Regulation FD, adopted by the SEC in 2000, prohibits “selective disclosure” by requiring public companies to disclose material information through broadly accessible channels. Thirteen years ago, this meant EDGAR filings, press releases and quarterly earnings calls.

The SEC recently issued a report of investigation under Section 21(a) of the Securities Exchange Act of 1934 regarding its inquiry into a post by Netflix’s CEO on his personal Facebook page. In the report, the SEC affirmed that a company may use social media to communicate with investors without violating Regulation FD – as long as the company had adequately informed the market that material information would be disclosed in this manner. The report states that whether a company’s social media disclosure satisfies Regulation FD will depend upon the principles outlined in the SEC’s 2008 guidance, Commission Guidance on the Use of Company Web Sites, while recapping that guidance in a way that should make these principles more workable for companies that want to use websites, social media and other evolving communication methods to disclose important information to the market.

…continue reading: How to Use Social Media for Regulation FD Compliance

The Staff of the Securities and Exchange Commission has announced its intention to recommend to the Commission that enforcement proceedings alleging a violation of Regulation FD be instituted against Netflix, Inc. and its CEO, Reed Hastings, because of a posting on Mr. Hastings’ personal Facebook page. Mr. Hastings’ webpage had more than 200,000 followers, including reporters who covered the posting in the traditional press. The posting was also the subject of a tweet by TechCrunch, which has approximately 2.5 million followers on Twitter.

This article, Regulation FD in the Age of Facebook and Twitter: Should the SEC Sue Netflix?, is in the form of an amicus Wells Submission suggesting that the Commission would, for nine distinct reasons, be prudent not to initiate an action on the facts of the Netflix posting. In particular, the public record suggests that the posting did not contain material information, was not a selective disclosure, and because of its spread through social media constituted a “broad non-exclusionary distribution” that did not violate Regulation FD. A prosecution would also diverge dramatically from all prior Regulation FD enforcement proceedings, and would violate the Commission’s prior representations not to “second guess” good faith efforts to comply with Regulation FD. In addition, the posting is not inconsistent with the Commission’s 2008 Guidance on the Use of Company Webpages — guidance that is seriously outdated because of the emergence of social media.

…continue reading: Regulation FD in the Age of Facebook and Twitter

This month marked an important milestone in the development of securities law at its newest frontier: social media. For the first time, the Enforcement Division of the U.S. Securities and Exchange Commission (“SEC”) issued a Wells Notice based on a social media communication. This Wells Notice, which notified Netflix, Inc. and its CEO of the Enforcement Division’s intent to recommend an enforcement case to the Commission, demonstrates the potential for liability arising from disclosures by corporate officers through social media. Although the SEC itself uses social media to disclose important information, the agency has yet to offer formal guidance concerning the use of social media to communicate with the investing public. For this reason, the outcome of the SEC’s investigation into Netflix and its CEO’s social media usage will prove instructive to issuers, directors, corporate officers, investors, and members of the securities and white collar bars.

…continue reading: Applying Securities Laws to Social Media Communications

In the paper, Who Killed the Inner Circle? The End of the Era of the Corporate Interlock Network, which was recently made publicly available on SSRN, I show that the American board interlock network has changed in fundamental ways.

Throughout the 20th century, the American board interlock network—in which companies are linked by shared board directors—exhibited a stable cohesiveness, characterized by short path lengths between companies and the existence of an “inner circle” of well-connected directors. This enduring cohesiveness of the interlock network was both the result of elite social cohesion and a key mechanism for maintaining this elite cohesion (e.g., Mills, 1956; Useem, 1984). The characteristics of the interlock network were so stable that Davis, Yoo, and Baker (2003) asserted that short path lengths and an inner circle were inevitable properties of “networks qua networks”.

…continue reading: The End of the Era of the Corporate Interlock Network

In our paper, The Independent Board Requirement and CEO Connectedness, which was recently made publicly available on SSRN, we investigate unintended consequences of the independent board requirement.  Following highly publicized corporate scandals in 2001 and 2002, firms listed on the NYSE and NASDAQ are required to have a majority of independent directors. The intent is to better protect shareholders by making boards more independent from managerial influence and thereby more effective monitors. However, the majority requirement represents a ceiling on the percentage of dependent directors a firm may have.

If board composition is endogenous, the quota may trigger reactions by firms affected by the regulation. Board composition is but one of many facets of governance. Imposition of a quota on one governance mechanism may spillover to other governing bodies as firms find ways to counteract it. This paper attempts to identify the spillover effects, analyze their consequences, and answer several questions: How do CEOs react to a regulation that may reduce their influence over the board? How do the reactions, if any, manifest in the softer side of governance, namely, CEO connectedness with other key players in governing the firm? How do the spillover effects impact the regulatory intent?

…continue reading: The Independent Board Requirement and CEO Connectedness

It is well-known in finance and economics that firms possess private information about their own fundamental values. In our paper, Director Histories and the Pattern of Acquisitions, which was recently made publicly available on SSRN, we contribute to this literature by examining, in the context of the market for corporate control, how the transmission of non-public information about potential targets influences mergers and acquisitions. This is interesting because, despite extensive research on the determinants of acquisitions, we can still only imperfectly predict which firms will choose to initiate acquisitions and, for those that do, how they choose among potential targets.

We capture a potential acquirer’s exposure to target-specific non-public information by tracking the service histories of its directors over time. If a current director was formerly on the board of another firm, we say that the two firms have an historical interlock. We treat these directed firm-pair interlocks as containing information about the firm where the current director once served, and estimate the impact of this information on the decision to initiate an acquisition of that firm. Our main results indicate that a given firm is about five times more likely to initiate an acquisition of a historically-interlocked target than some other unlinked firm.

…continue reading: Director Histories and the Pattern of Acquisitions

In our paper, External Networking and Internal Firm Governance, forthcoming in the Journal of Finance, we use panel data on S&P 1500 companies to identify external network connections between directors and CEOs. We observe network connections stemming from shared external board seats, prior employment in other firms, education, or charitable and leisure activities. We test whether these ties affect firm policies and performance.

A well-functioning board of directors provides both valuable advice to management and a check on its policies. An effective director should not just rubber stamp management’s actions, but should take a contrarian opinion when management’s proposals are not in the interest of the firm’s shareholders. Thus, it is important to identify director characteristics which affect their ability or willingness to bring valuable new information into the firm and to properly perform their monitoring role. Our results suggest that having directors with external network ties to the CEO may undermine the effectiveness of corporate governance.

…continue reading: External Networking and Internal Firm Governance

In the paper, Board Interlocks and Earnings Management Contagion, which was recently made publicly available on SSRN, we test whether earnings management (like a virus) spreads from firm to firm via board connections of shared directors (virus carriers).

We use earnings restatements to identify firms that managed earnings and to identify the period when these firms manipulated earnings. We consider firms as infectious in the period when they manipulated earnings. We test whether the directors of the infected firms carry these earnings management behaviors to susceptible firms on whose boards they also sit on.

…continue reading: Board Interlocks and Earnings Management Contagion

In our recent working paper Acquirer-Target Social Ties and Merger Outcomes, we estimate the relationship between merger announcement returns and the extent of social ties between the top managers and directors of the two merging firms. We focus on educational institutions as well as employment history as the basis of the social networks that we use in our analyses.

Using a sample of 539 mergers between publicly-traded U.S. firms between 1999 and 2007, we find that acquirers’ announcement returns associated with a merger tend to be lower in the presence of many social connections. Upon examining the relationship between target announcement returns and social ties, we find no significant relationship that would indicate that targets are overpaid based on social networks. We then consider the acquirer and target weighted average announcement return for the combined entity and confirm that the overall effect of social ties is significantly negative, both statistically and economically. This supports the view that the negative impact of social networks outweighs whatever positive information-based effects might be present.

…continue reading: Acquirer-Target Social Ties and Merger Outcomes

Business connections can mitigate agency conflicts by facilitating efficient information transfers, but can also be channels for inefficient favoritism. In my forthcoming Journal of Finance paper Business Networks, Corporate Governance, and Contracting in the Mutual Fund Industry, I analyze the extent to which these effects are present in the mutual fund industry, and measure their impact on the welfare of fund investors.

I construct a large and unique data set containing information about advisory contracts for all U.S. mutual funds during 1993 to 2002, as well as information about the identity of the directors of these funds during the same period. This data set tracks business relationships between mutual fund directors and advisory firms, as well as between advisory firms themselves. I identify 257 cases of funds that hired a new subadvisor between 1993 to 2002. These events are used to study which candidates (from a pool of about 1,000 firms each year) win subadvisory contracts from funds. I also study a sample of 216 open-end U.S. mutual funds newly created in 1998 to test whether the connections of potential candidate directors (3,005 individuals) influence the assignment of board seats by the primary advisors of these new funds.

I show that when mutual funds choose among candidate subadvisors, the more connected such a firm is to the directors of these funds through past business relationships, the more likely it is to win the contract. This effect holds even after controlling for the candidate’s reputation, degree of specialization in the investment objective of the fund, cost, and also for the connections between the fund’s primary advisor and the candidate. The preferential selection of connected subadvisors by directors is mirrored by the preferential hiring of connected directors by primary advisory firms when these firms create (sponsor) new funds. In contrast, I find that connections do not have an economically significant impact on investors’ bottom line.

The strong effects of business ties on reciprocal hiring by directors and managers that I document are consistent with both of the possible roles of connections – as means for efficient information exchange, or as channels for favoritism. Overall, my results suggest that the two effects of board-management connections on investor welfare – improved monitoring and increased potential for collusion – balance out in this setting.

The full paper is available for download here.