Incumbent Management Research Articles

Promoting Innovation: The Law of Publicly Traded Corporations

Improving economic welfare requires that societys scarce savings be allocated among proposed real investment projects in a way that appreciates the prospects of promising new innovations. Corporate and securities law help structure important elements of this process of allocation. This article sketches out an approach based upon a seemingly paradoxical analogy of a market economys overall finance process to the way a hierarchical organization gathers and processes relevant bits of information dispersed among many individuals in order to make decisions. It thereby takes advantage of important thinking in communications and organizational theory about how to make organizations sensitive to the potentialities of new information and ideas.The analysis suggests that established firms should pay out a relatively high portion of their cash flows. There should be a substantial venture capital sector and an active market for IPOs. Primary and secondary market prices should be relatively accurate. Incumbent managers of established firms should be judged in part by the medium term share price performance of their firms and poor performers should be under threat of replacement.A comparison of four moments in economic historythe United States in the 1970s and 1980s, Japan since 1995, continental Europe since the 1995, and the United States since the 1995supports these conclusions. The United States since 1995, relative to the other three moments in economic history, has had the least capital deepening and the fastest rate of growth in productivity per hour worked. It has also had, relative to the other three moments, a finance system most closely resembling what is called for here.Achieving such a system requires rigorous, effectively enforced securities disclosure and anti-fraud laws. Corporate law must leave poorly performing incumbent management vulnerable to removal by hostile tender offer, or shareholder or independent board vote. Share price based compensation must be legally practical. And there must be serious constraints on non-pro-rata distribution among shareholders of the wealth created by the firm.

Unbundling Ownership and Control

Treating control as an asset that can be bought and sold, we introduce a model of the simultaneous and separable trading of ownership and control in a private information setting. The model provides a novel explanation for the prevalence and persistence of the separation of ownership from control in modern corporations: efficiency in the market for corporate control is more easily achieved when ownership is not concentrated in the hands of the manager. The central reason is that low managerial ownership reduces informational rents in the market for control. Using a mechanism design approach, we fully characterize the optimal mechanism for restructuring ownership and control. Under the optimal mechanism, corporations typically increase the number of shares of the incumbent manager if he remains in control, and give him a generous golden parachute that includes both stock and cash if he is deposed. By contrast, combining ownership and control is optimal only if agency costs are extreme.

Ownership structure and the likelihood of financial distress in the Netherlands

This article examines the impact of ownership structure on the likelihood of financial distress of Dutch firms listed on the Amsterdam Stock Exchange (Euronext) from 1992 to 2002. We find that firms with higher levels of managerial shareholdings are less likely to experience financial distress. This finding is consistent with the alignment hypothesis that managers with higher ownership stakes are more likely to avoid financial distress. We also find empirical evidence that large outside shareholders reduce the probability of financial distress. Monitoring incumbent management by large outside shareholders might prevent sub optimal managerial behaviour and reduce the likelihood of financial distress. Finally, we find no evidence that high levels of institutional shareholdings are associated with a lower probability of financial distress.

Manager Replacement, Employee Protesting and Corporate Control

When faced with replacement threat, incumbent managers can look for support from employees to keep their position, by investing in an employee-friendly relationship. Enjoying such relationship, employees will help managers to preserve their job by protesting against shareholders. Interestingly, I find that when the benefits from the close relationship are large enough compared with the difference in managers' ability, shareholders' welfare increases with the investment in relationship and they prefer to share part of their power on the firm with employees. When considering industrial characteristics, shareholders, from industries where human capital is more important than physical assets, are more willing to share the power and managers are more willing to invest in the employee close relationship than those from the industries with less human capital importance.

Compensation for Tournament Losers?

In a corporate tournament, executive directors are motivated by the prospect of promotion to CEO. When a rival is promoted, an executive director might expect compensation for the loss of the promotion incentive, otherwise she might leave. However, if loser compensation is anticipated ex-ante, the original promotion incentive is compromised. Further, the very act of being passed over may diminish the market’s valuation of the director’s human capital. Nevertheless, in a large panel of UK companies, incumbent directors receive approximately a 10% increase in salary following a rival’s promotion to CEO. Further, the losing directors are almost twice as likely to leave, suggesting that the loss of the promotion incentive is of material value, as predicted by tournament theory.

Steel Partners' activism efforts at United Industrial, Ronson, and BKF Capital

PurposeThis paper seeks to analyse Steel Partners' investments and activism targeting United Industrial, Ronson, and BKF Capital to provide context for the debate surrounding shareholder activism by hedge funds and how incumbent management should cope with it. Steel Partners is one of the busiest and most controversial activist investors in both the USA and Japan.Design/methodology/approachAn in‐depth clinical analysis of Steel Partners activism at three targets is performed. Context is then provided with a broader study of 63 companies targeted by Steel Partners.FindingsThe paper reveals that Steel achieved remarkably different degrees of success with each target. This analysis suggests the use of longer post‐activism windows to examine performance, more nuanced definitions of successful activism, and the inclusion of officer and director ownership as a predictor of activist success and target performance.Practical implicationsManagers wishing to maintain their independence face a difficult balancing act. One option is simply to refuse to negotiate, preferably while maintaining a substantial ownership stake. However, the activist might launch a proxy fight or hostile bid, file a lawsuit, or even encourage a wolf‐pack type campaign. For activists, target selection, especially managerial ownership, and patience are important. Steel quickly achieved its goals at BKF and failed at Ronson despite maintaining its stake for more than 13 years. It suffered large losses in both cases.Originality/valueThis paper provides researchers and practitioners with additional insights into the debate concerning the value of hedge fund activism. It also suggests several new questions to researchers examining corporate governance and activism.

Proxy Voting by Exchange-Traded Funds: An Analysis of ETF Voting Policies, Practices and Patterns

Exchange-traded funds (ETFs) are an important and growing segment of the securities markets and have amassed considerable voting power through their equity holdings. This study examined the proxy voting policies, guidelines and recent voting records of seven of the largest exchange-traded fund sponsors. We found that, among these large ETF sponsors, there is considerable variation in the voting patterns and philosophies of these funds. This variation is highlighted by how the seven funds voted during the 2008 proxy season at a sample of twenty-one specific votes on a variety of important governance and social policy issues. On one end of the spectrum, Profunds voted with management on only 5 of the 21 proposals in our sample; at the other end, Rydex voted with management on 19 of the 21 proposals, with the remaining funds falling in between.We found some evidence that the three largest ETF sponsors - Barclays Global Investors, State Street and Vanguard - who together have a dominant share of the ETF market, are somewhat less likely to vote against management on management proposals and shareholder proposals than are most of the smaller fund sponsors. On the other hand, the three largest ETFs also appear to withhold votes from incumbent directors at a greater number of companies than the smaller funds. This likely indicates the use of 'withhold' votes against directors as a substitute method for expressing dissatisfaction with certain management practices, rather than voting against management on specific proposals. Our voting review also found that funds that relied heavily or exclusively on a proxy advisory firm for their voting guidelines tended to vote against management more frequently than those that did not. The votes examined were generally consistent with the written voting policies of the funds, although we identified a few cases where votes appeared to be potentially contrary to a fund’s written voting policies. Case-by-case voting policies are utilized by many of the funds - where voting decisions are based on the specific facts and circumstances at a particular company, as well as on the issue being voted - and explain some of this consistency.There were also significant differences between the ETFs in terms of the level of detail and length of their proxy voting guidelines, with firms relying on guidelines provided by proxy advisory firms tending to have the most detailed, and also the most prescriptive, voting guidelines. Proxy voting guidelines ranged from lengthy documents describing highly detailed voting guidelines on a wide range of issues to very cursory guidelines that stipulated voting with management on virtually all issues.

Pre‐packin' in the UK

AbstractA pre‐pack administration is one where a deal has already been agreed prior to the company entering administration. The company's business will commonly be sold to the incumbent management team immediately the company is placed into administration. The business survives relatively intact but will have managed to jettison its unsecured debt. The business is saved and jobs are saved. The pre‐pack will usually require the support of the company's bankers. Recent research suggests that pre‐packs may constitute between 50% and 80% of all insolvent going concern sales. The UK version of a pre‐packaged administration appears to have been rare until the administration process under the Insolvency Act 1986 was significantly amended in 2002, permitting a company to be placed into administration without a court order. The UK version of pre‐packaged administration does not involve any plan being approved by different classes of creditor nor for the court to be involved in approving activities of the administrator before or after the plan is put into effect. The paper considers whether or not pre‐pack administrations fit into the statutory framework of the Insolvency Act, the professional ethics requirements of being an insolvency practitioner and the equitable rules governing fiduciaries. Some aspects of the policy underpinning pre‐packs are also considered in particular the decision to allow insolvency practitioners to claim pre‐appointment fees as an expense of the administration. This decision appears to herald a change in government policy. This policy change is also considered. Copyright © 2009 John Wiley & Sons, Ltd.

Managerial Entrenchment and the Market for CEOs

This paper studies how the generality of managerial skills affects firms' governance decisions. As managerial skills become less firm-specific and more portable across firms, the market for talent offers better opportunities for replacing an incumbent chief executive officer (CEO) with an external hire. This results in higher pay in the market, but, overall, the profitability of an external appointment increases in large firms, where managerial talent is most productive. As a consequence, large firms limit the entrenchment of incumbent managers to take advantage of the improved replacement opportunities offered by the market. The analysis rationalizes the recent trend toward stronger corporate governance and offers novel empirical predictions concerning the relationship between managerial entrenchment, firm size and the generality of managerial skills.

Are Poison Pills Poison for Shareholders? Evidence from Japan

It remains debatable whether poison pills create or dilute shareholder wealth. The present study examines the Japanese market, where the adoption of poison pills accelerated during 2006 and 2007. Companies with lower ownership by keiretsu affiliates, employees and management are more likely to adopt poison pills. The adoption of a poison pill is associated with lower post-adoption excess returns, relative to firms that do not employ the defense. However, this is mitigated where there is a positive perception of incumbent management.

When Do Managers Seek Private Equity Backing in Public-to-Private Transactions?

Over the last decade, the going private market has experienced a considerable boom in size and also has become more interesting for private equity investors that are looking to partner with incumbent management. This offers managers the choice to take the firm private themselves in a traditional management buyout or to seek private equity backing. We propose that managers decide for a management buyout without any involvement of private equity in case they are less financially constrained: when their firms are undervalued, have high cash levels, are smaller and less financially visible, and the managers own a large toehold. In contrast, managers invite participation of private equity investors when they cannot complete the deal themselves: in firms that are larger, have less cash and managers own a smaller fraction of the firm. Our analysis on a sample of UK public-to-private transactions completed over the period 1997-2003 provides results that are in line with these predictions.

The impact of corporate governance legislation on the market for corporate ownership

Over the past few years, the number of corporate scandals and failures throughout the world has escalated, prompting new legislation designed to enhance corporate governance. While the efforts to legislate corporate governance policies are designed to protect the public interest, they have altered the relationship between shareholders and management (Canada et al. 2008). Rather than be subjected to new corporate governance requirements, many companies have indicated an interest in not being traded on the various stock exchanges and have chosen to alter their corporate structure. The purpose of this study is to examine how a company‟s decision to shift corporate ownership and/or corporate control in the face of new corporate governance legislation and regulatory requirements can alter the traditional markets for ownership and control. In order to examine this issue, the paper first develops a typology for predicting the type of organizational restructuring that might occur. This typology incorporates factors from prior research and disentangles the market for ownership from the market for corporate control. The typology is then used as a basis for an in-depth examination of an organization whose corporate structure changed in response to mandated changes in corporate governance. The results provide evidence that corporate governance legislation can potentially induce incumbent management to voluntarily compete in the market for ownership, notwithstanding the associated exposure in the market for managerial control.

Do differences in institutional and legal environments explain cross-country variations in IPO underpricing?

We empirically analyse the determinants of Initial Public Offering (IPO) underpricing using panel data for 24 countries over the period 1988–2005. Our hypotheses stress the importance of institutional and legal factors in explaining cross-country variations. We find evidence that underpricing is higher in countries with stronger protection of outside investors, suggesting that incumbent managers try to use underpricing as a tool to safeguard their private benefits of control when going public. Moreover, the results show that underpricing is reduced when stronger law enforcement and the availability of accounting information reduce the value of private benefits of control.

It's good to share

A traditional way for protestors against business activities to make their point is to buy one or two shares in the business, turn up at the annual shareholders' meeting, and ask awkward questions. The business panjandrums—who are usually hard to reach, unless you're Michael Moore—are made to squirm, and the protestors feel that at least momentarily they have some power. Anti-tobacco campaigners have been doing this for years. I had my first experience of such activity on Tuesday 17 April, when a small group of us went to the annual meeting of Reed Elsevier to protest at the hypocrisy of the company, the largest publisher of medical journals, promoting arms fairs. Are they about life or death? Despite wearing a suit in order to seem ‘business respectable’, I felt like Swampy and thoroughly enjoyed myself. I'd never been to an annual shareholders meeting, and I vaguely imagined smart MBA analysts pinning the besuited panjandrums to the wall. The panjandrums were certainly there—13 of them, all middle aged to old men but for one middle-aged woman. They sat in a row on the stage and looked uncomfortable in the gloom. This was not, I thought, the highlight of their year. But instead of the smart MBAs, there was a small collection of people, mostly very elderly, and they attacked the free food with gusto. The few questions the shareholders asked were largely inane, but it was amusing to see Sir Crispin Davis, Reed Elsevier's chief executive, struggling to answer a question from a woman who seemed to hope that computers would go away and textbooks stage a return. This was after Sir Crispin had announced ‘strong growth in online sales’, a movement to ‘workflow solutions’, and the sale of their education business. After wittering for a while he ended lamely by saying that he too loved books. The whole thing was largely an empty ritual, and perhaps our questions provided some light relief. The minute that Sir Crispin finished his low-energy presentation we leapt in. Hadn't Reed Elsevier invited Iran to an arms fair? Wasn't the company damaging the reputation and brand of journals like the Lancet by running arms fairs? How could that be sensible when Sir Crispin had just emphasized the importance of brand? How could it make business sense to put at risk its large and profitable scientific journals business by running a small arms fair business? What about their staff, many of whom are passionate about science and health and horrified by the arms business? One of the snags of these meetings is that the panjandrums are not obliged to answer the questions. They simply didn't at first, but luckily the chairman called me again—not realizing in the gloom, I suspect, that I'd already had one go. The second time they did better, but with discomfort. Eventually the audience began to tire of our questions, longing perhaps for their cucumber sandwiches. Much better, said one woman, to have a respectable company like Reed Elsevier promoting arms rather than some ‘banana republic’. She hovered on the edge of political incorrectness, and probably the panjandrums could have done without her support. But then another man—PG Wodehouse might have described him as a small gin and tonic with a moustache—said that he didn't care for these lobbyists, and the thin crowd applauded. We then raced through the votes. Around 80 of us in the audience voted electronically, while up on the screen hundreds of thousands voted in favour of the motions, most passing with 99% majority. I dutifully voted against all the incumbent directors up for re-election (these are the people who have approved the arms business) but in a moment of charity voted for the new man from Gucci. I felt I ought to give him a chance. As the crowd staggered to their light refreshments we chatted to some board members. One at least seemed to have enjoyed our contributions and suggested we may have had impact. The empire of Reed Elsevier will not crumble because of our morning out, but the board might well decide, in purely business terms, that the small profits from the arms fares don't justify the hassle and the damage to reputation. We shall see, but the campaign goes on. Why not buy a share and come along next year? It's rather fun, and the lunch looked good.

Fire the manager to improve performance? Managerial turnover and incentives after privatization in the Czech Republic

AbstractThis paper analyses the effect of the introduction of managerial incentives and new human capital on enterprise performance immediately after privatization in the Czech Republic. We find weak evidence for the presence of managerial incentives: only from 1997, 3 to 4 years after privatization, does poor performance significantly increase the probability of managerial change. Nevertheless, replacing the managing director in a newly privatized firm improves subsequent performance. This indicates that the privatized firms operate below potential under the incumbent management. We show that the institutional framework matters as well: managerial turnover improves performance only if the management is closely interconnected with the board of directors and thus holds effective executive authority.

What Do Shareholders’ Coalitions Really Want? Evidence from Italian voting trusts

This paper studies the effects of having multiple large shareholders who share the control of firms, by analysing a unique dataset of Italian shareholders’ agreements (voting trusts). We investigate the separation between ownership and control granted by such agreements, showing that, on average, a voting trust owning 52 per cent of the total company’s cash‐flow rights is able to exercise up to 87 per cent of the total board rights; the wedge is particularly beneficial to the largest shareholder within the voting trust who is able to get the majority of board rights despite owning only a minority fraction of the company’s cash‐flow rights. Then, an event‐study analysis of a sample of voting trusts’ announcements is performed. The results support the “entrenchment effects” hypothesis (Stulz, 1988) linking the ownership structure and the firm value, and are consistent with the view that, in Italy, voting trust agreements are mainly aimed at both protecting controlling shareholders from hostile takeovers and entrenching incumbent management.

Shareholders in Action

Recently a new category of shareholders is manifesting itself: as activist shareholders they intervene in the actual running of the company, dictating its governance, determining its strategies, and often taking a very aggressive attitude against the incumbent management. Their action is severely criticized by the politicians or in the media, as being destructive of the firms, of enterprise values or of employment. The paper aims at describing the features of the activist shareholders, comparing them to their elderly brothers, the institutional investors, concluding that more disclosure should be available about them, while suggesting that in case they effectively take control of the company, a remedy similar to the mandatory bid may be considered.

Korea's Newly Enacted Unified Bankruptcy Act: The Role of the New Act in Facilitating (or Discouraging) the Transfer of Corporate Control

Korea recently enacted the Unified Bankruptcy Act. It aims to streamline existing bankruptcy procedure by consolidating various statutes governing bankruptcy into a single statute. Prior to the current enactment, when a company was in distress, it could restructure itself and continue its operation through corporate reorganization or through composition and, during the reorganization procedure, the incumbent manager was often discharged. Under the new statute, a single type of rehabilitation proceeding is available for a distressed company and the incumbent manager is generally retained as the receiver. This article reviews the current bankruptcy regime in Korea and argues that this change has a risk of being used as an entrenchment device for incumbent managers. In a country where control transfer rarely takes place, the transfer of corporate control would become even more difficult. Further, this article argues that in order to ameliorate this risk, it would be desirable to require a sales process once a distressed company is in corporate bankruptcy proceedings.

When Do Managers Seek Private Equity Backing in Public-to-Private Transactions?

Over the last decade, the going private market has experienced a considerable boom in size and also has become more interesting for private equity investors that are looking to partner with incumbent management. This offers managers the choice to take the firm private themselves in a traditional management buyout or to seek private equity backing. We propose that managers decide for a management buyout without any involvement of private equity in case they are less financially constrained: when their firms are undervalued, have high cash levels, are smaller and less financially visible, and the managers own a large toehold. In contrast, managers invite participation of private equity investors when they cannot complete the deal themselves: in firms that are larger, have less cash and managers own a smaller fraction of the firm. Our analysis on a sample of UK public-to-private transactions completed over the period 1997-2003 provides results that are in line with these predictions.

Separation of control rights and cash-flow rights in emerging economies: theory and Mexican evidence

Researchers have identified that corporate ownership structures appear to be quite different in developed and developing economies. For instance, Castañeda Ramos (1999) provides evidence of considerable separation of cash-flow rights and control rights accruing to inside and outside equityholders in publicly listed firms in Mexico. Insiders use mechanisms such as dual voting rights, majority rules and pyramids to maximise their control rights while holding minimal cash-flow rights. In contrast, there is a much closer alignment of cash-flow rights and control rights in developed countries such as UK or US. The purpose of this paper is to develop a game-theoretic model that explains these features. We argue that factors in emerging markets, such as large private benefits of control, extreme risk, low investor protection, inefficient capital markets, and governments sympathetic to incumbent management at the expense of outside investors, all contribute to insiders’ incentives to create a separation of cash flow and control rights. We present evidence from Mexico that supports our results