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.)

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'?

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.

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.

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.

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

From USAToday.com:

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:

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."

Tussle over regulation of hedge funds

Should hedge funds be regulated?

The tussle over regulation of hedge funds has resulted in a number of missteps and failed attempts.

Last year, for instance, regulators tried to get a better handle on the industry by requiring them to register with the SEC and submit to random inspections. But an appeals court last year overturned the rule, saying the SEC lacked the authority to regulate hedge funds.

Firmly in the 'more regulation of hedge funds is better' camp is House Financial Services Committee Chairman and Massachussetts Democrat Barney Frank, who has called for global leaders to study the funds' effects on markets. Reuters reports on a letter written by him to President Bush: "Private equity and hedge funds have, in a short period, become owners and movers of vast pools of financial capital, with significant influence on the real economy, employment and long-term competitiveness for our companies."

Protection of the small investor is another important reason proposed to support more hedge fund regulation.

However people on the other side of the issue argue that confidentiality is essential for hedge funds to be able to maintain their superior returns in an increasingly crowded market. They also argue that the hedge fund investor, is not a 'typical' small investor - has higher net worth on average - and consequently may not need the SEC's help.

Currently, the SEC requires hedge funds to submit Form D disclosing how much it intends to raise, how much it has already raised, the names of its managers and the 10-percent beneficial owners in the fund. However, the changes the SEC is considering -- dropping the beneficial owner disclosure and requiring electronic filings -- would make it easier for hedge funds to comply. Still, it will mean that regulators and others who want to know more about who owns the funds are likely to get even less information.

A final decision is expected in early July.

Sarbanes-Oxley and Director Pay

A new study by academics at the University of Georgia and Clemson University finds that director pay has increased post-SOX. In addition, companies pay more for D&O premiums now compared to before the legislation.

But, and this is no surprise to many of us, companies are now also getting more bang for their buck from their board of directors:
* Post-SOX boards are larger and more independent
* Director workload and risk increased: audit committees meet more than twice as often post SOX as they did pre SOX
* The corporate director pool also changed post SOX: more post-SOX directors are lawyers/consultants, financial experts and retired executives and fewer are current executives.

Well, its great that directors have more financial expertise, because this older study from 2004 found that the probability of restatement is lower in companies that have independent directors with financial expertise on their boards. In the authors' words, "Our findings are consistent with the idea that independent directors with financial expertise are valuable in providing oversight of a firm's financial reporting practices."

That's not the last word on board composition and firm performance, though. Watch this space for a neat summary of studies on board composition and various aspects of corporate performance.

Institutions, govern thyselves

Earlier this month, the Stanford Investors' Forum came out with a report on best practices of fund governance in connection with Stanford University's Rock Center for Corporate Governance.
Since institutional investors are often prominent advocates for better governance in corporates, it seems only right for them to prescribe standards for their own behavior.

This WSJ article notes that prominent governance lapses at funds in recent years include:

- The Securities and Exchange Commission inquiry into New Jersey's state pension system, which is billions of dollars short in assets to cover obligations.
- TIAA-CREF's trustees resigning in 2004 after it was revealed that they had invested in a company that had done business with TIAA-CREF's independent auditor, Ernst & Young. The problems were attributed to poor judgment rather than malfeasance.
-Last year, a former trustee of the Illinois Teachers' Retirement System pleaded guilty to accepting hundreds of thousands of dollars in kickbacks from investment firms seeking to do business with the pension provider.
- In 2004, the San Diego City Employees' Retirement System projected it was $1.4 billion short of assets to cover its obligations. Subsequent investigations highlighted poor decisions by the fund's board, and some former board members face criminal charges. A fund-sponsored investigation found that former board members ignored conflicts of interest, didn't properly investigate funding proposals and failed to heed warnings by experts.

The full text of the best practices report can be found here.

Back to Blogging..

..after a hiatus once again.
My job and lifestyle made it hard for me to find time to blog. I've made some changes now, though, and I hope to be able to continue blogging.