Professor Bainbridge...on law, politics, religion, culture & food

SOX Costs

From Financial Executives Int'l (link via Broc), here's an analysis of what it is costing corporation to comply with just one provision of Sarbanes Oxley (§ 404):

In looking at initial one-time expenses for a "typical" $3 billion company, The Johnsson Group estimates incremental unanticipated expenditures totaling $1.1 to $3.5 million, itemized as follows:

Section 404-Related Activity- Initial one-time costs estimates:
Independent audit scope changes/fee increases	$500,000 - $2 million
Internal audit expansion	$200,000 - $500,000
Outside consulting services	$400,000 - $1 million
SubTotal	$1.1 - 3.5 million in one-time Section 404-related costs

And that's just the beginning. Given the heightened new requirements, companies can reasonably expect to incur ongoing incremental costs in the range of $800,000 to $2.8 million:

Section 404-Related Activity- Ongoing annual costs estimates:
Independent audit scope changes/fee increases	$500,000 - $2 million
Internal audit expansion	$200,000 - $500,000
Outside consulting services	$100,000 - $300,000
SubTotal	$800,000 - $2.8 million in ongoing Section 404-related costs

Delaware corporate law’s puzzling hostility to precommitment strategies: The case of dead hand and n

In an earlier post, I discussed the legal background for my analysis of Delaware corporation law’s puzzling hostility to corporate precommitment strategies. In this post, I offer a policy justification for reversing that hostility.

A conversation in my office of interest for civil procedure students

A more or less true story:

Colleague: Are you related to the "one Bainbridge" of Pennsylvania Railroad v. Chamberlain [Ed: 288 U.S. 333 (1933)]?

Me: Yes [Ed.: Looking sheepish].

Colleague: Did you know that Learned Hand said "one Bainbridge's" testimony was "not only 'somewhat suspicious in itself, but its contradiction ... so manifold as to leave little doubt"?

Me: Yes [Ed.: Becoming annoyed].

Colleague: Did you know that the Supreme Court of these United States said: "Not only is Bainbridge's testimony considered as a whole suspicious, insubstantial, and insufficient, but his statement ... is simply incredible"?

Me: Yes, [Ed.: expletive deleted], I did, you [Ed.: very offensive expletive deleted].

Colleague: Well, there's no need to get all huffy about it.

Me: [Ed.: A completely uncalled for string of great obscenities deleted.]

Delaware corporate law’s puzzling hostility to precommitment strategies: The case of dead hand and n

In class today, we discussed the Delaware supreme court's puzzling hostility to strategies by which a board of directors precommits to a particular course of action. In this post, I discuss the legal background; namely, a pair of cases in which Delaware courts invalidated the dead hand and no hand variants of the poison pill. In a subsequent post, I take up the policy issues posed by Delaware's treatment of corporate precommitment strategies.

The corporate governance racket

The special report on corporate governance in yesterday's WSJ (sub. req'd) included an interesting article by Phyllis Plitch entitled A Piece of the Action: Corporate governance is hot -- and there's no shortage of companies promising to help:

With corporate governance showing no signs of fading as a hot business buzzword as executives scramble to meet new regulations, companies of all kinds and sizes are trying to get a piece of the action. "This looks like the first widespread new potential to sell software and services to the whole economy since the dot-com bust three years ago," says Lane Leskela, research director at Gartner Inc. Mr. Leskela says he found at least 50 high-tech vendors marketing services related to the Sarbanes-Oxley Act of 2002, the legal centerpiece of sweeping reforms aimed at preventing corporate malfeasance. The businesses, he says, range "from the usual suspects all the way down to companies no one has really heard of before." ...

To critics, however, the onslaught of "you must hire us" pitches can scare companies into thinking they have no choice but to pony up big bucks. Some promotions "seem designed to put the fear of God in companies -- that complying is so difficult, you can't possibly do it without expensive and extensive outside help," says Beth Young, senior research associate at the Corporate Library, an independent research firm and corporate watchdog. "It's making people extremely paranoid about the requirements and what it takes to comply."

Well, that's just great. As an investor, I don't want my portfolio companies spending a dollar on "good corporate governance" unless doing so adds at least a buck to the bottom line. I don't have any voice in how much to spend on corporate governance, however. The board of directors and top management make that decision (as they should, of course). Unfortunately for the bottom line, however, directors and management have a strong incentive to over-invest in corporate governance consultants and so on.

Why? The answer lies in the incentive structures of the relevant players. Who pays the bill if a director is found liable for breaching his federal or state duties? The director. if the director has adequately processed decisions and consulted with advisors, will the director be held liable? Unlikely. Who pays the bill for hiring corporate governance consultants, lawyers, investment bankers and so on to advise the board? The corporation and, ultimately, the shareholders. Suppose you were faced with potentially catastrophic losses, for which somebody offered to sell you an insurance policy. Better still, you don't have to pay the premiums, someone else will do so. Buying the policy therefore doesn't cost you anything. Would not you buy it? isn't that exactly the choice we're giving directors and senior managers?

Corporate governance reforms have thus given us the corporate governance racket. We know that these reforms have significantly raised the regulatory burden on Corporate America. Will we get a commensurate bang for our buck? Regular readers know that I'm very skeptical. What I've tried to show here is even modest reforms can result in costs that outweigh their benefits so long as those upon whom the reforms impose new liabilities control the purse strings.

Today’s Shareholder Access Question: Relationship with 14a-8

It's time for another installment of our series on the SEC's shareholder access proposal. Today's question is # B2:

[S]hould companies subject to Exchange Act Rule 14a-11 be permitted to exclude certain security holder proposals that they would otherwise be required to include? If so, what categories of proposals

Yes, they should be allowed to exclude all precatory proposals, regardless of whether the proposal goes to corporate governance or social issues.

In my earlier post, Why Not Rule 14a-8 Too?, I suggested that the SEC allow firms to opt-out of Rule 14a-8, just as the SEC is considering allowing firms to opt-out of Rule 14a-11. In a subsequent post, I asked:

If the SEC's shareholder access proposal goes through, why would we need rule 14a-8? If shareholders are that worked up about something at a firm, let them try to elect a director under the new proposed access regime.

I still think that's the right question. At the very least, however, firms subject to proposed Rule 14a-11 should get some reduction in the resulting regulatory burden. Eliminating precatory 14a-8 proposals strikes me as a reasonable trade-off.

I have estimated that the aggregate annual cost to Corporate America of complying with proposed Rule 14a-11 could run as high as $5 billion (here). Surely some regulatory relief is therefore justified. According to the SEC's own figures, the cost per company of determining whether or not a 14a-8 proposal should be included in the proxy statement is $37,000 and the cost per company of including a proposal (printing etc....) is $50,000. ISS tracked 1,042 shareholder proposals in the 2003 proxy season (see here). Assuming a cost of $87.000 per proposal, we get total expenditures of $90,654,000. A small fraction of what Rule 14a-11 might cost, of course, but still a nontrivial number. If shareholders want to put corporations to the expense of a contested director election, they should be obliged to forego putting the corporation to the added expense of dealing with precatory proposals.

Precatory proposals not only add cost, but they lengthen the proxy statement, raising the opportunity costs of making informed decisions. In addition, because these costs come out of the corporate treasury, all shareholders are paying them. Why should I have to subsize activism by my fellow shareholders? I pay for my blog, let them pay for their own solicitations.

More on Dow 10,000

Alert reader Eric Grannan sent in a very interesting email follow-up to my post Dow 10000, Psychology, and the ECMH:

Let's define the stickiness of a level to be the number of times based on daily closes (so I'm not using intraday prices) that an index crosses a given level. As you state in your piece, currently 10,000 has a stickiness of 18.

So a question is whether 10,000 or other round numbers are stickier than other numbers. Taking the geometric mean as a representative odd number we get the following sticky numbers:

100 -- 46 316 -- 7 1,000 -- 31 3,160 -- 3 10,000 -- 18

Which seems to be consistent with the hypothesis that the DOW sticks around round numbers more than uneven numbers. On the other hand, the 50, 500, ... numbers are quite slippery, which may invalidate the beautiful theory:

50 -- 7 500 -- 9 5,000 -- 1 (crossed for the only time on Nov 21, 1995)

The stickiest recent level is 10,526.8, which has been crossed 42 times so far. The stickiest level ever for the DOW was 93.4, which has a sticky index of 92. This level was first crossed on Dec 11, 1905, and was crossed for the last time more than 36 years later on Apr 29, 1942. At that rate we'll see that last of 10,000 in around 2035...

Very cool. Of course, there could be multiple reasons why a particular number is sticky, so the data may not falsify the psychology hypothesis, but at the very least it does suggest that there is more going on than psychology. Which, by the way, is exactly what one would expect in an efficient market!

Today’s shareholder access question: What will it cost?

As part of our continuing coverage of the SEC's shareholder access proposal, today's SEC question is # A.2:

What would be the cost to companies if the Commission adopted proxy rules requiring companies to include security holder nominees in company proxy materials?

A review of contests in the late 1980s survey found that insurgents spent an average of $1.8 million and incumbents an average of $4.4 million. (Aranow & Einhorn on Proxy Contests for Corporate Control at 21-4 to 21-7.) Those costs are almost certainly much higher today, but let's use them as a baseline. Assume that a company faces a Rule 14a-11 contested director election every three years. Assume further that a Rule 14a-11 contested election costs one-third what a full proxy contest costs. On those assumptions, each public corporation would face annualized costs of about $500,000. Using the 10,000 actively traded U.S. companies in the Compustat data base as a proxy for the number of companies potentially subject to Rule 14a-11, we estimate an aggregate annual cost of $5 billion. Ouch. Of course, I may be overestimating the number of contests and the cost of each contest. Remember two things, however: (1) I'm using 1980s era cost estimates and (2) the SEC grossly underestimated the cost of complying with Sarbanes-Oxley.