Person:

Ferrell, Allen

In order to have recoverable damages in a Rule 10b-5 action, plaintiffs must establish loss causation, i.e. that the actionable misconduct was the cause of economic losses to the plaintiffs. The requirement of loss causation has come to the fore as the result of the Supreme Court's landmark decision in Dura Pharmaceuticals v. Broudo. We address in this paper a number of loss causation issues in light of the Dura decision, including issues surrounding the proper use of event studies to establish recoverable damages, the requirement that there be a corrective disclosure, what types of disclosure should count as a corrective disclosure, post-corrective disclosure stock price movements, the distinction between the class period and the damage period, collateral damage caused by a corrective disclosure, and forward-casting estimates of recoverable damages.

We investigate which provisions, among a set of twenty-four governance provisions followed by the Investor Responsibility Research Center (IRRC), are correlated with firm value and stockholder returns. Based on this analysis, we put forward an entrenchment index based on six provisions - four constitutional provisions that prevent a majority of shareholders from having their way (staggered boards, limits to shareholder bylaw amendments, supermajority requirements for mergers, and supermajority requirements for charter amendments), and two takeover readiness provisions that boards put in place to be ready for a hostile takeover (poison pills and golden parachutes). We find that increases in the level of this index are monotonically associated with economically significant reductions in firm valuation, as measured by Tobin's Q. We present suggestive evidence that the entrenching provisions cause lower firm valuation. We also find that firms with higher levels of the entrenchment index were associated with large negative abnormal returns during the 1990-2003 period. Moreover, examining all sub-periods of two or more years within this period, we find that a strategy of buying low entrenchment firms and selling short high entrenchment firms out-performs the market in most such periods and does not under-perform the market even in a single sub-period. Finally, we find that the provisions in our entrenchment index fully drive the correlation, identified by prior work, that the IRRC provisions in the aggregate have with reduced firm value and lower stock returns during the 1990s; we do not find any evidence that the other eighteen IRRC provisions are negatively correlated with either firm value or stock returns during the 1990-2003 period.

Data on the entrenchment index for the period 1990-2007, and a list of over seventy-five studies using our entrenchment index, is available for downloading at Lucian Bebchuk's home page.

We investigate the relative importance of the twenty-four provisions followed by the Investor Responsibility Research Center (IRRC) and included in the Gompers, Ishii, and Metrick governance index (Gompers, Ishii, and Metrick 2003). We put forward an entrenchment index based on six provisions: staggered boards, limits to shareholder bylaw amendments, poison pills, golden parachutes, and supermajority requirements for mergers and charter amendments. We find that increases in the index level are monotonically associated with economically significant reductions in firm valuation as well as large negative abnormal returns during the 1990–2003 period. The other eighteen IRRC provisions not in our entrenchment index were uncorrelated with either reduced firm valuation or negative abnormal returns.

The desirability of mandatory disclosure requirements in securities regulation has been the subject of a longstanding debate among corporate law scholars and economists. The debate has largely focused on the desirability of mandatory disclosure requirements in the United States, a country characterized by dispersed ownership structures. This article argues that there are strong theoretical reasons to believe that mandatory disclosure requirements can play a socially useful role in countries with concentrated ownership structures. Controlling shareholders will tend to prefer poor firm transparency, to protect their private benefits of control, even if the presence of a demanding disclosure regime would have the socially desirable effect of increasing competition in the capital and product markets and reducing the agency costs associated with concentrated ownership structures. Recent empirical work is consistent with mandatory disclosure requirements fulfilling the valuable role of enhancing competition and reducing agency costs.

The modern approach to corporate reorganizations begins in a curious place. Everywhere else in corporate law, we focus on those who control the firm and on when others should be able to go to court and reverse their decisions. With respect to corporate reorganizations, however, we ignore these questions and instead focus on priority rights. Our lodestar is the real estate foreclosure. A real estate foreclosure is an actual sale of a physical asset, and the proceeds of the sale are distributed to old creditors and shareholders according to nonbankruptcy priorities. A reorganization is also a sale, albeit a hypothetical one, and the proceeds of the sale (usually in the form of new claims against the reorganized firm) are again distributed to the old creditors and shareholders. Hence, nonbankruptcy priorities should be respected here as well. According to this conventional wisdom, the primary challenge in the law of corporate reorganizations lies in devising a process that allows us to respect priority rights when there is not an actual foreclosure with competing bids.

In this paper, we show that this conventional understanding of corporate reorganizations is wrong. It might seem that the primary question when all cannot be paid in full is who gets what, but this question is in the first instance merely distributional. It concerns only the size of the slices, not the size of the pie. Rational investors are indifferent to the priority they enjoy in bad states as long they enjoy a competitive risk-adjusted return on their investment. Hence, the central focus of corporate reorganizations should not be upon priority rights. Instead, as in corporate law generally, it should remain upon how the firm's assets are used and who controls them. Investors care intensely about ensuring that control of a firm's assets resides in able hands in good times; they care even more in bad times. When a firm is in financial distress, a large part of its value can be lost in a short period of time.

The starting place for corporate reorganization scholarship since the 1930s -- the real estate foreclosure -- ignores the question of control. Real estate foreclosure turns tangible assets into cash. With such a sale, there is no need to decide whether to liquidate the firm or to replace the current managers. These decisions can be entrusted to the new buyer. The only question is the distribution of cash among old creditors and shareholders. By contrast, in a reorganization that might last months or years, we must ask whether to continue the firm, how to identify those who will run it, and how to monitor them. About these questions, the real estate foreclosure analogy has nothing to say.

Moreover, the foreclosure analogy leads to a method of allocating rights among old investors in the new entity that is affirmatively suspect. This distributional scheme-the absolute priority rule- demands that shareholders of insolvent firms be wiped out in the event of a reorganization. This rule exists uncomfortably with a persistent and pervasive feature of the capital structures of all but the largest, publicly held firms. In smaller firms, there is a near identity between shareholder and manager.

The value of such firms as going concerns depends upon the firm-specific human capital of its manager. To be sure, if the firm lacks any value as a going concern, it should be liquidated. In such a case, there is an actual sale and nonbankruptcy priorities should be respected. But a significant number of firms have value as going concerns, and this value can be preserved only if the current manager remains in place and continues to hold the equity of the firm. When such a firm is kept as a going concern, a deal must be struck with the current manager one way or another. The dynamics of these renegotiations are such that the absolute priority rule likely has no effect on the share of the firm the manager enjoys after the reorganization, nor does it change her incentives beforehand. In short, modern scholars of corporate reorganizations have asked the wrong question and then offered an answer that is very likely irrelevant.

In this Essay, we reexamine the foundations of corporate reorganizations. More in harmony with the modern understanding of corporate law, our approach does not begin with the real estate foreclosure and does not assume the centrality of the absolute priority rule. With respect to small firms or firms in less developed capital markets, we show that the question of whether to shut down the firm is of central importance. The challenge of the law of corporate reorganizations should be one of ensuring that this decision is in the hands of someone well equipped to make it.

The thesis put forward in this Essay is straightforward. When the managers and shareholders cannot be easily separated, control rights should lie in the hands of someone whose loyalties are aligned with the creditors, but the reorganization itself should not affect the value of the managers' equity interest. These principles are not new, but rather forgotten. Although they barely made a toehold in the academic literature of the time, 10 the early law of corporate reorganizations in this country adopted these principles in an environment in which it seems likely that they vindicated the creditors' bargain. Hence, it is this body of law to which we turn first.

The paper puts forward a new approach to two corporate subjects that have been intensively debated in the last three decades, the regulation of takeovers and state competition in the production of corporate law. During this period, U.S. state takeover law has produced considerable and quite possibly excessive protection for incumbent managers from hostile takeovers. Although the shortcomings of state takeover law have been widely recognized, there has been little support for federal intervention because of the concern that such intervention might produce even worse takeover arrangements. This paper, however, identifies a form of federal intervention in the regulation of takeovers "choice-enhancing" intervention that would address these shortcomings without raising such a concern.

"Choice-enhancing" federal intervention would consist of two elements: (i) an optional body of substantive federal takeover law which shareholders would be able to opt into (or out of) and (ii) a mandatory process rule that would provide shareholders the right to initiate and adopt, regardless of managers' wishes, proposals for opting into (or out of) the federal takeover law. An alternative version of choice-enhancing intervention would provide a federal law requiring states to allow shareholders to initiate and approve opting out of anti-takeover arrangements provided by the state's law. We argue that such a federal role in takeover law cannot harm and would likely improve the regulation of takeovers. Moreover, by showing how federal law can be used to improve regulatory competition in the provision of takeover law rather than preempt it, our analysis lays the groundwork for a more general reconsideration of regulatory competition in the corporate law.

This piece provides our amicus curiae brief in the case of American Federation of State, County & Municipal Employees Pension Plan v. American International Group, which is now under consideration by the Second Circuit Court of Appeals. In this case, a shareholder submitted a proposal to amend the company's bylaws to require the company in certain circumstances to place candidates nominated by shareholders on the company's ballot, and the company sought to exclude this proposal from the ballot. We suggest in our amicus curiae brief that companies should not be allowed to exclude form the company ballot bylaw amendments concerning corporate elections. Prohibiting companies from doing so, we argue, is required by a reasonable interpretation of the proxy rules and necessary to advance the policy goals underlying the rules. As an appendix to the brief we attach a letter to the SEC sent by forty-eight law professors including ourselves that expresses a similar position.

This paper addresses one of the key issues – the foreseeability of the housing market downturn that began in September of 2007 and intensified in the fourth quarter of 2007 – that must be addressed in assessing the extensive securities class action litigation that has been filed against financial institutions (and others) seeking to recover damages for investor losses arising out of the credit market crisis. We begin our analysis of this issue by first discussing the legal centrality of this issue to much of this litigation. We then turn to answer the question of when the housing market downturn became foreseeable by analyzing housing prices (regional and nationwide), housing sales, housing future contracts, and various market spreads such as the ABX triple A indexes. We conclude that these data are consistent with the view that the housing market downturn was in fact not foreseen by the market prior to the fourth quarter of 2007.