Posts Tagged ‘Equity-based compensation’

Compensating for Long-Term Value Creation in U.S. Public Corporations

Editor’s Note: Joseph Bachelder is special counsel in the Tax, Employee Benefits & Private Clients practice group at McCarter & English, LLP. The following post is based on an article by Mr. Bachelder, with assistance from Andy Tsang, which first appeared in the New York Law Journal.

Three categories of performers are rewarded for value creation in U.S. public corporations. They are: (1) the executives who manage the corporations; (2) the directors who oversee the performance of these corporations; and (3) the individual asset managers and others who provide investment services to investors who own, directly or indirectly, these corporations.

The following post takes a look at the correlation between the long-term incentive compensation of these three categories of performers and long-term value creation in U.S. public corporations that is attributable to them. In fact, such correlation appears to be limited. In addition, the article will consider a definition of “long-term” value creation, the roles of these three categories of performers in creating “long-term” value and the methods of compensating these different categories of performers in their respective roles in “long-term” value creation.

…continue reading: Compensating for Long-Term Value Creation in U.S. Public Corporations

Executive Remuneration and the Payout Decision

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Friday July 11, 2014 at 9:00 am
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Editor’s Note: The following post comes to us from Philipp Geiler of the Department of Economics, Finances, and Control at EMLYON Business School and Luc Renneboog, Professor of Finance at Tilburg University.

Corporations rely on dividends, share repurchases, or a combination of both payout methods to return earnings to their shareholders. Over the last decade, the importance of the dominating payout method—dividends—seems to be somewhat eroded at UK firms, with an increasing number of firms combining share repurchases with dividends. What explains the surge in the use of combined share repurchases and dividends in the UK? Is there a link between firm’s payout decision and executive remuneration?

…continue reading: Executive Remuneration and the Payout Decision

Motivating Innovation in Newly Public Firms

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Wednesday February 12, 2014 at 9:00 am
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Editor’s Note: The following post comes to us from Nina Baranchuk and Robert Kieschnick, both of the Finance and Managerial Economics Area at the University of Texas at Dallas, and Rabih Moussawi of the Wharton School at the University of Pennsylvania.

How do shareholders motivate managers to pursue innovations that result in patents when substantial potential costs exist to managers who do so? This question has taken on special importance as promoting these kinds of innovations has become a critical element of not only the competition between companies, but also the competition between nations. In our paper, Motivating Innovation in Newly Public Firms, forthcoming in the Journal of Financial Economics, we address this question by providing empirical tests of predictions arising from recent theoretical studies of this issue.

…continue reading: Motivating Innovation in Newly Public Firms

Managerial Risk Taking Incentives and Corporate Pension Policy

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Wednesday January 15, 2014 at 9:00 am
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Editor’s Note: The following post comes to us from Divya Anantharaman of the Department of Accounting and Information Systems at Rutgers Business School and Yong Gyu Lee of the School of Business at Sungkyunkwan University.

In our paper, Managerial Risk Taking Incentives and Corporate Pension Policy, forthcoming in the Journal of Financial Economics, we examine whether the compensation incentives of top management affect the extent of risk shifting versus risk management behavior in pension plans.

The employee beneficiaries of a firm’s defined benefit pension plan hold claims on the firm similar to those held by the firm’s debtholders. Beneficiaries are entitled to receive a fixed stream of cash flows starting at retirement. The firm sponsoring the plan is required to set aside assets in a trust to fund these obligations, but if the sponsor goes bankrupt with insufficient assets to fund pension obligations, beneficiaries are bound to accept whatever reduced payouts can be made with the assets secured for the plan.

…continue reading: Managerial Risk Taking Incentives and Corporate Pension Policy

A Theory of Debt Maturity

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Tuesday January 14, 2014 at 9:23 am
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Editor’s Note: The following post comes to us from Douglas Diamond, Professor of Finance at the
 University of Chicago Booth School of Business, and Zhiguo He of the
 Department of Finance at the University of Chicago Booth School of Business.

In our paper, A Theory of Debt Maturity: The Long and Short of Debt Overhang, forthcoming in the Journal of Finance, we study the effects of the debt maturity on current and future real investment decisions of an owner of equity (or a manager who is compensated by equity). Our analysis is based on debt overhang first analyzed by Myers (1977), who points out that outstanding debt may distort the firm’s investment incentives downward. A reduced incentive to undertake profitable investments when decision makers seek to maximize equity value is referred to as a problem of “debt overhang,” because part of the return from a current new investment goes to make existing debt more valuable.

Myers (1977) suggests a possible solution of short-term debt to the debt overhang problem. In part, this extends the idea that if all debt matures before the investment opportunity, then the firm without debt in place can make the investment decision as if an all-equity firm. Hence, following this logic, debt that matures soon—although after relevant investment decisions, as opposed to before—should have reduced overhang.

…continue reading: A Theory of Debt Maturity

ISS Releases 2014 Voting Policies

Editor’s Note: David A. Katz is a partner at Wachtell, Lipton, Rosen & Katz specializing in the areas of mergers and acquisitions and complex securities transactions. This post is based on a Wachtell Lipton memorandum by Mr. Katz, Trevor S. Norwitz, David E. Kahan, Sabastian V. Niles, and S. Iliana Ongun.

Institutional Shareholder Services Inc. (ISS) recently published its 2014 Corporate Governance Policy Updates, which would apply to annual meetings beginning in February 2014. ISS updated relatively few of its policies this year, but the changes largely represent a more measured, company-specific approach to corporate governance practices, which reflects a move by ISS to avoid “one-size-fits-all” policies and recommendations. ISS also announced a new consultation and comment period concerning potential policy changes applicable to the 2015 proxy season or beyond with respect to director tenure, director independence, independent chair shareholder proposals, equity-based compensation plans and auditor ratification.

2014 Policy Updates

Board Response to Majority Supported Shareholder Proposals. As announced last year, ISS evaluates a company’s response to shareholder proposals that receive a majority of shares cast in considering “withhold” recommendations against the full board, committee members or individual directors. With respect to such majority supported shareholder proposals, ISS will now make vote recommendations on director elections on a case-by-case basis and will no longer require boards to fully implement majority supported shareholder proposals in all cases. Instead, ISS will consider mitigating factors in cases involving less than full implementation, including the board’s articulated rationale for its response and level of implementation (with consideration of such rationales being a new factor not previously considered by ISS), disclosed shareholder outreach efforts by the board in the wake of the vote, the level of support and opposition for the proposal, actions taken, and the continuation of the underlying issue as a voting item on the ballot (as either shareholder or management proposals).

…continue reading: ISS Releases 2014 Voting Policies

Determinants and Performance of Equity Deferral Choices by Outside Directors

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Monday November 18, 2013 at 9:35 am
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Editor’s Note: The following post comes to us from Christopher Ittner, Professor of Accounting at the University of Pennsylvania; and Francesca Franco and Oktay Urcan, both of the Accounting Area at the London Business School.

In our paper, Determinants and Trading Performance of Equity Deferral Choices by Corporate Outside Directors, which was recently made publicly available on SSRN, we investigate the determinants and trading performance of outside directors’ “equity deferrals,” which represent the choice to convert part or all of the current cash compensation into deferred company stock. Director equity deferrals are interesting for two reasons. First, by deferring, the directors give up a sure amount of cash today for firm stock with an uncertain future value, while at the same time substantially increasing the proportion of their compensation that is tied to future firm performance. Second, the equity deferrals can become a form of insider trading, because directors can use these options as a tax-advantaged alternative to open-market purchases of the firm’s stock.

We examine director equity deferrals using a hand-collected sample of U.S. firms that allowed outside board members to defer their cash compensation into equity between 1999 and 2003. We first focus on the factors affecting director equity deferral choices. Consistent with a certainty equivalent story, we find that directors are more likely to defer cash into equity when they receive higher cash compensation levels and when the plans offer premiums for deferrals made into equity. Deferral likelihood also increases with the size of the taxes that are deferred.

…continue reading: Determinants and Performance of Equity Deferral Choices by Outside Directors

Equity Vesting and Managerial Myopia

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Wednesday October 9, 2013 at 9:30 am
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Editor’s Note: The following post comes to us from Alex Edmans, Professor of Finance at the London Business School, Vivian Fang of the Department of Accounting at the University of Minnesota, and Katharina Lewellen of the Tuck School of Business at Dartmouth College.

In our paper, Equity Vesting and Managerial Myopia, which was recently made publicly available on SSRN, we study the link between real investment decisions and the vesting horizon of a CEO’s equity incentives. We find that research and development (“R&D”) is negatively associated with the stock price sensitivity of stock and options that vest over the course of the same year. This association continues to hold when including advertising and capital expenditure in the investment measure. Moreover, CEOs with significant newly-vesting equity are more likely to meet or beat analyst consensus forecasts by a narrow margin. However, the market recognizes such CEOs’ incentives to inflate earnings—the lower announcement returns to meet or beating earnings forecasts are decreasing in the sensitivity of vesting equity. These results provide empirical support for managerial myopia theories.

Many academics and practitioners believe that managerial myopia is a first-order problem faced by the modern firm. While the 20th century firm emphasized cost efficiency, Porter (1992) argues that “the nature of competition has changed, placing a premium on investment in increasingly complex and intangible forms,” such as innovation, employee training, and organizational development. However, the myopia theories of Stein (1988, 1989) show that managers may fail to invest due to concerns with the firm’s short-term stock price. Since the benefits of intangible investment are only visible in the long run, the immediate effect of such investment is to depress earnings and thus the current stock price. Therefore, a manager aligned with the short-term stock price may turn down valuable investment opportunities.

…continue reading: Equity Vesting and Managerial Myopia

Governance Through Threat

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Monday October 7, 2013 at 9:14 am
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Editor’s Note: The following post comes to us from Massimo Massa, Professor of Finance at INSEAD, Bohui Zhang of the Australian School of Business at the University of New South Wales, and Hong Zhang of the Finance Area at INSEAD.

The last decade has witnessed a renewed interest in the role of financial markets in disciplining managers. Shareholders—particularly blockholders—may induce good managerial behavior by exiting and pushing down stock prices when bad managerial actions are taken (e.g., Admati and Pfleiderer, 2009; Edmans, 2009; Edmans and Manso, 2011). In this regard, informed trading (“exit”) provides an alternative governance mechanism that shareholders can adopt in addition to the traditional “intervention” type of internal governance (e.g., Parrino et al., 2003; Chen et al., 2007; McCahery et al., 2010). Indeed, to some extent, exit and intervention offer substituting governance mechanisms that shareholders can select based on their trade-off between benefits and costs (e.g., Edmans and Manso, 2011; Edmans et al., 2013).

In our paper, Governance Through Threat: Does Short Selling Improve Internal Governance?, which was recently made publicly available on SSRN, we study how “trading-based governance” affects internal governance through the channel of short selling. Using a simple model, we argue that the threat of short-selling attacks triggered by bad managerial actions pushes existing shareholders to better control management, either through improved internal governance or via enhanced equity compensation. Thus, short-selling-based discipline mechanisms are complementary with, instead of substituting for, internal governance.

…continue reading: Governance Through Threat

Delaware Court Ruling Raises Questions About Informal NYSE Interpretations

Posted by Noam Noked, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Saturday July 6, 2013 at 2:41 pm
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Editor’s Note: The following post comes to us from Robert Buckholz, partner and co-coordinator of the Corporate and Finance Group at Sullivan & Cromwell LLP. This post is based on a Sullivan & Cromwell publication, and is part of the Delaware law series, which is cosponsored by the Forum and Corporation Service Company; links to other posts in the series are available here.

Louisiana Municipal Police Employees Retirement System v. Bergstein [1] concerns a $120 million equity grant to the Chief Executive Officer of Simon Property Group, Inc. (“SPG”) and a related amendment to SPG’s stock incentive plan that was required to make the grant. The shareholder plaintiff alleges that the board of directors’ amendment of the plan was a breach of fiduciary duty because the plan mandated shareholder approval of amendments where required by law, regulation or applicable stock exchange rules. The defendants moved to dismiss, noting that SPG had received email confirmation from New York Stock Exchange staff that shareholder approval of the amendment was not required under NYSE rules. Ruling from the bench, Chancellor Leo E. Strine, Jr. denied SPG’s motion to dismiss, citing concerns that a staff email did not serve as a definitive interpretation of NYSE rules – particularly where, in Chancellor Stine’s view, the email to the NYSE did not adequately describe the broader circumstances.

The process SPG used is the customary one by which listed companies receive interpretations from the NYSE staff on governance matters, and Chancellor Strine’s ruling is at an early stage of the case. However, until there is more definitive guidance as to the weight that courts will give NYSE staff interpretations, listed companies should bear in mind the Chancery Court’s ruling when evaluating the weight that a court will give an NYSE email interpretation on a governance matter, particularly when evaluating whether a proposed change to an equity compensation plan would require shareholder
approval.

…continue reading: Delaware Court Ruling Raises Questions About Informal NYSE Interpretations

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