http://www.ecgi.org/rss/wp.xml RSS feed of the European Corporate Governance Institute (ECGI) Tue, 20 Mar 2012 23:14 GMT en-us http://www.ecgi.org/assets/logos/ECGI fonts only.gif http://www.ecgi.org/wp/index.php In order to understand the role of private equity firms in the restructuring of financially distressed firms, we examine the private equity ownership of 2,156 firms which obtained leveraged loan financing between 1997 and 2010. The economic downturn beginning in 2007 is associated with a marked increase in defaults of these highly leveraged companies; approximately 50percent of defaults involve PE-backed companies. However, PE-backed firms are no more likely to default during this period than other firms with similar leverage characteristics. But defaulting firms that are private equity backed spend less time in financial distress and are more likely to survive as an independent reorganized company versus being sold to a strategic buyer or liquidated. The ability to restructure more efficiently seems to be affected by the PE sponsor's financial as well as reputational capital. In contrast, recovery rates to junior creditors are lower for PE-backed firms. http://www.ecgi.org/wp/wp_id.php?id=517 Tue, 20 Mar 2012 23:14 GMT Finance series We use an important legal event as a natural experiment to examine the effect of management fiduciary duties on equity-debt conflicts. A 1991 Delaware bankruptcy ruling changed the nature of corporate directors’ fiduciary duties in firms incorporated in that state. This change limited managers’ incentives to take actions favoring equity over debt for firms in the vicinity of financial distress. We show that this ruling increased the likelihood of equity issues, increased investment, and reduced firm risk, consistent with a decrease in debt-equity conflicts of interest. The changes are isolated to firms relatively closer to default. The ruling was also followed by an increase in average leverage and a reduction in covenant use. Finally, we estimate the welfare implications of this change and find that firm values increased when the rules were introduced. We conclude that managerial fiduciary duties affect equity-bond holder conflicts in a way that is economically important, has impact on ex ante capital structure choices, and affects welfare. http://www.ecgi.org/wp/wp_id.php?id=516 Tue, 20 Mar 2012 23:10 GMT Finance series Private equity funds pay particular attention to capital structure when executing leveraged buyouts, creating an interesting setting for examining capital structure theories. Using a large, detailed, international sample of buyouts from 1980-2008, we find that buyout leverage is unrelated to the cross-sectional factors – suggested by traditional capital structure theories – that drive public firm leverage. Instead, variation in economy-wide credit conditions is the main determinant of leverage in buyouts, while having little impact on public firms. Higher deal leverage is associated with higher transaction prices and lower buyout fund returns, suggesting that acquirers overpay when access to credit is easier. http://www.ecgi.org/wp/wp_id.php?id=515 Tue, 20 Mar 2012 23:06 GMT Finance series We examine the impact of the Split Share Structure Reform on the well-known foreign share discount puzzle in China. Existing literature confirms that foreign investors are more concerned about insider expropriation because of their information disadvantage relative to domestic investors. The split share structure of the ownership of Chinese listed firms created a conflict of interests between state and private shareholders. Since, before the reform, state shareholders held restricted shares that denied them any wealth effect from share price movements, they had a limited incentive to work with private shareholders to ensure that managers maximized the stock market value of the firm. By abolishing the trading restrictions for state shareholders, this reform has increased the incentive alignment between state and private shareholders, encouraging them to monitor managers. If foreign investors’ concerns over the corporate governance implications of the split share structure at least partly contributed to their discounting of Chinese listed firms, then this discount should be reduced following the reform. Indeed, our evidence confirms this prediction, especially among Chinese listed firms with more state ownership or restricted shares. Our findings imply that this significant institutional reform of the Chinese stock market has benefitted http://www.ecgi.org/wp/wp_id.php?id=514 Tue, 20 Mar 2012 23:02 GMT Finance series We investigate the impact of measures of firms' prestige on CEO compensation and find that CEOs of more prestigious companies earn less. For example, total CEO compensation is on average 9percent lower for firms rated among Fortune's ranking of America's most admired companies. We suggest that CEOs derive social benefits in the form of an enhanced social status if they work for a company that enjoys public admiration, and that boards extract pay concessions for this non-monetary benefit. Results obtain only for firms with independent compensation committees and other measures of strong boards, presumably because weak boards leave rents to powerful CEOs. The effect also obtains for alternative measures of firm prestige and for younger CEOs. We perform a range of robustness checks and can exclude several alternative explanations, including that CEOs wish to signal higher status through lower pay, or that results are driven by owner-CEOs who forego higher compensation. http://www.ecgi.org/wp/wp_id.php?id=513 Tue, 20 Mar 2012 22:57 GMT Finance series In this paper we argue that boards of directors lack the mandate, the incentives and the ability to control insiders, especially in jurisdictions where the main agency problem arises between controlling and minority shareholders. We analyze the problems that render independents an inefficient monitoring device for companies with concentrated ownership structures and conclude that the current focus of the regulators and codes of best practice on empowering independents is ineffective and companies would be better off choosing their board members at liberty. Nevertheless, we also present two different proposals for reform: independents as gatekeepers for the regulator and independents as surrogates of the minority. Both proposals are based on the idea that if independent directors are expected to monitor controlling shareholders their most important characteristic should be accountability rather than mere independence. http://www.ecgi.org/wp/wp_id.php?id=511 Fri, 16 Mar 2012 21:33 GMT Law series Following a slow start, the European Company (Societas Europaea – SE) has become a popular legal form amongst European firms. It is rendered attractive by corporate governance features such as the contractual freedom of capital and labor to design a firm-specific employee involvement regime. By analyzing what has been settled for in such agreements, we investigate whether national mandatory employee involvement rules are efficient and which factors impede firm-specific bargained-for solutions http://www.ecgi.org/wp/wp_id.php?id=510 Mon, 30 Jan 2012 11:09 GMT Law series Governments in Europe and the US have recently acquired significant stakes in a number of financial institutions, raising fears that they will use their investments to pursue interventionist goals. The comparative analysis of 16 major bail-outs in Belgium, Germany, France, Ireland, Switzerland, the UK and the US provides evidence to the contrary. Fiscal and political considerations have prompted governments to generally avoid common stock investments, limit direct managerial involvement and favor early exits. While this investment strategy may prove detrimental to other stakeholders, it resembles the approach distressed asset investors would adopt under the circumstances. http://www.ecgi.org/wp/wp_id.php?id=509 Sun, 29 Jan 2012 01:13 GMT Law series In many bilateral transactions, the seller fears being underpaid because its outside option is better known to the buyer. We rationalize a variety of observed contracts as solutions to such smart buyer problems. The key to these solutions is to grant the seller upside participation. In contrast, the lemons problem calls for offering the buyer downside protection. Yet in either case, the seller (buyer) receives a convex (concave) claim. Thus, contracts commonly associated with the lemons problem can equally well be manifestations of the smart buyer problem. Nevertheless, the information asymmetries have opposite cross-sectional implications. To avoid underestimating the empirical relevance of adverse selection problems, it is therefore critical to properly identify the underlying information asymmetries in the data. http://www.ecgi.org/wp/wp_id.php?id=508 Sun, 29 Jan 2012 00:50 GMT Finance series “Corporate governance” first came into vogue in the 1970s in the United States. Within 25 years corporate governance had become the subject of debate worldwide by academics, regulators, executives and investors. This paper traces developments occurring between the mid-1970s and the end of the 1990s, by which point “corporate governance” was well-entrenched as academic and regulatory shorthand. The paper concludes by surveying briefly recent developments and by maintaining that analysis of the inter-relationship between directors, executives and shareholders of publicly traded companies is likely to be conducted through the conceptual prism of corporate governance for the foreseeable future. http://www.ecgi.org/wp/wp_id.php?id=507 Sun, 29 Jan 2012 00:47 GMT Law series This paper presents a contracting model of governance based on the premise that CEOs are the main promoters of governance change. CEOs use their power to extract higher pay or private benefits, and different governance structures are preferred by different CEOs as they favor one or the other type of compensation. The model explains why good country-wide investor protection breeds good firm governance and predicts a race to the top in firm-governance quality after the Sarbanes-Oxley Act. However, such governance changes may be associated with higher rather than lower CEO pay as CEOs substitute away from private benefits. The model also provides an explanation for the observed correlation of CEO pay and firm governance as driven by CEO power. http://www.ecgi.org/wp/wp_id.php?id=506 Sat, 14 Jan 2012 18:32 GMT Finance series A large amount of activity in the financial sector occurs in secondary financial markets, where securities are traded among investors without capital flowing to firms. The stock market is the archetypal example, which in most developed economies captures a lot of attention and resources. Is the stock market just a side show or does it affect real economic activity? In this article, we discuss the potential real effects of financial markets that stem from the informational role of market prices. We review the theoretical literature and show that accounting for the feedback effect from market prices to the real economy significantly changes our understanding of the price formation process, the informativeness of the price, and speculators’ trading behavior. We make two main points. First, we argue that a new definition of price efficiency is needed to account for the extent to which prices reflect information useful for the efficiency of real decisions (rather than the extent to which they forecast future cash flows). Second, incorporating the feedback effect into models of financial markets can explain various market phenomena that otherwise seem puzzling. Finally, we review empirical evidence on the real effects of secondary financial markets. http://www.ecgi.org/wp/wp_id.php?id=505 Fri, 13 Jan 2012 16:28 GMT Finance series The European Company (Societas Europaea, SE) has become a popular company law form for businesses, and it is most popular in the Czech Republic, which is puzzling. We study the motives of Czech SE founders on the basis of data from the Czech national Commercial Register on all Czech SEs registered in 2010 and 88 interviews with Czech SE users. SE incorporations in the Czech Republic are mainly driven by the desire to economize on board size and the positive European image of the SE (brand management). The large number of Czech shelf SEs probably results either from service providers overestimating these advantages and, as a consequence, demand for new SEs or, conversely, from users underestimating the beneficial effects of (re-) incorporating as an SE. Time will tell which conjecture comes closer to the truth. http://www.ecgi.org/wp/wp_id.php?id=504 Mon, 12 Dec 2011 23:22 GMT Law series We analyze the effect of public information on rational investors' incentives to reveal private information during the bookbuilding process and their demand for allocations in the IPO. Our model generates several new predictions. First, investors require more underpricing to truthfully reveal positive private information in bear markets than in bull markets (the incentive effect). Second, the fraction of positive private signals and of underpriced IPOs is increasing in market returns (the demand effect). Combined, these two effects can explain why IPO underpricing is positively related to pre-issue market returns, consistent with extant evidence. Using a sample of 5,000 U.S. IPOs from 1981-2008, we show that the empirical implications of the model are borne out in the data. http://www.ecgi.org/wp/wp_id.php?id=503 Mon, 12 Dec 2011 23:18 GMT Finance series We propose that an active takeover market provides incentives by offering acquisition opportunities to successful managers. This allows firms to reduce performance-based compensation and can rationalize loss-making acquisitions. At the same time, takeovers remain a substitute for board dismissal in the replacement of poorly performing managers. The joint impact of the two mechanisms on managerial turnover is, however, multi-faceted: In firms with strong boards, turnover and performance-based pay are non-monotonic in the intensity of the takeover threat. In firms with weak boards, turnover (performance-based pay) increases (decreases) with the intensity of the takeover threat. When choosing its acquisition policy and the quality of its board, each firm ignores the adverse effect on other firms' acquisition opportunities and takeover threat. As a result, the takeover market is not sufficiently liquid and too few takeovers occur. http://www.ecgi.org/wp/wp_id.php?id=502 Mon, 12 Dec 2011 23:14 GMT Finance series This paper studies optimal contracting under synergies. We define influence as the extent to which effort by one agent reduces a colleague's marginal cost of effort, and synergy to be the sum of the (unidimensional) influence parameters across a pair of agents. In a two-agent model, effort levels are equal even if influence is asymmetric. The optimal effort level depends only on total synergy and not individual influence parameters. An increase in synergy raises total effort and total pay, consistent with strong equity incentives in small firms, including among low-level employees. The influence parameters matter only for individual pay. Pay is asymmetric, with the more influential agent being paid more, even though the level and productivity of effort are both symmetric. With three agents, effort levels differ and are higher for more synergistic agents. An increase in the synergy between two agents can lead to the third agent being excluded from the team, even if his productivity is unchanged. This has implications for optimal team composition and firm boundaries. Agents that influence a greater number of colleagues receive higher wages, consistent with the salary differential between CEOs and divisional managers. http://www.ecgi.org/wp/wp_id.php?id=501 Wed, 23 Nov 2011 12:24 GMT Finance series This paper studies the effect of stock liquidity on blockholders’ choice of governance mechanisms. We focus on hedge funds as they are unconstrained by legal restrictions and business ties, and thus have all governance channels at their disposal. Since the threat of governance, not just actual governance, can discipline managers, we use Section 13 filings to measure governance intent rather than only studying instances of actual governance. We find that liquidity increases the likelihood that a hedge fund acquires a block in a firm. Conditional upon acquiring a stake, liquidity reduces the likelihood that a blockholder governs through voice (intervention) – as evidenced by the greater propensity to file Schedule 13Gs (passive investment) rather than 13Ds (active investment). Liquidity is more likely to lead to a 13G filing if the manager’s wealth is sensitive to the stock price, consistent with governance through exit (trading). A 13G filing leads to positive announcement returns, especially in liquid firms. These two results suggest that liquidity does not dissuade blockholders from governing altogether, but instead encourages them to govern through exit rather than voice. We use decimalization as an exogenous shock to liquidity to identify causal effects. http://www.ecgi.org/wp/wp_id.php?id=500 Sat, 19 Nov 2011 11:47 GMT Finance series This paper identifies a limit to arbitrage that arises from the fact that a firm's fundamental value is endogenous to the act of exploiting the arbitrage. Trading on private information reveals this information to managers and helps them improve their real decisions, in turn enhancing fundamental value. While this increases the profitability of a long position, it reduces the profitability of a short position -- selling on negative information reveals that firm prospects are poor, causing the manager to cancel investment. Optimal abandonment increases firm value and may cause the speculator to realize a loss on her initial sale. Thus, investors may strategically refrain from trading on negative information, and so bad news is incorporated more slowly into prices than good news. The effect has potentially important real consequences -- if negative information is not incorporated into stock prices, negative-NPV projects may not be abandoned, leading to overinvestment. http://www.ecgi.org/wp/wp_id.php?id=499 Sat, 19 Nov 2011 11:44 GMT Finance series Legal origins theory suggests that law reform should have a causal impact on financial development. We use recently created datasets measuring legal change over time in a sample of 25 developing, developed and transition countries to test this claim. We find that increases in shareholder protection contribute to stock market growth in the common law world and in developing countries, but not in the civil law world. We also find evidence of reverse causation, with financial development triggering legal changes in the developing world. We consider a number of reasons for the selective impact of law reform, focusing on the endogeneity of the legal system to its economic context, and on resulting complementarities between legal and financial institutions. http://www.ecgi.org/wp/wp_id.php?id=498 Wed, 26 Oct 2011 16:21 GMT Law series Lifecycle theories of mergers and diversification predict that firms make acquisitions and diversify when their internal growth opportunities become exhausted. Free cash flow theories make similar predictions. In contrast to these theories, we find that the acquisition rate of firms (defined as the number of acquisitions in an IPO cohort-year divided by the number of firms in that cohort-year) follows a u-shape through their lifecycle as public firms, with young and mature firms being equally acquisitive but more so than middle-aged firms. Firms that go public during the merger/IPO wave of the 1990s are significantly more acquisitive early in their public life than firms that go public at other times. Young public firms have a lower acquisition rate of public firms than mature firms, but the opposite is true for acquisitions of private firms and subsidiaries. Strikingly, firms diversify early in their life and there is a 41percent chance that a firm’s first acquisition is a diversifying acquisition. The stock market reacts more favorably to acquisitions by young firms than to acquisitions by mature firms except for acquisitions of public firms paid for with stock. There is no evidence that the market reacts more adversely to diversifying acquisitions by young firms than to other acquisitions. http://www.ecgi.org/wp/wp_id.php?id=497 Sat, 22 Oct 2011 10:08 GMT Finance series Corporate governance of banks differs considerably from general corporate governance. For banks the scope of corporate governance goes beyond the shareholders (equity governance) to include debtholders (debt governance). From the perspective of bank supervision debt governance is the primary governance concern. Equity governance and debt governance face partly parallel and partly divergent interests of management, shareholders, debtholders, and supervisors. Failures in the corporate governance of banks contributed to the financial crisis. Corporate law reforms are less suited for bank governance, strengthening supervisory law requirements is more promising. Prominent proposals include clearer separation of the management and control function, possibly by a two-tier board as in Switzerland and Belgium; establishment of a separate risk committee of the board or an independent chief risk officer; dealing with the problem of complex or opaque bank structure; and group-wide corporate governance in single entities as well as in the bank group. Appropriate supervisory law requirements are needed for bank-internal procedures, specifically for risk management, internal control and compliance, and internal and external auditing. Supervisory fit and proper tests for the board, the management and major shareholders of banks are useful. Qualification and experience of bank board members is at least as important as independence. But the severe requirements of bank regulation and bank supervision must not spill over to the corporate governance of the firm. http://www.ecgi.org/wp/wp_id.php?id=496 Fri, 30 Sep 2011 09:37 GMT Law series Using a comprehensive sample of U.S. mergers and acquisitions (M and A) bids over 1990-2008, we document that the top-10 market share (the prominent) law firms are associated with a number of important bid outcomes and characteristics. Top bidder law firms are associated with significantly higher offer completion rates than other bidder law firms. In contrast, top target law firms are associated with significantly higher offer withdrawal rates than other target law firms. Top bidder and target law firms are both associated with significantly higher takeover premia in completed deals than less prominent law firms. These associations are significant even after controlling for selection bias and major offer, bidder, and investment bank advisor characteristics. Our interpretation is that top bidder law firms have stronger incentives to support deal completions, while top target law firms have stronger incentives to help realize higher takeover premia, consistent with their respective clients’ objectives. In fact, top bidder and target law firms appear to be chosen by their clients to help achieve these offer outcomes. Our findings suggest that law firm market share is an important omitted variable in current models of M and A deal outcomes. http://www.ecgi.org/wp/wp_id.php?id=495 Sat, 10 Sep 2011 11:05 GMT Finance series This study explores the effects of local director labor markets on corporate board structure. We examine whether firms can more easily attract independent directors to their boards when a larger pool of prospective directors (executives of other firms) is located nearby a firm’s headquarters. Empirically, firms close to large pools of local director talent have more independent boards and more local independent directors. Proximity to local pools of specialized expertise – academic, legal, financial, technological or similar growth experience – is associated with greater board representation of such directors. Local labor markets are less important for well established, highly visible firms. Using the local director pools as an exogenous predictor of board composition, we reexamine the relations between board independence and firm value, performance and CEO compensation for small and medium size firms. http://www.ecgi.org/wp/wp_id.php?id=494 Sat, 20 Aug 2011 00:26 GMT Finance series Virtually all IPO prospectuses feature lockup provisions that limit pre-IPO shareholders’ share sales for some period of time after negotiations start. The aim of the paper is to analyze in-depth voluntary lockups in the Italian setting and to draw conclusions about their effect both on different shareholder classes and on share prices. We show that the lockups are considerably longer and heterogeneous than US or European evidence shows, and their duration and size serves primarily as a commitment device to alleviate the moral hazard problem faced by the incumbent shareholders. We show that abnormal returns around the lockup expiration dates are associated solely with venture-capital backed IPOs. http://www.ecgi.org/wp/wp_id.php?id=493 Sat, 13 Aug 2011 16:47 GMT Finance series The value of a right should not be lower than zero. The present paper overcomes some possible measurement errors and proposes a new measure of the voting right, the Relative Vote Segment, which incorporates dividend privileges into the inferior class of shares, when granted. Results from Italian non-voting shares listed in the 1999-2008 period show that our more accurate measure reports an average voting right equal to 45.58 per cent, while the standard relative price difference and the Nenova (2003) measure greatly underestimate its value and report average values equal to 20.35 per cent and 1.30 per cent, respectively. Our methodology reports almost no negative values, while traditional measures report almost 25 per cent of negative values. Though a more correct measure of the voting right is essential to estimate its average value and make unbiased cross-country comparisons, the determinants of the voting rights are also well captured by the relative price difference, once the dividend yield differences are controlled for. http://www.ecgi.org/wp/wp_id.php?id=492 Fri, 12 Aug 2011 01:21 GMT Finance series This study investigates the employment consequences of private equity acquisitions, in particular institutional buy-outs (IBOs), in the UK. It involves a pre- and post-acquisition analysis of employment and performance characteristics for a sample of acquired firms and a matched sample of non-acquired firms. The study finds a significant decrease in employment in acquired firms in the year immediately after the completion of the IBO compared to the non-acquired firms. Further analysis fails to identify any parallel or subsequent increase in firm productivity or profitability. This evidence suggests that the observed downsizing has not been effective either in disciplining staff or imparting a clearer focus to activities. http://www.ecgi.org/wp/wp_id.php?id=491 Sun, 07 Aug 2011 14:41 GMT Finance series We estimate holdings of highly-rated tranches of mortgage securitizations of American deposit-taking banks ahead of the credit crisis and evaluate hypotheses that have been advanced to explain these holdings. We find that holdings of highly-rated tranches were economically trivial for the typical bank, but banks with greater holdings performed more poorly during the crisis. Though univariate comparisons show that banks with large trading books had greater holdings, the holdings of highly-rated tranches are not higher for banks with large trading books in regressions that control for bank size. The ratio of highly-rated tranches holdings to assets increases with bank assets, but not for banks with more than $50 billion of assets. This evidence is inconsistent with explanations for holdings of highly-rated tranches that emphasize the incentives of banks deemed “too-big-to-fail”. Further, the evidence does not provide support for “bad incentives” theories of holdings of highly-rated tranches. We find, however, that banks active in securitization held more highly-rated tranches. Such a result can be consistent with regulatory arbitrage as well as with securitizing banks holding highly-rated tranches to convince investors of the quality of these securities. Our evidence supports the latter hypothesis. http://www.ecgi.org/wp/wp_id.php?id=490 Sun, 07 Aug 2011 13:26 GMT Finance series This study of initial public offerings (IPOs) carried out on the Berlin and London stock exchanges between 1900 and 1913 casts doubt on the received “law and finance” wisdom that legally mandated investor protection is pivotal to the development of capital markets. IPOs that resulted in official quotations on the London Stock Exchange performed as well as Berlin IPOs despite the Berlin market being more extensively regulated than the laissez faire London market. Moreover, the IPO failure rate on these two stock markets was lower than it was with better regulated US IPOs later in the 20th century. http://www.ecgi.org/wp/wp_id.php?id=489 Tue, 02 Aug 2011 06:42 GMT Law series Using a sample of voting turnouts of annual general meetings of European companies, we document that shareholder voting turnouts are significantly different according to the ownership structure of the company. Different types of shareholder classes show different voting engagements according to the ownership concentration and the ownership structure. The number of directors that stand up for (re)election positively influences voting turnouts. Special resolutions like changes of the articles of associations have no major impact on shareholders’ engagements. Corporate performance and other governance mechanisms do not change shareholder activism measured as voting turnout. These results provide important benchmarks for the current debate of shareholder empowerment. The agenda and hence the role of shareholders should be restructured. The AGM should be used as a strategic governance tool for director elections while the central decision making body should be the board, balancing shareholder primacy with board primacy. http://www.ecgi.org/wp/wp_id.php?id=488 Thu, 21 Jul 2011 14:10 GMT Finance series This paper examines how corporate governance reform of banks relates to systemic risk. Although there has been substantial emphasis on the importance of corporate governance of banks, it is not entirely clear how this enterprise relates to the goal of financial stability. The first part of the paper differentiates between kinds of risk that arise from the structure of the firm, such as shareholder ownership, limited liability and the separation between control and ownership, and kinds of risk that arise from interactions at the systemic level. It highlights why the risk-taking of banks presents, in many respects, a special case not only because of the structure of their business but also because of recent innovation in the financial sector. It then analyzes how these different kinds of risk are related to each other, showing how firm-level sources of risk are much easier for corporate governance and regulation to address than risk arising at the systemic level. Then, with particular emphasis on recent reforms in the European Union, the paper analyzes policy proposals, including those related to strengthening risk management, altering board remuneration, reformulating board duties and altering the limited liability structure of the firm. The paper concludes that corporate governance reforms have a necessary yet often limited role in the regulation of systemic risk and then relates this discussion to the current state of affairs in the European Union. http://www.ecgi.org/wp/wp_id.php?id=487 Thu, 21 Jul 2011 14:07 GMT Law series We introduce indexed contracts into the standard model of executive compensation. We calibrate the model to a sample of US CEOs and analyze two settings, one that assumes efficient contracting and another one in which shareholders can use indexed contracts to recapture rents from CEOs. The main finding is that the benefits from indexing are typically small: On average they are about 3 per cent of compensation costs in our baseline case. The main reason is that for about 75 per cent of the CEOs in our sample, indexing destroys incentives because it reduces the likelihood of bad outcomes. Much of the incentives of observed contracts come from the desire to avoid these bad outcomes. This effect also applies to the scenario where CEOs extract rents, so that indexing contracts is an inadequate instrument to recapture these rents. We show why conventional arguments for indexation often do not apply and conclude that the prevalence of pay for luck does not generally prove that contracting is inefficient or that corporate governance is poor. http://www.ecgi.org/wp/wp_id.php?id=486 Mon, 18 Jul 2011 09:32 GMT Finance series We study how company law reforms, particularly the reduction or abolition of minimum capital requirements, in various European jurisdictions affect the decision of entrepreneurs to incorporate by means of a private limited liability company (LLC). Since the landmark rulings of the European Court of Justice (ECJ) in the years 1999, 2002 and 2003, entrepreneurs in the European Union (EU) have been able to choose the country of incorporation independently of their real seat. As a result, the proliferation of the UK private company limited by shares has posed a competitive threat to many European legislators. We analyze whether the reforms adopted in Spain, France, Hungary, Germany and Poland have promoted the popularity of domestic legal forms and encouraged entrepreneurship more generally. Using a difference-in-difference approach, we record a strong impact in both respects, especially if the minimum capital requirement was reduced or abolished. http://www.ecgi.org/wp/wp_id.php?id=485 Mon, 18 Jul 2011 09:22 GMT Finance series Relatively little is known about the corporate governance practice of firms in emerging markets. We provide a detailed overview of the practices of publicly traded firms in India, and identify areas where governance practices are relatively strong or weak, relative to developed countries. We also examine whether there is a cross-sectional relationship between measures of governance and measures of firm performance and find evidence of a positive relationship for an overall governance index and for an index covering shareholder rights. The association is stronger for more profitable firms and firms with stronger growth opportunities. http://www.ecgi.org/wp/wp_id.php?id=484 Mon, 18 Jul 2011 09:17 GMT Law series Using hand-collected data, we examine the targeting of lawsuits in M and A transactions, the effect of these suits on offer completion rates and takeover premiums, and the factors that lead to positive settlement outcomes in these cases. Shareholder lawsuits form the vast majority of all lawsuits. We find that M and A offers that are subject to lawsuits are completed at a significantly lower rate than offers that are not subject to litigation, after controlling for offer features, M and A financial and legal advisor reputation, and industry and time fixed effects, as well as selection bias. However, litigation significantly increases the takeover premium in deals that are completed. Economically, the expected rise in the takeover premium more than offsets the fall in the probability of deal completion, so there is a rise in the expected takeover premium paid in offers that are subject to pre-deal-completion litigation. Examining the different types of lawsuits, suits challenging controlling shareholder squeeze-outs are significantly more likely to lead to settlement and the payment of cash settlements. Target lawsuits, generally designed to impede deal completion, are significantly associated with higher takeover premia in completed deals. http://www.ecgi.org/wp/wp_id.php?id=483 Mon, 18 Jul 2011 09:04 GMT Finance series During the past two decades, there has been a dramatic change in IPO activity around the world. Though vibrant IPO activity, attributed to better institutions and governance, used to be a strength of the U.S., it no longer is. IPO activity in the U.S. has fallen compared to the rest of the world and U.S. firms go public less than expected based on the economic importance of the U.S. In the early 1990s, the declining U.S. IPO share was due to the extraordinary growth of IPOs in foreign countries; in the 2000s, however, it is due to higher IPO activity abroad combined with lower IPO activity in the U.S. Global IPOs, which are IPOs in which some of the proceeds are raised outside the firm’s home country, play a critical role in the increase in IPO activity outside the U.S. The quality of a country’s institutions is positively related to its domestic IPO activity and negatively related to its global IPO activity. However, home country institutions are more important in explaining IPO activity in the 1990s than in the 2000s. The evidence is consistent with the view that access to global markets helps firms overcome the obstacles of poor institutions. Finally, we show that the dynamics of global IPO activity and country-level IPO activity are strongly affected by global factors. http://www.ecgi.org/wp/wp_id.php?id=482 Mon, 18 Jul 2011 08:43 GMT Finance series A central issue in corporate governance research is the extent to which “good” governance practices are universal (one size mostly fits all) or instead depend on country and firm characteristics. We report evidence that supports the second view. We first conduct a case study of Brazil, in which we survey Brazilian firms’ governance practices at year-end 2004, construct a corporate governance index, and show that the index, as well as subindices for ownership structure, board procedure, and minority shareholder rights, predict higher lagged Tobin’s q. In contrast to other studies, greater board independence predicts lower Tobin’s q. Firm characteristics also matter: governance predicts market value for nonmanufacturing (but not manufacturing) firms, small (but not large) firms, and high-growth (but not low-growth) firms. We then extend prior studies of India, Korea, and Russia, and compare those countries to Brazil, to assess which aspects of governance matter in which countries, and for which types of firms. Our “multi-country” results suggest that country characteristics strongly influence both which aspects of governance predict firm market value, and at which firms that association is found. They support a flexible approach to governance, with ample room for firm choice. http://www.ecgi.org/wp/wp_id.php?id=480 Thu, 07 Jul 2011 14:32 GMT Finance series Insiders (managers and controlling shareholders) can extract (tunnel) wealth from firms using a variety of methods. This article examines the different ways in which U.S. law limits, or fails to limit, three types of tunneling – cash flow tunneling, asset tunneling, and equity tunneling. We examine how U.S. corporate, securities, bankruptcy, and tax law, accounting rules, and stock exchange rules impact each form of tunneling, and identify important weaknesses in these rules. Using case studies, we show how tunnelers exploit these gaps. We discuss how decisions to tunnel reflect both legal and informal constraints. We conclude that even though the overall level of tunneling in the U.S. is limited, complex asset and equity transactions and excessive equity compensation can escape both legal and informal constraints. http://www.ecgi.org/wp/wp_id.php?id=479 Mon, 06 Jun 2011 16:20 GMT Law series In the context of the global market for syndicated bank loans, we provide evidence that the collapse of international markets during financial crises can in part be explained by a flight home effect. We show that the home bias of lenders’ loan origination increases by approximately 20 percent if the bank’s country of origin experiences a banking crisis. Banks with less stable funding sources, being more vulnerable to liquidity shocks, exhibit a stronger flight home effect. This flight home effect is distinct from a flight to quality effect because borrowers in emerging markets and advanced economies are similarly affected by the lenders’ portfolio rebalancing in favor of domestic borrowers. Similarly, the flight home of international lenders does not appear to be exclusively away from countries with weak investor protection or from borrowers with lower credit ratings. Overall, the results indicate that the home bias of international capital allocation tends to increase in the presence of adverse economic shocks affecting the net wealth of international investors. http://www.ecgi.org/wp/wp_id.php?id=478 Mon, 30 May 2011 20:25 GMT Finance series During the financial crisis, questions arose concerning links between the Federal Reserve and the business community. This paper provides the first in-depth study of one mechanism creating such links: Reserve Bank directorships. By law, each Reserve Bank is governed by a nine member board consisting of three banking representatives and six representatives of the public. Member banks elect six directors, the remaining directors are appointed by the Board of Governors. The representation of private interests on Reserve Bank boards may clearly benefit the public. However, it may also benefit individual director employers, which may not be consistent with the goals of Federal Reserve governance. To shed some light on this issue, I examine who sits on Federal Reserve Bank boards and the market reaction to the appointments of executives of publicly-traded companies over the period 1990-2009. I document that banking representatives are more likely to be chosen from large banks. Furthermore, the average stock price reaction to the appointment of a firm’s officer to a Reserve Bank board is positive only for banks. I discuss potential explanations for these findings. http://www.ecgi.org/wp/wp_id.php?id=477 Wed, 04 May 2011 13:12 GMT Finance series We analyze the relation between CEO compensation and networks of executive and non-executive directors for all listed UK companies over the period 1996-2007. We examine whether networks are built for reasons of information gathering or for the accumulation of managerial influence. Both indirect networks (enabling directors to collect information) and direct networks (leading to more managerial influence) enable the CEO to obtain higher compensation. Direct networks can harm the efficiency of the remuneration contracting in the sense that the performance sensitivity of compensation is then lower. We find that in companies with strong networks and hence busy boards the directors’ monitoring effectiveness is reduced which leads to higher and less performance-sensitive CEO compensation. Our results suggest that it is important to have the ‘right’ type of network: some networks enable a firm to access valuable information whereas others can lead to strong managerial influence that may come at the detriment of the firm and its shareholders. We confirm that there are marked conflicts of interest when a CEO increases his influence by being a member of board committees (such as the remuneration committee) as we observe that his or her compensation is then significantly higher. We also find that hiring remuneration consultants with sizeable client networks also leads to higher CEO compensation especially for larger firms. http://www.ecgi.org/wp/wp_id.php?id=476 Tue, 22 Mar 2011 22:01 GMT Finance series This article examines the recent development of EU regulatory policy with respect to the alternative investment industry up to and including the adoption of a major new Directive. This Directive is just one part of a much larger package of new EU measures relating to the financial markets but its emergence merits being singled out for three reasons. First, the account of how it came about and what it sets out to do touches upon two overarching concerns that are frequently expressed about laws that are made in the immediate aftermath of a crisis: opportunistic use of crisis situations to achieve unrelated goals, and crisis-induced regulatory over-reaction. Second, with the regulation of alternative investments being addressed internationally as well as in Europe, close examination of this area provides revealing glimpses of ways in which key players in the EU policy formation process have simultaneously used the financial crisis to exert influence internationally and used international developments to further an internal agenda. Finally, out of the exceptional level of controversy that surrounded the legislative process for the Directive come some important insights on relations between the EU Institutions and, in particular, on the European Parliament’s increasing deftness in putting its mark on EU financial market regulation. http://www.ecgi.org/wp/wp_id.php?id=475 Tue, 01 Mar 2011 21:12 GMT Law series Institutional shareholders around the world increasingly use active share-voting to protect their portfolio investments and improve corporate governance. However, exercising voting rights involves costly and often arcane country-specific legal rules. This report is one of a series examining the potential for increased harmonization of cross-border share-voting systems and proxy voting in the U.S. and Member States of the European Union (EU). The report describes the share-registration system and voting chain for publicly traded companies in Italy. We highlight voting impediments and examine recent regulatory attempt to make the voting process both more efficient and conforming to the 2007 EU Shareholder Rights Directive. We also provide some first empirical evidence on how Italian listed firms adapt to Italy's share-voting system in practice. http://www.ecgi.org/wp/wp_id.php?id=474 Mon, 14 Feb 2011 02:02 GMT Law series Institutional shareholders around the world increasingly use active share-voting to protect their portfolio investments and improve corporate governance. However, exercising voting rights involves costly and often arcane country-specific legal rules. This report on Sweden is one of a series examining the potential for increased harmonization of cross-border share-voting systems and proxy voting in the U.S. and Member States of the European Union (EU). The first report, on Italy, is in Eckbo, Paone and Urheim (2009). Our Swedish report describes the share-registration system and voting chain for publicly traded companies in Sweden. We highlight voting impediments and examine recent regulatory attempts to make the voting process both more efficient and conforming to the 2007 EU Shareholder Rights Directive. We also provide empirical evidence on how Swedish listed firms have adapted to Sweden's share-voting system. http://www.ecgi.org/wp/wp_id.php?id=473 Mon, 14 Feb 2011 01:55 GMT Law series Corporate governance, i.e. the system by which companies are directed and controlled, has become a key topic for legislation, practice and academia in all modern industrial states. The financial crisis has highlighted the problems. Yet one goes astray if one does not understand how the unique combination of economic, legal and social determinants of corporate governance functions in each country. A functional comparative analysis based on reports from 33 countries and with references to economic literature may help. After dealing with the concepts, instruments (including soft law) and sources of corporate governance, the Article analyses the regulation and practice of the various actors in corporate governance: mainly the board and the shareholders, but also labor, gatekeepers (in particular the auditors), the supervisors and the courts. In the end, a great deal of convergence appears, though many pathdependent differences remain. http://www.ecgi.org/wp/wp_id.php?id=472 Mon, 14 Feb 2011 01:39 GMT Law series European corporate law has enjoyed a renaissance in the past decade. Fifteen years ago, this would have seemed most implausible. In the mid-1990s, the early integration strategy of seeking to harmonise substantive company law seemed to have been stalled by the need to reconcile fundamental differences in approaches to corporate governance. Little was happening, and the grand vision of the early pioneers appeared more dream than ambition. Yet since then, a combination of adventurous decisions by the Court of Justice, innovative approaches to legislation by the Commission, and disastrous crises in capital markets has produced a headlong rush of reform activity. The volume and pace of change has been such that few have had time to digest it: not least policymakers, with the consequence that the developments have not always been well coordinated. The recent 2007/08 financial crisis has yet again thrown many - quite fundamental - issues into question. In this article, we offer an overview that puts the most significant developments of this decade into context, alongside each other and the changing patterns of corporate structure in European countries. http://www.ecgi.org/wp/wp_id.php?id=471 Wed, 26 Jan 2011 16:31 GMT Law series Unlike the failure of a non-financial firm, the failure of a systemically important financial firm will reduce the value of a diversified shareholder portfolio because of an increased level of systemic risk. Thus diversified shareholders of a financial firm generally internalize systemic risk whereas managerial shareholders and blockholders do not. This means that the governance model drawn from non-financial firms will not fit financial firms. Regulation that limits risk taking by financial firms can thus provide a benefit, rather than necessarily impose a cost, for the typical diversified public shareholder. Managerial shareholding also gives rise to particular problem of the CEO who, despite the increasing precariousness of the firm’s position, may be reluctant to pursue equity infusions or to sell the firm because of the consequent dilution of his ownership stake. This might be called the “Fuld problem.” To mitigate excessive risk-taking both in ordinary operations and as the firm approaches financial distress, the paper proposes a new compensation mechanism for senior managers, convertible equity-based pay. Upon certain external triggers, such as a downgrade into a high risk category by regulators or a stock price decline of a particular percentage, such stock-based compensation should convert into subordinated debt, at a valuation discount. This will give managers an incentive to curb excessive risk-taking and in particular to steer the firm away from financial distress. http://www.ecgi.org/wp/wp_id.php?id=470 Wed, 19 Jan 2011 21:00 GMT Law series Called to vote for a reduction in their dividend privileges, the non-voting shareholders of one of the largest Italian firms appeared to expropriate themselves and favor the voting class of shares. However, what at first seemed to be self-expropriation turned out to be self-interest, as soon as the media coverage, the voting decision, and the dual-class ownership of 36,361 shareholders were investigated. Firstly, our new anecdotal evidence shows that the media can mislead investors and help the approval of harmful proposals when they are not independent of the companies they report on. Secondly, most of institutional investors who cast the “for” vote were in conflict of interest either because of ownership ties with the controlling shareholders or because they held both classes of shares. Finally, we find that both retail and institutional dual-class shareholders are more likely to vote for self-expropriating one class of shares if they benefit from the other class in their portfolios. When conflict of interest in dual-class voting is not regulated, dual-class ownership protects from dual-class wealth transfers but favors the approval of the operations it is meant to hedge from. http://www.ecgi.org/wp/wp_id.php?id=469 Wed, 29 Dec 2010 10:22 GMT Finance series We offer a menu of mechanisms to improve the governance of ‘normal times’ financial supervisors (as opposed to resolution agencies and systemic risk boards). To enhance supervisory effectiveness, we propose to institutionalize strong CEOs, with boards or commissions being limited to basic policy decision-making and to monitoring. Moreover, lower level staff would get increased line responsibilities. Market responsiveness, for its part, would be improved by subjecting supervisors to reinforced disclosure requirements. In addition, they would have to ‘act or explain’ when a financial intermediary’s RoE or CDS spreads rise above pre-set thresholds. Finally, the market for supervisory control would be fostered by reinforcing the contingent powers of resolution agencies. This menu approach facilitates implementation and avoids ‘one size fits all’ effects. http://www.ecgi.org/wp/wp_id.php?id=468 Fri, 10 Dec 2010 23:07 GMT Law series We investigate patterns of abnormal stock performance around insider trades and option exercises on the Dutch market. Listed firms in the Netherlands have a long tradition of employing many anti-shareholder mechanisms limiting shareholders rights. Our results imply that insider transactions are more profitable at firms where shareholder rights are not restricted by anti-shareholder mechanisms. This finding goes against the monitoring hypothesis which states that more shareholder orientation and stronger blockholders would reduce the gains from insider trading. We show robust support for the substitution hypothesis as insiders of firms which effectively curtail shareholder rights enjoy valuable private benefits of control in lieu of engaging in insider trading to exploit their position. http://www.ecgi.org/wp/wp_id.php?id=467 Fri, 10 Dec 2010 23:04 GMT Finance series We simultaneously analyze two mechanisms of the managerial labor market (CEO turnover and remuneration schemes) in two different regulatory regimes, namely before and after the sweeping governance reforms adopted in the UK in the 1990s. We employ sample selection models to examine firms in a pre-Cadbury Code period (1988-1993) and a post-Combined Code period (1998-2004). CEOs’ compensation and CEO replacement are performance-sensitive in both periods. There is little evidence of outside shareholder monitoring, whereas powerful CEOs successfully resist replacement irrespective of corporate performance. With regard to CEO remuneration, we sketch a nuanced picture as we find some evidence supporting the alignment of interests hypothesis, but also supporting the managerial power or skimming model for managerial remuneration practices in the UK prior to the governance reforms. In particular, equity-owning CEOs compensate disappointing stock performance by augmenting their monetary compensation. Our results are consistent with the widely perceived failure of internal governance mechanism in tackling the agency problems associated with managerial pay: these mechanisms have relatively little impact on executive remuneration. We also conclude that the regulatory effort undertaken in the UK over the 1990s has had at best a moderate effect on increasing executives’ accountability and performance sensitivity of their turnover. http://www.ecgi.org/wp/wp_id.php?id=466 Fri, 10 Dec 2010 22:25 GMT Finance series After negative shocks, investors with short trading horizons are inclined or forced to sell their holdings to a larger extent than investors with longer trading horizons. This may amplify the effects of market-wide shocks on stock prices. We test the relevance of this mechanism by exploiting the negative shock caused by Lehman Brothers’ bankruptcy in September 2008. Consistent with our conjecture, we find that short-term investors sell significantly more than long-term investors around and after the Lehman Brothers’ bankruptcy. Most importantly, we show that stocks held by short-term institutional investors experience more severe price drops and larger price reversals than those held by long-term investors. Since they are obtained after controlling for the stocks’ exposure to volatility, various firms’ and investors’ characteristics, including the momentum effect and the propensity of institutional investors to follow an index, our results cannot be explained by characteristics of the institutions’ investment styles other than their investment horizons. We also show that the effect of shareholder trading horizon emerges during other large market declines. Overall, the empirical evidence strongly indicates that investors’ short horizons amplify the effects of market-wide negative shocks. http://www.ecgi.org/wp/wp_id.php?id=465 Sun, 05 Dec 2010 20:38 GMT Finance series This paper examines whether reducing a debt overhang improves borrowers' operating performance using a sample of distressed and highly overleveraged Austrian ski hotels undergoing debt restructurings. The vast majority of the ski hotels experience substantial debt forgiveness, resulting in reductions in leverage of about 23 per cent on average. These reductions in leverage, in turn, bring about statistically and economically significant improvements in operating performance of about 28 per cent on average. Changes in leverage during the debt restructurings are instrumented with the level of snow in the years prior to the debt restructurings. The effect of snow is both statistically and economically significant: a one-standard deviation increase in snow is associated with a reduction in leverage of about 23 per cent. http://www.ecgi.org/wp/wp_id.php?id=464 Sun, 05 Dec 2010 20:07 GMT Finance series We analyze the profitability of government-owned banks' lending to their owners. We find evidence that such related lending is used to transfer bank profits to the governments, but only in localities where the incumbent politicians face significant competition for reelection. In localities where the incumbent party has a high probability of reelection there is no such evidence. This result establishes a causal link behind extant evidence that banks' lending to controlling parties (owners and directors) can result in "looting" of the banks. We show that such looting occurs when controlling parties are at risk of losing control. http://www.ecgi.org/wp/wp_id.php?id=463 Mon, 29 Nov 2010 21:18 GMT Finance series We study the impact of the announcement of enforcement of financial and securities regulation by the UK’s Financial Services Authority and London Stock Exchange on the market price of penalized firms. Since these agencies do not announce enforcement until a penalty is levied, their actions provide a uniquely clean dataset on which to examine reputational effects. We find that reputational sanctions are very real: their stock price impact is on average ten times larger than the financial penalties imposed. Furthermore, reputational losses are confined to misconduct that directly affects parties who trade with the firm (such as customers and investors). The announcement of a fine for wrongdoing that harms third parties has, if anything, a weakly positive effect on stock prices. Our results have significant implications for understanding both corporate reputation and regulatory policy. http://www.ecgi.org/wp/wp_id.php?id=462 Mon, 29 Nov 2010 21:07 GMT Finance series The regulation of hostile takeovers constitutes an interesting corporate governance microcosm. It is an area where clear contrasts in approach, regarding the balance of power between shareholders and the board of directors, are evident across different jurisdictions. Takeovers also reflect the dynamic operation of legal regulation (which includes the strategic responses of regulated parties themselves), and the growing tension between globalization and protectionism. This paper analyses the regulation of hostile takeovers across a number of Western and Asian jurisdictions. First, the paper discusses the rise of takeovers and takeover defences in the United States. Against this backdrop, it examines recent developments in some other common law jurisdictions, such as the United Kingdom and Australia. It also raises the experience of the European Takeover Bid Directive, which Professor Hopt has described as “sobering”, in view of the large number of members states adopting a protectionist stance towards the directive’s implementation. The theme of protectionism in takeovers is continued in discussion of takeovers and takeover defences in relation to two major Asian economies, Japan and China. As the paper shows, in spite of the apparent promise of open capital markets offered by globalization, protectionism is on the rise internationally and takeovers play a central role in this evolving story. http://www.ecgi.org/wp/wp_id.php?id=461 Mon, 29 Nov 2010 20:46 GMT Law series We study the role of institutional investors in markets where concentrated ownership and business groups are prevalent. Whereas investors in dispersedly-owned firms are primarily concerned with disciplining managers, investors in firms with a controlling shareholder are concerned with self-dealing and “tunneling.” Institutional investors, however, can effectively use voting to discipline corporate insiders only when the law empowers minority shareholders to influence vote outcomes. Moreover, the presence of powerful families who control many public companies through business groups creates new potential conflicts for institutional investors. Using hand-collected data on voting by institutional investors in Israel, we find that (i) legal intervention plays an important role in driving institutional investors’ activism; (ii) institutional investors are most likely to object to firms’ compensation-related proposals (and not tunneling transactions), but even when their votes do not matter; (iii) institutional investors with other business activities (e.g. underwriting) and those affiliated with a public company or business group are more likely to support insider-sponsored proposals than “pure-play,” stand-alone investors. Again, this tendency persists even when outside investors’ votes do not matter; and (iv) Large firms tend to enjoy a more favorable treatment from institutional investors, whereas firm performance has virtually no impact on voting. http://www.ecgi.org/wp/wp_id.php?id=460 Wed, 24 Nov 2010 21:38 GMT Law series Delaware’s courts and well-developed case law are widely seen as integral elements of Delaware’s success in the competition among states for incorporations. Today, however, Delaware’s popularity as a venue for corporate litigation is under threat. Increasingly, as the empirical evidence summarized in this paper shows, corporate cases involving Delaware-incorporated companies are being brought and decided elsewhere. This paper examines the implications of this “out-of-Delaware” trend, emphasizing in so doing a difficult balancing act that the Delaware courts face. If Delaware accommodates litigation too readily, plaintiffs’ attorneys will file a plethora of “weak” cases and companies, fearful of lawsuits, may begin to incorporate elsewhere. On the other hand, if plaintiffs’ attorneys believe the Delaware judiciary is unwelcoming, they will tend to file cases in other courts. Delaware could then lose its status as the de facto national corporate law court and may no longer offer the rich body of up-to-date case law precedent upon which “users” of Delaware corporate law depend. Delaware’s overall corporate law “brand” could in turn become less valuable, thus jeopardizing its pre-eminence in the competition for incorporations. http://www.ecgi.org/wp/wp_id.php?id=459 Tue, 23 Nov 2010 20:25 GMT Law series This paper studies mergers between competing firms and shows that while such mergers reduce the level of product market competition, they may have an adverse effect on employee incentives to innovate. In industries where value creation depends on innovation and development of new products, mergers are likely to be inefficient even though they increase the market power of the post-merger firm. In such industries, a stand-alone structure where independent firms compete both in the product market and in the market for employee human capital leads to a greater profitability. Furthermore, our analysis shows that multidivisional firms can improve employee incentives and increase firm value by reducing firm size through a spin-off transaction although doing so eliminates the economies of scale advantage of being a larger firm and the benefits of operating an internal capital market within the firm. Finally, our paper suggests that established firms can benefit from creating their own competition in the product and labor markets by accommodating new firm entry, and the desire to do so is greater at the intermediate stages of industry/product development. http://www.ecgi.org/wp/wp_id.php?id=458 Tue, 16 Nov 2010 22:25 GMT Finance series In this Article we submit that the compensation structures at banks before the financial crisis were not necessarily flawed and that recent reforms in this area largely reflect already existing best practices. In Part I we review recent empirical studies on corporate governance and executive pay at banks and suggest that there is no strong support for regulating bankers’ compensation structures. We also argue that detailed regulation of incentives would subtract essential decisionmaking powers from boards of directors and make compensation structures too rigid. In Part II we note that political support for regulating bankers’ pay has been strong and led to reforms promoting long-term incentives to executives on the assumption that short-term incentives were a cause of the crisis. The Financial Stability Board Principles for Sound Compensation Practices (the “Principles”) follow this trend, at the same time representing a political compromise between the various interest groups concerned. They pick up traditional compensation criteria from pre-crisis best practices, adapting them to the post-crisis setting, while leaving some flexibility in pay structures. We suggest that a certain degree of flexibility should be kept when implementing the Principles in national jurisdictions. In Part III we analyze the regulatory developments concerning executive pay at banks in Europe and find variations in the implementation of the Principles. We also show that remuneration policies at large European banks are converging towards the international Principles, while varying in the implementation of individual standards. However, recent EU reforms may change the situation considerably by imposing detailed requirements as to pay structures in the financial sector. http://www.ecgi.org/wp/wp_id.php?id=457 Fri, 12 Nov 2010 16:39 GMT Law series In this article, we study the choice of issuer location and regulatory competition in the European corporate debt market. We find that, in absolute terms, Germany has by far the highest outflow of debt issues, while the Netherlands, the UK, Luxembourg and Ireland see the most inflows (in that order). We use a panel gravity model to investigate country specific factors attracting foreign subsidiaries as issuer. The data clearly support the prediction that the locational choice is positively influenced by a low withholding tax rate. There is also some evidence that corporate tax rates play a role. We do not find support for creditor protection rules in bankruptcy as a driver of cross-border debt securities issues. Hence, countries who wish to attract issuers are well-advised to reduce their withholding tax rates – creditor rights seem not to matter. http://www.ecgi.org/wp/wp_id.php?id=456 Wed, 10 Nov 2010 14:48 GMT Finance series This study compares CEO employment contracts across two very different common law countries. In order to do our comparison, we create pairs of U.S. and Australian firms that are matched on a number of dimensions including firm size and industry. We find that Australian CEOs have significantly greater base salaries than their U.S. counterparts, while U.S. CEOs are more likely to be compensated with restricted stock and stock options than the Australians. More striking is the fact that U.S. CEO employment contracts tend to last longer than Australian contracts, and are more likely to have arbitration provisions, change-in-control provisions, tax gross ups, do not compete clauses, and SERPs. http://www.ecgi.org/wp/wp_id.php?id=455 Tue, 02 Nov 2010 21:31 GMT Law series The paper was prepared as the Australian National Report on Corporate Governance for the International Academy of Comparative Law, 18th International Congress of Comparative Law, which was held in Washington from July 25 - August 1, 2010. The paper provides an overview of the structure of corporate governance in Australia, focusing on a number of recent developments in this area. Many elements of Australian corporate law differ markedly from the U.S. system. Specific corporate governance issues, which are discussed in the paper in an Australian context include: the effect of financial scandals on corporate law reform; composition and structure of the board of directors, including recent developments concerning board diversity; directors’ duties and the operation of the antipodean version of the business judgment rule; trends in the structure and regulation of executive compensation; shareholder rights and minority shareholder protection; shareholder activism; takeover regulation; the continuous disclosure regime; and enforcement by regulator, the Australian Securities and Investments Commission (ASIC). http://www.ecgi.org/wp/wp_id.php?id=454 Sun, 26 Sep 2010 20:19 GMT Law series This article is published in a special symposium edition on the work of Adolf Berle, which includes papers from a conference, In Berle’s Footsteps, held in November 2009 to celebrate the launch of the Adolf A. Berle, Jr. Center on Corporations, Law and Society. Shareholders, and the relationship between shareholders and management, lay at the heart of Professor Berle’s scholarship. The goal of this Article is to compare the image of shareholders emerging from The Modern Corporation and Private Property and the Berle/Dodd debate with a range of contemporary visions of the shareholder that underpin some international regulatory responses to recent financial debacles, from Enron to the current global financial crisis. As the Article discusses, these recent developments in the era of financial crises, including the US shareholder empowerment debate, have prompted a re-evaluation of the traditional image of the shareholder and the role of the shareholder in the modern corporation that emerged in Professor Berle’s work. http://www.ecgi.org/wp/wp_id.php?id=453 Sun, 26 Sep 2010 20:17 GMT Law series In this article, I provide a comparative historical account on the debate of whether corporations should exclusively be run by the company in the interest of shareholders, or whether managers should be permitted or required to take the interests of others groups (stake-holders) into account. The comparison focuses on the US, Germany and France and traces the debates through the most important formative periods of these countries’ corporate governance systems. It is generally assumed that shareholder primacy has a stronger following in the US and the UK than in Continental Europe, where the stakeholder view is thought to be more influential. Without doubt, the respective political histories and cultures of these countries have influenced this divergence. Without ignoring the significance of these factors, this article emphasizes a core issue that has so far been largely overlooked in comparative analysis. I argue that the respective historical debates exhibited important differences that can be attributed to the shareholder-manager balance of powers and differences in stock ownership structure across countries. Scholars in the US, Germany and France were therefore arguing about different issues due to different economic circumstances, which is why it is problematic to equate adherents of shareholder primacy or a stakeholder view of the firm with their counterparts in other corporate governance systems. In the US, Berle and Means famously identified the prevalence of a strong separation of ownership and control in 1933. US-style dispersed ownership has always generated debates about the question of how to best address what is today described as an agency cost problem, but also to what extent managerial power is legitimate. By contrast, larger blocks of share ownership prevailed around 1930 in Continental Europe, as they still do today. Participants in the German and French debates were therefore concerned with issues of controlled companies and corporate groups, which undermined the power of the board of directors. At the same time, the comparatively strong influence of shareholders raised other concerns that were rarely an issue in large US corporations, such as blockholders’ private benefits of control and conflicts between competing groups of shareholders that arguably harmed business development. Institutional theories of the corporation, which are traditionally hospitable to stakeholder concerns, seemed to provide a defense of the corporation against its shareholders. The different nature of the main issues put pro-management and pro-shareholder on different sides of the shareholder-stakeholder debate on the two sides of the Atlantic. In the US, reformers typically had the goal of limiting the power of management to the benefit of shareholders, thereby “taming” the large corporations, whose power was (and is) often identified with that of top management. In France and Germany, critics of the prevailing allocation of control advocated an institutional theory of the corporation to protect the “business in itself” in Continental Europe, and by proxy, its stakeholders from destructive shareholder influence. Continental critics of the status quo therefore sought to limit allegedly excessive influence of shareholders and capital on corporate management. http://www.ecgi.org/wp/wp_id.php?id=452 Wed, 15 Sep 2010 14:35 GMT Law series Both in Europe and in the United States, major steps have been taken to render credit rating agencies more accountable. But do these steps address the causes of the debacle in the subprime mortgage market that triggered the 2008-2009 crisis? Surveying the latest evidence on how and why credit ratings became inflated, this paper argues that conflicts of interest cannot be purged on a piecemeal basis. The fundamental choice is between (1) implementing a “subscriber pays” model that compels rating agencies to compete for the favor of investors, not issuers, and (2) seeking to deemphasize or eliminate the role of credit ratings to reduce the licensing power of rating agencies. Although it strongly favors the first option over the second, it also recognizes that the “public goods” nature of ratings makes it unlikely that a “subscriber pays” system will develop on its own without regulatory interventions. Thus, it considers how best to encourage the development of a modified system under which the investor would choose and the issuer/deal arranger would pay for the initial rating on structured finance transactions. http://www.ecgi.org/wp/wp_id.php?id=451 Fri, 10 Sep 2010 19:53 GMT Law series We construct a comprehensive data set with detailed biographic data on 12,010 board directors working for 740 large banks from 41 countries over the period 2000-2008. The data allow us to create a novel and reliable measure of director independence. We report many new findings. Bank board independence increases rapidly and substantially in the pre-crisis period, peaking at about 67 per cent in 2006. High independence levels are predominantly a US phenomenon, as US banks display board independence levels that are on average 19 percentage points higher than those of non-US banks with similar characteristics. We find that country characteristics explain most of the cross-sectional variation in bank board independence. This evidence suggests that country-specific laws and regulations affect the composition of boards of banks. Consistent with this interpretation, we find that bank board independence is lower in countries where courts can remove bank directors and where regulations allow for two-tiered boards. In contrast, there is no robust evidence that investor protection and financial development are related to bank board independence. We also find that bank characteristics play a more pronounced role in determining other board characteristics (such as board size and director busyness) than in determining board independence. http://www.ecgi.org/wp/wp_id.php?id=450 Wed, 01 Sep 2010 12:16 GMT Finance series We analyze several proposals to restrict CEO compensation and calibrate two models of executive compensation that describe how firms would react to different types of restrictions. We find that many restrictions would have unintended consequences. Restrictions on total realized (ex-post) payouts lead to higher average compensation, higher rewards for mediocre performance, lower risk-taking incentives, and the fact that some CEOs would be better off with a restriction than without it. Restrictions on total ex-ante pay lead to a reduction in the firm’s demand for CEO talent and effort. Our model predicts an average reduction in firm value of 0.65 per cent when total pay is reduced by 20 per cent. Restrictions on particular pay components, and especially on cash payouts, can be easily circumvented. While restrictions on option pay lead to lower risk-taking incentives, restrictions on incentive pay (stock and options) result in higher risk-taking incentives. http://www.ecgi.org/wp/wp_id.php?id=449 Fri, 20 Aug 2010 08:14 GMT Finance series This paper provides a comprehensive look at the first decade of foreign investor activism in Japan, the second largest stock market in the world with many underperforming and cash-rich firms. Barriers to shareholder activism have historically been high but we document an unprecedented wave of block acquisitions by hedge fund and other investors with a total of 916 stakes reported in the period between 1998 and 2009. There is, on average, a modest positive stock price reaction to the announcement of activist investments, particularly for events involving hostile funds. The long-run returns on activism are low overall, but positive for events involving hostile funds. We find that while activists have forced target firm managers to increase their payouts compared to peer firms, there is no evidence of major operational improvements or restructuring. Finally, after 2006 there was a widespread adoption of "poison pills" by firms, particularly those targeted by activists, and a subsequent drop in investor activism. Our paper illustrates the limits to shareholder activism in a country where the takeover market is thin and cannot be used by the activist investor as an exit strategy. http://www.ecgi.org/wp/wp_id.php?id=448 Sun, 11 Jul 2010 20:58 GMT Finance series One of the main objectives of transnational banking regulation over the past two decades has been the standardization of regulatory practices and the allocation of regulatory powers to minimize the regulatory burden for banks. The resulting division of labor between home and host country regulators strongly favors Home over Host; And the regulatory scope has continued to focus on entities rather than activities. This paper argues that this has created several blind spots in transnational regulation of finance. First, Home is unlikely to monitor and respond to risks that are unique to Host, even though they might emanate from activities of banks that are subject to their consolidated regulatory supervision. Second, Host, may have regulatory supervision over a subsidiary of Home’s parent company, but may rely on Home to exert regulatory controls. Moreover, Host has little regulatory leverage if the parent bank side-steps regulatory restrictions imposed on subsidiaries by engaging in direct lending practices, or by channeling capital through entities that are not subject to similar regulations. Second, the continued focus on entity based regulation ignores the fact that the core function of banks, maturity transformation, is increasingly performed by non-bank institutions that escape the existing transnational regulatory framework. Against this background, this paper proposes effect-based regulation, which gives Host the power to regulate any activity that has a systemic effect on its financial system, irrespective of who undertakes it and where it is carried out. The paper uses the recent example of Central and Eastern Europe during the global financial crisis to illustrate the failure of the existing regime. http://www.ecgi.org/wp/wp_id.php?id=447 Thu, 01 Jul 2010 20:41 GMT Finance series We investigate the link between compensation and risk-taking among finance firms during the period of 1992-2008. First, there are substantial cross-firm differences in residual pay (defined as total executive compensation controlling for firm size). Second, residual pay is correlated with price-based risk-taking measures including firm beta, return volatility, the sensitivity of firm stock price to the ABX subprime index, and tail cumulative return performance. Third, these risk-taking measures are correlated with pay even though executives are highly incentivized as measured by insider ownership. Finally, compensation and risk-taking are not related to governance variables but covary with ownership by institutional investors who tend to have short-termist preferences and the power to influence firm management policies. Our findings suggest that our residual pay measure is picking up other important high-powered incentives not captured by insider ownership. They also point to substantial heterogeneity in both firm culture and investor preferences for short-termism and risk-taking. http://www.ecgi.org/wp/wp_id.php?id=446 Wed, 16 Jun 2010 21:48 GMT Finance series In this study we find that the set of policies that favour liberalization in credit markets (regulatory quality) are negatively correlated with countries’ resilience to the recent recession as measured by output growth in 2008 and 2009. http://www.ecgi.org/wp/wp_id.php?id=445 Wed, 16 Jun 2010 12:09 GMT Finance series The standard narrative of the meltdown of Bear Stearns and Lehman Brothers assumes that the wealth of the top executives of these firms was largely wiped out along with their firms. In the ongoing debate about regulatory responses to the financial crisis, commentators have used this assumed fact as a basis for dismissing both the role of compensation structures in inducing risk-taking and the potential value of reforming such structures. This paper provides a case study of compensation at Bear Stearns and Lehman during 2000-2008 and concludes that this assumed fact is incorrect. We find that the top-five executive teams of these firms cashed out large amounts of performance-based compensation during the 2000-2008 period. During this period, they were able to cash out large amounts of bonus compensation that was not clawed back when the firms collapsed, as well as to pocket large amounts from selling shares. Overall, we estimate that the top executive teams of Bear Stearns and Lehman Brothers derived cash flows of about $1.4 billion and $1 billion respectively from cash bonuses and equity sales during 2000-2008. These cash flows substantially exceeded the value of the executives’ initial holdings in the beginning of the period, and the executives’ net payoffs for the period were thus decidedly positive. The divergence between how the top executives and their shareholders fared implies that it is not possible to rule out, as standard narratives suggest, that the executives’ pay arrangements provided them with excessive risk-taking incentives. We discuss the implications of our analysis for understanding the possible role that pay arrangements have played in the run-up to the financial crisis and how they should be reformed going forward. http://www.ecgi.org/wp/wp_id.php?id=444 Mon, 14 Jun 2010 13:19 GMT Finance series The majority of commentators, along with the public opinion, are inclined to identify the causes of the last financial crisis in a combination of traditional market and regulatory failures in the operation and regulation of financial markets. Whatever cannot be explained along these lines is interpreted as evidence of inability of individuals, including market professionals, to make rational choices. Without denying the importance of these factors in explaining the behavior of some of the players involved, this paper argues that the extraordinary proportions of the crisis we have experienced are better understood by looking at the specific dynamics of financial innovation through securitization of illiquid assets. Particularly, a perverse combination of Knightian uncertainty and externalities in banking seems to have been the major responsible of the financial crisis. This paper investigates the role of uncertainty and externalities in the unfolding of events that determined the financial crisis. In this perspective, financial regulation has not been just too lax or too lenient. Rather, it has distorted the choices of financial intermediaries ex-ante (inducing them to rely too much and too quickly on liquidity for funding and profits) and it has turned out to be too rigid ex-post (failing to provide the banking system with incentive-compatible forms of resilience). The implications of this approach are discussed with regard to the regulation of credit rating agencies, the pro-cyclicality of capital adequacy regulation, and the corporate governance of banks. http://www.ecgi.org/wp/wp_id.php?id=443 Fri, 11 Jun 2010 21:19 GMT Law series Corporate governance codes and corporate law contain provisions of internal control and risk management. First, this paper analyses the state of the art of these provisions in five Western European countries. The regulatory framework stretches from a Frühwarnsystem in Germany over the internal control report of the French chairman of the board and the internal control statement of the Dutch board to the European corporate governance statement and the UK sound risk management maintenance principle. Next, the paper provides insights how a sample of REIT’s put the internal control and risk management rules and principles into corporate practice over the last decade. The analysis demonstrates that risk identification, financial risk management and risk response grew to an advanced stage while risk assessment – in particular the impact assessment of non-financial risks – and control activities are still in a development stage. The evidence shows that risk management practices are driven by regulation and legislation. Many but not all internal control features have been harmonized. The last section discusses some of the legal consequences of the finding that in view of both the regulatory developments and corporate practices new risks have emerged. First, the legal requirements as well as the eagerness of companies to fully comply with all best practices create a field of tension between the basic assumption of risk management frameworks in providing (only) reasonable assurance and the (reported) state of the art of managing and apparently controlling all (material) risks. Second, there is the risk related to the friction between the progress in identifying the risk management responsibilities of the concerned corporate parties while there is a standstill of other areas of law and in particular of the liability regimes. http://www.ecgi.org/wp/wp_id.php?id=442 Fri, 11 Jun 2010 20:41 GMT Law series In 2008 the European Commission put forward proposals for a European Private Company (SPE), following up on the adoption of the European Public Company legislation of 2001. Although speedy adoption of the SPE proposals was initially hoped for, subsequent negotiations among the member states have stalled, despite at least two revised drafts of the proposals having been produced by the Presidency of the European Council. This article seeks to identify the challenges posed to the national company laws of the member states by the Commission’s proposals for a ‘simple and flexible’ Community form of incorporation. It seeks to argue that the discussions among the member states have revolved mainly around the question of the appropriate role for mandatory rules in modern company law. Member states have been reluctant to see the SPE freed from mandatory rules to which their national companies are subject, because of the competition to their national laws which the SPE would generate. On the other hand, member states with few mandatory rules in their domestic law have been reluctant to see the SPE burdened with mandatory rules which do not apply to domestic companies, because otherwise their businesses will be deterred from taking up the new European form and obtaining its advantages. The article predicts that, of the possible legislative solutions to this conflict, referring more of the rules applicable to the SPE to the national law of the state in which the SPE is registered is likely to be the dominant one, even though this will undermine both the uniformity and flexibility goals of the proposed legislation. It also considers how effective the ‘national law’ strategy is likely to be in the light of the Treaty provisions on freedom of establishment. http://www.ecgi.org/wp/wp_id.php?id=441 Thu, 10 Jun 2010 14:39 GMT Law series We analyze how 13,600 US top executives exercise their stock options. We run a horse race of competing explanatory approaches to identify the main variables that influence executives’ timing decisions. We find that the time value of the option, characteristics of managers’ option portfolios, and institutional factors (vesting dates, blackout periods) have a first-order impact on exercise behavior. Behavioral factors (e.g., trends in past stock prices) and timing based on inside information also influence stock option exercises, but are quantitatively less important. While there is evidence for some behavioral biases, managers seem to see through investor sentiment and apply useful heuristics for choosing among their exercisable options. http://www.ecgi.org/wp/wp_id.php?id=440 Tue, 08 Jun 2010 14:28 GMT Finance series The paper analyzes 362 European activist interventions by hedge funds, focus funds and other activist investors from 2000 to 2008. The sample includes both public and private interventions. The private interventions are based upon proprietary data collected from five activist funds. For public interventions the disclosure of acquired stakes is associated with large positive abnormal returns across a number of jurisdictions. Private activism is extensive and profitable but less so than public activism, in large part because the incidence of takeovers is higher in public activism. The returns from hostile activist interventions are more profitable than co-operative ones, and returns for specialist activist funds are substantially larger than for other investors. After controlling for these factors legal jurisdiction does not explain differences in returns across countries. http://www.ecgi.org/wp/wp_id.php?id=439 Mon, 07 Jun 2010 20:41 GMT Finance series We examine whether stock market-listed firms in the U.S. invest suboptimally due to agency costs resulting from separation of ownership and control. We derive testable predictions to distinguish between underinvestment due to rational 'short-termism' and overinvestment due to 'empire building'. Empirical identification relies on a proxy for optimal investment derived from a rich new data source on unlisted U.S. firms. Listed firms invest less and are less responsive to changes in investment opportunities compared to matched unlisted firms, especially in industries in which stock prices are particularly sensitive to current profits. Listed firms also tend to smooth their earnings growth and dividends and are reluctant to report negative earnings. These findings are consistent with short-termism and contrary to what one would expect if empire-building were the dominant agency problem in the stock market. Our results suggest that the stock market harms investment incentives, at least for the fast-growing companies in our sample. http://www.ecgi.org/wp/wp_id.php?id=438 Fri, 28 May 2010 08:39 GMT Finance series The inherent tensions in the financial sector mean that episodes of extreme stress are inevitable, if unpredictable. This is so even if the regulatory and supervisory regimes are in many respects effective. The capacity of government to intervene may determine whether the distress is confined to the financial sector or breaks out into the real economy. Although adequate resolution authority to address a failing financial firm is a necessary objective of the current regulatory reform, a firm-by-firm approach will be unable to address a major systemic failure such as the Crisis of 2007-08, which may require capital support of the financial sector to avoid severe economic harm. We therefore propose standby systemic emergency finding authority, triggered by agreement among Treasury, the Federal Reserve, and the FDIC. Such a fund, scaled appropriately to the size of the US economy, $1 trillion, should be funded (and partially pre-funded) by risk-adjusted assessments on all large financial firms, who benefit from systemic stability. Standby emergency authority avoids the need for high stakes legislative action mid-crisis, which can be destabilizing even if successful and catastrophic if not. The triple key? constraint and on-going monitoring and oversight should address concerns of legitimacy and accountability. http://www.ecgi.org/wp/wp_id.php?id=437 Fri, 14 May 2010 13:18 GMT Finance series Outside directors have incentives to resign to protect their reputation or to avoid an increase in their workload when they anticipate that the firm on whose board they sit will perform poorly or disclose adverse news. We call these incentives the dark side of outside directors. We find strong support for the existence of this dark side. Following surprise director departures, affected firms have worse stock and operating performance, are more likely to suffer from an extreme negative return event, are more likely to restate earnings, and have a higher likelihood of being named in a federal class action securities fraud lawsuit. http://www.ecgi.org/wp/wp_id.php?id=436 Wed, 12 May 2010 15:31 GMT Finance series Outside directors have incentives to resign to protect their reputation or to avoid an increase in their workload when they anticipate that the firm on whose board they sit will perform poorly or disclose adverse news. We call these incentives the dark side of outside directors. We find strong support for the existence of this dark side. Following surprise director departures, affected firms have worse stock and operating performance, are more likely to suffer from an extreme negative return event, are more likely to restate earnings, and have a higher likelihood of being named in a federal class action securities fraud lawsuit. http://www.ecgi.org/wp/wp_id.php?id=436 Wed, 12 May 2010 15:31 GMT Finance series This Article examines the consequences of regulatory arbitrage in European corporate law on the position of employees. Two innovations of secondary EU law, namely the possibility to create a European Company (“SE”) out of existing firms and the Directive on Cross-Border Mergers, have made regulatory arbitrage with respect to employee involvement in existing firms possible. While these instruments require the merging firms to negotiate with employees about their representation rights as a precondition to the merger, a closer analysis of the law and recent experience show that the protection accorded to existing employee participation systems is incomplete. There can be little doubt about some potential advantages of regulatory arbitrage, such as the possibility to avoid excessive regulation. However, the possibility of an “erosion” of employee participation systems (such as codetermination) undermines their economic function, which is to foster long-term commitment. This Article takes a broad view on the role of labor in corporate governance and also addresses other mechanisms affected by regulatory arbitrage opportunities that are potentially relevant for the position of employees, such as the degree to which management is directly or indirectly influenced by shareholders, and directors’ duties in general and in takeovers in particular. It suggests that controlling shareholders, whose presence characterizes corporate governance structures in much of Europe, are in a good position to exploit arbitrage opportunities to the disadvantage of other groups, including labor. http://www.ecgi.org/wp/wp_id.php?id=435 Wed, 12 May 2010 07:01 GMT Law series This paper discusses differences in countries’ approaches to reporting regulation and explores the reasons why they exist in the first place as well as why they are likely to persist. I first delineate various regulatory choices and discuss the tradeoffs associated with these choices. I also provide a framework that can explain differences in corporate reporting regulation. Next, I present descriptive and stylized evidence on regulatory and institutional differences across countries. There are robust institutional clusters around the world. I discuss that these clusters are likely to persist given the complementarities among countries’ institutions. An important implication of this finding is that reporting practices are unlikely to converge globally, despite efforts to harmonize reporting standards. Convergence of reporting practices is also unlikely due to persistent enforcement differences around the world. Given an ostensibly strong demand for convergence in reporting practices for globally operating firms, I propose a different way forward that does not require convergence of reporting regulation and enforcement across countries. The idea is to create a “Global Player Segment” (GPS), in which member firms play by the same reporting rules and face the same enforcement. Such a segment could be created and administered by a supra-national body like IOSCO. http://www.ecgi.org/wp/wp_id.php?id=434 Tue, 11 May 2010 20:56 GMT Law series In this paper, we examine recent developments and new perspectives of European banking regulation from the viewpoint of multinational banks. Our approach is justified on at least three grounds. First, cross-border banking groups were at the centre of the recent financial turmoil, which seriously affected many of them. Second, and as a consequence, recent reforms in Europe and elsewhere were particularly addressed to cross-border banking groups and other systemically relevant institutions. Third, European harmonization was largely built along the model of the (stand-alone) cross-border bank mainly operating through branches, whereas European financial markets see cross-border banking groups with subsidiaries in several countries as major players. After introducing the mismatch between national banking supervision and international banking groups, we analyze the recent developments of EU cross-border supervision with respect to both branch and subsidiary structures of multinational banks. Subsequently, we examine the proposed new regulatory architecture, which is based on the distinction between macro- and micro- prudential supervision, and includes new European bodies and a network of European financial supervisors. We claim that the proposed new European supervisory architecture should be backed with an appropriate framework for crisis management and resolution. Due to the specificities of multinational banks and the unique features of their corporate governance, we argue for uniform rules and a set of tools for early intervention and resolution. Otherwise, fragmentation of ailing institutions along national borders will limit the scope for and possibly lead to a reversal of the European financial integration process. From this perspective, the steps taken so far in the EU, while remarkable, do not seem sufficient. Moreover, their effectiveness very much depends on how crisis management and resolution will be regulated. http://www.ecgi.org/wp/wp_id.php?id=433 Wed, 28 Apr 2010 09:14 GMT Law series The proposals to limit auditor liability, principally aimed at protecting the Big-4 from the risk of a catastrophic exposure to damages, are grounded on the assumption that auditors are generally over-deterred. The 2008 EC Commission Recommendation on auditor liability relies heavily on this assumption and the economic rationale that underpins it, which is entirely focused on liability towards investors and the US narrative concerning securities class actions. However, the case is much more complex. Any discussion about auditor liability must investigate the following questions: who the auditor’s principals are; whether they are in a position to negotiate in order to design the optimal liability regime; whether and at what stage market failures prevent contractual negotiation; what kind of positive (or negative) interferences stem from multiple negotiations and a multi-layered liability regime; how such a multi-layered regime might be designed. This article covers these issues. It conducts a step-by-step analysis of each layer and considers the potential interactions amongst them. Its conclusion is that it is impossible to assess the optimal level of deterrence in multi-layered liability regimes of such complexity. From a wealth perspective, the case for a mandatory limitation of liability can be argued exclusively with regards to liability towards secondary market investors, albeit subject to numerous qualifications that the conventional wisdom too easily overlooks. http://www.ecgi.org/wp/wp_id.php?id=432 Wed, 28 Apr 2010 09:07 GMT Law series Chapter 11 bars bankrupts from immediately repaying their creditors, so that the court can reorganize the debtor without creditors shredding the bankrupt firm’s business. Not so for the bankrupt’s derivatives counterparties, who can seize and liquidate collateral, net out gains and losses, terminate their contracts with the bankrupt, and keep both preferential eve-of-bankruptcy payments and fraudulent conveyances they obtained from the debtor in ways that favor them over other creditors. Their right to jump to the head of the bankruptcy repayment line, ahead of even ordinary secured creditors, warps their pre-bankruptcy incentives both to monitor the pre-bankruptcy debtor and to adjust their investments to better account for counterparty risk, since they do well in any resulting bankruptcy. If they bear less risk, other creditors bear more risk and have more incentives to monitor the debtor or to assure themselves that the debtor is a safe bet. But the other creditors - such as the United States of America - are poorly positioned to provide that monitoring. Moreover, the policy justification for the super-priorities - reducing financial contagion risk - is difficult to maintain today: contagion is as likely to be propagated by the priorities as it is to be stifled, the priorities did not prevent contagion in the 2007-2008 financial melt-down and may have spread it, and we use alternate resolution mechanisms anyway for systemically vital failing financial institutions. Bankruptcy policy was made in the erroneous belief that it could contain contagion and that there was no other way to do so. The best regulatory reaction to these monitoring and regulatory disconnects is for Congress to cut back the extensive de facto priorities embedded now in chapter 11 for these derivatives counterparties. Repeal would induce the derivatives market to better recognize the risks of counterparty financial failure, which in turn should dampen the possibility of another AIG/Bear/Lehman financial melt-down, thereby helping to maintain financial stability. Yet the major financial reform packages now in Congress do not contemplate the needed cutbacks. http://www.ecgi.org/wp/wp_id.php?id=431 Tue, 27 Apr 2010 19:43 GMT Law series This article explores the rising tension between shareholder and director power in the common law world. First the article analyzes key arguments in the shareholder empowerment debate, and current US reform proposals to grant shareholders stronger rights, from a comparative corporate law perspective, examining how traditional US legal rules diverge from other common law jurisdictions. Secondly, the article discusses power shifts in the opposite direction – namely toward the board – in some parts of the common law world. The article shows that US shareholders have traditionally had unusually restricted rights compared to their counterparts in common law jurisdictions, such as the United Kingdom and Australia. It challenges a number of arguments supporting the traditional US approach, by showing that the arguments are often US-specific, and are less persuasive from a comparative corporate governance perspective. The article also identifies an important tension between legal rules designed to enhance shareholder power, and commercial practices designed to subvert it. It shows how strategic commercial responses to regulation can affect the operation of legal rules. The existence of commercial pushback of this kind suggests that, even if US shareholder powers are significantly strengthened, that will by no means be the end of the story. http://www.ecgi.org/wp/wp_id.php?id=430 Tue, 27 Apr 2010 19:35 GMT Law series As a consequence of the financial crisis, the effectiveness of self-regulation has been increasingly questioned. In particular, self-regulatory initiatives on corporate governance have been often put under scrutiny so as to assess whether, by favouring the actual adoption of best practices, these codes are really effective in prompting better governance. Looking at one of the most important features of the Code, this paper tries to address this issue by building up an indicator (so-called CoRe) that assesses the actual level of compliance for Italian listed companies. We fi nd that actual compliance, as measured by the CoRe indicator, is much lower than formal compliance, as declared by issuers. A second finding is that actual compliance is driven by some key aspects of fi rms’ governance. The CoRe indicator is systematically higher in fi rms in which: i) minority shareholders have appointed one or more directors; ii) independent directors are organized in a committee; iii) institutional investors, especially if foreign, participate to GMs; iv) normative control enhancing mechanisms are adopted, v) there is no separation between ownership and control by means of pyramids http://www.ecgi.org/wp/wp_id.php?id=429 Fri, 09 Apr 2010 14:29 GMT Finance series This study investigates how directors make decisions that involve shareholders and other stakeholders. Using vignettes derived from seminal court cases, we construct an index of directors’ shareholderism as a general orientation on this issue. In a survey of the entire population of directors and CEOs in public corporations in one country, we find that directors’ personal values and roles play an important part in their decisions. Directors and CEOs are more pro-shareholder the more they endorse entrepreneurial values - specifically, higher achievement, power, and self-direction values and lower universalism values. While employee representative directors exhibit a lower baseline level of shareholder orientation, they nonetheless often side with shareholders. http://www.ecgi.org/wp/wp_id.php?id=428 Fri, 09 Apr 2010 09:40 GMT Finance series In the last few years, also in the light of the financial crisis in which the world has plummeted, the concern for self-referential and unaccountable boards has gained momentum and prompted several important reforms aimed at enhancing shareholders’ democracy. The reforms recently implemented or currently under consideration both at the state and federal levels, focusing on proxy access, might however prove to be too timid to exorcise this specter. This Article discusses the limits of the latest legislative and regulatory initiatives and advances a new, bold if not heterodox, proposal to empower shareholders and better align the composition of the board to the interests of all the owners of the corporation. The core of the proposal is a proportional voting system called 'list voting.' Building also on a brief comparative analysis, the Article advocates that 'list voting' is superior to the traditional U.S. 'cumulative voting' both from the point of view of directors, managers and controlling shareholders, and of minority shareholders. http://www.ecgi.org/wp/wp_id.php?id=427 Fri, 09 Apr 2010 09:29 GMT Law series The legal origins hypothesis is one of the most important and influential ideas to emerge in the social sciences in the past decade. However, the empirical base of the legal origins claim has always been contestable, as it largely consists of cross-sectional datasets which provide evidence on the state of the law only at limited points in time. There is now a growing body of data derived from techniques for coding cross-national legal variation over time. This time-series evidence is reviewed here and is shown to cast new light on some of the central claims of legal origins theory. Legal origins are shown to be of little help in explaining trends in the law relating to shareholder protection, although the classification of legal systems into English-, French- and German-origin ‘families’ has greater explanatory force in the context of creditor rights. The widely-held view that increases in shareholder rights foster financial development is not supported by time-series analyses. More generally, the new evidence casts doubt on the suggestion that legal origins operate as an ‘exogenous’ force, independently shaping both the content of laws and economic outcomes. It is more plausible to see legal systems as evolving in parallel with changes in economic conditions and political structures at national level. http://www.ecgi.org/wp/wp_id.php?id=426 Thu, 08 Apr 2010 17:26 GMT Law series With the state competition for incorporations, Delaware’s courts are seen as an integral part of the Delaware “brand”, which implies most corporate cases involving Delaware companies are litigated in Delaware. In this paper, we show that over the past decade the proportion of corporate suits involving Delaware public companies filed in Delaware has dropped markedly and that Delaware courts now hear only a minority, perhaps a small minority, of the cases involving such firms. Because Delaware is losing its cases, it is in danger of losing its status as the dominant locus for corporate law for U.S. public companies. However, it will be difficult for Delaware courts to execute a successful rearguard action to recapture “market share”. To document the out-of-Delaware litigation trend we rely on three hand-collected datasets: (i) corporate law cases arising between 1995-2009 where directors of public companies were named as defendants and the case generated one or more judicial opinions on Lexis, Westlaw, or the Delaware Chancery Court website (ii) lawsuits arising under corporate law from leveraged buyouts taking place between 1999-2009 and (iii) lawsuits arising under corporate law from allegations of options backdating. The first dataset encompasses the broadest range of litigation subject matter but fails to cover the large number of lawsuits that fail to generate a publicly available judicial opinion. The latter two focus only on two specific types of corporate law litigation but address the question whether an out-of-Delaware trend extends from judicial opinions to cases filed. All three datasets tell a consistent story: Delaware is losing its own cases. http://www.ecgi.org/wp/wp_id.php?id=425 Wed, 07 Apr 2010 20:41 GMT Law series We explore the relevance of systems theory for an understanding of legal evolution, with specific reference to the law and practice of corporate governance. The legal system can be understood as a cognitive resource which, by stabilising normative expectations, reduces transaction costs and enhances contractual cooperation. However, the cognitive capacity of the legal system is not simply a function of its adaptability to external economic conditions. Because of the need to ensure legal continuity and certainty, there is a trade-off between innovation and stabilisation in the production of legal rules. Legal change is discontinuous, asynchronic, and imperfectly matched with developments in the economy. We discuss the relevance of this model for understanding and evaluating corporate governance default rules. http://www.ecgi.org/wp/wp_id.php?id=424 Wed, 07 Apr 2010 20:29 GMT Law series Countries pursuing economic development confront a fundamental obstacle. Reforms that increase the size of the overall pie are blocked by powerful interests that are threatened by the growth-inducing changes. This problem is conspicuous in efforts to create effective capital markets to support economic growth. Controlling owners and managers of established firms successfully oppose corporate governance reforms that would improve investor protection and promote capital market development. In this article, we examine the promise of regulatory dualism as a strategy to diffuse the tension between future growth and the current distribution of wealth and power. Regulatory dualism seeks to mitigate political opposition to reforms by permitting the existing business elite to be governed by the old regime, while allowing other firms to be regulated by a new parallel regime that is more efficient. Regulatory dualism goes beyond similar but simpler strategies, such as grandfathering and statutory menus, by incorporating a dynamic element that is key to its effectiveness, but that requires a sophisticated approach to implementation. A paradigmatic example of regulatory dualism is offered by Brazil’s “New Market” (Novo Mercado), a voluntary premium segment within the São Paulo Stock Exchange that allows companies to commit credibly to significant protection of minority shareholders without imposing reform on companies controlled by the established elite. Yet regulatory dualism as a strategy for capital market reform is not unique to Brazil, nor is it suited just to developing countries. The long-standing U.S. approach to state-level corporate chartering is arguably better understood as a form of regulatory dualism than -- as is the custom -- as a form of regulatory competition, and the same can be said of EU corporate law post-Centros. The dramatic failure of Germany’s Neuer Markt illustrates some of the pitfalls of regulatory dualism. If thoughtfully deployed, however, regulatory dualism holds substantial promise in overcoming political barriers to reform, not just of corporate governance and capital markets, but of other economic institutions as well. http://www.ecgi.org/wp/wp_id.php?id=423 Wed, 07 Apr 2010 20:14 GMT Law series We model the impact of public and private ownership structures on firms' incentives to choose innovative projects. Innovation requires the exploration of new ideas with potential advantages but unknown probability of success. We show that it is optimal to go public when firms wish to exploit the current technology and to go private when firms wish to explore new ideas. This result follows from the fact that privately-held firms are less transparent to outside investors than publicly-held firms. In private firms, insiders can time the market by choosing an early exit strategy when they learn bad news. This option makes insiders more tolerant of failures and thus more inclined to choose innovative projects. In public firms, an early exit strategy is less valuable because there is less information asymmetry about cash flows. In such firms, prices of publicly-traded securities react quickly to good news, providing insiders with incentives to choose conventional but safer projects in order to cash in early when good news arrive. Extensions to the model allow us to incorporate other drivers of the decision to go public or private, such as liquidity and cost of capital. Our model rationalizes recent evidence linking private equity to innovation and creative destruction and also generates new predictions concerning the determinants of going public and going private decisions. http://www.ecgi.org/wp/wp_id.php?id=422 Wed, 07 Apr 2010 19:32 GMT Finance series This paper studies the impact of five dimensions of venture capitalist (VC) power on the likelihood of VC board representation in their portfolio firms at the initial public offering (IPO) as well as the effect of the latter on IPO performance. The dimensions of VC power are based on Finkelstein’s (1992) four dimensions of power which are ownership power, structural power (i.e. the VC’s rank within the firm’s financial hierarchy), expert power (i.e. VC industry specialization), prestige power (i.e. the number of IPOs the VC has been involved with so far). We add controlling power (i.e. how pivotal the VC is to the voted decision) to these four dimensions. We find that all five dimensions of power have a significantly positive impact on the likelihood of VC board membership. While controlling for the possible endogeneity of the latter, underpricing and the IPO premium are higher when there is VC board membership, which is consistent with both the grandstanding and management support hypotheses. Our results suggest that VCs have a real impact on IPO performance and that they do not just maintain a strong presence in better performing companies after the IPO. http://www.ecgi.org/wp/wp_id.php?id=421 Wed, 31 Mar 2010 11:45 GMT Finance series When the European Commission first proposed a harmonised legal framework for takeovers in the EU, its aim was to facilitate takeover bids in order to create a more efficient and competitive corporate landscape and to further the single market. In the view of the Commission, a functioning market of corporate control required rebalancing the division of powers between shareholders and management in companies facing a takeover bid. Taking the UK, EU’s most active takeover market, as a model, the Commission proposed to assign the sole decisionmaking power regarding the bid to the shareholders, with management primarily playing an advisory role. This so-called board neutrality rule, however, caused much controversy among the member states, and it was one of the main reasons for the Takeover Directive’s notoriously long adoption history. Failing to achieve consensus on this topic, the Takeover Directive was finally adopted in a “watered down” version, without a mandatory board neutrality rule. Instead, a rather complicated system of “options” was introduced, both at member state and at company level. Although it was clear that this approach would not create the same barrier-free market for corporate control the Commission originally had in mind, it was still hoped that it would be a step in this direction. At the very least, it was certainly expected that this approach would retain the status quo. This paper examines how the implementation of the Directive changed the takeover rules applicable to European companies. To that end, we analyse the pre-implementation rules regarding management’s role in takeovers in all member states, and compare them with the current legal framework. We find that, instead of facilitating the Commission’s ideal of a comprehensive, mandatory board neutrality rule, the Directive has, in aggregate, likely had an opposite effect. We argue that there are signs of protectionist motives driving member states’ choices regarding board neutrality, and we find that the system of company-level choices is ineffective in its current form. We propose a simplified and more coherent board neutrality rule, solely based on shareholder decision making. Acknowledging that a system allowing management to prevent unwanted bids might have advantages over a pure board neutrality rule in certain circumstances, we argue that shareholders are in a better position to decide on the optimal rules for a particular company than legislators. http://www.ecgi.org/wp/wp_id.php?id=420 Mon, 29 Mar 2010 11:55 GMT Law series This paper provides evidence on the corporate governance role of shareholder-initiated proxy proposals. Previous studies debate over whether activists use proxy proposals to discipline firms or to simply advance their self-serving agendas, and whether proxy proposals are effective at all in addressing governance concerns. Using the largest sample yet examined as well as extensive controls for governance quality, we find that activists use the proxy process as a disciplinary mechanism, and as such are valuable monitoring agents. Moreover, proposal announcements in the proxy statements have positive stock price effects, and both the market and the voting shareholders respond as much to the target firm’s governance quality as to the proposal’s objective and sponsoring shareholder. We address the endogeneity of target selection and proposal success using sample selection models. We conclude that shareholder proposals have nontrivial control benefits, countering arguments that they should be restricted by the SEC. http://www.ecgi.org/wp/wp_id.php?id=419 Mon, 29 Mar 2010 08:50 GMT Finance series In many parts of the world, it is commonplace for wealthy families and successful entrepreneurs to parlay a relatively small financial investment into control of a sprawling corporate empire through the use of a pyramid-like structure in which they directly control a firm that owns a dominant stake in a company or companies with outside investors, which in turn controls other firms in the same manner and so on. In the United States, however, corporate pyramids are the exception to the rule. Why is this controversial business arrangement, stigmatized as a device economic elites use to disguise market power and manipulate government, largely absent from the U.S. corporate landscape? The conventional wisdom is that they were dismantled by New Deal policymakers who introduced in 1935 a tax on dividends paid to corporate shareholders. We show that this version of events is more fable than truth, relying primarily on a hand collected dataset drawn from filings made with the Securities and Exchange Commission between 1936 and 1938 by companies owning 10 per cent or more of shares of companies registered with the Commission. We account for the rarity of corporate pyramids in the U.S. largely in terms of history, indicating that prior to the New Deal they were only ever extensively used in the utilities sector, where elimination of pyramidal structures was driven primarily by the Public Utilities Holding Company Act of 1935. Tax may have had an effect on corporate structure, but, at least in this instance, it was not the great leveller that the corporate pyramid fable would suggest. http://www.ecgi.org/wp/wp_id.php?id=418 Fri, 26 Mar 2010 17:32 GMT Law series This paper offers a new explanation of the gender pay gap in leadership positions by examining the relationship between managerial bonuses and company performance. Drawing on findings of gender studies, agency theory, and the leadership literature, we argue that the gender pay gap is a context-specific phenomenon which results partly from the fact that company performance has a moderating impact on pay inequalities. Employing a matched sample of 192 female and male executive directors of UK listed firms we corroborate the existence of the gender pay disparities in corporate boardrooms. In line with our theoretical predictions, we find that bonuses awarded to men are not only larger than those allocated to women, but also that managerial compensation of male executive directors is much more performance-sensitive than that of female executives. The contribution of attributional and expectancy-related dynamics to these patterns is highlighted in line with previous work on gender stereotypes and implicit leadership theories such as the romance of leadership. Gender differences in risk-taking and confidence are also considered as potential explanations for the observed pay disparities. The implications of organizations’ indifference to women’s performance are examined in relation to issues surrounding the recognition and retention of female talent. http://www.ecgi.org/wp/wp_id.php?id=417 Tue, 23 Mar 2010 14:32 GMT Finance series This paper examines whether foreign firms can raise public debt capital at a lower cost after their equity shares are cross-listed in the U.S., and the sources of these potential debt market benefits. Employing a large global sample of public bonds, we find strong evidence that firms with shares cross-listed on U.S. exchanges or in the over-the-counter market can lower their offering yield spreads by about 48 basis points. Consistent with legal bonding, the reduction in bond spreads is larger for firms from countries with lax disclosure regulation, higher private control benefits and underdeveloped local debt markets. However, equity cross-listings do little to overcome weak debt-market institutions in the country of domicile as firms from countries with poor creditor protection pay significantly higher spreads. Moreover, consistent with greater risks of wealth transfer from debt to equity holders, firms likely to face substantial agency conflicts exhibit higher bond spreads after U.S. cross-listings. In further analyses, we show that the public bond results do not extend to the syndicated loan market, suggesting that private communication and tight monitoring in private debt markets play a mitigating role. http://www.ecgi.org/wp/wp_id.php?id=416 Tue, 23 Mar 2010 11:42 GMT Finance series This Article critically analyzes News Corp.’s reincorporation in Delaware against the backdrop of two major contemporary corporate governance debates relating to shareholder empowerment and convergence theory. Legal scholars opposing greater shareholder power often argue that the lack of shareholder participatory rights under U.S. law provides evidence that such rights are neither desired nor valued by investors. Also, an underlying assumption of convergence theory is that a unified “Anglo-American” model of shareholder protection exists, suggesting that shareholder rights are similarly restricted throughout the common law world. This Article challenges both these assumptions by means of a detailed case study of News Corp.’s migration from Australia to Delaware. News Corp.’s original reincorporation proposal prompted a revolt by a number of institutional investors, who argued that a move to Delaware would strengthen managerial power and reduce shareholder rights. The institutional investors were particularly concerned about the effect of the move on the ability of the board of directors to adopt anti-takeover mechanisms, such as poison pills, which are not generally permissible under Australian law. This Article places News Corp.’s reincorporation in Delaware within the framework of contemporary corporate governance theory and debate. It also uses the reincorporation to highlight a number of significant, but underappreciated, differences between U.S. corporate law and the law of other common law jurisdictions. Specifically, this Article shows how News Corp.’s migration from Australia to Delaware effectively subverted shareholder rights. The News Corp. reincorporation, in sum, has significant implications for Delaware law generally, and for current shareholder empowerment developments in the United States. http://www.ecgi.org/wp/wp_id.php?id=415 Mon, 22 Mar 2010 21:59 GMT Law series This paper, which was first presented as a conference paper at the Annual 2009 Supreme Court of New South Wales Conference in June 2009, considers the impact of the global financial crisis on the regulation of executive pay in a range of common law jurisdictions, including the United States, the United Kingdom and Australia. As the paper shows, the current focus on executive pay reflects the fact that, as a result of the global financial crisis, business once again has 'a legitimacy problem.' Although opinion is divided about the extent to which executive remuneration practices actually contributed to the global financial crisis, there has nonetheless been an outpouring of regulatory responses to executive pay in the United States, United Kingdom and Australia. The paper compares the varying reforms and reform proposals across these jurisdictions, identifying common themes and differences in approach, and considering their implications for future regulation of executive remuneration around the world. http://www.ecgi.org/wp/wp_id.php?id=414 Mon, 22 Mar 2010 21:55 GMT Law series The European Company Law Action Plan of 2003 has been in the center of corporate law discussions in Europe for almost a decade. This introduction re-visits five of the main reform problems and outlines reform perspectives beyond the financial markets crisis. The five areas that the introduction re-examines are legal capital, corporate governance, one share/one vote, financial reporting, and corporate mobility. For the future, the introduction identifies as critical a mixed system of regulatory approaches, i.e. between market and regulation as well as between national regulation and European rules, a focus on adequate enforcement, and prudence in the aftermath of the financial crisis. http://www.ecgi.org/wp/wp_id.php?id=413 Wed, 10 Mar 2010 20:38 GMT Law series Both Europe and the United States are rethinking their approach to aggregate litigation. In the United States, class actions have long been organized around an entrepreneurial model that uses economic incentives to align the interest of the class attorney with those of the class. But increasingly, potential class members are preferring exit to voice, suggesting that the advantages of the U.S. model may have been overstated. In contrast, Europe has long resisted the U.S.’s entrepreneurial model, and the contemporary debate in Europe centers on whether certain elements of the U.S. model - namely, opt-out class actions, contingent fees, and the “American rule” on fee shifting - must be adopted in order to assure access to justice. Because legal transplants rarely take, this Essay offers an alternative “non-entrepreneurial model” for aggregate litigation that is consistent with European traditions. Relying less on economic incentives, it seeks to design a representative plaintiff for the class action who would function as a true “gatekeeper,” pledging its reputational capital to assure class members of its loyal performance. Effectively, this model marries aspects of U.S. “public interest” litigation with existing European class action practice. Examining the differences between U.S. and European practice, this Essay argues none of these differences are dispositively prohibitive and that functional substitutes, including an opt-in class action and third party funding, could be engineered so as to yield roughly comparable results. Although the two systems might perform similarly in terms of compensation, the ultimate question, it argues, is the degree to which a jurisdiction wishes to authorize and arm a private attorney general to pursue deterrence for profit. http://www.ecgi.org/wp/wp_id.php?id=412 Mon, 01 Mar 2010 21:22 GMT Law series From a global perspective, the single most noticeable fact about corporate governance is the radical dichotomy between dispersed ownership and concentrated ownerships systems, with the latter being much in the majority. Several prominent academics have offered grand theories to explain when dispersed share ownership arises, which have emphasized either legal or political preconditions. Nonetheless, mounting evidence suggests that these theories are overgeneralized and, in particular, do not account for the appearance (to varying degrees) of dispersed ownership in all securities markets. This article concludes that neither legal rules nor political conditions can adequately explain the spread of dispersed ownership across both the U.S. and the U.K., which developments occurred at different times, in different political and legal environments, and were precipitated by different exogenous factors. Instead, this article offers an alternative and simpler explanation: dispersed ownership arises principally from private ordering, with legal rules playing a minor role at best. Intermediaries - investment bankers, stock exchanges, and others - fill the void created by legal shortcomings and create bonding mechanisms that allow dispersed ownership to spread beyond the limited geographic area in which the founding entrepreneur is known and trusted. This process has two steps: (1) the appearance of numerous minority shareholders, gradually spreading across a broad geographic area, and (2) the break-up of controlling blocks. At the latter stage, historical contingencies have played a major role. In the United States, the merger boom of the 1890s played a critical role, and in the U.K. punitive tax changes compelled controlling shareholders to sell. The only common denominators across the two countries were: (1) political changes followed once share ownership dispersion was achieved, as law followed the market; and (2) private ordering and self-regulation encouraged minority owners to invest and protected their voting and control rights. This may suggest that in decentralized political economies (in which political and economic power tend to be separated and in which self-regulation is more common, such as the U.S. and the U.K.), dispersed ownership is more likely to arise, but it can arise for individual firms through private ordering in any market. http://www.ecgi.org/wp/wp_id.php?id=411 Mon, 01 Mar 2010 21:19 GMT Law series This paper presents an innovative approach to the regulation of self-dealing by controlling shareholders. Our proposal is grounded on the identification - through the lenses of economic analysis - of the shortcomings inherent in the existing legal solutions, ranging from the absolute prohibition of self-dealing, to the prohibition of voting with conflicting interests, or to the imposition of fairness duties to the majority shareholders. We present our proposal for an alternative regulation, based on the use of options, in a two period game between the controlling shareholder, who is able to pursue an identified self-dealing opportunity, and the minority shareholders, who desire to determine the merits of this business opportunity. We show that our regulatory proposal is more efficient than existing regulation in the circumstances of our model. The enhanced efficiency of our proposed regime is mainly due to two novel characteristics of our approach. First, it takes advantage of the repeated nature of the relationship between the controller and the corporation. In particular, our proposal implies that obtaining future private benefits requires limiting current private benefits. By doing this we can provide at no cost an additional incentive that aligns the interest of the controller with that of the small shareholders. Second, we allow the controller to determine the level of private benefits that he will extract in each period and apply an automatic penalty for excessive levels. By doing this we eliminate both the costs of collective action, and the costs of legal action that critically affect the outcome of the existing regulatory regimes. http://www.ecgi.org/wp/wp_id.php?id=410 Sun, 07 Feb 2010 22:28 GMT Law series The representation of women in top corporate officer positions is steadily increasing. However, little is known about the impact this will have. A large literature documents that women are different from men in their choices and in their preferences, but most of this literature relies on samples of college students or workers at lower levels in the corporate hierarchy. If women must be like men to break the glass ceiling, we might expect gender differences to disappear among top executives. In contrast, using a large survey of directors, we show that female and male directors differ systematically in their core values and risk attitudes. While certain population gender differences disappear at the director level, others do not. Consistent with the findings for the general population, female directors are more benevolent and universally concerned, but less power-oriented than men. However, they are less traditional and security-oriented than their male counterparts. Furthermore, female directors are slightly more risk-loving than male directors. This suggests that having a women on the board need not lead to more risk-averse decision-making. http://www.ecgi.org/wp/wp_id.php?id=409 Mon, 25 Jan 2010 10:54 GMT Finance series We test under what circumstances boards discipline managers and whether such interventions improve performance. We exploit exogenous variation due to the staggered adoption of corporate governance laws in formerly Communist countries coupled with detailed 'hard' information about the board's performance expectations and 'soft' information about board and CEO actions and the board's beliefs about CEO competence in 473 mostly private-sector companies backed by private equity funds between 1993 and 2008. We find that CEOs are fired when the company underperforms relative to the board's expectations, suggesting that boards use performance to update their beliefs. CEOs are especially likely to be fired when evidence has mounted that they are incompetent and when board power has increased following corporate governance reforms. In contrast, CEOs are not fired when performance deteriorates due to factors deemed explicitly to be beyond their control, nor are they fired for making 'honest mistakes.' Following forced CEO turnover, companies see performance improvements and their investors are considerably more likely to eventually sell them at a profit. http://www.ecgi.org/wp/wp_id.php?id=408 Fri, 08 Jan 2010 09:42 GMT Finance series We examine whether institutional investors affect corporate governance by analyzing institutional holdings in companies from 23 countries during the period 2003-2008. We find that firm-level governance is positively associated with international institutional investment. Changes in institutional ownership over time positively affect subsequent changes in firm-level governance, but the opposite is not true. Foreign institutions and independent institutions drive governance improvements outside of the U.S. The origin of the institution matters, as institutions in countries with strong shareholder protection are more effective in promoting good governance than are institutions from countries with weak shareholder protection. The shareholder protection of the country where the firm is located also matters, with foreign institutions playing a crucial role in countries with weak shareholder protection. Institutional investors affect not only which corporate governance mechanisms are in place, but also outcomes. Firms with higher institutional ownership are more likely to terminate poorly performing CEOs and exhibit improvements in valuation over time. Our results suggest that institutional investors promote good corporate governance practices around the world. http://www.ecgi.org/wp/wp_id.php?id=407 Fri, 08 Jan 2010 09:27 GMT Finance series This paper presents a simple model of takeover regulation in a federal system. The theory has two parts. First, the model predicts that the rules applicable at more general political levels will be more favorable to takeover bids than will the rules applicable at local levels. The reason is that unlike bidders, who do not know ex ante where they will find targets, targets can concentrate their political activities knowing that the law of their jurisdiction will apply to any attempt to take them over. On the other hand, at more general political levels this advantage for target firms disappears, so the rules are expected to be less target-friendly. This is in fact the pattern we observe both in the United States and the European Union. Second, the model predicts that rules on takeovers will reflect the degree of concern that targets have about potential hostile bids. Where firms are well-protected against unfriendly takeovers – for example, in jurisdictions where companies are under family control – takeover regulation is likely to be less target-friendly than in jurisdictions where potential targets are more exposed to a hostile acquisition. This pattern is also observed in takeover regulation. http://www.ecgi.org/wp/wp_id.php?id=406 Fri, 08 Jan 2010 09:20 GMT Law series Family firms are a widespread control structure in most countries, especially among smaller firms. A vast literature addresses the question of whether they are performing better or worse than comparable non family firms, with not entirely conclusive results. Here we take a different, indirect approach and test whether investment decisions in family firms are more sensitive to uncertainty than in other firms. By using a novel dataset that includes both a better definition of family firms than commonly used (through self evaluation) and a very good proxy of the uncertainty on future demand that firms face, we are able to verify that – as compared to other firms – family firms are significantly more sensitive to uncertainty: this might contribute to explain why in some situations they perform better, whereas in others they do worse. We find evidence that this greater sensitivity to uncertainty in family firms is basically due to the effects of risk aversion and capital irreversibility, where the latter appear to be associated to a greater opaqueness of family firms rather than to the degree of sunkness of fixed capital. Finally, we propose some evidence that the prevalence of family firms in Italy might be associated to long standing institutional factors, such as an inefficient law enforcement system and a low social capital. http://www.ecgi.org/wp/wp_id.php?id=405 Thu, 10 Dec 2009 17:34 GMT Finance series Commission Regulation (EC) No 2273/2003 regulates the price stabilization activities for equity initial public offerings (IPOs) in Europe as a form of permitted market manipulation. To test the actual practices and effects of stabilization we empirically analyze the support provided by the underwriters of 141 Italian IPOs from 2000 through to 2008. We find that the underwriters support the share prices not only by short covering, but also by posting pure stabilization bids. Pure short covering is mostly used by more reputable underwriters for IPOs with higher institutional participation and more secondary shares in the offer, whereas the opposite is true for pure stabilization IPOs. We try to identify some patterns in underwriters’ aftermarket activities and analyze the extent to which the stabilization activity, permitted for four weeks after trading begins, produces temporary or permanent effects on share prices. http://www.ecgi.org/wp/wp_id.php?id=404 Wed, 09 Dec 2009 16:49 GMT Finance series We examine the association of a venture capital (VC) firm’s reputation with the post-IPO long-run performance of its portfolio firms. We find that VC reputation, as measured by the past market share of VC-backed IPOs, has significant positive associations with an array of long-run firm performance measures. While more reputable VCs initially select better quality firms, more reputable VCs continue to be associated with superior long-run performance even after controlling for VC selectivity. More reputable VCs exhibit more active post-IPO involvement in their portfolio firms, and continued VC involvement has a positive influence on post-IPO firm performance. http://www.ecgi.org/wp/wp_id.php?id=403 Wed, 09 Dec 2009 11:08 GMT Finance series This paper determines optimal capital structure and value of Holding-Subsidiary structures (HS), when there is a trade-off between bankruptcy costs and taxation. HS have higher firm value than their stand alone counterparts, as the holding provides a guarantee to its subsidiary’s lenders which lowers expected bankruptcy costs, at a given debt level. HS may also reach higher debt capacity, which further increases their value by reducing the tax burden below that of stand alone firms. Optimal debt in the holding and in the subsidiary are respectively lower and higher than in their stand-alone counterparts. Such debt diversity preserves the holding ability to rescue its subsidiary, hence value creation by HS, even with perfect cash flow correlation. http://www.ecgi.org/wp/wp_id.php?id=402 Wed, 09 Dec 2009 10:49 GMT Finance series The recent financial crisis has led to a major debate about fair-value accounting. Many critics have argued that fair-value accounting, often also called mark-to-market accounting, has significantly contributed to the financial crisis or, at least, exacerbated its severity. In this paper, we assess these arguments and examine the role of fair-value accounting in the financial crisis using descriptive data and empirical evidence. Based on our analysis, it is unlikely that fair-value accounting added to the severity of the 2008 financial crisis in a major way. While there may have been downward spirals or asset-fire sales in certain markets, we find little evidence that these effects are the result of fair-value accounting. We also find little support for claims that fair-value accounting leads to excessive writedowns of banks’ assets. If anything, empirical evidence to date points in the opposite direction, that is, towards overvaluation of bank assets. http://www.ecgi.org/wp/wp_id.php?id=401 Wed, 09 Dec 2009 10:36 GMT Finance series Many observers have argued that credit default swaps contributed significantly to the credit crisis. Of particular concern to these observers are that credit default swaps trade in the largely unregulated over-the-counter market as bilateral contracts involving counter-party risk and that they facilitate speculation involving negative views of a firm’s financial strength. Some observers have suggested that credit default swaps would not have made the crisis worse had they been traded on exchanges. I conclude that credit default swaps did not cause the dramatic events of the credit crisis, that the over-the-counter credit default swaps market worked well during much of the first year of the credit crisis, and that exchange trading has both advantages and costs compared to over-the-counter trading. Though I argue that eliminating over-the-counter trading of credit default swaps could reduce social welfare, I also recognize that much research is needed to understand better and quantify the social gains and costs of derivatives in general and credit default swaps in particular. http://www.ecgi.org/wp/wp_id.php?id=400 Wed, 09 Dec 2009 09:33 GMT Finance series One of the most crucial, but systematically neglected, comparative differences between corporate law systems in Europe and in the United States concerns the regulations governing freeze-out transactions in listed corporations. Freeze-outs can be defined as transactions in which the controlling shareholder exercises a legal right to buy out the shares of the minority, and consequently delists the corporation and brings it private. Beyond this essential definition, the systems diverge profoundly. This gap exists despite the fact that minority freeze-outs are one of the most debated issues in corporate law, in the public media, in a vast body of scholarly work and in case law in the United States and, to a lesser degree, in Europe. In light of the relevance of the subject and the extensive and growing number of cross-Atlantic mergers in which the acquiring and the target corporations are subject to different legal regimes, it is startling how little research has focused on a comparison between the European and the American approaches in this area. This Article fills this gap offering a first comparative discussion of freeze-out regulations in the U.S. and in Europe. The Article proposes some explanations for the causes and consequences of the differences between the two regulatory regimes, and advances reform proposals for the development of financial markets both in Europe and in the U.S. The Article is organized as follows. Part I briefly discusses the economic reasons for going private. Part II analyzes U.S. rules concerning freeze-outs and going private transactions, focusing in particular on Delaware law. Part III discusses the corresponding European rules. While every single European country has its own rules, freeze-outs enjoy a certain degree of harmonization. Even though the level of harmonization is partial and insufficient, European Union’s directives on mergers and on takeovers provide for a general uniform framework. Specific details on a selected number of countries will also be offered, but the goal of this work is more to capture the fundamental traits of the European approach, rather than to dig in the technicalities of single jurisdictions. Part IV sums up the major differences between the two systems and offers an explanatory theory of the different developments of the law in Europe and in the U.S. Finally, Part V is dedicated to the normative implications of the analysis. http://www.ecgi.org/wp/wp_id.php?id=399 Wed, 25 Nov 2009 09:56 GMT Law series This article is the second chapter of the second edition of 'The Anatomy of Corporate Law: A Comparative and Functional Approach,' by Reinier Kraakman, John Armour, Paul Davies, Luca Enriques, Henry Hansmann, Gerard Hertig, Klaus Hopt, Hideki Kanda and Edward Rock (Oxford University Press 2009). The book as a whole provides a functional analysis of corporate (or company) law in Europe, the U.S., and Japan. Its organization reflects the structure of corporate law across all jurisdictions, while individual chapters explore the diversity of jurisdictional approaches to the common problems of corporate law. In its second edition, the book has been significantly revised and expanded. 'Agency Problems and Legal Strategies' establishes the analytical framework for the book as a whole. After further elaborating the agency problems that motivate corporate law, this chapter identifies five legal strategies that the law employs to address these problems. Describing these strategies allows us to more accurately map legal similarities and differences across jurisdictions. Some legal strategies are 'regulatory' insofar as they directly constrain the actions of corporate actors: for example, a standard of behavior such as a director's duty of loyalty and care. Other legal strategies are 'governance-based' insofar as they channel the distribution of power and payoffs within companies to reduce opportunism. For example, the law may accord direct decision rights to a vulnerable corporate constituency, as when it requires shareholder approval of mergers. Alternatively, the law may assign appointment rights over top managers to a vulnerable constituency, as when it accords shareholders - or in some jurisdictions, employees - the power to select corporate directors. We then consider the relationship between different enforcement mechanisms - public agencies, private actors, and gatekeeper control - and the basic legal strategies outlined. We conclude that regulatory strategies require more extensive enforcement mechanisms - in the form of courts and procedural rules - to secure compliance than do governance strategies. However, governance strategies, for efficacy, require shareholders to be relatively concentrated so as to be able to exercise their decisional rights effectively. In addition to Chapter 2, Chapter 1, 'What is Corporate Law?,' is available in full text on the SSRN at http://ssrn.com/abstract=1436551 http://www.ecgi.org/wp/wp_id.php?id=398 Tue, 17 Nov 2009 12:05 GMT Law series This article is the first chapter of the second edition of The Anatomy of Corporate Law: A Comparative and Functional Approach, by Reinier Kraakman, John Armour, Paul Davies, Luca Enriques, Henry Hansmann, Gerard Hertig, Klaus Hopt, Hideki Kanda and Edward Rock (Oxford University Press, 2009). The book as a whole provides a functional analysis of corporate (or company) law in Europe, the U.S., and Japan. Its organization reflects the structure of corporate law across all jurisdictions, while individual chapters explore the diversity of jurisdictional approaches to the common problems of corporate law. In its second edition, the book has been significantly revised and expanded. As the book's introductory chapter, this article describes the functions and boundaries of corporate law. We first detail the economic importance of the corporate form's hallmark features: legal personality, limited liability, transferable shares, delegated management, and investor ownership. We then identify the major agency problems that attend the corporate form, and that, therefore, corporate law must address: conflicts between managers and shareholders, between controlling and minority shareholders, and between shareholders as a class and non-shareholder constituencies of the firm such as creditors and employees. In our view, corporate law serves in part to accommodate contract and property law to the corporate form and, in substantial part, to address the agency problems that are associated with this form. We next consider the role of law in structuring corporate affairs so as to achieve these goals: whether, and to what extent standard forms - as opposed, on the one hand, to private contract, and on the other, to mandatory rules - are needed, and the role of regulatory competition. Whilst the ‘core’ features of corporate law are present in all - or almost all - legal systems, different systems have made different choices regarding the form and content of many other aspects of their corporate laws. To assist in explaining these, we review a range of forces that shape the development of corporate law, including domestic share ownership patterns. These forces operate differently across countries, implying that in some cases, complementary differences in corporate laws are functional. However, other such differences may be better explained as a response to purely distributional concerns. In addition to Chapter 1, Chapter 2 of the Anatomy of Corporate Law (2nd ed.), Agency problems, Legal Strategies, and Enforcement is also available (full text) on SSRN at http://ssrn.com/abstract=1436555. http://www.ecgi.org/wp/wp_id.php?id=397 Tue, 17 Nov 2009 12:00 GMT Law series We investigate whether bank performance during the credit crisis of 2008 is related to CEO incentives and share ownership before the crisis and whether CEOs reduced their equity stakes in their banks in anticipation of the crisis. There is no evidence that banks with CEOs whose incentives were better aligned with the interests of their shareholders performed better during the crisis and some evidence that these banks actually performed worse both in terms of stock returns and in terms of accounting return on equity. Further, option compensation did not have an adverse impact on bank performance during the crisis. Bank CEOs did not reduce their holdings of shares in anticipation of the crisis or during the crisis; further, there is no evidence that they hedged their equity exposure. Consequently, they suffered extremely large wealth losses as a result of the crisis. http://www.ecgi.org/wp/wp_id.php?id=396 Fri, 30 Oct 2009 14:21 GMT Finance series The reform of bank supervision represents one of the great institutional challenges for the European Union. The recent pattern of cross-border failures in supervision reflects the extent to which a better functioning system of supervision is critical for the safe operation of the banking system in the EU. Within this framework, the main institutional reforms currently being proposed are likely to fail. It is thus worth considering alternatives. This paper explores the merits of a choice-oriented approach under which individual Member states have the option to delegate prudential supervision of their largest banks to the European Central Bank, while still retaining the right to re-assume such a role at a later date. Responsibilities, commitments and costs would be allocated by means of a binding agreement with the ECB that can be tailored to Member states’ specific circumstances, to the extent permitted by supervisory coherence and equal treatment. The proposal offered here is superior to existing supervisory arrangements, and is likely to produce a more socially desirable outcome than the proposed alternatives. http://www.ecgi.org/wp/wp_id.php?id=395 Thu, 29 Oct 2009 14:06 GMT Finance series Exploiting the Japanese banking crisis as a laboratory, we provide firm-level evidence on the real effects of bank bailouts. Government recapitalizations result in positive abnormal returns for the clients of recapitalized banks. After recapitalizations, banks extend larger loans to their clients and some firms increase investment, but do not create more jobs than comparable firms. Most importantly, recapitalizations allow banks to extend larger loans to low and high quality firms alike, and low quality firms experience higher abnormal returns than other firms. Interestingly, recapitalizations by private investors have similar effects. Moreover, bank mergers engineered to enhance bank stability appear to hurt the borrowers of the sounder banks involved in the mergers. http://www.ecgi.org/wp/wp_id.php?id=394 Mon, 19 Oct 2009 20:30 GMT Finance series Shareholder activism by hedge funds has over the past few years become a major corporate governance phenomenon. This paper puts the trend into context. The paper begins by distinguishing the “offensive” form of activism hedge funds engage in from “defensive” interventions “mainstream” institutional investors (e.g. pension funds or mutual funds) undertake. Variables influencing the prevalence of offensive shareholder activism are then identified using a heuristic device we call “the market for corporate influence”. The rise of hedge funds as practitioners of offensive shareholder activism is traced by reference to the “supply” and “demand” sides of this market, with the basic chronology being that, while there were direct antecedents of hedge fund activists as far back as the 1980s, hedge funds did not move to the activism forefront until the 2000s. The paper brings matters up-to-date by discussing the impact of the recent financial crisis on hedge fund-driven shareholder activism and draws upon the market for corporate influence heuristic to predict future trends. http://www.ecgi.org/wp/wp_id.php?id=393 Thu, 15 Oct 2009 22:02 GMT Law series Since World War II, direct stock ownership by households has largely been replaced by indirect stock ownership by financial institutions. We argue that tax policy is the driving force. Using long time-series from eight countries, we show that the fraction of household ownership decreases with measures of the tax benefits of holding stocks inside a pension plan. This finding is important for policy considerations on effective taxation and for financial economics research on the long-term effects of taxation on corporate finance and asset prices. http://www.ecgi.org/wp/wp_id.php?id=392 Wed, 30 Sep 2009 20:15 GMT Finance series This paper explores the use of leverage in pyramidal control chains and its relationship to dividend policy. Analyzing a comprehensive sample of French firms, we document that leverage in holding companies constitutes an important part of the overall discrepancy between control rights and cash flow rights. We postulate that the use of leverage commits dominant owners to more generous payouts since dividends are needed to service debt in the pyramidal structure (Debt Service Hypothesis). Consistent with our hypothesis, we find that debt in pyramids leads to higher dividend payouts, whereas dividends decrease in the equity portion of the control wedge. Only a fraction of the cash made available to controlling owners is paid out to them, which is consistent with the view that servicing debt along the control chain is a primary motive for dividends. http://www.ecgi.org/wp/wp_id.php?id=391 Mon, 28 Sep 2009 20:50 GMT Finance series While empirical studies that use event-study methodology find on average that the gains from mergers and acquisitions are positive, those focusing on accounting figures tend to find a significant drop in performance. We argue that each of the four possible combinations between positive or negative abnormal stock returns and accounting performance is due to a distinct acquisition motive. We find strong empirical evidence in support of this claim. http://www.ecgi.org/wp/wp_id.php?id=390 Fri, 18 Sep 2009 08:08 GMT Finance series We use new data from recently expanded disclosure rules to analyze the level and structure of compensation for CEOs in 27 countries. We show that U.S. CEOs earn more than their foreign counterparts. The U.S. “pay premium” is explained by differences in firm, industry, and governance characteristics, and the intensive use of incentive compensation in U.S. firms, which in turn seems related to strong legal enforcement and security-market regulation. In addition, we document that CEO pay worldwide is converging to U.S. levels as the premium was sharply reduced from 2000 to 2006. http://www.ecgi.org/wp/wp_id.php?id=389 Fri, 11 Sep 2009 08:14 GMT Finance series We provide evidence suggesting that incumbents’ access to group deep pockets has a negative impact on entry in product markets. Relying on a unique French data set on business groups, our paper presents three major findings. First, the amount of cash holdings owned by incumbent-affiliated groups is negatively related to entry in a market. Second, the impact on entry of group deep pockets is more important in markets where access to external funding is likely to be more difficult. Third, the “entry deterring effect” of group deep pockets is more pronounced when groups have more active internal capital markets. Our findings suggest that internal capital markets operate within corporate groups and that they have a potential anti-competitive effect. http://www.ecgi.org/wp/wp_id.php?id=388 Tue, 08 Sep 2009 09:40 GMT Finance series is paper examines the conditions under which CEOs are able to affect the timing and the price of the stock options they are granted at the time of their firm’s IPO. Contrary to Lowry and Murphy (2007) who do not find a relationship between IPO grants and IPO underpricing, this paper finds such a relationship when board independence, the power of the CEO and venture capital (VC) backing are taken into account. The results suggest that powerful CEOs and VCs are able to reap substantial gains from IPO options to the detriment of the shareholders. http://www.ecgi.org/wp/wp_id.php?id=387 Mon, 07 Sep 2009 12:10 GMT Finance series Though overall bank performance from July 2007 to December 2008 was the worst since at least the Great Depression, there is significant variation in the cross-section of stock returns of large banks across the world during that period. We use this variation to evaluate the importance of factors that have been discussed as having contributed to the poor performance of banks during the credit crisis. More specifically, we investigate whether bank performance is related to bank-level governance, country-level governance, country-level regulation, and bank balance sheet and profitability characteristics before the crisis. Banks that the market favored in 2006 had especially poor returns during the crisis. Using conventional indicators of good governance, banks with more shareholder-friendly boards performed worse during the crisis. Banks in countries with stricter capital requirement regulations and with more independent supervisors performed better. Though banks in countries with more powerful supervisors had worse stock returns, we provide some evidence that this may be because these supervisors required banks to raise more capital during the crisis and that doing so was costly for shareholders. Large banks with more Tier 1 capital and more deposit financing at the end of 2006 had significantly higher returns during the crisis. After accounting for country fixed effects, banks with more loans and more liquid assets performed better during the month following the Lehman bankruptcy,and so did banks from countries with stronger capital supervision and more restrictions on bank activities. http://www.ecgi.org/wp/wp_id.php?id=386 Fri, 04 Sep 2009 14:36 GMT Finance series Private equity has reaped large rewards in recent years. We claim that one major reason for this success is due to the corporate governance advantages of private equity over the public corporation. We argue that the development of substantial derivative contracts and trading has signifi cantly weakened the governance of public corporations and has created a need for fi nancially sophisticated directors and much closer supervision of management. The private equity model delivers these benefits and allows corporations to be better governed, creating wealth gains for investors. http://www.ecgi.org/wp/wp_id.php?id=385 Sun, 23 Aug 2009 20:31 GMT Finance series We study private enforcement of corporate law in a civil law jurisdiction that has a relatively weak company law regime. First, we develop a benchmark for how effective the court is in resolving confl icts in a speedy and decisive manner. We base our findings on a hand-collected database of filings of legal actions brought against companies between 2002-2008. The main conclusion is that the grant of injunctive relief provides an incentive for the parties to the lawsuit to seek out settlements and thereby prevent further costly and unwanted litigation. Our results emphasize the importance of the private enforcement of intra-firm disputes and the effectiveness of a specialized court in providing protection to minority shareholders. http://www.ecgi.org/wp/wp_id.php?id=384 Fri, 21 Aug 2009 17:49 GMT Law series This paper investigates the role of corporate governance in the current financial crisis using a unique dataset of 306 global financial firms across 31 countries that were at the center of the 2007-2008 credit crisis. We document that financial firms experienced substantial CEO turnover during this period. We find that CEOs were more likely to be replaced following large losses if boards had more independent directors and firms were held more by institutional investors, but not when firms were controlled by insider blockholders. There was also a high level of director turnover in corporate boards, especially for directors in risk committees. We then examine whether board and ownership governance mechanisms were associated with risk taking in financial institutions. We find that firms with more independent boards and institutional ownership experienced larger accounting writedowns during the crisis, and firms with more institutional ownership also had higher default risk before the crisis. Finally, we look at the role of a crucial governance mechanism: CEO executive pay. We find that firms that awarded CEOs more compensation in the form of cash bonuses (instead of equity-based incentives) experienced higher losses. Our findings highlight the importance of governance mechanisms for the regulatory reform of financial institutions. http://www.ecgi.org/wp/wp_id.php?id=382 Mon, 17 Aug 2009, 19:49 GMT Finance series There is much we do not understand about the “location” of innovation; the confluence, for a particular innovation, of the technology associated with the innovation, the innovating firm’s size and organizational structure, and the financial contracting that supports the innovation. This article develops the theme that these three determinants of the location of innovation are simultaneously determined through examination of examples of innovative activity whose location is characterized by tradeoffs between pursuing the activity in a an established company or in a smaller, earlier stage company, or some combination of the two. It first considers the dilemma faced by an established company in deciding whether to keep an employee’s innovation or allow the employee to pursue the innovation through a venture capital-backed startup. It next takes up a very different relationship between an established company and an earlier stage company: the development by the smaller company of an innovation that “disrupts” existing industry patterns by devaluing the skills and experience of the industry’s dominant companies. The article then considers an established company’s instrumental use of the startup market to outsources development of a particular innovation to a technology race with the intention of acquiring the winner of the race. Finally, the article addresses a form of innovation located between an established and earlier stage company - the pattern of joint ventures between large pharmaceutical companies and smaller, earlier stage biotechnology companies. http://www.ecgi.org/wp/wp_id.php?id=381 Mon, 17 Aug 2009, 19:45 GMT Law series The standard approach to the legal foundations of corporate governance is that corporate law promotes separation of ownership and control by protecting minority shareholders from expropriation. This paper takes a broader perspective on the economic and legal determinants of corporate governance. It shows that legal entitlements to corporate control and their exchange on the market are as important as investor protection. This is based on a third category of ‘idiosyncratic’ private benefits of control, which supplements the more traditional specifications as inefficient consumption of control perquisites (‘distortionary’ private benefits) or outright expropriation of shareholder value (‘diversionary’ private benefits). The framework departs from the standard principal-agent models by assuming that private benefits of control also account for a further value to be appropriated as reward of entrepreneurship in the corporate structure. The quasi-rent nature of this value makes appropriation by corporate controllers a necessary condition for efficiency ex-ante, which implies that control rights are allocated separately from ownership at the going public stage. Under certain assumptions (corresponding to legal restrictions on the behavior of controllers and non-controlling shareholders), a constrained-efficient outcome is derived ex-post as Coasian bargain between the incumbent and the insurgent at the takeover stage. To preserve interdisciplinarity of the discussion, these results are illustrated with a limited degree of formalization. The above findings have important implications for corporate law. When legal institutions effectively constrain expropriation of non-controlling shareholders, they may still distort separation of ownership and control by making ownership structures either more concentrated or more dispersed than it would be efficient. This happens when corporate law fails to provide those who run the company with entitlements to control tenure independently of how much ownership they retain. Likewise, mandatory bid regulations undermine the takeover process by restricting side payments that ultimately support efficient bargaining over the value of corporate control. http://www.ecgi.org/wp/wp_id.php?id=380 Sun, 16 Aug 2009, 13:18 GMT Law series Good corporate governance of banks is of a vital concern to banks themselves as well as to the banking supervisors. During the past decade, listed banks and even non-listed institutions worldwide started to publicly emphasize that good corporate governance is of vital concern for the company, and even to adopt individualized corporate governance codices. In turn, the Basel Committee on Banking Supervision already published two editions of a guideline entitled 'Enhancing corporate governance for banking organisations' which reflects the supervisors’ taking on the issue to perfection. Last but not least, two years into the financial crisis, the issue of banks’ good corporate governance has started to attract pronounced interest, with the OECD taking a leading role. Against this backdrop, the article, on the one hand, discusses the particularities of banks’ corporate governance - due in large part to banking regulation and to deposit insurance - in a principal-agent framework, and, on the other hand, presents the supervisors’ financial stability perspective taking the Basel Committee’s guidance as a starting point. The article concludes with reflections on some tentative lessons from the current crisis for (banks’) good corporate governance: Banks’ corporate governance differs from that of a generic firm. Deposit insurance and prudential regulation, while aimed at compensating for deficits in the monitoring and control of banks, both act to exacerbate the particular problems that are inherent in banks’ corporate governance. From this perspective, banking regulation and banks’ corporate governance interact as the driving forces of a vicious circle that produces ever more regulation. Hence, one may doubt whether banks’ corporate governance should map the way forward for corporate governance in general. In particular, this holds true for the way forward to regulating bankers’ pay. http://www.ecgi.org/wp/wp_id.php?id=379 Sun, 16 Aug 2009, 13:13 GMT Law series Although the relationship between religion and economic development on the macro-level has been investigated, it is less clear how religious background influences economic attitudes and financial decision-making on the level of the individual or household, the micro-level. We use panel data from the extensive DNB Household Survey, covering the period from 1995 to 2008, to investigate whether - and through which channel - religious denomination affects household finance in the Netherlands. We find evidence that, in general, religious households care more about saving, are more risk-averse, consider themselves more trusting, have a more external locus of control, and have a stronger request motive. Furthermore, Catholics and Protestants have longer planning horizons, and Protestants and Evangelicals seem to have a greater sense of individual financial responsibility. Most of these factors matter for household financial decision-making, albeit to differing degrees. Using our religion variables as instruments for economic attitudes (and controlling for demographic and background risk characteristics), we demonstrate that the above-mentioned differences in economic beliefs and preferences explain the higher propensity to save by religious households in general and the lower investments in risky assets by Catholic households. http://www.ecgi.org/wp/wp_id.php?id=378 Wed, 12 Aug 2009, 15:32 GMT Finance series Not all stock recommendation changes are equal. In a sample constructed to minimize the impact of confounding news, relatively few analyst recommendation changes are influential in the sense that they impact investors' beliefs about a firm in a way that could be noticed in that firm's stock returns. More than one-third of the stock-price reactions to analyst recommendation changes have the wrong sign and only approximately 10 per cent have significant stock-price reactions at the 5 per cent level using an extended market model. We find that the probability of an influential recommendation is higher for leader analysts, star analysts, away-from-consensus revisions, revisions issued contemporaneously with earnings forecasts, analysts with greater relative experience, and those with more accurate earnings estimates. Growth firms, small firms, high institutional ownership firms, and high prior turnover firms are also more likely to have influential stock recommendations. Strikingly, analyst recommendations are more likely to be influential after Reg FD and the settlement. Finally, influential recommendations are associated with increases in stock volatility and large absolute changes in consensus earnings forecasts. http://www.ecgi.org/wp/wp_id.php?id=377 Wed, 12 Aug 2009, 11:27 GMT Finance series We set up a model to study how ownership structure, corporate law and employment law interact to set the incentives that influence the decision by the large shareholder or manager effectively controlling the firm to divert resources from minority shareholders and employees. We suggest that agency problems between the controller and other investors and holdup problems between shareholders and employees are connected if the controller bears private costs of 'expropriating' these groups. Corporate law and employment law may therefore somethimes be substitutes; employees may benefit from better corporate law intended to protect minority shareholder, and vice versa. Our model has implications for the domestic and comparative study of corporate governance structure and addresses, among other things, the question whether large shareholders are better able to 'bond' with employees than dispersed ones, or whether the separation of ownership facilitates longterm relationships with labor. http://www.ecgi.org/wp/wp_id.php?id=376 Mon, 10 Aug 2009, 15:09 GMT Law series This paper is the first to investigate the corporate governance role of shareholderinitiated proxy proposals in European firms. While proposals in the US are nonbinding even if they pass the shareholder vote, they are legally binding in the UK and most of Continental Europe. Nonetheless, submissions remain relatively infrequent in Continental Europe in particular, with major variations across countries in ownership structures, monitoring incentives, and the laws and regulations governing shareholder access to the proxy. We use sample selection models to analyze target selection and proposal success in terms of the voting outcomes and the stock price effects, and make several contributions to the literature. First, proposal submissions remain infrequent compared to the US in Continental Europe in particular. In the UK proposals typically relate to a proxy contest seeking board changes, while in Continental Europe they are more focused on specific governance issues. Second, there is some evidence that the proposal sponsors are valuable monitors, because the target firms tend to underperform and have low leverage. The sponsors also observe the identity of the voting shareholders, because proposal probability increases in the target’s ownership concentration and the equity stake of institutional investors. Third, while proposals enjoy limited voting success across Europe, they are relatively more successful in the UK. The outcomes are strongest for proposals targeting the board but are also affected by the target characteristics including the CEO’s pay-performance sensitivity. Finally, proposals are met with strong negative stock price effects when they are voted upon at general meetings. This suggests that rather than attribute them control benefits, the market often interprets proposals and their failure to pass the vote as a negative signal of governance concerns. Indeed, the market responds better to proposals submitted against large firms with low leverage, which is consistent with agency considerations. However, the stock price effects are most negative for poorly performing firms with low market-to-book ratios, which implies that the proposal outcomes only intensify the market’s concerns over firms that have previously underperformed. http://www.ecgi.org/wp/wp_id.php?id=375 Fri, 10 Jul 2009, 15:54 GMT Finance series Nonprofit organizations have been called the '0neglected stepchildren of modern organization law.' Deficits of control in nonprofit organizations are widespread. This is due to the absence of shareholders who could monitor and of the discipline by takeover markets. This article focuses on the board of nonprofit organizations as the center of nonprofit governance and tries to see what an be learned from the corporate governance discussion. The differences between the United States and Europe as to the board of nonprofit organizations is discussed at the outset. Then the organization and functioning of the board of nonprofit organizations and board responsibility are analyzed. Key problems of organization and functioning are the board structure (one-tier/two-tier), composition and size, committees, remuneration and audit. As to responsibility the duties of the board and its liability must be distinguished. At the end much can be learned from the corporate governance movement, but everything depends on enforcement, legal or non-legal. http://www.ecgi.org/wp/wp_id.php?id=374 Wed, 08 Jul 2009, 16:10 GMT Law series Should boards of financial firms be blamed for the financial crisis' Using a large sample of data on nonfinancial and financial firms for the period 1996-2007, I document that the governance of financial firms is, on average, not obviously worse than in nonfinancial firms. Even the issue of executive compensation is not as clear cut as suggested by the media. I also document that bank directors earned significantly less compensation than their counterparts in nonfinancial firms and banks receiving bailout money had boards that were more independent than in other banks. I discuss implications of these findings. http://www.ecgi.org/wp/wp_id.php?id=373 Wed, 08 Jul 2009, 15:10 GMT Finance series Much attention has been devoted in recent literature to the claim that a country’s ‘legal origin’ may make a difference to its pattern of financial development and more generally to its economic growth path. Proponents of this view assert that the ‘family’ within which a country’s legal system originated, be it common law, or one of the varieties of civil law, has a significant impact upon the quality of its legal protection of shareholders, which in turn impacts upon economic growth, through the channel of firms’ access to external finance. Complementary studies of creditors’ rights and labour regulation have buttressed the core claim that different legal families have different dynamic properties. Specifically, common law systems are thought to be better able to respond to the changing needs of a market economy than are civilian systems. This literature has, however, largely been based upon cross-sectional studies of the quality of corporate, insolvency and labour law at particular points in the late 1990s. In this paper, we report findings based on newly constructed indices which track legal change over time in the areas of shareholder, creditor and worker protection. The indices cover five systems for the period 1970-2005: three ‘parent’ systems, the UK, France and Germany; the world’s most developed economy, the US; and its largest democracy, India. The results cast doubt on the legal origin hypothesis in so far as they show that civil law systems have seen substantial increases in shareholder protection over the period in question. The pattern of change differs depending on the area which is being examined, with the law on creditor and worker protection demonstrating more divergence and heterogeneity than that relationg to shareholders. The results for worker protection are more consistent with the legal origin claim than in the other two cases, but this overall result conceals significant diversity within the two ‘legal families,' with different countries relying on different institutional mechanisms to regulate labour. Until the late 1980s the law of the five countries was diverging, but in the last 10-15 years there has been some convergence, particularly in relation to shareholder protection. http://www.ecgi.org/wp/wp_id.php?id=372 Tue, 07 Jul 2009, 17:25 GMT Law series When Council Regulation (EC) No 2157/2001 on the Statute for a European Company (Societas Europaea - SE) became effective on 8 October 2004, it offered publicly traded companies, for the first time, a choice between competing company laws, namely the national law of the company’s home state and the law of the supranational SE. Using an event study methodology, we analyse a unique dataset of publicly traded firms that have announced to re-incorporate under the SE Regulation. We find the re-incorporation decision to have a positive impact on firms’ stock market value. The abnormal returns associated with re-incorporating as an SE increase over the years, which we interpret as the result of declining legal uncertainty and a rising reputational value of the SE corporate form. http://www.ecgi.org/wp/wp_id.php?id=371 Tue, 07 Jul 2009, 17:23 GMT Law series We provide an overview of Indian corporate governance practices, based primarily on responses to a 2006 survey of 370 Indian public companies. Compliance with legal norms is reasonably high in most areas, but not complete. We identify areas where Indian corporate governance is relatively strong and weak, and areas where regulation might usefully be either relaxed or strengthened. On the whole, Indian corporate governance rules appear appropriate for larger companies, but could use some strengthening in the area of related party transactions, and some relaxation for smaller companies. Executive compensation is low by U.S. standards and is not currently a problem area. We also examine whether there is a cross-sectional relationship between measures of governance and measures of firm performance and find evidence of a positive relationship for an overall governance index and for an index covering shareholder rights. We find an overall association, which is stronger for more profitable firms and firms with stronger growth opportunities. A subindex for shareholder rights is individually significant, but subindices for board structure (board independence and committee structure), disclosure, board procedure, and related party transactions are not significant. The non-results for board structure contrast to other recent studies, and suggest that India's legal requirements are sufficiently strict so that overcompliance does not produce valuation gains. http://www.ecgi.org/wp/wp_id.php?id=370 Tue, 07 Jul 2009, 17:21 GMT Law series We examine evidence for a systematic underperformance of Germany's state-owned banks in the current financial crisis and study if the bank losses can be traced to the quality of bank governance. For this purpose, we examine the biographical background of 593 supervisory board members in the 29 largest banks and find a pronounced difference in the finance and management experience of board representatives across private and state-owned banks. Measures of 'boardroom competence' are then related directly to the magnitude of bank losses in the recent financial crisis. Our data confirms that supervisory board (in-)competence in finance is related to losses in the financial crisis. Improved bank governance is therefore a suitable policy objective to reduce bank fragility. http://www.ecgi.org/wp/wp_id.php?id=369 Fri, 12 Jun 2009, 11:14 GMT Finance series This paper analyses the regulatory framework which applies to the determination of directors’ remuneration in Europe and the extent to which European firms follow best practices in corporate governance in this area, drawing on an empirical analysis of the governance systems which European firms adopt in setting remuneration and, in particular, on an empirical assessment of their diverging approaches to disclosure. These divergences persist despite recent reforms. After an examination of the link between optimal remuneration, corporate governance and regulation and an assessment of how regulatory reform has evolved in this area, the paper provides an overview of national laws and best practice corporate governance recommendations across the Member States following the adoption of the important EC Recommendations on directors’ remuneration and the role of non-executive directors in 2004 and 2005, respectively. This overview is largely based on the answers to questionnaires sent to legal experts from seventeen European Member States. The paper also provides an empirical analysis of governance practices and, in particular, firm disclosure of directors’ remuneration in Europe’s largest 300 listed firms by market capitalisation. The paper reveals that, notwithstanding a swathe of reforms across the Member States in recent years and harmonisation efforts, disclosure levels still vary from country to country and are strongly dependent on the existence of regulations and best practice guidelines in the firm’s home Member State. Convergence in disclosure practices is not strong; only a few basic standards are followed by the majority of the firms examined and there is strong divergence with respect to most of the criteria considered in the study. Consistent with previous research, our study reveals clear differences not only with respect to remuneration disclosure, but also with respect to shareholder engagement and the board’s role in the remuneration process and in setting remuneration guidelines. Ownership structures still ‘matter’; these divergences tend to follow different corporate governance systems and, in particular, the dispersed ownership/block-holding ownership divide. They do not appear to have been smoothed since the EC Company Law Action Plan was launched and notwithstanding the harmonisation that has been attempted in this field. http://www.ecgi.org/wp/wp_id.php?id=368 Fri, 12 Jun 2009, 11:04 GMT Law series Using a large panel of firms across the world from 1991-2006, we show that the median foreign firm has lower idiosyncratic risk than a comparable U.S. firm. Country characteristics help explain variation in the level of idiosyncratic risk, but less so than firm characteristics. Idiosyncratic risk falls as government stability and respect for the rule of law improve. Idiosyncratic risk is positively related to stock market development but negatively related to bond market development. Surprisingly, we find that idiosyncratic risk is generally negatively related to corporate disclosure quality. Finally, idiosyncratic risk generally increases with shareholder protection. Though there is evidence that R2 increases with creditor rights and falls with the quality of disclosure, these results are driven by the relations between these variables and systematic risk rather than by the impact of these variables on idiosyncratic risk. http://www.ecgi.org/wp/wp_id.php?id=367 Sun, 07 Jun 2009, 21:47 GMT Finance series This paper investigates Securities and Exchange Commission (SEC) deregistrations by foreign firms from the time the Sarbanes-Oxley Act (SOX) was passed in 2002 through 2008. We test two theories, the bonding theory and the loss of competitiveness theory, to understand why foreign firms leave U.S. equity markets and how deregistration affects their shareholders. Firms that deregister grow more slowly, need less capital, and experience poor stock return performance prior to deregistration compared to other foreign firms listed in the U.S. that do not deregister. Until the SEC adopted Exchange Act Rule 12h-6 in 2007 the deregistration process was extremely difficult for foreign firms. Easing these procedures led to a spike in deregistration activity in the second-half of 2007 that did not extend into 2008. We find that deregistrations are generally associated with adverse stock-price reactions, but these reactions are much weaker in 2007 than in other years. It is unclear whether SOX affected foreign-listed firms and deregistering firms adversely in general, but there is evidence that the smaller firms that deregistered after the adoption of Rule 12h-6 reacted more negatively to announcements that foreign firms would not be exempt from SOX. Overall, the evidence supports the bonding theory rather than the loss of competitiveness theory: foreign firms list shares in the U.S. in order to raise capital at the lowest possible cost to finance growth opportunities and, when those opportunities disappear, a listing becomes less valuable to corporate insiders and they go home if they can. But when they do so, minority shareholders typically lose. http://www.ecgi.org/wp/wp_id.php?id=366 Sun, 07 Jun 2009, 21:49 GMT Finance series In 2008, share prices on U.S. stock markets fell further than they had during any one year since the 1930s. Does this mean corporate governance “failed”? This paper argues “no”, based on a study of a sample of companies at “ground zero” of the stock market meltdown, namely the 37 firms removed from the iconic S and P 500 index during 2008. The study, based primarily on searches of the Factiva news database, reveals that institutional shareholders were largely mute as share prices fell and that boardroom practices and executive pay policies at various financial firms were problematic. On the other hand, there apparently were no Enron-style frauds, there was little criticism of the corporate governance of companies that were not under severe financial stress and directors of troubled firms were far from passive, as they orchestrated CEO turnover at a rate far exceeding the norm in public companies. The fact that corporate governance functioned tolerably well in companies removed from the S and P 500 implies that the case is not yet made out for fundamental reform of current arrangements. http://www.ecgi.org/wp/wp_id.php?id=365 Sun, 07 Jun 2009, 21:48 GMT Law series firms that maintained their dual share structure at least until 2000. Our main findings are as follows. First, controlling shareholders offset the dilution of voting rights they incurred upon unification by: 1) increasing their holdings prior to the unification (ex-ante preparation), and 2) by buying shares afterwards; by the end of the sample period their voting power was only marginally lower than in the control sample. This suggests that marginal voting rights are important to controlling shareholders even beyond the 50 per cent threshold. Second, share unifications were not associated with much change in the identity of controlling shareholders. Third, the proportion of firms affiliated with pyramidal business groups in the sample of unifying firms was lower than in the population of listed firms as a whole and not different from that in the control sample, suggesting that pyramidal ownership structures did not replace dual class shares. Finally, unifying firms did not exhibit a substantial improvement in their performance and valuation in comparison with the control sample. We conclude that the regulatory attempt to enforce one shareone vote yielded, at best, a minor improvement in corporate governance. http://www.ecgi.org/wp/wp_id.php?id=364 Sun, 07 Jun 2009, 21:46 GMT Finance series This essay takes stock of the corporate governance reform efforts Italian policymakers have engaged in since the beginning of the 1990s. After describing the reform process and its drivers (a concern for Italian equity markets’ attractiveness in an increasingly competitive and global framework, scandals, and EC activism), the essay analyzes the main reforms to single out what has worked (i.e. had a practical positive impact on Italian listed companies’ corporate governance) and what has not worked. After concluding that the corporate governance legal framework has greatly improved as a result of reforms, the essay identifies a number of areas in which further steps could be taken to protect investors against the risk of expropriation by corporate insiders. It is also argued, however, that the mother of all corporate governance reforms in Italy would be a change in legal and political culture; legal culture should change so as to put substance over form, function over doctrine. That would be a precondition to effective enforcement of corporate and securities laws. Political culture should change from one that deems it to be the norm for politicians to decide on the allocation of corporate control to one more respectful of property rights. Two modest, bottom-up proposals to help change legal culture in the long run are finally put forth. http://www.ecgi.org/wp/wp_id.php?id=363 Mon, 01 Jun 2009, 20:13 GMT Law series In recent years, the emphasis in corporate governance has shifted from board composition, independent directors, separating the position of chairperson and CEO, and establishing board committees to “being in control” and risk management issues. However, the corporate law perspective of internal control and risks management does not match up to the multidisciplinary perspective of these themes. This paper analyses the dichotomy between the US and the EU corporate law approaches to internal control and risk management. Lawmakers from the US, the EU, and the EU member states reacted to the scandals between 2000 and 2003 with provisions requiring public companies to have internal control and risk management systems in order to restore public confidence, but the substance of their responses differed. A regulatory framework is put forward in order to address the steps to be taken in establishing an operational internal control and risk management framework and to address the role of the different parties involved from a corporate law perspective. The above mentioned steps are: (1) initiate and identify, (2) assess and operate, (3) monitor, and (4) report on the systems relating to the companies’ risks and uncertainties, strategy, financial reporting, and operations. The parties legally involved include: (1) senior management, (2) board, (3) audit committee, and (4) auditor. The US and the EU regulatory frameworks indicate not only that their corporate law approaches to internal control and risk management are different, but also that both approaches are incomplete – but not necessarily insufficient – in several areas. http://www.ecgi.org/wp/wp_id.php?id=362 Mon, 01 Jun 2009, 19:57 GMT Law series This paper uses a large survey of directors to investigate variation in directors' dual roles as advisors and monitors of management. I examine whether the advisory role encourages information exchange between the CEO and the board, as suggested by Adams and Ferreira (2007). I also examine factors related to directors' perceptions of their roles. Amongst others the data suggests that a) directors vary in their perceptions of their roles and directors' roles affect their perceptions of information exchange, b) directors who agree more that they primarily monitor management perceive that they participate less in boardroom discussion than directors who agree that the CEO often asks them for advice, c) directors with a stronger personal relationship with management perceive their advisory role to be more important, and d) directors on boards with more decision-making power perceive their monitoring role to be less important relative to their advisory role. The results are robust to using Heckman selection techniques to address nonresponse bias. Overall, the data suggests that monitoring alone may not be sufficient for good governance. http://www.ecgi.org/wp/wp_id.php?id=361 Mon, 01 Jun 2009, 19:47 GMT Finance series During the period of 1998 to 2006, over 13 per cent of large U.S. public corporations have independent directors domiciled in foreign countries. We find that firms appointing foreign independent directors (FIDs) experience significantly negative announcement-period abnormal stock returns and the presence of FIDs leads to significant lower firm performance and value. Further analyses reveal that FIDs are more likely to miss board meetings than U.S. based directors and firms with FIDs on board give their CEOs excessively high compensation and are more prone to commit financial misreporting that requires future restatement. Overall, our findings support the conjecture that FIDs’ geographic location creates significant logistical and informational problems hindering their ability to engage in the governance of firms, and as a result, they undermine board effectiveness and lead to more agency problems and poor firm performance. We find only limited evidence that firms benefit from the international perspective and expertise of FIDs. http://www.ecgi.org/wp/wp_id.php?id=360 Wed, 17 Jun 2009, 16:29 GMT Finance series Two existing theories of insiders on corporate boards posit opposing roles and shareholder wealth effects, while treating inside directors homogeneously. We differentiate inside directors holding outside directorships as more independent relative to other insiders and find they are more frequent when firm-specific information is important and CEOs are less influential. Firms with independent inside directors are associated with better operating performance and higher market-to-book ratios, especially when firm-specific information is highly important. Announcements of inside director appointments to outside boards exhibit shareholder wealth gains, while departure announcements trigger stock declines. Departures of other inside directors have no effect. http://www.ecgi.org/wp/wp_id.php?id=359 Wed, 17 Jun 2009, 16:27 GMT Finance series We analyze whether family-controlled business groups, which are often structured as pyramids, are a means to facilitate better access to capital or to expropriate minority shareholders. Using a sample of 27,987 firms from 45 countries we find that, group-affiliated firms on average have lower Tobin's Q than unaffiliated firms. However, after controlling for endogeneity in group membership choice, we find that group structure helps improve firm value. Within groups, we find that Q increases down the pyramidal chain and decreases with the ultimate owner's cash flow rights, and that the direct shareholding of the group in a firm is an important (positive) determinant of Q. These results are contrary to previous findings that emphasize agency problems and expropriation of minority shareholders in business groups. Our evidence indicates that such expropriation risk is outweighed by the funding and corporate control benefits provided by a group, similar to a venture capitalist in a developed market. Additionally, our supplementary country-level analysis finds that access to outside funding, taxation and regulatory factors are more important than the strength of the corporate governance environment in explaining the prevalence of business groups. Overall, both firm- and country-level analyses point to a consistent implication that business groups exist and persist because of their critical roles in assisting projects that might not be otherwise funded by external investments, especially in underdeveloped capital markets. http://www.ecgi.org/wp/wp_id.php?id=358 Wed, 17 Jun 2009, 16:22 GMT Finance series We develop a model of internal governance where the self-serving actions of top management are limited by the potential reaction of subordinates. We find that internal governance can mitigate agency problems and ensure firms have substantial value, even without any external governance. Internal governance seems to work best when both top management and subordinates are important to value creation. We then allow for governance provided by external financiers and show that external governance, even if crude and uninformed, can complement internal governance in improving efficiency. Interestingly, this leads us to a theory of investment and dividend policy, where dividends are paid by self-interested CEOs to maintain a balance between internal and external control. Finally, we explore how the internal organization of firms may be structured to enhance the role of internal governance. Our paper could explain why firms with limited external oversight, and firms in countries with poor external governance, can have substantial value. http://www.ecgi.org/wp/wp_id.php?id=357 Mon, 01 Jun 2009, 19:19 GMT Finance series This study focuses on a major global issue: the rise of sovereign wealth funds (SWFs). Using the largest data set of their holdings to date, we document a large SWF premium of more than 15 per cent of firm value. Using data from 2002 through 2007 that includes SWF holdings in 8,000 firms in 58 countries, we find that firms with higher ownership by SWFs have higher firm valuations and better operating performance. Additionally, they tend not to invest heavily in firms in high-tech industries or those operating in areas involving intensive research and development. http://www.ecgi.org/wp/wp_id.php?id=356 Mon, 01 Jun 2009, 19:09 GMT Finance series Berle and Means famously declared in 1932 that a separation of ownership and control was a hallmark of large U.S. corporations and their characterization of matters quickly became received wisdom. A series of recent papers (Hannah, 2007; Santos and Rumble, 2006, Holderness, forthcoming) has called the Berle-Means orthodoxy into question. This paper surveys the relevant historical literature on point, acknowledging in so doing that the pattern of ownership and control in U.S. public companies has been anything but monolithic but saying a separation between ownership and control remains an appropriate reference point for analysis of U.S. corporate governance. http://www.ecgi.org/wp/wp_id.php?id=355 Wed, 01 Apr 2009, 22:59 GMT Law series Institutional investors are the dominant force in financial markets today, yet their preferences about corporate governance are generally undisclosed and their activities in this area tend to be performed privately. We conduct a survey to elicit their views on investor protection and corporate governance mechanisms. We find that among the institutions who responded to our survey corporate governance is of importance to their investment decisions and a number of them are willing to engage in shareholder activism. Further, an examination of the institutional investors' portfolio holdings shows that their investment decisions appear to be related to their preferences. http://www.ecgi.org/wp/wp_id.php?id=354 Tue, 24 Mar 2009, 20:08 GMT Finance series We interview 20 executives in the UK who have been members of both PE and PLC boards of relatively large companies. The main difference we find in PE and PLC board modus operandi is in the single-minded value creation focus of PE boards versus governance compliance and risk management focus of PLC boards. PE boards see their role as 'leading' the strategy of the firm through intense engagement with top management; in contrast, PLC boards 'accompany' the strategy of top management. PE boards report almost complete alignment in objectives between executive and non-executive directors, whereas the PLC boards report lack of complete alignment and focus on management of broader stakeholder interests. Finally, PE board members receive information that is primarily cash-focused and undergo an intensive induction during the due diligence phase. In contrast, PLC board members collect more diverse information and undergo a more structured (formal) rather than an intense induction. http://www.ecgi.org/wp/wp_id.php?id=353 Mon, 23 Mar 2009, 09:39 GMT Finance series We examine deal-level data on private equity transactions in the UK initiated during the period 1996 to 2004 by mature private equity houses. We un-lever the deal-level equity return and adjust for (un-levered) return to quoted peers to extract a measure of 'alpha' or abnormal performance of the deal. The alpha is significantly positive on average and robust during sector downturns. In the cross-section of deals, higher alpha is related to greater improvement in EBITDA to Sales ratio (margin) and greater growth in EBITDA multiple during the private phase, relative to that of quoted peers. In particular, deals with higher alpha either grow their margins more substantially, and/or grow multiples more substantially, whilst expanding their revenues only in line with the sector. Based on interviews with general partners involved with the deals, we find that deals with higher alpha and higher margin growth are associated with greater intensity of engagement of private equity houses during the early phase of the deal, employment of value-creation initiatives for productivity and organic growth, and complementing top management with external support. Overall, our results are consistent with mature private equity houses creating value for portfolio companies through active ownership and governance. http://www.ecgi.org/wp/wp_id.php?id=352 Mon, 23 Mar 2009, 09:36 GMT Finance series It is often assumed that strong securities markets require good legal protection of minority shareholders. This implies both 'good' law -- principally corporate and securities law -- and enforcement, yet there has been little empirical analysis of enforcement. We study private enforcement of corporate law in two common law jurisdictions with highly developed stock markets, the United Kingdom and the United States, examining how often directors of publicly traded companies are sued, and the nature and outcomes of those suits. We find, based a comprehensive search for filings over 2004-2006, that lawsuits against directors of public companies alleging breach of duty are nearly nonexistent in the UK. The US is more litigious, but we still find, based on a nationwide search of decisions between 2000-2007, that only a small percentage of public companies face a lawsuit against directors alleging a breach of duty that is sufficiently contentious to result in a reported judicial opinion, and a substantial fraction of these cases are dismissed. We examine possible substitutes in the UK for formal private enforcement of corporate law and find some evidence of substitutes, especially for takeover litigation. Nonetheless, our results suggest that formal private enforcement of corporate law is less central to strong securities markets than might be anticipated. http://www.ecgi.org/wp/wp_id.php?id=351 Wed, 04 Mar 2009, 15:16 GMT Finance series It is often assumed that strong securities markets require good legal protection of minority shareholders. This implies both 'good' law -- principally corporate and securities law -- and enforcement, yet there has been little empirical analysis of enforcement. We study private enforcement of corporate law in two common law jurisdictions with highly developed stock markets, the United Kingdom and the United States, examining how often directors of publicly traded companies are sued, and the nature and outcomes of those suits. We find, based a comprehensive search for filings over 2004-2006, that lawsuits against directors of public companies alleging breach of duty are nearly nonexistent in the UK. The US is more litigious, but we still find, based on a nationwide search of decisions between 2000-2007, that only a small percentage of public companies face a lawsuit against directors alleging a breach of duty that is sufficiently contentious to result in a reported judicial opinion, and a substantial fraction of these cases are dismissed. We examine possible substitutes in the UK for formal private enforcement of corporate law and find some evidence of substitutes, especially for takeover litigation. Nonetheless, our results suggest that formal private enforcement of corporate law is less central to strong securities markets than might be anticipated. http://www.ecgi.org/wp/wp_id.php?id=350 Wed, 04 Mar 2009, 15:14 GMT Law series Rapidly innovating industries are just not behaving the way theory expected. Conventional industrial organization theory predicts that when parties in the supply chain have to make transaction-specific investments, the risk of opportunism will drive them away from contracts and toward vertical integration. Despite the conventional theory, contemporary practice is moving in the other direction. Instead of vertical integration, we observe vertical disintegration in a significant number of industries, as producers recognize that they cannot themselves maintain cutting-edge technology in every field required for the success of their product. In doing this, the parties are developing forms of contracting beyond the reach of contract theory models. In this Article, we connect the emerging contract practice to theory, learning from what has happened in the real world to frame a theoretical explanation of this cross-organizational innovation and to reconceptualize the boundaries of the firm accordingly. We argue that the vertical disintegration of the supply chain in many industries is mediated neither by fully specified technical interfaces that allow suppliers to produce a modular piece of the ultimate product, nor by entirely implicit relational contracts supported only by norms of reciprocity and the expectation of future dealings. Rather, we suggest that the change in the boundary of the firm has given rise to a new form of contracting between firms - what we call contracting for innovation. This pattern braids explicit and implicit contracting to support iterative collaborative innovation by raising switching costs. These costs, represented by the parties' parallel investment in transaction specific investment in knowledge about their collaborators' capacities, deter opportunism under circumstances when explicit contracting, renegotiation and the anticipation of future dealings cannot. http://www.ecgi.org/wp/wp_id.php?id=349 Wed, 04 Mar 2009, 15:12 GMT Law series We examine the impact of lead arrangers' reputation on the design of loan contracts such as spread, fees and the inclusion of restrictive covenants. Controlling for the non-randomness of the lender-borrower match (self-selection bias), we find that the reputation of top tier arrangers leads to higher spreads, and that top tier arrangers retain larger fractions of their loans in their syndicates. These larger spreads are especially pronounced for borrowers without credit rating that have the most to gain from the certification assumed by virtue of a loan contract with a top tier arranger. Top tier arrangers are able to select the best deals and thereby sell larger portions of their loans to syndicate banks. This certification channel differs from the one found in public markets (Fang, 2005), where certification leads to a reduced spread offered to the best clients. In the private syndicated loan market, certification seems to be through the higher retention of loans by the lead arranger-however, only for borrowers without credit rating. We find no evidence of certification for rated borrowers. These differences between public and private markets can be explained by differences in the way they operate and are structured. Interestingly, the effect is strongest for transactions done after the changes in the banking regulations (including the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994) that led to significant consolidations in the banking industry, including among the largest commercial banks. Consistent with the overall results on spreads, top tier arrangers charge lower arranger fees only to borrowers with credit ratings that have little need for additional certification by lenders. http://www.ecgi.org/wp/wp_id.php?id=348 Wed, 04 Mar 2009, 15:10 GMT Finance series We analyze corporate fraud in a model in which managers have superior information but are biased against liquidation, because of their private benefits from empire building. This may induce them to misreport information and even bribe auditors when liquidation would be value-increasing. To curb fraud, shareholders optimally choose auditing quality and the performance sensitivity of managerial pay, taking external corporate governance and auditing regulation into account. For given managerial pay, it is optimal to rely on auditing when external governance is in an intermediate range. When both auditing and incentive pay are used, worse external governance must be balanced by heavier reliance on both of those incentive mechanisms. In designing managerial pay, equity can improve managerial incentives while stock options worsen them. http://www.ecgi.org/wp/wp_id.php?id=347 Tue, 03 Mar 2009, 10:23 GMT Finance series This paper investigates how firm age affects performance. Consistent with the presence of organizational rigidities, the evidence suggests that performance gets worse with age. Profits fall, margins thin, and costs rise. Firms do best when they are young, and roughly 15 years after listing (37 years after incorporation), they start underperforming the average firm in the industry. This relation cannot be explained away by sample selection, manager age, industry age, risk, corporate governance, and ownership structure. Overall, firms seem to face a serious aging problem. http://www.ecgi.org/wp/wp_id.php?id=346 Mon, 02 Mar 2009, 16:52 GMT Finance series CEOs have a potential conflict of interest when their company is acquired: they can bargain to be retained by the acquirer and for private benefits rather than for a higher premium to be paid to the shareholders. We investigate the determinants of target CEO retention by the acquirer and whether target CEO retention affects the premium paid by the acquirer. The probability that a CEO is retained increases with a private bidder, the performance of the target, and with the fraction of target shares held by insiders. Regardless of the bidder type, we find no evidence that the premium paid is lower when the CEO is retained by the acquirer. Strikingly, the target stock price increases more at the announcement of an acquisition by a private firm when the CEO is retained than when she is not. This result holds whether the private acquirer is a private equity firm or an operating company and for management buyouts. http://www.ecgi.org/wp/wp_id.php?id=345 Sat, 28 Feb 2009, 16:18 GMT Finance series Shareholder and public dissatisfaction with executive compensation has led to calls for an annual shareholder advisory vote on a firm's compensation practices and policies, so-called say on pay. Governance activists have recently begun to use the proxy machinery to target specific firms for such a shareholder vote. Some governance activists have also backed federal legislative proposals that would implement say on pay generally for US public companies. This paper assesses the case for such a mandatory federal rule in light of the UK experience with a similar regime adopted in 2002. The best argument for a mandatory rule is that it would destabilize pay practices that have produced excessive compensation and that would not yield to firm-by-firm pressure. This has not been the UK experience; pay continues to increase. The most serious concern is the likely evolution of a best compensation practices regime which would embed normatively-opinionated practices that would ill-suit many firms. There is some evidence of a UK evolution in that direction. This problem might be more pronounced in the US because US shareholders are even more likely than their UK counterparts to delegate judgments over compensation practices to a small number of proxy advisors who themselves will be economizing on analysis. The paper argues that the jury-rigged system now operating to push for compensation reform in US firms in light of the SEC's robust new compensation disclosure regime should be permitted to operate for a few more years before mandatory say-on-pay is seriously considered. In any event, if compensation levels are unacceptable as social matter rather than as a pay-for-performance matter, then general tax law changes would be more productive than tinkering with corporate governance. http://www.ecgi.org/wp/wp_id.php?id=344 Wed, 25 Feb 2009, 18:55 GMT Law series In this paper, we argue that chief executive officers of publicly-held corporations in the United States are losing power to their boards of directors and to their shareholders. This loss of power is recent (say, since 2000) and gradual, but nevertheless represents a significant move away from the imperial CEO who was surrounded by a hand-picked board and lethargic shareholders. After discussing the concept of power and its dimensions, we document the causes and symptoms of the decline in CEO power in several areas: share ownership composition and shareholder activism; governance rules and the board response to shareholder activism; regulatory changes related to shareholder voting; changes in the board of directors; and executive compensation. We argue that this decline in CEO power represent a long-term trend, rather than a temporary response to economic and political conditions. The decline in CEO power has several important implications, including implications with respect to the possibility of a regulatory backlash against certain newly empowered shareholder groups, the type of persons who will serve on corporate boards in the future, the type of shareholder initiatives that will be introduced and the corporate response to them, the convergence of corporate laws across countries, and the source of resistance to acquisitions and the legal regulation of target defenses. http://www.ecgi.org/wp/wp_id.php?id=343 Wed, 25 Feb 2009, 18:53 GMT Law series Traditionally, the impacts of the rights of financial institutions and workers on corporate performance have been analyzed independently. Yet, theory clearly indicates that the combination of relative powers of different stakeholders affects a firm overall performance. Using U.S. state level and state-industry level data, we investigate how output growth is affected by bank branch deregulation and employment protection occurring over 1972-1993. We find that financial liberalization positively impact overall state growth but greater workers' rights affects it ambiguously. At the industry level, however, employment protection promotes those industries that are more knowledge intensive, while the effect of financial liberalization does not differ across industries that vary in external financing dependency. The results hold controlling for changes in shareholders' rights, which itself is not significant. The findings suggest that financial liberalization operates mostly through an efficiency channel, better reallocating resources across sectors, while employment protection creates higher incentives and encourages more sector-specific, human capital investments. Overall, the results show that the strength of stakeholders' protection affects performance through efficiency channels and provide support for a stakeholders' view of corporate governance. http://www.ecgi.org/wp/wp_id.php?id=342 Wed, 25 Feb 2009, 18:51 GMT Finance series Soccer clubs listed on the London Stock Exchange provide a unique way of testing stock price reactions to different types of news. For each firm, two pieces of information are released on a weekly basis: experts' expectations about game outcomes through the betting odds, and the game outcomes themselves. The stock market reacts strongly to news about game results, generating significant abnormal returns and trading volumes. We find evidence that the abnormal returns for the winning teams do not reflect rational expectations but are high due to overreactions induced by investor sentiment. This is not the case for losing teams. There is no market reaction to the release of new betting information although these betting odds are excellent predictors of the game outcomes. The discrepancy between the strong market reaction to game results and the lack of reaction to betting odds may not only be the result from overreaction to game results but also from the lack of informational content or information salience of the betting information. Therefore, we also examine whether betting information can be used to predict short-run stock returns subsequent to the games. We reach mixed results: we conclude that investors ignore some non-salient public information such as betting odds, and betting information predicts a stock price overreaction to game results which is influenced by investors' mood (especially when the teams are strongly expected to win). http://www.ecgi.org/wp/wp_id.php?id=341 Wed, 18 Feb 2009, 22:25 GMT Finance series This paper is a survey of the literature on boards of directors, with an emphasis on research done subsequent to the Hermalin and Weisbach (2003) survey. The two questions most asked about boards are what determines their makeup and what determines their actions? These questions are fundamentally intertwined, which complicates the study of boards due to the joint endogeneity of makeup and actions. A focus of this survey is on how the literature, theoretical as well as empirically, deals - or on occasions fails to deal - with this complication. We suggest that many studies of boards can best be interpreted as joint statements about both the director-selection process and the effect of board composition on board actions and firm performance. http://www.ecgi.org/wp/wp_id.php?id=340 Wed, 18 Feb 2009, 22:23 GMT Finance series This paper studies the promotion of senior executives. We consider the impact of rankings of senior executives on management incentive pay, CEO influence, and firm valuation. Board membership, relative total pay, and firm titles are used to identify firms that designate a single executive below the CEO versus firms that provide tournament-like incentives with multiple insiders next in line below the CEO. Our results show that greater board independence, recent MA activity, and intensity of industry competition are positively related to the likelihood of tournament like rankings. In contrast, service industries, where soft information is important, are associated with a higher likelihood of a single designated executive below the CEO. Consistent with the hypothesis that tournaments among managers are a significant factor in motivating managers, we find that companies with multiple managers below the CEO receive less equity and pay for performance compensation than the managers in firms with one designated manager below the CEO. Although the pay gap between the CEO and the next-in-line managers is higher in firms with multiple managers below the CEO as predicted by tournament theory, the CEO total compensation is higher in firms with a single executive below the CEO. In spite of the higher pay for performance incentive to the top executives in firms with a single designated insider, we find a negative association between firm value and the organization structures with a single manager below the CEO. The single manager model is also associated with a lower sensitivity of CEO turnover to accounting measures of firm performance. Finally, we find that the negative relation in firm value in the single manager model disappears when CEO nears retirement. Our results are consistent with the view that a tournament like organization structure is an efficient method to motivate managers when CEO succession is not imminent. http://www.ecgi.org/wp/wp_id.php?id=339 Mon, 19 Jan 2009, 15:53 GMT Finance series This paper shows that marriage can function in a similar way as mergers and acquisitions. To set up alliances that would benefit the firms, a controlling family would encourage their children to marry a person from a politically or economically powerful family. To test this hypothesis, we collect wedding announcements for the offspring of big-business owners in Thailand. The results from the event study show positive abnormal returns when the partner is from a well-connected family. The probit analysis shows that offspring are more likely to choose their partner from a well-connected family when the family's businesses are in the property and construction industries, based on state contracts, more diversified and heavily in debt. Overall, the results suggest that family networks might provide reputation capital, reliable information, and enforce contracts, thus reducing market frictions faced by entrepreneurs in weak institutional environments. http://www.ecgi.org/wp/wp_id.php?id=338 Sun, 23 Nov 2008, 02:29 GMT Finance series Traditional theories argue that governance is strongest under a single large blockholder, as she has strong incentives to undertake value-enhancing interventions (engage in 'voice'). However, most firms are held by multiple small blockholders. This paper shows that, while such a structure generates free-rider problems that hinder voice, the same co-ordination difficulties strengthen a second governance mechanism: disciplining the manager through trading (engaging in 'exit'). Since multiple blockholders cannot co-ordinate to limit their orders and maximize combined profits, they trade competitively, impounding more information into prices. This makes the threat of disciplinary exit more credible, inducing higher managerial effort. The optimal blockholder structure depends on the relative effectiveness of manager and blockholder effort, the complementarities in their outputs, liquidity, monitoring costs, and the manager's contract. http://www.ecgi.org/wp/wp_id.php?id=337 Sun, 23 Nov 2008, 02:27 GMT Finance series When-issued trading concerns transactions in securities that have not yet been issued. This type of trade often takes place in a so-called 'grey market', in which all contracts are conditional on the issuance of the security. In this paper, we investigate the Dutch grey market for when-issued shares prior to stock splits and IPOs, using a unique, handcollected dataset. Stock splits are more likely to be preceded by when-issued trading when the underlying firm is larger, the relative trading volume of the stock is higher, and the stock return is less volatile. This implies that market makers are more likely to set up a when-issued market after a stock split announcement when the number of expected transactions is large and the expected costs are low. On the basis of when-issued and regular share closing prices, we calculate premiums of 0.50 per cent to 1.50 per cent on nearly all of the 50 trading days leading up to the stock split. When corrected for the time value of money, these when-issued securities trade at a small but economically significant premium of on average about 0.60 per cent over the regular shares during a limited period before the effective date of the stock split. However, this when-issued premium disappears in the last days prior to the stock split. In the case of when-issued trading in the run-up to an IPO, we find that the prices paid in the grey market are in line with the first day closing prices. This confirms the findings of Loffler, Panther and Theissen (2005) that pre-IPO prices are highly informative. http://www.ecgi.org/wp/wp_id.php?id=336 Thu, 13 Nov 2008, 20:48 GMT Finance series This paper explores the appropriate system of civil liability for mandatory securities disclosure violations by established, publicly traded issuers. The U.S. system's design has become outmoded as the underlying mandatory disclosure regime that has moved from an emphasis on disclosure at the time that an issuer makes a public offering, to an emphasis on the issuer's ongoing periodic disclosures. An efficiency analysis shows that, unlike U.S. law today, the relevant actors should have equally great civil liability incentives to comply with the disclosure rules whether or not the issuer is offering securities at the time. An issuer not making a public offering of securities should have no liability because the compensatory justification is weak. Deterrence will be achieved instead by imposing liability on other actors. An issuer's annual filings should be signed by an external certifier - an investment bank or other well capitalized entity with financial expertise. If the filing contains a material misstatement and the certifier fails to do due diligence, the certifier would face measured liability. Officers and directors would be subject to similar liability. Damages would be payable to the issuer. When an issuer is making a public offering, it would be liable to investors for its disclosure violations as an antidote to what otherwise would be an extra incentive not to comply. This design would address two major complaints concerning the existing U.S. civil liability system: underwriter Section 11 liability for a lack of due diligence concerning disclosures that in modern offerings underwriters have no realistic ability to police, and litigation-expensive issuer class action fraud-on-market liability. The system suggested here would eliminate both sorts of liability. But unlike elimination reforms proposed by underwriters and issuers, it would retain deterrence by substituting in place of these liabilities more effective and efficient civil liability incentives for disclosure compliance. http://www.ecgi.org/wp/wp_id.php?id=335 Thu, 13 Nov 2008, 20:42 GMT Law series Using a novel dataset that allows us to trace the primary bank relationships of a sample of mostly unlisted firms, we explore which borrowers are able to benefit from foreign bank presence in emerging markets. Our results suggest that the limits to financial integration are less tight than the static picture of bank-firm relationships implies. Even though foreign banks are more likely to engage large and foreign-owned firms, they do not terminate relationships with the clients of banks they acquire as often as domestic financial acquirers do. Most importantly, firms appear to have the same access to financial loans and ability to invest whether they borrow from a foreign bank or not. Since firms without bank relationships make lower use of financial loans, and invest less, our results suggest that by making relationships more stable and by indirectly enhancing access to the financial system, foreign banks may benefit all firms. http://www.ecgi.org/wp/wp_id.php?id=334 Thu, 6 Nov 2008, 18:53 GMT Finance series We investigate whether inheritance law constrains investment in family firms. Using a model of succession in family firms where the law may constrain the entrepreneur to give a minimal stake to non-controlling heirs, we show that the size of this stake reduces investment in family firms, by reducing the firm's ability to pledge future income streams to external financiers. We take this prediction to the data, by collecting information about inheritance law in 62 countries. Wherever present, these laws effectively constrain the stake that can be given to the controlling and non-controlling heirs. Using a purpose-built indicator of the permissiveness of inheritance law together with measures of investor protection and data for 10,245 firms from 32 countries over the 1990-2006 interval, we find that stricter inheritance law is associated with lower investment in family firms, while it leaves investment unaffected in non-family firms, and that this result survives several robustness checks. Moreover, as predicted by the model, inheritance laws affects investment only in family firms that experience a succession. http://www.ecgi.org/wp/wp_id.php?id=333 Tue, 4 Nov 2008, 19:39 GMT Finance series We investigate whether cultural differences between professional decision-makers affect financial contracts in a large dataset of international syndicated bank loans. We find that lead banks offer smaller loans at a higher interest rate to more culturally distant borrowers. Furthermore, lead banks are more likely to require third-party guarantees as cultural distance with the borrower increases. The effects of cultural differences are not confined to the relation between borrower and lender and appear to hamper risk sharing within the syndicate as well. Ceteris paribus, participant banks fund smaller portions of syndicated loans led by culturally distant banks. These cultural biases are not significantly reduced by repeated interaction with the counterparty or with other agents in the foreign country. http://www.ecgi.org/wp/wp_id.php?id=332 Tue, 4 Nov 2008, 19:36 GMT Finance series This article reviews regulatory concerns prompted by the difficulties that were encountered by four British banks in making rights issues and other pro rata equity offerings between April and August 2008 against a background of adverse market conditions. Its conclusion that rights issues are too cumbersome and too time-consuming swims with the mainstream of current thinking. The article contributes to the debate by considering Limits of Private Sector Solutions for Banks: Recent UK Rights Issues options for change it is realistic to pursue given the confines of the existing mandatory legal framework, much of which is now set at the European level. http://www.ecgi.org/wp/wp_id.php?id=331 Sat, 1 Nov 2008, 10:53 GMT Law series This paper examines the hypothesis that firms in competitive industries should benefit relatively less from good governance, while firms in non-competitive industries - where lack of competitive pressure fails to enforce discipline on managers - should benefit relatively more. Whether we look at the effects of governance on long-horizon stock returns, firm value, or operating performance, we consistently find the same pattern: The effect is monotonic in the degree of competition, it is small and insignificant in competitive industries, and it is large and significant in non-competitive industries. By implication, the effect of governance (in non-competitive industries) reported in this paper is stronger than what has been previously reported in Gompers, Ishii, and Metrick (2003, GIM) and subsequent work, who document the average effect across all industries. For instance, GIM's hedge portfolio - provided it only includes firms in non-competitive industries - earns a monthly alpha of 1.47 per cent, which is twice as large as the alpha reported in GIM. The alpha remains large and significant even if the sample period is extended until 2006. We also revisit the argument that investors in the 1990s anticipated the effect of governance, implying that the alpha earned by GIM's hedge portfolio is likely due to an omitted risk factor. We find that while investors were indeed not surprised on average, they underestimated the effect of governance in non-competitive industries, the very industries in which governance has a significant effect in the first place. http://www.ecgi.org/wp/wp_id.php?id=330 Fri, 10 Oct 2008, 13:02 GMT Finance series As barriers to international investment fall and technology improves, the cost advantages for a firm's securities to trade publicly in the country in which that firm is located and for that country to have a market for publicly traded securities distinct from the capital markets of other countries will progressively disappear. However, securities laws remain an important determinant of whether and where securities are issued, how they are valued, who owns them, and where they trade. The value of public firms depends on these laws, so that identical firms subject to different laws are likely to have different values. We show that mandatory disclosure through securities laws can decrease agency costs between corporate insiders and minority shareholders, but only provided the investors can act on the information disclosed and the laws cannot be weakened ex post too much through lobbying by corporate insiders. With financial globalization, national disclosure laws can have wide-ranging effects on a country's welfare, on firms and on investor portfolios, including the extent to which share holdings reveal a home bias. In equilibrium, if firms can choose the securities laws they are subject to when they go public, some firms will choose stronger securities laws than those of the country in which they are located and some firms will do the opposite. These effects of securities laws can be expected to become smaller if differences in national laws and their enforcement decrease and if the costs of private solutions to manage corporate agency conflicts that are substitutes for securities laws fall. http://www.ecgi.org/wp/wp_id.php?id=329 Mon, 6 Oct 2008, 09:42 GMT Law series As barriers to international investment fall and technology improves, the cost advantages for a firm's securities to trade publicly in the country in which that firm is located and for that country to have a market for publicly traded securities distinct from the capital markets of other countries will progressively disappear. However, securities laws remain an important determinant of whether and where securities are issued, how they are valued, who owns them, and where they trade. The value of public firms depends on these laws, so that identical firms subject to different laws are likely to have different values. We show that mandatory disclosure through securities laws can decrease agency costs between corporate insiders and minority shareholders, but only provided the investors can act on the information disclosed and the laws cannot be weakened ex post too much through lobbying by corporate insiders. With financial globalization, national disclosure laws can have wide-ranging effects on a country's welfare, on firms and on investor portfolios, including the extent to which share holdings reveal a home bias. In equilibrium, if firms can choose the securities laws they are subject to when they go public, some firms will choose stronger securities laws than those of the country in which they are located and some firms will do the opposite. These effects of securities laws can be expected to become smaller if differences in national laws and their enforcement decrease and if the costs of private solutions to manage corporate agency conflicts that are substitutes for securities laws fall. http://www.ecgi.org/wp/wp_id.php?id=328 Tue, 30 Sep 2008, 12:37 GMT Finance series German firms pay out a lower proportion of their cash flows, but a higher proportion of their published profits than UK and US firms. We estimate partial adjustment models and report two major findings. First, German firms base their dividend decisions on cash flows rather than published earnings as (i) published earnings do not correctly reflect performance because German firms retain parts of their earnings to build up legal reserves, (ii) German accounting is conservative, (iii) published earnings are subject to more smoothing than cash flows. Second, to the opposite of UK and US firms, German firms have more flexible dividend policies as they are willing to cut the dividend when profitability is only temporarily down. http://www.ecgi.org/wp/wp_id.php?id=327 Tue, 30 Sep 2008, 12:34 GMT Finance series Private equity has reaped large rewards in recent years. We claim that one major reason for this success is due to the corporate governance advantages of private equity over the public corporation. We argue that the development of substantial derivative contracts and trading has significantly weakened the governance of public corporations and has created a need for financially sophisticated directors and much closer supervision of management. The private equity model delivers these benefits and allows corporations to be better governed, creating wealth gains for investors. http://www.ecgi.org/wp/wp_id.php?id=326 Wed, 24 Sep 2008, 21:28 GMT Law series While the means of payment in takeovers has been a focal point in the takeover literature, what has largely been ignored is the analysis of how the takeover bid is financed and what its impact is on the expected value creation of the takeover. This paper investigates the sources of transaction financing in European corporate takeovers launched during the period 1993-2001 (the fifth takeover wave). Using a unique dataset, we show that the external sources of financing (debt and equity) are frequently employed in takeovers involving cash payments. Acquisitions with the same means of payment but different sources of transaction funding are quite distinct. For instance, a significantly negative price revision following the announcement of a takeover is not unique to the equity-paid Mamp;As; it is also observed in any other deals that involve equity financing (including cash-paid and mixed-paid Mamp;As). Also, acquisitions financed with internally generated funds significantly underperform those financed with debt. Our multinomial logit and nested logit analyses show that the takeover financing decision is influenced by the bidder's pecking order preferences, its growth potential, and its corporate governance environment, all of which are related to the cost of external capital. There is also evidence that the choice of equity versus internal cash or debt financing is influenced by the bidder's strategic preferences with respect to the means of payment. We find no evidence of financing decisions driven by agency conflicts between managers and shareholders or between shareholders and creditors. http://www.ecgi.org/wp/wp_id.php?id=325 Wed, 03 Sep 2008, 21:58 GMT Finance series Using a sample that provides unprecedented detail on foreign listings, new listings and delistings for 29 exchanges in 24 countries starting from the early eighties, we document large waves in exchanges' ability to attract foreign companies. We highlight the following determinants of these waves. First, new regulations aiming to improve firm corporate governance bring more foreign listings to the exchange, but stricter disclosure requirements discourage foreign listings. Second, as corporate governance improves in the country of origin, firms become less likely to list in countries with weak investor protection, but more likely to list in the U.K. and the U.S., the countries with strongest investor protection in the sample. This can explain why U.S. and U.K. exchanges have gained foreign listings at the expense of smaller exchanges. Finally, foreign listing waves appear to be related to market timing in the same way as domestic equity issues do. http://www.ecgi.org/wp/wp_id.php?id=324 Wed, 03 Sep 2008, 21:53 GMT Finance series While the means of payment in takeovers has been a focal point in the takeover literature, what has largely been ignored is the analysis of how the takeover bid is financed and what its impact is on the expected value creation of the takeover. This paper investigates the sources of transaction financing in European corporate takeovers launched during the period 1993-2001 (the fifth takeover wave). Using a unique dataset, we show that the external sources of financing (debt and equity) are frequently employed in takeovers involving cash payments. Acquisitions with the same means of payment but different sources of transaction funding are quite distinct. For instance, a significantly negative price revision following the announcement of a takeover is not unique to the equity-paid M and As; it is also observed in any other deals that involve equity financing (including cash-paid and mixed-paid M and As). Also, acquisitions financed with internally generated funds significantly underperform those financed with debt. Our multinomial logit and nested logit analyses show that the takeover financing decision is influenced by the bidder's pecking order preferences, its growth potential, and its corporate governance environment, all of which are related to the cost of external capital. There is also evidence that the choice of equity versus internal cash or debt financing is influenced by the bidder's strategic preferences with respect to the means of payment. We find no evidence of financing decisions driven by agency conflicts between managers and shareholders or between shareholders and creditors. http://www.ecgi.org/wp/wp_id.php?id=323 Sun, 31 Aug 2008, 22:29 GMT Law series To our knowledge, this is the first paper that investigates the links between trust, the institutional setting (in terms of employment protection legislation (EPL) and investor rights) and studies the impact of all three on economic performance. In line with the previous literature (e.g. Knack and Keefer (1997), Zak and Knack (2001)), we find that trust has a positive impact on GDP per capita growth. Our novel results are twofold. First, we find that EPL and investor rights have a negative relationship and that both (although the latter to a lesser extent) are substitutes for trust. Second, all three variables have a positive effect on economic growth. http://www.ecgi.org/wp/wp_id.php?id=322 Thu, 14 Aug 2008, 21:46 GMT Finance series As the regulation of public companies has progressively tightened in recent years, many companies have chosen to switch to stock exchanges with lower regulatory requirements. We analyse the consequences of switching for smaller quoted companies, using the unusual regulatory environment in London, which has two markets with different regulatory regimes but the same trading technology. Firms that switch to lighter regulation experience negative announcement returns of approximately 4 percent. However these initial price reactions are reversed after the actual switch. We also find an intriguing longer-term upward drift in stock returns, which we relate to improved operating performance. http://www.ecgi.org/wp/wp_id.php?id=321 Tue, 29 Jul 2008, 15:51 GMT Finance series In Unocal Corp v Mesa Petroleum Co, the Delaware Supreme Court stated that 'our corporate law is not static. It must grow and develop in response to, indeed in anticipation of, evolving concepts and needs'. Historically, however, this evolution and growth has occurred with only limited and sporadic attention to international corporate governance regimes. This relative lack of attention in the US to international corporate regimes was hardly surprising for several reasons. First, the US has traditionally been a regulatory leader, rather than follower. Secondly, under competition for corporate charter theory each state within the US itself was viewed as a corporate law 'laboratory'. Thirdly, it is often assumed that US law represents a standardized common law model of corporate governance. The paper challenges this assumption, by reference to differences between the approach of the US and some other common law jurisdictions in the topical area of shareholder rights. At a time when there is growing skepticism about the influence of the competition for corporate charters, the paper argues it makes sense for the US to examine and test how international jurisdictions address common problems in corporate regulation. One recent event reflecting growing interest in this regard was the announcement by the SEC in March 2008 that it had entered into a pilot mutual recognition program with Australia in relation to securities market regulation. http://www.ecgi.org/wp/wp_id.php?id=320 Sun, 27 Jul 2008, 23:36 GMT Law series 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 and 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-a-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 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. http://www.ecgi.org/wp/wp_id.php?id=319 Sun, 27 Jul 2008, 23:32 GMT Law series We test the 'law matters' and 'legal origin' claims using a newly created panel dataset measuring legal change over time in a sample of developed and developing countries. Our dataset improves on previous ones by avoiding country-specific variables in favour of functional and generic descriptors, by taking into account a wider range of legal data, and by considering the effects of weighting variables in different ways, thereby ensuring greater consistency of coding. Our analysis shows that legal origin explains part of the pattern of change in the adoption of shareholder protection measures over the period from the mid-1990s to the present day: in both developed and developing countries, common law systems were more protective of shareholder interests than civil law ones. We explain this result on the basis of the head start common law systems had in adjusting to an emerging 'global' standard based mainly on Anglo-American practice. Our analysis also shows, however, that civil law origin was not much of an obstacle to convergence around this model, since civilian systems were catching up with their counterparts in the common law. We then investigate whether there was a link in this period between increased shareholder protection and stock market development, using a number of measures such as stock market capitalisation, the value of stock-trading and the number of listed firms, after controlling for legal origin, the state of economic development of particular countries, and their position on the World Bank rule of law index. We find no evidence of a long-run impact of legal change on stock market development. This finding is incompatible with the claim that legal origin affects the efficiency of legal rules and ultimately economic development. Possible explanations for our result are that laws have been overly protective of shareholders; transplanted laws have not worked as expected; and, more generally, the exogenous legal origin effect is not as strong as widely supposed. http://www.ecgi.org/wp/wp_id.php?id=318 Sun, 06 Jul 2008, 21:46 GMT Law series We use a sample of U.S. dual-class companies to examine how the divergence between insider voting rights and cash-flow rights affects managerial extraction of private benefits of control. We find that as the divergence widens at dual-class companies, corporate cash holdings are worth less to outside shareholders, CEOs receive higher levels of compensation, managers are more likely to make shareholder-value destroying acquisitions, and capital expenditures contribute less to shareholder value. These findings support the hypothesis that managers with greater control rights in excess of cash-flow rights are prone to waste corporate resources to pursue private benefits at the expense of shareholders. As such, they contribute to our understanding of why firm value is decreasing in the insider control-cash flow rights divergence. http://www.ecgi.org/wp/wp_id.php?id=317 Sun, 06 Jul 2008, 21:41 GMT Finance series Examining private firm acquisitions, we analyze acquirer announcement returns and target purchase pricing, the impact of venture capital (VC) backing and the importance of VC conflicts of interest with other private equity investors. We find that VC backing leads to significantly higher acquirer announcement returns, averaging 2 to 4 percent, even after controlling for deal characteristics and endogeneity in venture funding. On further investigation of the VC-backed sample, we find that acquirer announcement returns are particularly high when VC investors have close financial ties to acquirers and the announcement effect increases with a VC's acquirer shareholdings. For these same acquisitions, target firms receive significantly lower purchase prices relative to their book values. Also, acquisitions of targets backed by corporate VCs exhibit higher acquirer announcement returns, which is consistent with corporate VCs having strategic goals that can conflict with maximizing financial returns. We also show that targets backed by VC funds nearing maturity have lower purchase price to book value ratios, which supports VC willingness to accept lower financial returns to obtain liquidity as their funds near maturity. Taken together, this evidence is consistent with VC conflicts of interest with other target investors affecting the acquisition negotiation process. We conclude that VC conflicts of interest adversely affect target acquisition prices and enhance acquirer profitability, and outweigh any negotiation expertise or certification benefits VCs provide to their portfolio companies. http://www.ecgi.org/wp/wp_id.php?id=316 Thu, 03 Jul 2008, 17:19 GMT Finance series We examine IPOs of startups backed by corporate venture capitalists (CVCs) and the propensity of CVC parents to establish strategic alliance with these startup firms. We investigate the differences in the governance structures of venture capital (VC) backed IPO firms. A major difference in objectives between CVCs and traditional venture capitalists (TVCs) is that CVCs often invest for strategic reasons and their parent firms frequently enter into various forms of strategic business relations with their portfolio firms which persist well beyond the IPO. We argue that such strategic alliances can have a significant impact on the governance structure of CVC backed firms, both when they go public and in the following years. Using a sample of VC backed IPOs, we evaluate several hypotheses concerning a CVC's role in the corporate governance of newly public firms. We find that strategic CVC backed IPOs have weaker CEOs and a larger proportion of independent directors on their boards and compensation committees compared to a matched sample of TVC backed IPO firms. CVC backed IPO firms also have a higher frequencies of staggered boards and forced CEO turnovers. Comparing the corporate governance of IPO firms having strategic alliances with CVC parents with TVC backed IPOs with outside strategic alliances, we find strategic CVC investors have a mean ownership stake of 16.4 per cent compared to 2.2 per cent for outside strategic partners and the strategic CVCs hold significantly more board seats than other strategic alliance partners, both pre- and post-IPO. Finally, these two subsamples of IPO issuers have similar frequencies of takeover defenses. http://www.ecgi.org/wp/wp_id.php?id=315 Thu, 03 Jul 2008, 17:14 GMT Law series As institutional investors are the largest shareholders in most listed UK firms, one expects them to monitor the firms they invest in. However, there is mounting empirical evidence which suggests that they do not perform any monitoring. This paper provides a new test on whether UK institutional investors engage in monitoring. The test consists of an event study on directors' trades. If institutional shareholders act as monitors, their monitoring activities convey new information about a firm's future value to other outside shareholders and reduce the informational asymmetry between the managers and the market. As a result, directors' trades convey less information to the market, and the stock price reaction is weaker. However, our results show that institutional shareholders do not have any significant impact on the stock price reaction which stands in marked contrast with the impact that families, individuals and other firms have on stock prices. http://www.ecgi.org/wp/wp_id.php?id=314 Tue, 27 May 2008, 21:48 GMT Finance series Companies have the choice to deviate from their national corporate governance standards by opting into another system. They can do so via contractual devices - such as cross-border mergers and acquisitions, (re)incorporations, and cross-listings - which enable firms to choose their preferred level of investor protection and regulation. This paper reviews these three main contractual governance devices, their effect on value, and whether their adoption by firms induces a race to the bottom or a race to the top. Indeed, firms may opt for less shareholder-orientation or investor protection shareholder-expropriation hypothesis) rather than for more stringent rules that require firms to focus on shareholder value (bonding hypothesis). http://www.ecgi.org/wp/wp_id.php?id=313 Tue, 27 May 2008, 21:43 GMT Finance series The process of liberalization of India's economy since 1991 has brought with it considerable development both of its financial markets and the legal institutions which support these. An influential body of recent economic work asserts that a country's 'legal origin' - as a civilian or common law jurisdiction - plays an important part in determining the development of its investor protection regulations, and consequently its financial development. An alternative theory claims that the determinants of investor protection are political, rather than legal. We use the case of India to test these theories. We find little support for the idea that India's legal heritage as a common law country has been influential in speeding the path of regulatory reforms and financial development. There is a complementarity between (i) India's relative success in services and software, (ii) the relative strength of its financial markets for outside equity, as opposed to outside debt, and (iii) the relative success of stock market regulation, as opposed to reforms of creditor rights. We conclude that political explanations have more traction in explaining the case of India than do theories based on 'legal origins'. http://www.ecgi.org/wp/wp_id.php?id=312 Tue, 27 May 2008, 21:38 GMT Law series Shares in publicly-quoted UK companies are, similarly to those in their US counterparts, dispersed amongst many holders. The central problem of corporate governance for UK listed firms is therefore rendering managers accountable to shareholders. This paper investigates the way in which the mechanisms used to control these managerial agency problems are enforced. It provides a roadmap of the enforcement strategies employed, and a first approximation of their empirical significance. The results suggest three stylised facts about the UK corporate governance system. First, shareholder lawsuits are conspicuous by their absence. Formal private enforcement plays little or no role in controlling managers. Secondly, and contrary to leading accounts in the economic literature, it is public, rather than private, enforcement which dominates in relation to listed companies. However, the lion's share of the interventions by the relevant agencies - the Takeover Panel, the Financial Reporting Review Panel, and the Financial Services Authority - is of an informal character, not resulting in any legal action. Suasion, rather than sanction, is the order of the day. Thirdly, a simple divide between public and private enforcement fails fully to take account of the role played by institutional investors in the UK, who have engaged systematically in informal private enforcement activity. Strong informal private enforcement has historically therefore been the flipside, in the UK, of weak formal private enforcement. http://www.ecgi.org/wp/wp_id.php?id=311 Tue, 20 May 2008, 21:49 GMT Law series Entrepreneurs, catalysts for innovation in the economy, are increasingly the object of policymakers' attention. Recent initiatives both in the UK and at EU level have sought to promote entrepreneurship by reducing the harshness of the consequences of personal bankruptcy law. Whilst there is an intuitive link between the two, relatively little attention has been paid to the question empirically, particularly in the international context. We investigate the link between bankruptcy and entrepreneurship using data on self employment over 16 years (1990-2005) and 15 countries in Europe and North America. We compile new indices reflecting how `forgiving' personal bankruptcy laws are, reflecting the time to discharge. These measures vary over time and across the countries studied. We show that bankruptcy law has a statistically and economically significant effect on self employment rates when controlling for GDP growth, MSCI stock returns, and a variety of other legal and economic factors. The results have clear implications for policymakers. http://www.ecgi.org/wp/wp_id.php?id=310 Tue, 20 May 2008, 21:45 GMT Law series This study investigates how personal values may affect strategic decisions of board members in Swedish public corporations in dilemmas between shareholders and other stakeholders. Using vignettes that are based on seminal court cases, we find that shareholderism stances correlate systematically with value priorities. Directors and CEOs tend to side with shareholders' interests the more they endorse entrepreneurial values - namely, higher achievement, power, and self-direction values and lower universalism, benevolence, and conformity values. Employee representative directors - a special feature of Swedish corporate governance - exhibit more stakeholderist stances, but in most cases side with shareholders. Finally, directors in more profitable firms exhibit stronger shareholderism. http://www.ecgi.org/wp/wp_id.php?id=309 Fri, 16 May 2008, 14:24 GMT Finance series We extend here our prior work on equity decoupling (Hu and Black, 2006, 2007, 2008). We developed there the terms empty voting and hidden (morphable) ownership. Empty voting involves holding greater voting power than economic ownership. Morphable ownership is economic ownership, ostensibly without voting rights, which can readily morph to include voting ownership. This ownership is often hidden, because it can fall outside most countries' rules for disclosing share ownership. In this Article, we treat empty voting and hidden (morphable) ownership as instances of a broader concept of equity decoupling. Investors, and corporations themselves, can unbundle a variety of the shareholder rights - not only voting rights; as well as a variety of shareholder obligations - not only disclosure obligations. Equity decoupling in turn, is one instance of a broader range of decoupling possibilities. Debt decoupling, involving the unbundling of the economic, contractual control rights, and legal and other rights normally associated with debt, through credit derivatives and securitization, is also common. Corporations can have empty and hidden creditors, just as they can have empty and hidden shareholders. Hybrid decoupling across standard equity and debt categories is also possible. Debt decoupling can pose risks at the firm level for what can be termed debt governance - the overall relationship between creditor and debtor, including creditors' exercise of contractual and legal rights with respect to firms and other borrowers. Widespread debt decoupling can also involve externalities and therefore creates systemic financial risks; we explore those risks. http://www.ecgi.org/wp/wp_id.php?id=308 Thu, 15 May 2008, 11:37 GMT Finance series We provide an overview of the corporate governance practices of Brazilian public companies, based primarily on an extensive 2005 survey of 116 companies. We focus on the 88 responding 'Brazilian private firms' which are not majority owned by the state or a foreign company. We identify areas where Brazilian corporate governance is relatively strong and weak. Board independence is an area of weakness: The boards of most Brazilian private firms are comprised entirely or almost entirely of insiders or representatives of the controlling family or group. Many firms have zero independent directors. At the same time, minority shareholder have legal rights to representation on the boards of many firms, and this representation is reasonably common. Financial disclosure lags behind world standards. Only a minority of firms provide a statement of cash flows or consolidated financial statements. However, many provide English language financial statements, and an English language version of their website. Audit committees are uncommon, but many Brazilian firms use an alternate approach to ensuring financial statement accuracy -- establishing a fiscal board. A minority of firms provide takeout rights to minority shareholders on a sale of control. Controlling shareholders often use shareholders agreements to ensure control. http://www.ecgi.org/wp/wp_id.php?id=307 Thu, 15 May 2008, 11:32 GMT Finance series Researchers debate whether environmental investments reduce firm value or can actually improve financial performance. We provide some first evidence on shareholder wealth effects of voluntary corporate environmental initiatives. Companies announcing membership in Climate Leaders and Ceres - two voluntary environmental programs related to climate change - experience significantly negative abnormal stock returns. The price decline is smaller in carbon-intensive industries, where regulatory actions are more likely, and for high book-to-market firms, suggesting that green expenditures crowd out growth-related investments. We also document insignificant announcement returns for portfolios of industry rivals. Overall, the environmental investments appear to conflict with shareholder value-maximization. This has far reaching implications since the U.S. government relies on voluntary initiatives to reduce the emissions of greenhouse gases. http://www.ecgi.org/wp/wp_id.php?id=306 Wed, 07 May 2008, 23:05 GMT Finance series We examine whether pre-bid target stock price runups lower bidder takeover gains and deter short-term toehold purchases in the runup period. A dollar increase in the runup raises the initial offer price by $0.80 (markup pricing). Bidder gains, while decreasing in offer price markups, are increasing in runups, suggesting that runups are interpreted by the negotiating parties as reflecting increases in target stand-alone values. We also show that short-term toehold purchases increase runups. However, when purchased by the initial bidder (as opposed to by other investors), short-term toeholds lower markups, possibly because they provide evidence to the target that the runup anticipates the pending offer premium (supporting substitution between the runup and the markup). We conclude that markup pricing per se is unlikely to deter short-term toehold aquisitions. http://www.ecgi.org/wp/wp_id.php?id=305 Wed, 07 May 2008, 23:00 GMT Finance series The primary way in which directors obtain necessary information is by attending board meetings. Bank directors, in particular, are strongly urged to attend meetings by regulators. We investigate whether such pressure is sufficient for bank directors to have good attendance records. Using data on whether directors were named in proxy statements as attending fewer meetings than they were supposed to, we find that a) bank directors appear to have worse attendance records than their counterparts in nonfinancial firms, b) their attendance behavior is related to explicit and implicit incentives for attendance, and c) past attendance records are not related to the likelihood a director departs the board. Our results suggest that explicit and implicit incentives may provide important complements to regulatory pressure in influencing director behavior. http://www.ecgi.org/wp/wp_id.php?id=304 Sun, 20 Apr 2008, 120:21 GMT Finance series This paper provides new evidence on the evolution of ownership of a large sample of companies in five European countries - Belgium, France, Italy, Spain and the UK - between 1999 and 2008 to understand ownership dynamics and the influence of legal developments on ownership patterns. Ownership concentration decreased at a moderate pace over the last 8 years in three countries - France, Italy and Belgium - but increased in two others, Spain and the UK. In France, Italy and Belgium approximately half of the companies have a de jure controlling shareholder. In Spain and the UK the largest group of companies have a shareholder with a voting block between 10 per cent and 30 per cent. In all civil law countries in this study, the majority of the largest shareholders are families or non-financial companies. However there are large differences between the civil law countries as well as over time. Banks remained major shareholders in a large number of Spanish companies and acquired smaller blocks in British companies. All over Europe, there is evidence that insurance companies acquire large stakes, though not controlling voting blocks. In France and Italy privatisation processes continue and the number of companies with government shareholdership is reduced. In all countries more companies are confronted with foreign shareholders. Foreign shareholders are the largest group of shareholders, measured by the number of companies in which a shareholder class is present in all countries, with Spain as the only exception. The analysis of ownership structures enables a more detailed analysis of its relationship with company and securities law. Lele and Siems (2008) developed the LLSV's index of investor protection rights in two indices relating to the protection against board and management on the one hand and protection against other shareholders on the other hand. Their analysis is used to study the relationship between company and securities law development and ownership structures. The results by and large confirm LLSV's thesis, especially for France, though the relationships are relatively weak. The increase of the anti-director index resulted in smaller voting blocks in hands of the largest shareholder. As the anti-blockholder index did not improve in France, (other minority)shareholders increased their voting blocks as a second best substitute. http://www.ecgi.org/wp/wp_id.php?id=303 Sun, 20 Apr 2008, 20:03 GMT Law series We study the determinants of private benefits of control in negotiated block transactions. We estimate the block pricing model in Burkart, Gromb, and Panunzi (2000) explicitly accounting for both block premia and block discounts in the data. The evidence suggests that the occurrence of a block premium or discount depends on the controlling block holder's ability to fight a potential tender offer for the target's stock. We find evidence of large private benefits of control and of associated deadweight losses, but also of value creation by controlling shareholders. Finally, we provide evidence consistent with Jensen's free cash flow hypothesis. http://www.ecgi.org/wp/wp_id.php?id=302 Thu, 20 Aug 2009 14:36 GMT Finance series We investigate whether the diffusion of information sharing among banks has affected credit market performance in the transition countries of Eastern Europe and the former Soviet Union, using a large sample of firm-level data. Our estimates show that information sharing is associated with improved availability and lower cost of credit to firms, and that this correlation is stronger for opaque firms than transparent firms. In cross-sectional estimates, we control for variation in country-level aggregate variables that may affect credit, by examining the differential impact of information sharing across firm types. In panel estimates, we also control for the presence of unobserved heterogeneity at the firm level and for changes in selected macroeconomic variables. http://www.ecgi.org/wp/wp_id.php?id=301 Thu, 17 Apr 2008, 16:32 GMT Finance series liquidity, cost of equity capital and Tobin's q in 26 countries using a large sample that includes over 3,800 first-time adopters. We find that market liquidity and equity valuations increase around the time of the mandatory introduction of IFRS. The results for firms' cost of capital are mixed. Partitioning our sample, we find that the capital-market benefits exist only in countries with strict enforcement regimes and institutional environments that provide strong reporting incentives. Furthermore, the effects are weaker when local GAAP are closer to IFRS, in countries with an IFRS convergence strategy, and in industries with higher voluntary adoption rates. In terms of magnitude, the capital market effects are most pronounced for firms that voluntarily switch to IFRS, both in the year when they switch and again when IFRS becomes mandatory. While the first result likely reflects selection effects, the latter result, together with our evidence for the sample partitions, cautions us to attribute the capital-market effects for first-time adopters solely to the adoption of IFRS. Many countries have made concurrent efforts to improve enforcement and governance regimes, which likely play into our findings. Overall, the results are consistent with the view that reporting quality is shaped by many factors in countries' institutional environments, pointing in particular to the importance of firms' reporting incentives and countries' enforcement regimes. http://www.ecgi.org/wp/wp_id.php?id=300 Thu, 17 Apr 2008, 16:30 GMT Finance series The Russian language version of this report is available at http://ssrn.com/abstract=1001991. This Report was prepared, with support by the World Bank, for the Russian Center for Capital Market Development and the Russian Federal Service on the Securities Market (FSFM). We discuss the liability under company law of members of the board of directors, senior managers, and controlling shareholders of public companies in Canada, France, Germany, Korea, the United Kingdom, and the United States (plus a more limited look at Austria, the European Union, Italy, Japan, and Latvia), and apply this comparative analysis to the Russian context. We recommend amendments to the Russian Law on Joint Stock Companies and related legislation. We propose measures to enhance the effectiveness of derivative suits; define the concepts of good faith and conflict of interest; establish duties of disclosure and confidentiality; extend duties under company law to controlling shareholders and de facto directors for conflict of interest transactions; protect directors against liability for business decisions adopted without a conflict of interest. We do not recommend the creation of significant administrative or criminal liability, nor expanded duties of directors for a company in financial distress. This document includes a separate Overview of the Report by Professor Black which provides an overview of Russia's progress in creating a modern company law. The Overview and Chapters 1 and 3 will be published separately as Legal Liability of Directors and Company Officials Part 1: Substantive Grounds for Liability (Report to the Russian Securities Agency), 2007 Columbia Business Law Review 614-799, available at http://ssrn.com/abstract=1010306. Chapters 8-9 and 11-13 will be published separately as Legal Liability of Directors and Company Officials Part 2: Court Procedures, Indemnification and Insurance, and Administrative and Criminal Liability (Report to the Russian Securities Agency), 2008 Columbia Business Law Review (forthcoming), available at http://ssrn.com/abstract=1010307. http://www.ecgi.org/wp/wp_id.php?id=299 Wed, 02 Apr 2008, 11:54 GMT Law series The paper describes the European Model Company Law Project. Last year, a commission was formed on the initiative of the authors with the goal of drafting a European Model Company Law Act (EMCLA). This project aims neither to force a mandatory harmonization of national company law nor to create a further, European corporate form. The goal is rather to draft model rules for a corporation that national legislatures would be free to adopt in whole or in part. Thus, the project is thought as an alternative and supplement to the existing EU instruments for the convergence of company law. The present EU instruments, their prerequisites and limits are being discussed in the paper. Furthermore, the paper describes the US experience with such model acts in the area of company law. It concludes by discussing several topics concerning the content of an EMCLA, introducing the members of the EMCLA Working Group, and explaining the Group's preliminary working plan. http://www.ecgi.org/wp/wp_id.php?id=298 Wed, 02 Apr 2008, 11:52 GMT Law series We apply the paradigm of the firm as a nexus of contracts to the debate on regulatory competition vs. unification of law as an alternative way of regulating the business corporation. This approach views the business corporation as a set of coordinated contracts among different parties. Agency problems and related agency costs are the result of this interaction. The economic analysis of corporate law, securities regulation and bankruptcy law identifies law as a means to minimize such agency costs. In this paper we develop a model where companies are heterogeneous in their preferences about the legal regulation of contractual relationships. We then compare a regime of regulatory competition to a regime of single supply of regulation and we analyse their relatives costs and benefits. http://www.ecgi.org/wp/wp_id.php?id=297 Tue, 25 Mar 2008, 15:53 GMT Law series In this paper, we examine the impact of the PSLRA and more particularly the impact the type of lead plaintiff on the size of settlements in securities fraud class actions. We thus provide insight into whether the type of plaintiff that heads the class action impacts the overall outcome of the case. Furthermore, we explore possible indicia that may explain why some suits settle for extremely small sums – small relative to the “provable losses” suffered by the class, small relative to the asset size of the defendant-company, and small relative to other settlements in our sample. This evidence bears heavily on the debate over “strike suits.” Part I of this paper sets forth the contemporary debate surrounding the need for further reforms of securities class actions. In this section, we set forth the insights advanced in three prominent reports focused on the competitiveness of U.S. capital markets. In Part II we first provide descriptive statistics of our extensive data set, and then use multivariate regression analysis to explore the underlying relationships. In Part III, we closely examine small settlements for clues to whether they reflect evidence of strike suits. We conclude in Part IV with a set of policy recommendations based on our analysis of the data. http://www.ecgi.org/wp/wp_id.php?id=296 Fri, 21 Mar 2008, 22:59 GMT Law series This paper examines the UK's system for public oversight of financial and corporate governance disclosures by issuers and of auditors, taking account of the framework of European law and institutional arrangements within which that system operates. The paper examines the role of the public bodies that are responsible for oversight and how they relate to the Financial Services Authority (FSA). By presenting a detailed picture of this part of the UK's supervisory infrastructure, the paper demonstrates that there is a more complex allocation of institutional power than the impression that may be created by the emphasis on the FSA as the UK's single financial regulator. The paper also considers strategies that the various bodies employ to promote compliance so as to explain why analysis based exclusively on formal enforcement data is liable to be misleadingly incomplete. By seeking to improve the quality of the basic data about the UK and drawing out features of the system that may not be easy to capture in objective measurements, the paper contributes to the task of addressing the crucial question: what substitutes for the very heavy reliance on public enforcement in the form of penalties and other punitive measures that is associated with the United States in other credible and effective systems of regulation and supervision? http://www.ecgi.org/wp/wp_id.php?id=295 Thu, 20 Mar 2008, 22:48 GMT Law series Activist hedge funds have transformed how bondholders respond to violations of their contractual rights. Insurance companies and mutual funds, the traditional investors in bonds, often slept on their rights and turned active only little and late. Hedge funds, by contrast, seek out opportunities for activism in order to make profits. In the wake of their activism, hedge funds have not only benefitted themselves, but their fellow bondholders as well. Alas, the remedy scheme for violations of bondholders rights - in particular, the centrality of the acceleration remedy - introduces its own set of imperfections. When treasury interest rates have increased or the stock price of a company that has issued convertible bonds has declined, acceleration generates a windfall: bondholders receive compensation in excess of the harm associated with the violation. In these cases, activists will spend excessive resources in detecting and pursuing potential claims and companies have excessive incentives to stave off potential violations. When treasury rates have declined, the tables are turned, and bondholder rights are underenforced. Whether this selective enforcement has generated aggregate benefits for bondholders and companies in the short term is unclear. Over the long term, however, the market will adjust to hedge fund activism by changing other terms in corporate bond indentures. In particular, we suggest that the contractual remedy scheme be revised by giving companies an expanded defeasance option and offering bondholders a make-whole premium upon acceleration, which would reduce, respectively, the incentives for overenforcement and underenforcement. http://www.ecgi.org/wp/wp_id.php?id=294 Thu, 20 Mar 2008, 22:46 GMT Law series Hedge fund activism is a new form of arbitrage. 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. The abnormal stock return upon announcement of activism is approximately seven percent, with no reversal during the subsequent year. Target firms experience increases in payout, operating performance, and higher CEO turnover after activism. We also find large positive abnormal return to the self-reported hedge fund activists during our sample period. The abnormal return significantly exceeds the returns to all hedge funds, the returns to equity-oriented hedge funds and is robust to alternative risk adjustments and selection biases. http://www.ecgi.org/wp/wp_id.php?id=293 Thu, 20 Mar 2008, 22:44 GMT Law series Sovereign wealth funds (SWFs) have increased dramatically in size as a result of increased commodity prices and the increase in the foreign currency reserves of Asian trading countries. SWF assets now roughly equal those in hedge and private equity funds combined. This growth, and the shift of SWF investment strategy toward equities and increasingly high profile investments like capital infusions into U.S. financial institutions following the subprime mortgage problem, have generated calls for domestic and international regulation. The U.S. and other western economies already regulate the foreign acquisition of control of domestic corporations. However, acquisitions of significant but non-controlling positions are not regulated. The danger is that new regulation will compromise the beneficial recycling of trade surpluses accomplished by SWF investments. In this paper, we situate the controversy over SWF investments in the increasing global trend toward direct governmental involvement in corporate activity, a phenomenon we label the New Merchantilism. We explain why increased transparency of SWF investment portfolios and strategy, the most commonly advanced policy recommendation, does not respond to the chief concern that SWF investments have engendered. We offer a regulatory minimalist response to fears that SWFs will make portfolio investments for strategic rather than economic reasons. Under our proposal, voting rights of SWF equity investments in U.S. corporations would be suspended but reinstated on sale. Thus, SWFs would buy and sell fully voting rights, thereby assuring that the incentives to make non-strategic investments would be unaffected, while the capacity to exercise influence for strategic motives would be constrained. The paper concludes by assessing the extent to which even a regulatory minimalist response remains both over and under inclusive; however, the limited imprecision does not undermine the effectiveness of the response. http://www.ecgi.org/wp/wp_id.php?id=292 Wed, 19 Mar 2008, 22:41 GMT Law series Most comparative corporate governance scholarship is preoccupied with the protection of shareholders against illicit self-dealing by managers and controlling shareholders, and the problem of agency cost. Differences in the role of stakeholders such as employees are acknowledged in the literature, but usually not explained in functional terms. At the same time, US legal scholars are increasingly debating the strong insulation of the board of directors from shareholders in the United States, and are seeking to find an explanation for it. Proponents of a stakeholder view of corporate law have argued that the insulation of the board of directors in the United States from shareholders mitigates the risk of holdup of members of nonshareholder constituencies by shareholders, thus encouraging specific investment by these groups. The most hotly debated type of specific investment is the human capital of employees. However, US corporate law is unusual in the large degree of autonomy enjoyed by managers vis-à-vis shareholders. Since holdup of stakeholders typically takes place within what is considered legitimate managerial business judgment, but shareholders are the primary financial beneficiary of this type of ex-post opportunism, comparative corporate governance needs to take into account the degree to which managers are shielded against shareholder influence, an issue that is quite unrelated to shareholder protection. I argue that concentrated ownership, as it is typical for Continental Europe, is conducive to holdup problems because it implies strong shareholder influence on management decision-making. Given their costs, laws aiming at the protection of stakeholders (such as codetermination or restrictive employment law) are therefore normatively more desirable in the presence of stronger shareholder influence, particularly under concentrated ownership. Without postulating that each corporate governance system of the Wealthy West has an optimal level of such laws, the theory is corroborated by the observation that they tend to be more strongly developed in corporate governance systems with stronger shareholder infl uence. Thus, I provide a new explanation for institutional complementarities in different corporate governance systems. The United Kingdom, which (in spite of dispersed ownership) has both stronger shareholder influence than the US and stronger employment law, is classified as an intermediate case. http://www.ecgi.org/wp/wp_id.php?id=291 Thu, 13 Mar 2008, 23:13 GMT Law series The Sai-Fondiaria case is Italy's most significant action in concert case. In this case public enforcement was unable to prevent the concerting parties from reaching their target. Minority shareholders therefore sued, even though Italian mandatory bid rules (MBRs) do not contain any specific rule concerning minority shareholders' entitlement to damages. At stake is private enforcement of MBRs. Courts and scholars are called to establish whether the law contains an implied right of action in favour of minority shareholders. The problem has also arisen in other European countries, where it is the object of much current debate. The Milan Tribunal thinks that minority shareholders have a right to damages, whereas the view of the Court of Appeal is diametrically opposed. Needless to say, both positions have considerable support amongst legal writers. Since deterrence arguments are still taboo with regards to private remedies, traditional interpretive canons and concepts are being employed in the debate: on one side to disguise deterrence ideas underpinning the reasoning; on the other, to retort using radical formalism, with its built-in bias against legal change. In this paper I analyze the case, the decisions and the comments. I suggest how deterrence arguments can be appropriately adopted in the reasoning of civil law courts and propose how the case should be decided in favour of minority shareholders, with beneficial effects on private enforcement status. I also analyze the recent amendments to MBRs that implement the Takeover Directive and endanger the future of private enforcement in this area of law. http://www.ecgi.org/wp/wp_id.php?id=289 Fri, 7 Mar 2008, 19:20 GMT Law series We analyse 161 Italian IPOs on the Italian Stock Exchange in the period 1999-2007, focusing on the empirical praxis of share allocations by underwriters. In Italy, one offering (the public one) is reserved for retail investors and is conducted according to Italian regulation, while the second (the institutional one) is reserved for institutional investors and is usually implemented according to Regulation S and Rule 144A of the Securities Act. Effective allocation proportions between the two offerings are determined at a high level of syndicate discretion, setting aside the minimum amount for the public offering. Claw back clauses, a typical device of Italian IPOs, allow the syndicate to shift shares ex post from the retail to the institutional offering and vice versa in order to manage demand in a discretionary fashion. We document significant increases of the retail offering size ex post and show that this mostly happens at times of preceding negative market performance and in weaker IPOs marked by lower institutional demand, a higher proportion of the offering coming from selling shareholders and significantly lower levels of initial underpricing. As a result, retail investors end up buying more shares only in weaker and less profitable IPOs, raising inevitable questions as to the fairness of the use of the claw back clauses in Italian public offerings. http://www.ecgi.org/wp/wp_id.php?id=290 Fri, 7 Mar 2008, 19:18 GMT Finance series The current debate over shareholder access to the issuer's proxy for the purpose of making director nomination is both overstated in its importance and misses the serious issue in question. The Securities Exchange Commission's new e-proxy rules, which permit reliance on proxy materials posted on a website, should substantially reduce the production and distribution cost differences between a meaningful contest waged via issuer proxy access and a freestanding proxy solicitation. The serious question relates to the appropriate disclosure required of a shareholder nominator no matter which avenue is used. Institutional investors and other shareholder activists should focus their energies on working through the mechanics of waging short-slate proxy contests using e-proxy solicitations. Activist institutions need to prepare the disclosure package required under the existing proxy rules. Such disclosure may be tested (and refined) through litigation, but a standardized package should emerge relatively quickly that the institution could use in proxy contests without a control motive. Institutional investors need to become facile with the e-proxy model (including coordinating a practice for opting-in to web-access) and should appreciate the extent to which proxy advisory services will do much of the actual solicitation work. If institutions are unwilling to make the relatively modest investment to master the mechanics of e-proxy contest, both in their initiation as well as voting in support of them, then their role in corporate governance will necessarily be limited. http://www.ecgi.org/wp/wp_id.php?id=288 Wed, 5 Mar 2008, 14:58 GMT Law series Current arguments to increase shareholder power in the large public U.S. corporation need to take account of the well-established historical practice of extensive delegation by shareholders of business decision-making and agenda-control to management and the board, what might be characterized as an absolute delegation rule. This practice sharply limits the power of shareholders to put either business or governance proposals to the shareholders for dispositive resolution. The paper, originally published in 1991 but newly relevant, argues that the rule is based on potential pathologies in shareholder voting rather than the inherent information asymmetry between shareholders and managers. Rational shareholders who know of this asymmetry (and know that others know) would simply vote against most shareholder proposals. But shareholder voting gives rise to potential cycling problems, as shifting shareholder majorities vie for preferred policies, and potential opportunism, as shareholders engage in side deals with management and other shareholders to extract rents in corporate decision-making. Since shareholding patterns are in part a response to control rights, deviations from the absolute delegation rule will predictably lead to greater block ownership, for defensive and offensive reasons. These concerns need to be addressed in arguments for the expansion of shareholder power. http://www.ecgi.org/wp/wp_id.php?id=287 Thu, 28 Feb 2008, 16:18 GMT Law series We argue that the choice of corporate governance by a firm affects and is affected by the choice of governance by other firms. Firms with weaker governance give higher payoffs to their management to incentivize them. This forces firms with good governance to also pay their management more than they would otherwise, due to competition in the managerial labor market. This externality reduces the value to firms of investing in corporate governance and produces weaker overall governance in the economy. The effect is stronger the greater the competition for managers and the stronger the managerial bargaining power. While standards can help raise governance towards efficient levels, market-based mechanisms such as (i) the acquisition of large equity stakes by raiders and (ii) the need to raise external capital by firms can help too, and we characterize conditions under which this happens. http://www.ecgi.org/wp/wp_id.php?id=286 Wed, 27 Feb 2008, 15:34 GMT Finance series We analyze the role of bankers on the boards of German non-financial companies. We assemble a unique panel data set for 137 firms and 11 banks for the period from 1994 to 2005. We find that banks that are represented on a firm's board promote their investment banking services and increase their lending to firms in the same industry. We also find evidence that the presence of bankers on the board causes a decline in the valuations of non-financial firms. We do not find convincing evidence for standard explanations that bankers use board seats to monitor their equity interests or their interests as lenders, or that bankers are capital market experts and help firms to overcome financial constraints. We conclude that board representation in non-financial firms is in the interest of banks, but not in the interest of the non-bank shareholders in these firms. http://www.ecgi.org/wp/wp_id.php?id=285 Tue, 19 Feb 2008, 10:43 GMT Finance series In cross-border acquisitions, the differences between the bidder and target corporate governance have an important impact on the takeover returns. Our country-level corporate governance indices capture the changes in the quality of the national corporate governance regulations over the past 15 years. When the bidder is from a country with a strong shareholder orientation (relative to the target), part of the total synergy value of the takeover may result from the improvement in the governance of the target assets. In full takeovers, the corporate governance regulation of the bidder is imposed on the target (the positive spillover by law hypothesis). In partial takeovers, the improvement in the target corporate governance may occur on voluntary basis (the spillover by control hypothesis). Our empirical analysis corroborates both spillover effects. In contrast, when the bidder is from a country with poorer shareholder protection, the negative spillover by law hypothesis states that the anticipated takeover gains will be lower as the poorer corporate governance regime of the bidder will be imposed on the target. The alternative bootstrapping hypothesis argues that poor-governance bidders voluntarily bootstrap to the better-governance regime of the target. We do find support for this bootstrapping effect. http://www.ecgi.org/wp/wp_id.php?id=284 Thu, 24 Jan 2008, 08:07 GMT Finance series This paper examines the impact of increased corporate mobility on corporate lawmaking in the European Union (EU). More specifically, we seek an answer to a simple question: Has the increased mobility which arose from the implementation of the Societas Europaea (SE) and the path-breaking decisions of the European Court of Justice (ECJ) led to an outbreak of regulatory competition and the emergence of a Delaware-like member state in Europe? Two types of corporate mobility are distinguished: (1) the incorporation mobility of start up firms and (2) the reincorporation mobility of established firms. As to incorporation mobility, the Centros triad of cases makes it possible for start-up firms to incorporate in a foreign jurisdiction. Many entrepreneurs have taken advantage of this new freedom of establishment. However, recent data from Germany and The Netherlands indicate declining numbers of such foreign incorporations over time. Moreover, Centros-based incorporation mobility is a rather trivial phenomenon, economically speaking. The actors in question seek only to minimize costs of incorporation. National lawmakers have been responding, amending their statutes to lower these costs. But, because out of pocket cost minimization at the organization stage operates as only a secondary motivation of 'choice-of-business-form' decisions, there arise no competitive pressures that cause national legislatures to engage in thorough-going reform addressed to corporate governance more generally. As to reincorporation mobility, which concerns the migration of the statutory seat of a firm incorporated in one member state to another member state, the SE has opened the door, but not widely enough to serve as a catalyst for company law arbitrage. Reincorporation mobility is still far from generally available in the EU. As a result, competitive pressures do not yet motivate changes in the fundamental governance provisions of national corporate law regimes. http://www.ecgi.org/wp/wp_id.php?id=283 Thu, 24 Jan 2008, 08:03 GMT Law series Unlike the US, the European Union has a tradition of national securities laws significantly differing from each other. Regulatory idiosyncrasies largely remain today despite recent efforts aiming at more comprehensive harmonization. In addition, in important respects, the current conflict of laws rules contained in European Community securities laws bundle the choice of applicable securities laws with the issuer's registered office, while leaving some regulatory aspects to the law of the market where the issuer's securities are admitted to trading. Hence, to the extent that EU companies can choose their state of incorporation and trading location, they can also choose the applicable securities law among those in place in the 27 EU countries. This paper scrutinizes the policy implications of the confl ict of laws rules EC securities regulation has chosen in two scenarios: the present one, in which obstacles to companies mobility across the EU still make regulatory arbitrage in practice unavailable, and a prospective one in which these obstacles are removed. We consider the bundling of securities laws with the issuer's registered office for conflict of laws purposes overall detrimental when corporate law arbitrage is unavailable. On the other hand, we argue that the impact of such rules is beneficial if companies can transfer their registered office without facing severe obstacles. Yet, we qualify our optimistic assessment by showing that bundling securities regulation and corporate law for conflict of laws purposes may have a negative impact on the dynamics of the market for corporate charters. For the regulatory aspects that are governed by the law of the affected market (and specifically for securities law aspects of takeover regulation), we argue that already today issuer choice offers a broad variety of options and a separating equilibrium represents the likely outcome. http://www.ecgi.org/wp/wp_id.php?id=282 Fri, 30 Nov 2007, 12:07 GMT Law series This paper analyzes optimal executive compensation contracts when managers are loss averse. We establish the general optimal contract analytically and calibrate the model to the observed contracts of 595 CEOs. We find that the Loss Aversion-model explains the observed structure of executive compensation contracts significantly better than the Risk Aversion-model. This holds especially for the mix of stock and options. The Loss Aversion-model predicts convex contracts with substantial option holdings that provide a stronger upside (carrots). By contrast, the optimal contract is concave for the standard Risk Aversion-model where it provides a significant downside (sticks). Our results suggest that loss aversion is a better paradigm for analyzing design features of stock options and for developing preference-based valuation models than the conventional model used in the literature. http://www.ecgi.org/wp/wp_id.php?id=281 Thu, 22 Nov 2007, 15:54 GMT Finance series In this paper I analyze the competitiveness of the U.S. equity markets by studying the recent trend in the share of global IPOs they are able to attract. I find that the U.S. equity market share has dropped dramatically from 2000 to 2005. This drop cannot be explained by changes in the geographical or the sectoral composition of IPOs. The most likely cause is a combination of an improvement in the competitors (mostly European equity markets) and an increase in the compliance costs for publicly traded companies. http://www.ecgi.org/wp/wp_id.php?id=280 Fri, 12 Nov 2007, 16:39 GMT Finance series The centrality of the CEO is reflected in the empirical literature linking CEO turnover to poor firm performance. However, less is known about the institutional and personal correlates of CEO turnover. In this study, we find two CEO characteristics interact with turnover: tenure and ownership. We interpret our results as indicating that CEOs of Samp;P 500 firms divide into two groups with different tenure patterns - “owners” (who have large personal shareholdings) and “managers” (who have smaller holdings). The tenure of manager-CEOs (as opposed to owner-CEOs) exhibits a term structure loosely similar to the one produced by the tenure process at academic institutions. Turnover of all kinds is low during a CEO's first four years on the job. In contrast, once a CEO reaches his fifth year, retirements begin a multi-year increase and exits via merger exhibit a large one-year spike. These term effects are strongest for relatively young CEOs, and appear to be independent of such factors as firm performance or retirement norms. We also find that deals and retirements are partially related, but partially distinct, modes of CEO turnover in other respects, which are similar along some dimensions but sharply different along others. http://www.ecgi.org/wp/wp_id.php?id=279 Fri, 12 Nov 2007, 16:40 GMT Finance series We consider the advantages and disadvantages of stakeholder-oriented firms that are concerned with employees and suppliers as well as shareholders compared to shareholder-oriented firms. Societies with stakeholder-oriented firms have higher prices, lower output, and can have greater firm value than shareholder-oriented societies. In some circumstances, firms may voluntarily choose to be stakeholder-oriented because this increases their value. Consumers that prefer to buy from stakeholder firms can also enforce a stakeholder society. Competition between stakeholder and shareholder firms in the context of globalization is relatively more attractive for shareholder firms than for stakeholder firms. http://www.ecgi.org/wp/wp_id.php?id=278 Fri, 12 Nov 2007, 16:39 GMT Finance series Financial economists and commercial providers of governance services have in recent years created measures of the quality of firms' corporate governance which collapse into a single number (a governance index or rating) the multiple dimensions of a company's governance. The aim of this paper is twofold, to analyze the performance of corporate governance indices in predicting corporate performance, and to consider the implications for public policy that follow from that assessment. We highlight methodological shortcomings of the extant papers that claim a relation between particular governance measures and corporate performance. Our core conclusion is that there is no consistent relation between governance indices and measures of corporate performance. Namely, there is no one “best” measure of corporate governance: the most effective governance institution appears to depend on context, and on firms' specific circumstances. It would therefore be difficult for an index, or any one variable, to capture critical nuances for making informed decisions. As a consequence, we conclude that governance indices are highly imperfect instruments for determining how to vote corporate proxies, let alone for portfolio investment decisions, and that investors and policymakers should exercise caution in attempting to draw inferences regarding a firm's quality or future stock market performance from its ranking on any particular corporate governance measure. Most important, the implication of our analysis is that corporate governance is an area where a regulatory regime of ample flexible variation across firms that eschews governance mandates is particularly desirable, because there is considerable variation in the relation between the indices and measures of corporate performance. http://www.ecgi.org/wp/wp_id.php?id=277 Fri, 12 Nov 2007, 16:38 GMT Law series All jurisdictions supply corporations with legal tools to prevent or punish asset diversion by those, whether managers or dominant shareholders, who are in control. As previous research has shown, these rules, doctrines and remedies are far from uniform across jurisdictions, possibly leading to significant differences in the degree of investor protection they provide. Comparative research in this field is wrought with difficulty. It is tempting to compare corporate laws by taking one benchmark jurisdiction, typically the US, and to assess the quality of other corporate law systems depending on how much they replicate some prominent features. We take a different perspective and describe how three major continental European countries (France, Germany, and Italy) regulate dominant shareholders' self-dealing by looking at all the possible rules, doctrines and remedies available there. While the doctrines and remedies reviewed in this article are familiar enough to corporate lawyers and legal scholars from the respective countries, this is less true for many participants in the international discussion, which remains dominated by Anglophone legal scholars and economists. We suggest that some of these doctrines and remedies, namely the German prohibition against concealed distributions, the role of minority shareholders in the prosecution of abus de biens sociaux in France, and nullification suits in all three countries and especially in Germany and Italy, have not received the attention they deserve. http://www.ecgi.org/wp/wp_id.php?id=276 Fri, 12 Nov 2007, 16:37 GMT Law series We analyze financial contracting in start-ups backed by corporate venture capitalists. CVCs strategic goals can economically hurt or benefit the start-ups, depending on product market relationships between start-ups and CVC parents. Empirically, startups prefer funding from CVCs with complementary products. Second, start-up insiders commonly limit the influence of competitive CVCs, awarding them lower board power, while retaining higher board representation for themselves. Third, lead CVCs receive lower board representation, indicating heightened concerns about their greater influence in start-ups early stages. Fourth, start-ups extract higher valuations from competitive CVCs, refl ecting greater moral hazard problems. Overall, CVC strategic objectives affect their inclusion in VC syndicates, their control rights and share pricing. http://www.ecgi.org/wp/wp_id.php?id=275 Thu, 8 Nov 2007, 10:36 GMT Finance series This paper uses a large-scale database to test the link between corporate governance regimes (specifically, the varieties of capitalism literature), investment in training and economic performance. The evidence presented here does not match with common assumptions that countries can be classified into Anglo-Saxon and other forms of capitalism, supporting a considerable body of the more empirically orientated literature on employment security and human resource development. We propose a new categorization of countries that links types of broad corporate governance regimes and associated sets of regulations with the relative propensity of firms to engage in specific types of investment towards a core stakeholder: employees. http://www.ecgi.org/wp/wp_id.php?id=274 Thu, 11 Oct 2007, 11:32 GMT Finance series This paper examines the effect of trust in a micro-economic environment, where trust is clearly exogenous. Using a hand-collected data on European venture capital, we show that the Eurobarometer measure of trust among nations significantly affects investment decisions. This holds even after controlling for investor and company fixed effects, geographic distance, information and transaction costs. The national identity of venture capital firms' partners is shown to matter for the effect of trust. We also considers the relationship between trust and sophisticated contracts involving contingent control rights. We find trust and sophisticated contracts to be complements, not substitutes. http://www.ecgi.org/wp/wp_id.php?id=273 Thu, 11 Oct 2007, 11:29 GMT Finance series Using firm, industry, and country-level data, we document a link between family ownership and labor relations. Across countries, we find that family ownership is relatively more prevalent in countries in which labor relations are difficult, consistent with firm-level evidence suggesting that family firms are particularly effective at coping with difficult labor relations. Our cross-country results are robust to controlling for minority shareholder protection and other potential determinants of family ownership. Our results also hold if we use strike data from the 1960s to predict cross-country variation in family ownership thirty years later. We address causality in two ways. First, we instrument our measure of the quality of labor relations using Labor Origin, a variable describing the extent to which the emerging European liberal states in the 18th and 19th centuries confronted guilds and labor organizations. Second, making use of within-country variation at the industry level, we show that - controlling for industry and country fixed effects - industries that are more labor dependent have relatively more family ownership in countries with worse labor relations. http://www.ecgi.org/wp/wp_id.php?id=272 Thu, 11 Oct 2007, 11:24 GMT Finance series By reducing the fear of a hostile takeover, business combination (BC) laws weaken corporate governance and create more opportunity for managerial slack. Using the passage of BC laws as a source of identifying variation, we examine if such laws have a different effect on firms in competitive and non-competitive industries. We find that while firms in noncompetitive industries experience a substantial drop in performance, firms in competitive industries experience virtually no effect. Though consistent with the general notion that competition mitigates managerial agency problems, our results are, in particular, supportive of the stronger view expressed by A. Alchian, M. Friedman, and G. Stigler that managerial slack cannot survive in competitive industries. When we examine which agency problem competition mitigates, we find evidence consistent with a “quiet-life” hypothesis. While capital expenditures are unaffected by the passage of BC laws, input costs, wages, and overhead costs all increase, and only so in non-competitive industries. We also conduct event studies around the dates of the first newspaper reports about the BC laws. We find that while firms in non-competitive industries experience a significant decline in their stock prices, the stock price impact is small and insignificant in competitive industries. http://www.ecgi.org/wp/wp_id.php?id=271 Thu, 11 Oct 2007, 11:18 GMT Finance series Using an index which increases as a firm adopts more governance attributes, we find that 12.7 per cent of foreign firms have a higher index than matching U.S. firms. The best predictor for whether a foreign firm adopts more governance attributes than a comparable U.S. firm is whether the firm comes from a common law country. We show that the value of foreign firms is negatively related to the difference between their governance index and the index of matching U.S. firms. This relation is robust to various approaches to control for the endogeneity of corporate governance and is consistent with the hypothesis that foreign firms are valued less because country characteristics make it suboptimal for them to invest as much in governance as comparable U.S. firms. Overall, our evidence suggests that firm-level governance attributes are complementary to rather than substitutes for country-level investor protection, so that better country level investor protection makes it optimal for firms to invest more in internal governance. Our evidence supports the view that minority shareholders of a typical foreign firm would benefit from an increase in investment in governance, but that the firm's controlling shareholder and possibly other stakeholders would not. http://www.ecgi.org/wp/wp_id.php?id=270 Thu, 11 Oct 2007, 11:13 GMT Finance series We suggest, on the basis of empirical research into the implementation of recent legal reforms, that Japan is not moving inexorably towards a 'global standard' in corporate governance, based on external monitoring and a market for corporate control. Japanese corporate governance is nevertheless changing: in part as an indirect response to legal initiatives, new structures and practices are emerging, aimed at providing greater flexibility in decision-making, while retaining the organisational core of the Japanese firm. The paradoxical effect of legal reforms aimed, in large part, at transplanting the global standard, may be to renew the distinctive Japanese model of the corporation. http://www.ecgi.org/wp/wp_id.php?id=267 Thu, 11 Oct 2007, 11:10 GMT Law series