University of Colorado-Boulder
Leeds School of Business
FNCE 4826
Seminar in Corporate Governance
Spring 2015
KOBL 340
W 3:30 pm - 6:15 pm
Sanjai Bhagat
Office: KOBL S431
sanjai.bhagat@colorado.edu
Office Hours: TH 1 pm – 3pm
I. Course Objective
Corporate governance consists of the set of corporate policies that ensures outside investors a
fair return on their investment. The objective of the course is to provide the student with a stateof-the-art understanding of corporate governance as it relates to
 Corporate control
 Corporate performance
 Board structure and effectiveness
 Executive and board compensation
 Entrepreneurship and private equity
 Corporate social responsibility
II. Course Materials and Prerequisite
Course materials consist of scholarly journal articles and working papers. These and
lecture notes/overheads and class announcements can be accessed from my home-page:
http://leeds-faculty.colorado.edu/bhagat
The recommended textbook for this course is Corporate Governance Matters by David
Larcker and Brian Tayan, FT Press, 2011.
Articles from the Wall Street Journal will be used to motivate some of the class discussion.
www.wsj.com/studentoffer www.wsj.com/quarter
This is a Finance elective. FNCE 3010 is a prerequisite.
III. Course Outline and Readings
A. Introduction
Corporate Governance Matters Chapter 1. IntroductionAgencyTheoryApplication
IntroductionCorporateGovernance
B. Corporate Control: Mergers and Takeovers
Corporate Governance Matters Chapter 11.
Andrade, M. Mitchell, and E. Stafford. "New Evidence and Perspectives on Mergers." Journal of
Economic Perspectives (2001): 103-120. NewEvidenceMergers.ppt
target-gain-goodfile.doc
S. B. Moeller, F. P. Schlingemann, R. M. Stulz, “Firm Size and the Gains From Acquisitions,” Journal of
Financial Economics 73, 2004, 201-228.
J. Harford, M. Humphery-Jenner, R. Powell. “The sources of value destruction in acquisitions by
entrenched managers,” Journal of Financial Economics, Volume 106, November 2012, Pages 247–26.
U. Malmendier and G. Tate, “Who Makes Acquisitions? CEO Overconfidence and the Market’s
Reaction,” Journal of Financial Economics 89, 20-43, 2008. CEO-Overconfidence.ppt
M. Zhao and K. Lehn, “CEO Turnover After Acquisitions: Do Bad Bidders Get Fired?” 2006, Journal of
Finance 61, 1759-1812.
Spinoffs and Corporate Refocusing
P. G. Berger and E. Ofek, “Causes and Effects of Corporate Refocusing Programs,” Review of Financial
Studies 12, 1999, 311-346. Spinoffs.ppt
S. Krishnaswami and V. Subramaniam, “Information asymmetry, Valuation, and the Corporate Spin-off
Decision,” 1999, Journal of Financial Economics 53, 1999, 73-112.
C. Shareholder Voting and Activism
J.A. Brickley, R.C. Lease and C.W. Smith, Jr., "Ownership Structure and Voting on Antitakeover
Amendments," Journal of Financial Economics 20, 1988, 267-292. Antitakeover.ppt
S. Bhagat and R.H. Jefferis, "Voting Power in the Proxy Process: The Case of Antitakeover Charter
Amendments," Journal of Financial Economics 30, 1991, 193-226.
L. Bebchuk, A. Brav and W. Jiang, “The Long-Term Effects of Hedge Fund Activism,” Harvard
University working paper, 2013.
A. Brav, W. Jiang, F. Partnoy, and R. Thomas, “Hedge Fund Activism, Corporate Governance, and Firm
Performance,” 2010, Duke University working paper.
Paul Gompers*, Steven N. Kaplan and Vladimir Mukharlyamov, “What Do Private Equity Firms Do?”
2014, Harvard University working paper.
2
Steven Davis, et al, “Private Equity, Jobs, and Productivity,” 2014, University of Chicago working paper.
Corporate Governance Matters Chapter 12.
D. Corporate Board Structure
Corporate Governance Matters Chapters 3, 4, and 5.
Gompers, P. A., J. L. Ishii, and A. Metrick, 2003, Corporate governance and equity prices, Quarterly
Journal of Economics 118(1), 107-155.
S. Bhagat and B. Bolton, “Corporate Governance and Firm Performance,” Journal of Corporate Finance
14, 257-273, 2008. Corporate Governance – Performance.ppt
S. Bhagat and B. Bolton "Director Ownership, Governance and Performance," Journal of Financial &
Quantitative Analysis, 2013, Sox-GovernancePerformance.
S. Bhagat , B. Bolton, and R. Romano, “The Promise and Pitfalls of Corporate Governance Indices,”
Columbia Law Review, v108 n8, pp 1803-1882, 2008
E. Management and Board Compensation
Corporate Governance Matters Chapter 8.
S. Bhagat and B. Bolton, “Financial Crisis And Bank Executive Incentive Compensation,” Journal of
Corporate Finance, 2014. BankCompensationCapitalReform
S. Bhagat , B. Bolton, and R. Romano, “Getting Incentives Right: Is Deferred Bank Executive Compensation
Sufficient?” Yale Journal on Regulation, 2014.
F. Corporate Social Responsibility
Kitzmueller, Markus and Jay Shimshack. "Economic Perspectives On Corporate Social Responsibility,"
Journal of Economic Literature, 2012, v 50(1), 51-84.
Simons, Robert, “The Business of Business Schools: Restoring a Focus on Competing to Win,” Harvard
Business School, Capitalism and Society: Vol. 8: Iss. 1 , Article 2., 2013.
3
IV.
Course Policies
Course Schedule
January 14
January 21
January 28
February 4
February 11
February 18
February 25
March 4
March 11
March 18
March 25
April 1
April 8
April 15
April 22
April 29
May 6
Introduction
Corporate Control
Corporate Control
Proposal due
Shareholder Voting and Activism
Corporate Board Structure
Corporate Board Structure
Corporate Board Structure
Management and Board Compensation
Management and Board Compensation
Paper draft due
Governance and Venture Financing
Spring Break
Governance and Venture Financing
Corporate Social Responsibility
Corporate Social Responsibility
Student Presentations
Student Presentations
Final Exam (8:30 am – 10:00 am)
Grading
The grade breakdown is as follows:
Item
A.
Class participation and attendance
B.
Term Paper (proposal, due: January 28)
C.
Term Paper (draft, due: March 11)
D.
Term Paper (write-up, due: April 8)
E.
Term Paper (presentation)
F.
Final Exam (May 6)
Paper due
Weight
10%
5%
15%
25%
15%
30%
A.
Class participation is critical to the success of this course. Student questions and comments are
expected and welcome. Attendance will be taken at random (unannounced). Students are requested to
place their name-cards in front of their desk at all times during class.
The class will be conducted in a professional manner: Students and the instructor are expected to
be prepared for each class, and behave professionally in the class.
B.
Proposals for the term paper are due on January 28, 2015, before the start of class. The proposal
should answer the following two questions:
 What will the paper be about?
 Why is this topic interesting and important?
You should also include a list of at least four academic papers or book chapters that you intend to read
as background for your paper. The proposal should be no more than a page.
C, D, E. The term paper draft is due on March 11, 2015, before the start of class. The term paper draft
4
should be at least ten pages long, and include the following:
 What is the paper about?
 Why is this interesting and important to study/read?
 A critical survey of the literature.
 Outline of the original analysis that would be of interest to somebody in the real world: an
investment banker, venture capitalist, or entrepreneur.
 References that includes at least four academic papers or book chapters.
The term paper is due on April 8, 2015.
Student presentations are scheduled for April 15, 22 and 29, 2015. The paper can be on any topic that
will be covered in the course. The paper should include a critical survey of the literature and some
original analysis that would be of interest to somebody in the real world: Chairman of Board,
CEO, CFO, policy makers and their staffs, compensation consultants, investment bankers, or
private equity investors. The paper (including exhibits) should be between 20 and 25, double-spaced
pages (twelve-point font, one-inch margin all-around).
On your paper please note the following:
On my honor, as a University of Colorado at Boulder student, I have neither given nor received
unauthorized assistance on this paper.
A Note on Academic Honesty & Plagiarism: The development of the Internet has provided students with
historically unparalleled opportunities for conducting research swiftly and comprehensively. The
availability of these materials does not, however, release the student from appropriately citing sources
where appropriate; or applying standard rules associated with avoiding plagiarism. Please see
http://www.colorado.edu/academics/honorcode
Grade distribution:
http://leeds.colorado.edu/asset/undergraduate/gradingpolicy.pdf
Also, please review
http://www.colorado.edu/policies/fac_relig.html,
http://www.colorado.edu/policies/classbehavior.html,
http://www.Colorado.EDU/disabilityservices,
and http://www.colorado.edu/policies/discrimination.html.
5
Guidance to Faculty Regarding Grade Distributions
In May 2011, the faculty of the Leeds School voted to establish the “grading guidelines” shared below.
With this vote, the faculty returns to its preͲ2009 approach of grading guidelines.
These guidelines embody the faculty’s consensus about competition and fairness within, and across,
classroom experiences at Leeds. In its discussions and preparations, the faculty relied heavily on
norms and customs at topͲtier business schools throughout the U.S.
The following matrix provides guidance on grade distributions either at the course level or aggregated
across multiple, simultaneous sections.
Course Level
1000 and 2000
Maximum Average Course Grade
2.8
3000
3.0
4000
3.2
6
Recommended Distribution
Not more than 15% AͲ or above
Not more than 65% BͲ or above
At least 35% C+ or below
Not more than 25% AͲ or above
Not more than 75% BͲ or above
At least 25% C+ or below
Not more than 35% AͲ or above
Not more than 85% BͲ or above
At least 15% C+ or below
Guidelines for the Term Paper
Suggested order for the sections:
Cover Page
Paper Title, Student Names, Course, Date
Executive Summary
No more than one page. The most important part of your paper! Briefly explain what the paper is about, why this is
an interesting and important topic, and your main findings/conclusions. Consider an entrepreneur, investment banker,
investor, or venture capitalist as your primary reader of this page.
Introduction
What is the paper about?
Motivation: Why is this interesting and important to study/read?
Overview of the paper.
(Main Body)
Please consider using sub-sections to better organize your paper, and improve its readability.
Please check the transition between paragraphs.
(Footnotes on same page.)
Summary and Conclusions
Exhibits (Tables, Graphs, etc.)
Captions and legends in the exhibits should make them self-explanatory. Cite data sources.
References
____________________________________________________________________
Check for grammar and spelling.
All arguments/assertions should be supported using:
logical constructs, and/or
theoretical considerations (cite references), and/or
previous empirical evidence (cite references).
Paper should be revised by you at least four times over a period no less than a week.
7
F.
The exam will consist of essay-type questions, and will be closed-book, closed-notes, and inclass. The exam will be based on study questions that will be handed out during the semester. The exam
will be graded anonymously in the sense that students will not write their names on the exam and at the
time I grade the exam I will not know whose exam it is.
Readings
You are advised to read the “critical portions” of the assigned readings for a particular class
before that class. The critical portions of a reading include the abstract, introduction,
summary/conclusions of the paper. You might wish to read the main body of the paper after we
have discussed it in class.
V. Additional Readings (Particularly helpful if your term paper is on one of the following
topics)
B. Corporate Control
Mergers and Takeovers
1. S. Bhagat, A. Shleifer, and R.W. Vishny, "Hostile Takeovers in the 1980s: The Return to Corporate
Specialization," Brookings Papers on Economic Activity, 1990, 1-84. target-gain-goodfile.doc
2. G. Andrade, M. Mitchell, and E. Stafford. "New Evidence and Perspectives on Mergers." Journal of
Economic Perspectives (2001): 103-120. NewEvidenceMergers.ppt
3. E.H. Kim and V. Singal, "Mergers and Market Power: Evidence from the Airline Industry," American
Economic Review 83, 1993, 549-569.
4. S. Bhagat, M. Dong, D. Hirshleifer and R. Noah, "Do Tender Offers Create Value?" Journal of
Financial Economics, 2005, V76 N1, 3-60. b-hirshleifer.ppt
5. S. B. Moeller, F. P. Schlingemann, R. M. Stulz, “Firm Size and the Gains From Acquisitions,”
Journal of Financial Economics 73, 2004, 201-228.
6. S.B. Moeller, F. P. Schlingemann, and R.M. Stulz, “Wealth Destruction on a Massive scale? A Study
of Acquiring-Firm returns in the Recent Merger Wave, Journal of Finance 60, 2005, 757-782.
7. J. Harford, M. Humphery-Jenner, R. Powell. “The sources of value destruction in acquisitions by
entrenched managers,” Journal of Financial Economics, Volume 106, November 2012, Pages 247–
26.
8. U. Malmendier and G. Tate, “Who Makes Acquisitions? CEO Overconfidence and the Market’s
Reaction,” Journal of Financial Economics 89, 20-43, 2008.
9. M. Zhao and K. Lehn, “CEO Turnover After Acquisitions: Do Bad Bidders Get Fired?” 2006,
8
Journal of Finance 61, 1759-1812.
10. S. Bhagat, S. Malhotra and P.C. Zhu, “Emerging country cross-border acquisitions: Characteristics,
acquirer returns and cross-sectional determinants,” Emerging Markets Review, Volume 12, September
2011, Pages 250-27.
11. I. Erel, R.C. Liao, and M.S. Weisbach, “Determinants of Cross-Border Mergers and Acquisitions,”
Journal of Finance 67, 2012, pages 1045–1082.
Spinoffs and Corporate Refocusing
1. B. E. Eckbo and K.S. Thorburn, Corporate Restructuring, Foundations and Trends in Finance, 2013.
2. P. G. Berger and E. Ofek, “Causes and Effects of Corporate Refocusing Programs,” Review of
Financial Studies 12, 1999, 311-346. Spinoffs.ppt
3. L Daley, V. Mehrotra, and R. Sivakumar, “Corporate Focus and Value Creation: Evidence fron
Spinoffs,” 1997, Journal of Financial Economics 45, 257-281.
4. S. Krishnaswami and V. Subramaniam, “Information asymmetry, Valuation, and the Corporate Spinoff Decision,” 1999, Journal of Financial Economics 53, 1999, 73-112.
5. S. Ahn and D.J. Denis, “Internal Capital Markets and Investment Policy: Evidence From Corporate
Spinoffs,” Journal of Financial Economics 71, 2004, 489-516.
6. T.R. Burch and V. Nanda, “Divisional Diversity and the Conglomerate Discount: Evidence From
Spinoffs,” Journal of Financial Economics 70, 2003, 69-98.
C. Shareholder Voting and Activism
1. J.A. Brickley, R.C. Lease and C.W. Smith, Jr., "Ownership Structure and Voting on Antitakeover
Amendments," Journal of Financial Economics 20, 1988, 267-292. Antitakeover.ppt
2. S. Bhagat and R.H. Jefferis, "Voting Power in the Proxy Process: The Case of Antitakeover Charter
Amendments," Journal of Financial Economics 30, 1991, 193-226.
3. D. DelGuercio and J. Hawkins, “The Motivation and Impact of Pension Fund Activism,” Journal of
Financial Economics 52, 1999, 293-340.
4. L. Bebchuk, A. Brav and W. Jiang, “The Long-Term Effects of Hedge Fund Activism,” Harvard
University working paper, 2013.
5. L.A. Bebchuk and E. Kamar, “Bundling and Entrenchment,” Harvard Law Review, May 2010.
6. A. Brav, W. Jiang, F. Partnoy, and R. Thomas, “Hedge Fund Activism” 2010, Duke University
working paper.
7. S. Bhagat and R. Romano, “Empirical Studies of Corporate Law,” in Handbook of Law & Economics, 2007.
9
CorporateLaw.ppt
D. Corporate Board Structure
1. S. Bhagat and B. Black, “The Non-Correlation Between Board Independence and Long-Term Firm
Performance” Journal of Corporation Law, 2002, Volume 27, Number 2. b-black.ppt
2. S. Bhagat and R.H. Jefferis, The Econometrics of Corporate Governance Studies, 2002, MIT Press.
3. S. Bhagat and B. Bolton, “Corporate Governance and Firm Performance,” Journal of Corporate
Finance 14, 257-273, 2008. Corporate Governance – Performance.ppt
4. S. Bhagat and B. Bolton "Director Ownership, Governance and Performance," Journal of Financial
& Quantitative Analysis, 2013, Sox-GovernancePerformance.
5. S. Bhagat , B. Bolton, and R. Romano, “The Promise and Pitfalls of Corporate Governance Indices,”
Columbia Law Review, v108 n8, pp 1803-1882, 2008
6. S. Bhagat and H. Tookes, “Voluntary and Mandatory Skin in the Game: Understanding Outside
Director's Stock Holdings,” European Journal of Finance, 2011.
E. Management and Board Compensation
M.C. Jensen and K.J. Murphy, "Performance Pay and Top-Management Incentives," Journal of Political
Economy 98, 1990, 225-264.
B. J. Hall and J. B. Liebman, “Are CEOs Really Paid Like Bureaucrats?” 1998, Quarterly Journal of
Economics 108, 653-691. Hall-Liebman.ppt
C.S. Armstrong, D. F. Larcker, G. Ormazabal, and D. J. Taylor, “The Relation Between Equity
Incentives and Misreporting: The Role of Risk-taking Incentives,” Journal of Financial Economics
109, 327-350, 2013.
Armstrong, C. S., A. Jagolinzer and D. Larcker, “Chief Executive Officer Equity Incentives and Accounting
Irregularities”, Journal of Accounting Research 48, 225-271, 2010.
S. Bhagat and B. Bolton, “Financial Crisis And Bank Executive Incentive Compensation,” Journal of
Corporate Finance, 2014.
S. Bhagat , B. Bolton, and R. Romano, “Getting Incentives Right: Is Deferred Bank Executive Compensation
Sufficient?” Yale Journal on Regulation, 2014. ReformingExecComp
Anat R. Admati, Peter M. DeMarzo, Martin F. Hellwig, Paul C. Pfleiderer, “Fallacies, Irrelevant Facts,
and Myths in the Discussion of Capital Regulation: Why Bank Equity is Not Expensive,” Stanford
University working paper, September 2011.
10
F. Governance and Venture Financing
1. S.N. Kaplan and Per Stromberg. "Financial Contracting Theory Meets The Real World: An
Empirical Analysis Of Venture Capital Contracts," Review of Economic Studies, 2003,
v70(2,Apr), 281-315.
2. S. N. Kaplan, B. A. Sensoy, and P. Stromberg, “Should Investors Bet on the Jockey or the
Horse? Evidence from the Evolution of Firms from Early Business Plans to Public
Companies,” Journal of Finance 64, 2009, 75-115.
3. O. Bengtsson and B. A. Sensoy, “Changing the Nexus: The Evolution and Renegotiation of
Venture Capital Contracts,” Ohio State University working paper, 2009.
4.
O. Bengtsson and B. A. Sensoy, “Investor Abilities and Financial Contracting: Evidence
from Venture Capital,” Ohio State University working paper, 2009.
5. O. Bengtsson and S.A.Ravid, “The Geography of Venture Capital Contracts,” Ohio State
University working paper, 2009.
6. H. Chen, P. Gompers, A. Kovner, and J. Lerner, “Buy Local? The Geography of Successful
Venture Capital Expansion,” Harvard University working paper, 2009.
7. Brian Broughmana and Jesse Fried, “Renegotiation of cash flow rights in the sale of VCbacked firms,” Journal of Financial Economics 95, Issue 3, March 2010, Pages 384-399.
G. Corporate Social Responsibility
Kitzmueller, Markus and Jay Shimshack. "Economic Perspectives On Corporate Social Responsibility,"
Journal of Economic Literature, 2012, v50(1), 51-84.
Simons, Robert, “The Business of Business Schools: Restoring a Focus on Competing to Win,” Harvard
Business School, 2013.
Dhaliwal, Dan S., Oliver Zhen Li, Albert Tsang and Yong George Yang. "Voluntary Nonfinancial Disclosure
And The Cost Of Equity Capital: The Initiation Of Corporate Social Responsibility Reporting," Accounting
Review, 2011, v86(1), 59-100.
Dravenstott, John and Natalie Chieffe. "Corporate Social Responsibility: Should I Invest For It Or Against
It?," Journal of Investing, 2011, v20(3), 108-117.
El Ghoul, Sadok, Omrane Guedhami, Chuck C.Y. Kwok and Dev R. Mishra. "Does Corporate Social
Responsibility Affect The Cost Of Capital?," Journal of Banking & Finance, 2011, v35(9), 2388-2406.
Goss, Allen and Gordon S. Roberts. "The Impact Of Corporate Social Responsibility On The Cost Of Bank
Loans," Journal of Banking & Finance, 2011, v35(7), 1794-1810.
Becchetti, Leonardo and Rocco Ciciretti. " Corporate Social Responsibility And Stock Market Performance,”
Applied Financial Economics, 2009, v19(16), 1283-1293
Jensen, Michael C., Putting Integrity into Finance: A Positive Approach, 2011, Harvard NOM Working
11
Paper No. 06-06; Available at SSRN: http://ssrn.com/abstract=876312
J.M. Karpoff, D.S. Lee and G.S. Martin, “The Cost of Cooking the Books,” Journal of Financial and
Quantitative Analysis, 43 (September 2008), 581-612.
J.M. Karpoff, D.S. Lee and G.S. Martin , The consequences to managers for financial misrepresentation,
Journal of Financial Economics,Volume 88, Issue 2, May 2008, Pages 193-215
Glaeser, Edward L., The Governance of Not-for-Profit Firms (April 2002). Harvard Institute of
Economic Research Paper No. 1954. Available at SSRN: http://ssrn.com/abstract=313203 or
http://dx.doi.org/10.2139/ssrn.313203
H. Private Equity
1. S. N. Kaplan and P. Stromberg, “Leveraged Buyouts and Private Equity, NBER paper, 2008.
http://www.privateequityatwork.com/
2. Steven J. Davis , John Haltiwanger , Ron S. Jarmin , Josh Lerner and Javier Miranda, “Private Equity and
Employment,” US Census Bureau Center for Economic Studies Paper No. CES-WP-08-07R, 2014. Private
Equity
3. Paul Gompers, Steven N. Kaplan and Vladimir Mukharlyamov, “What Do Private Equity Firms Do?”
2014, Harvard University working paper.
4. Paglia, John and Harjoto, Maretno Agus, The Effects of Private Equity and Venture Capital on Sales and
Employment Growth in Small and Medium Sized Businesses (June 5, 2014). Journal of Banking and Finance,
Vol. 47, pp. 177-197, 2014.
5. J. Haltiwanger, R. Jarmin, J. Miranda, “Who Creates Jobs?” Review of Economics and
Statistics 95, May 2013, 347-361.
I. Financial Crisis
K. French et al, The Squam Lake Report, 2010, Princeton University Press.
A. Purnanandam, "Originate-to-Distribute Model and the Sub-prime Mortgage Crisis"
Review of Financial Studies, 2011, 24, 1881-1915.
Bhattacharyya, Sugato and Purnanandam, Amiyatosh K., Risk-Taking by Banks: What Did We
Know and When Did We Know It? (November 18, 2011).
Taylor D.Nadauld, ShaneM.Sherlund,The impact of securitization on the expansion of subprime
credit, Journal of Financial Economics 107, 2013, 454-476.
12
Study Questions – FNCE 4825 (March 31, 2015)
1. (a) What is corporate governance?
(b) Why would a private high-tech start-up care about corporate governance?
[IntroductionCorporateGovernance.ppt]
2. Discuss the advantages and disadvantages of common stock residual claims.
[IntroductionAgencyTheoryApplication]
3. Discuss the sources of conflict of interest between managers and shareholders. Discuss the
mechanisms to control this conflict of interest. [IntroductionAgencyTheoryApplication]
3. (a) What does it mean to say that a market is efficient?
(b) A certain investment advisor claims that the clients she has advised in the past have done “better than
the market” because in the past five years the portfolio she had recommended beat the market by the
following: 1.5%, 2.5%, 0.5%, -0.5%, -1.25%. Evaluate her claim. [CAPM-EMH.ppt]
4. a) Target shareholders generally receive substantial positive abnormal returns during takeovers. What
are the hypothesized sources of these abnormal returns? [target-gain.doc] [NewEvidenceMergers.ppt]
4. b) What is the empirical evidence on returns to bidders in takeovers? Discuss potential problems in
the traditional ways of measuring returns to bidders in takeovers. [b-hirshleifer.ppt]
[NewEvidenceMergers.ppt]
5. (a) What is Roll’s Hubris Hypothesis of corporate acquisitions? Explain. Discuss Malmendier-Tate’s
(2008) evidence on this. How do they identify hubristic CEOs?
(b) Do bad bidders get fired? [CEO-Overconfidence.ppt]
6. (a) During the last decade corporations are said to be refocusing. What is meant by “corporate
refocusing”? Discuss why corporations might be refocusing; please consider the evidence in
Krishnaswami and Subramaniam (1999), Ahn and Denis (2004) and Daley, et al (1997).
(b) What might be the role of market disciplinary forces, and internal governance mechanisms in
spurring corporate refocusing as discussed in Berger and Ofek (1999). [Spinoffs.ppt]
7. (a) What are antitakeover amendments?
(b) Why might antitakeover amendments be in shareholders’ interest?
(c) Why might antitakeover amendments not be in shareholders’ interest?
(d) What is the empirical evidence on when managers are more likely to propose antitakeover
amendments? [Antitakeover.ppt]
8 (a) What are the long term effects of hedge fund activism?
(b) Why might hedge fund activism be different than institutional investor activism? [Antitakeover.ppt]
Bebchuk-Brav-Jiang (2013)
9. Recently academics (GIM, Bhagat and Bolton (2008)), and industry advisors to institutional investors
(The Corporate Library) have suggested ways to measure corporate governance for companies.
13
(a) Describe the three measures of corporate governance.
(b) What are the pros and cons of these three measures of corporate governance?
(c) What is the empirical evidence on the effectiveness of these three measures of corporate governance?
[Corporate Governance-Performance.ppt]
10. What is the impact of the following corporate governance measures on corporate performance,
disciplinary management turnover, and M&A activity before and after the passage of the SarbanesOxley Act?
a) GIM index; (b) director ownership; (c) board independence. [Sox- Governance-Performance.ppt]
11. Bebchuk, Cohen and Spamann (2010) study the compensation structure of the top executives in
Bear Stearns and Lehman Brothers and conclude, “…given the structure of executives’ payoffs, the
possibility that risk-taking decisions were influenced by incentives should not be dismissed but rather
taken seriously.”
Fahlenbrach and Stulz (2011) focus on the large losses experienced by CEOs of financial institutions via
the declines in the value of their ownership in their company’s stock and stock option during the crisis
and conclude, “Bank CEO incentives cannot be blamed for the credit crisis or for the performance of
banks during that crisis.”
(a) How might you differentiate between these two points of view?
(b) What recommendations might you make regarding executive compensation, and capital structure of
large financial institutions? Why?
[BankCompensationCapitalReform]
_____________________________
Please note: The Final Exam will consist of four questions drawn from the above.
You will be asked to answer three of these four questions.
It is expected that the answer to each question would take about 30 minutes.
14
Test the Medical Skills of Aspiring
Doctors
WALL STREET JOURNAL April 26, 2015 5:08 p.m. ET
The new sections of the MCAT will prepare our young doctors for their medical careers (“MedicalSchool Test Gets a Revamp,” U.S. News, April 16). The “power, privilege and prestige” section will
enable them to understand government, insurance companies, administrators and the board examination
industry. “Class consciousness” questions will help them accept their large debt load and inability to
purchase a home. They will be able to tolerate that their salaries are less than those of their handlers and
regulators.
I am glad that there are dedicated, intelligent, hardworking students to take care of us when we are sick.
They have no advocate and are at the mercy of government and career academicians. Let’s stop making
them jump through hoops to become doctors. Don’t waste their time on political correctness. I hope the
doctor operating on me doesn’t spend 25% of his time reading sociology textbooks.
Thomas F. O’Malley Jr., M.D.
Huntingdon Valley, Pa.
15
WALL STREET JOURNAL, PAGE A1, MARCH 31, 2015
MARKETS
Regulators Intensify Scrutiny of Bank
Boards
Fed and others hold more frequent meetings with directors
By
VICTORIA MCGRANE and
JON HILSENRATH
Updated March 30, 2015 11:48 p.m. ET
44 COMMENTS
WASHINGTON—U.S. regulators are zeroing in on Wall Street boardrooms as part of the government’s
intensified scrutiny of the banking system, shifting from light-touch oversight of bank directors to
regular questioning.
The Federal Reserve and other bank regulators are holding frequent, in some cases monthly, meetings
with individual directors at the nation’s biggest banks, demanding detailed minutes and other
documentation of board meetings and singling out boards in internal regulatory critiques of bank
operations and oversight.
In some instances, Fed supervisors meet more often with directors than the directors meet formally as a
full board. Boards at small banks are also getting new attention from regulators. This account is based
on interviews with government, industry and other people familiar with the efforts as well as public
statements.
The change has Washington overseeing the overseers, as regulators home in on whether directors are
adequately challenging management and monitoring risks in the banking system.
They are reviewing information directors get from bank management, asking about succession planning
and inquiring about how directors gauge the potential downsides of certain transactions, among other
things, according to industry and government officials.
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“We have the independent directors’ attention,” Comptroller of the Currency Thomas Curry said in an
interview. Examiners from his office, which regulates national banks including units of large firms
like Bank of America Corp. and Citigroup Inc., meet informally with lead directors and audit and risk
committees several times a year.
Within the last month, Fed supervisors have had numerous conversations with directors about the results
of the annual “stress tests” which determine whether the bank can return capital to shareholders.
The Fed and the OCC say the board oversight helps make the financial system safer, but directors
complain they are being asked to take on too much responsibility.
“A director isn’t management,” said an independent board member of a large Fed-supervised U.S. bank.
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ENLARGE
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The threat of being held accountable for failing to properly supervise management is “creating a ton of
tension” for directors, this person said. This person also complained about the board being “written up”
regularly in confidential supervisory reports on the bank.
Interviews with people familiar with the situation said interaction varies depending on the bank.
At Goldman Sachs Group Inc., the bank’s lead independent director meets monthly with its primary Fed
supervisor. Morgan Stanley, under the direction of Chief Executive James Gorman, allows Fed
supervisors to sit in on a portion of each board meeting, where they can listen and ask questions.
The lead director at Bank of America holds monthly calls with supervisors at the Fed and OCC while
board committee leaders meet in person with supervisors several times a year. At J.P. Morgan Chase &
Co., Fed supervisors attend some board committee meetings and directors meet regularly with
supervisors outside of the formal board meetings.
A bank executive referred to the Fed’s increased focus as “Occupy Board Meetings,” saying supervisors
had become a regular presence at director gatherings.
In at least one instance, the Fed is proposing to dictate the board makeup of a company under its
purview. The Fed has told General Electric Co.’s GE Capital unit, which recently came under Fed
supervision because of its designation as a “systemically important financial institution,” to add two new
members to its seven-member board who are independent of the financial-services business and the
parent company’s board.
The GE board, in a Feb. 2 letter to the Fed, called the requirement “unprecedented” and said it would
“actually undermine our independent oversight of GE Capital’s enterprise risks by disrupting the
cohesive decision-making that is necessary for the effective governance of a complex wholly-owned
subsidiary like GE Capital.” Among those who signed the letter was Mary Schapiro, former Securities
and Exchange Commission chairman, who joined GE’s board as an independent director in 2013. The
letter is on file at the Fed.
Outside groups have also raised alarms about the Fed’s proposal, including two investment managers
with positions in GE stock. The Fed’s proposed director requirement “blurs the lines of accountability
that are central to a strong, effective corporate governance,” John N. Iannuccillo, a vice president at
Dodge & Cox, one of the GE investors, wrote in a letter to the Fed.
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While Fed and OCC supervisors have long interacted with bank boards, including meeting to discuss the
confidential ratings assigned to each bank, directors and other industry officials say directors have begun
facing a new level of scrutiny over the past two years.
“There is more supervisory contact with the boards than ever before,” said Eugene Ludwig, chief
executive officer of advisory firm Promontory Financial Group and a former comptroller of the
currency.
After years of pushing banks to boost their capital cushions, regulators are now focusing on corporate
governance and the role of directors to ensure banks have the right culture and controls to prevent
excessive risk taking. The 2008 crisis showed regulators that some boards—and senior management—
didn’t understand the risks firms were taking or didn’t exercise appropriate oversight.
In some cases, board members weren’t experienced enough or were too closely tied to the bank to
perform their duties. Studies since the financial crisis—for example, the International Monetary Fund’s
October 2014 Global Financial Stability report— have shown banks with independent directors are less
likely to take on risk, while boards chaired by the bank’s CEOs take more risk.
Directors at small banks are also being pressed, including on how much they understand the kinds of
loans banks are making and the associated risks, said Camden Fine,president and CEO of the
Independent Community Bankers of America.
Last year, the OCC ignited a firestorm when it proposed new requirements for directors at the biggest
banks, including that they “ensure” senior management addressed risks. In comment letters and
meetings with OCC officials, directors and banks said such language pushed directors to take on
managerial duties beyond their traditional role as overseers.
“We are concerned that the language of the proposal may have the unintended consequence of
establishing new, material obligations on boards that are impractical to meet and that could give rise to
new director liability claims and deter interest in board service,” Wells Fargo & Co. wrote in a March
2014 letter.
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The OCC revised sections of the final version to “avoid imposing managerial responsibilities on board
members” and said they never intended to change the board’s fundamental role.
Washington’s laser focus on boards has raised concerns banks will have trouble recruiting and retaining
qualified directors, stoked by lawsuits brought by the Federal Deposit Insurance Corp. against former
directors of banks that failed during the crisis, industry officials say.
About 25% of the 80 banks that responded to an American Association of Bank Directors survey last
year reported they had either had a director resign, decline to join the board or refuse to serve on the
board’s loan committee “out of fear of personal liability.”
David Baris, who heads the group and is a partner at law firm BuckleySandler LLP, said there are
“simply people who won’t serve as directors who would otherwise be qualified to serve because of that
fear” of personal liability. Some lawyers are advising would-be directors to just say no. Oliver Ireland, a
partner at Washington law firm Morrison & Foerster, said on a panel in November he recommends
against anyone joining a bank board. “I think the downside risks exceed the benefits that the individual
would achieve,” he said.
Regulators defend the new approach, saying board engagement benefits both sides by giving a clearer
view of supervisors’ expectations and the firms’ most pressing regulatory issues. Some directors have
told regulators they welcome the increased interaction with supervisors, with at least one director saying
regulators should be tougher on board members who don’t do their jobs.
Officials say directors are also reaching out on their own and traveling to Washington more frequently to
meet with senior Fed officials.
Still, Fed Gov. Daniel Tarullo acknowledged in a speech last summer that regulators are sometimes
guilty of placing too many requirements on boards and would be better off advising boards to spend
most of their time overseeing risk management systems and controls.
“We should probably be somewhat more selective in creating the regulatory checklist for board
compliance and regular consideration,” he said.
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Sarah Dahlgren, head of bank supervision at the Federal Reserve Bank of New York, said in a speech
last fall that her team had seen progress in the program of “enhanced engagement” with boards and
senior management she launched three years earlier when she took over the division. Boards seem more
comfortable with supervisors, she observed, with directors no longer tending to bring a compliance or
regulatory-relations officer along to meetings, as many did at the start.
“While the level of engagement varies across firms, in general, we are seeing boards being more active
in asking questions, providing oversight of management and engaging with supervisors. We, in turn,
have deeper insight into decision-making dynamics at the board and c-suite level, including the how and
why of decision making on key strategic issues,” she said.
—Ted Mann contributed to this article.
Corrections & Amplifications:
John N. Iannuccillo, a vice president at Dodge & Cox, one of the GE investors, wrote in a letter to the
Fed that the Fed’s proposed director requirement “blurs the lines of accountability that are central to a
strong, effective corporate governance.” An earlier version of this article omitted that he was the source
of the quote.
Write to Victoria McGrane at victoria.mcgrane@wsj.com and Jon Hilsenrath atjon.hilsenrath@wsj.com
22
WALL STREET JOURNAL, MARCH 24, 2015
MEDIA & MARKETING
Vivendi Urged to Bolster Returns to
Investors
Activist fund calls the media group undervalued, faults ‘excessive’ cash
holdings
ENLARGE
Vivendi Chairman Vincent Bolloré has said little about his plans for the future of the media
conglomerate. PHOTO: BLOOMBERG NEWS
By
RUTH BENDER
Updated March 23, 2015 4:34 p.m. ET
0 COMMENTS
PARIS—A U.S. activist fund is raising pressure on Vivendi SA to boost shareholder returns and clarify
its strategy ahead of next month’s annual meeting, highlighting a growing malaise among minority
shareholders over where group Chairman Vincent Bolloré is driving the media conglomerate.
U.S. hedge fund P. Schoenfeld Asset Management on Monday submitted to Vivendi management two
resolutions for the meeting on April 17 demanding Vivendi return a total of €9 billion ($10 billion) in
the form of a special dividend.
“PSAM believes that Vivendi is significantly undervalued due to its excessive cash holdings, inadequate
capital return policy and the uncertainty over Vivendi’s future use of its capital,” the U.S. hedge fund
founded by Peter M. Schoenfeld said in a written statement.
The pressure on Vivendi’s chairman comes as the company stands at a strategic crossroads.
Faced with the challenge of reviving growth, Vivendi has sold off assets that accounted for more than
half of its revenue, including videogames maker Activision Blizzard and telecommunications companies
in France and Morocco. As a result, the once-sprawling conglomerate has slimmed down to two media
businesses: California-based Universal Music Group and French pay-television provider Canal
Plus Group.
MORE

Heard on the Street: Vivendi’s Playlist Is Only on Hold (March 10)
23


Vivendi Awaits Its Chairman’s Next Move (March 8)
Bolloré Group Raises Stake in Vivendi to 8.2% from 5.2% (March 2)
At stake is what Vivendi will do with the roughly €10 billion it will have on its balance sheet after
closing outstanding asset sales and planned returns to shareholders.
“Excess cash on Vivendi’s balance sheet is distorting the potential returns for investors in the company,”
PSAM said. The fund said it submitted a white paper to Vivendi outlining its views on how Vivendi
should use its cash, which it believes should create better value for shareholders. After paying back more
money to shareholders via a special dividend, Vivendi would be left with €5 billion of cash it could use
to expand, the fund said.
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In letters to Vivendi, PSAM has made several requests in recent months, seeking higher returns for
shareholders and explanations on how Vivendi intends to use a multibillion-euro cash pile, according to
people familiar with the matter.
In December, PSAM, which owns less than 1% of Vivendi, also recommended Vivendi sell Universal
Music Group.
Vivendi said Monday it opposes the idea of parting with the music business. “The management board
opposes the dismantling of Vivendi and reaffirms its desire to build a Paris-based global industrial
content and media group,” Vivendi said in a written statement.
Vivendi also said that the majority of shareholders it met with recently had expressed satisfaction with
the company’s strategy.
Mr. Bolloré, who owns 8.2% of Vivendi’s capital and took over as chairman last June, has said little
about his strategic goals beyond pledging to create closer ties between the music and TV units and that
he wants Vivendi to be a French version of German media group Bertelsmann.
Vivendi said in February that it would plow €5.7 billion into dividends and share buybacks by mid-2017
on top of the €1.3 billion paid in 2014. Vivendi said Monday that its planned shareholder returns are
“well balanced.”
24
Some analysts have said they expected returns to be higher after Vivendi agreed to sell its remaining
stake in French telecom group Numericable-SFR last month and as Vivendi management had stated that
acquisitions were possible—although only under “strict financial discipline.”
Many also struggled to understand why Vivendi decided to sell its 20% stake in Numericable-SFR at a
price many believed was too low.
Write to Ruth Bender at Ruth.Bender@wsj.com
25
WALL STREET JOURNAL< MARCH 12, 2015
United Technologies May Spin Off
Sikorsky Helicopter Unit
Sikorsky had $7.5 billion of sales last year
26
ENLARGE
Sikorsky, known for its Black Hawk helicopters, is one of the world’s largest helicopter makers but is United
Technologies’ smallest division. PHOTO: ASSOCIATED PRESS
By
DANA MATTIOLI and
DANA CIMILLUCA
Updated March 11, 2015 9:18 p.m. ET
6 COMMENTS
United Technologies Corp. on Wednesday said it will explore strategic alternatives for its Sikorsky
Aircraft business, including a potential spinoff of the helicopter unit.
The review process should conclude before the end of the year, the industrial conglomerate said in a
news release that followed an earlier report on the move by The Wall Street Journal.
United Technologies will discuss its decision to review alternatives for Sikorsky, which had $7.5 billion
of sales last year, during its annual investor and analyst meeting on Thursday.
Sikorsky, best known for its Black Hawk helicopters, is one of the world’s largest helicopter makers. It
manufactures military and commercial helicopters and is the Pentagon’s largest helicopter supplier by
value. Sikorsky also has an aftermarket business that sells parts and maintenance contracts.
The decision would be the latest shake-up for United Technologies, whose chief executive, Louis
Chênevert, abruptly stepped down in November after board members lost confidence in him.
A number of companies have announced plans to break themselves apart or shed divisions in recent
years, amid a push by some investors for greater focus and accountability on the part of executives.
In addition to its helicopter division, United Technologies makes Otis elevators, Pratt & Whitney jet
engines and Carrier air-conditioning units. The Hartford, Conn., conglomerate has a market value of
$106 billion.
United Technologies CEO Greg Hayes told analysts in December that he was going to re-evaluate the
company’s portfolio, but said he had no plans to sell Sikorsky.
“Everybody wants to sell Sikorsky, but the fact is we’re going to take a hard look at the portfolio, and
we’re going to do what’s right,” Mr. Hayes said at the time.
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Sikorsky, started in 1925 by Igor Sikorsky on New York’s Long Island and later picked up by United
Technologies in an acquisition, is the company’s smallest division by revenue. Last year, it made $219
million in profit after taking a big charge for the renegotiation of a maritime helicopter contract with the
Canadian government.
The unit has come under pressure amid soft military spending and weakness in demand from oil-field
services companies following the steep drop in crude-oil prices. But it has landed several high-profile
new contracts, including the new presidential helicopter program with Lockheed Martin Corp.
In December, Mr. Hayes said he expected 5% growth for the business compounded through the end of
the decade.
J.P. Morgan Chase & Co. is advising United Technologies on the Sikorsky review.
Peter J. Wallison, Hidden in Plain Sight: What Really Caused the World’s Worst Financial
Crisis and Why It Could Happen Again, 2015, Encounter Books.
http://www.wsj.com/articles/book-review-hidden-in-plain-sight-by-peter-j-wallison1424820768?KEYWORDS=mulligan+casey
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
WALL STREET JOURNAL
MARCH 10, 2015
BUSINESS
GM Sets Buyback, Placating Activists
Nation’s largest car maker is latest to feel pressure by hedge funds
critical of management spending
GM Chief Executive Mary Barra agreed to a $5 billion share buyback and spending on dividends amid pressures
from prominent investors, balancing the auto maker’s need to boost spending on new vehicles and maintain its
investment grade rating. PHOTO:BLOOMBERG NEWS
By
VIPAL MONGA and
DAVID BENOIT
Updated March 9, 2015 10:22 p.m. ET
6 COMMENTS
General Motors Co. on Monday became the latest company to return billions of dollars to shareholders
amid tussles with investors over how to better allocate corporate cash.
Facing a potentially contentious fight over a board seat and a larger buyback, the car maker tried to walk
the line between placating big investors and spending more on its future.
GM disclosed a $5 billion stock repurchase, a sum that comes on top of a previously announced
dividend increase, and an additional $9 billion it will spend this year to improve brands including
Cadillac, boost fuel efficiency and develop electric and driverless cars, among other things.
GM’s decision highlights a dilemma facing many companies as activists cement their toehold in
boardrooms: Who is better at determining the appropriate use of cash as corporate balances grow?
Some data suggest activists discourage companies from investing in their businesses, something many
activists would readily admit, citing wasteful spending.
29
ENLARGE
Companies in the S&P 500 targeted by activists between 2003 and 2013 reduced their spending on
plants, equipment and research to 29% of their cash from operations in the five years after activists
bought their shares from a median of 42%, according to an analysis conducted for The Wall Street
Journal by S&P Capital IQ’s Quantamental Research unit.
That compares with the much smaller drop to 25% from 27% for nontargeted companies over the same
period.
Meantime, corporations targeted by activists boosted dividends and stock repurchases to a median of
37% of operating cash flow in the first year after being approached by activists, from 22%. S&P 500
companies that weren’t targeted by activists showed a 10-point increase, to 36%.
“Companies only have a finite amount of cash,” said David Pope, a managing director at S&P Capital
IQ. “If they spend it on shareholder returns, there is less cash to spend on everything else.”
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GM made its buyback decision after top officials determined its $25 billion in cash was more than
enough to fulfill spending plans and handle uncertainties like the federal investigation into a botched
ignition-switch recall. People familiar with the decision said a buyback already was under consideration
and investor talks sped it up.
‘Companies have a finite amount of cash...’
—David Pope, S&P Capital IQ
“We believe an initial $5 billion share buyback is good for our owners because we cannot earn better
returns by investing that cash in the business at this time,” GM finance chief Chuck Stevens said on a
conference call.
Separately, on Tuesday, some large investors and corporate chiefs are gathering in New York to debate
the social and economic impact of rising shareholder pressure.
The nation’s largest auto maker had come under fire from Harry Wilson, a former architect of GM’s
federal bailout, who wanted an $8 billion buyback and had the backing of four hedge funds in his bid to
get a seat on the company’s board.
“Capital allocation is an underappreciated discipline,” Mr. Wilson said in an interview on Monday.
“When activism works well, one of the things it does is try to create a disciplined framework around this
decision.”
GM had said last month that it would discuss more capital returns later this year.
The company was waiting for clarity around any fine the Justice Department might levy as well as other
litigation that may result from a massive recall due to faulty ignition switches, the people said.
Mr. Wilson and the funds have dropped the request for a board seat in light of the buyback and GM’s
pledge to better explain its spending and goals.
GM stock rose 3.1% to $37.66 in 4 p.m. New York Stock Exchange trading on Monday.
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Not all investors were excited. James Potkul, a Parsippany, N.J., investment manager who controls about
10,000 GM shares, said the auto maker should instead marshal its cash to protect against uncertainties.
“Are they worried about a downturn? They should be,” he said. “These companies can burn cash pretty
badly when a downturn comes.”
How and when to use capital will be the topic of debate when the group of prominent investors and
executives calling itself Focusing Capital on the Long Term meets in New York.
As a sign of the issue’s weight, U.S. Treasury Secretary Jacob Lew is expected to discuss how public
policy can support the goals of the group’s members, including chief executives such as BlackRock Inc.
’s Laurence Fink , Unilever PLC’s Paul Polman andBarclays PLC Chairman Sir David Walker.
Elliott Management Corp., a New York-based hedge fund, last year started criticizing networkingequipment manufacturer Juniper Networks Inc. for spending $7 billion on acquisitions and nearly $8
billion in research and development while its stock price greatly underperformed the Nasdaq Composite
Index since the company’s 1999 initial public offering.
Last year, after settling with Elliott to change the board, Juniper cut spending and repurchased $2.3
billion of stock. It plans to buy back almost $2 billion more through 2016.
The company paid its first-ever dividend and borrowed money to fund some of the returns.
“The Juniper share repurchase and cost-cutting efforts are the largest contributor to the stock staying
stable,” said Scott Thompson , an analyst with Wedbush Securities.
At the same time, he warned that continued cuts could eventually hamper Juniper’s ability to keep pace
with innovation in the industry.
Some efforts haven’t garnered the same praise. In early 2012, New York investment firm Clinton Group
Inc. took a stake in teen fashion retailer Wet Seal Inc. and began urging a share buyback. By February
2013, the company disclosed it was cutting jobs and expenses and would repurchase $25 million of
stock after appointing four Clinton representatives to its board.
This January, Wet Seal closed two-thirds of its stores and filed for bankruptcy protection.
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In court documents, executives cited a broader drag on teen retailers as well as missteps that alienated
core customers. People familiar with the bankruptcy say that in hindsight the buyback was a bad
decision.
“If we had rewound and said they hadn’t done the buyback, that would have given them substantially
more flexibility,” said Jeff Van Sinderen, an analyst at B. Riley & Co. “In those situations, $25 million
dollars can go a long way.”
WALL STREET JOURNAL
MARCH 8, 2015
BUSINESS
GM Plans Share Buyback, Averting
Proxy Fight
Investor Harry J. Wilson to drop request to join board in light of
repurchase plan
ENLARGE
Harry J. Wilson has criticized GM’s stock price, cash management and operating
performance. PHOTO: BLOOMBERG NEWS
By
MIKE SPECTOR,
JEFF BENNETT and
JOANN S. LUBLIN
Updated March 8, 2015 11:31 p.m. ET
General Motors Co. as soon as Monday will disclose plans to return billions of dollars to shareholders, a
move that is expected to avoid a potential proxy fight with investor Harry J. Wilson, said people familiar
with the matter.
Mr. Wilson will drop a previous request to join the Detroit auto maker’s board in light of the buyback
plan, the people said. GM plans to repurchase shares over time in an amount less than the $8 billion Mr.
Wilson previously proposed, they said. The size of the buyback and its time frame couldn’t be learned.
Mr. Wilson in February put GM on notice that he intended to nominate himself for a board seat at the
company’s upcoming annual meeting and propose an $8 billion stock buyback. Mr. Wilson has
criticized GM’s stock price, cash management and operating performance.
33
Mr. Wilson and hedge funds backing him have held discussions with GM representatives over the past
several weeks, according to people familiar with the matter, culminating in talks over the weekend that
led both sides to reach a deal that is expected to avoid acrimony, at least in the short term.
GM’s board likely needed to decide soon whether to put Mr. Wilson in its proxy to have ballot materials
ready before the company’s annual meeting, which could take place as soon as June. A rejection, or lack
of some kind of settlement, could have led Mr. Wilson to mount a proxy fight.
Mr. Wilson wants GM to manage its cash better. The auto maker, flush with $25 billion, faces financial
pressures in the months ahead, including a possible hefty fine from the Justice Department over the
company’s failure for more than a decade to recall vehicles equipped with defective ignition switches.
The auto maker has said it plans to weigh returning cash to shareholders as soon as the second half of
this year. The auto maker views its plans as responsive to all shareholders and not solely driven by Mr.
Wilson, said a person familiar with the mater.
Last week, Mr. Wilson beat back criticism over a compensation arrangement with hedge funds that are
backing him related to his possible service on GM’s board. He could receive anywhere from 2% to 4%
of the upside of their GM shares over three years. Mr. Wilson owns about 30,000 GM shares, while the
funds backing him collectively own more than 30 million, or about 2% of the shares outstanding.
Mr. Wilson, among the architects of GM’s 2009 government bailout and bankruptcy restructuring, last
week was criticized by Warren Buffett , who suggested the pay arrangement created a short-term
incentive. “It’s just not the way to run a business,” said Mr. Buffett, whose Berkshire Hathaway Inc. is a
GM shareholder, on CNBC. Mr. Wilson responded that he has held GM stock since 2011 and expects to
for many years, and is willing to lock up any payouts in GM stock “for an extended period of time.”
Such compensation deals have sparked controversy at other companies including Dow Chemical Co.
Many company executives and advisers deride the practice as a “golden leash” that compromises
independence and a director’s duty to serve all shareholders and weigh the long-term.
Activist investors contend such payouts motivate their director selections to shake up boardrooms and
increase value for all shareholders.
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Mr. Wilson ended up on the board of Sotheby’s last year as part of activist investor Daniel Loeb ’s
settlement with the auction house for three board seats. Domenico De Sole, lead independent director at
Sotheby’s, bemoaned the proxy fight. “I thought it was an unfortunate expenditure of money for
someone who turned out to be an exemplary board member,” said Mr. De Sole, a former Gucci chief
executive. He said Mr. Wilson “really knows how to draw the line between governing and managing”
and can work with executives without overstepping boundaries.
Steve Wolosky, a partner at law firm Olshan Frome Wolosky LLP who represents activist investors,
says Mr. Wilson’s compensation is justified and his offer to lock up any payments “clearly evidences his
long-term commitment to improving value at GM.” Mr. Buffett later during the CNBC interview said:
“If Harry has a ton of stock himself that he’s going to put away for a long period of time, that’s one
thing.”
Still, some management lawyers find Mr. Wilson’s deal problematic.
“I don’t care how long he locks up the payouts,” said Avrohom J. Kess, a partner at Simpson Thacher
Bartlett LLP. He said Mr. Wilson instead should defer any payments unless GM’s stock is up a decade
from now. “That’s putting your money where your mouth is.”
The pay agreements are sometimes fraught but have improved over the years, said Robert Jackson, a
Columbia University Law School professor. The debate over Mr. Wilson’s arrangement “is a bit of a red
herring,” he said, adding that three-year compensation horizons for directors are “absolutely standard.”
http://www.wsj.com/articles/u-s-regulators-revive-work-onincentive-pay-rules-1424132619?KEYWORDS=mcgrane
U.S. Regulators Revive Work on
Incentive-Pay Rules
Compensation That Rewards Excessive Risk Taking Is a Concern
By
35
VICTORIA MCGRANE And
ANDREW ACKERMAN
Feb. 16, 2015 7:23 p.m. ET
26 COMMENTS
WASHINGTON—U.S. financial regulators are focusing renewed attention on Wall Street pay and are
designing rules to curb compensation packages that could encourage excessive risk taking.
Regulators are considering requiring certain employees within Wall Street firms hand back bonuses for
egregious blunders or fraud as part of incentive compensation rules the 2010 Dodd-Frank law mandated
be written, according to people familiar with the negotiations. Including such a “clawback” provision in
the rules would go beyond what regulators first proposed in 2011 but never finalized.
The clawback requirement, which is being hashed out among six regulatory agencies, would be part of a
broader compensation program in which firms are required to hang onto a significant portion, perhaps as
much as 50%, of an executive’s bonus for a certain length of time. The Dodd-Frank law included
provisions for an incentive-compensation rule to help ensure Wall Street incentive packages are aligned
with a company’s long-term health rather than short-term profits.
Exactly which firms will be covered is still a matter of debate among the agencies involved in the
discussions, but the 2010 law requires regulators to impose incentive-compensation rules on banks,
broker dealers, investment advisers, mortgage giantsFannie Mae and Freddie Mac and “any other
financial institution” deemed necessary. It also remains to be seen what type of behavior—besides
fraud—would trigger a clawback and whether conduct identified by the firm or regulators would
necessitate reclaiming compensation.
Some banks are already voluntarily recouping money from employees who engage in misconduct or
excessive risk. J.P. Morgan Chase & Co. clawed back about two years’ worth of total compensation
from three traders involved in the 2012 “London whale” trading debacle, which cost the firm $6 billion.
Many banks have implemented stricter bonus practices since the 2008 financial crisis, including
deferring more pay and linking more compensation to longer-term performance.
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Shareholder activists say the existing clawbacks some firms have are too weak and that it remains
unclear how often those policies are invoked because banks don’t usually disclose when the tool is used.
The New York City comptroller has been successful in getting banks such as Citigroup Inc. and Wells
36
Fargo & Co. to expand their clawback policies in recent years. But many big banks have resisted the
office’s efforts to have them routinely disclose when and how much compensation they claw back,
according to the comptroller’s office.
“While many banks now have strong clawback policies on paper, absent disclosure, it’s impossible for
investors to know when and how they are being applied,” New York City Comptroller Scott M. Stringer
said in an email statement.
Related Video
U.S. financial regulators are focusing renewed attention on Wall Street pay and are designing rules to curb
compensation packages that could encourage excessive risk taking. Victoria McGrane joins MoneyBeat. Photo:
Getty
American Bankers Association CEO Frank Keating discusses proposals to reign in Wall Street risk and bonus
pay, as well as the debate over additional funding to enforce Dodd-Frank regulations. Photo: AP.
Work on the incentive-compensation proposal has renewed after more than three years of dormancy, but
the details are far from settled. At the end of last year, informal discussions among staff from the various
agencies prompted the three major bank regulators—the Federal Reserve, Office of the Comptroller of
the Currency and Federal Deposit Insurance Corp.—to send a conceptual proposal to the Securities and
Exchange Commission, according to people familiar with the discussions. The document sparked
several areas of debate, including how long the deferral period should be and how to treat asset
managers under the rule.
Fed governor Jerome Powell in a Jan. 20 speech said regulators plan to reissue a revised draft proposal
for public comment, though he didn’t give a specific timeline.
He hinted at the contours of banking regulators’ proposal, saying regulators are aiming at “deferral of
larger amounts of compensation over a longer period for people who are senior in these companies or
important risk takers” and for that compensation to come “in particular form…with particular triggers
for forfeiture and clawback.”
He said forfeiture should happen when “there appears to have been risk-management errors
or…malfeasance.”
37
As for clawbacks—or plans that require employees return compensation already paid if losses occur
later—Mr. Powell said “that’s fairly extreme, but there should be the possibility for that.”
Big Wall Street banks have instituted their own changes to their bonus pay practices since the financial
crisis, with the encouragement of regulators and shareholders. Many banks moved to defer more of
employees’ bonus payments over several years and give more of those bonuses in stock as opposed to
cash compared with the years preceding the 2008 crisis, consultants say. Goldman Sachs Group Inc. in
January disclosed it would subject part of top executives’ bonuses paid in restricted shares “to
performance conditions” going forward.
The banks “went way further than anybody else in financial services and that became a competitive
disadvantage to get people [and] keep people,” said Alan Johnson, managing director of Johnson
Associates.
Yet some banks have already begun reversing some of those moves in the face of rising competition for
talent from hedge funds and asset-management firms, paying more cash and delaying a smaller portion
of bonus payments, consultants say. Late last year,Morgan Stanley announced it would defer for several
years about half of employee bonuses, down from an average of about 80% at its peak a few years ago.
A 2014 analysis by Johnson Associates estimated about 36% of a $1 million bonus on Wall Street is
deferred, compared with 45% in 2010.
In October, President Barack Obama gathered the heads of the top U.S. financial regulators for a White
House meeting and urged them to finish the outstanding compensation rules required by the 2010 DoddFrank law, a White House spokesman said at the time. Top Fed officials including New York Fed
President William Dudley have stressed that changing compensation practices can help address ethical
lapses on Wall Street.
Work on the rule had stalled after an initial proposal in March 2011 sought to have the largest financial
firms—those with $50 billion or more in assets—hang on to at least half of the bonuses paid to top
executives for at least three years. Smaller firms with at least $1 billion in assets would be subject to less
prescriptive rules but would have to get the signoff from regulators.
The Fed, OCC and FDIC circulated their draft proposal at the end of last year in a bid to move
negotiations forward with the SEC by securing their agreement on the concepts or soliciting changes,
38
one person close to the discussion said. It follows a pattern that regulators followed to restart work on
the high-profile Volcker rule in 2012. It is unclear if the document was shared with the other two
agencies tasked with writing the rule, the National Credit Union Administration and the Federal Housing
Finance Agency.
One flash point in the current talks is how long firms should defer compensation for executives,
according to people familiar with the discussions. It is still early and officials haven’t landed on a
specific period yet, a person familiar with the matter said. The debate over the rule is said to at least
partly mirror the 2011 proposal, when Republican members of the SEC objected to any mandatorydeferral requirement, saying the agency was poorly equipped to dictate the specifics of how individuals
must be paid at companies.
Another wrinkle, according to a person familiar with the discussions, is how to apply the rule to
financial institutions that have different methods for compensating executives than a traditional bank.
For instance, regulators are still debating how to defer the compensation—and potentially claw some of
it back—from an asset manager, who is primarily compensated with “carried interest” as opposed to a
salary and year-end bonus, the person said. Carried interest is a share of a partnership’s profits. Still, the
rule has the potential of capturing hedge funds, private-equity firms and investment advisers that haven't
been covered by prior efforts to regulate executive compensation.
Also up in the air is whether the rule would apply to fraud or excessive risk taking that occurred before
the regulation was in place.
The ECONOMIST
Activist funds
An investor calls
Sometimes ill mannered, speculative and wrong, activists are rampant. They will change American capitalism
for the better
39
Feb 7th 2015 | From the print edition
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

IMAGINE that you are an American CEO. You have just spent your week dealing with the damned
regulators, the latest BS on social media, the lawyers and their ever more brain-aching rules about what you
can say and to whom, a president in Washington who urges you take a patriotic rather than merely lawabiding stance to paying taxes and campaigners who think it is your corporation’s obligation to reduce social
inequality. You finally get a moment to do the job you are remarkably well paid for—running a global firm in
the pursuit of long-term profit—when the phone rings. It’s a banker on the line.
“Hello? We’re hearing rumours that an activist hedge fund has bought 4.9% of your shares.” Activists are
not, in this instance, tree-huggers who dislike what your company is doing to the atmosphere. They are
hedge funds that seek to shake up your company’s management. It is like a ruler hearing rumours of a coup.
It is the call that every CEO in America dreads getting—or has already received.
In the 1980s activists were called corporate raiders and were the jackals of capitalism, outcasts that
attacked and dismembered weak companies to widespread opprobrium but consoling profit. They were
immortalised in the film Wall Street, whose charismatic criminal, Gordon Gekko, showed his mettle by
treating greed as good and lunch as for wimps. They faded from prominence after a series of scandals and
the collapse of the junk-bond market in the late 1980s.
40
Today activism is mainstream and arguably the biggest preoccupation of America’s boardrooms. The
current activist crop are not the red-in-tooth-and-braces raiders of the 1980s; but they are determined to
shake up the companies in which they invest, shaking that very often leads to change in the corner office.
Since 2011 activists have helped depose the CEOs of Procter & Gamble and Microsoft, and fought for the
break up of Motorola, eBay and Yahoo—which on January 27th said it would spin off its stake in Alibaba, a
Chinese internet firm, after pressure from Starboard Value, an activist. They have won board seats at
PepsiCo, orchestrated a huge round of consolidation across the pharmaceutical industry, and taken on Dow
Chemicals and DuPont.
Neither age, status nor systemic importance offers any protection. Activists have removed the management
of the oldest firm on the New York Stock Exchange, Sotheby’s. They have won a board seat on Bank of
New York Mellon, a too-big-to-fail bank at the heart of the global financial system. And they have attacked
the world’s most valuable company, Apple. The chairman of one of Silicon Valley’s biggest firms admits,
“We think about an attack all the time.” A CEO with a superb record of running a giant industrial firm says
that a slip up would make him vulnerable. Inside activists’ offices you can have breezy chats about
dismantling pillars of the establishment like Ford and Citigroup.
Since the end of 2009, 15% of the members of the S&P 500 index of America’s biggest firms have faced an
activist campaign, according to FactSet, a research firm, and estimates by The Economist—a “campaign”,
here, being an effort to change a firm’s strategy, acquire board seats or remove managers. As activists often
buy stakes in firms without going on to launch such campaigns that underestimates the number of scary
phone calls the CEOs must take. The Economist estimates that about 50% of S&P 500 firms have had an
activist on their share register over the same period. The only proven defence that a firm can offer is to not
be American in the first place; 80% of activist interventions are in America, where the culture and legal
system are better suited to shareholder revolts than those in Europe or Asia.
For some all this is the doctrine of shareholder value taken to an absurd extreme—“they are having a
serious impact on the economy and are an aggressive deterrent to investment, research and development
and employee training,” says Martin Lipton, a lawyer who advises many firms that come under attack. For
others activism is a breath of fresh air in the stuffy, complacent world of the big American corporation.
Money never sleeps
Back in the office of the CEO under attack a well oiled defence machine is slipping into action. Many big
firms practise “emergency drills” for this moment. The CEO will summon a war cabinet and the room will fill
with lawyers, bankers, experts in investor relations and spin-doctors to deal with the media. The first
casualty of an activist conflict is the CEO who underestimates his opponents.
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Activists are a small sliver of the hedge-fund world. Hedge Fund Research (HFR), a research firm, says that
of about 8,000 hedge funds activists number just 71—less than 1%. But they are larger than most; at $120
billion under management the activists account for about 4% of the hedge-fund total (see chart 1). Their
clients now include many of the world’s big endowments, family offices and sovereign-wealth funds. And
their assets have risen by a factor of five over the past decade. In 2014 they raised $14 billion of new
money, a fifth of all flows into hedge funds.
42
A dossier prepared by an investment bank will help the CEO and his consiglieri understand who they are
dealing with. The big funds (see table) are differentiated by their vintage, staying power and propensity to
campaign, and by their belligerence once the game is afoot.
43
44
The old guard includes Carl Icahn, an outrageous and outrageously successful septuagenarian, who has
been on the warpath since the 1980s. Nelson Peltz has similarly deep roots, but rather more gravitas. Over
the years he has attacked Cadbury, Pepsi and Kraft.
The new establishment includes ValueAct, Third Point and Elliott Advisors, all of which earned their spurs in
the 2000s. Its most prominent figure is William Ackman of Pershing Square, who says Warren Buffett is his
inspiration. Mr Ackman has had some disasters, including J.C. Penny, a department store he tried to
resuscitate, but also some triumphs, including Allergan, a pharmaceutical firm that was taken over last year.
The industry’s young guns include Sachem Head and Corvex, set up by protégés of the old guard.
The established funds lock in their clients’ money for one to two years, more than the typical hedge-fund
lock-in of a few months. Last year Mr Ackman launched a $3 billion vehicle listed in Amsterdam with an
indefinite life.
In theory this allows activists to take a medium-term view. In practice most trade in and out of firms often—
the typical position is held for less than a year, according to JP Morgan Chase. But big bets are made for
longer. In firms where it has board seats ValueAct holds its positions for two to four years, according to
Jeffrey Ubben, its boss.
Activists’ propensity to campaign varies. Southeastern, based in Memphis, says it invests in about 20 firms
at any given time but only intervenes in firm’s management occasionally. Starboard Value runs a portfolio of
20 stocks, too, but thinks that it can help each firm it owns to improve.
The last differentiating factor is belligerence. Mr Icahn is famous for public insults, and in his young-punk
days Dan Loeb of Third Point wrote strikingly acerbic letters, though he says he has mellowed. ValueAct is
known for its quiet diplomacy—at Microsoft it argued for change behind the scenes, helping to ease Steve
Ballmer out of the top job in favour of Satya Nadella in 2014. But it does occasionally bare its teeth—on
January 5th it publicly criticised MSCI, a firm which runs financial indices. By January 30th MSCI had caved
in to its demands.
Whether they favour a knockout punch, a hug or torture-by-PowerPoint, activists are persistent: if they
commit themselves to a full-blown campaign they usually get at least some of what they want. The CEO’s
first tactic is thus to try to persuade them that he is already working behind the scenes to meet their
concerns in the hope they will relent. Even if they agree with the activists, most CEOs would prefer to reform
their companies on their own. At this stage the odds of an all-out campaign are probably about 50%.
Impossible relationships
Within a month the activist and the CEO will meet. If the CEO is confident he may agree to a casual dinner.
If he is weak he will come phalanxed by lawyers and some of the firm’s directors. If it comes to war, both
sides need to be able to claim they talked, so there will be a veneer of courtesy. But privately the CEO will
45
be wondering how on earth the activist has so much clout. After all, such people typically own only 5% of the
equity in firms in which they invest. In total, activists’ assets amount to only 1% of the value of the S&P 500
index of top firms.
Activists wield disproportionate power because the ownership of big firms in America has polarised. On one
side is the lazy money. About 20% of the typical firm is owned by index managers such BlackRock and
Vanguard, which mimic the market and charge low fees. Followers of the market rather than its trendsetters,
they have not in the past felt much need to worry about how the firms they invest in are run. Alongside them
are the managers of mutual funds and pension funds, such as Capital Group and Fidelity. They actively pick
stocks and talk to bosses but their business is running diversified portfolios and they would rather sell their
shares in a struggling firm than face the hassle of fixing it.
At the other end of the spectrum is the bossy money. Berkshire Hathaway, the $350 billion fund run by
Warren Buffett, buys entire firms and runs them for ever. Private-equity funds also buy whole firms,
replacing managers and setting strategy.
Activists provide a way for lazy money to outsource the messy task of fixing subpar firms. It is a task which,
because they do not pay takeover premiums or rely heavily on debt, activists can do more efficiently than
private equity.
46
Because their fees are charged over a smaller pool of capital, the absolute sum the activists skim off is
small. And their performance is pretty good, at least before fees. The typical activist position has
outperformed the S&P 500 (see chart 2). After fees the picture is murkier. The HFR index of activists has
risen by 89% since the end of 2008, after fees. That is worse that the S&P (159%) but better than most
hedge funds (50%) and demonstrably good enough to convince many investors seeking to diversify their
holdings to give activists more cash.
The essence of the evolutionary spirit
A week after meeting the CEO the activist sends a letter and 300-page presentation to the board. Once the
directors have waded through the numbers and snarky asides about the corporate jet, it boils down to three
47
demands: a buy-back, the spin-off of a non-core subsidiary and the search for a merger partner. Just over
half of the demands made by activists in 2014 fell into these categories, according to FactSet.
The typical CEO will feel defensive, and his board of directors will dither. Perhaps the activists’ suggestions
were examined several years ago and rejected by clever folk at McKinsey & Co, a consultancy, and by the
helpful banker who made that initial warning call. An old-timer on the board may suggest playing dirty, by
putting in place a poison pill—a cap on the number of votes any individual shareholder can have—or
“staggering” the board so that only a few directors can be ousted each year. But such defences are more
likely to provoke than to deter, and these days boards avoid them. Instead the board will often string the
activist along, hinting it agrees with him while doing nothing. Big mistake, as Julia Roberts, consort of
another 1980s corporate raider in Pretty Woman, memorably remarked.
At this point the diddled-around activist may go public, raising its stake to over 5% (which triggers a
regulatory disclosure), putting its documents online with a video and campaigning for shareholders’ votes
like a politician in a primary. The media go wild, especially about the corporate jet.
The typical CEO launches a roadshow of his own to elicit his big shareholders’ solidarity. But he may well
find that up to a fifth of the firm’s shares have changed hands and now lie with “event-driven” traders who
make very short-term speculative bets on events like takeovers and deals. They gamble that the activist will
succeed and that the shares will jump.
When he enters the Los Angeles offices of his biggest shareholder—call it Capital—the typical CEO
discovers the people there have already met the activist and have bought in to spinning off the subsidiary.
The final straw comes when the CEO visits ISS and Glass, Lewis & Co, two proxy-advisory firms. They have
a duopoly on guiding passive index funds how to vote in “proxy contests”—campaigns to win shareholders’
vote at companies’ annual meetings. Most CEOs have never met the proxy firms before; the activist funds
have spent years building up relationships and know how to present their ideas in a way that fits with these
firms’ thinking.
After a month’s campaigning the CEO knows he faces a good chance of losing the vote. In 2014 73% of socalled proxy votes were won by dissidents, according to FactSet (see chart 3). Now it is the CEO’s turn to
pick up the phone and call the activist.
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49
All these quick victories have helped activists bring about short-term outperformance. But what do they do
for investors and companies in the long term? Naturally activists embellish their role. Mr Icahn claims credit
for a big return to shareholders of some of Apple’s $177 billion cash pile and the break-up of eBay, but both
events would have happened anyway. Big firms can have a short-term mentality without any help—IBM has
spent twice as much on buy-backs as on research and development and is shrinking, perhaps as a result.
Activists point out that if they were to propose changes that clearly damaged a firm’s prospects the stock
price would fall. “Unless you have one eye on the long term
—how customers and products are affected—you will not succeed,” says Mr Loeb.
Every economy has rotten firms that need bitter medicine, which is why some bosses admit a grudging
respect for the activists. “It keeps management on their toes,” says a former chairman of one of Mr Peltz’s
conquests. And some activist funds lay good claim to long-term vision. ValueAct backed a turnaround plan
at Adobe, a software maker, that sacrificed short-term earnings and took years to come good, says Mr
Ubben.
A study of activism in 1994-2007 by Lucian Bebchuk of Harvard Law School, and his colleagues, found that
activist interventions lead to a sustained, if modest, improvement in operating performance and better
shareholder returns. Its period of interest precedes the recent growth in activism, but there is reason to
believe that the pattern persists. The Economist has analysed the 50 largest activist positions taken since
2009. In most cases profits, capital investment and R&D have risen (see chart 4). There is little evidence of
Gekko-style “asset stripping”. Even when firms have cut back, it is worth considering that others in the same
sector may have done just the same with no campaign.
50
The biggest threat to activism is not a poor record, but a paucity of prey. Given the size of activist funds and
their pace of intervention, they collectively need to find 100 large target companies over the next three
years. Only 76 firms in the S&P 500 are currently showing persistently poor returns on equity (an average of
below 7% for five years) and only 29 trade at below their liquidation value, which suggests 100 targets may
be hard to find. “I think it’s saturated,” says one of the biggest activists, adding that some of his competitors
may not have cottoned on to this. “You have a lot of people who don’t have experience or a track record.”
One option might be to look abroad, but most big funds think the cultural barriers are too great. European
activist funds such as Cevian and Knight Vinke tread very softly. Asia is a world unto itself. An attempt by
TCI, an activist fund in London, to take on Coal India, a giant state-owned firm, was like a gnat biting at an
elephant. In 2013 Mr Loeb’s efforts to force Sony to restructure proved a damp squib.
51
Wanting the fairy tale
Instead overcrowding may lead activists to attack well-run firms in America. About a third of recent targets
were outperforming the wider market when the activist campaign began, according to JP Morgan Chase. On
January 8th Mr Peltz launched a proxy fight against DuPont, a chemicals group that has performed strongly
and has a widely admired manager. That a firm is doing well does not mean it couldn’t do better, but the
case gets harder to make.
Even if activists start to attack unwisely, though, the outcome for America Inc could still be good, because
the lazy money is being roused from its slumber.
Rather than face a proxy fight the typical CEO cuts a deal—awarding the activist, say, two board seats out
of a total of 12 and promising to consider the spin-off idea. If the activist is one of those prone to theatre he
will boast, inaccurately, of his total victory. The CEO considers resigning. But what if, after six months, the
activist starts to agitate again, calling for a drastic cut in capital investment—not routine, but not unheard of?
At this point, something unexpected happens. The CEO consults the index funds and traditional managers,
with whom he now has a more intimate relationship. This time they support the firm not the activist.
This scenario is more likely than it may seem. Provoked by the activist wave, big passive money managers
are waking up. In 2014 Larry Fink, the head of BlackRock, the world’s biggest asset manager, declared “we
need to work for the long-term interest”. Vanguard, another big passive manager, has said it wants to
intensify its contact with companies’ boards. Most big companies are also making more effort to talk to index
funds directly, says Abe Friedman, of Camberview, a consulting firm. Once viewed by companies as dumb
bystanders, passive funds may come to be seen in a new light. Since they own stocks indefinitely they
should have a longer-term perspective than almost anyone else.
52
Meanwhile mutual- and pension-fund managers are being forced to engage in more intense debates about
strategy with managers and activists. Since their support is vital for any activist campaign, they are enablers
but also potential restraints. “Activism is about floating balloons,” says Mr Ackman. “If the ideas are good,
they will happen. If they are bad, they won’t get support. It is hard for activism to be harmful.”
Natural selection will ensure that activists who make foolish suggestions fade away over time, says the head
of a big equity-fund manager of the old school. He says his firm is becoming more involved in companies
than in the past. Mr Ubben of ValueAct, says he has a “symbiotic” relationship with such managers.
Over the long run activism will evolve in one of two ways—both of them positive. It could mature to become
a complement to the investment-management industry—a specialist group of funds that intervene in the
small number of firms that do not live up to their potential, with the co-operation of other shareholders.
Alternatively it could overreach—and in so doing force index funds and money managers into taking a closer
interest in the firms they own. If that is the way things go, activists could eventually become redundant.
Until, that is, stockholders return to lazy ways and managers feel they have nothing to worry about. Then it
will be time once again for the phone call of fear.
From the print edition: Briefing
53
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BUSINESS
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Starboard Seeking Special Meeting of Darden Shareholders
Barington Says it Would "Strongly Support" the Starboard Proposal
By
DAVID BENOIT
Updated Feb. 24, 2014 1:18 p.m. ET
A Red Lobster eatery in New York in 2012. Darden Restaurants wants to spin off the seafood chain. Bloomberg
The activist hedge fund fighting Darden Restaurants Inc. over its plan to spin off Red Lobster is
trying a new tactic: a shareholder vote that could halt the plan.
Starboard Value LP is launching a plan that would have shareholders vote on a resolution telling
the restaurant operator to halt any plans to shed the seafood chain unless they get to vote directly
on the decision, according to a letter Starboard sent to shareholders that was reviewed by The
Wall Street Journal.
Given the timing of Darden's annual meeting, where such a vote would typically be held, Starboard
decided to call for the special meeting in what's known as a consent solicitation, the letter said.
Starboard, which owns a 5.5% stake, must win the support of more than 50% of the shareholders
in the next 60 days to hold the special meeting.
If the special meeting happens, Starboard would ask shareholders to vote on a nonbinding
proposal urging Darden not to approve any Red Lobster plan without a shareholder vote, the letter
said. Starboard has been pushing the restaurant operator to spin off more than just the Red
Lobster chain.
56
Darden said in a statement Monday that it is focused on creating value.
"We are confident in the actions we are taking to deliver on this responsibility, including our
previously announced initiatives," the company said.
Consent solicitations have been used by activist investors in recent years to attempt to replace
board members and push corporate change, but activists rarely seek to stop a company from
acting on specific plans.
Darden, which announced the plan to separate Red Lobster in December, has previously said the
move doesn't require a shareholder vote. In the face of pressure from Starboard and from
Barington Capital Group LP to break up more of the company, Darden has stood by the plan as in
the best interests of shareholders. It argues Red Lobster is different from its other brands. Darden
has said it expects to complete the spinoff early in its fiscal year, which begins on May 26.
Barington, which heads a group the controls about 2% of Darden, said in a statement it would
"strongly support" the Starboard proposal.
"We therefore hope these efforts will lead the Darden board to more thoughtfully evaluate all
alternatives, including those that we have recommended, to improve long-term shareholder value,"
said Barington Chairman and CEO James A. Mitarotonda.
Starboard has said it believes the Red Lobster plan would hurt Darden. It is instead pushing for the
company to separate Red Lobster, Olive Garden and LongHorn Steakhouse into one company and
also to put Darden's real estate holdings into a separate publicly traded real-estate investment
trust.
Earlier this month, Starboard said in a letter it was concerned that Darden would complete the Red
Lobster separation before the annual meeting, which wouldn't allow shareholders a chance to
change the board to stop the plan. Starboard said it was considering running a campaign to
change the board.
"We ask that you and the Board take a step back, listen to your shareholders, and do what is right,"
Starboard wrote in the letter earlier this month.
Last week, Starboard also announced it had signed former Olive Garden President Bradley D.
Blum as an adviser.
Write to David Benoit at david.benoit@wsj.com
Copyright 2013 Dow Jones & Company, Inc. All Rights Reserved
This copy is for your personal, non-commercial use only. Distribution and use of this material are governed by our Subscriber Agreement and by
copyright law. For non-personal use or to order multiple copies, please contact Dow Jones Reprints at 1-800-843-0008 or visit
57
Buttonwood ECONOMIST.com
Against the odds
The costs of actively managed funds are higher than most investors realise
Feb 22nd 2014 | From the print edition


EVERYONE knows that if you go to a casino, the odds are rigged in favour of the house. But people still
dream of making a killing. The same psychology seems to apply to fund management, where investors flock
to high-cost mutual funds even though the odds are against them. Russel Kinnel, the director of fund
research at Morningstar, has described fund costs as “the most dependable predictor of performance”.
It is really a simple matter of maths. A stockmarket index reflects the performance of the average investor,
before costs. Given that the costs of active fund-management are higher than those of tracker funds, the
average active investor must underperform his passive counterpart. But many do not realise just how
substantial the costs can be. In an article* in the latest Financial Analysts Journal (FAJ), Jack Bogle of
Vanguard, a fund-management group that specialises in index-tracking, goes through the sums. The annual
gap between the expense ratio cited by the average large-stock mutual fund and Vanguard’s index fund is
1.06 percentage points. That comes mostly in the form of investment-management fees.
But these costs are only the beginning. Active fund managers also trade more than index funds. One study
put these trading costs at 1.44 points a year; Mr Bogle uses a more conservative estimate of half a point. A
further factor is the drag of holding cash. Index funds are usually fully invested; active managers hold about
5% of assets as cash so they can seize opportunities to buy their favoured stocks. Since equities tend to
beat cash over the long run, this reduces returns still further; Mr Bogle estimates by about 0.15 points a
year.
58
Then there are the sales costs paid by investors in American mutual funds. Happily, so-called front-end load
funds, which could take up to 8% of an investor’s capital at the start, are less common than they once were.
But most investors still buy funds through some kind of adviser or broker, for a charge or a fee; Mr Bogle
estimates this cost at 0.5 points a year.
Yet another cost arises from the tax treatment of American mutual funds: every year, funds distribute to
investors the capital gains they make within the portfolio. Investors must then pay tax on the proceeds.
Because active funds trade more than index funds, investors in active funds face a higher tax bill.
Add all these costs together and the net return to investors may be reduced by 2.66 points a year, a huge
differential considering that long-term real returns from American equities have been 6.45%.
Some will argue that Mr Bogle’s numbers are exaggerated. Not all passive funds successfully track the
index; some have substantially higher fees than the example he used; some investors buy passive funds
with the help of brokers or advisers and incur sales charges or extra fees. Costs are not everything; asset
allocation is also important. And some active managers do outperform the indices over the long term.
However, such arguments do not make much of a dent in Mr Bogle’s case. Without the benefit of a Tardis,
we cannot know the best asset allocation in advance; the costs are pretty certain. There is little evidence
that outperforming managers can be identified in advance. Worse still, the search for the best managers
leads clients to buy hot funds at the top of a bull market; this further reduces their returns as they buy high
and sell low. Morningstar estimated that the average large-stock fund earned 4.5% a year in the 15 years to
June 30th, 2013, but the average investor earned just 2.59%.
Annual numbers are one thing but the real damage for the long-term saver is cumulative. A journalist at
the Financial Times was recently sent a statement that showed, on conservative assumptions, that if he
kept saving for another 22 years, his pension pot would be worth less in real terms than it is now: the
charges would more than eat up the returns.
In a previous FAJ article**, Bill Sharpe, a Nobel laureate for economics, calculated that someone who saved
via a low-cost fund would have a standard of living in retirement 20% higher than someone who saved in a
high-cost fund. That calculation was made using the impact of investment-management fees alone. If Mr
Bogle is even close to right, the hit to retirement incomes is substantially greater. Yet hope springs eternal.
Just as the slot-machine addict believes the next spin of the reels will bring the jackpot, savers still insist on
trying to beat the odds.
* “The Arithmetic of ‘All-In’ Investment Expenses”,
** “The Arithmetic of Investment Expenses”,
Financial Analysts Journal, Volume 70, Number 1
Financial Analysts Journal, Volume 69, Number 2
59
Corporate governance ECONOMIST.com
Anything you can do, Icahn do better
The pressure on companies from activist shareholders continues to grow
Feb 15th 2014 | NEW YORK | From the print edition
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TIM COOK’S nightmare is over, but John Donahoe’s has just begun. On February 10th Carl Icahn, the
godfather of activist shareholders, ended his campaign to get Mr Cook, the boss of Apple, to return some of
its $160 billion cash mountain to shareholders through share buy-backs. Mr Icahn declared victory, although
Apple is not handing back as much of its cash as he had wanted. His next target is eBay, which he is
pressuring to spin off PayPal, its online-payments business. Mr Donahoe, eBay’s boss, has told Mr Icahn to
get lost, but surely knows he cannot brush off the pugilistic investor so easily.
A visit from an activist shareholder is now a possibility for any publicly traded company: if not the 77-year-old
Mr Icahn, then one of the growing army of younger imitators he has inspired. Mr Cook was first put under
pressure to “stop hoarding cash” last year by David Einhorn, boss of Greenlight Capital, a hedge fund.
Having shaken up Yahoo’s management and strategy in 2012, Dan Loeb and his fund, Third Point, have
turned their attention to Sony, calling for it to separate its electronics and entertainment arms; to Sotheby’s,
an auction house they want to repurchase shares; and to Dow Chemical, which they want to shed its
petrochemicals business.
Nelson Peltz, who has been a shareholder activist almost as long as Mr Icahn, last month joined the board
of Mondelez, a snacks business he had targeted. TCI, a London-based fund run by Chris Hohn, has
rediscovered its activist mojo after having been badly hurt by the financial crisis. Last year it urged EADS
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(now Airbus Group) to sell its military-planes business, and took on the management of Japan Tobacco.
Steve Ballmer was helped on his way out of Microsoft’s top job by ValueAct Capital, run by Mason Morfit.
Last month Bill Ackman’s Pershing Square made a tasty profit when Suntory acquired Beam (the maker of
Jim Beam bourbon), which had been spun out of Fortune Brands as a result of his activism. But Mr Ackman
has also demonstrated that activists have no monopoly on wisdom: Ron Johnson, the new boss he lobbied
for J.C. Penney to install in 2011, made things worse at the struggling retailer, and lasted just 17 months. Mr
Ackman has been at loggerheads with Messrs Icahn and Loeb over Herbalife, a nutritional-supplements
business. Mr Ackman has shorted its shares, calling the firm a “pyramid scheme” (a charge Herbalife
denies). His rivals have gone long on them. So far, Mr Ackman is out of pocket.
The activists’ growing influence has many causes, including rule changes that have given shareholders
more voting power and have made institutional investors cast their votes more thoughtfully. Social media
have made it easier for activists to mount a campaign: Mr Icahn now tweets like a budgie on speed. And,
says Bob Monks, a campaigner for shareholder rights, Mr Icahn has had a huge impact by “making it clear
to the greediest people in the world that you can make a lot of money out of activism”.
It is the way these profits are made that is the focus of the activists’ critics. Activists usually buy a block of
shares, make a public call for change and lobby management and other shareholders to implement it. When
they do, the activists sell at a profit. Martin Lipton, a lawyer who has long helped protect incumbent
management, not least by inventing the “poison pill”, a potent defence against takeovers, argues that
activists encourage firms to do things that boost their share price in the short run but harm their long-term
performance. This critique has plenty of adherents, in academia, business and government.
Where’s the evidence?
Yet empirical proof that activists exacerbate short-termism is strangely elusive. Indeed, such evidence as
there is suggests the opposite. “The Long-Term Effects of Hedge-Fund Activism”, a recent paper by Lucian
Bebchuk of Harvard Law School and others, examined the roughly 2,000 interventions at companies by
activist funds from 1994 to 2007. Over the five years following an intervention both the share price and the
operating performance of the target company improved, on average. The operating performance got
stronger towards the end of the five-year period, not weaker.
This is the sort of evidence that has convinced Mary Jo White, the chairman of America’s Securities and
Exchange Commission, to argue in a recent speech that activist shareholders should no longer be
automatically viewed negatively. These days, she said, “There is widespread acceptance of many of the
policy changes that so-called ‘activists’ are seeking to effect.”
A recent article in the Columbia Law Review, “The Agency Costs of Agency Capitalism: Activist Investors
and the Revaluation of Governance Rights”, argues that the activists have become a vital adjunct to the
institutional investors who own most shares, and who are “willing to respond to governance proposals but
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not to propose them”. Activists have thus become “governance intermediaries”, who find underperforming
firms and offer their managers and institutional shareholders “concrete proposals for business strategy
through mechanisms less drastic than takeovers”.
So it is crucial, the authors argue, to pass reforms that help the activists do their job. Mr Lipton and others
are pressing for a rule change that would have the opposite effect, by obliging activists to disclose stakes at
a lower threshold (2% of a firm’s shares rather than the current 5%) and more quickly (within a day rather
than the current ten). That would force them to show their hand before they had built a big enough stake to
make a decent profit if and when their proposals succeeded.
Boards have an obvious motive to back curbs on troublesome activists. But a better strategy—and one that
big firms are increasingly adopting—is to talk to them, consider their ideas and even invite them or their
representatives to become directors, as firms from Microsoft to Mondelez have done. If a board’s strategy is
in fact better than that proposed by the activist, having the debate in public may strengthen the incumbent
management, as happened when activists took on firms such as AOL, Target and Clorox.
Indra Nooyi, the boss of PepsiCo, chose to work with Ralph Whitworth, a veteran activist who took a stake in
the company. By doing so she was able to head off calls for a break-up of the firm (led by Mr Peltz), while
still boosting its shares, thereby restoring her authority. Mr Donohoe’s encounter with Mr Icahn may prove
less nightmarish if he treats his ideas about eBay on their merits rather than dismissing them out of hand.
From the print edition: Business
http://www.economist.com/news/business/21596556-pressure-companies-activist-shareholderscontinues-grow-anything-you-can-do
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WALL STREET JOURNAL
Icahn Targets Silicon Valley Directors' Club
Activist Investor Accuses eBay Directors of Conflicts for Holding Seats at High-Tech Rivals
Updated Feb. 24, 2014 7:34 p.m. ET
Carl Icahn accused eBay of lapses in corporate governance, including conflicts of interest, and has renewed his fight to split off Paypal. David Benoit reports on
MoneyBeat. Photo: AP.
Activist investor Carl Icahn stepped up his attack on eBay Inc. EBAY +1.29% on Monday, accusing the
online retailer of overlooking conflicts of interest on its board in what amounts to a broadside against a
common practice in Silicon Valley.
Mr. Icahn said two long-serving directors, venture capitalist Marc Andreessen andIntuit
Inc. INTU +3.90% founder Scott Cook, were conflicted because of other business interests. Mr. Icahn, who
disclosed a 2.2% stake in San Jose, Calif.-based eBay, wants two seats on its board to pursue a spin off of its
PayPal electronic-payments unit.
Mr. Icahn's accusations strike at the heart of Silicon Valley's culture, where venture capitalists spread their
bets and accept board seats at companies that can compete with one another. Mr. Andreessen is a director of
several firms, including Hewlett-Packard Co.HPQ +1.31% and Facebook Inc. FB +2.06%
In particular, Mr. Icahn criticized Mr. Andreessen's involvement in an investor group that bought 70% of
Internet-calling service Skype from eBay for about $2 billion, less than what eBay had paid to acquire it,
derailing a planned initial public offering of the unit. Microsoft Corp. MSFT +1.67% later acquired Skype
from the group that included Mr. Andreessen for $8.5 billion.
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"One cannot help but wonder what happened to Mr. Andreessen's fiduciary responsibility to share his
feelings with [eBay Chief Executive John] Donahoe and the board rather than pre-empt the planned [Skype]
IPO to further his own interests," Mr. Icahn wrote to eBay investors.
In an interview, he added his eBay concerns are bigger than most venture capital issues. "This is a major
public company and the amount [of money involved] is enormous and it's blatant."
Messrs. Andreessen and Cook were unavailable to comment.
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John Donahoe
EBay declined to make Mr. Donahoe available to comment. In a statement, eBay said directors had explored
several options to separate Skype and felt the sale represented the best value for shareholders. Mr.
Andreessen also had recused himself from board conversations about the Skype transaction, it said.
Mr. Icahn questioned Mr. Cook's place on the board of financial software developer Intuit, which competes
with PayPal in payment processing.
"It's certainly appropriate for him to raise these questions," said David Larcker, a Stanford University
Graduate School of Business professor, noting he saw no evidence of malfeasance at eBay. "The valley is an
extremely networked place and no doubt when you bring a venture capitalist on board with a variety of
investments, some of those companies are going to intersect."
Kate Mitchell, a partner at Scale Venture Partners and former chair of the National Venture Capital
Association, said the presence of venture capitalists on many boards is how business is conducted in Silicon
Valley.
"It is expected by our institutional investors that we sit on multiple boards," she said. When potential
conflicts of interest come up, she said the venture capitalist-directors and founders are tuned in to the issue.
"It happens all the time now, and people are very careful."
But Vivek Wadhwa, a fellow at Stanford University's Arthur and Toni Rembe Rock Center for Corporate
Governance, said venture capitalists like Mr. Andreessen sit on too many boards and put their own interests
apart from those of shareholders.
"I respect and admire Marc Andreessen a lot," Mr. Wadhwa said. He added, "there is a widespread problem
with corporate governance in Silicon Valley.…They don't get it."
Mr. Icahn disclosed an eBay stake last month, saying PayPal is worth more as a stand-alone company.
Monday, he said separating the businesses would foster innovation and help PayPal attract necessary talent.
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Carl Icahn
Mr. Donahoe "seems to be completely asleep or, even worse, either naive or willfully blind to these grave
lapses of accountability," said Mr. Icahn.
EBay has said PayPal's growth would be stifled without the backing of eBay's online marketplace. Monday,
it accused him of "mudslinging."
In a news release, eBay said the investor "cherry-picked old news clips and anecdotes out of context to attack
the integrity" of its top executives, whom it called "impeccably qualified."
"As we are sure our other shareholders would agree, we prefer to engage in more constructive and
substantive discussions of why, in our view, PayPal and eBay are better together," eBay said.
Write to Greg Bensinger at greg.bensinger@wsj.com and David Benoit atdavid.benoit@wsj.com
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Snacks and drinks ECONOMIST
Let my Fritos go
The Pepsi challenge: keep the company in one piece
Mar 1st 2014 | From the print edition
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Preparing them for sale?
COMPARED with most documents bearing a corporate letterhead, Nelson Peltz’s 37-page argument for the
break-up of PepsiCo, published on February 20th, is a good read. The drinks and snacks firm has “lost its
entrepreneurial spirit” and is “shifting to a plodding, ‘big company’ mentality”, it claims. Its managers “may
fundamentally misunderstand the business”. The answer is to spin off PepsiCo’s successful snacks division,
Frito-Lay, from its battered beverages business. Each would recapture its competitive zeal and gain the
freedom to act on it. It is a refreshing change from PepsiCo’s blather about driving choice in the “macrosnack universe”.
Mr Peltz’s fusillade is also a broader claim about how companies with lots of consumer brands should be
structured. Whatever synergies there may be from packaging pretzels and bottling cola under the same
corporate roof are undone by bureaucracy and extra cost. The share prices of focused companies like
Hershey’s (sweets) and L’Oréal (cosmetics), not to mention Coca-Cola, which concentrates on drinks, are a
higher multiple of earnings than those of diversified PepsiCo and Procter & Gamble. Trian Partners, Mr
Peltz’s investment vehicle, used similar arguments to push for the separation of another drinks firm,
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Schweppes (now Dr Pepper Snapple), from Cadbury, a British confectioner, in 2008, and for the 2012 split
between Kraft’s North American and international food businesses.
A few weeks ago it looked like Pepsi’s boss, Indra Nooyi (pictured), had seen off the challenge from Mr
Peltz. But his fresh onslaught will oblige her to work harder to show that the two product lines are “better
together”. Mr Peltz says that since 2006, when Mrs Nooyi took over, PepsiCo has delivered total
shareholder returns of 47%, compared with an average of 103% for shares in the S&P consumer-staples
index.
Not only have Americans been guzzling fewer fizzy drinks in recent years, but Pepsi’s share of those falling
sales has slipped. Coca-Cola’s diet version overtook regular Pepsi as the number two soft drink in 2010.
Pepsi has failed to match Coca-Cola’s prices and was slow responding to Coke’s “Freestyle” soda fountain,
which lets people pick their own flavours. Frito-Lay’s fat American profit margins unhelpfully spare the
beverage businesses from pressure to trim costs, says Ali Dibadj of Sanford C. Bernstein, a research firm. If
it were a separate company it could invest more in fast-growing emerging markets.
All this does not mean that diversification is doomed, or that focus is inherently good. There is no “black and
white” case for separating snacks from drinks, says Richard Webster of Bain & Company, a consulting firm.
The focus championed by Mr Peltz works best in big developed markets, where each category can be
bewilderingly complex (think of shampoos, conditioners and hair dye) but the number of retailers which sell
the stuff is relatively small. In less developed countries, with fragmented retailing, it makes more sense to
have a broad product range and a big sales force. That argues against breaking up global companies, says
Mr Webster.
Doritos with Mountain Dew
Among the blessings of togetherness, Mrs Nooyi claims $800m-1 billion of annual costs saved because of
synergies (though she gives few details) and extra clout with retailers. The clinching argument comes from
the way Pepsi views its market: two-thirds of the time people consume snacks and drinks together. Pepsi
thinks its sales will increasingly come from exploiting such “demand spaces”. One recent promotion aimed at
videogamers paired a “limited edition gamer pack” of Doritos with Mountain Dew “game fuel”.
Mrs Nooyi hired “the best bankers and consultants” to consider the case for breaking up this happy union. In
February she told Mr Peltz that he was wrong. He now promises to create a “groundswell of support” for
divorce among shareholders. Mrs Nooyi must convince them that the snacks and drinks teams, which are
headquartered in separate states, can work together without cramping each other’s style. If she can do that,
she may save the marriage.
From the print edition: Business
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OPINION
WALL STREET JOURNAL
The SEC's Corporate Proxy Rules Need a Rewrite
More than token ownership should be required to get a proposal on the ballot.
By
EDWARD S. KNIGHT
March 26, 2014
Communicating with shareholders is a crucial part of the job for 21st century business leaders, and most of
them understand the value of doing it. The proxy-proposal system is an important, regulated part of this
process for publicly traded companies. It gives investors the option of bringing an issue to a vote by all
shareholders and ensures that the owners have a voice in how their company is managed. But the current
process is outdated, burdensome and costly.
Last year, shareholders submitted more than 800 proxy proposals to public companies. About 30% of the
proposals fielded by Fortune FT.T 0.00% 250 companies were initiated by a small handful of individual
activist investors, according to ProxyMonitor.org, a Manhattan Institute for Policy Research database that
tracks proxy proposals.
To address shareholder proposals, companies listed on U.S. exchanges must follow an established process
that costs tens of millions of dollars annually. Based on our experience at Nasdaq NDAQ -1.14% OMX
talking to corporate secretaries at several hundred of our listed companies, it costs a minimum of $50,000 per
proposal, which includes staff hours, outside counsel, proxy firm outreach, solicitations and outreach to
institutional and retail investors. Companies that exclude even a seemingly irrelevant proposal without
following this process risk lawsuits and enforcement proceedings.
In addition, the Securities and Exchange Commission must direct its limited resources toward determining
whether the proposals are eligible for a shareholder vote. According to data on the SEC website, public
companies submitted more than 330 no-action letters to the SEC in 2013, representing close to half of all
shareholder proxy proposals received by public companies.
Meanwhile, 93% of shareholder proposals that came to a vote at Fortune 250 companies last year failed to
win support from a majority of shareholders. Notably, the small number of proxy proposals that did win
majority support were largely focused on matters of corporate governance, such as board declassification,
according to the Manhattan Institute data.
Clearly, shareholders and companies are spending significant amounts of money to manage the legal process
involving proxy proposals. This cost is one that even shareholders would agree often will not add any longterm value to the company.
The low success rate of shareholder proposals is in part due to the low, nearly nonexistent barriers to their
submission. Since 1998, the SEC's proxy rules have required that a shareholder interested in getting a
proposal into the proxy own just $2,000 of the company's shares for at least one year.
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The spirit of the rules encourages shareholder engagement. We certainly agree that ongoing, transparent
communications with shareholders is a hallmark of good governance. But it is far better to communicate with
shareholders through regular contact rather than the ballot box.
This regular contact is happening in myriad ways that could not have been anticipated when the proxy rules
were written. Publicly traded companies increasingly use online tools such as webcasts, online voting, social
networks and message boards to keep a discussion going with retail and institutional investors, especially
about corporate governance. We at Nasdaq applaud the SEC for clarifying last year when companies could
use inexpensive venues such as Facebook FB -1.61% and other social-networking sites for many shareholder
communications.
Yet, given all this, should a single shareholder with $2,000 in company stock be able to submit a proxy
proposal and divert substantial company resources and ultimately SEC resources to address it? It happens all
the time. Proposals from individual investors accounted for 86% of the proposals excluded from proxy
ballots last year at Fortune 250 companies after an SEC no-action letter, according to the Manhattan Institute.
Does this minimal requirement undercut the very positive intent of the proxy rules? More than a little.
Corporations are not meant to be perfect democracies, but even in democracies we require citizens to gather
a threshold number of signatures to qualify an initiative for a state or municipal ballot. That threshold is
markedly lower for publicly traded companies in the U.S., and the ultimate costs are high for the owners of
those companies. Shareholders of U.K.-registered companies face a more reasonable test: They must be
supported by at least 5% of eligible voting shareholders to submit a proposal, or represent a group of at least
100 shareholders whose collective stake is valued at a minimum of £10,000, or approximately $16,660.
Why not require a minimum level of support for proxy initiatives to get onto a corporate ballot in the U.S.?
For example, the SEC could require any shareholder with at least $2,000 in company stock to demonstrate
wider shareholder support, perhaps 5% or 10%, in an online vote—a virtual petition-signing exercise, if you
will—before the more costly process is triggered to determine whether a proposal should go onto the proxy
ballot.
The time has come for the SEC to consider whether the 1998 proxy proposal rule is serving its purpose for
the vast majority of shareholders. The corporate world has progressed considerably in 16 years, and there are
better, more efficient ways in today's world for shareholders to be heard, and to have their money used
productively.
Mr. Knight is executive vice president, general counsel and chief regulatory officer of Nasdaq OMX Group
Inc. He was general counsel of the U.S. Treasury Department from 1994-99.
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WALL STREET JOURNAL MEDIA & MARKETING
Comcast Stock Drop Complicates TWC Deal
Takeover Value Falls to $144 a Share, Giving Charter a Possible Opening
April 1, 2014 4:48 p.m. ET
The agreement to buy Time Warner Cable was originally valued at $158.82 per share. Reuters
Comcast Corp.'s CMCSA +0.65% deal to buy Time Warner Cable Inc. TWC +0.70%has run into an
unexpected source of turbulence: a weak stock price.
In the nearly seven weeks since the deal was announced, Comcast's share price has dropped nearly 10%,
reducing the value of its all-stock offer for Time Warner Cable to $143.55 a share from $158.82 per share
when it was announced.
Time Warner Cable shares, meanwhile, have followed Comcast's stock down and closed Tuesday at $137.55
apiece, only a few dollars above where TWC stock was trading before the companies announced the deal on
Feb. 13. TWC's stock is trading about 4% lower than the current value of Comcast's offer, in part due to
uncertainty about whether regulators will approve the deal.
A continued decline in Comcast's stock could pose problems for the company when TWC shareholders come
to vote on the deal, which is expected in the summer, investors and analysts say.
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Unlike some all-stock takeover offers, the deal—originally valued at $45.2 billion—doesn't have a "collar"
that would require Comcast to increase the number of shares it is offering for each TWC share if its price
falls below a certain level.
Investors and analysts say the drop may have created an opening for TWC's erstwhile suitor,Charter
Communications Inc., CHTR -1.24% to come back with a new offer.
Charter, which is backed by John Malone'sLiberty Media Corp. LMCA -2.16% , put TWC into play last
spring, making three separate offers over a period of nine months, each rejected as too low by TWC. Its most
recent offer was $132.50 in cash and stock.
Charter still hasn't withdrawn its slate of candidates for election to Time Warner Cable's board at its annual
meeting this spring, a key component of the hostile bid Charter was gearing up to pursue. And last Friday,
Charter formally urged Time Warner Cable's shareholders to reject Comcast's deal, noting that the value of
Comcast's proposed takeover has "declined substantially" and "will continue to be exposed to negative
trading patterns."
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People close to Charter say the company is keeping its options open. Charter stock, which in recent months
traded up whenever a TWC deal looked likely, had declined about 10% since the Comcast deal was
announced although on Tuesday the stock was up 2% while TWC shares were also up slightly. Comcast
shares were down.
Some Time Warner Cable investors said this week that if Charter were to come back with a bid worth more
than the current value of Comcast's offer—and include $100 a share in cash or more—it might have a shot.
"I don't think that Charter could put a price up that could make TWC's board change their position," one
TWC investor said. "But if it came in north of $145, as long as Comcast's stock is as weak as it's been, it
does make it difficult" for Comcast at the shareholder vote.
Craig Moffett, an analyst at MoffettNathanson LLC, said TWC shareholders are more likely "playing for a
sweetener from Comcast rather than for a serious counterbid from Charter."
One TWC investor said Comcast has a strong balance sheet and could easily counter a sweetened Charter
offer if it so desired. Comcast also could improve its offer by inserting a collar. The investor said Charter's
moves to stay in the race for TWC could just be a negotiating ploy as it seeks to buy the three million
subscribers that Comcast has proposed to divest if its TWC deal goes through.
"Charter sent a message Friday," another TWC investor said. "If [Comcast's] stock is where it is today in
June or July"—around the time of the shareholder vote—Comcast could run into "problems."
To be sure, Comcast's stock could rally in coming months. And some degree of a selloff isn't unexpected. At
least some of the stock price fall is due to short selling by hedge funds, which typically engage in speculative
trading around stocks involved in takeovers. But the size of the selloff so far has caught people on Wall
Street by surprise, according to Vijay Jayant, analyst at ISI Group LLC, and comes at a time when the share
prices of many acquirers are rising.
On Monday, Comcast confirmed a Bloomberg report that the company plans to increase its share-buyback
program if shareholders vote for the deal—a move investors and analysts said was aimed at boosting
Comcast's stock price.
Comcast said it views its accelerated buyback program as a way to give cash back to shareholders even
though cash isn't part of the TWC deal.
While long-term investors could step in to buy Comcast shares in this situation, those investors are holding
back from doing so right now due to uncertainty about Comcast's ability to get regulatory approval for the
deal, analysts said. Comcast has said it expects the regulatory review to take up to a full year.
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—Dana Cimilluca
contributed to this article.
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BUSINESS
Sears CEO Slices Off Assets, Leaves Less for Bondholders
Spinoff of Lands' End Is Latest Move in a Pattern That Could Affect Bondholders
April 6, 2014 7:25 p.m. ET
Sears's core business of Sears (shown) and Kmart generates losses. Associated Press
Chief Executive Edward Lampert is carving out some of the best pieces of Sears Holdings Corp. SHLD 2.91% for its shareholders, moves that could leave bondholders at risk if its remaining businesses continue to
deteriorate.
The latest step in that pattern was Sears's spinoff of Lands' End, one of the crumbling holding company's few
bright spots. Shares in the preppy clothing maker were distributed to existing Sears shareholders on Friday.
Lands' End had net income of $79 million in the most recent year, compared with a loss of $1.4 billion for
Sears Holdings.
All told, in the past 27 months Mr. Lampert, whose hedge fund owns nearly half of Sears's stock, has
distributed to shareholders—through various means—assets and divisions valued at roughly $2.3 billion.
They include Sears Hometown & Outlet StoresInc. SHOS -0.21% and a stake in Sears Canada Inc., SCC.T 0.18% in addition to Lands' End. There could be more to come. Sears is considering alternatives for its autorepair shops and is looking into ways of cashing in on its remaining stake in Sears Canada.
"Sears is getting rid of all the good stuff and leaving bondholders with the underperforming assets," said
Mary Gilbert, an analyst with Imperial Capital LLC, a boutique investment bank.
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The retailer said the moves are aimed at unlocking value for shareholders, making it possible for them to
pick and choose among the assets they want to hold, while also allowing the company to focus on running its
core business.
That core business, which includes the flagship Sears and Kmart chains, has produced $5.4 billion in losses
in the past three years. Much of the company's remaining value is tied up in its real estate, and estimates
differ widely on what those properties are worth.
The company said it has plenty of resources to cover its obligations to bondholders. "Sears Holdings is an
asset-rich enterprise, with significant financial flexibility and multiple resources at our disposal," said
spokesman Chris Brathwaite.
The company's secured debt stood at $3.5 billion on Feb. 1. According to Ms. Gilbert, the collateral, which
includes inventories and some receivables, has a value of $6.6 billion. (Sears also has $327 million in
unsecured bonds, which have no claim on the collateral.)
The company had $1 billion in cash and $885 million in available credit on Feb. 1.
Not all bondholders think the spinoffs are a bad idea. "Sears needs cash, and if they raise money by spinning
off assets that don't materially dilute the collateral, that is not something we view negatively," said
Christopher Kocinski, an analyst with Neuberger Berman Group LLC, which owns more than $200 million
in Sears bonds, according to publicly available information compiled by data provider Ipreo.
Others are less sanguine. "Bondholders should be very worried about what Eddie is doing," said Lesya
Paisley, a portfolio manager with Aberdeen Asset Management PLC, who thinks the bonds are likely to fall
in value. "Eddie is talking about fixing the company, but in reality he is engaging in financial engineering."
Mr. Brathwaite, the Sears spokesman, counters that, saying, "Our primary focus is on creating long-term
sustainable value and increasing the return on assets....We are continuously evaluating our asset structure and
whether specific assets and/or businesses are better managed within the current Sears Holdings asset
configuration or outside it."
Claims that the company has plenty of collateral wouldn't be tested unless Sears finds itself in bankruptcy
court, which no one thinks is imminent. The retailer's performance is getting worse, not better, however,
which has invited closer scrutiny of the decisions it makes about its assets.
In a bankruptcy or liquidation, secured lenders get paid first, followed by unsecured lenders who don't have a
direct claim on the company's assets. At the end of the line are shareholders, who typically get little, if
anything.
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The company's secured bonds were trading at around 92 cents on the dollar last week, about even with where
they started the year, according to Markit, a financial-data firm. Investors are paying a lot to insure the
unsecured bonds against default—about $1 million a year for every $10 million of debt. That is down from
$1.1 million on Jan. 1, Markit said.
But the collateral has been shrinking, as Sears spins off assets and businesses and the remaining Sears and
Kmart chains get smaller. Over the past two years, the collateral has fallen by $1.2 billion, according to Ms.
Gilbert's estimates. The Lands' End spinoff will reduce that further. On Jan. 31, the unit had $370 million in
inventory and $34 million in accounts receivables.
Sears's so-called second lien notes have added protection: If the collateral falls below the amount needed to
cover the notes for two consecutive quarters, Sears is required to repurchase some of the securities.
Mr. Lampert is both a shareholder and a bondholder. His hedge fund, ESL Investments Inc., owns 48% of
Sears. Those shares were valued at $2.6 billion on April 4. Sears stock is down by a third over the past three
years. He and his hedge fund also own $95 million of Sears's secured bonds and $3 million of the unsecured
notes.
The 51-year-old Mr. Lampert has proved adept at creating value for shareholders in the past. His hedge fund
has notched annualized returns of more than 20% a year for 20 years, according to a person familiar with the
situation.
Sears will get some benefit from the separation of Lands' End. Lands' End will pay a $500 million dividend
when it leaves and will also pay rent on the 275 shops it has in Sears's stores.
Lands' End shares closed on Friday at $31.67, down 13 cents.
—Anupreeta Das contributed to this article.
Write to Suzanne Kapner at Suzanne.Kapner@wsj.com
BUSINESS
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Weakened Lands' End Won't Be Freed by Sears Spinoff
Apparel Maker Reveals Surprisingly Poor Financials as It Announces Plans to Separate
Email
By
SUZANNE KAPNER
CONNECT
Updated
Dec. 6, 2013 6:19 p.m. ET
Lands' End has suffered under Sears, and the planned spinoff won't exactly set it free.
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The companies originally heralded the merger as a strategic fit that would help the mail-order retailer grow
faster and drive traffic to the venerable department store. But the ambitious goals bogged down in Sears's
deteriorating stores. After a string of record profits that ended in 2008, Lands' End's results have deteriorated.
The 50-year-old maker of preppy chinos and fleece jackets brought in $50 million in profit on $1.6 billion in
revenue in the company's last fiscal year, down from $135 million in profit on $1.7 billion in revenue in
2008.
Gary Balter, an analyst with Credit Suisse, on Friday called Lands' End's numbers "surprisingly weak." Sears
Holdings Corp.'s SHLD -2.99% shares fell 3.8% Friday to $48.10, even as the broader market rallied.
Sears took steps Friday to separate its Lands' End unit by filing a registration statement with the Securities
and Exchange Commission. The move will end a rocky marriage between the two companies that began
when Sears bought Lands' End for $1.86 billion in 2002.
Enlarge Image
Lands' End gets 18% of its total revenue from retail stores, which are mostly shops inside Sears locations. Clayton Hauck for The Wall Street Journal
Yet even after the spinoff, the chains will remain linked. Lands' End drew 18% of its revenue from its brickand-mortar retail business, and that depends on its ability to operate shops within Sears's stores. If Sears
"sells or disposes of its retail stores or if its retail business does not attract customers," this could hurt Lands'
End's business, the filing warned.
Timeline: The History of Sears
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Lands' End will initially depend on Sears for a host of logistical and operational services, according to the
filing. Nearly half its shares will be controlled by billionaire hedge fund manager Edward Lampert, who
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controls a similar stake in Sears and serves as its chairman and chief executive. According to the filing, Mr.
Lampert will be able to exert "substantial influence" over Lands' End after the spinoff, and his hedge fund's
interests "may from time to time diverge from the interests of our other stockholders."
The eventual spinoff of one of Sears's best-performing assets underscores the challenges facing the larger
company, which was created after Mr. Lampert bought Kmart out of bankruptcy in 2003 and two years later
combined it with Sears, Roebuck & Co. Mr. Lampert has pushed the company to become more
technologically savvy, but underinvestment in its stores has hurt traffic and led to a steady decline in sales.
Sears's losses ballooned to $1 billion for the nine months ended Nov. 2 from $441 million a year earlier, as
revenue fell 7% to $25.6 billion. The company has closed more than 300 stores since 2010 and has been
selling or spinning off assets. The company disclosed in October that it was considering strategic alternatives
for its line of auto centers.
Enlarge Image
Sears Holdings said it plans to spin off Lands' End, which would be its third spinoff since the beginning of last year. Associated Press
Sears also said at the time that it might spin off Lands' End. The company had shopped Lands' End to
private-equity firms as recently as last year, but no deal was reached, according to people familiar with the
situation.
The 2002 acquisition that brought the companies together surprised the retail industry and didn't
resonate with consumers. Lands' End's customers tended to be wealthier than Sears shoppers but had
plainer tastes. Sears shoppers didn't warm to the brand's offerings, and Lands' End's reputation for
quality and customer service suffered under its new owners, former executives said.
Still, the unit was a big contributor to Sears's results. Mr. Balter, the Credit Suisse analyst, said he expected
Sears's operational performance to deteriorate further without Lands' End, which he said was likely the most
profitable piece of the company.
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Sears said it plans to distribute all of the shares of Lands' End Inc. to existing Sears shareholders. The spinoff
won't generate cash like an outright sale, but could help unlock value by creating a separately traded stock
that investors can buy or sell at will.
Still unknown is how much debt the spun-out Lands' End will carry and whether it will pay a dividend back
to its parent.
Sears has used the spinoff tactic before. In 2011, it handed shareholders the stock of California hardwarestore chain Orchard Supply Hardware, which filed for bankruptcy protection two years later. In 2012, Sears
separated its Hometown & Outlet Stores Inc. and spun off a stake in Sears Canada Inc.
Write to Suzanne Kapner atSuzanne.Kapner@wsj.com
Struggling Sears to spin off
Lands' End clothing business
BY MARIA AJIT THOMAS AND ADITI SHRIVASTAVA
Fri Dec 6, 2013 2:18pm EST
7 COMMENTS
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A customer leaves the Sears store in Denver February 26, 2009.
CREDIT: REUTERS/RICK WILKING
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(Reuters) - Eddie Lampert-controlled Sears Holdings Corp(SHLD.O) said it would spin off its
Lands' End clothing business, adding to the assets the company is shedding as it struggles with
mounting operating losses and declining sales.
The company, operator of Sears department stores and the Kmart discount chain, has been selling
or spinning off assets and closing stores for the past few years to try to turn around its business.
Sales have been dropping since Lampert combined Sears and Kmart in an $11 billion deal in 2005.
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The billionaire hedge fund manager, who took over as chief executive in February, has been
criticized for not investing enough in the business, which has earned a reputation for dowdy
merchandise and poor service compared to Wal-Mart Stores Inc (WMT.N) and Target Corp
(TGT.N).
Sears shares were slightly down on Friday afternoon after rising as much as 4 percent in
early trading.
"... The spinoff announcement essentially points to a number of negatives, including an inability to
find a buyer, as previously Lands' End was listed as an asset that the company would monetize,"
Credit Suisse analyst Gary Balter wrote in a note to clients.
The New York Post reported in March 2012 that Lampert was exploring a sale of Lands' End.
Lampert later told investors that while he was not actively looking for a buyer, there was always a
possibility the business could be "separated."
When asked if the spinoff pointed to its inability to find a buyer for the business, a Sears
spokesman referred to a company statement in late October.
The company said then that any separation, if pursued, would not be structured as a sale but rather
through a transaction that would allow shareholders to benefit from the significant potential for
value creation.
The spinoff will not raise cash for Sears but will allow Lampert to more efficiently chart a course for
the two businesses, which compete for management time and capital within the Sears group.
"Sears is in a steady state of decline," said Brian Sozzi, chief executive of Belus Capital Advisors.
"They're essentially selling their body parts so they stay alive today."
Apart from losing market share to Wal-Mart and Target, Sears is facing increased competition from
online retailers.
Sears spun off its Orchard Supply Hardware Stores unit in 2011 and its Sears Hometown and
Outlet business last year.
In October, the company sold some Canadian real estate assets for $383 million and said it was
considering separating Lands' End and its auto center business.
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Sears had cash and cash equivalents of $599 million as of November 2, down from $671 million on
August 3.
"... This spinoff is another wooden block being pulled out in our Jenga scenario, with Lands' End
likely the most profitable piece that was left in the company," Balter said, referring to a game in
which players pull blocks from a stack until the stack collapses.
LOSING SOME CACHET
Lands' End sells casual clothing, accessories, footwear, and home products online, through catalogs
and in stores.
Competitors include Eddie Bauer LLC and L.L. Bean Inc as well as department stores such as J.C.
Penney Co Inc (JCP.N).
The business, which was bought by Sears in 2002, generated sales of $1.59 billion in 2012, down
from $1.73 billion in 2011. Sears' sales fell to $39.85 billion from $41.57 billion.
Founded in Chicago 50 years ago as a catalog business, Lands' End has lost some of its cachet since
the brand started to be sold at Sears stores.
About 16 percent of the brand's sales came from Lands' End shops located in Sears stores in 2012.
"(Sears has) been slowly destroying it," Balter told Reuters.
Lands' End said the spinoff would give both it and Sears simplified focus and operational flexibility.
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