In the paper, The Sensitivity of Corporate Cash Holdings to Corporate Governance, forthcoming in the Review of Financial Studies, my co-authors (Qi Chen, Xiao Chen, Yongxin Xu, and Jian Xue) and I analyze the change in cash holdings of a large sample of Chinese-listed firms associated with the split share structure reform that required nontradable shares held by controlling shareholders to be converted to tradable shares, subject to shareholder approval and adequate compensation to tradable shareholders. The reform removed a substantial market friction and gave controlling shareholders a clear incentive to care about share prices, because they could benefit from share value increases by selling some of their shares for cash.

We predict and find that this governance improvement led to reduced cash holdings of affected firms, and that the effect is more pronounced for private firms than for state-owned enterprises (SOEs), for firms with more agency conflicts, and for firms for which financial constraints are most binding. We interpret these results as consistent with both a direct free cash flow channel and an indirect financial constraint channel. These results are robust to several alternative specifications that address concerns about endogeneity and concomitant effects. They provide strong evidence that governance arrangements affect firms’ cash holdings and cash management behaviors. To the extent that cash management is a key operational decision that affects firm value, our findings suggest an important mechanism for corporate governance to affect firm value.

…continue reading: The Sensitivity of Corporate Cash Holdings to Corporate Governance

In our paper Ownership Dynamics with Large Shareholders: an Empirical Analysis, forthcoming in the Journal of Financial and Quantitative Analysis, we study ownership dynamics in a country where controlling shareholders are prevalent. We find that ownership structures are very persistent and that pyramidal structures are associated with less dispersion than other control structures. We also find that dilution is preceded by higher returns and predicts low returns in the future, which is a typical feature of market timing.

It is an established fact that ownership is typically dispersed in the US and the UK, but concentrated in the rest of the world. Yet, why is it that markets do not converge to the dispersed ownership paradigm of the US/UK? Why is it that approximately 20% of firms in the US and UK are tightly controlled, whereas 70% of firms in Continental Europe are tightly controlled? What prevents controlling shareholders from diluting their stakes in the firms they control? We aim to provide an answer to these questions by examining Chilean firms’ ownership dynamics in a 20 year period (1990-2009). We benefit from Chile’s unique features, such as improvements in the protection to minority shareholders, economy’s steep growth (per capita GDP more than doubled in PPP terms), markets’ booms and busts, and excellent data sources. Despite these unique features, what we learn sheds light on ownership dynamics in a number of different markets, as Chile is similar to other developed and emerging economies in terms of financial development, the overall level of ownership concentration, and protection to minority shareholders.

…continue reading: Ownership Dynamics with Large Shareholders

According to a reform applicable as of January 1, 2012, the right to deduct interest due with respect to the purchase of shares in French target companies will be denied, unless the French acquiring company demonstrates — by any means — that (i) the decisions relating to such shares and (ii) the control over the target companies are effectively made by it or by a related party established in France.

For the purpose of this reform, a related party can be a controlling company or an entity controlled by or under common control with the acquiring company.

This new rule targets the purchase of shareholdings that are eligible for the French long-term participation exemption regime, i.e. mainly shares that represent at least 5% of the financial and voting rights of companies (other than certain real estate property companies).

…continue reading: French Thin Cap Reform

On December 14, 2011, the FTSE Group published the results of its market consultation on the minimum free float [1] requirements for inclusion of premium London-listed companies [2] in the FTSE UK Index Series – one of the most recognized indices in the world, which includes the FTSE 100 Index. The key outcome of the consultation is that, as of January 1, 2012, the minimum free float required for UK-incorporated companies will increase from 15% to 25%, with grandfathering of existing FTSE companies until January 1, 2014.

I. Current Free Float Requirements

Under the FTSE Ground Rules, companies that wish to be included in the FTSE UK Index Series must maintain a minimum free float:

• of at least 50%, if not incorporated in the UK; or
• of at least 15% (or 5% where the relevant company’s market capitalization exceeds US $5 billion), if incorporated in the UK.

…continue reading: FTSE Announces Change to Minimum Free Float Requirements

On October 14, 2011, Chancellor Strine of the Court of Chancery of the State of Delaware issued a decision in In re Southern Peru Copper Corp. Shareholder Derivative Litig., C.A. No. 961-CS. In the 105-page decision, Chancellor Strine ultimately found that the controlling stockholder defendants had breached their fiduciary duty of loyalty and awarded damages of over $1.2 billion, which may be paid by the controlling stockholder by returning some of the stock consideration received from the controlled company in the transaction. The decision provides important guidance for companies engaging in M&A transactions with their controlling stockholders.

In 2004, Southern Peru Copper Corporation, an NYSE-listed mining company, received a proposal from its majority stockholder, Grupo Mexico, S.A.B. de C.V. Under the proposal, Southern Peru would acquire Grupo Mexico’s 99.15% interest in Minera Mexico, S.A. de C.V., a non-publicly traded Mexican mining company, for $3.1 billion in Southern Peru stock. Because of Grupo Mexico’s self-interest in the transaction, Southern Peru formed a Special Committee of disinterested directors to consider the transaction. The Special Committee retained its own financial and legal advisors.

…continue reading: Delaware Court Issues Guidance for M&A Transactions with Controlling Stockholders

Recently, a debate has emerged about the merits of certain proposed piecemeal reforms to the Williams Act’s 13(d) disclosure regime. The aim of our paper, The Williams Act: A Truly “Modern” Assessment, is to examine the implications of these proposals and to suggest that, before making any changes to the regime, the Commission should undertake a comprehensive review of the role of the Williams Act in today’s market and decide what best serves overall shareholder interests. The paper was prepared on behalf of certain members of the Managed Funds Association and was sent in advance of various meetings with the Staff of the Securities and Exchange Commission and with certain SEC Commissioners. The participants at those meetings included Pershing Square Capital and JANA Partners, as well as BlackRock, California State Teachers’ Retirement System, Florida State Board of Administration, The New York State Common Retirement Fund, Ontario Teachers’ Pension Plan Board, TIAA-CREFF, T. Rowe Price, and pension fund representatives of Change to Win and the United Food and Commercial Workers Union.

The Williams Act: An Historical Perspective

Enacted in 1968, the Williams Act was a response to a wave of hostile coercive takeover attempts, primarily cash tender offers. At the time the Williams Act was passed, the vast majority of shares were owned by individual shareholders, a fragmented and ill-informed group unprepared to exert their rights as shareholders. Cash tender offers posed the real risk of destroying value by forcing shareholders to tender their shares on a compressed timetable.

…continue reading: The Williams Act: A Truly “Modern” Assessment

In a recent post-trial decision, the Delaware Court of Chancery upheld as entirely fair the third-party acquisition of a controlled company in which the controlling shareholder received consideration that differed from that provided to the public minority. In re John Q. Hammons Hotels Inc. S’holder Litig., C.A. No. 758-CC (Del. Ch. Jan. 14, 2011).

The matter arose from the 2005 sale of John Q. Hammons Hotels, Inc., a publicly traded company controlled by John Hammons. In the transaction, the public shareholders were cashed out at a substantial premium while Hammons himself received an ongoing preferred equity interest and other contractual rights. In an important decision earlier in the case, the Chancellor ruled that with proper planning such a transaction may be reviewed under the deferential business judgment rule, but held that the Hammons transaction would nevertheless be subject to the plaintiff-friendly “entire fairness” test due to the lack of sufficient procedural safeguards.

…continue reading: Delaware Confirms Fairness of Third-Party Transaction with Controlled Company

In our paper When the Government Is the Controlling Shareholder, recently made publicly available on SSRN, we analyze the ways in which existing corporate law structures of accountability change when the government is the controlling shareholder, and the extent to which federal “public law” structures substitute for displaced state “private law” norms.

As a result of the 2008 bailouts, the United States Government is now the controlling shareholder in AIG, Citigroup, GM, GMAC, Fannie Mae and Freddie Mac. Corporate law provides a complex and comprehensive set of standards of conduct to protect noncontrolling shareholders from controlling shareholders who have goals other than maximizing firm value, but are designed with private parties in mind. We show that when the government is the controlling shareholder, the Delaware restrictions are largely displaced, but hardly replaced, by federal provisions. When GM goes public again, government ownership of a controlling position will be a significant “risk factor.”

…continue reading: When the Government Is the Controlling Shareholder

In a recent Delaware decision issued in In re CNX Gas Corp. Shareholders Litigation, C.A. No. 5377-VCL (Del Ch. May 25, 2010), Vice Chancellor Travis Laster imposed additional requirements for controlling stockholders and boards to obtain the benefit of the more deferential business judgment standard of review by a court in litigation over a going private tender offer, and advocates a unified standard of review for going private transactions generally, whether structured as a merger or a tender offer. Vice Chancellor Laster endorsed the reasoning first set forth in dicta in Cox Communications (Del. Ch. 2005), in which Vice Chancellor Leo Strine, Jr. argued that the Delaware courts should reject the notion that negotiated mergers with controlling stockholders are subject to the stringent “entire fairness” review, while certain two-step transactions (i.e., a tender offer followed by a short-form merger) with the same controlling stockholders are subject to the business judgment rule. In CNX, Vice Chancellor Laster held that the business judgment rule (and not entire fairness) will apply to a going private transaction by its controlling stockholder only if the transaction is both (1) negotiated and recommended by an active and informed special committee of independent, disinterested directors and (2) subject to a “majority-of-the-minority” tender or vote condition.

…continue reading: Delaware Court Adopts Unified Standard for Controlling Stockholder Going Private Transactions

In our NBER working paper, Agency Costs, Mispricing, and Ownership Structure, we propose an explanation based on stock market mispricing for why firms with a controlling shareholder raise outside equity even when they cannot commit not to expropriate minority shareholders. Our main idea is that the controlling shareholder takes advantage of stock market mispricing to offset the burden of agency costs. To the extent that agency costs are deadweight instead of distributional transfers, mispricing facilitates the creation of inefficient ownership structures.

In perfectly efficient markets, minority shareholders anticipate the full extent of agency problems and form unbiased estimates of the cash flows they will receive. If the controlling shareholder is expected to divert resources, minority shareholders price the equity accordingly, and it is the controlling shareholder who ultimately bears all agency costs. Controlling shareholders therefore sell shares to dispersed outside investors only when there are substantial benefits to doing so. The existing literature focuses on motivations related to financial constraints. Our findings suggest another possible, though not mutually exclusive, explanation: equity is sold when it is overpriced. Stock mispricing offsets agency costs and induces a controlling shareholder to raise capital. Higher misvaluations are required to support the creation of ownership structures that give rise to more expropriation.

…continue reading: Agency Costs, Mispricing, and Ownership Structure