Archive for the ‘Disclosure’ Category

What do investors expect from a proxy statement? How should it be?

What would proxy readers like to get rid of?


According to Nicholas Rummell, (1), size is the first obstacle to a useful proxy statement. Complex language and structure could be the following. Poor design and graphing also hinders an easy reading. Inconsistency through time is a noise too.

What changes could help? A good skills and capacities matrix for directors and their photos would help understand board quality, composition and diversity. Proxy design also helps: tables, colours, different fonts, etc. Remarking particular features that have been newly adopted or abandoned is a good idea also, according to Rummell.
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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.


Pay for Performance. (I) Pay definitions

January 15, 2013 1 comment

A correct pay definition is relevant when analyzing the connection of Actual Pay to Performance, and its relationship with the universe of peers.

In this post, we will limit to the first concept of the Compensation principle that “Pay” needs to be connected with “Performance”.We will first name and define the main alternative definitions for pay, while taking for given that Performance is well defined, for instance, as represented by Total Shareholder Return, (TSR).

  1. Target or Expected Pay

It includes a total compensation offered to executives in a given year, in an attempt to link his efforts to future performance. Very often, those plans are designed and disclosed around minimum and maximum values, tied to minimum and maximum performance targets.

The problem of “Target Pay” is that it`s more often used on a prospective basis, not in retrospective, which would allow to validate the ties between Pay and Performance.

When Target Pay is used in Proxy filings, it includes Base Pay, Target value of annual cash bonuses and nonequity incentives, target value of any performance-based cash awards, and grant date fair value of long-term equity (options or other) awards.

ISS uses a concept similar to this one. Companies using target pay normally use it to demonstrate the actual ties between Pay and Performance, (perhaps not so easy to explain with other definitions). It shows how the committee intends to link the two variables, but is not useful to show that they were really connected.

  1. Earned Compensation.


It is defined as the “total value of compensation that an executive “earns the right to keep” as cash is delivered and vesting restrictions are removed from equity-linked elements. Long-term cash awards are earned at the end of multi-year periods normally, (so, accrual is not considered in the first years of the multi-year period). RSU are included when they vest, at the vesting day price, and stock options are also included at the Black-Scholes (or intrinsic) vesting day value. In general, Earned value includes elements granted in the year, and some other granted in previous years, (stocks vesting in the year, granted before).


  1. Realized Pay (also named Actual, or Value Received)

This is more accurate to what an executive receives, and can be disclosed with transparency as to whether pay and performance are connected. It includes actual cash compensation, (base salary and bonuses), actual payouts under performance share or cash awards, and exercised or taxable equity incentives, (vested or sold in the period). In progress equity awards –not yet vested- are excluded. If the executive cashes out in the period, the cash amount will equal realized pay, but it he holds equity or options for longer, realized value for that equity will go up (down) with stock price.

So, in summary:

–         Stock options: gains from exercised options.

–         RSU: the value of those vested in the period, (in other versions, those sold by the executive).

–         Performance Shares: value of those vested in the period, (in other versions, those sold by the executive).

Realized pay has also some disadvantages: firms may differently calculate it, as exposed; it introduces external movements in compensation due to investment decisions by managers, (as they decide when to hold or sell the equity component); also, some options or shares granted before the performance period can be counted, if vested, exercised, or sold in the period, (depending on the exact definition used).

  1. Realizable Pay

It is increasingly being adopted by many firms. It includes compensation earned in the period, based on the amount thar can be realized, (so it is counted when paid, vested or realized), that is: actual base salary and bonus, and the value of equity that executives may recognize, based on actual stock performance as of a specified date, so:

–         Stock options: embedded value of those outstanding, (market value minus strike price). The time value is lost, though.

–         Restricted Shares: value of those granted in the period, vested or not, valued at stock price at the end of period.

–         Performance Shares: value of the target number of performance shares, valued at stock price at the end of period. Using the target number, instead of the actual earned number is a flaw of this method.

This allows stock performance to be reflected in the value of equity components, as equity is overlooked over a multiyear period. It includes intrinsic value of all equity awards outstanding, (realized or not in the case of options or SARs), and paid or vested, (RSU or other equity awards). The greater the % of pay is at risk, (equity linked somehow), the better the case for realizable pay is.

Disadvantages are: different calculations used by companies, the fact that it is not “fully actual pay”, as some events eventually affecting stock value in the future, may dramatically change the actual pay to be received. But it is clearly better than target and realized, (as for investment decisions by executives do not affect).

Until January 2013, ISS dismissed this concept, but from then it decided to combine its own with this one: when its analysys shows some concern, a higher stock (lower) price linked to a higher (lower) realizable than grant date value pay would mean there is a certain adherence to the principle.

The doubt remains as for the best day to take stock price values, (end of period, last quarter, an average value….). Additionally, should exercised options, sold equity, or cashed in tools be counted? Not if granted out of the performance period, but shouldn`t the value change in the reporting period also be counted?

  1. Performance-adjusted Compensation

The focus is on stock options, SARs, RSU, and performance shares, (from now on, Equity Long-term incentives, or LTI). Those may be valued at Grant-date value, (as in Target Pay or USA regulation ordered Summary Compensation Tables, (SCT), (using accounting procedures, such as as Black-Scholes), or as in ISS assessments, (using its own procedures). To cope with the problem of Target Pay, Earned, Realized and Realizable pay were defined, but they, as seen, have their own problems.

Performance Adjusted Compensation, is similar to Realizable Pay, but addresses some of the defects. It can be defined as “annualized total compensation after stock price performance is taken into account”. In brief:

–         Stock options: Black-Scholes value of options granted in the period, vested or not, based on stock price at the end of the period. This includes the time value of options.

–         RSU: value of those granted in the performance period, vested or not, at the stock price at the end of the period.

–         Performance Shares: value of those earned and vested during the period, at the stock price at the end of the period.

Whatever standard definition is used, it should follow below principles:

–          Data should be shown over the long-term (e.g., at least three 3-year rolling cycles).

–          All elements of compensation should be valued after performance has happened, not at grant date.

–          The time horizon of the pay components should match the horizon of the performance measured.

–          The pay definition should put the various LTI vehicles on comparable footing, so that pay and performance comparisons are not distorted.

–          The pay definition should make it easy to compare actual pay across companies.

–         The pay and performance discussion should cover total compensation.

–         The data should be readily available and easily replicated by third parties

In the post we followed “Pay definitions:…” by Farient, (, and What Does It Mean for an Executive To Make $1 Million?, by Rock Center Corporate Governance, ( ).

Blockholder Disclosure: a case for transparency or for monitoring benefits?

November 9, 2012 1 comment

We refer in this post to the norm that in the USA and most other countries forces significant beneficial owners report their shareholdings. In particular, in the USA, any holder tresspassing a 5% threshold has a 10 day term to report that fact. Beneficial ownership is said to exist over securities over wich voting or investment power is held, including the power to dispose of it. As for ownership through derivatives, it is only counted when they confer the right to acquire beneficial ownership within 60 days.

The purpose of the ruling is to alert investors about potential changes in corporate control and provide them with the opportunity to evaluate their effect and to react accordingly. In what follows, we explain the controversy that has arisen in the las year about this, between academics –Bebchuk and others- and practitioners, -the law firm Wachtell, Lipton, Rosen and Katz-.

As for the concept, Wachtell, Lipton, Rosen and Katz made the point, in a 2011 letter addressed to the SEC, that cash-settled derivatives, share-parking and other “voting right and economic risk decoupling practices”, are not included. Thus, they propose economic risk holdings should also be included in the concept, because they allow the holder to exercise market control, even short positions, and at the end, they may eventually be settled in kind.

As for the 10 day delay, once the threshold is passed, WLRK suggest that it is used by many hedge funds, or other aggresive investors, to increase their holdings, so that valuable information is hidden from the public.They propose to shorten the period, as investors accumulating significant stakes are sophisticated ones, that do not need so much time, and they even suggest to introduce a “cooling-off period” equivalent to the disclosure lag, so that investors are prevented from increasing their holding in that period. Hedge funds often argue they need that lag to amass large enough holdings to force companies to take efficient actions, to the profit of all shareholders.

Bebchuk and Jackson first argue that the ten day lag was an explicit equilibrium tool between blockholders` interests and the need for disclosure. They afterwards argue about the costs of tightening the rules: given the free riding problem that affects the blockholder that tries to monitor a certain company, (which makes incumbent accountable and reduces agency costs and managerial slack), tightening the rules would diminish their incentives to do so. They provide references to empirical evidence regarding that latter effect of large blockholdings, and also argue that without large stakes the case of a proxy fight is reduced, as the benefits coming from their eventual existence. The ability to buy a large stake at prices before monitoring and engagement expectations are included, is critical for them to have incentives to incur in those costs. As for the benefits of tightening the rules: WLRK argue that the appropiation of part of the control premium by blockholders would be avoided. Bebchuk and Jackson counterargue that blockholders do not really control the company as a result of the ten day lag, but they still need to convince other shareholders to drive the company`s actions. Bebchuk and Jackson also argue against regulating isolated aspects of the balance between blockholders and management, without considering the broad picture, (for instance poison pills are commonly approved by state law in the USA).

On their response to the previous, WLRK argue that what they intend is to assure that there is no loophole to what the law tries to enforce, “transparency and disclosure”. If a large 25% stake can be accumulated before anything is broadcasted, what is the law for? Besides, they say, the law was not a balance between insiders and outsiders, the ten day lag was the recognition of some costs and administrative burden, not anymore existent, and the law aim was transparency, having failed in that purpose. Besides, they argue there is no evidence for the blockholders` monitoring benefits, (wealth creation in the long term), but only for short term price increases derived from the M&A option appearing, for instance. Moreover, institutional investors, rather than opportunistic hedge funds are to be credited for monitoring activities.

A fascinating debate, usual between Bebchuk and Lipton in the last decade, over this and other topics, that will for sure continue!