Lucian Arye Bebchuk

Stock Pyramids, Cross-Ownership, and the Dual Class Equity: the Creation and Agency Costs of Seperating Control from Cash Flow Rights

This paper examines common arrangements for separating control from cash flow rights: stock pyramids, cross-ownership structures, and dual class equity structures. We describe the ways in which such arrangements enable a controlling shareholder or group to maintain a complete lock on the control of a company while holding less than a majority of the cash flow rights associated with its equity. Next, we analyze the consequences and agency costs of these arrangements. In particular, we show that they have the potential to create very large agency costs -- costs that are an order of magnitude larger than those associated with controlling shareholders who hold a majority of the cash flow rights in their companies. The agency costs of these structures, we suggest, are also likely to exceed the agency costs of attending highly leveraged capital structures. Finally, we put forward an agenda for research concerning structures separating control from cash flow rights.

A Theory of Path Dependence in Corporate Ownership and Governance

Corporate structures differ among the advanced economies of the world. We contribute to an understanding of these differences by developing a theory of the path dependence of corporate structure. The corporate structures that an economy has at any point in time depend in part on those that it had at earlier times. Two sources of path dependence--structure driven and rule driven--are identified and analyzed. First, the corporate structures of an economy depend on the structures with which the economy started. Initial ownership structures have such an effect because they affect the identity of the structure that would be efficient for any given company and because they can give some parties both incentives and power to impede changes in them. Second, corporate rules, which affect ownership structures, will themselves depend on the corporate structures with which the economy started. Initial ownership structures can affect both the identity of the rules that would be efficient and the interest group politics that can determine which rules would actually be chosen. Our theory of path dependence sheds light on why the advanced economies, despite pressures to converge, vary in their ownership structures. It also provides a basis for why some important differences might persist.

A Rent-Protection Theory of Corporate Ownership and Control

This paper develops a rent-protection theory of corporate ownership structure - and in particular, of the choice between concentrated and dispersed ownership of corporate shares and votes. The paper analyzes the decision of a companys initial owner whether to maintain a lock on control when the company goes public. This decision is shown to be very much influenced by the size that private benefits of control are expected to have. Most importantly, when private benefits of control are large - and when control is thus valuable enough - leaving control up for grabs would attract attempts by rivals to grab control and thereby capture these private benefits; in such circumstances, to preclude a control grab, the initial owner might elect to maintain a lock on control. Furthermore, when private benefits of control are large, maintaining a lock on control would enable the companys initial shareholders to capture a larger fraction of the surplus from value-producing transfers of control. Both results suggest that, in countries in which private benefits of control are large, publicly traded companies will tend to have a controlling shareholder. It is also shown that separation of cash flow rights and voting rights will tend to be used in conjunction with a controlling shareholder structure but not with a dispersed ownership structure. Finally, the paper analyzes why companies might make control partially contestable, as many US companies currently do by adopting antitakeover arrangements. The results of the paper are consistent with the available evidence, can explain the observed patterns of corporate ownership, and yield testable predictions for future empirical work. The analysis also implies that a corporate law system that effectively limits private benefits of control can produce more efficient choices of ownership structure.

The CEO Pay Slice

We investigate the relationship between the CEO Pay Slice (CPS) – the fraction of the aggregate compensation of the top-five executive team captured by the CEO – and the value, performance, and behavior of public firms. The CPS may reflect the relative importance of the CEO as well as the extent to which the CEO is able to extracts rents. We find that, controlling for all standard controls, CPS is negatively associated with firm value as measured by industryadjusted Tobins Q. CPS also has a rich set of relations with firms‘ behavior and performance: in particular, CPS is correlated with (i) lower (industry-adjusted) accounting profitability, (ii) lower stock returns accompanying acquisitions announced by the firm and higher likelihood of a negative stock return accompanying such announcements, (iii) higher odds of the CEO receiving a ―lucky‖ option grant at the lowest price of the month, (iv) lower performance sensitivity of CEO turnover, and (v) lower stock market returns accompanying the filing of proxy statements for periods where CPS increases. Taken together, our results are consistent with the hypothesis that higher CPS is associated with agency problems, and indicate that CPS can provide a useful tool for studying the performance and behavior of firms.

Suing Solely to Extract a Settlement Offer

In many disputes, the expected value to the plaintiff from going to trial is negative, either because the chances of winning are small or because the litigation costs are large. While such a plaintiff would not go to trial, he might sue in the hope of extracting a settlement offer: the defendant might make such an offer if he is uncertain as to whether or not the expected value to the plaintiff of going to trial is negative. This paper seeks to identify the factors that determine: (i) whether a plaintiff who does not intend to go to trial will nonetheless succeed in extracting an offer; and (ii) how much will such a plaintiff succeed in extracting.

Misreporting Corporate Performance

This paper develops a model of the causes and consequences of misreporting of corporate performance. We model why and when managers of public companies will choose to misreport and to invest in creating opportunities for misreporting. Even managers who cannot sell their shares in the short run might misreport in order to improve the terms upon which the company would be able to issue equity to finance new projects or stock acquisitions. When managers are free to sell some of their holdings in the short-run, incentives to misreport and the incidence of misreportin g i n c r e a s e t o a n e x t e n t d e p e n d i n g o n the fraction of their holdings that managers may sell and on their ability to sell without the market knowing about it. Investments in misreporting have real economic costs and lead to distortions in capital raising decisions, with firms that misreport raising too much equity and firms that do not misreport raising too little. Lax accounting and legal rules increase investments in opportunities to misreport and the incidence of misreporting and, as a result, reduce ex ante share value. Our analysis provides a range of testable predictions concerning the periods, industries, and type of firms in which misreporting is likely to occur. The analysis also has implications for corporate governance and executive compensation.

Federalism and Corporate Law: The Race to Protect Managers from Takeovers

This paper analyzes certain important shortcomings of state competition in corporate law. In particular, we show that, with respect to takeovers, states have incentives to produce rules that excessively protect incumbent managers. The development of state takeover law, we argue, is consistent with our theory. States have adopted antitakeover statutes that have little policy basis, and, more importantly, they have provided managers with a wider and more open-ended latitude to engage in defensive tactics than endorsed even by the commentators most favorable to such tactics. Furthermore, states have elected, even though they could have done otherwise, to impose antitakeover protections on shareholders, who did not appear to favor them, in a way that left shareholders with little choice or say. Finally, we conclude by pointing out that proponents of state competition cannot reconcile their views with the evolution of state takeover law--and should, therefore, reconsider their unqualified support of state competition.

The Long-Term Effects of Hedge Fund Activism

We test the empirical validity of a claim that has been playing a central role in debates on corporate governance — the claim that interventions by activist hedge funds have a detrimental effect on the long-term interests of companies and their shareholders. We subject this claim to a comprehensive empirical investigation, examining a long five-year window following activist interventions, and we find that the claim is not supported by the data. We find no evidence that activist interventions, including the investment-limiting and adversarial interventions that are most resisted and criticized, are followed by short-term gains in performance that come at the expense of long-term performance. We also find no evidence that the initial positive stock-price spike accompanying activist interventions tends to be followed by negative abnormal returns in the long term; to the contrary, the evidence is consistent with the initial spike reflecting correctly the intervention’s long-term consequences. Similarly, we find no evidence for pump-and-dump patterns in which the exit of an activist is followed by abnormal long-term negative returns. Our findings have significant implications for ongoing policy debates. Policymakers and institutional investors should not accept the validity of the assertions that activist interventions are costly to firms and their shareholders in the long term; such claims do not provide a valid basis for limiting the rights, powers, and involvement of shareholders.

A New Theory Concerning the Credibility and Success of Threats to Sue

Negative-expected-value (NEV) suits are ones in which the expected litigation costs exceed the expected judgment. This article offers a new theory for the credibility and success of plaintiffs with NEV suits. The theory is based on recognizing that litigation costs are generally not incurred all at once but rather over time; this divisibility of the litigation process is shown to play a crucial strategic role. The analysis identifies the conditions under which a plaintiff with an NEV suit will have a credible threat and succeed in extracting a settlement. It is demonstrated that plaintiffs have credible threats in a much wider set of cases--including in numerous small-stakes cases--than has been suggested by prior economic analysis of the subject.

The Case for Facilitating Competing Tender Offers

Last year in this journal, Professors Easterbrook and Fischel advocated a rule that would require management to be passive in the face of a takeover bid, and argued that even resistance that triggers a bidding contest is undesirable. They reasoned that bidding contests curtail the search for takeover targets and thus are ultimately detrimental to shareholder welfare. In this Comment, Mr. Bebchuk maintains that bidding contests are consistent with a substantial level of search, and argues that facilitating competing bids is desirable for both target shareholders and society. Consequently, he endorses regulations that provide time for competing bids, and supports a rule that would allow management to solicit competing bids as long as it does not obstruct the initial or any subsequent tender offer.