The Japanese insider ownership system began to fall apart approximately twenty years after it came into operation at the beginning of the 1970s. In our paper, The Ownership of Japanese Corporations in the 20th Century, which was recently made publicly available on SSRN, we suggest that the insider system emerged in the first place because the alternative institutions for promoting outside ownership failed. The problem was not with the legal framework, which was relatively strong in Japan. Instead, the failure was due to the absence of institutional reputational capital in equity markets equivalent to that embedded in the business coordinators and zaibatsu earlier in the century. The first point that this brings out is that the destruction of institutions, such as zaibatsu, can be serious in terms of economic performance. The second point is that the creation of new institutions of trust to replace previous institutions is complex and not readily achieved by design.
Posts Tagged ‘Ownership’
In our paper, When Blockholders Leave Feet First: Do Ownership and Control Affect Firm Value?, which was recently made publicly available on SSRN, we investigate the effect of ownership and control on firm value, a longstanding question in finance, by employing the sudden death of large individual shareholders as a natural experiment. Our analysis focuses on stock price reactions to the deaths of individual blockholders who hold 5% or more in a U.S. listed firm. The main advantage of this approach is that sudden deaths are exogenous events that allow us to identify the impact of ownership and control on firm value. We analyze the value of inside and outside blockholders. Outside blockholders differ from insiders in that they are not actively involved in day-to-day management. We compare the magnitude of stock price reactions between inside and outside blockholders and note that any effect of ownership transition on firm value due to liquidity or anticipated takeover activity is likely to cancel out. The difference in the stock price reactions between inside and outside blockholders is therefore informative about the value of ownership and control.
Our study is the first to evaluate the effect of blockholders on firm value through the use of sudden deaths. In a related paper Slovin and Sushka (1993) analyze the event of death of blockholders. We draw a distinction between sudden and non-sudden deaths because entrenched blockholders are likely to hold onto their ownership until their deaths. Our concerns about entrenchment appears to be relevant as our findings show that stock price reactions are systematically more positive for non-sudden deaths than for sudden deaths. Using sudden death as opposed to non-sudden death is thus important for the interpretation of the effect of blockholders on firm value.
In December 2012, we published an Alert after a Federal District Court concluded that: (1) a private equity fund was not a “trade or business” for purposes of determining whether the fund could be liable under the Employee Retirement Income Security Act of 1974 (“ERISA”) for the pension obligations of one of its portfolio companies and (2) consequently, the private equity fund could not be liable for its portfolio company’s pension obligations under Title IV of ERISA, even if the fund and the portfolio company were part of the same “controlled group.” Our December Alert, which contains background on the issue and a summary of the state of the law through December 2012, may be found here. This post is to advise that the First Circuit Court of Appeals has reversed the 2012 Federal District Court opinion.
In Sun Capital Partners III LP v. New England Teamsters & Trucking Indus. Pension Fund (No. 12-2312, July 24, 2013), the First Circuit Court of Appeals has concluded that: (a) a private equity fund can be a “trade or business” for purposes of determining “controlled group” joint and several liability under ERISA and (b) as a result, the private equity fund could be held liable for the pension obligations of its portfolio company under Title IV of ERISA, if certain other tests are satisfied. Under ERISA, a “trade or business” within a “controlled group” can be liable for the ERISA Title IV pension obligations (including withdrawal liability for union multiemployer plans) of any other member of the controlled group. This “controlled group” liability represents one of the few situations in which one entity’s liability can be imposed upon another simply because the entities are united by common ownership, but in order for such joint and several liability to be imposed, two tests must be satisfied: (1) the entity on which such liability is to be imposed must be a “trade or business” and (2) a “controlled group” relationship must exist among such entity and the pension plan sponsor or the contributing employer.
The Supreme Court’s decision in the case of Petrodel v Prest, handed down June 12, 2013, marks a crucial shift in the extent to which the courts will allow the “piercing of the corporate veil”. Although the case revolved around a matrimonial dispute, it has profound implications for corporate governance.
In October 2011, the High Court ruled that Mrs Prest (“W”) was entitled to a divorce settlement of £17.5 million from Mr Prest (“H”), a wealthy oil trader. Since H failed to comply with court orders by failing to give full and frank disclosure of his finances during proceedings, his appeal was dismissed at a preliminary stage. The award therefore stood regardless of later court decisions concerning enforcement.
In terms of enforcement of the award, Moylan J ordered that properties in London and overseas, owned by Petrodel Resources and two other companies (collectively “X”) were assets of H and formed part of the divorce settlement since they were beneficially owned by H as the sole shareholder. Whilst Moylan J found there had been no impropriety in relation to X, so as to permit the corporate veil to be pierced, he nevertheless held that H, exercising complete control over X both in terms of their operation and management, was ‘entitled’ to the relevant properties within the meaning of s24(1)(a) Matrimonial Causes Act 1973 (“MCA”), despite not personally owning the assets.
X appealed to the Court of Appeal, submitting that in order for company assets to become subject to s24(1)(a) MCA, the corporate veil would have to be pierced and this only occurred in exceptional circumstances, this not being one of them.
There are two main sources of confusion in the public corporate governance debate. One is the confusion about the role of public policy in corporate governance. The other is a lack of empirical knowledge among commentators about the corporate landscape and the way that today’s stock markets influence the conditions for exercising long term and value creating corporate governance. This paper tries to mitigate some of this confusion and to increase awareness in both respects.
In terms of public policy it is important to understand that the general corporate governance discussion usually takes place on two different levels. And both are legitimate. One is concerned with the everyday workings of individual companies: how they organize their internal procedures, staff their company organs and build their corporate culture. Much of this is unique to the company in question. The choices to be made are often a matter of business judgment and are seldom in a domain where policy makers and regulators have any specific expertise.
In the paper, Corporate Governance and Value Creation: Evidence from Private Equity, forthcoming in the Review of Financial Studies, my co-authors (Oliver Gottschalg, Moritz Hahn, and Conor Kehoe) and I attempt to bridge two strands of literature concerning PE, the first of which analyzes the operating performance of acquired companies, and the second that analyzes fund IRRs. In addition, we investigate how human capital factors are associated with value creation in PE deals. We focus on the following questions: (i) Are the returns to equity investments by large, mature PE houses simply due to financial leverage and luck or market timing from investing in well-performing sectors, or do these returns represent the value created at the enterprise level in the so-called portfolio companies, over and above the value created by the quoted sector peers? (ii) What is the effect of ownership by large, mature PE houses on the operating performance of portfolio companies relative to that of quoted peers, and how does this operating performance relate to the financial value created (if any) by these houses? (iii) Are there any distinguishing characteristics based on the background and experience of PE houses or partners involved in a deal that are best associated with value creation?
The high pay of U.S. CEOs relative to their foreign counterparts has been cited as evidence of excesses in U.S. executive compensation practices. This perception of a “pay divide” between the United States and the rest of the world is usually based on estimates provided by professional services firms like Towers Watson that receive a good deal of press coverage. However, attempts to understand the magnitude and determinants of the U.S. pay premium have been plagued by data limitations due to international differences in rules regulating the disclosure of executive compensation.
In our paper, Are U.S. CEOs Paid More? New International Evidence, forthcoming in the Review of Financial Studies, we use new data to compare CEO pay in 1,648 U.S. firms versus 1,615 firms from 13 foreign countries. Thanks to recently expanded disclosure rules, our sample includes publicly listed firms from both Anglo-Saxon and continental European countries that had mandated disclosure of CEO pay by 2006. It covers nearly 90% of the market capitalization of firms in these markets and, importantly, comprises firms with different corporate governance arrangements.
The SEC recently issued Staff Legal Bulletin No. 14G providing additional guidance on shareholder proposals submitted to companies pursuant to Rule 14a-8. The guidance is in response to several issues that came up during the 2012 proxy season.
Proof of ownership
In a prior bulletin, SLB No.14F, the SEC had reconsidered its view as to who constitutes a “record holder” for purposes of Rule 14a-8 and indicated that only DTC participants may provide adequate proof of ownership for shareholder proponents. Consistent with its no-action letter decisions during 2012, the Staff indicated in this bulletin that it would also view ownership letters from affiliates of DTC participants as satisfying the proof of ownership requirement.
Also, the Staff indicated that a shareholder who holds securities through a securities intermediary that is not a broker or a bank can satisfy Rule 14a-8’s documentation requirement by submitting a proof of ownership letter from that securities intermediary. If the securities intermediary is not a DTC participant or an affiliate of a DTC participant, then the shareholder will also need to obtain a proof of ownership letter from the DTC participant, or an affiliate of the DTC participant, that can verify the holdings of the securities intermediary.
In our forthcoming American Economic Review paper, Innovation and Institutional Ownership, we examine the incentives to innovate at the firm level by studying the relationship between innovation and institutional ownership. Innovation is the main engine of growth. But what determines a firm’s ability to innovate? Innovating requires taking risk and forgoing current returns in the hope of future ones. Furthermore, while any type of financing is plagued by moral hazard and adverse selection, the financing of innovation is probably the most vulnerable to these problems (Arrow, 1962) since the information that needs to be conveyed is hard to communicate to outsiders. This paper is an attempt at analyzing the corporate governance of innovation and more specifically the role of institutional owners in fostering (or hindering) innovation.
While the ability to diversify risk across a large mass of investors makes publicly traded companies the ideal locus for innovation, managerial agency problems might undermine the innovation effort of these companies. In publicly traded companies, the pressure for quarterly results may induce a short-term focus (Porter, 1992). And the increased risk of managerial turnover (Kaplan and Minton, 2008) might dissuade risk-averse senior managers from this activity. Finally, innovation requires effort and “lazy” managers might not exert enough of it. Hence, it is especially important to study the governance of innovation in publicly traded companies, which account for a large share of the private investments in research and development (R&D).
In our recent NBER working paper, Do Private Equity Fund Managers Earn Their Fees? Compensation, Ownership, and Cash Flow Performance, we use a large, proprietary database of private equity funds to study the links between the terms of private equity management contracts and the subsequent cash flow behavior and performance of the funds. The database is the largest and most recent source of private equity compensation terms available to date, and is the first to provide information on manager ownership and to include cash flow information along with the terms of management contract.
We use these data to contrast two views of the state of managerial compensation practices in private equity. The first is that highly compensated GPs, or those with little skin in the game, extract excessive rents and have inadequate incentives, which ultimately spells poor returns for limited partners. The second view is that the management contracts we observe reflect (potentially constrained) efficient bargaining outcomes between sophisticated parties, and that management contracts reflect the productivity of GP skills and the agency problems that LP’s face.