Civil Law countries nor correlated with stock market size and ownership dispersion. All of the many results derived with the index will have to be revisited.

(NB: This paper is a revision of Spamann (2006).

By way of background, the cited article “Law and Finance” by La Porta, Lopez-de-Silanes, and Vishny (1998) started an entire literature of the same name. I have recently described the current state of this literature on this blog here.

With my co-authors Reena Aggarwal (Georgetown), Isil Erel (Ohio State) and Rohan Williamson (Georgetown), I have recently completed a revision of the paper “Differences in Governance Practices between U.S. and Foreign Firms: Measurement, Causes, and Consequences.” The paper is available at SSRN. The paper is now forthcoming at The Review of Financial Studies. The paper shows that foreign firms invest less in firm-level governance and that this lower investment is associated with lower valuations.

Using the well-known definition of Shleifer and Vishny (1997), governance consists of the mechanisms which insure that minority shareholders receive an appropriate return on their investment. Governance depends both on country-level as well as firm-level mechanisms. The country-level governance mechanisms include a country’s laws, its culture and norms, and the institutions which enforce the laws. Firm-level or internal governance mechanisms are those that operate within the firm. Firm-level governance mechanisms that increase the power of minority shareholders to receive a return on their investment are costly, so that the adoption of such mechanisms by a firm is an investment. The payoffs from that investment differ across countries and across firms.

The U.S. is recognized to have extremely high financial and economic development, to have strong investor protection, and to protect property rights well. Consequently, we would expect the internal governance of firms in the U.S. to come as close as possible to what the optimal internal governance of a firm would be in a foreign country if it were not constrained by weaker institutions and lower development than in the U.S. The internal governance of firms in the U.S. therefore provides a benchmark that can be used to evaluate the impact of different institutions and different development from the U.S. on governance choices and, through these choices, on firm value.

On theoretical grounds, it is not clear whether the characteristics of the U.S. make firm-level investment in governance mechanisms that increase the power of minority shareholders more or less advantageous for U.S. firms relative to firms from countries which do not have the same high level of development and investor protection. One possibility is that foreign firms would invest less in firm-level governance if they were in the U.S. because firm-level governance and country-level investor protection are substitutes. An alternative possibility is that investment in firm-level governance is less productive in countries with poor economic development and weak investor protection than it is in the U.S., implying that firm-level governance and investor protection are complements.

We find strong evidence that foreign firms invest less in internal governance mechanisms that increase the power of minority shareholders than comparable U.S. firms do. In other words, investment in firm-level governance is higher when a country becomes more economically and financially developed and better protects investor rights. Further, to the extent that institutional and development weaknesses reduce a foreign firm’s investment in corporate governance compared to a U.S. firm, we would expect the value of the foreign firm to be lower. As expected, we find that the value of foreign firms is negatively related to the magnitude of their governance investment shortfall relative to U.S. firms.

To conduct our investigation, we need information about firm-level corporate governance attributes that increase the power of minority shareholders for a large number of firms across a large number of countries and we would like individual governance attributes to be assessed similarly across all these firms. We use the corporate governance attributes recorded by Institutional Shareholder Services (ISS). By doing so, we can analyze 44 common governance attributes for 2,234 non-U.S. firms and 5,296 U.S. firms covering 23 developed countries. We create a governance index making sure that the governance attributes included are relevant both for U.S. firms and foreign firms. We call it the GOV Index.

To evaluate the governance a foreign firm would have if it were in the U.S., we use a propensity score matching method in order to match each foreign firm with a comparable U.S. firm. We then show that foreign firms generally have a lower GOV index, so that they give less power to minority shareholders, than if they were U.S. firms. We define the governance gap to be the difference between the governance index of a foreign firm and the governance index of a comparable U.S. firm. A firm with a positive governance gap has a higher value of the GOV index than its matching U.S. firm. Only 12.7% of foreign firms have a positive governance gap. Strikingly, 86.1% of these firms come from Canada and the U.K., so that firms from countries with similar investor protection as in the U.S. are the ones that are the most likely to invest more in governance than comparable U.S. firms. Such a result is inconsistent with the hypothesis that investor protection and internal governance mechanisms are substitutes.

Having compared the governance of foreign and U.S. firms, we turn to the question of whether the governance gap helps explain a firm’s valuation. We find that the value of foreign firms is increasing in their GOV index. More importantly, perhaps, the lower the GOV index of a foreign firm compared to its matching U.S. firm, the lower the value of that foreign firm. We find that this result holds controlling for firm characteristics known to affect q and controlling for the endogeneity of the choice of governance mechanisms.

If firm-level governance is more costly for foreign firms than for U.S. firms, we expect that the foreign firms comparable to the U.S. firms that benefit the most from investing in internal governance will find it optimal to invest less in governance than matching U.S. firms do and will suffer a loss of value as a result. We can therefore use regression analysis to investigate whether a foreign firm’s q is negatively related to the governance index value it would have in the U.S. We find that this is the case. Such a coefficient is not subject to an endogeneity bias because we are measuring the governance of a U.S. firm and the valuation of a foreign firm.

In addition to investigating the value relevance of differences in the aggregate governance index between foreign firms and comparable U.S. firms, we also consider the value relevance of specific governance provisions. We focus on provisions that have attracted considerable attention in the literature and among policymakers. We find that firms that have an independent board, auditors that are ratified annually, and an audit committee comprised solely of outsiders, have a higher value when their U.S. matching firm has these governance attributes. In contrast, neither board size nor separation of the chairman and CEO functions are value relevant.

(Editor’s Note: This post comes to us from Jie Cai and Ralph A. Walkling of Drexel University.)

We have recently released a new paper entitled Shareholders’ Say on Pay: Does it Create Value? The paper examines stock returns around the time of the passage of the Say on Pay Bill in the House of Representatives in search of evidence whether the market views the legislation as creating value. The Abstract of the piece follows:

The post Sarbanes-Oxley Act period is associated with several initiatives designed to give shareholders a greater voice in the boardroom. The latest of these initiatives is the Say-on-Pay Bill (H.R. 1257) which passed the House of Representatives on April 20, 2007 by a 2 to 1 margin. This bill does not limit CEO pay but requires an advisory shareholder vote on executive compensation packages. Using the abnormal return of 1,245 firms surrounding the House passage of this bill, we examine whether the market interprets shareholders’ say on executive pay as adding or subtracting firm value. Stocks of firms with positive abnormal CEO compensation react in a significant, positive manner to the Say-on-Pay Bill. The positive market reaction is stronger among the firms with weaker, but not the weakest governance. In addition, abnormal returns are higher in the subset of firms more likely to receive higher disapproval votes from shareholders and firms more likely to implement changes under the pressure of shareholder votes. Thus, the bill has the greatest impact among the subset of firms most likely to benefit and implement changes. Given the uncertainty surrounding passage, implementation and efficacy of this proposed advisory vote, the results are likely to understate the actual impact of Say on Pay legislation. Our findings suggest that the market views this legislation as value-creating for the companies where it is likely to have the most impact. These results provide important evidence for the current debate regarding the Say-on-Pay legislation in Congress and shareholder access to proxy. Our results also shed light on the role of activist investors.

The full Article is available for download here.

The Program on Corporate Governance has recently issued as a discussion paper my piece, co-authored with Zvika Neeman, entitled Investor Protection and Interest Group Politics. We develop in this paper a framework for analyzing how interest group politics influence investor protection levels. Our analysis identifies factors that impede desirable corporate governance reforms, and can help explain the ways in which investor protection levels vary around the world and over time. The abstract of the paper is as follows:

We model how lobbying by interest groups affects the level of investor protection. In our model, insiders in existing public companies, institutional investors (financial intermediaries), and entrepreneurs who plan to take companies public in the future, compete for influence over the politicians setting the level of investor protection. We identify conditions under which this lobbying game has an inefficiently low equilibrium level of investor protection. Factors that operate to reduce investor protection below its efficient level include the ability of corporate insiders to use the corporate assets they control to influence politicians, as well as the inability of institutional investors to capture the full value that efficient investor protection would produce for outside investors. The interest that entrepreneurs (and existing public firms) have in raising equity capital in the future reduces but does not eliminate the distortions arising from insiders’ interest in extracting rents from the capital public firms already have. Our analysis generates testable predictions, and can explain existing empirical evidence, regarding the way in which investor protection varies over time and around the world.

The full paper is available for download here.

Recently, in the Law, Economics, and Organization Seminar here at the Law School, Robin Greenwood presented his paper, co-authored with Michael Schor, entitled Hedge Fund Investor Activism and Takeovers. Using data derived from 13D filings following stock purchases by shareholder activists, the study examines the effect of activist investors on performance. The abstract of the Article follows:

We examine long-horizon stock returns around investor activism in a comprehensive sample of 13D filings by portfolio investors between 1993 and 2006. Announcement returns and long-term abnormal returns surrounding investor activism are high for the subset of targets that are acquired ex-post, but not detectably different from zero for firms that remain independent a year after the initial filing. Firms that are targeted by activists are more likely to get acquired than those in a control sample. The results suggest that hedge funds’ short investment horizons make them better suited to identifying undervalued targets and prompting a takeover than at fixing corporate strategy or tackling long-term corporate governance issues.

The full Article is available for download here.

The SEC has been considering the issue of increased shareholder access to the corporate proxy and director elections. Labor union pension funds have been among the more vocal proponents of increased access, arguing that such access will lead to improved financial performance. Business groups, such as the Business Roundtable, have argued against increased access on the grounds that such access would encourage special-interest shareholders and would decrease shareholder value. The desirability of increased shareholder access, then, depends to a large degree on the extent to which labor unions (and other politically minded shareholders) pursue the interests of shareholder value rather than their own self-interest.

One of our Ph. D. students, Ashwini Agrawal, has written one of the first papers that addresses this issue. Ashwini noticed that in 2005, the AFL-CIO (the central federation of labor unions in the U.S.) split into two groups. Several of its member unions, representing roughly 35% of its members, left to form a new organization–the Change To Win (CTW) coalition. This exogenous shift in AFL-CIO membership allows Ashwini to examine changes in the voting behavior of AFL-CIO affiliated shareholders toward management and director nominees.

The results are striking. Ashwini finds that AFL-CIO affiliated pension funds are significantly more supportive of director nominees once the AFL-CIO no longer represents workers at a given firm (roughly 74% after versus 55% before). At the same time, AFL-CIO affiliated pension funds do not change their voting behavior when the AFL-CIO still represents workers at a given firm. Ashwini finds the opposite pattern in voting behavior for a pension fund associated with the CTW coalition. Finally, he finds no change in voting behavior for mutual funds.

These differences suggest that labor unions use their pension funds to pursue labor relations issues at the expense of shareholder value. And they suggest that there is some truth to the concerns that increased shareholder access might have unintended consequences.

Ashwini’s full paper, Corporate Governance Objectives of Labor Union Shareholders, is available for download here.

(Editor’s Note: This post comes to us from Claudia H. Allen of Neal, Gerber & Eisenberg LLP.)

We have recently released the November 2007 edition of the Study of Majority Voting in Director Elections, which demonstrates that majority voting for the election of directors, which has been characterized by its advocates as a tool for increasing director accountability, has become the prevailing election standard among large, public companies. As issuers prepare for the 2008 proxy season, a few statistics and examples drawn from the Study underscore that majority voting has become a relatively mature, as well as widespread, movement.

Majority Voting in the S&P 500 and Fortune 500. 66% of the companies in the S&P 500 and over 57% of the companies in the Fortune 500 have adopted a form of majority voting, notwithstanding robust levels of merger and acquisition activity early in 2007 that resulted in several firms with majority voting going private. By way of contrast, when the Study was initially published in 2006, only 16% of the companies in the S&P 500 had adopted a form of majority voting.

…continue reading: Study of Majority Voting in Director Elections

I recently presented my new discussion paper with Mark Roe, Public Enforcement of Securities Laws: Preliminary Evidence, at the Conference on Empirical Legal Studies at the New York University School of Law. The paper develops a measure of securities-enforcement intensity and examines financial outcomes worldwide in light of enforcement activity. The abstract of the paper follows:

The legal consequence of economic actors ignoring their legal obligations, such as laws that protect outside investors in firms, is a recurring issue. Recent scholarship examines the relative importance of private enforcement for investor protection on the one hand–via disclosure and lawsuits among contracting parties–and public enforcement on the other–via financial, regulatory, and even criminal rules and penalties. Recent financial work has seen the former to be more important than the latter. Yet much recent legal scholarship has seen private enforcement of securities laws in the United States as poorly designed, with firms–and, hence, wronged shareholders–often bearing the cost of insiders’ errors and disclosure failure. To better understand the relative importance of public and private enforcement, we here develop an enforcement variable based on securities regulators’ staffing levels and budgets. We then examine financial outcomes around the world–such as stock market capitalization, trading volume, number of domestic firms, and number of IPOs–in light of these measures of public enforcement and find that more intense public enforcement regularly correlates with strong financial outcomes. In horse races between our measures of public enforcement and the measures of private enforcement prominent in recent financial scholarship, public enforcement is typically at least as important as private enforcement in explaining important financial market outcomes around the world.

The full paper is available for download here.

In an earlier post, I discussed my recent discussion paper on loss causation in Rule 10b-5 action