Archive for the ‘Regulación’ Category

The case for Corporate Governance

November 18, 2012 Leave a comment

Mr. Lipton, the poisson pill inventor back in 1982, recently wrote “The shareholder as owner, principal-agent model is a flawed model as applied to the modem public company. It does not provide an affirmative basis for the adoption of shareholder access proposals”, (“Twenty-Five Years After Takeover Bids in the Target’s Boardroom: Old Battles, New Attacks and the Continuing War”.This led me to revisit the theories that back some usual Corporate Governance principles of our days.

Corporate Governance is supported by several theories, basically the Principal-Agent one, based on information asymmetries, but it is not the only one. Let`s review the different foundations, not always disconnected among themselves.

  1. The Agency Theory.

Adam Smith, (1776), Bearle and Means, (1932), first explain their concern about separation of management and ownership. But the seminar contribution arrives in 1976 with Jensen&Meckling`s “Theory of the firm; management behavior, agency costs and ownership structure”.

Managers, (agents), are hired to maximize shareholders`s returns, (they are principals). As they do not own the corporations`s resources, they may act in their own interest, at the cost of principals. What follows is, first, an efficient split of risk bearing among agents and principals, and second, a correct monitoring through contractual monitoring and bonding. The aim is minimizing the efficiency losses, or “agency costs”.These costs are (i) monitoring costs, (incentive systems, incomplete contracting, and monitoring), (ii) bonding costs, (resources spent in assuring principals that no action against their interests will be done), and (iii) residual losses, (those not prevented from occurring in any case).

Jensen and Meckling do not advance in their view on how corporations establish monitoring systems. Fama, (Agency Problems and the Theory of the Firm, 1980), develops the idea in that sense. Internal and external managerial labor markets are the discipline enhancers in the firm. Risk bearers, (security owners and residual claimants), can sell their stakes with no relevant transaction costs in the capital markets, but rely on an efficient market that correctly values securities. Managers can expect the human capital market to correctly value their services, according to their previous experiences related to firm failure or success, so that they have correct incentives to behave to maximize firm`s performance. On the other hand, internal managers` pressures also force managers at the top to pursue the firm`s best performance, (all managers putting pressure for their future wage maximization). This would work jointly with certain monitoring systems.  The board is the system through which top managers are monitored: it should not be controlled by security owners, (given their diversified portfolios), nor managers, (if they supervise themselves, they would tend to extract wealth from security owners), but include also outsiders, (they would be controlled by their services` markets); for other resources, there may be other more efficient features so that they defend their interests, (unions and so on would control managers on their behalf), rather than participating in the Board. The capital market takeover threat represents for Fama only a last resort mechanism, given the obstacles it confronts in the case of big corporations.

Fama and Jensen, (“Separation of ownership and control”, 1983), argue that firms efficiently separate decision management and decision control rights, both at the top, (managers and board) and lower levels, (managers and workers). Managers keep for themselves Initiation and Implementation, with the specific knowledge required. The risk bearers keep decision control rights, (ratification and monitoring). Whenever risk bearing is diffused, residual claimants are also separated from decision control, thus agency costs appearing. Separating decision management and control helps avoiding those costs, allowing valuable knowledge being hired at every corner of the organization. And the Board, as a body that holds ratification and monitoring powers, is helpful in that process.

  1. The Transaction Costs economic foundation for Corporate Governance.

Following Hart, (“Corporate Governance: Some theory and implications”, 1995), agency costs are not enough to justify governance principles, as contracts could be drafted to reward agents in a performance based system, (that would avoid agency costs). Nevertheless, contracts are incomplete, and cannot include all future events with the corresponding rewards, (because of the cost of thinking all possible events, the cost of negotiating them all, and the cost of writing an enforceable contract).Corporate governance establishes a mechanism to allocate residual rights of control over the firm`s non human assets, when their usage has not been settled previously.

Following Williamson, (Corporate finance and Corporate Governance, 1988), the transaction costs theory introduces the agent`s bounded rationality and opportunism. So, governance is about crafting governance structures that save on bounded rationality, while avoiding opportunism. “Incomplete contracting in its entirity”, introduces the need to be aware of prospective misinformation, and the need to (i) realign incentives and (ii) draft governance structures that fill the gaps. The Board is an endogenous development to safeguard equity financing. Transaction costs are considered ex post: (i) maladaptation costs when misalignment appears in relation to the “shifting contract curve”, (ii) bilateral costs incurred to obtain alignment, (iii) cost of governance structures, and (iv) bonding costs, the first being the key feature. Williamson introduces the idea that the debt equity choice is not only a corporate finance concern, but also a governance one, related to asset specificity, (that favours equity, with a more intrusive oversight and involvement through the Board of Directors). The boards reduce cost of capital when assets are specific and not redeployable, (a case in which debt imposes too high a burden).

  1. The Resource Dependence Theory.

Udayasankar, (The foundations of Governance Theory: a case for the Resource-Dependence Perspective, 2005), refers to a resource based view of firm performance, where the focus is on how the firm generates unique and valuable resources, and to the fact that Corporate Governance may help in that process, instead of being just a tool for the preservation of existing assets and profits in the firm, and their correct distribution. Following Pfeffer and Salanchik, (1978), directors, through their linkages can procure expertise, reputation and a positive valuation of the firm, legitimacy, and so on; they can also provide tools to afford uncertainty, and help for the firm to generate, maintain and develop specific assets and knowledge, which result in the competitive advantage of the firm. The model is compatible with shareholder maximization, as governance would help bring capital in a differential manner, (helping to deal with agency costs, thus this theory remaining embedded in Resource-dependence theory).

  1. The Stakeholder Theory.

Donaldson and Preston, (The stakeholder theory of the corporation: concepts, evidence and implications, 1995), argue with many that corporations have stakeholders, (owners of a constellation of cooperative and competitive interests with intrinsic value, all of them embedded in the firm). And their support relies on the Property Rights theory, (which is slightly ironic, if the theory is to be opposed to the maximization for shareholders theories). Property is a bundle of many rights, (Coase, and others), some of them restricted. If rights are relations among humans, property rights cannot be separated from human rights, and consequently that introduces restriction on the use of rights because of others`interests. So, managers do not act solely on behalf of owners. The managerial implications are: a) Who is a legitimate stakeholder, (one having a contract with the firm, belonging to its broad community, receivers of either benefits or costs, etc), and b) How do managers need tobehave? They need to be aware of those interests, but the danger of opportunism still remains, so the theory needs to be developed in rules and sanctions. Mahoney, Asher, and Mahoney argue that all the economic value generated for all stakeholders needs to be considered, and all relationships also, so as to understand how the value is distributed, (instead of only considering distribution of profits to shareholders).

Although it is difficult to disagree with Mr Lipton that all those theories may lack a sound empirical and thus normative foundation, there is just enough evidence that when corporations are controlled by managers, without an appropriate corporate governance framework, it is not guaranteed that all interests affected by the firm performance are well and fairly treated, that the distribution of economic value is fair, and survival assured.

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!

Hidden ownership and disclosure recommendations

November 3, 2012 1 comment

We can define Hidden Ownership as the situation of an economic agent having an economic interest over a certain share, over which he hasn`t got any control or voting right, not being the owner of the share. The derivative market is the tool with which this result is usually built, (a future contract, a call option, an equity swap are valid instruments for that).

Hidden owners may also negotiate with short traders in the transaction that they will vote the shares according to the long traders`preferences. In that case the long trader is a hidden and morphable owner. Morphable ownership also appears when the economic risk holder may assume he will be able to decide the sense of the vote of the subjacent shares, whether by agreement with the short trader or because the case is clear for him that the normal solution at the settlement date will be a share acquisition from the short trader, that would buy the shares then, or would have had the shares since the beginning, (imagine the case of an illiquid market for these shares).

The huge growth of derivative markets has led to a parallel increase in the number of decoupling (of economic and control interests) incidents, both empty voting (see our post dated October 7th 2012) and hidden ownership. In the case of a hidden owner, the bank facilitating the derivative usually becomes an empty voter, (hedging his position purchasing shares in the stock market). As the bank has no economic interest with the company, but a commercial interest in the customer, it can eventually accept to vote with the customers`preferences, this one becoming also a morphable owner. As derivatives are today mostly cash-settled, there is no limit to its amount, so that hidden ownership is now easier than it was.

The concern with decoupling is about efficiency, fairness, (decoupling is used by hedge funds, industries, but not by small investors), and regulation circumvention.

Known hidden and morphable ownership cases have been unveiled in Switzerland in 2007, when several companies saw large stakes being disclosed in a takeover hidden attempt; regulation only asked to disclose voting rights and physically settled options. Hu and Black unveil a huge number of cases, and analyse regulatory proposals, (“Equity and Debt Decoupling and Empty Voting II: Imprtance and Extensions”).

Since then a clear case is made for disclosure, pursuing the efficiency result that all shareholders know who is buying or selling, so that the price mechanism works well. For disclosure, Hu and Black propose:

–         Disclosure should involve voting and economic rights, from share od coupled assets (derivatives, share borrowing…), ownership,

–         Disclosure should involve both positive and negative economic interest,

–         Disclosure should involve share lending and borrowing,

–         Consistency of disclosure asset type obligation and types counted for thresholds,

–         Disclosure of empty voting,

As for hidden ownership, disclosure could be enough, as it will not be hidden anymore, and inefficient effects on pricing will not appear. Hu and Black also recommend that voting rights are passed on to the economic owner, as generally banks in a derivative contract are empty voters. This would prevent investors from keeping hidden ownership. Moreover, they recommend that economic owners vote directly, and not through the empty voter, (bank, broker, and so on), so as to avoid complexities and mistakes in the voting process.


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.



CNMV recomienda regular la actividad de las Proxy Advisors.

La CNMV hizo público el 16 de abril el documento elaborado por el Grupo de Expertos que evalúa la actividad de los Proxy Advisors en España.

El grupo,en relación con España, corrobora la influencia de las recomendaciones de los proxy advisorors (PA): las secretarías de los emisores de los Consejos visitan a los proxy advisors, para explicar las propuestas del Consejo a la Junta, yde igual forma visitan a los inversores institucionales (II) fundamentales, para mitigar le influencia de los primeros.

Es de reseñar que la recomendación del advisor no siempre es seguida al pie de la letra, sino que es evaluada por el inversor; en USA se estima que las recomendaciones de los PA influyen directamente entre un 6% y un 10 del voto. En España podría ser algo menos, pues la existencia en muchos emisores de accionistas de control, o participaciones significativas controladas por el Consejo, así como el hecho de que, (frente a un control accionarial del 70% de las compañías por parte de los II en USA), los II en España sólo controlan un tercio del capital, (en el Ibex). No obstante, la influencia es creciente.

Del análisis de su operativa, se destaca:

  • una cierta falta de transparencia, no ya de sus recomendaciones, lo cual es lógico, sino de las directrices utilizadas,
  • la primacía de criterios de buen gobiernos asentados en la experiencia anglosajona, con un mercado societario mucho menos concentrado que el nuestro,
  • el hecho de que no asumen riesgo económico de sus decisiones, (el partícipe lo soporta), ni la responsabilidad del voto, (recae sobre el II),
  • la preocupación de la calidad técnica de las recomendaciones,
  • la existencia posible de conflictos de interés, (al prestar otros servicios también relacionados con el principal).

Alternativas regulatorias: el grupo de trabajo recomienda cierta intervernción regulatoria, en razón a la creciente influencia de las PA, y a los problemas antes referidos, especialmente el primero, cuarto y quinto.

La autorregulación es descartada, pues al ser un mercado oligopólico, internacional, y siendo la sanción en caso de incumplimiento el riesgo reputacional, no parece que la propouesta de realizarse pudiera tener gran efecto.

La adopción de medidas regulatorias imperativas por la Unión Europea no se considera la opción más adecuada, por las barreras de entrada que podría suponer, la existencia de prácticas diferentes en Francia e Inglaterra, y la falta de evidencia concluyente aún hoy, sobre la capacidad de influencia de las PA.

La medida recomendada es la promoción de un código europeo elaborado por la ESMA, (European Securities and Markets Authority) que funcionaría sobre la base del principio de “cumplir o explicar”, lo que iría en línea con las regulaciones francesa e inglesa, así como con la regulación general de gobierno corporativo.

El Grupo de Expertos recomienda que el Código recoja:

  • La obligación de las PA de publicar sus estructura accionarial y de ingresos, sus políticas generales de voto, y de gestión de conflictos de interés.
  • Recomendaciones de formación técnica y regulatoria de los analistas, así como de la carga de trabajo máxima de estos.
  • La obligación de motivar correctamente las recomendaciones, y de que se faciliten previamente al emisor, para corrección de errores y mejora de la calidad del voto en consecuencia.