Monday, July 30, 2007

Suing the lawyers

There's another big principal-agent problem in a large corporation: that of the in-house lawyer. Though hired to protect the interests of the company, the lawyers are told what to do by executives, agents of the company. Business Week quotes Stephen Gillers, a NYU law professor as saying with regard to in-house lawyers:"They have to be aware of the risk that their bosses are violating a duty to their clients, and it's a real challenge, because you don't want to accuse your boss of illegal activity."

The Business Week article discussed a Chicago jury's decision to convict the in-house attorney of Hollinger Intl., a company whose former chairman Conrad Black was also recently convicted of fraud.
Prosecutors alleged Black concocted a scheme to demand noncompete payments from buyers of Hollinger publications, and then he and others pocketed the money without telling the board. Kipnis' role in drafting the noncompetes was so extensive, says juror Tina Kadisak, that "we definitely came to the conclusion that he did know what was going on."

The article goes on to say that of 1,236 convictions obtained by a federal Corporate Fraud Task Force in the last five years, 23 were of corporate counsel.
I'm not sure that this can be construed as representing an increasing trend in going after in-house counsel. However, the high profile of this case is making that possibility more apparent. Consider the precedent set.

Thursday, July 26, 2007

Should I renew my subscription to the WSJ?

I'm waiting to find out what happens with the takeover.
And if the takeover succeeds, is Rupert going to mess with our beloved Journal ?

From the article:

"In the long run, the owner of the newspaper is going to wind up calling the shots," said newspaper industry analyst John Morton.

"There has been this history, whether (Murdoch) acknowledges it or not, that his publications have sometimes operated in furtherance of his business and political interests," Morton said. "Although he denies it, his publications and some of his broadcast operations have not vigorously investigated things that go on in China because he has business interests there."

Ben Bagdikian, a media critic and former dean of the Graduate School of Journalism at the University of California at Berkeley, said that because of Murdoch's history, "any promise, written or oral, not to change things toward his own ideology has to be taken with a grain of salt."

"The Wall Street Journal's editorials are already the most conservative in the country, so his changes, I think, will be in what news he prints and what he does not, what sources he uses and which ones he shuns," Bagdikian said.

The Dark Lord's taking over the world, all right.

An economy ground in finance won't work!

According to Business Week at least.

Fueled by headlines about top managers such as Home Depot (HD ) CEO Robert Nardelli, who received stratospheric pay even as his company's stock price stalled, shareholder activists this year took aim at executive compensation. Unfortunately, they should not expect much from those efforts, even if every corporation in the U.S. adopts "say on pay"measures that allow shareholders to vote on pay deals. That's because such proposals treat only a symptom, not a cause, of a more dangerous trend within American capitalism.
The real culprit is the growing preeminence of finance over operations. It causes stock market considerations to trump those that improve the actual workings of a business. And the quicker the stock payoff can be engineered, the better. Until that changes, don't expect CEOs to stop gaming the system.
The real culprit is the growing preeminence of finance over operations. It causes stock market considerations to trump those that improve the actual workings of a business. And the quicker the stock payoff can be engineered, the better. Until that changes, don't expect CEOs to stop gaming the system.

This reward bias toward finance has been with us since the creation of the giant public corporation in the late 19th century.
Today you see the consequence of this financial dominance. Ask the 400 CFOs who in a 2005 survey revealed a consensus opinion that they would mutilate their own companies to keep stock prices high. Ask the derivatives traders and hedge fund managers who control the direction of the market by trading in instruments that have nothing to do with financing the production of goods and services and everything to do with stock price movements. Ask the stock-trading public who in 2006 turned over share ownership on the New York Stock Exchange (NYX ) by 118% (almost 30% more than in 2000). Meanwhile, CEOs figure that if their job is to make shareholders as rich as possible as quickly as possible--as opposed to managing companies to generate long-term profits--they should be paid like the investment bankers, money managers, and hedge fund czars who do the same.

Read the full article here. Though the author doesn't explicitly say so, he adds his voice to the chorus against private equity since the key to their operations is really leverage and not, um, operations.

Thursday, July 12, 2007

Moody's criticism of Private Equity: Part 2 of 2

Arguments for and against taking companies private:

There are two related issues that are somewhat buried in the article. One is reporting pressure. I am usually a little leery of when companies want to do something that reduces their level of transparency to investors, citing the costs of reporting etc. (case in point: Sarbox.) My reasoning being that if they do not want to be open and upfront about their activities, they are probably doing something that will not withstand public scrutiny. On the other side of the issue, the need to report earnings quarterly (and meet or beat expectations) does put undue pressure on companies. (Case in point: The statistically abnormally large number of companies that beat expectations by one penny. Managers have a strong incentive to avoid negative earnings surprises.)

The second issue here is investing horizon. Generally, equity is seen as a longer-horizon investment than debt, simply because equity is long-lived. However the PE guys claim that the stock market induces short-termism because of quarterly reporting and scrutiny. Moody's disagrees with that.
On the other hand, (and this reminds me of my grandfather's joke: Economists have to have many hands because they keep saying "on the other hand.."!) academics have long posited, and tested the theory that debt is what induces short-termism. The reason is that the threat of bankruptcy associated with being unable to keep up payments leads firms to often pass up very profitable projects which are even slightly risky.
(This is called the debt overhang problem relating to companies - not countries - definition in the bottom paragraph).

To summarize, reporting pressure is a very real consequence of listing a company. However the argument that debt has a longer investing horizon, in my opinion, is bogus. Surely there are ways to manage the short-termism induced by reporting pressures by clearly indicating that long-term beneficial actions are being taken by the company!

Moody's criticism of Private Equity: Part 1 of 2

The FT recently reported on Moody's criticism of private equity:

Moody's takes issue with the argument that private ownership frees companies from the short-term pressures of equity markets, enabling them to invest and plan for the long term. Its report says: "The current environment does not suggest that private equity firms are investing over a longer-term horizon than do public companies despite not being driven by the pressure to publicly report quarterly earnings."

The agency says buy-out funds' tendency to increase a portfolio group's indebtedness to pay themselves large dividends runs counter to their claim of being long-term investors. It cites the dividend received by Thomas H Lee, Bain Capital and Providence Equity following their takeover of Warner Music in 2004 and the one paid to Blackstone after the purchase of Celanese.

It also takes aim at private equity's claim that improvements in companies' performance are driven by more focused management teams rather than financial engineering and higher debt.

The private equity industry rejected Moody's claims. "Corporate leaders who have experienced . . the positive effects of private equity ownership are quick to tell you that this structure can and does liberate management to focus on long-term growth," said Doug Lowenstein, president of the Private Equity Council. There was "compelling evidence" that private equity made companies "stronger".

(Part 2: My two cents.)

Qwest sentencing update: What's Nacchio's liability?

The Race to the Bottom blog has an excellent summary of the government's and the defendant's views on what Nacchio's sentence should be.

Addressing the “extraordinary family circumstances” issue, government cites States v. McClatchey , 316 F.3d 1122, 1130-31(10 Cir. 2005) for the rule that this downward adjustment applies only where the defendant is the only person that can take care of a family member. Since Nacchio’ wife “has the time and resources” to care for the children, the government asserts the exception does not apply and states the following:

“While Dr. Hammer certainly paints an unfortunate picture of David Nacchio’s prognosis, it simply does not justify absolving the defendant from his crimes and allowing him to avoid his just punishment.”

Addressing the issue of Nacchio’s charitable works, the government again cites case law that only extraordinary charitable works will support a more-lenient sentence and business executives do not meet this test since they ordinarily become leaders in community charities. The government labels Nacchio’s charitable works as not extraordinary, but ordinary and “entirely consistent” with Qwest’s business development goals.

Wednesday, July 11, 2007

Qwest sentencing: Did the crime, doing the time?

The WSJ Law Blog yesterday discussed the conviction of Joe Nacchio, the former chief executive at Qwest on multiple counts of insider trading. He is set to be sentenced on July 27 and prosecutors are calling for a 10-year sentence plus $71 million in fines and restitution.
In response:

Nacchio’s lawyers countered the government on Friday, arguing that Judge Edward Nottingham should consider the perilous health of two of Nacchio’s family members before agreeing to the 10-year sentence. The motion doesn’t identify the family members, and Nacchio’s lawyer wasn’t reached by the Post for comment..The government’s sentencing statement said a departure from guidelines is warranted only where the defendant is the only one able to provide assistance to a family member.

Aging relative or not, the comments to the blog debate the appropriateness of the 10-year sentence for a white-collar crime. Not to minimize the crime itself: The reality was brought home to me by posters who had lost 80% or more of their 401Ks thanks to the insider trading.

Others might argue that the ex-CEO is not a physical danger to society and that fines alone should be enough for proper restitution and to "make whole" the plaintiffs.
Not knowing enough about the law, I can't comment. But I, like others, will be following the developments in the case with interest.

Governance Metrics: predictor of corporate performance?

From an article in the WSJ: Governance Metrics claims that its ranking of corporate behavior is a good predictor of investment returns.
The graphic on the right indicates that companies with above-average scores appear to have significantly positive investment returns compared to companies with below-average or average scores.

The reasons why not everyone's convinced:

- Many of the governance-related studies are sponsored by governance consulting services and others with vested interests.
- The measures chosen are not systematic and vary depending on the study. As a result, top ranked companies by one measure may be poorly ranked by another. Case in point: Google.
"The company made the 2007 "World's Most Ethical Companies" list of governance-tracker Ethisphere, because of its strong code of conduct and positive customer views of its behavior. But Audit Integrity Inc., which scrutinizes accounting behavior and litigation risk, ranks Google poorly. One recent red flag: Viacom Inc.'s copyright lawsuit against Google and its newly acquired YouTube video-sharing site. "

- On my part, I do not have any indication whether the numbers on the left are statistically significant, adjusted for other predictors of returns etc. It is well known in the academic community that it is not easy to find corporate governance variables that are consistently and strongly related to corporate performance.

The rebuttal:

- Just like with any other predictor, once information about a company's governance practices is known, it is quickly priced into the stock.
- From the article: Audit Integrity Chairman and founder James Kaplan says the company tried -- and failed -- to find a connection between share performance and corporate governance alone. After including the accounting analysis, however, the firm's top-rated large companies posted better returns than the Standard & Poor's 500-stock index.
The link between accounting quality, litigation risk and corporate performance is harder to refute based on several academic studies on the topic.
- Some governance variables - such as the number of antitakeover provisions in the charter - may be more remotely related to corporate performance than others such as disclosure transparency. These studies help direct our attention to what matters.

Tuesday, July 03, 2007

SECs awards payouts to Columbia Fund investors

The SEC today awarded payouts to investors in Columbia Funds who were damaged by their market timing and fradulent practices between 1998 and 2003.

From this article:

More than 600,000 investors damaged as a result of fraudulent "market timing" in the Columbia Funds will be collecting a total of $140 million from a distribution fund set up by regulators, the Securities and Exchange Commission said Monday.
The first distribution will be in the amount of $37 million and go to more than 300,000 investors harmed due to market timing between 1998 and 2003, the SEC said.

At the time of the fraud, Columbia Funds was owned by FleetBoston, subsequently taken over by Bank of America.

Friday, June 29, 2007

The Media as Enforcers

I wrote earlier about the role of the Wall Street Journal in exposing the first few options backdating cases. The threat of media ridicule has also resulted in other clean-ups and corporate reorganizations, notably the increasing tendency to dismiss badly behaving CEOs and top executives. This is not restricted to the USA.

Prof. Alexander Dyck of the University of Toronto and two co-authors are studying the role of the media as enforcers of good governance standards in their paper: "The Corporate Governance role of the media: Evidence from Russia". The background, described in more detail here, is the story of how Bill Browder of the Hermitage Fund, which invests in Russian companies, was instrumental in getting the WSJ, FT and Business Week to write articles about serious governance issues at Gazprom, the Russian oil company. The media attention resulted in corporate reforms and the firing of the CEO. Very heartening. (Bill Browder has his own selfish reasons in exposing Gazprom, well described in the article. Still, heartening.)

Thursday, June 28, 2007

Grappling with Blog Issues

1) The blog is currently undergoing a metamorphosis into Blogger's new template, so not all links might be working. Please bear with me while I get it fully up and running in its new form.

2) In order to make the blog content more relevant to you, readers, I will soon be posting a poll on the blog so that I can find out more about your interests and the content you would like to see. Please take the time to respond so I can provide relevant blog content.

3) For some time now I have been thinking about adding AdSense to the blog. I realize that having ads will be distracting to readers, and have avoided it upto now. However posting on this blog takes time, and despite my loftiest intentions I sometimes just don't get around to it on a given day. The addition of AdSense, I thought, would better help me justify the time I put into it. At the same time, it troubles me that AdSense would show 'relevant' ads - i.e. corporate governance related ads that I'm not sure I want to endorse. What if its a corporate governance consulting service? I would feel morally responsible for any such ads that showed up on my blog.
Any thoughts or advice from you, readers?

SOX, IPOs and Corporate Risk Taking: Part 3 of 3

A give-and-take of critical feedback on new research studies is the medium by which academics are able to constantly improve the quality of their research. Typically working paper presentations take place in closed forums and the feedback received is used to improve upon the paper before it is released to the public.
As such, the AEI forum is unique in that it allowed both the draft working paper and the comments to be freely available on the web for perusal and comment.

All this is by way of saying that my post was not meant to single out the study for criticism, but instead to use the study and its responses to highlight the important and very topical question of SOX's impact on corporates. I believe Dr.Calomiris in his review of the paper said it best: "There are still potential alternative explanations for the ...results, and there are things the authors can do to make the results more convincing."
In the meantime, all those people out there claiming that SOX has hurt our corporates will just have to back up their claims with hard data. I'm with Doidge, Karolyi and Stulz myself.

SOX, IPOs and Corporate Risk Taking: Part 2 of 3

Though the study asks 3 very timely and important questions, the consensus of the reviewers appears to be that the methodology they used in arriving at their conclusions lacks rigor.
Notably, some of the criticisms were:

1) In order to answer the first question regarding corporate risk-taking (R&D expenditures etc.) the study should be extremely careful to control for the commonly known determinants of corporate risk-taking. Of which there are many - notably leverage (which has been widely discussed in prior literature) and other firm-specific and industry-specific characteristics..and size. (Pretty much ANY study in ANY area of finance should control for size, as we are taught in grad school).
In short, there may be other differences between the US and UK firms that may account for their level of risk-taking and these (as a non-scientist, am I permitted to say 'Occam's Razor' here?) should first be considered and eliminated before attributing the difference to SOX.

2) Dr. Kate Litvak in her discussion of point 2 regarding the number of IPOs listed in the UK and US, points out this paper: "Has New York become less competitive in global markets? Evaluating foreign listing choices."
They summarize their findings:
"We find that cross-listings have been falling on U.S. exchanges as well as on the Main Market in London. This decline in cross-listings is explained by changes in firm characteristics rather than by changes in the benefits of cross-listings. We show that, after controlling for firm characteristics, there is no deficit in cross-listing counts on U.S. exchanges related to SOX. Investigating the cross-listing premium from 1990 to 2005, we find that there is a significant premium for U.S. exchange listings every year, that the premium has not fallen significantly in recent years, that it persists even when allowing for unobservable firm characteristics, and that there is a permanent premium in event time....Our evidence is consistent with the theory that an exchange listing in New York has unique governance benefits for foreign firms. These benefits have not been seriously eroded by SOX and cannot be replicated through a London listing. "

Why do their conclusions differ so dramatically from those of the AEI paper? I cannot be sure without some analysis, but Dr. Litvak does so and provides a big clue: If we control for firm characteristics, then there is no change in the number of US listings.

One other point is the country of origin effect. It may be hypothesized that a UK company is more likely to IPO in the UK than the US, other things remaining equal. However it appears that the authors do not provide for this country of origin preference.

3) The third conclusion was regarding the risk of US and UK equity. Without challenging the finding itself, I cannot conclude that this is a bad thing. The US stock market, as the most developed market in the world, may well be the lease volatile. Further it may be becoming less and less volatile i.e. gaining in strength. Even if SOX did make the market less risky, where do we draw the line between 'less risky' and 'so less risky it may be unhealthy'?

Thursday, June 21, 2007

SOX, IPOs and Corporate Risk-Taking: Part 1 of 3

A reader recently drew my attention towards the AEI seminar on SOX entitled "Is SOX impeding corporate risk taking?"

The seminar is a presentation of a paper of the same title by three authors from the University of Pittsburgh and includes critical discussions of the subject matter by three independent discussants whose research is in this area. (Funding for the paper was provided by AEI).

For those of us not located in Washington, D.C. or otherwise unable to attend, the AEI website has links to download the paper as well as links to the discussants' slides.

Here's what the study concludes: an extract from the abstract of the paper is below.

Many policymakers and corporate executives have argued that the Sarbanes-Oxley Act of 2002 ("SOX") has had a chilling effect on the risktaking behavior of U.S. corporations. This paper empirically examines this proposition. Using a large sample of U.S. and U.K. companies, we find that
i) compared with their U.K. counterparts U.S. firms have significantly reduced their R&D and capital expenditures and significantly increased their cash holdings since SOX.
ii) We also find that the equity of U.S. companies has become significantly less risky vis-à-vis U.K. companies since SOX.
iii) Finally, using a large sample of U.S. and U.K. initial public offerings ("IPOs"), we find that the likelihood that an IPO was conducted in the U.K. increased significantly after SOX and that this effect was especially high for firms in high R&D industries. Taken together, the results support the view that SOX has had a chilling effect on risk-taking
by publicly traded U.S. corporations.
(Numerals are mine)

In short, the paper concludes that SOX has led to reduced R&D expenditures among US firms, shares of US firms have become less risky, and finally the UK had a spike in the likelihood of IPOs post-SOX.

The question addressed is a very important and timely one. However some of the points made by the discussants indicate that the conclusions may have been premature.
Watch this space tomorrow for a dissection of the arguments against these conclusions!

CalPERS news: relaxed restrictions on emerging markets, more investment in governance

CalPERS, the activist pension fund responsible for huge strides in shareholder activism and corporate accountability, announced today that it is scaling back its governance based restrictions on investing in emerging market countries.

From this article:

Trustees of the California Public Employees' Retirement System have suspended their plans to hire market researchers to start work on an annual report card ranking more than two-dozen emerging market countries for such things as unfair labor practices and geopolitical dangers.
The strategy shift comes after CalPERS consultants reported that the pension fund has lost some $200 million in potential profits because of rigid rules.

However, CalPERS is still making governance strides in other respects: their investments in corporate governance based funds has gone up:

CalPERS' trustees approved increased hedge fund and corporate governance fund allocations, totaling up to $15 billion in new investments. At its meeting Monday, the board increased each target to 5% of the $156.5 billion global equity portfolio, plus or minus three percentage points each, up from 3%. The $247.9 billion California Public Employees' Retirement System, Sacramento, currently invests $5.1 billion in corporate governance funds and $5 billion in absolute return funds.

Wednesday, June 20, 2007

Executives Behaving Badly!

Executives misbehavior on the personal front is no longer allowed to go unpunished, according to this article in the WSJ:

Corporate directors are far less willing than they were a few years ago to look the other way if an executive does something that threatens to embarrass a company. This is the case even if the executive is a star performer. It's also true even if the action had nothing to do directly with work and isn't tied to illegal behavior, such as sexual harassment or "creating a hostile work environment." The offense could be getting drunk or acting lewd at parties or having tangled or abusive love relationships.

The increased scrutiny of executives' conduct also reflects heightened governance in general, and a greater willingness on the part of employees to blow the whistle. Some who see executives behaving in ways that could hurt their company's reputation are speaking out more -- helped by employer hot lines established after the accounting scandals of prior years.

The article also goes on to cite instances of ousted execs at companies such as Home Box Office, WellPoint, Kaiser Aluminum and Boeing.

Tuesday, June 19, 2007

Supreme Court's decision: not a setback for investors

The Supreme Court ruled in favor of Wall Street banks on a class-action lawsuit over the banks' alleged conduct on IPOs during the tech bubble.

The banks in question:

- Credit Suisse

- Bear Stearns

- Citigroup

- Goldman Sachs Group

were accused of creating illegal "tie-ins" and "laddering" agreements by investors. The investors alleged that preferred customers were allowed to buy hot technology stocks if a buyer agreed to purchase more shares of the stocks at higher prices and that such an arrangement artificially jacked up the price of new stocks.

However, this commentary goes on to quote experts as saying that this isn't a big setback to investors. John Coffee, a Columbia University law professor, said that the ruling shouldn't greatly harm investors since the Securities and Exchange Commission can and does prosecute laddering.

"I don't think investors are exposed to any great risk by this," Coffee said in a telephone interview Monday. "The federal securities laws give investors ample remedies."

For further reading:

+ Check out the WSJ Law Blog's interview with Steve Shapiro, who represented the plaintiff investment banks.

+ There is also an excellent description of the SEC's legal status on this post, as it relates to the Wall St. banks case before the Supreme Court. An extract:

When it comes to litigation, the SEC has the authority to litigate its own cases, including appeals. Thus, a decision to participate as amicus in a case at the US court of appeals is something the SEC decides on its own, without any obligatory consultation with the Justice Department. This is what occurred in connection with the amicus brief filed in Simpson when it was before the Ninth Circuit.
With respect to litigation at the Supreme Court, however, the rules are different. In most instances, agencies do not have the authority to represent themselves before the Supreme Court. The general rule is that all litigation involving the US government at the Supreme Court is handled by the Solicitor General’s Office within the Department of Justice. The practices are not, however, uniform. The Federal Trade Commission, for example, may represent itself at the Supreme Court when the Solicitor General otherwise refuses to do so. See 15 USCS § 56. The Commission, however, has no such authority and may not, without approval, litigate before the Supreme Court.
Thus, to get its views before the Court, the SEC must convince the Solicitor General’s Office to file the certiorari petition or amicus brief.

Monday, June 18, 2007

The Buzz About Blackstone

Blackstone CEO Stephen Schwarzman's 2006 pay? $400 million.

Blackstone CEO's 2006 earnings from options? Almost double the combined pay of the bosses of Wall Street's five largest investment banks.

Blackstone CEO's stake when the company goes public? $7.7 billion.

Good publicity earned by taking a reduced retirement package? Priceless.

...Or so they thought. Investors aren't buying it.

Options Backdating: First-ever Criminal Trial


The first criminal trial in the nationwide stock-option backdating scandals starts today in federal court in San Francisco, and attorneys say the case will define whether backdating-related practices are serious crimes — or just sloppy bookkeeping.
With more than 200 investigations and corporate internal probes into backdating, many are watching the securities-fraud trial of former Brocade Communications
(BRCD) CEO Gregory Reyes for clues on how prosecutors will handle the cases.
"This trial is going to establish where the line is between shoddy accounting practices and criminal conduct," says Peter Henning, a Wayne State University law professor and co-editor of the White-Collar Crime Prof Blog "What type of conduct is securities fraud in the context of backdating? That line isn't clear at the moment."

Read the backstory on the civil case that Brocade settled here:

Friday, June 15, 2007

TIAA-CREF investors to set executive compensation

TIAA-CREF, an active campaigner for better corporate governance and reasonable executive pay packages for companies in its portfolio, is now going to let its investors have a say in its own compensation policies.
From an article in the Financial Times: " Officials stressed that policyholders would be asked to vote on the company’s policies and disclosure on compensation rather than the level of pay of (..) executives. "

This move is an unprecendented and welcome one. TIAA-CREF is so far the only company in the US to allow shareholders to have a say in setting compensation policies.
According to the article:

" Only one US company, the health insurer Aflac, has voluntarily agreed to hold an advisory vote on pay but only in 2009.
Shareholders in four other groups, including telecoms groups, Verizon and Motorola, have voted in favour of such a ballot but the companies have the right to ignore such requests.
Allowing policyholders to vote on executive pay will give TIAA-CREF, which is unlisted, more leverage in asking companies to introduce the measure."