Research Debate Regulatory competition and board insulation: Lessons the UK should not learn from the US

Transcription

1 Research Debate Regulatory competition and board insulation: Lessons the UK should not learn from the US Prof. Lucian A. Bebchuk (Harvard Law School) 8 May 2006, LSE

2 Lessons not to Learn from the US Lucian Bebchuk Presentation at "Corporate Governance at LSE" London, May 8, 2006

3 My subject: US-UK comparisons are of interest countries are similar in important respects, including the dispersion of ownership Speakers from the US often focus on what other countries can learn from the US. I will talk about what lessons should not be learnt from the US. My focus will be on: -- The problems with regulatory competition -- The costs of board insulation from shareholders -- The political economy of US corporate governance

4 US regulatory competition Each pubic company is subject to the corporate code of the state where it is incorporated. Delaware is the dominant state (60% of the incorporations of Fortune 500 firms) "Creeping federalization" over the past seventy years but presumption is in favor of state law. Should Europeans embrace the regulatory competition model?

5 The pro-competition view Demand side premise: firms will choose to incorporate where the rules are best for shareholders. Supply side premise: states will seek to maximize the number of incorporations => Conclusion: regulatory competition produces a "race to the top" -- and Delaware won it by offering the rules that maximize share value.

6 The Evidence offered for the procompetition view: Events duties of reincorporation (Starting with Romano, 1985) -- Initial studies find positive returns but subsequent studies report mixed results. --Moreover, there is a problem of endogeneity. Tobin's Q studies -- Daines (2002) finds negative correlation -- but results do not hold in subsequent studies [Subramanian (2004), Bebchuk, Cohen, and Ferrell (2004)] -- And, again, there is endogeneity problem

7 Problems with the demand side Decisions where to reincorporate are controlled by management reincorporation must be initiated by the board => reincorporations will happen only when management prefers them. Tension between the substantive content of current state law and the reason supporters for why state competition be expected to produce optimal rules.

8 Problems with the demand side (cont.) Evidence on antitakeover provisions: (Bebchuk and Cohen, 2003): States that have more antitakeover statutes are more successful in attracting incorporations Estimates that, compared with adopting no antitakeover statutes, adopting all standard antitakeover statutes enabled the states that adopted them to more than double the percentage of local firms that incorporated in-state (from 23% to 49%).

9 Problems with the supply side (1) Lack of vigorous competition: * Although 40% of companies are incorporated outside Delaware, more than 90% of companies are incorporated either in Delaware or in their states of headquarters. (Bebchuk and Hamdani, 2002; Bebchuk and Cohen, 2003) In the market for out-of-state incorporations, Delaware is a virtual monopolist other states are not competing and are merely offering incorporation services to local companies

10 Problems with the supply side (cont.) (2) State law has chosen not to use some tools that federal law has used effectively: (Bebchuk and Hamdani, 2006) -- Federal law uses not only judge-made law but also detailed regulations -- Federal law uses not only private enforcement but also public enforcement -- Federal law imposes liability not only on insiders but also on outsiders -- Federal law uses not only civil liability but also criminal liability

11 The History of Federal Intervention Bebchuk and Hamdani (2006) study the patterns of federal intervention over the past seven decades. Conclude: federal intervention has systematically replaced state law arrangements with regimes more protective of investors. Without the federal interventions of the past seven decades, the U.S. level of investor protection would be dramatically than it is at present. Anyone not prepared to accept that existing U.S. law provides investors with vastly excessive level of protection should not be prepared to accept the race-to-the-top view.

12 The Pro-insider Tilt of US Corporate Law Board insulation from removal via takeover or proxy fights Board control over the rules-of-the-game

13 Board insulation from removal Unlike the UK, public companies in the US may use a poison pill and all have at least a shadow pill. Unlike the UK, the board is staggered in about half of US public companies two elections are needed to replace a majority of directors.

14 The Staggered Board - Poison Pill Combination A powerful takeover defense Doubles the likelihood of remaining independent both in the short run (from 34% to 61%) and in the long run ( We also find that an ESB nearly doubled the odds of remaining independent for an average target in our data set,, halved the odds that a first bidder would be successful, from 34% to 14%, and reduced the odds of a sale to a white knight, from 32% to 25%. (Bebchuk., Coates, Subramanian (2002)) Remaining independent results in significant loss both in the short run and the long run (from 23% to 47%). Having a staggered board reduces the return to target shareholders by about 8-10%.

15 Board insulation from a proxy fight Shareholders cannot place candidates on the ballot Exacerbates the financing disadvantage of challengers. During , there were on average only about 10 challenges a year, with only two a year in companies with market cap exceeding $200 million. There were about 3 challenger victories a year, with only 2 during the decade in companies with market cap exceeding $200 million. (Bebchuk, 2003, 2006)

16 The Costs of Entrenched Boards Bebchuk and Cohen (2005) find a negative correlation between Tobin s Q and staggered boards. Bebchuk, Cohen, and Ferrell (2005) find a negative correlation between Tobin s Q and an entrenchment index. -- Also find a negative correlation between the level of the entrenchment index and risk-adjusted returns during the period going long companies with low entrenchment and short companies with high entrenchment would have produced abnormal returns of 3% a year, [Glass Lewis now offers a Board Accountability Index product the S&P 500 with adjustments based on the entrenchment index]

17 Board control over the rules-of-the-game Companies live a long life in an ever changing environment. Under US state law, only the board may initiate charter amendments and reincorporation. This + the limits on shareholder power to remove the board enable boards not to follow shareholder preferences with respect to rules-of-the-game decisions: In a majority of the companies where precatory resolutions to dismantle a staggered board passed during , boards did not follow them by 2004 (Bebchuk, 2005).

18 Why the Difference? If indeed shareholders have weaker rights in the US than in the UK, what explains this? Are shareholders a more powerful interest group in the UK than in the US?-- and if so why? Are institutional investors: -- More concentrated? -- More long-term holders? -- Capturing a larger fraction of improvement in the value of firms? -- Less dependent on management for business

19 Conclusion The US might be a great country But: Much caution is advised before following its example in the corporate governance area.