My thanks to Gordon for inviting me to guest blog.  I picked this week because it coincides with a conference on Shareholder Rights, Shareholder Voting and Corporate Performance, co-sponsored by the Amsterdam, Vanderbilt and the University of Cagliari, and held here at Cagliari.  So here we are in Sardinia to talk governance.  One does not usually associate the two, but no is complaining about the venue.  Meanwhile, finding an internet outlet on Good Friday has proven daunting.  Thanks to the good people at the economics department at Cagliari for helping out.

Today we had papers from, among others, Merritt Fox, Bob Thompson, Henry Hu, and Randall Thomas.

Merritt Fox’s paper, Civil Liability and Mandatory Disclosure, argues against issuer liability for disclosure violations, including those made in connection with public offerings.  Merritt grounds his view on a recharacterization of the purpose of the securities laws.  He sees them as enhancing efficiency through better governance and enhancing liquidity and dispenses with “investor protection” and its concerns with fair price and risk.  He agrees that public offerings present special niceties for noncompliance, but believes that issuer liability leads to avoidance of the public markets, skewing investment and financing decisions.  Issuer liability at the same time has a weak compensatory justification because investors are as likely to win as to lose from violations and compensation is ultimately paid by innocent outside shareholders.  The deterrence interest is better served by imposing liability directors and officers (subject to limitations) and on an outside certifier modeled as an investment banker. 

            Chris Brummer of Vanderbilt commented.  He wondered where mandatory disclosure fits in a global market populated by institutional investors.  He also wondered why Merritt singles out investment bankers for the certifier role, comparing lawyers, who although not expert on the projection of net cash flows at least know the rules.  Merritt responded that he’s not wedded to IBs – his certifier just needs to be expert and have adequate capital.  What type of firm steps up is not critical to the analysis.

Henry Hu gave his paper with Bernie Black, Equity and Debt Decoupling and Empty Voting II: Importance and Extensions, which recently appeared in Penn.  Here Hu and Black apply and extend the empty voting concept to address the question asked in the wake of their first paper: How much does the phenomenon matter?  The answer, unsurprisingly, is that it matter very much. The count of incidences has gone from 20 to 81.  But the list of phenomena described also has increased.  More particularly, this paper emphasizes what management can do to uncouple the vote from the economic interest so as to park votes in favorable hands.  Some of this is familiar – defensive use of an ESOP or restricted stock plan to mint votes in advance of an accompanying economic interest.  Some of it is new -- a defending management in need of votes could enter into an equity swap, a set up that causes its friendly swap dealer to go long to hedge and thereby acquire a block.  European managers have been borrowing using treasury stock to get votes into friendly hands.  The law reform recommendation is taken up a notch – firms should be able to control empty voting through (carefully drafted) charter amendments.  Henry promises a forthcoming extension to debt.

            Bob Thompson gave Corporate Voting, co-written with Paul Edelman of Vanderbilt. The paper describes corporate voting as an error correction device.  It is there to remove dysfunctional boards, screen bad acquisitions, and forward a beneficial sale of the firm.  Bob’s framework is notably narrower than the agency model advanced by Easterbrook and Fischel a generation ago.  The framework is asserted to provide a justification for the traditional vote buying prohibition: The vote, in order to serve its corrective purpose, must be tied to an economic interest in the firm; more particularly, it must follow from the collective shareholder interest.  It follows that empty voting is indeed a problem, and that voting rights should be expanded to cover poison pill adoption.  At the same time, there’s no compelling reason to expand shareholder access to board nomination – selecting directors, in Bob’s view, is just not as important as the vote’s other functions.

            Ehud Kamar commented.  I note that some of Bob’s points cut against points made in a paper Ehud is giving here tomorrow, as did Ehud.  Ehud asked whether shareholders in fact know better on the matters in question.  He also questioned whether Bob’s approach really differs materially from the Easterbrook & Fischel precedent.

            Ed Rock gave a paper co-written with Marcel Kahan, Hedge Fund Activism in the Enforcement of Bondholder Rights.  This is a great paper that pulls together a lot of under-the radar evidence on aggressive hedge fund enforcement of bondholder rights.   Inveterate bondholder advocate that I am, I have looked on this as a positive development.  But Ed and Marcel lay out the opportunities for opportunism, showing under- and overenforcement incentives depending on the interest rate picture.  I was left with no objections.  They make sensible suggestions – use a make-whole premium to better allocate interest rate risk and expand the issuer’s defeasance option.  Joe McCahery commented, questioning as to how much we can expect from either remedy.

            Randall Thomas gave a second installment of his project with Brav, Jiang, and Partnoy, The Returns to Shareholder Activism.  Here the team marshalls evidence on activist hedge funds returns, showing that they beat the returns of hedge funds in general and the S&P 500 to boot.  The degree of effort is very high – they sorted out mountains of data to get the sample.  I commented on the paper taken in the context of the project as a whole, complaining about their choice of an explanatory theoretical context.  Randall’s team cabins the activism phenomenon in classical agency theory, looking for agency cost reductions like free cash flow redirection.  I suggested that the market mispricing literature has something to tells us here too, suggesting that hedge fund returns can be explained in part as a function of good stock picking.

Bill Bratton

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