DealLawyers.com Blog

Here is a DealBook column entitled “For Whom Golden Parachutes Shine” penned by Harvard Prof. Lucian Bebchuk that explains a recent study. Here is an excerpt:

We confirm that golden parachutes do indeed have a beneficial effect on acquisitions. We find that companies that offer such packages have a higher likelihood of both receiving an acquisition offer and being acquired.

Because golden parachutes make executives more eager to sell, they are also associated with lower premiums in the event of an acquisition. But this effect is sufficiently small so that, over all, golden parachutes are associated with higher expected gains from acquisitions. On average, shareholders in companies with golden parachutes pocket larger benefits from acquisition premiums, and we find evidence that this association is produced by the effect that golden parachutes have on executives’ incentives.

So far, so good. However, when we look beyond acquisitions to examine the relationship between golden parachutes and company value, we find that such packages hardly shine for the shareholders of companies adopting them. Companies that have adopted golden parachutes tend to see their valuations (relative to their industry peers) erode over time. Such companies have lower valuation already before adopting a golden parachute, but their value declines further in the subsequent several years.

We find a similar pattern when analyzing the stock returns of companies with and without a golden parachute during the period of more than 15 years for which we have data. Companies that adopted golden parachutes have lower (risk-adjusted) stock returns relative to those that didn’t – both during the two-year period surrounding the adoption and in the next several years.

What explains this pattern? Why do companies with golden parachutes fail to deliver for their shareholders overall even though they provide them with more benefits in the form of acquisition premiums? This pattern could be at least partly a result of the adverse effect that golden parachutes have on the incentives and performance of executives not facing an acquisition offer.

The market for corporate control benefits shareholders not just by providing the prospect of pocketing an acquisition premium but also by affecting performance more generally. Executives face the possibility that they might be ousted if they underperform. By ensuring executives of a cushy landing in the event of an acquisition, golden parachutes weaken the disciplinary force exerted by the market for corporate control.

Our corporate system provides executives with a significant power to impede or facilitate an acquisition. Golden parachutes are offered as a remedy to the concern that executives will deviate from shareholder interests in exercising this power. But this remedy is a highly imperfect one. While it does lead to more acquisitions, it also carries significant countervailing costs with it. Golden parachutes are not the easy fix for the incentives of executives as some might have hoped.

More work should be done to fully understand the consequences of golden parachutes and how they should be used. In the meantime, however, the evidence suggests that investors should continue to pay close attention to the use — and potential costs — of golden parachutes.

Recently, Schulte Roth released a “Middle Market PE Buyer/Public Target M&A Deal Study” that identifies “market practice” involving private equity buyer acquisitions of U.S. public companies specifically in the middle market for the period from January 2010 to June 30, 2012.

Key observations in the middle market include:

1. Activity in the middle market is down year over year
2. While fewer deals are getting done, it is taking targets less time to get to signing
3. The usage of pre-signing market checks rose in 1H 2012 as compared to 2011, but so did the use of “go-shop” provisions
4. Since 2010, market practice has changed dramatically on two issues — the target’s right to obtain specific performance to force a buyer to close and use of reverse termination fee (“RTF”)

Key observations: middle market vs. large market:

1. In general, market practice is consistent across middle market and large market deals — with a few notable exceptions
2. In 1H 2012, middle market deals were signed up much faster than large market deals
3. “Go-shop” provisions were used less frequently in middle market deals — in particular, where the tar¬get did not conduct a pre-signing market check
4. While RTFs in middle market deals were high¬er than large market deals in 2010, they have since fallen below those of large market deals

We have posted the transcript for the recent webcast: “Evolution of M&A Executive Pay Arrangements.”

A few weeks ago, Chuck Nathan taped this podcast about an interesting situation in a proxy contest in which The Clinton Group sought to remove 6 out of 7 directors through a written consent campaign and replace them with five new directors of Clinton’s choosing. Now, Greg Taxin of the Clinton Group has penned this blog about the results of his winning solicitation.

We have posted the transcript from our recent webcast: “M&A Deal Protections: The Latest Developments and Techniques.”

Here’s a blog from Gibson Dunn’s Jim Moloney and Andrew Fabens regarding Corp Fin’s latest interpretive guidance on the JOBS Act:

While most commentary regarding the JOBS Act has focused on capital markets issues and the impact the new rules will have on capital-raising transactions, the JOBS Act can also have significant implications in the merger and acquisition context.

While many of the provisions of the JOBS Act were primarily intended to reduce the costs and risks associated with initial public offerings for “Emerging Growth Companies” (“EGCs”), the SEC has confirmed that certain provisions can extend benefits to parties to a merger or acquisition when one of the parties to the transaction does not qualify as an EGC. In this regard we note that on September 28, 2012, the Division of Corporation Finance released 13 additional FAQs, a number of which address this point.

For example, the FAQs clarify that where a target company that does not qualify as a smaller reporting company will be acquired by an EGC (that is not a shell company) presenting only two years of its financial statements in a registration statement for an exchange offer or merger, then the target company need only present two years of financial statements, as well. The Staff’s FAQs also detail how the various disqualification provisions from being an EGC can apply in the context of forward acquisitions and reverse mergers between various types of companies. Questions 42 through 47 relate to the merger and acquisition context.

Section 106 of the JOBS Act is another provision with significant implications in the merger and acquisition context. Pursuant to Section 106, an EGC may submit a confidential draft registration statement to the SEC for confidential, non-public review, provided that the initial confidential submission and all amendments are filed publicly 21 days before the EGC’s roadshow. We discussed the new process for submitting draft registration statements in a prior post.

This provision may benefit late stage private companies pursuing a “dual-track” strategy, where the company files an IPO registration statement while simultaneously holding discussions with prospective acquirors. Companies typically undertake a dual-track approach when they wish to (i) put pressure on potential buyers by introducing the threat of a viable IPO process and (ii) retain flexibility regarding their exit options. This approach is particularly common among private equity-backed companies.

An EGC pursuing a dual-track could use the confidential submission process to its advantage in negotiations with potential acquirors. For instance, the EGC could inform potential acquirors that it has confidentially submitted a draft registration statement to the SEC and that it considers an IPO a viable alternative without those acquirors knowing how far along the company is in the IPO process. An EGC could respond to all comments from the Staff and be a mere 21 days from a road show without the public knowing. This makes the threat of a quick IPO much more credible.

Additionally, if a deal falls apart, the confidential submission process will allow an EGC to pull its registration statement without the public knowing, thus avoiding the stigma associated with a failed transaction or IPO. This process also allows EGCs to keep sensitive information, such as financial statement information, trade secrets and names of key customers, out of the public eye until 21 days before the company conducts a road show. If the EGC is ultimately acquired and does not go public, this information will never need to be disclosed to the public.

Of course, EGCs must weigh the benefits of confidential submission against the potential advantages of filing publicly. A publicly-filed registration statement can send a strong signal to potential acquirors. In addition, it can have a positive impact on customers and employee recruiting.

Tune in tomorrow for the webcast – “Evolution of M&A Executive Pay Arrangements” – to hear Sullivan & Cromwell’s Matt Friestedt, Wachtell Lipton’s Jeremy Goldstein and Simpson Thacher’s Andrea Wahlquist cover the latest in executive compensation arrangements in deals.

Here’s news from this Wachtell Lipton memo:

Last week, the Federal Trade Commission announced that Biglari Holdings, Inc. has agreed to pay an $850,000 civil penalty to resolve allegations that it violated the premerger notification and waiting period requirements of the Hart-Scott-Rodino Act in connection with its 2011 acquisition of stock of Cracker Barrel Old Country Store, Inc.

The HSR Act and its rules require that parties to certain mergers and acquisitions notify the federal antitrust agencies of their proposed transactions and observe a waiting period before consummation. Acquisitions of up to 10% of the stock of a company are exempt from the notification and waiting requirements, but only if they are made solely for the purpose of investment and “the person holding or acquiring such voting securities has no intention of participating in the formulation, determination, or direction of the basic business decisions of the issuer.” Buyers who intend to be involved in the management of the target company or to seek representation on its board of directors are not eligible for the passive investment exemption. Failure to comply with the HSR Act’s requirements may result in civil penalties of up to $16,000 for each day during which a person is in violation.

According to the FTC’s complaint, on June 8, 2011, Biglari Holdings acquired voting securities of Cracker Barrel in excess of the HSR Act’s notification threshold, and it continued to acquire voting securities through June 13, 2011, when it filed a Form 13D with the SEC. The 13D disclosed a 9.7% stake in Cracker Barrel valued at $100 million. Biglari Holdings did not file and observe the waiting period under the HSR Act prior to making those acquisitions, apparently maintaining that, at the time the acquisitions occurred, they were made “solely for the purpose of investment.” One day after the last purchase, however, Sardar Biglari, the Chairman and CEO of Biglari Holdings, contacted Cracker Barrel’s CEO to request a meeting at which he and Biglari Holdings’ Vice Chairman asked to be appointed immediately to Cracker Barrel’s board of directors. The FTC’s complaint and press release allege that Biglari Holdings’ actions, including the request for two board seats, were inconsistent with investment-only intent, and that Biglari Holdings “intended to actively participate in the management of Cracker Barrel” at the time it purchased the stock. As a result, the FTC maintained that Biglari Holdings was not eligible for the passive investor exemption and failed to observe the notification and waiting period requirements in violation of the HSR Act.

While some activist investors may perceive tactical advantages in not reporting their acquisitions under the HSR Act, to claim an “overnight” change of intent is neither credible nor consistent with decades of FTC enforcement. As indicated by the FTC’s Chairman in its press release, “the passive investment exemption is a narrow one,” and the agency “will not hesitate to seek civil penalties against companies that try to abuse it.”

In this podcast, Chuck Nathan of RLM Finsbury discusses an interesting – and potentially novel – situation in a proxy contest in which The Clinton Group (led by Greg Taxin, formerly a Glass Lewis founder) is seeking to remove 6 out of 7 directors through a written consent campaign and replace them with five new directors of Clinton’s choosing. Clinton seems to be day trading Wet Seal stock, which may be the first instance in which an activist investor day traded the stock of a company during a proxy contest it was sponsoring.

In this podcast, Chuck Nathan of RLM Finsbury discusses his big life change, including:

– Why did you make the move?
– What will you be doing?
– How has the practice of law in M&A evolved over the years?