Larry was a brilliant, prolific, and provocative scholar who will be sorely missed. His articles, blog posts, comments on my work, etc. sharpened my thinking and writing immeasurably. Rest in peace Larry. Your friend, Bill.
A draft of my new paper entitled The AIG Bailout is now up on SSRN. Here’s the abstract:
On February 28, 2008, American International Group, Inc. (AIG), the largest insurance company in the United States, announced 2007 earnings of $6.20 billion or $2.39 per share. Its stock closed that day at $50.15 per share. Less than seven months later, however, AIG was on the verge of bankruptcy and had to be rescued by the United States government through an $85 billion loan. AIG’s stock currently trades at less than $1.00 per share.
The Article explains why AIG, a company with $1 trillion in assets and $95.8 billion in shareholders’ equity, suddenly collapsed. It then details the terms of the government bailout, explores why it was undertaken, and questions its necessity. Considering a likely legacy of AIG is increased regulation of credit default swaps, the Article concludes by describing the current regulatory landscape for credit default swaps and offers some thoughts on regulatory reforms.
You can download the paper here. If you do read it and have comments, please email them to me at sjostromw [at] nku [dot] edu. Regardless, I will be revising the paper in light of the latest developments once the details come out.
From the 8-K:
On September 22, 2008, American International Group, Inc. (“AIG”) entered into an $85 billion revolving credit facility (the “Credit Facility”) and a Guarantee and Pledge Agreement (the “Pledge Agreement”) with the Federal Reserve Bank of New York (“NY Fed”).
The Credit Facility has a two year term and bears interest at 3-month LIBOR plus 8.5%. The Credit Facility provides for an initial gross commitment fee of 2% of the total Credit Facility on the closing date. AIG will also pay a commitment fee on undrawn amounts at the rate of 8.5% per annum. Interest and the commitment fees are generally payable through an increase in the outstanding balance under the Credit Facility. Borrowings under the Credit Facility are conditioned on the NY Fed being reasonably satisfied with, among other things, AIG’s corporate governance.
AIG is required to repay the Credit Facility from, among other things, the proceeds of certain asset sales and issuances of debt or equity securities. These mandatory repayments permanently reduce the amount available to be borrowed under the Credit Facility.
The Credit Facility contains customary affirmative and negative covenants, including a requirement to maintain a minimum amount of liquidity and a requirement to use reasonable efforts to cause the composition of the Board of Directors of AIG to be satisfactory to the trust described below within 10 days after the establishment of the trust.
Under the agreement, AIG will issue a new series of perpetual, non-redeemable Convertible Participating Serial Preferred Stock (the “Preferred Stock”) to a trust that will hold the Preferred Stock for the benefit of the United States Treasury. The Preferred Stock will, from issuance (i) be entitled to participate in any dividends paid on the common stock, with the payments attributable to the Preferred Stock being approximately, but not in excess of, 79.9% of the aggregate dividends paid on AIG’s common stock, treating the Preferred Stock as if converted, and (ii) vote with AIG’s common stock on all matters submitted to AIG’s shareholders, and will hold approximately, but not in excess of, 79.9% of the aggregate voting power of the common stock, treating the Preferred Stock as if converted. The Preferred Stock will remain outstanding even if the Credit Facility is repaid in full or otherwise terminates.
Pursuant to the Credit Facility, AIG is required to hold a special shareholders meeting to amend its restated certificate of incorporation to increase its share capitalization and to lower the par value of its common stock in order to permit the conversion of the Preferred Stock into common stock. Once this amendment is effective, the Preferred Stock will be convertible at any time into 79.9% of the shares of common stock outstanding at the time of issuance.
AIG is required to enter into a customary registration rights agreement that will permit the NY Fed to require AIG to register the Preferred Stock and the underlying common stock under the Securities Act of 1933.
The Credit Facility will be secured by a pledge of the capital stock and assets of certain of AIG’s subsidiaries, subject to exclusions for certain property the pledge of which is not permitted by AIG debt instruments, as well as exclusions of assets of regulated subsidiaries, assets of foreign subsidiaries and assets of special purpose vehicles.
An interesting new paper by Ferri and Maber entitled Say on Pay Vote and CEO Compensation: Evidence from the UK has recently been posted on SSRN. Here’s the abstract:
In this study, we examine the effect on CEO pay of new legislation introduced in the United Kingdom (UK) at the end of 2002 that requires publicly-traded firms to submit an executive remuneration report to a non-binding shareholder vote (“say on pay”) at the annual general meeting. Based on a large sample of UK firms over the period from 2000 to 2005, we find no evidence of a change in the level and growth rate of CEO pay after the adoption of say on pay. However, we document an increase in the sensitivity of CEO cash and total compensation to negative operating performance, particularly in firms with excessive compensation in the “pre” period (2000-2002) and in firms with high voting dissent. To assess whether the results are driven, respectively, by other governance changes in the UK or global trends in the CEO labor market, we use a control sample of UK firms not subject to the new rule (within-country test) and a control sample of US firms (between-country test). These tests confirm the increase in sensitivity of CEO cash and (more weakly) total pay to negative operating performance. Our findings are consistent with widespread calls for less “rewards for failure” that led to the legislation’s introduction and may be of interest to regulators and investors who are pondering the merits of a similar rule in the US and in other countries.
Yesterday the W$J ran an article with the above-referenced title (see here). The gist of the article is that whenever a household is blessed with an unexpected windfall, it will be cursed by an equal, unexpected cost. When I read the column, I thought to myself that it’s funny because it’s true. Now I’m thinking it’s true but not so funny. Earlier this week I learned that I’m getting a bigger than expected raise for the coming year. Well, a few hours ago my wife called me from the orthodontist to tell me that my oldest son needs braces. After answering the question of “how much is that going to cost us” she remarked “there goes the raise” and she hadn’t even read the article. Damn the law of household economics.
As you may be aware, in July 2007, the NASD and the member regulation, enforcement and arbitration functions of the New York Stock Exchange were consolidated into the Financial Industry Regulatory Authority (FINRA). Technically, NYSE Regulation functions and employees were transferred to the NASD, and the NASD changed its name to FINRA.
Ever since, I’ve been unsure as to how to cite former NASD/NYSE rules. Are they now all called FINRA rules? I finally took the time to figure it out this morning (notwithstanding the two black eyes I now have (see here)). According to the FINRA website:
The FINRA rulebook currently consists of both NASD Rules and certain NYSE Rules that FINRA has incorporated (Incorporated NYSE Rules). FINRA is in the process of consolidating the NASD and Incorporated NYSE rules into a single set of FINRA rules.
I interpret this to mean that it is still correct to cite to the NASD and NYSE rules until the single set of FINRA rules are published.
So I was playing centerfield in softball the other night, lost the ball in the sun, and ended up with seventeen stitches (4 internal, 13 external) over my right eyebrow. Unpleasant picture after the jump.
Dammann and Schundeln have a new paper up on SSRN entitled “Where are Limited Liability Companies Formed? An Empirical Analysis” (see here) that examines the state of formation choice of 64,000+ LLCs. Here’s the abstract:
We empirically study the incorporation choices or, more accurately: formation choice, of limited liability companies. Most of the firms in our large sample of more than 64,000 limited liability companies are formed in the state where their principal place of business is located (the PPB state). As their size increases, however, firms become more likely to be formed outside that state, with Delaware emerging as the primary destination for those that are not formed in the PPB state. In particular, of those firms that have 1,000 or more employees, roughly half are formed outside their home state, and of the latter, more than 80% are formed in Delaware.
We show that substantive law matters to the formation choices of closely held limited liability companies. More specifically, limited liability companies appear to be migrating away from those states that offer lower levels of protection for minority investors: We find statistically significant evidence that firms are less likely to be formed in their PPB state if the latter offers relatively lenient rules on managerial liability or if it allows companies to be dissolved via a less than unanimous resolution of the members.
For at least two years, my boys (Liam, 9 and Ollie, 6) have been clamoring for a pet chinchilla. While perusing craigslist a few days before Ollie’s birthday, I ran across a listing for a 18-month-old chinchilla that came with a cage and all accessories (including a dust bather!) for a mere $75. Better yet, he was living less than one mile from my house. I had to teach that night so I dispatched my wife to check him out as a possible birthday present for Ollie. She brought the boys with so of course they insisted on getting Ripley (the Chinchilla). I arrived home from class to find Ripley and his large cage sitting in our dinning room. I don’t think Ripley liked me because he’d make a high pitched noise any time a wandered near his cage. I equated it with cat hissing.
Around 7:00 a.m. the next morning, I was awoken by screaming and wailing. It seems Laim took Ripley out of his cage to hold him. Ripley promptly jumped out of Liam’s arms and scampered under our couch. My wife lifted the couch in an effort to capture Ripley, but as she was lifting Ripley apparently attempted to scamper through the space between the back edge of the couch and the floor which was quickly shrinking as my wife lifted. Unfortunately for us all, Ripley was crushed and died instantly. Elapsed time from his arrival at our house until his death: 11 hours.
We decided that a chinchilla is not the best choice for a pet. As a replacement, we went with a dog, in part because he’s too big to scamper under the couch. Anyone in the market for a chinchilla cage? It comes with a dust bather!
For those interested in small company finance, I’ve recently posted on SSRN a draft of the short piece I’ve written for the Entrepreneurial Business Law Journal symposium issue. The piece is entitled “The Truth About Reverse Mergers” and can be downloaded here. Here’s the abstract:
The Article examines the reverse merger method of going public. It describes the principal features of reverse mergers, including deal structure and legal compliance. Although reverse mergers are routinely pitched as cheaper and quicker than traditional IPOs, the Article argues that such pitches are misleading and, for many companies, irrelevant.
Per Securities Law Daily:
Under pressure from congressional leaders, institutional investors and business groups, Securities and Exchange Commission Chairman Christopher Cox Nov. 1 said he thinks the SEC “should go back to the drawing board” in early 2008 on the controversial “proxy access” issue.
“I agree that we should go back to the drawing board and think of this problem anew,” Cox said to reporters after an SEC Historical Society program at the agency’s headquarters.