Person:

Fried, Jesse

This Article identifies a cost to public investors of tying executive pay to the future value of a firm’s stock - even its long-term value. In particular, such an arrangement can incentivize executives to engage in share repurchases (when the current stock price is low) and equity issuances (when the current stock price is high) that reduce “aggregate shareholder value,” the amount of value flowing to all the firm’s shareholders over time. The Article also puts forward a mechanism that ties executive pay to aggregate shareholder value and thereby eliminates the identified distortions.

Thousands of US companies appear to have secretly backdated stock options. This paper analyzes three forms of secret option backdating: (1) the backdating of executives' option grants; (2) the backdating of non-executive employees' option grants; and (3) the backdating of executives' option exercises. It shows that each type of backdating less likely reflects arm's-length contracting than a desire to inflate and camouflage executive pay. Secret backdating thus provides further evidence that pay arrangements have been shaped by executives' influence over their boards. The fact that so many firms continued to secretly backdate after the Sarbanes Oxley Act, in blatant violation of its reporting requirements, suggests recent reforms may have failed to adequately curb such managerial power.

We explain why firms should have a policy requiring directors to recover “excess pay” – payouts to executives resulting from an error in compensation metrics (such as inflated earnings). We then analyze the clawback policies voluntarily adopted by S&P 500 firms as of 2010 and find that only a small fraction had such a policy. Our findings suggest that the Dodd-Frank Act, which requires firms to adopt a clawback policy for certain types of excess pay, will improve compensation arrangements at most firms. We also suggest how the types of excess pay not reached by Dodd-Frank should be addressed.

Firms, investors, and regulators around the world are now seeking to ensure that the compensation of public company executives is tied to long-term results, in part to avoid incentives for excessive risk taking. This Article examines how best to achieve this objective. Focusing on equity-based compensation, the primary component of executive pay, we identify how such compensation should best be structured to tie pay to long-term performance. We consider the optimal design of limitations on the unwinding of equity incentives, putting forward a proposal that firms adopt both grant-based and aggregate limitations on unwinding. We also analyze how equity compensation should be designed to prevent the gaming of equity grants at the front end and the gaming of equity dispositions at the back end. Finally, we emphasize the need for widespread adoption of limitations on executives’ use of hedging and derivative transactions that weaken the tie between executive payoffs and the long-term stock price that well-designed equity compensation is intended to produce.

In many business bankruptcies in which the firm is to be preserved as a going concern, one of the most difficult and important problems is that of valuing the assets that serve as collateral for secured creditors. Valuing a secured creditor's collateral is needed to determine the amount of the creditor's secured claim, which in turn affects the payout that must be made to the creditor. Such valuation has generally been believed to require either litigation or bargaining among the parties, which in turn give rise to uncertainty, delay, and deviations from parties' entitlements. This paper puts forward a new approach to valuing collateral that involves neither bargaining nor litigation. Under this approach, a market-based mechanism would determine the value of collateral in such a way that no participant in the bankruptcy would have a basis for complaining that secured creditors are either over- or under-compensated. Our approach would considerably improve the performance of business bankruptcy and could constitute an important element of any proposal for bankruptcy reform.

We report the results of an online survey, conducted on behalf of Harvard Law School, of 124 practicing attorneys at major law firms. The survey had two main objectives: (1) to assist students in selecting courses by providing them with data about the relative importance of courses; and (2) to provide faculty with information about how to improve the curriculum and best advise students. The most salient result is that students were strongly advised to study accounting and financial statement analysis, as well as corporate finance. These subject areas were viewed as particularly valuable, not only for corporate/transactional lawyers, but also for litigators. Intriguingly, non-traditional courses and skills, such as business strategy and teamwork, are seen as more important than many traditional courses and skills.

In our recent book, Pay without Performance, and in several accompanying and subsequent papers, we seek to provide a full account of how managerial power and influence have shaped executive compensation in publicly traded U.S. companies. Financial economists studying executive compensation have typically assumed that pay arrangements are produced by arm’s-length contracting, contracting between executives attempting to get the best possible deal for themselves, and boards trying to get the best possible deal for shareholders. This assumption has also been the basis for the corporate law rules governing the subject. We aim to show, however, that the pay-setting process in U.S. public companies has strayed far from the arm’s-length model. Our analysis indicates that managerial power has played a key role in shaping executive pay. The pervasive role of managerial power can explain much of the contemporary landscape of executive compensation, including practices and patterns that have long puzzled financial economists. We also show that managerial influence over the design of pay arrangements has produced considerable distortions in these arrangements, resulting in costs to investors and the economy. This influence has led to compensation schemes that weaken managers’ incentives to increase firm value and even create incentives to take actions that reduce long-term firm value.