JCPenney became the third company this proxy season to reach an agreement with me to amend its by-laws to limit the adoption of poison pills.

The adopted by-law is based on a shareholder proposal to amend the company’s by-laws that I submitted for the company’s upcoming annual meeting. Following my agreement with the company, the company’s board adopted the new by-law and I withdrew the shareholder proposal. The company’s amended by-laws were filed yesterday and are available here.

Under the new by-law provision, any extension of a poison pill plan not ratified by the shareholders must be approved by at least 75% of the members of the board of directors, and a pill not so extended will expire one year after its adoption or last such extension. An article about my model pill by-law on which this provision is based is available here.

JCPenney’s adoption of my poison pill by-law was preceded in this proxy season by an adoption by Safeway and an adoption by CVS Caremark, as well as an earlier adoption by Disney and an adoption by Bristol-Myers Squibb. Disney amended its by-laws after my proposal won 57% of the votes in Disney’s annual meeting. Safeway, CVS Caremark, and Bristol-Myers Squibb, like JCPenney now, amended their by-laws following an agreement with me that made a shareholder vote unnecessary. I hope that other public companies will follow the example set by these five companies.

I would like to express my appreciation again to Michael Barry and Ananda Chaudhuri from the law firm of Grant & Eisenhofer for their valuable legal advice and legal representation in connection with my shareholder proposals in general and the pill by-law proposals in particular. I also wish to thank again Greg Taxin and Julie Gresham of Spotlight Capital Management for advising me on engagement with companies.

The materials generated in the drafting of the 1967 revision to the Delaware General Corporation Law (including the report by Professor Ernest Folk to the Corporation Law Revision Committee and the minutes of that committee’s deliberations) are now available online here.

These materials, not widely available before, provide extensive background about the substance and process of the major 1967 corporate law revision project. Janet Lindenmuth and the staff of the Widener Law School Legal Information Center arranged to gather, scan and post this material.

Three federal district courts have now ruled that a company’s delay in filing its Form 10-Q or 10-K with the SEC does not violate either (1) a widely used indenture provision that requires issuers to deliver copies of such reports to an indenture trustee within a specified time after their filing with the SEC or (2) the federal Trust Indenture Act. See UnitedHealth Group, Inc. v. Cede & Co., No. 06-cv-4307 (D. Minn. Mar. 10, 2008); Affiliated Computer Services, Inc. v. Wilmington Trust Co., No. 06-cv-1770, 2008 WL 373162 (N.D. Tex. Feb. 12, 2008); Cyberonics, Inc. v. Wells Fargo Bank N.A., No. H-07-121, 2007 WL 1729977 (S.D. Tex. June 13, 2007).

Applying New York contract law, these courts rejected the reasoning of a New York trial court decision finding that an issuer with similar language in its indenture was obligated to file such reports with the trustee within the time limit for their filing with the SEC. The Cyberonics decision is currently on appeal to the Fifth Circuit, and dispositive motions are pending in at least two similar cases in federal courts.

These decisions demonstrate the need to consider carefully the language of new indentures relating to the delivery of SEC reports to the indenture trustee.

A summary of the decisions is available here.

I recently circulated an AEI Financial Services Outlook entitled Healthy Hedge Funds, Sick Banks. The essay discusses the regulatory implications of the unregulated hedge fund industry’s apparent health when compared to the financial weakness of the heavily regulated banking industry in the current subprime crisis. The principal question addressed in the essay is whether the regulation of banks allows an industry that is inherently unstable to function with a reasonable degree of stability or whether the regulation itself is responsible for the instability that has historically afflicted banking.

I argue that risk-taking and instability in the banking industry is enhanced because market discipline is reduced by moral hazard. In this context, moral hazard refers to the sense among investors and depositors that in the end the government will rescue banks and other private sector institutions from the consequences of their own errors. The numerous actions by the Federal Reserve to increase liquidity in the face of the subprime crisis provide direct support for this belief. As a result, I suggest that the actions taken to shore up banks adversely affected by the subprime collapse has increased the level of moral hazard, and thus increased the likelihood that another similar crisis will result in the future.

The positive experience of the hedge fund industry suggests strongly that market discipline is a powerful mechanism for controlling risk. In fact, it implies that market discipline may be more effective than regulation in maintaining an industry’s stability. I also argue that regulation itself must be significantly improved in order to be effective in overcoming the moral hazard it fosters. I incorporate both implications in my suggestion to introduce specialized subordinated debt into the banking industry. The subordinated debt would be designed to provide bank supervisors with a market-based signal about bank risk-taking that is roughly equivalent to what the market would do in the absence of government regulation.

The full outlook is available here.

(Editor’s note: The Agrawal study is described on our blog here; the initial AFL-CIO response is available on our blog here; two reactions to that AFL-CIO response - from Ashwini Agrawal and from Steven Kaplan - are available here).

Regarding the recent posting by Mr. Agrawal and Professor Kaplan,

Ashwini Agrawal, a graduate student at the University of Chicago, posted a paper on this blog that used a statistical model whose key variables were custom built by him to assert that the AFL-CIO votes its public company proxies based not on proxy voting guidelines, but on the union affiliation of public company employees. Through a series of e-mails (he has refused to meet in person or communicate over the phone) we told him he was completely and utterly wrong and asked him to release his data set. Mr. Agrawal accused the AFL-CIO of not responding to his questions after refusing to meet or release his data. University of Chicago Professor Steven Kaplan, who is advising Mr. Agrawal on this project, wrote a lengthy post defending these opaque methods.

Mr. Agrawal’s claim that he contacted the AFL-CIO and was denied information is false. Mr. Agrawal has never contacted a member of the AFL-CIO program staff to discuss his paper or ask for any data, and has refused every opportunity to meet and ask us questions.

Both posts also contain a series of important contradictions. Professor Kaplan and Mr. Agrawal repeatedly assert that the study can be easily replicated using publicly available sources of data. Kaplan emphasizes that this is “an important point. It does not rely on data that can be shaded by an interested party.”

Despite this, Kaplan later asserts that “in putting together a data set, a researcher spends a great deal of time and effort.” Which is it then? Is it a lengthy endeavor worthy of “great time and effort,” or something that’s “easily replicated?”

We continue to demand access to Agrawal’s data because it cannot be replicated. His data collection efforts were more subjective than mechanical. For example, when data on company unionization was incomplete Mr. Agrawal relied on information “from the Investor Relations departments of firms themselves.” [Appendix A, pg. 29]

The difficulty of replicating this skewed effort at data collection is obvious. How would the AFL-CIO go about determining which companies he contacted directly? Should we selectively call random Investor Relations departments and ask for the individual who spoke with Mr. Agrawal two years ago? What if the person he spoke with no longer works at the company? How do we know what source the Investor Relations Department used, and was it the same across all companies? Was a record of his phone conversations kept to back up his methodology?

Mr. Agrawal and Professor Kaplan assert that his paper has not been published, and that because it is not published they should be able to keep their data secret. It’s true that it hasn’t appeared in any peer reviewed setting–but it has been twice cited on the editorial page of the Wall Street Journal as evidence for repeated false accusations against the AFL-CIO, as well as being posted on this blog and widely circulated in academic and business circles.

Professor Kaplan’s defense that they won’t release data to a competing researcher is misplaced. We are the subject of a widely published study which makes false accusations based on unreproduceable statistical models. We are not seeking to complete a research project for a rival journal, but instead correct the record.

We would be happy to receive Mr. Agrawal’s data on the strict condition that we won’t turn it over to competing researchers or publish it in a competing paper. As outlined above, we need to review the accuracy of Mr. Agrawal’s data and statistical model, and when given the opportunity to talk to him, inform him of the serious flaws in his research.

A copy of the AFL-CIO’s recent report, Facts About the AFL-CIO’s Proxy Votes, is available here. We repeat our request that Mr. Agrawal release his data set or withdraw his paper.

On March 17, I presented my paper titled Hold-up, Asset Ownership, and Reference Points in the Law, Economics, and Organization Seminar here at the Law School.

This paper studies two parties who desire a smooth trading relationship under conditions of value and cost uncertainty. The existing literature in this area has found that trading relationships become problematic in situations where the gains from trade are unevenly divided under an existing contract. Under these situations, one party will engage in costly opportunistic or non-cooperative behavior in order to renege on or renegotiate the contract. However, the existing literature does not explain why the parties cannot negotiate around the costs of opportunism.

I show that there is a range of self-enforcing prices, which depend on the state of the world, such that, if the long-term contract price lies in this range, hold-up is avoided; while if it lies outside this range hold up occurs. Under this formulation, a contract fixing price works well in normal times since there is nothing to argue about. However, when value or cost is exceptional, one party will deviate from the contract and hold up the other party, causing deadweight losses as parties withhold cooperation. I show that contract indexation can help by making it more likely that price remains within the “self-enforcing” range. In addition, a judicious allocation of asset ownership increases efficiency to the extent that it raises the correlation between parties’ outside options and their value inside the relationship, since this reduces the likelihood of hold-up.

In contrast to much of the literature, the driving force in this model is payoff uncertainty rather than non-contractible investments. One notable benefit of the approach used in this paper is that I am able to formalize hold-up costs by introducing behavioral features. The analysis provides useful insights into the empirical contracting and the vertical integration literature.

The full paper is available for download here.

The recent acquisition of Bear Stearns by J.P. Morgan has cast a spotlight on the reliability of fairness opinions. On March 16, when the board of Bear Stearns agreed to sell the company for $2 a share, the investment banking firm Lazard Ltd., who was acting as Bear Stearns’ main adviser, provided the board with a fairness opinion that $2 a share was a fair price for the company, which was then teetering on the brink of bankruptcy. Eight days later, on March 24, when J.P. Morgan agreed to raise its offer to $10 a share to address shareholder discontent, the same investment bank issued a fairness opinion indicating that $10 a share was a fair price. If $10 a share is a fair price, how could $2 be a fair price as well?

This turn of events vividly illustrates how little has changed in the world of fairness opinions since the publication in 1989 of the first critical academic study of fairness opinions, Fairness Opinions: How Fair Are They and What Can Be Done About It? by Lucian Bebchuk and Marcel Kahan. This study highlighted two issues that generate serious problems with fairness opinions. First, investment banks have significant discretion in arriving at the fair price. Second, investment banks do not have incentives to provide an accurate valuation and might have incentives to provide a fairness opinion supporting the position of the party inviting the opinion. The study went on to advocate a judicial approach that takes these issues into account.

The Bear Stearns event suggests that the problems identified by the academic critics of fairness opinions might well persist. It also highlights the limits on the ability of investors and courts to rely on such opinions.

Up Close and Personal: House Hearing on CEO Pay and the Mortgage Crisis

My colleague Dave Lynn wandered down to the House Hearing on severance pay recently and wrote up these thoughts (for other reports, see the WSJ article and NY Times article):

“The hearing of the House Committee Oversight and Government Reform on CEO pay was a little disappointing. It had all of the potential to be the sort of public spectacle that the same Committee’s hearings on steroid use in baseball had become, but instead it was a relatively straightforward identification of some CEO pay abuses, juxtaposed to the people that are unfortunately losing their houses to foreclosure in the midst of the mortgage mess.

In addition to testimony from some experts on the state of the mortgage crisis and issues with executive pay (which was covered by Nell Minow of The Corporate Library), the hearing featured Angelo Mozilo from Countrywide, E. Stanley O’Neal formerly at Merrill Lynch, and Charles Prince formerly at Citigroup. The respective compensation committee chairmen from those organizations also appeared, including Richard Parsons, Chairman of Time Warner.

The questioning was relatively light – both in volume and in tone – given the sparse turnout from Committee members on an unusual Friday hearing (the day when many members are heading home to their district). Much of the questioning focused on issues outlined in the Committee’s majority Staff memorandum, which outlined a number of issues that tend to be wrong with the CEO pay process – “confusion” about for who a compensation consultant is working (i.e. the CEO, the comp committee or the company), questionable use of 10b5-1 plans, awards that don’t seem to make sense in light of the circumstances or the rationale, extraordinary low performance targets, and payment of performance bonuses and the awarding of retirement and severance benefits even in a year as bad as 2007.

The battle lines were clearly drawn, with Chairman Waxman (D-CA) and his colleagues in the majority pointing out the financial distress that many Americans face while these three executives reaped rich rewards. Meanwhile, Representative Tom Davis (R-VA) repeatedly drew the old sports and entertainment analogy for executive pay – saying that no one expected Ben Affleck and Jennifer Lopez to pay reparations for Gigli.

Both sides were careful not to sully the reputations of the three CEOs who all represented classic American success stories, and clearly the CEOs (particularly Mozilo) seemed to be emboldened as the hearing went on and the “light” touch was evident. The only thing that tripped up Mozilo were questions concerning a threatening email that he sent seeking reimbursement of taxes for his wife’s travel on company aircraft – he apologized, noting that he was an “emotional person” – but Representative Issa (R-CA) was quick to jump to his defense and note that many of his colleagues in Congress fly their spouses all over the world on government aircraft because they need to have their spouse with them when conducting business.

One of the particular areas of questioning was on Mr. Mozilo’s sales of substantial amounts of stock under Rule 10b5-1 plans while Countrywide was conducting an accelerated share repurchase program. Mr. Mozilo asserted that all of his stock sales were done pursuant to a plan to diversify his holdings in anticipation of retirement and were unrelated to the stock repurchase program. The Chairmen of the Merrill Lynch and Citigroup compensation committees noted that these kinds of sales were unlikely at their companies, given their very high stock ownership and retention requirements.

While the Democrats on the Committee may not have been able to establish these CEOs as suitable scapegoats, the majority was certainly able to put some questionable pay practices under the microscope at a time when most people are worried about paying for their house – as opposed to paying for taxes on spousal travel on the company jet.”

My Ten Cents: It’s too bad the committee members did such a poor job of questioning the hearing’s compensation committee members. Had they simply followed the path of the Committee staff’s memo, they could have called for an explanation of each of the actions by the compensation committees (although some of the meaty issues were addressed, like why did Prince get a bonus for 2007?).

My primary “take-away” is that when a successful CEO throws a temper tantrum over pay - even if the demands are unreasonable - the board caves in. My guess is that all too often boards are told the consultant is hard to work with - or is not responsive or does not understand the company - and has to go. Boards comply - and there is typically no explanation other than “the board thought it was time for a change.”

I can’t resist addressing the mistaken comparison between CEO pay and the pay levels in the sports & entertainment industry. Putting aside the fact that only the top 1% of athletes and actors get paid astronomically - remember all those starving actors and baseball players buried in the minor leagues - it’s apple and oranges because the processes by which the relative amounts are established are completely different. I recently addressed this point by posting a comment on this compensation consultant’s blog. I guess the argument that public company CEOs will be flocking to hedge funds doesn’t hold much water anymore…

(Editor’s note: This post is by Lesley Rosenthal of Lincoln Center for the Performing Arts)

Once-in-a-generation capital projects at nonprofit cultural institutions require heightened involvement by trustees. Because major projects impose unusual legal, financial, risk management, and other obligations on charitable organizations, the familiar principles of not-for-profit good governance become amplified and require even greater attention. What special obligations do trustees have to help their organizations manage such an undertaking? What are the broader impacts of the project on the organization as a whole—on its balance sheet, on its institutional identity, on its program and its future plans? If the project is funded in part or in whole with public funds, or if the project involves acquisition of or changes to publicly owned or accessible spaces, how might trustees facilitate needed communications with the public and with government officials? How should trustees, staff, and government work together to see the project through to successful completion and operation?

Because of the dearth of study materials pertaining to governance of mature not-for-profit institutions in a time of growth and transition, it is exciting to have access to documents and individuals that detail how governance matters are handled during a major capital project at one of the nation’s most respected institutions. My article, entitled “Redeveloping” Corporate Governance Structures: Not-For-Profit Governance During Major Capital Projects, discusses in detail how the Board of Directors of Lincoln Center for the Performing Arts has risen to the challenges of major capital projects, and assesses the performance of the organization’s governance practices under evolving standards, with special attention to how those standards play out during a time of institutional transition.

The article is available here.

My partners Michael J. Segal, Jeannemarie O’Brien, Adam J. Shapiro and Jeremy L. Goldstein recently issued Executive Compensation 2008, a memorandum outlining key recommendations for directors to consider as they address executive compensation matters in the year ahead. The memorandum considers the importance of rewarding long-haul performance, paying for performance and retention, planning for executive succession, and using wealth accumulation analyses and internal pay equity studies. The memorandum also discusses the disclosure of executive compensation, including the merits of disclosing the terms of confidential compensation arrangements.

(Editor’s note: We received two responses - from Ashwini Agrawal and from Steven Kaplan - to the AFL-CIO post responding to the study by Mr Agrawal of the AFL-CIO’s proxy-voting record. The Agrawal study is described on our blog here, and the AFL-CIO response is available on our blog here.)

Ashwini Agrawal wrote to us:

In my study, Corporate Governance Objectives of Labor Union Shareholders, I examine the proxy votes of the AFL-CIO Reserve Fund and Staff Retirement Fund. I compare the votes before and after the AFL-CIO split into two groups: the AFL-CIO and the Change to Win Coalition. After the breakup, the funds become relatively more supportive of directors of firms in which workers become primarily affiliated with the Change to Win Coalition.

In his blog post and letter, Daniel Pedrotty makes a number of mischaracterizations regarding my study.

For example, in the paper I note that the AFL-CIO proxy votes are cast by a third party fiduciary in accordance with AFL-CIO proxy voting guidelines; I do not argue otherwise, as Pedrotty claims. AFL-CIO proxy voting guidelines can be found here.

In another example, Pedrotty states that changes in AFL-CIO voting patterns solely reflect changes in governance characteristics. To investigate this, I look at the votes of other institutional investors who take governance characteristics into account, such as mutual funds Fidelity, Vanguard, TIAA-CREF and union pension funds associated with the Brotherhood of Carpenters (UBCJA). I find that these other investors do not change their voting patterns in the same ways as AFL-CIO funds, suggesting the AFL-CIO votes are not solely based on governance characteristics.

Pedrotty also erroneously claims I treat all firms with mixed union representation as though they are affiliated with the AFL-CIO only. Based on publicly available data, I distinctly categorize a company based on whether a significant fraction (at least 90%) of the unionized workers at the firm switches affiliation from the AFL-CIO to the Change to Win Coalition. This is meant to capture significant decreases in the AFL-CIO’s labor representation across firms. For example, if 50% of a firm’s unionized workers remain part of the AFL-CIO, while the other 50% switch to the Change to Win coalition, then I assume the AFL-CIO still has substantial labor representation in this firm. If labor interests do not influence proxy votes, this categorization should not impact the findings in the paper.

Pedrotty asserts I gather data on certain Change to Win funds but that I do not compare their voting behavior with the AFL-CIO. This is incorrect; I compare the UBCJA pension fund votes (a Change to Win affiliate) with those of the AFL-CIO funds. Upon joining the Change to Win Coalition, the UBCJA funds become relatively more opposed to directors of firms in which workers are primarily affiliated with the Change to Win Coalition.

Pedrotty also claims that I made no effort to inquire into the methods by which AFL-CIO proxies are voted. When I requested this information from the AFL-CIO Office of Investment (in May, 2007), I was told by the AFL-CIO Office of Investment that this information would not be disclosed to me (in June, 2007).

The AFL-CIO’s claim that their voting fiduciary cast votes the same way for certain CTW funds does not change the findings as they pertain to AFL-CIO affiliated funds. In addition to the AFL-CIO not disclosing the sizes of these CTW funds and the extent to which AFL-CIO proxy voting guidelines are applied to them, the AFL-CIO’s claim could reflect agency issues within the voting structure of union pension funds. However, making any such assessment is beyond the scope of my paper.

This study can be easily replicated using publicly available sources of data. Both the sources and methodologies are described in the paper, available online here. It should also be noted that I use publicly available data because it is verifiable by other researchers and because my requests to the AFL-CIO for access to their own database on union membership were denied. I am happy to incorporate the AFL-CIO’s internal data into my study, however this data has still not been given to me.

I encourage blog readers to read both my study and the AFL-CIO’s report to reach their own conclusions. Peer review, comments, and criticisms are welcome.

Steven Kaplan wrote to us:

I would like to respond to Daniel Pedrotty’s post on Ashwini Agrawal’s work. I am a member (but not the chairman) of Mr. Agrawal’s dissertation committee so I know his work well. His committee consists of four professors at the University of Chicago Graduate School of Business.

Daniel Pedrotty’s post (criticizing Ashwini Agrawal’s study) does not in any way contradict Mr. Agrawal’s study. Mr. Pedrotty claims the paper makes a “serious and completely false accusation of voting behavior.” That is not true. Mr. Agrawal’s paper reports the results of his data collection and analysis. Mr. Agrawal’s results use publicly available data and are replicable. Using data on AFL-CIO votes and data from public sources regarding AFL-CIO union representation, Mr. Agrawal finds significant changes in AFL-CIO votes. After the split of the AFL-CIO and CtW, the AFL-CIO pension fund was much more likely to vote for management and directors of companies with unions primarily represented by the CtW than before the split. At the same time, the AFL-CIO pension fund remained less likely to vote for management and directors of companies still mainly represented by the AFL-CIO. The union voting behavior that Mr. Agrawal’s analysis reports is more consistent with union self-interest than with shareholder value maximization. While any such behavior cannot be proved beyond a shadow of a doubt, the results are very statistically significant.

Mr. Pedrotty has not attempted to replicate Mr. Agrawal’s methodology or tests. He presents some other data and claims that are irrelevant to Mr. Agrawal’s analysis. And, therefore, Mr. Pedrotty’s post does not have anything substantive to say about Mr. Agrawal’s results. Given this, it is extraordinary that Mr. Pedrotty request Mr. Agrawal to withdraw or revise his paper.

Let me examine Mr. Agrawal’s paper and Mr. Pedrotty’s post in more detail.

…continue reading: Responses to AFL-CIO’s Critique of the Agrawal Study

(Editor’s note: This post by Luigi Zingales is part of the series of posts on corporate governance articles accepted for publication in prominent Finance Journals.)

A forthcoming article in the Journal of Finance titled “The Corporate Governance Role of the Media: Evidence from Russia”, which is co-written by Alexander Dyck, Natalya Volchkova, and myself studies the effect of media coverage on corporate governance. The article focuses on Russia during the period 1999 to 2002 to answer two main questions: Can hedge funds (or shareholders in general) increase the level of coverage received by certain companies? And if so, does this coverage have any effect on corporate governance outcomes? The article develops four main conclusions:

The article notes that an egregious corporate governance violation is more likely to be covered by newspapers regardless of any effort by hedge fund managers, and it is also more likely to generate a reaction. To attempt to disentangle these effects, we employ an instrument—the portfolio composition of the Hermitage Fund, an investment fund that consciously played a media strategy in post-1998 Russia—to provide further evidence that there is a causal link from press coverage to the governance outcome.

The full article is available here.

I have recently finished a paper, with two co-authors, Jennifer Bethel and Gang Hu, titled “Law and Economic Issues in Subprime Litigation”.

The losses suffered by mortgaged-backed security (MBS) holders, collateralized debt obligations (CDOs) holders and security holders in investment banks, mortgage originators, bond insurers and credit rating agencies is generating, and will continue to generate, an enormous wave of litigation. In the paper we provide some basic descriptive statistics and institutional details on the mortgage origination process, MBS and CDOs, including the evolution of MBS tranche structure over time, the underwriting quality of mortgage originations, CDO trustees and liquidations, and the identity of MBS and CDO sponsors. In addition the paper also discusses some of the main issues that will likely be critical in much of this subprime litigation; issues such as whether the subprime crisis was foreseeable; the distinction between ex ante expectations and ex post losses; the distinction between the transparency of the quality of the underlying assets being securitized and the transparency as to which market participants are exposed to subprime losses; and the distinction between what investors and the market generally knew and what individual entities in the structured finance process knew.

The paper can be found here.

Safeway and I have reached an agreement under which the company adopted a by-law provision I proposed for limiting the adoption of poison pills. Safeway is the second company in this proxy season, and the fourth overall, to adopt a poison pill bylaw I proposed.

The adopted by-law is based on a shareholder proposal to amend the company’s by-laws that I submitted for the company’s upcoming annual meeting. Following my agreement with the company, the company’s board adopted the new by-law and I withdrew the shareholder proposal. The amended by-laws of Safeway, including the new section 9 of Article VI, were filed yesterday and are available here.

Under the new by-law provision, any extension of a poison pill plan not ratified by the shareholders must be approved by at least 75% of the members of the board of directors, and a pill not so extended will expire one year after its adoption or last such extension.

My shareholder proposal and the by-law adopted by Safeway are based on a model by-law that was the subject of a court decision in the CA case, which led CA to abandon its attempt to exclude my proposal from the corporate ballot. An article about this case and my model by-law is available here.

Safeway’s adoption of my poison pill by-law was preceded by an adoption last month by CVS Caremark, an adoption by Disney, and an adoption by Bristol-Myers Squibb. Disney amended its by-laws after my proposal won 57% of the votes in Disney’s annual meeting, while CVS Caremark and Bristol-Myers Squibb, like Safeway now, amended their by-laws following an agreement with me that made a shareholder vote unnecessary.

I commend Safeway’s board of directors for agreeing to adopt the pill-limiting by-law. I hope that other public companies will follow the example set by Safeway, CVS, Disney, and Bristol-Myers and adopt similar by-law provisions.

I would like to thank Michael Barry and Ananda Chaudhuri from the law firm of Grant & Eisenhofer for their valuable legal advice and legal representation in connection with my shareholder proposals in general and the pill by-law proposals in particular. I also wish to thank Greg Taxin and Julie Gresham of Spotlight Capital Management for advising me on engagement with companies.

The AFL-CIO has issued a new report, Facts about the AFL-CIO’s Proxy Votes, to explain how the AFL-CIO votes in corporate director elections. In summary, the AFL-CIO votes for corporate directors based on recommendations by an independent proxy advisor following proxy-voting guidelines that address corporate governance issues, and not union representation.

Last year, an unpublished, unreviewed paper by Ashwini Agrawal, a graduate student at the University of Chicago, was posted on this blog, making the very serious and completely false claim that the AFL-CIO is more likely to support directors at companies whose employees are no longer affiliated with the AFL-CIO.

Despite publishing his accusations in news sources and on public websites, Agrawal has refused to discuss his findings, disclose his data set, or respond to substantive criticisms of his paper. After receiving an email requesting peer review and the release of his data, he did publish a revised version on February 7th that failed to address any of the AFL-CIO’s comments, and further failed to release his data.

A letter from the AFL-CIO to Mr. Agrawal pointing out the methodological flaws in his paper and again seeking the release of his data can be viewed here.

Every year, the AFL-CIO publicly discloses each proxy vote that it casts and the corporate governance policy rationale for each vote. Disclosure of the AFL-CIO’s proxy voting record enables interested parties to monitor how the AFL-CIO voted in specific director elections and to make their own determination as to whether these votes are in shareholders’ best interests.

While the information disclosed in the AFL-CIO’s report directly contradicts the Agrawal paper, no meaningful conclusion can be drawn from any correlation between the AFL-CIO’s proxy voting and union representation. The AFL-CIO’s proxy votes are based on corporate governance issues, and any correlations with union representation are entirely coincidental and unlikely to persist over time.

The AFL-CIO has requested that the Agrawal paper be revised or withdrawn. The report Facts about the AFL-CIO’s Proxy Votes is available here.

On Wednesday February 27, HLS Professor George Triantis delivered his inaugural lecture “The Future of Transactional Legal Practice” marking his appointment to the Eli Goldston Professorship of Law.

In his lecture, Triantis surveyed the reasons why major U.S. law firms have enjoyed robust growth in their transactional practices over the past several decades, including the fact that they have often provided their clients with substantial business guidance in addition to legal advice. But he warned that many of the services they’ve offered are increasingly provided by others—investment bankers, management consultants, accountants, offshore outsourcing firms, and other business professionals—more cheaply.

Triantis observed that transactional firms grew and rose to prominence by negotiating and drafting three kinds of contracts: “standardized” contracts that are easily adaptable for use by successive clients; “innovative” contracts; and “tailored” contracts uniquely geared to their clients’ particular circumstances. But increasingly, he said, law firms are losing market share to other players in all three categories.

To recapture lost market share and to stem the tide against further erosion, Triantis said, law firms should refocus on innovative contract design that does what other business professionals can’t do as well: anticipate and plan for what happens if and when a deal doesn’t work out—litigation.

“Litigation, in its various forms, is the core competency from which lawyers can derive comparative advantage in designing transactions for their clients,” said Triantis. “Lawyers can help their clients choose the mode of enforcement and mold their legal commitments accordingly, knowing that they will be enforced through or in the shadow of an adversarial judicial process. …The modern law firm is organized around practice groups. Two of these groups—litigation practice and corporate transactions—often fail to mesh at the interface of particular transactions because the firm that litigates a transaction is often not the firm that did the deal in the first instance. … By connecting these two services, rather than treating them as distinct tasks or modules, law firms can recapture some of the lost revenues.”

Click here for a webcast of this event.

The National Law Journal recently published Securities Class Actions: Time to Fix Broken System, an opinion piece by defense counsel Daniel Small. The piece explains the rationale underpinning the existence of class actions and focuses on aspects of the system the author regards as broken. The piece is critical of the ability of the first “victim” in the court house to “help decide which [law] firm is lead counsel, help approve settlement and fee agreements and take other important actions.” The author suggests that 1995 amendments designed to minimize the perverse incentives created by the system suffered from a lack of regulatory oversight. The author cites events surrounding the sentencing of Seymour Lazar in support of his critique, but cautions against focusing on the wrongdoing of particular individuals or law firms if this would obscure systemic problems requiring attention.

Mr Small recommends systemic changes to securities class actions, which include the following: limiting the number of times one person (or family) can be a class representative; limiting class representatives to shareholders who satisfy stiffer requirements concerning their shareholding; requiring attorneys to sign the class representative certification; and limiting attorney fees.

The article is available here.

The Program on Corporate Governance has recently released a new discussion paper entitled Perpetuities, Taxes, and Asset Protection: An Empirical Assessment of the Jurisdictional Competition for Trust Funds, which I co-wrote with Max Schanzenbach. The paper abstract is as follows:

This chapter provides an accessible overview of our previous work on the impact of the abolition of the Rule Against Perpetuities (RAP) on trust fund situs. The implementation of the Generation Skipping Transfer (GST) Tax by the Tax Reform Act of 1986 sparked a movement to repeal the RAP. Since 1986, nearly half the states have abolished or effectively abolished the RAP as applied to interests in trust. Prior to 1986, only three states had abolished the RAP. We find no evidence that abolishing the RAP prior to the 1986 GST tax attracted trust business. By contrast, between 1986 and 2003, abolishing states reported an average increase in trust assets of $6 billion (a 20 percent increase). In addition, average account size in abolishing states increased by $200,000, implying that abolishing the rule attracted relatively larger trusts. Our findings imply that roughly $100 billion in trust funds have moved to take advantage of the abolition of the RAP. Further, we can trace these results to the subset of abolishing states that did not levy a tax on income accumulated in trusts attracted from out of state. This finding, which implies that abolishing the RAP does not directly increase state tax revenue, bears on the scholarly debate over the mechanisms of jurisdictional competition. Our analysis also controls for whether a state validated the so-called self-settled asset protection trust (APT). We did not find consistent evidence that validating APTs increases a state’s reported trust business, but in the period studied few states had validated APTs, so we draw no firm conclusions.

We conclude that the jurisdictional competition for trust funds is real and intense, with the primary margin of competition being the rules that bear on trust duration, and that the enactment of the GST tax sparked the rise of the perpetual trust. In future work using more refined data, we intend to revisit the jurisdictional competition for trust funds and to expand our inquiry to include directed trustee statutes and the recent reforms to trust-investment laws.

Alon Brav, Wei Jiang and Frank Partnoy and I have recently released a paper, entitled Hedge Fund Activism, Corporate Governance, and Firm Performance. The abstract is as follows:

Using a large hand-collected data set from 2001 to 2006, we find that activist hedge funds in the U.S. propose strategic, operational, and financial remedies and attain success or partial success in two-thirds of the cases. Hedge funds seldom seek control and in most cases are nonconfrontational. The abnormal return around the announcement of activism is approximately 7%, with no reversal during the subsequent year. Target firms experience increases in payout, operating performance, and higher CEO turnover after activism. Our analysis provides important new evidence on the mechanisms and effects of informed shareholder monitoring.

Together with Iman Anabtawi, I have just issued a new article on SSRN entitled Fiduciary Duties for Activist Shareholders. The article is to be published in the Stanford Law Review, and a current draft is available here. The article was recently profiled in the Financial Times.

Fiduciary Duties for Activist Shareholders argues that corporate law seems to impose few or no fiduciary duties on minority shareholders in public corporations because historically, minority shareholders in public firms enjoyed little or no power or influence within the firm. The most important trend in corporate governance today, however, is the move toward “shareholder democracy.” Activist investors, especially hedge funds, are using their new power to pressure managers and directors into pursuing corporate transactions ranging from share repurchases, to special dividends, to the sale of assets or even the entire firm. In many cases these transactions benefit the activist while failing to benefit, or even harming, the firm and other shareholders.

Greater shareholder power should be coupled with greater shareholder responsibility. Fiduciary Duties for Activist Shareholders argues that the rules of fiduciary duty traditionally applied to officers and directors and, more rarely, to controlling shareholders, should be applied to activist minority investors as well. There is no reason to believe that newly-empowered activist shareholders are immune to the forces of greed and self-interest widely understood to tempt corporate officers and directors. Corporate law can and should adapt to this reality.

(Editor’s note: The post below comes to us from Andriy Bodnaruk of the University of Maastricht, Massimo Massa of INSEAD, and Andrei Simonov of the Stockholm School of Economics and CEPR).

We have recently released a paper, entitled The Dark Role of Investment Banks in the Market for Corporate Control. Our paper studies M&A transactions in the US in the 20 year-period 1984 to 2003. Its focus is on transactions in which the investment bank advising the bidder in an M&A transaction also holds a stake in the shares of the target company at the time the deal was announced. In broad terms, the paper provides evidence as to (1) the extent to which investment banks advising bidders took advantage of confidential information garnered from their advisory assignments to acquire stakes in the target prior to the deal’s announcement; and (2) the extent to which the investment bank’s stake in the target compromised the financial interests of the bank’s bidder client.

We show that the presence of advisors helps to predict if a firm will be a takeover target. Conditioning on firms with similar industry and size characteristics, firms in which the advisors to the bidder hold a stake are 45 percentage points more likely to become targets, with the probability of becoming a target increasing from the unconditional sample mean of 4.2% to 6.1%. When we build the trading strategy long in the actual positions of the advising investment banks and short in the positions of the non-advisory banks, we find the strategy delivers 1.40% per month (adjusted for risk). This provides a lower bound estimate of the informational advantage that the advisory bank has relative to other sophisticated market players.

We further show that where an investment bank advising the bidder holds a stake in the target, the bidder will pay a higher premium for the target relative to deals in which the advisor holds no target stake. The target’s premium increases by 590 basis points from 30.6% to 36.5% relative to non-conflicted deals. An increase of one standard deviation in the (dollar value of the) average fraction of the target firm held by the advisor to the bidder implies a premium 310 (290) basis points higher than average. Deals involving the bidder’s advisor holding a stake in the target are more likely to succeed than other deals. Moreover, targets in these deals tend to be overvalued by more than 10% compared to deals in which the bidder’s advisor holds no target stake.

These findings suggest that advisors do take advantage of their privileged position, not only by acquiring positions in the deals on which they advise, but also by directly affecting the outcome of the deal in order to realize higher capital gains from their positions. These results provide important insights into the conflicts of interest affecting financial intermediaries that can both advise on corporate events and invest in the equity market.

The paper is available here.

Two committees of the American Accounting Association have produced detailed reports evaluating the SEC’s proposal to accept financial statements prepared in accordance with International Financial Reporting Standards (IFRS) from foreign-private issuers without reconciliation to U.S. GAAP (the SEC subsequently voted in favor of the proposal on November 15, 2007). This proposal was also discussed by Carl Olson in his November 28 post. These two papers highlight the difficult nature of this issue. Despite the common background of the members of each group and the common academic research utilized in preparing each proposal, the recommendations of the two committees are distinctly different.

The Financial Accounting Standards Committee report (available here) argues that since there is no conclusive research evidence that financial reports prepared using U.S. GAAP are better than reports prepared using IFRS, the prudent approach is to promote competition among them. This finding supports adopting the SEC’s proposal to permit foreign private issuers a choice between IFRS and U.S. GAAP.

The Financial Reporting Policy Committee report (available here) concludes that the proposed elimination of the GAAP reconciliation requirement is premature. This conclusion is based on research that finds that material reconciling items exist that are relevant to U.S. investors, that there are differences in the implementation of uniform standards and that compliance to IFRS or U.S. GAAP by foreign firms is a concern, that foreign firms benefit from greater access to capital by listing in the U.S., that U.S. investors tend to prefer U.S. GAAP, and that U.S. GAAP - IFRS harmonization might improve the functioning of the U.S. capital markets.

(Editor’s Note: The post below comes to us from Jennifer G. Hill of the University of Sydney, Australia, who is Visiting Professor at Vanderbilt Law School during Spring 2008 and 2009.)

I have recently completed a paper, entitled “The Shifting Balance of Power Between Shareholders and the Board: News Corp’s Exodus to Delaware and Other Antipodean Tales”. The paper is posted on SSRN here.

The abstract to the paper is as follows:

The balance of power between shareholders and the board of directors is a contentious issue in current corporate law debate. It also lay at the heart of a controversy concerning the re-incorporation of News Corporation (News Corp) in Delaware. News Corp has recently been the subject of intense media attention due its successful bid to acquire Dow Jones & Company. Nonetheless, News Corp’s move to the US, which paved the way for this victory, was neither smooth nor a fait accompli. Rather, the original 2004 re-incorporation proposal prompted a revolt by a number of institutional investors, on the basis that a move to Delaware would strengthen managerial power vis-à-vis shareholder power. The institutional investors were particularly concerned about the effect of the re-incorporation on shareholder participatory rights, and the ability of the board of directors to adopt anti-takeover mechanisms, such as poison pills, which are not permissible under Australian law. It was this latter concern, which ultimately led a group of institutional investors to commence legal proceedings in the Delaware Chancery Court in UniSuper Ltd v News Corporation (2005 WL 3529317 (Del Ch)).

The News Corp re-incorporation saga highlights a number of important differences between US, UK and Australian corporate law rules relating to shareholder rights, and provides a valuable comparative law counterpoint to the recent US shareholder empowerment debate. Other recent Australian commercial developments discussed in the article show a tension between legal rules designed to enhance shareholder power, and commercial practices designed to readjust power in favor of the board of directors. These developments are interesting because they demonstrate how some Australian companies have tried to create a de facto corporate governance regime, which mimics certain aspects of Delaware law.

I have just posted on SSRN a paper that put forwards a new approach to improving the structure of executives’ equity-based pay arrangements, Hands-Off Options. The current draft is available here.

The abstract is as follows:

Despite recent reforms, public company executives can still use inside information to time their stock sales, secretly boosting their pay. They can also still inflate the stock price before selling. Such insider trading and price manipulation imposes large costs on shareholders. This paper suggests that executives’ options be cashed out according to a pre-specified, gradual schedule. These hands-off options would substantially reduce the costs associated with current equity arrangements while imposing little burden on executives.

As I am continuing to work on this paper and a number of related projects, any comments would be most welcome.

We have just posted a paper on SSRN, Opting Only In: Contractarians, Waiver of Liability Provisions, and the Race to the Bottom, challenging one of the core positions of the contractarian approach to corporate law. Contractarians espouse an enabling approach to regulation allowing corporations to opt in or opt out and oppose a mandatory approach based on categorical rules. In their view, an enabling approach allows private ordering and enables owners and managers to derive the most efficient set of provisions, tailored to each company’s specific circumstances. This position has been reflected in attacks on legislations like SOX. Many commentators objected to its provisions because they were categorical and did not allow for private ordering.

Our study seeks to test this theory’s explanatory power in one area of corporate law. We chose a recent example of states replacing a categorical requirement with an enabling provision - waiver of liability provisions – for examination. These provisions allow companies to “opt out” of a rule that imposes liability on directors for breach of the duty of care. They may do so through the mechanism of an amendment to the articles. The amendment process requires the consent of both owners and managers, presenting conditions ripe, at least in theory, for the two groups to “bargain.”

We note first that waiver of liability provisions were authorized not in response to Van Gorkom, as is typically represented, but in response to the D&O insurance crisis occurring in the 1980s. In other words, the provisions were designed to interfere in the market for insurance. No evidence was offered, nor could we find any, indicating that this was a more efficient way of dealing with the economic uncertainties that existed at the time.

Second, we examined the waiver of liability provisions implemented by the Fortune 100 (data that we will eventually expand to the Fortune 500). Our analysis does not offer any evidence of private ordering. With one exception, all non-mutual companies in the Fortune 100 have eliminated liability for breach of the duty of care (in some states, this was done statutorily, with no company “opting out” of the no liability regime). Moreover, none of the waiver provisions reflected bargaining, with the wording of the provisions being remarkably similar. The companies in our sample waived liability to the fullest extent permitted by law.

Our analysis shows that one categorical rule favoring shareholders (liability for the breach of the duty of care) was replaced by another categorical rule favoring management (no liability for breach of the duty of care). While we do not rule out the possibility, we are not persuaded that any significant evidence demonstrating that one was more efficient than the other exists.

Our conclusion is supported by the fact that no actual bargaining occurs. Particularly where provisions are implemented by an amendment to the articles, it is management that drafts the language and only management that can initiate adoption or repeal. In other words, whatever theoretical benefit can result from the contractarian view of private ordering, it can only arise in practice if shareholders have the ability to meaningfully participate in the bargaining process. Our evidence suggests that they do not.

I have just released a working paper on the measurement of shareholder protection around the world, entitled “’Law and Finance’ Revisited” and available on SSRN here. The abstract is as follows:

The “Antidirector Rights Index” from La Porta et al.’s “Law and Finance” (1998) has been used as a measure of shareholder protection in almost 100 published studies. With articles by legal scholars questioning the accuracy of index values for several countries, I undertake a systematic study to verify these values for 46 countries with the help of local lawyers. My emphasis is on accuracy of the data; I do not change the original variable definitions. The study leads to a substantial revision: 33 of the 46 observations need to be corrected, and the correlation of corrected and original values is only .53. With accurate values, the well-known results of La Porta et al. (1997, 1998) no longer hold: accurate index values are neither distributed with significant differences between Common and Civil Law countries nor correlated with stock market size and ownership dispersion. All of the many results derived with the index will have to be revisited.

(NB: This paper is a revision of Spamann (2006).

By way of background, the cited article “Law and Finance” by La Porta, Lopez-de-Silanes, and Vishny (1998) started an entire literature of the same name. I have recently described the current state of this literature on this blog here.

Lawdragon magazine presented its third annual list of the “500 Leading Lawyers in America,” and the list includes eight individuals who are affiliated with the Harvard Law School Program on Corporate Governance and/or the Harvard Law School Corporate Governance Blog.

The 500 Leading Lawyers list includes professor Lucian Bebchuk (Harvard Law School), who serves as director of the Program, as well as four members of the Program’s advisory board: Peter Atkins (Skadden, Arps, Slate, Meagher & Flom), Theodore Mirvis (Wachtell, Lipton, Rosen & Katz), James Morphy (Sullivan & Cromwell), and Eileen Nugent (Skadden, Arps, Slate, Meagher & Flom).

In addition, the 500 Leading Lawyers list includes three guest contributors of the Blog: Jay Eisenhofer (Grant & Eisenhofer), Mark Morton (Potter, Anderson & Corroon), and Charles Nathan (Latham & Watkins).

Lawdragon’s list includes attorneys from private practice, in-house counsel, law professors, judges, government attorneys, and public interest lawyers. Lawdragon bases its selection of the leading lawyers through a combination of online balloting and independent research. Lawdragon’s announcement appears here.

On February 14, the SEC Advisory Committee on Improvements to Financial Reporting presented its interim report to the Securities and Exchange Commission. The report includes 12 developed proposals, conceptual approaches representing the Committee’s initial views on matters, and currently identified matters for further consideration. The key themes of the report are the following: increasing emphasis on the investor perspective in the financial reporting system; consolidating the process of setting and interpreting accounting standards; promoting the design of more uniform and principles-based accounting standards; creating a disciplined framework for the increased use of professional judgment; and taking steps to coordinate Generally Accepted Accounting Principles (GAAP) in the US with International Financial Reporting Standards (IFRS).

Formed by the SEC in July 2007, the Committee was tasked to examine the US financial reporting system and to recommend changes to increase the usefulness of financial information to investors, while reducing the financial reporting system’s complexity. The Committee’s final report is some months away. The Committee includes representatives from the Financial Accounting Standards Board and the Public Company Accounting Oversight Board.

The interim report is available here.

I’ve been giving some thought to the dust up last year between Marty Lipton and other governance experts as to whether Pfizer’s initiative of having several of its independent directors meet with its largest institutional investors represented a landmark in the decline of director-centric corporate governance, and have also been thinking about what we mean when we talk about director-centric vs. shareholder-centric governance. The working text of a talk I gave on the subject last week at the Corporate Governance Center at the University of Tennessee in Knoxville, at the invitation of Joe Carcello and Joan Heminway, is available here. I plan to do some more work on this and turn it into an article later this year. In the meantime, I’d greatly appreciate comments.

Does a Director Qua Director Have Standing to Sue Derivatively? No, so said the Delaware Supreme Court yesterday in Schoon v. Smith. The Supreme Court affirmed the Court of Chancery’s little-noticed ruling last year that dismissed a derivative claim brought by a director against the company’s other directors, including its controlling stockholder. The plaintiff-director, who was not a stockholder of the company, charged his fellow directors with, among other things, breach of fiduciary duty and unjust enrichment. The court held that, notwithstanding the equitable origins of derivative suits, the issue of director standing today is best left to the legislature. “Although the Delaware General Assembly has the prerogative to confer standing upon directors by statute,” the court wrote, “it has not chosen to do so.” Rejecting the American Law Institute Principles that give individual directors standing to sue on behalf of their corporations, the court continued that, “[b]ecause a stockholder derivative action is available to redress any breach of fiduciary duty, we decline to extend the doctrine of equitable standing to allow a director to bring a similar action.” The court concluded, however, by leaving itself a little room to permit directors to bring derivative suits, but only where the failure to do so would result in a “complete failure of justice”—a seemingly high standard.

As a practical matter, the decision is unlikely to have much significance because most directors are also stockholders. But the decision is still significant and may draw criticism with respect to its implications for corporate governance and director duties. In particular, the court noted that the concept of being an “independent director” does not mandate “a duty to sue on behalf of the corporation.”

The opinion is available here.

(Editor’s Note: The post below comes to us from Peter Moon of Universities Superannuation Scheme, Phil Spathis of the Australia Council of Super Investors, and Keith Johnson of Reinhart Institutional Investor Services.)

Verizon, Par Pharmaceutical and Aflac became the first US companies over the last year to adopt policies requiring an advisory vote of shareholders on company executive compensation practices. A network of over 70 institutional and individual investors lead by AFSCME and Walden Asset Management announced in January that adoption of this ’say on pay’ policy is expected to be put on proxies at more than 90 US companies this year. With majority shareholder votes having been cast for similar resolutions at seven companies during 2007, say on pay will be one of the hottest issues in the upcoming US proxy season. In their article, Global Investors Laud Shareholder Votes on Executive Compensation, Peter Moon from the $65 billion Universities Superannuation Scheme pension fund in Britain, Phil Spathis from the $200 billion Australia Council of Super Investors and Keith Johnson from the University of Wisconsin Law School’s International Corporate Governance Initiative describe the impact that say on pay has had in other markets and discuss the benefits it could produce for both companies and shareholders in the United States.