Supplement to Executive Compensation, A Road Map for the Corporate Advisor: Impact of Changes Made as the Result of DEFRA
Subcommittee on Executive Compensation of the committee on Employee Benefits, 41(1): 273–300 (Nov. 1985) This Report supplements the previous one covering the various laws applicable to executive compensation arrangements. See Executive Compensation: A Road Map for the Corporate Advisor, 40 BUS. LAW. 219 (1984). It describes the changes brought about as a result of the Deficit Reduction Act of 1984 (DEFRA) in the federal income tax treatment of these arrangements. In addition to analyzing the changes made by DEFRA to the tax rules for incentive stock options, low-interest and no-interest loans, payments made under change-of-control provisions (golden parachutes), and fringe benefits, this supplement adds a discussion of various welfare benefits (such as health, life, and disability) covering executives before and after retirement.
Executive Compensation: A 1987 Road Map for the Corporate Advisor
Subcommittee on Executive Compensation of the committee on Employee Benefits and Executive Compensation , 43(1): 185–430 (Nov. 1987)
This Report comprehensively revises and expands on the Report on executive compensation and related supplement that appeared in The Business Lawyer in 1984 and 1985. Executive Compensation: A Road Map for the Corporate Advisor , 40 BUS. LAW. 219 (1984); Supplement to Executive Compensation, A Road Map for the Corporate Advisor: Impact of Changes Made as the Result of DEFRA , 41 BUS. LAW. 273 (1985). Intended as a general guide and research aid for the practitioner who does not specialize in the executive compensation area, the Report describes the leading kinds of executive compensation arrangements and their principal legal and regulatory aspects, including tax, securities, corporation law, and financial accounting. The Report discusses the effects of the Tax Reform Act of 1986 as well as other recent legal and regulatory developments. It also covers some topics not addressed in the previous Report, including "rabbi" trusts, rules applicable to banking, insurance, and utility companies, and nonqualified deferred compensation in the tax-exempt entity.
Empty Voting and Hidden (Morphable) Ownership: Taxonomy, Implications, and Reforms
Henry T. C. Hu and Bernard Black, 61(3):1011–1070 (May 2006)
Most American publicly held corporations have a one-share, one-vote structure, in which voting power is proportional to economic ownership. This structure gives shareholders economic incentives to exercise their voting power well and helps to legitimate managers' exercise of authority over property the managers do not own. Berle-Means' "separation of ownership and control" suggests that shareholders face large collective action problems in overseeing managers. Even so, mechanisms rooted in the shareholder vote, including proxy fights and takeover bids, constrain managers from straying too far from the goal of shareholder wealth maximization.
In the past few years, the derivatives revolution, hedge fund growth, and other capital market developments have come to threaten this familiar pattern throughout the world. Both outside investors and corporate insiders can now readily decouple economic ownership of shares from voting rights to those shares. This decoupling—which we call "the new vote buying"—is often hidden from public view and is largely untouched by current law and regulation. Hedge funds, sophisticated and largely unfettered by legal rules or conflicts of interest, have been especially aggressive in decoupling. Sometimes they hold more votes than economic ownership, a pattern we call "empty voting." That is, they may have substantial voting power while having limited, zero, or even negative economic ownership. In the extreme situation of negative economic ownership, the empty voter has an incentive to vote in ways that reduce the company's share price. Sometimes hedge funds hold more economic ownership than votes, though often with "morphable" voting rights—the de facto ability to acquire the votes if needed. We call this "hidden (morphable) ownership" because under current disclosure rules, the economic ownership and (de facto) voting ownership are often not disclosed. Corporate insiders, too, can use new vote buying techniques.
This article analyzes the new vote buying and its corporate governance implications. We propose a taxonomy of the new vote buying that unpacks its functional elements. We discuss the implications of decoupling for control contests and other forms of shareholder oversight, and the circumstances in which decoupling could be beneficial or harmful to corporate governance. We also propose a near-term disclosure-based response and sketch longer-term regulatory possibilities. Our disclosure proposal would simplify and partially integrate five existing, inconsistent share-ownership disclosure regimes, and is worth considering independent of its value with respect to decoupling. In the longer term, other responses may be needed; we briefly discuss possible strategies focused on voting rights, voting architecture, and supply and demand forces in the markets on which the new vote buying relies.
The Uncertain Efficacy of Executive Sessions Under the NYSE's Revised Listing Standards
Robert V. Hale II, 61(4):1413-1426 (August 2006)
This article briefly explores key issues relating to the use of non-management executive sessions under Section 303A.03 of the NYSE's revised listing standards, including the authority of the SEC to enforce such a requirement, the status of board actions taken at such meetings, and whether such sessions may result in altering the principal roles of the board and management. In this respect, the Disney derivative litigation affords an opportunity to consider the use of executive sessions in relation to these issues, as well as the business judgment rule. Moreover, Disney raises the question whether mandatory non-management executive sessions might have created a different outcome under the circumstances in the case. The article concludes with a discussion of some practical considerations for attorneys and corporate secretaries in complying with the requirement.
Breaking the Corporate Governance Logjam in Washington: Some Constructive Thoughts on a Responsible Path Forward
Leo E. Strine, Jr., 63(4): 1079–1108 (August 2008)
The Clawback Provision of Sarbanes-Oxley: An Underutilized Incentive to Keep the Corporate House Clean
Rachael E. Schwartz, 64(1): 1-36 (November 2008)
The Sarbanes-Oxley Act of 2002, passed in the wake of corporate scandals involving misstated financial reports, included a provision for certain compensation and profits from the sale of company stock to be "clawed back" from chief executive officers and chief financial officers of companies that are required to restate their financials, due to material non-compliance with any financial reporting requirement of the securities laws as a result of misconduct. Courts have determined that only the Securities and Exchange Commission may sue to enforce this clawback provision. In the six years following passage of the law, there have been Sarbanes-Oxley clawbacks in only a small number of cases, each one an options backdating case involving allegations that the officer affected personally committed fraud. This Article takes the position that the clawback provision has no scienter requirement and its application should not be limited to officers who have personally engaged in misconduct. Rather, the wording of Sarbanes-Oxley, its legislative history, and the policies it serves call for the clawback to be applied to the chief executive officers and chief financial officers of companies that are required to restate their financials due to material non-compliance with any financial reporting requirement of the securities laws as a result of misconduct, regardless of whether those officers actively participated in the wrongdoing, knew of and failed to correct the wrongdoing, or were oblivious to wrongdoing by employees subject to their control. This general rule can be made subject to an exemption for circumstances involving certain misconduct by non-management employees.
Financial Innovation and Governance Mechanisms: The Evolution of Decoupling and Transparency
Henry T. C. Hu; 70(2): 347-406 (Spring 2015)
Financial innovation has fundamental implications for the key substantive and information-based mechanisms of corporate governance. “Decoupling” undermines classic understandings of the allocation of voting rights among shareholders (via, e.g., “empty voting”), the control rights of debtholders (via, e.g., “empty crediting” and “hidden interests”/ “hidden non-interests”), and of takeover practices (via, e.g., “morphable ownership” to avoid section 13(d) disclosure and to avoid triggering certain poison pills). Stock-based compensation, the monitoring of managerial performance, the market for corporate control, and other governance mechanisms dependent on a robust informational predicate and market efficiency are undermined by the transparency challenges posed by financial innovation. The basic approach to information that the SEC has always used—the “descriptive mode,” which relies on “intermediary depictions” of objective reality—is manifestly insufficient to capture highly complex objective realities, such as the realities of major banks heavily involved with derivatives. Ironically, the primary governmental response to such transparency challenges—a new system for public disclosure that became effective in 2013, the first since the establishment of the SEC—also creates difficulties. This new parallel public disclosure system, developed by bank regulators and applicable to major financial institutions, is not directed primarily at the familiar transparency ends of investor protection and market efficiency.
As starting points, this Article offers brief overviews of: (1) the analytical framework developed in 2006−2008 for “decoupling” and its calls for reform; and (2) the analytical framework developed in 2012−2014 reconceptualizing “information” in terms of three “modes” and addressing the two parallel disclosure universes.
As to decoupling, the Article proceeds to analyze some key post- 2008 developments (including the status of efforts at reform) and the road ahead. A detailed analysis is offered as to the landmark December 2012 TELUS opinion in the Supreme Court of British Columbia, involving perhaps the most complicated public example of decoupling to date. The Article discusses recent actions on the part of the Delaware judiciary and legislature, the European Union, and bankruptcy courts—and the pressing need for more action by the SEC. At the time the debt decoupling research was introduced, available evidence as to the phenomenon’s significance was limited. This Article helps address that gap.
As to information, the Article begins by outlining the calls for reform associated with the 2012−2014 analytical framework. With revolutionary advances in computer- and web-related technologies, regulators need no longer rely almost exclusively on the descriptive mode rooted in intermediary depictions. Regulators must also begin to systematically deploy the “transfer mode” rooted in “pure information” and the “hybrid mode” rooted in “moderately pure information.” The Article then shows some of the key ways that the new analytical framework can contribute to the SEC’s comprehensive and long-needed new initiative to address “disclosure effectiveness,” including in “depiction-difficult” contexts completely unrelated to financial innovation (e.g., pension disclosures and high technology companies). The Article concludes with a concise version of the analytical framework’s thesis that the new morphology of public information—consisting of two parallel regulatory universes with divergent ends and means—is unsustainable in the long run and involve certain matters that need statutory resolution. However, certain steps involving coordination among the SEC, the Federal Reserve, and others can be taken in the interim.
Securing Our Nation’s Economic Future: A Sensible, Nonpartisan Agenda to Increase Long-Term Investment and Job Creation in the United States
Leo E. Strine, Jr., 71(4): 1081-1112 (Fall 2016)
These days it has become fashionable to talk about whether the incentive system for the governance of American corporations optimally encourages long-term investment, sustainable policies, and therefore creates the most long-term economic and social benefit for American workers and investors. Many have come to the conclusion that the answer to that question is no. As these commentators note, the investment horizon of the ultimate source of most equity capital—human beings who must give their money to institutional investors to save for retirement and college for their kids—is long. That horizon is much more aligned with what it takes to run a real business than that of the direct stockholders, who are money managers and are under strong pressure to deliver immediate returns at all times. Americans want corporations that are focused on sustainable wealth and job creation. But there is too little talk accompanied by a specific policy agenda to address that incentive system.
This Article proposes a genuine, realistic agenda that would better promote a sustainable, long-term commitment to economic growth in the United States. This agenda should not divide Americans along party lines. Indeed, most of the elements have substantial bipartisan support. Nor does this agenda involve freeing corporate managers from accountability to investors for delivering profitable returns. Rather, it makes all those who represent human investors more accountable, but for delivering on what most counts for ordinary investors, which is the creation of durable wealth by socially responsible means.
The fundamental elements of this strategy to promote long-term American competitiveness include: (i) tax policy that discourages counterproductive behavior and encourages investment and work; (ii) investment policies to revitalize our infrastructure, address climate change, create jobs, and close our deficit; (iii) reforming the incentives of and enhancing the fiduciary accountability of institutional investors; (iv) reducing the focus on quarterly earnings estimates and improving the quality of information provided to investors; and (v) an American commitment to an international level playing field to reduce incentives to offshore jobs, erode the social safety net, and pollute the planet.
Dilution, Disclosure, Equity Compensation, and Buybacks
Bruce Dravis, 74(3) 631-658 (Summer 2019)
Equity compensation and company share buybacks are complementary: Equity compensation share issuances increase outstanding shares; buybacks decrease outstanding shares. Yet the two types of transactions require very different approval processes and securities and financial disclosures, and generate different financial and tax results, all of which are described in this article, and illustrated by data collected from fifty-nine of America’s largest public companies. This article encourages critics of buybacks to consider the complexity and interrelationship of buybacks and equity compensation.