Posts Tagged ‘Equity-based compensation’

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

Downside Risk and the Design of CEO Incentives

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Monday June 10, 2013 at 8:56 am
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Editor’s Note: The following post comes to us from David De Angelis, Gustavo Grullon, and Sebastien Michenaud, all of the Finance Area at Rice University.

In our paper, Downside Risk and the Design of CEO Incentives: Evidence from a Natural Experiment, which was recently made publicly available on SSRN, we investigate how downside risk influences the design of CEOs’ incentives. Studying the relationship between firm risk and managerial incentives is a difficult task due to the endogenous nature of the relationship: empiricists cannot easily disentangle the effect of compensation on risk from the effect of risk on compensation (Prendergast, 2002). We address the identification challenge by exploiting a randomized natural experiment that exogenously increased downside equity risk through the relaxation of short-selling constraints. Because the removal of short-selling constraints may cause an increase – or the fear of an increase – in bear raids and market manipulation by short-sellers (Goldstein and Guembel (2008)), this increase in downside risk potentially exposes managers to losses that are beyond their control. In this scenario, CEOs may sub-optimally reduce the risk of their firms to protect their personal wealth and firm-specific human capital (Amihud and Lev (1981), May (1995)). Consistent with this view, firms and their CEOs display an acute aversion to short-sellers, and go to great lengths to fight them and reduce their influence on stock prices (Lamont (2012)). As a result, firms that maximize shareholder value should respond to an exogenous increase in short selling activity by increasing their CEOs’ risk-taking incentives to avoid sub-optimal risk reduction policies, and/or by immunizing their CEOs against the downside risk that lies outside of their control and does not reflect their performance.

…continue reading: Downside Risk and the Design of CEO Incentives

SEC Issues SOX 402 Guidance

Posted by Michael G. Oxley, Baker & Hostetler LLP, on Thursday April 18, 2013 at 9:23 am
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Editor’s Note: Michael Oxley is of counsel at Baker & Hostetler LLP, and is former Congressman and Chairman of the House Financial Services Committee. Mr. Oxley co-authored the landmark Sarbanes-Oxley Act of 2002. The following post is based on a BakerHostetler memorandum by Mr. Oxley, Andrew W. Reich, and Thomas S. Gallagher.

The SEC staff for the first time issued interpretive guidance regarding Section 402 of the Sarbanes-Oxley Act of 2002 (SOX). To date, in the absence of authoritative guidance, issuers have largely steered clear of activities arguably within the ambit of SOX 402′s prohibition on personal loans to officers and directors. The staff’s new letter provides a measure of clarity regarding SOX 402′s scope.

SOX 402, codified as Section 13(k) of the Securities Exchange Act of 1934, makes it unlawful for an issuer “directly or indirectly … to extend or maintain credit, to arrange for the extension of credit, or to renew an extension of credit, in the form of a personal loan” to any of its directors or executive officers. Violations of SOX 402 can subject issuers to civil and criminal penalties under Sections 21B and 32(a) of the Exchange Act.

…continue reading: SEC Issues SOX 402 Guidance

What Motivates Minority Acquisitions?

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Friday March 1, 2013 at 9:26 am
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Editor’s Note: The following post comes to us from Paige Parker Ouimet of the Finance Division at the Kenan-Flagler Business School, the University of North Carolina at Chapel Hill.

What motivates minority acquisitions? We study the trade-off between minority acquisitions, involving less than 50% of the target, and majority acquisitions in the forthcoming Review of Financial Studies paper, “What Motivates Minority Acquisitions? The Trade-Offs between a Partial Equity Stake and Complete Integration.” Minority acquisitions have been shown to facilitate cooperation between two independent firms. For example, Allen and Phillips (2000) and Fee, Hadlock, and Thomas (2006) show that a minority acquisition can align the incentives of the acquirer with those of the target. However, similar benefits can also be achieved with a majority acquisition, suggesting that minority stakes are also motivated as a means to avoid certain costs associated with majority control.

Using a sample of 2,166 deals, we identify several key predictors in the choice between a minority or majority acquisition. The key insight provided in this paper is the importance of costs associated with the dilution to target managerial incentives following a majority acquisition in selecting the mode of acquisition. Evidence that firms are willing to forgo benefits to control to preserve target incentives speaks to the value of these incentives.

…continue reading: What Motivates Minority Acquisitions?

How to Prepare for Annual Meeting Litigation

Posted by Noam Noked, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Thursday February 7, 2013 at 9:32 am
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Editor’s Note: The following post comes to us from Regina Olshan, partner in the executive compensation and benefits practice at Skadden, Arps, Slate, Meagher & Flom LLP, and is based on a Skadden alert by Ms. Olshan, Neil Leff, Erica Schohn and Joseph Yaffe.

As the 2013 proxy season is now underway, companies should be aware of the recent wave of lawsuits alleging breaches of fiduciary duties by management and directors in connection with compensation-related decisions. These suits allege deficient disclosure with respect to compensation-related proxy proposals and seek to enjoin the company’s annual meeting until supplemental disclosures are made. They primarily target proposals to increase the amount of shares reserved for equity compensation plans and advisory votes on executive compensation (say-on-pay). There also have been a handful of suits relating to proposals seeking to amend certificates of incorporation to increase the total number of authorized shares.

More than 20 such cases were filed in 2012, and the plaintiffs’ law firm predominantly initiating these suits has announced that it is investigating nearly 40 additional companies. These cases are typically filed shortly after a company files its definitive proxy statement and make generic accusations of inadequate disclosure. Some companies concerned about potential disruption to their annual meetings have been willing to settle these claims. There have been at least six reported settlements, all involving proposals to increase the number of shares authorized under equity plans. These settlements have generally involved supplemental disclosure and payment of up to $625,000 of plaintiffs’ attorneys’ fees. Other companies have settled prior to the filing of a formal lawsuit. Although a preliminary injunction has been granted in only one of these cases, Knee v. Brocade Communications Systems, Inc., many cases in which preliminary injunctions were denied are still pending resolution regarding other relief requested by the plaintiffs, such as damages. An analysis of the claims made in filed cases to date may help companies decide whether to increase disclosure in their 2013 annual meeting proxy statements.

…continue reading: How to Prepare for Annual Meeting Litigation

What Works Best in Pay for Performance Analysis

Posted by Noam Noked, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Thursday December 27, 2012 at 10:33 am
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Editor’s Note: The following post comes to us from Robin A. Ferracone, founder and CEO of Farient Advisors. This post is an abridged version of a Farient white paper by Ms. Ferracone and Jack Zwingli; the full version is available here.

Executive Summary

Pay for performance. As the dust settles from year two of Say on Pay proxy voting, and more companies coalesce around accepted pay practices, the top issue for both shareholders and companies is whether pay is aligned with performance. While there is general acceptance that the performance side of that equation should primarily be based on total shareholder return (TSR), there is not yet a commonly accepted definition for pay. The result is that widely divergent compensation numbers currently are being used in pay for performance analysis, leaving shareholders and others unclear on how to evaluate this critical issue.

…continue reading: What Works Best in Pay for Performance Analysis

Internal vs. External CEO Choice and the Structure of Compensation Contracts

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Wednesday August 1, 2012 at 9:19 am
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Editor’s Note: The following post comes to us from Frédéric Palomino of the Department of Economics at EDHEC Business School and Eloïc-Anil Peyrache of the Department of Economics and Decision Sciences at HEC Paris.

The dramatic and unprecedented increase in CEO pay in the 1980s and 1990s led to questioning the efficiency of CEO compensation packages. The debate concentrated first on the pay-performance sensitivity and then moved to the compensation level, given the observed widening gap between the pay level of executive officers and other employees. However, another important change regarding CEOs took place over the same period—their working experience prior to being appointed as a CEO. Increasingly, boards of directors have hired CEOs outside their firm.

In our paper, Internal vs. External CEO Choice and the Structure of Compensation Contracts, forthcoming in the Journal of Financial and Quantitative Analysis, we provide a rationale for the simultaneous increases in (i) CEO pay, (ii) use of equity in compensation schemes, and (iii) hiring of CEOs externally.

…continue reading: Internal vs. External CEO Choice and the Structure of Compensation Contracts

The Efficacy of Shareholder Voting

Posted by David F. Larcker, Stanford Graduate School of Business, on Wednesday April 25, 2012 at 9:30 am
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Editor’s Note: David Larcker is the James Irvin Miller Professor of Accounting at Stanford University.

In the paper, The Efficacy of Shareholder Voting: Evidence from Equity Compensation Plans, which was recently made publicly available on SSRN, my co-authors (Christopher Armstrong of the University of Pennsylvania and Ian Gow of Harvard Business School) and I examine the efficacy of shareholder voting in effecting changes in corporate policy. We focus on the effects of shareholder voting on equity-based compensation plans on firms’ executive compensation policies for two reasons. First, equity compensation plans are widespread and require shareholder approval, making votes on these plans the most common subject of shareholder voting after director elections and auditor ratification. Second, equity compensation proposals attract much higher levels of shareholder disapproval than most other company-sponsored proposals that are put to shareholder vote (e.g., director elections and auditor ratification nearly always receive in excess of 90% shareholder support), making them a more powerful setting for empirical analysis.

Of the 619 management-sponsored proposals rejected by shareholders between 2001 and 2010, 183 (30%) related to equity compensation plans. For the 2,659 management-sponsored proposals where Institutional Shareholder Services (ISS), a leading proxy advisory firm, recommended a vote against the proposal, 1,719 (65%) related to equity compensation plans. Moreover, ISS recommended against 27% of the 6,270 equity compensation plans considered between 2001 and 2010. Although only 2% of equity compensation proposals fail to receive the required level of shareholder support, this is substantially larger than the 0.07% failure rate for director elections, which have received considerably greater attention in recent research on shareholder voting and executive compensation.

…continue reading: The Efficacy of Shareholder Voting

Post-Crisis Trends in U.S. Executive Pay

Posted by Carol Bowie, Institutional Shareholder Services Inc., on Monday February 27, 2012 at 10:07 am
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Editor’s Note: Carol Bowie is an Executive Director of MSCI and head of compensation policy development at ISS. This post is based on an ISS white paper by Subodh Mishra, available in full here.

Though the global financial crisis of 2008 prompted a seismic shift in attitudes toward executive pay on the part of lawmakers, the public, investors, and other stakeholders, average compensation levels continue to rise or have returned to where they were before the crisis.

Mindful of the outcry over particular elements of pay packages, companies began scaling back bonus awards as well as payments related to “golden parachutes” and other forms of exit pay following the crisis.

Indeed, such components of executives’ total annual compensation declined in fiscal 2009 with some elements, including those dealing with exit pay, continuing to decline modestly into fiscal 2010.

But that has been more than offset through increases in other pay elements, most notably awards tied to company stock. The result is a 37 percent surge in total annual compensation paid to C-suite officers from fiscal 2008 to 2010 with stock awards now constituting more than half of the total pay pie.

As such, this post explores how the executive pay package mix and overall total annual compensation levels have changed since fiscal 2008 and the role played by stock-based awards in fueling the spike in total executive pay.

…continue reading: Post-Crisis Trends in U.S. Executive Pay

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