Complaints that investors only look for short-term gains are nothing new. As early as 1990 an Economist article proclaimed: “The old bugbear of businessmen — that fund managers are too obsessed with the short term, and unwilling to buy shares in companies with ambitious research projects — is back on the prowl.”

Recently, the turnover of shares in listed companies has grown to numbers far exceeding those of 1990. Does this change in investor behavior influence the behavior of managers in listed firms?

The institutional innovation of freely tradable shares, traceable to Holland in the 17th century, made it possible for companies such as the Dutch East India Company to have longer investment horizons than individual investors. Listing shares ensured that an investor could recoup his money from other investors and that, as a result, companies didn’t have to repay individual investors. Seen in this light, one might assume that investor short-termism would have little influence on board decisions at listed companies and much more influence on board decisions at privately held companies. General opinion, however, disagrees.

…continue reading: Short-Termism of Institutional Investors and the Double Agency Problem

As you know, over the past couple of years, together with the board members and staff of the Public Company Accounting Oversight Board, I have been working to enhance the reliability of the external audit function and its usefulness to U.S. capital markets.

I will start off with an overview of some of the more significant issues confronting the audit profession. And then I’d like to open a more interactive discussion.

I. Corporate Governance Has Evolved to Suit the Needs of Capital Markets.

I have known many of you for years. I have watched and admired how you have navigated the many changes we have seen in both the energy industry and corporate governance.

Many of us have gained significantly more experience than we expected in identifying, addressing and preventing future threats to corporate success, such as differences in cultural expectations and business practices around the world and at home. Enron had a profound effect on Houston.

As this morning’s discussion demonstrated, you recognize that your work is never done. There is no perfect governance regime for all time.

…continue reading: Challenges Facing the Audit Profession and PCAOB Initiatives

Do firm boundaries mediate the effect of shocks to the financial intermediation sector? When the functioning of the intermediation sector is impaired – as was the case in the recent financial crisis – shocks can be transmitted to the broader economy since funds may not flow to highest value use without incurring significant cost. This issue has been extensively explored in the credit channel literature (e.g., Kashyap and Stein [2000]; Bernanke and Blinder [1988; 1992], and Bernanke and Gertler [1995]). However, unlike what is assumed in this literature, firms may be able to reallocate resources internally – for instance, between divisions in different industries – to ameliorate the effect of financial shocks. If so, external credit market conditions will impact the nature of resource allocation inside firms and between industries differently than they would in an economy with no internal capital markets. Diversified firms constitute a large part of economies around the world; therefore, resource allocation within firms can be of significant importance. In this paper we propose that firms shift resources between industries in response to shocks to the financial sector. We estimate a structural model to quantify the forces driving this reallocation decision, and show that these forces dampen shocks to the financial sector in economically significant ways.

…continue reading: Resource Allocation within Firms and Financial Market Dislocation

We in America have been blessed with a wonderful combination of geography, natural resources, and free market principles. These and other factors have allowed our economy and our financial system, including our capital markets, to thrive in the post-World War II era.

Although the United States has suffered its share of financial crises, most recently the one that erupted in 2008, our free market economy and robust capital markets have conferred an enviable prosperity on our people over a period of many years, and few in America can remember a time when the United States did not have strong and competitive capital markets.

However, the very strength and resilience of our capital markets could lead us to fall into the trap of believing that we are somehow entitled to such prosperity. Indeed, such a sense of complacency may well have taken root in our government and may threaten to jeopardize that prosperity. The reality is that we live in a world in which we must be constantly vigilant — sometimes taking affirmative action, but more often choosing not to act — in order to preserve the vitality of our markets.

An important part of my job, and that of my colleagues on the Commission, is to ensure that America’s capital markets remain strong, vibrant, and competitive. That’s not just good for U.S. investors, but also for other investors around the world. And, conversely, the rise of robust capital markets in other parts of the world has the potential to benefit the United States and the American people as well.

…continue reading: Emerging Challenges for Regulating Global Capital Markets

We in America often remark that we are blessed by our geography. And there is no doubt that Qataris feel the same about this incredibly unique and beautiful country. In the United States during the post World War II era, our geographical position and natural resources helped our economy develop while others experienced severe disruptions, particularly in Europe. That promoted the development of our capital markets to the great benefit of our citizens, as well as investors foreign and domestic and our partners-in-trade around the world.

It is certainly true that we have suffered our share of economic and financial crises, most recently the crisis that erupted in 2008. Even so, our free market economy and robust capital markets have conferred an enviable prosperity on our people over many years. Indeed, notwithstanding financial crises large and small, it is fair to point out that few in America can remember a time when the United States did not have strong and competitive capital markets.

The risk, however, is that the very resilience of our capital markets has, over time, fostered a latent complacency — a tendency to think strong and competitive markets are, somehow, ours by right — that we are entitled to them when, in reality, we must constantly act — and sometimes decide not to act — in order to preserve the vitality of our markets.

An important part of my job, and that of my colleagues on the Commission, is to ensure that America’s capital markets remain strong and competitive. That’s not just good for U.S. investors, I submit, but equally good for others — for all of you. And, of course, rising global markets are good for the United States.

…continue reading: Complexities of Capital Markets Regulation

In our paper, Effects on Comparability and Capital Market Benefits of Voluntary Adoption of IFRS by US Firms: Insights from Voluntary Adoption of IFRS by Non-US Firms, which was recently made publicly available on SSRN, we examine whether voluntary adoption of IFRS is associated with an increase in comparability of accounting amounts and capital market benefits after the firms adopt IFRS. Our evidence is based on samples of non-US firms that voluntarily adopt IFRS matched with firms of similar size in their country and industry that either adopted IFRS before them or do not adopt IFRS.

We find that after firms voluntarily adopt IFRS, their accounting amounts become more comparable to those of firms that adopted IFRS before them and less comparable to those of firms that do not adopt IFRS. We also find that adopting firms generally exhibit an increase in capital market benefits—liquidity, share turnover, and firm-specific information—relative to both adopted and non-adopting firms. However, there is little evidence of capital market consequences for adopted firms and little evidence that non-adopting firms suffer a decrease in capital market benefits.

…continue reading: Comparability, Capital Market Benefits, and the Voluntary Adoption of IFRS

As many of you know, I am now in my second term as an SEC Commissioner and this is my fifth time participating at SEC Speaks. During that time, I have served with three different SEC Chairmen, and a fourth is now in the works. It has been, and continues to be, a great privilege to serve at a time during which the SEC’s role as the capital markets regulator has never been more important. However, I must admit being frustrated that we haven’t done more to protect investors.

Clearly, my tenure as a Commissioner has been dramatically impacted by the financial crisis and the pressing need to address the many failings that were brought to light by that crisis. Throughout my tenure, I have worked to be a strong advocate for fulfilling the Commission’s mission to protect investors, facilitate capital formation, and promote a fair and orderly market. To that end, I want to talk to you today about the need to protect investors through robust and effective market oversight.

I am growing increasingly concerned about the stability of our market structure as we lurch from one crisis to another, be it the flash crash or the Knight trading fiasco. Today, I plan to focus on the dangers that investors face from a trading market structure that has shown too many signs of weakness and instability.

…continue reading: Addressing Market Instability through Informed and Smart Regulation

The Committee on Capital Markets Regulation (CCMR), an independent and nonpartisan research organization dedicated to improving regulation and enhancing the competitiveness of U.S. public equity capital markets, today released data from the third quarter of 2012. According to the new study, U.S. capital markets reversed the second quarter downgrade and showed slightly improved competitiveness, though most measures of competitiveness still fall short of historical averages. Hal S. Scott, Director of the Committee said, “While foreign companies continue to prefer non-U.S. financial markets for raising capital outside their home markets, and regulatory reform is still needed, this quarter’s data offers a promising sign that competitiveness can be restored to U.S. markets.”

Of the global initial equity offerings conducted outside a company’s home market, 18.3% of these IPOs, by value, were listed on a U.S. exchange. While this measure is at its highest level over the past five years, the U.S. share of this volume remains well below its historical average of 28.7% (1996-2006). These percentages include all IPOs by foreign companies listed on either U.S. public markets or issued through private Rule 144A offerings. Excluding global IPOs that use the Rule 144A markets, the percentage of global IPOs listed on a U.S. exchange rises to 55.9%. However, the total value of these IPOs has decreased from $79.8 billion in 2010 and $39.3 billion in 2011 to only $9 billion thus far in 2012.

…continue reading: Some Improvement in U.S. Public Equity Capital Market Competitiveness

Earlier in October, Federico Cenzi Venezze and I posted “A Capital Market, Corporate Law Approach to Creditor Conduct” up on SSRN. Michigan Law Review is scheduled to publish the article in their next volume.

In this article, we focus on the problem of creditor conduct in distressed firms — for which policymakers ought to have the economically-sensible repositioning of the distressed firm as a central goal. This problem has vexed courts for decades, without coming to a stable doctrinal resolution. It’s easy to see why developing an appropriate rule here has been difficult to achieve: A rule that facilitates creditor operational intervention going beyond ordinary collection on a defaulted loan can induce creditors to intervene perniciously, to shift value to themselves. But a rule that confines creditors to no more than collecting their debt can allow failed managers to continue mismanaging the distressed firm, with the only real alternative to the failed incumbent management — the creditor — being paralyzed by unclear and inconsistent judicial doctrine.

The article proceeds in four steps. For the first step, we show that existing doctrines do not address themselves to facilitating efficacious management of the failing firms. Yet with corporate and economic volatility as important as ever, courts should seek to make doctrine here more functionally-oriented than it now is.

…continue reading: A Capital Market, Corporate Law Approach to Creditor Conduct

As you may know, I am the Commission’s designated representative on the Financial Stability Board, or FSB, which is an international forum of prudential financial regulators, market regulators, international financial institutions and standard setting bodies. And last spring I finished a tour of duty as the Commission’s head of delegation to the International Organization of Securities Commissions, also known as IOSCO, a position now ably filled by the Commission’s Director of the Office of International Affairs, Ethiopis Tafara. The experience I have had representing the Commission in these institutions has been enlightening. While I, like most people, already understood that we are living in an increasingly interconnected world, serving on IOSCO and the FSB has helped me better appreciate the extent of these connections in the financial system, as well as both the power and the limitations of these international forums.

One of the better-known achievements of IOSCO is how it has increased international cooperation among securities regulators in the area of enforcement. This cooperation has been extraordinarily valuable, facilitating countless Commission cases where crucial evidence rests outside of the United States. Building on this success, we are now establishing cooperative arrangements with other regulators in our supervision program.

…continue reading: International Coordination Among Regulators