Roberta Romano

Empowering Investors: A Market Approach to Securities Regulation

This Article contends that the current legislative approach to securities regulation is mistaken. It advocates a market-oriented approach of competitive federalism that would expand the role of the states in securities regulation and would fundamentally reconceptualize the regulatory scheme. Under a system of competitive federalism for securities regulation, only one sovereign will have jurisdiction over all transactions in the securities of a corporation that involve the issuer or its agents and investors: the sovereign chosen by the issuer from among the federal government, the fifty states, or foreign nations. The aim is to replicate for the securities setting the benefits produced by state competition for corporate charters -- a responsive legal regime that has tended to maximize share value. As a competitive legal market supplants a monopolist federal agency in the fashioning of regulation, it will produce rules more aligned with the preferences of investors, whose decisions drive the capital market. Competitive federalism for U.S. securities regulation also has important implications for international securities regulation. The jurisdictional principle applicable to domestic securities transactions is equally applicable: Foreign issuers selling shares in the United States would be able to opt out of the federal securities laws and choose the law of another nation, such as their country of incorporation, or of a U.S. state, to govern those U.S. transactions.

The Political Economy of Takeover Statutes

I. Second Generation Takeover Statutes ............ 113 A. The Aftermath of MITE .................... 113 B. Why Is the Fair Price Approach So Popular? . 117 II. The Making of a Takeover Statute ............... 120 A. A Coalition Explanation of Takeover Legislation ....................................... 120 B. The Politics of Connecticuts Second Generation Statute ................................ 122 C. Predicting the Adoption of a Second Generation Takeover Statute ........................... 142 III. The Rationality of Investor Support of Fair Price Provisions ...................................... 145 A. A Decision Tree Analysis of the Decision to T ender .................................... 148 B. When Might Investors Decide to Support a Fair Price Provision? ... . . . . . . . . . . . . . . . . . . . . . . . . . 170 IV. Conclusion ..................................... 187

Event Studies and the Law - Part I: Technique and Corporate Litigation

Event studies are among the most successful uses of econometrics in policy analysis. By providing an anchor for measuring the impact of events on investor wealth, the methodology offers a fruitful means for evaluating the welfare implications of private and government actions. This paper is the first in a set of two papers that review the use and impact of the event study methodology in the legal domain. This paper begins by briefly reviewing the event study methodology and its strengths and limitations for policy analysis. It then reviews in detail how event studies have been used to evaluate the wealth effects of corporate litigation: Defendants experience economically-meaningful and statistically-significant wealth losses upon the filing of the suit, whereas plaintiff firms experience no significant wealth effects upon filing a lawsuit. Also, there is a significant wealth increase for defendant firms when they settle a suit with another firm, in contrast to other types of plaintiffs, and in contrast to the settling plaintiff firms. These findings suggest that, at a minimum, lawsuits are not a value-enhancing way for corporations to settle their disagreements with other corporations. In addition, the market appears to impose a higher sanction on firms than actual criminal sanctions, and reputational losses are of equal magnitude for civil fines as criminal ones. The paper concludes with some recommendations for researchers: The standards for conducting an event study are well established. Researchers can increase the power of an event study by increasing the sample size, and by narrowing the public announcement period to as short a time-frame as possible. The companion paper reviews the use of event studies in corporate law and regulation.

Regulating in the Dark

Foundational financial legislation is typically adopted in the midst or aftermath of financial crises, when an informed understanding of the causes of the crisis is not yet available. Moreover, financial institutions operate in a dynamic environment of considerable uncertainty, such that legislation enacted even under the best of circumstances can have perverse unintended consequences, and regulatory requirements correct for an initial set of conditions can become inappropriate as economic and technological circumstances change. Furthermore, the stickiness of the status quo in the U.S. political system renders it difficult to revise legislation, even though there may be a consensus to do so. This essay contends that the best means of responding to this dismal state of affairs is to include, as a matter of course, in crisis-driven financial legislation and its implementing regulation, two key procedural mechanisms: (1) a requirement of automatic subsequent review and reconsideration of the legislative and regulatory decisions at some future point in time; and (2) regulatory exemptive or waiver powers that encourage, where feasible, small scale experimentation, as well as flexibility in implementation. Both procedural devices will better inform and calibrate the regulatory apparatus, and could thereby mitigate, at least on the margin, the unintended errors which will invariably accompany financial legislation and rulemaking originating in a crisis. Given the centrality of financial institutions and markets to economic growth and societal well-being, it is exceedingly important for legislators acting in a financial crisis with the best of intentions, to not make matters worse.

Getting Incentives Right: Is Deferred Bank Executive Compensation Sufficient?

In the wake of the global financial crisis, attention has often focused on whether incentives generated by bank executives’ compensation programs led to excessive risk-taking. Post-crisis, compensation reform proposals have taken broadly three approaches: long-term deferred equity incentive compensation, mandatory bonus clawbacks upon accounting restatements and financial losses, and debt-based compensation. In earlier articles we recommended the following compensation structure for bank executives: incentive compensation should consist only of restricted stock and restricted stock options – restricted in the sense that the executive cannot sell the shares or exercise the options for two to four years after his or her last day in office. We contend that this incentive compensation package, which we term the Restricted Equity proposal, will focus bank managers’ attention on the long-run and discourage them from investing in high-risk, value-destroying projects. Equity based incentive programs such as our proposal may lose effectiveness in motivating managers to enhance shareholder value as a bank’s equity value approaches zero. As a consequence, some commentators have called for pay packages linked to bank debt. We contend, however, that the more appropriate approach is to retain equity-based incentive pay and to reform bank capital structure to reduce the probability of a tail event, and hence insolvency. We advance two approaches, not necessarily exclusive, that coupled with the Restricted Equity proposal, we maintain, would incentivize bank executives to not take on projects of excessive risk: meaningful higher and simpler capital requirements and mandatory issuance of contingent convertible capital – debt that converts to equity under specified adverse states of the world. Because the optimal capital level is unknown, we further advocate facilitating regulatory diversity within the international financial regulatory regime, to generate information concerning what level and form of capital works best, which would improve the quality of decision-making and the resiliency of the global financial system.

Chapter 13 Empirical Studies of Corporate Law

Abstract This chapter reviews the empirical literature, especially the event study literature, as it relates to corporate and securities law. Event studies are among the most successful uses of econometrics in policy analysis. By providing an anchor for measuring the impact of events on investor wealth, the methodology offers a fruitful means for evaluating the welfare implications of private and government actions. This chapter begins by briefly reviewing the event study methodology and its strengths and limitations for policy analysis. It then discusses one of the limitations of more conventional empirical work (cross-sectional analysis), the problem presented by the fact that the characteristics of firms that are studied in relation to each other (such as ownership and mechanisms of corporate governance) or to firm performance are not exogeneous but self-selected by firms. Thereafter it reviews in detail how event studies have been used to evaluate the wealth effects of corporate litigation. Subsequently, we focus on the methodologys application to corporate law and corporate governance issues, supplemented with discussion of other relevant empirical work as well. Event studies are emphasized because they have played an important role in the making of corporate law and in applied corporate finance and corporate law scholarship. The reason for this input is twofold. First, there is a match between the methodology and subject matter: the goal of corporate law is to increase shareholder wealth and event studies provide a metric for measurement of the impact upon stock prices of policy decisions. Second, because the participants in corporate law debates share the objective of corporate law, to adopt policies that enhance shareholder wealth, their disagreements are over the means to achieve that end. A further reason for emphasizing event study data is that they avoid the endogeneity concerns that can limit the results of other modes of empirical research in this area.

Comment on “Presidents and the Politics of Structure”

Terry Moe and Scott Wilsons article Presidents and the Politics of Structure1 develops and refines a theme that Moes work has emphasized: the importance of the president and, correspondingly, the incompleteness of models of the political process that focus on Congress and leave only a shadow role for the president as the exerciser of veto power. The purpose of the article is to supplement the McNollGast structure and process explanation of congressional establishment of administrative agencies2 by elaborating the presidents countervailing institutional motivation to strengthen and consolidate the bureaucracy under presidential control. I find Moe and Wilsons thesis highly suggestive and one which ought to be pursued and amplified. My comment consists of three points directed at exploring their thesis further. The first two concern two institutions that are omitted from the analysis but whose inclusion might well alter some of Moe and Wilsons conclusions on comparative institutional advantages-political parties and courts. These institutions offset some of the collective action problems that Moe and Wilson ascribe to Congress. The third point identifies lines of empirical inquiry which could make more compelling the president-centered explanation of the politics of agency structure offered by Moe and Wilson, by following up on what impact their three case studies of bureacratic reform favored by presidents have had on the formulation of public policy.

Reforming Financial Executives’ Compensation for the Long Term

A myriad of factors have been identifi ed as contributing to the ongoing global fi nancial crisis, running the gamut from misguided government policies to an absence of market discipline of fi nancial institutions that had inadequate or fl awed riskmonitoring and incentive systems.1 Such government policies include low interest rates by the Federal Reserve and promotion of subprime risktaking by governmentsponsored entities dominating the residential mortgage market so as to increase home ownership by those who could not otherwise aff ord it, which fueled a housing bubble, and bank capital and institutional investor holding requirements dependent on credit ratings by entities which were either confl icted or incompetent (or both), providing tripleA ratings to securitized packages of subprime mortgages. Identifi ed sources of inadequate market discipline include ownership restrictions, deposit insurance inducing moral hazard, ineff ective prudential regulation including capital requirements that favored securitized subprime loans over more conventional assets, while internal organizational factors contributing to the crisis include business strategies dependent on high leverage and shortterm fi nancing of longterm assets, reliance on risk and valuation models with grossly unrealistic assumptions, and poorly designed incentive compensation. This myriad of factors, taken as a whole, encouraged what was, as can readily be observed with the benefi t of hindsight, excessive risktaking. Yet only one of the items on the long laundry list of factors contributing to the crisis has consistently been a focal point of the reform agenda across nations: executive compensation. In the United States, for example, multiple legislative and regulatory initiatives have regulated the compensation of executives of fi nancial institutions receiving

The Sarbanes–Oxley Act at a Crossroads

Building on Oliver Williamson’s original analysis, the contributors introduce new ideas, different perspectives and provide tools for better understanding changes in the approach to regulation, the reform of public utilities, and the complex problems of governance. They draw largely upon a transaction cost approach, highlighting the challenges faced by major economic sectors and identifying critical flaws in prevailing views on regulation. Deeply rooted in sector analysis, the book conveys a central message of new institutional economics: that theory should be continuously confronted by facts, and reformed or revolutionized accordingly.