http://www.ecgi.org/rss/wp.xml RSS feed of the European Corporate Governance Institute (ECGI) Mon, 01 Mar 2010 21:22 GMT en-us http://www.ecgi.org/assets/logos/ECGI fonts only.gif http://www.ecgi.org/wp/index.php 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% have significant stock-price reactions at the 5% 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% 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% 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% 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% to 1.50% 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% 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%, 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% compared to 2.2% 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% and 30%. 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% 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