Archive for the ‘Conflictos de Interés y Transparencia’ Category

The Duty of Loyalty

February 19, 2017 Leave a comment

The Duty of Loyalty is established in the Spanish Corporate Law (1) in articles 227 until 232. According to it directors need to act with good faith and in the best interest of the corporation; a breach would entail restitution of the damage suffered by the corporation plus the return of the profit the director could have made.

The legislator wanted to further explain the extent of the obligations:

a) Directors must use their powers with the aim they were granted to them.
b) They must keep confidentiality.
c) They must refrain from deliberation and vote when they face a conflict of interest. They also need to adopt measures not to incur in situations where their interests (or those of related parties) face those of the corporation.
d) They need to act free from instructions and criteria established by third people.


Referring to the conflict of interest, the legislator further explains that it can appear when a director does a transaction with the corporation, when he uses the name of the corporation or its assets in its own interest, when he takes a business opportunity from the corporation, when he/she is paid by a third-party or acts in business as a competitor of the company.

The prohibitions to act may be relaxed if the shareholders general meeting (or in some cases the rest of directors if they are independent with regard to the affected director)) so decides. In general the approval can only be granted if no damage is produced to the company or if it is somehow compensated.

In connection with the Duty of Loyalty, some questions arise in all legal frameworks: Read more…


Work and Pensions and Business, Innovation and Skills Committees: The BHS Report

The inquiry (1 and 2) has tried to shed light into the reasons why some 11.000 BHS workers may be considered direct losers, up to 20.000 when pensioneers are included, many more if we consider eventual job losses in BHS providers, and up to 11 million when current and future pensioneers in other firms, (all of them contributors to the Pension Protection Fund that will afford part of the damage) are counted.

The big numbers also point to some winners: the company was bought in 2000 for £200 million; in the period 2002-04 some £423 million were given in dividends, (more than the £208m in Net Profit), £307m paid to the Green family. Goodwill and some real estate transactions allowed to pay these amounts, but also reduced the firm capacity to fulfill its pension obligations, invest or later afford the loss-making period until 2009, so that in 2014 the company had negative equity and was largely financed  by debt, (part of it granted by Green`s other companies). Operations didn`t really go well, as sales remained flat and profits might have increased mainly as a result of cost cuts. Read more…

Minority interests in Management or Controlling Interest Buyouts

In a previous post we dealt with the issue of the protection of minority shareholders, in the case of takeover bids made by controlling shareholders mainly. We will now include Management buyouts in our reasoning.

Should regulatory bodies be charged with the oversight of management or controlling shareholders` buyouts? What are the duties of directors and management in these cases?

Management buyouts are transactions in which managers purchase the shareholders` stakes, and take the company private. Controlling shareholders that hold executive positions have lately used to their advantage their privileged access to information, and their control over disclosures made about the proposed transaction. Cases like Dell, where the founder, still the first executive and a big shareholder, has offered to purchase the shares he does not own, (with the financial help of others) have again raised the concern of whether those transactions are fair, and whether the controlling shareholders, the managers and the board have done all the necessary to protect the interest of minority shareholders.

There is nevertheless a set of best practices that have been built over the last years to help all the actors deploy their activity fairly. These measures include:

–         Creation of a Special Committee of independent directors that, with the help of independent advisors, will initiate so-called Go-Shop activities, in order to search and find alternative offers in the market.

–         A majority of shareholders outside the buyout group should approve the transaction, so as to assure that independent shareholders are the ones to decide.

–         In some cases, the buyout group conditions its bid to the compliance of the previous provisions.

Courts in Delaware usually established a difference between the following two cases:

First, when the buyout group is made of managers but does not yet have a controlling interest in the company. In that case, if a majority of not involved –so, independent- shareholders approved the transaction, the Court would apply the business judgement rule, thus blocking any further court procedure.

Second, when the group is a controlling shareholder. In that case, Courts requires a higher standard, the so-called “Entire fairness review”. This means that Courts will guess if both “fair price and fair dealing” occurred.

Nevertheless, a recent decision by a judge has changed that sharp distinction, in the sense that, whenever there are enough tools in place to remove the conflict, (such as an independent committee and approval by majority of independent shareholders), Court estimates the Entire fairness review does not hold anymore, (MFW Shareholders Litigation).

But are those procedures enough? Do they really protect minority shareholders from abuse?

In Cain and Davidoff, the first measure, (independent committee), and even a board that strongly negotiates with management to obtain the best price for minority shareholders, is said to often produce a higher premium, which was not the case for the second measure, (the majority of the minority to vote in favor). Go-shop provisions don`t show good results either, as too often the shopping is not an actual auction.

Davidoff also points out that premiums in general are lower when the process is led by managers who are not directors, which would recommend a higher protection level.

Peter Henning introduces disclosure as a relevant element, when minority interests are at stake: as the regulatory bodies require certain aspects of the transaction to be disclosed, whenever companies declare or give information to the market, they are forced to be truthful and honest. In the case of Revlon, a Court declared proved that the company received an offer for the minority interests and also the information that it was not fair; after that, the company did everything to avoid receiving formal notices about that fact, so as to avoid its disclosure to the independent directors and the market. Disloyalty includes fraud, but also all activities entailing deceptive effects for third parties, the judge said, which is why the Revlon case is so relevant as it opens the window for a much more active role of Courts in this kind of case.

Anyway, those recent cases are likely to be appealed, so the debate will remain hot for some time.

Based on:

– Steven Davidoff: The Management Buyout Path of Less Resistance, June 2013, NYT.

– Peter J. Henning: A Warning Shot on Management Buyouts, June 2013, NYT.


Should third parties be allowed to reward directors at all?

There has recently been a lot of debate and regulation about Compensation to Directors by firms. Discussions include Non executive directors fixed or variable pay, equity compensation, long versus short-term compensation, the connection between pay and independence, and many other things, such as disclosure and  binding or not binding “say on pay” by shareholders.

But, what about the possibility that outsiders, shareholders or not, might reward directors, some or all of them? The debate has arisen after two hedge funds, (Elliot Management in Hess Corp. and Jana Partners in Agrium), bought respective stakes in the companies, arguing for change after years of underperformance versus peers. Both proposed a partial slate of directors, and also offered them if elected, (and if certain objective conditions were met), big rewards, (fixed amounts per percentage point of stock appreciation or percentages of the fund`s return).

The first answer by the affected firms against the proposed practice referred to the loss of independence by those directors, and the short-termism in which they would decide on company matters, (more linked to the long-term). Hedge funds opposed alignment increases, and also that they would be offering those packages to their nominees, not being able to withdraw the offer, so that directors` independence would be preserved.

There has been a public debate after these disclosures among academics and practitioners, and we will deploy the main arguments in what follows, both against and in favor of this practice. Some of those arguing against even recommend that a particular bylaw feature be introduced by companies that would veto the practice, and we will also comment that possibility.

Arguments in favor:

  1. Alignment, as rewards would be connected to stock price appreciation.. This is very relevant when, as in most companies attacked by shareholder activists, previous performance has been deceiving.
  2. It generates a certain value to the rest of shareholders, for which they would not be paying, as the reward is due by a particular shareholder.
  3. Independence: it should not be legally considered lost, as nominees still would remain independent from management. Even if there is a close tie to those sponsoring them, there is no reason to believe they lose their independence to act as such where it is legally required, (Compensation committees for example, and even in Audit Committees). The subject kept aside, independence would be lost if the sponsor could at a certain point decide to withdraw the compensation proposal, so as to execute a pressure in favor of certain decisions, but this is not the case.
  4. Those payment arrangements are needed if companies are to attract the most qualified directors.

Arguments against the practice:

  1. Loss of independence, as a third-party interest would be served, (shareholder or not). Some (Bainbdridge, for instance), strongly assert it would be a danger to introduce this self-interest feature between directors and their duty of loyalty to the corporation and all shareholders.
  2. It introduces short-termism in the boardroom.
  3. It creates a different class of directors, with much higher pay levels, which might generate unnecessary controversies in the boardroom for an external factor, and even entail a spiral of director pay.
  4. Those highly paid directors would presumably assume much more risk that those only paid normal fees, (the highest paid to NED`s near 500.000 USD), and would not act as a barrier to excessive risk-taking by executives.
  5. Some (Prof Coffee) state that, given late developments in capital markets, (ownership concentration, higher institutional investors power, removal of poison pill and other defenses), the additional ability of bribing directors should not be allowed to hedge funds or other institutional investors.

What should be done, as suggested by those against the practice?

  1. Prof. Coffee recommends that the law evolves so a director, , can only be said to be independent, it they are independent from management (current regulation) but also from those who sponsored or nominated them.
  2. The law firm Watchell, Lipton, Rosen & Katz propose that companies modify their bylaws so as to prohibit shareholder activists -or any agent other than the company- to compensate directors, (in all forms and size).

Should the Watchell-Lipton bylaw be adopted by companies? A general view is that W-L tries -as in many proposals by this firm- to disturb shareholder activism and help entrenched boards and management. A second argument is this bylaw would make it difficult to attract the best director candidates. Thirdly, W-L appears to consider directors brought by activists as more likely to breach their fiduciary duties than incumbents and management.

An additional topic to he considered is that in fact, there could be a wide variety of third parties interested in paying incentives to directors. M&A firms, or any other third-party could have an interest that could be (truly or not) dressed with the robe of the long-term shareholders` interests.

The Council of Institutional Investors in the US has rejected third-party bonuses or performance payments for directors.

In any case, it is very probable that this debate will continue, and many different realities might well contribute to its effervescence.


October 7, 2012 1 comment

Some definitions


Generally speaking, Empty voting is a practice by which insiders hold more voting rights than shares, and the name refers to the fact that votes have been decoupled of their economic interest.


The Formal Voting Right is held by someone, (perhaps a broker), independently of who has voting rights or voting ownership, (that is, the power to instruct how to vote). The economic ownership (long or short), belongs to the holder of shares or the holder of coupled assets, (derivatives, for instance). Full ownership of shares combines voting and economic ownership. Net economic ownership is the total economic ownership through shares or coupled assets. Empty voting refers to voting rights exceeding the net economic ownership. Related non-host assets, are those of a different company, whose value is connected to the value of the analysed or host company. Hidden ownership refers to a non-disclosed one, when ownership method is indirect, and/or regulation does not force such a disclosure.


What`s Empty Voting and why it is relevant


Empty Voting could be simply said to be an efficient reaction from all participants, and no regulatory recommendation would arise if no case was made for the existence of market failures. Some perspectives can be anlysed in that sense:


a)      Principal-Agent relationship: the fact that a new participant appears that forces all others to bear some additional agency costs can be defended. The “majority rule or One Share-One Vote principle” arises from the assumption that all shareholders vote on an optimal relationship to the capital invested; but voters that do not bear the risk, could in some cases act in a very suboptimal manner. Easterbrook and Fischel in 1983 argue, first, shareholders with higher voting power than economic risk could eventually accept a certain risk, that those who will suffer the eventual cost cannot reject; thus, in fact, the efficiency in voting is distorted; and second, the practice can be used to protect managers from takeovers, by a minority against all other shareholders` interest. On the other hand, the decoupling strategy can help those who hold more votes than economic interest obtain the so called “private benefits of control”, another agency cost indicator. For example they can make the company approve transactions only profitable for them.

b)      Information costs: corporate law introduces a limited number of corporate forms, in all cases with shares being a commodity, so that acquiring shares in a public market does not imply a high information gathering cost. If shares are not any more a commodity, as a result of risk decoupling strategies, information cost would eventually increase.

c)      Corporate finance: given the fact that equity providers are residual claimers, they are compensated for the risk with the control tool, so that they can influence the destiny of the firm and their funds. Risk decoupled shareholders reject the risk, but they still keep the control, and can exerce it for selfish or abusive purposes.


What are the techniques used to reduce or eliminate the economic risk


There are different tools used by hedge funds and other participants so as to be Empty Voters:


a)      Derivative instruments: futures, forwards, options, equity swaps, …, can all be used for the purpose of eliminating the economic risk of one of the parties, (that is, a shareholder, such as a hedge fund, a manager with an equity stake, probably an incentive not designed to be hedged, etc.).

b)      Share lending: it usually consists on a share sale, with an agreed future repurchase. The lender remains in this case the beneficial owner of the share, but will not vote if the General Meeting is held in the meantime.

c)      Record Date Capture: although this is something usually happening, certain shareholders might buy shares only to hold them at a certain date, (the cut-off day for registering to the General Meeting, selling them inmediately, but keeping and exercing the voting right).


What are the regulatory options


The options are depicted in what follows:


a)      Doing nothing: the free trade of voting rights would be permitted, and some argue this would help solve the passive attitute of small investors towards vote, thus introducing a better management monitoring.

b)      Self regulation: some companies have introduced economic ownership disclosure clauses in their bylaws, for those shareholders acting in the General Assembly. The Hedge Fund can also subscribe to Best Practices Codes.

c)      Ban or restriction: banning decoupling practices would be both difficult to implement, and damaging for efficient market practices, (hedging or share lending).

d)      Transparency: information costs, the fact that decoupled shares are not correctly valued, are at least partly due to lack of disclosure; disclosure would disuade those seeking rents in agency costs or private benefits, as showed above. The object of disclosure, its frequency and thresholds should be determined.

e)      Disclosure and Disinfranchisement: a too drastic measure, it could be acceptable in a case by case resolution mode by national investment authorities, (Sec and others).



In this post I have only referred to negative decoupling, where shareholders want to reduce their risk exposure; but the opposite, that is “positive decoupling”, or “hidden ownership”, has also huge effects in the markets, and will be dealt with soon in this blog.

Why independence in the Board, how do NEDs need to be, and how to assure their effectiveness

September 10, 2012 Leave a comment


a) Independent and friendly outside directors. Firm Value.


Corporate Governance scandals in early 2000`s led to increased director independence as a result of regulation. As Sung Wook Joh and Jin-Young Jung show –“Effects of Independent and Friendly Outside Directors”-, many studies bring forward the fact that directors connected with Ceo and management are “more likely to pay excessively the management, that succesively performs worse than otherwise”. Those studies centered on the Directors`monitoring role. In large firms, in those where directors easily acquire information, whithout asimmetries, this is the case.

But the advisory role, and the directors` connectedness (that helps expand businesses), both are also related with firm value, and perhaps this is more relevant when monitoring is already effective externally, through equity markets and the M&A threat, or because of a highly volatile environment. Friendly outsiders can in this case be positive for firm value, as they do in stand-alone and distressed firms.

When there is a strong regulatory pressure, politically connected ousiders are positive for firm value, through their help in resources` acquisition, (licenses, and so on). This is also the case for firms acting locally.


This helps understand why some firms still keep recruiting friendly directors, deeply believing that they act efficiently, even if they send a negative signal to markets


It would also help understand why “When regulation forces a board to become more independent than endogenously determined, the CEO may counteract by strengthening connectedness with other key players governing the firm” so as to weaken the regulatory effect, (“The Independent Board Requirement and CEO Connectedness”, by E. Han Kim and Yao Lu, where the authors consider a bad effect of Ceo connectedness on governance, monitoring, performance, and hence, firm value).


b) What is an Independent Director?


The Spanish Governance Code, (Código Conthe), establishes that an independent director is one that is elected for his/her personal and professional profile, and is isolated from pressure coming from management, significant shareholders and the corporation itself. He cannot have been Director in other group`s firm, he cannot be employee or otherwise receive significant fees or payments from the company; he cannot be himself or have been named to represent a significant shareholder; he cannot be a manager`s relative; he must have been proposed by the Nomination Committee. Basically, he needs to be an unconflicted director. As Richard Leblanc affirms, (“Rethinking what it means to be an “independent” Director”),  the problem is the way conflict is determined: it is usually judged by the Board, whether “there are material relationships,…., that can reasonably be expected,…, to interfere with their independent judgement”. For an employee, a conflict of interest is understood to exist, when a superior and objective body, (a manager, the Board), thinks it exists, and the judgement is not limited to what the employee thinks by himself. But when the Board assesses the subject itself, it very often forgets to notice social connection among directors, long tenure, other perks and capture instruments offered by management, and so on. Perhaps the existence of conflicts of interest should be assesed in a much objective, even external to the Board, manner.


c) What are the main qualities of an Independent Director?


According to a survey and report by Korn Ferry International, (“Greatness Cultivated in the Boardroom”), there are different sets of required attributes for a NED:

–         Core characteristics: they need to be strong but not domineering, strategic but able to drive into the detail, engaged and team oriented, while able to preserve thinking independence, and committed. Of course, experienced.

–         Characteristics on the rise: they need to deeply understand risk, (so as to determine the company`s risk appetite, not just approving managers` decisions on that), have a global outlook, be responsive to change, and familiar with new technologies and social media; of course, they need to have a long term view and perspective,  (both on corporate responsibility matters, and strategy).


There is also a perceived list of behaviors that Neds need to avoid:


–         Hostility, egocentrism, uncommitment, policeman style, captiveness of compliance.

–         Non-stop talkers, nodders, hesitators.

–         Particularly relevant, NEDs need to understand the challenges the company is facing.


d) What should a Board/and the NEDs themselves do to optimise a NED`s performance


–         Boards should use personal and collective evaluation of NEDs and boards, and of course provide them with all reasonable support.

–         NEDs need to: learn as much and as fast as possible, ask and listen before issuing uneducated comments, commit to add value, and reach out other directors and relevant people.



Chesapeake, conflictos de interés y falta de comunicación

April 28, 2012 4 comments

Recientemente la empresa, con base en la ciudad de Oklahoma, y especializada en la exploración, perforación y exploración de pozos de gas natural, se ha visto sometida a presión mediática en relación a su “Founder Well Participation Program”. El citado programa, aprobado en Junta de Accionistas en 2005, permitía por un periodo de 10 años al fundador y Ceo de la compañía, participar hasta en un 2.5% en cada pozo que la compañía perforara. Ello conllevaba el compromiso del Ceo, Aubrey K. McClendon, de afrontar proporcionalmente las inversiones requeridas, -cuantiosas-, con pago inmediato tras presentación de factura por la compañía.

La cuestión es que este programa, no ha ido acompañado por suficiente información respecto de su ejecución, ni en cuanto a los pozos en que el Ceo invertía, ni del montante de las inversiones, ni de cómo el Sr. McClendon las financiaba.

Reuters ha desvelado que en este periodo, a través de tres compañías con las que realizaba las inversiones, McClendon obtuvo financiación de hasta 1.100 millones de dólares para afrontar los pagos de prospección, entregando en garantía su 2.5% en los pozos. Ese volumen de deuda cuestiona su exclusiva defensa leal de los intereses de Chesapeake. Otro punto de conflicto se origina en que uno de los prestamistas es una entidad que habitualmente financia a la compañía, de forma que es cuestionable que los términos comerciales de los préstamos fueran de mercado. Más aún, alguno de esos prestamistas inviertieron en acciones preferentes, con una financiación interesante y previa a la entrega de dividendos. Asímismo, se desvela después que también un exconsejero de Chesapeake, -miembro de la Comisión de Remuneraciones, le había concedido financiación, con lo que queda en cuestión su lealtad para con la empresa o sus propios intereses. Ninguno de estos préstamos ni sus términos había sido dado a conocer por la compañía, o por el propio McClendon, y dados los potenciales conflictos de interés, ello era obligado.

El ejecutivo se defiende, y más expeditivamente lo hace la compañía, que publica una arrogante respuesta, (ya no está colgada en la web), donde defiende el alineamiento, la falta de conflicto de interés, (las transacciones financieras se dice era cuestión personal del Ceo, ningún interés de la Cía sería afectado por disputas derivadas de las transacciones financieras…), etc.

A fin de abril de 2012, la compañía decide que el Programa de Participación será rescindido, que el Ceo informará de sus intereses en pozos de la compañía, y que la compañía investigará si hubo conflictos de interés en las operaciones de financiación.

Es un caso que denota un fleco en la regulación de los conflictos de interés, pues la SEC requiere que la compañía informe de transacciones entre ella y terceras partes con “interés material directo o indirecto con la compañía”. Las transacciones financieras quedaban al margen de ello, cosa que claramente no es acertada.