The Law and Economics of Blockholder Disclosure

The Law and Economics of Blockholder Disclosure

Description

The past two decades has witnessed unprecedented changes in the corporate governance landscape in Europe, the US and Asia. Across many countries, A rulemaking petition recently submitted to the Securities and Exchange Commission (SEC) by the senior partners of a prominent law firm advocates tightening the rules that have long governed the disclosure of blocks of stock in public companies. The Commission has subsequently announced a rulemaking project to develop proposals for tightening these rules, and members of the Commission’s staff have signalled that the staff is prepared to recommend that the Commission adopt such proposals. Chairman Mary Schapiro, acknowledging the ‘controversy’ surrounding these important rules, has indicated that the Commission is actively considering whether to adopt the changes proposed in the Petition. In this chapter, we provide a detailed framework for the Commission’s examination of these rules. We argue that the Commission should not proceed with changes to these rules before undertaking a comprehensive examination of their economic implications for investors. In the meantime, the existing research and available empirical evidence provide no basis for concluding that the tightening of disclosure thresholds advocated by the petition would protect investors and promote efficiency, as the Commission’s rules must; indeed, the existing research and empirical evidence raise concerns that such tightening could harm investors and undermine efficiency. Our analysis proceeds as follows. In Section 18.2, we explain why policy analysis weighing the advantages and disadvantages of tightening these rules is needed before the Commission proceeds with the proposed tightening. It might be argued that more prompt disclosure of information is unambiguously desirable under principles of market transparency and was the clear objective of the Williams Act, which first established these rules by adding Section 13(d) to the Securities Exchange Act in 1968. Thus, at first glance one might conclude that the Commission should tighten the rules without consideration of the costs and benefits of doing so. Unlike ordinary disclosure rules that require insiders to provide information to investors, however, the Williams Act imposed an exception to the general rule that outside investors in public-company stock are entitled to remain anonymous. The drafters of the Williams Act made a conscious choice not to impose a hard 5% limit on pre-disclosure accumulations of shares, instead striking a balance between the costs and benefits of disclosure of blockholders’ activities to avoid excessive deterrence of the accumulation of these outside blocks. Thus, in deciding whether to tighten the rules in this area, the Commission should be guided by the general requirement that any costs associated with changes to its rules should be outweighed by benefits for investors. We therefore proceed to provide a framework for the policy analysis that the Commission should conduct. In Section 18.3, we begin by considering the costs of tightening the rules on blockholders. We first explain the benefits of these blockholders for corporate governance. We review the significant empirical evidence indicating that the accumulation and holding of outside blocks makes incumbent directors and managers more accountable, thereby reducing agency costs and managerial slack. Thus, we argue, tightening disclosure requirements can be expected to reduce the returns to blockholders and thereby reduce the incidence and size of outside blocks as well as blockholders’ investments in monitoring and engagement—which, in turn, could well result in increased agency costs and managerial slack. In Section 18.4, we consider the asserted benefits of tightening the rules described in the Petition. We explain that there is no empirical evidence to support the Petition’s contention that tightening these rules is needed to protect investors from the risk that outside blockholders will capture a control premium at shareholders’ expense. Section 18.5 considers whether the proposed tightening is justified by changes in trading practices, legal rules in the United States, or legal rules in other jurisdictions that have occurred since the passage of Section 13(d). We first explain that there is no systematic empirical evidence supporting the suggestion that investors can now acquire large blocks of stock more quickly than they could when Section 13(d) was first enacted. We then show that changes in the legal landscape since that time have tilted the balance of power between incumbents and blockholders against the latter—and therefore counsel against tightening the rules in a way that would further disadvantage blockholders. We also explain why comparative analysis of the regulation of blockholders in other jurisdictions does not justify tightening the rules governing blockholders in the United States. Overall, we argue, law- makers should recognize that the rules governing the balance of power between management and outside blockholders are already tilted in favour of insiders—both in absolute terms and in comparison to other jurisdictions—rather than outside blockholders. We conclude by recommending that the Commission pursue a comprehensive examination of the rules in this area along the lines we put forward. Such an examination should include an investigation of the empirical questions we identify. In the meantime, however, as we explain below, existing research and empirical evidence offer no basis for tightening the disclosure obligations of outside blockholders. Before proceeding, we note that we focus on the timing of disclosure by blockholders and, in particular, the Petition’s assertion that the Commission should shorten the ten-day period in which blockholders must disclose their presence after they have reached 5% ownership. Other questions, such as whether derivatives and similar securities should count toward the 5% threshold, are beyond the scope of this chapter. We do, however, offer a framework for analysing these questions that should be considered in future work on any rules that affect the balance of power between incumbents and blockholders. As we explain below, any analysis of such rules should give adequate weight to the beneficial role played by blockholders described in this chapter.

Source Publication

Institutional Investor Activism: Hedge Funds and Private Equity, Economics and Regulation

Source Editors/Authors

William W. Bratton, Joseph A. McCahery

Publication Date

2015

Edition

1

The Law and Economics of Blockholder Disclosure

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