Washington Update—Proxy Process Focus Continues

Nichol Garzon is Senior Vice President and General Counsel at Glass, Lewis & Co. This post is based on a Glass Lewis memorandum by Ms. Garzon.

Following the SEC Proxy Roundtable last month, the Senate Committee on Banking, Housing, and Urban Development held a hearing on Proxy Process and Rules: Examining Current Practices and Potential Changes. The December 6th hearing allowed Senators to hear from, and question, witnesses on what could and should be done to improve the proxy process. Specific legislation was not discussed but policy concepts and priorities were.

Much of the conversation revolved around shareholder proposals, resubmission thresholds and the role of proxy advisory firms—and reflected a number of misconceptions regarding the proxy process. Most participants stated that proxy advisors play a critical role helping investors meet their obligations, but some argued for an increased regulatory scheme and questioned conflict disclosure policies.

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Governance Under the Gun: Spillover Effects of Hedge Fund Activism

Nickolay Gantchev is Associate Professor at the Cox School of Business Southern Methodist UniversityOleg Gredil is Assistant Professor at the A.B. Freeman School of Business at Tulane University; and Chotibhak Jotikasthira is Associate Professor at the Cox School of Business Southern Methodist University. This post is based on their recent article, forthcoming in the Review of Finance. Related research from the Program on Corporate Governance includes The Long-Term Effects of Hedge Fund Activism by Lucian Bebchuk, Alon Brav, and Wei Jiang (discussed on the Forum here) and Dancing with Activists by Lucian Bebchuk, Alon Brav, Wei Jiang, and Thomas Keusch (discussed on the Forum here).

Hedge fund activism has become pervasive in today’s corporate landscape. In response to activist demands, targeted firms have been shown to improve governance (e.g., raising shareholder payout) and performance (e.g., boosting return on assets and asset utilization). These positive effects often come at the expense of managers and directors who see a sharp drop in their compensation and a higher likelihood of being replaced. Ample anecdotes suggest that executives of yet-to-be-targeted firms feel threatened, and often seek the help of external advisers to monitor activism in their industry and perform “periodic fire drills” to address any potential vulnerabilities before an activist emerges. In its 2018 Public Company Governance Survey, the National Association of Corporate Directors (NACD) finds that “two-thirds of [survey] respondents reported taking action to prepare for a potential activist challenge”.

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Preparing for the 2019 Reporting Season

Doug Schnell, Lisa Stimmel, and David Thomas are partners at Wilson Sonsini Goodrich & Rosati. This post is based on a WSGR memorandum by Mr. Schnell, Ms. Stimmel, Mr. Thomas, John Aguirre, Scott McCall, and Wendy Guo.

With 2018 quickly drawing to a close, attention now turns to preparing for the 2019 reporting season. As always, there are a number of compliance “musts” to focus on, as well as items that can be addressed in 2018 to make 2019 a little easier.

Determine Your Status as an Issuer

The U.S. Securities and Exchange Commission (SEC) recently adopted final rules to expand the availability of scaled disclosure requirements for a registrant to qualify as a smaller reporting company (SRC). Registrants with a public float of less than $250 million now qualify as an SRC, as compared to the $75 million threshold under the prior definition. [1] In addition, registrants that either do not have a public float or have a public float of less than $700 million are now permitted to provide scaled disclosures if annual revenues are less than $100 million, as compared to the prior threshold of less than $50 million in annual revenues. Companies that did not previously qualify as an SRC may wish to avail themselves of the scaled disclosure option. If your company did not previously qualify as an SRC but now does, decisions to scale back disclosure should be made in consultation with legal counsel, the independent auditors and the board of directors. You should also consider more indirect impacts from a scaling back disclosure. For example, Glass, Lewis & Co. (Glass Lewis) has said that if scaled-back disclosure substantially affects shareholders’ ability to make an informed assessment of executive pay practices, then this could result in Glass Lewis recommending votes against (or withholding votes from) compensation committee members.

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Testimony on Oversight of the U.S. Securities and Exchange Commission

Jay Clayton is Chairman of the U.S. Securities and Exchange Commission. This post is based on Chairman Clayton’s recent testimony before the U.S. Senate Committee on Banking, Housing, and Urban Affairs, available here. The views expressed in this post are those of Mr. Clayton and do not necessarily reflect those of the Securities and Exchange Commission or its staff.

Chairman Crapo, Ranking Member Brown and Senators of the Committee, thank you for the opportunity to testify before you today about the work of the U.S. Securities and Exchange Commission (SEC or Commission or Agency). [1] Chairing the Commission is a great privilege, and I am fortunate to be able to observe firsthand the incredible work done by the agency’s almost 4,500 dedicated staff, approximately 41 percent of whom are outside of Washington, D.C., in our eleven regional offices.

Our people are our greatest assets, and they are our direct connection to the investors we serve. None of the important work described in this testimony would have been achieved without the solutions-oriented attorneys, accountants, examiners and economists at the SEC, whose work, in turn, is made possible thanks to the important, often behind-the-scenes work of the agency’s administrative and operations personnel. The agency’s supervisors and program managers also play a critical role in ensuring effective and efficient operations and activities.

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The Implementation of Corporate Governance in Pre-IPO Companies

David F. Larcker is James Irvin Miller Professor of Accounting at Stanford Graduate School of Business and Brian Tayan is a Researcher with the Corporate Governance Research Initiative at Stanford Graduate School of Business. This post is based on a recent paper by Professor Larcker and Mr. Tayan.

We recently published a paper on SSRN, Scaling Up: The Implementation of Corporate Governance in Pre-IPO Companies, that examines the process by which startup companies implement corporate governance systems.

An effective system of corporate governance is considered critical to the proper oversight of companies. While companies are required to have a reliable corporate governance system in place at the time of IPO, relatively little is known about the process by which they implement it.

At its founding, a typical private company lacks many, if not all, of the features that will later be required by regulatory authorities. The board of directors is composed primarily of insiders—founders, investors, managers—and usually has no directors who meet the independence standards of the New York Stock Exchange and NASDAQ. Financial statements may be subject to an external audit but are usually not prepared in accordance with generally accepted accounting principles (GAAP). Financial reporting systems lack many of the controls necessary to comply with the Sarbanes-Oxley Act of 2002. Compensation contracts are dominated by equity awards and milestone-based payouts whose amounts are not justified in an annual proxy or explained in light of the company’s compensation philosophy, pay objectives, or the peer-group analysis that public companies are required to disclose. And yet, by the time companies go public, they have in place fully established (if not fully matured) systems of corporate governance.

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Preparing for the 2019 Proxy Season: Practical Guidance for Directors and Board Committees

Melissa Sawyer is partner and Kathy Wang is an associate at Sullivan & Cromwell LLP. This post is based on a Sullivan & Cromwell memorandum by Ms. Sawyer, Ms. Wang, Catherine Clarkin, Heather ColemanJames Shea, Jr., and Marc Treviño.

Corporate governance circles are abuzz with discussions about board refreshment, sustainability proposals and the repercussions of the #MeToo movement, among other hot topics. For most companies, however, these topics do not warrant immediate reactions. This post summarizes our recommendations and observations of emerging trends for the 2019 proxy season in response to the recent focus on these and other hot topics.

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The Misguided Attack on Common Ownership

Lucian Bebchuk is the James Barr Ames Professor of Law, Economics, and Finance, and Director of the Program on Corporate Governance, at Harvard Law School. Scott Hirst is Associate Professor at Boston University School of Law and Director of Institutional Investor Research at the Harvard Law School Program on Corporate Governance. Related research from the Program on Corporate Governance includes The Agency Problems of Institutional Investors by Lucian Bebchuk, Alma Cohen, and Scott Hirst (discussed on the Forum here) and Index Funds and the Future of Corporate Governance: Theory, Evidence, and Policy by Lucian Bebchuk and Scott Hirst (discussed on the forum here).

We have posted to SSRN a presentation titled The Misguided Attack on Common Ownership. The document is based on the slides we prepared for presentation by one of us at FTC hearing on common ownership that took place last week. The slides discuss the implications of our research work—Bebchuk, Cohen, and Hirst, The Agency Problems of Institutional Investors (2017), and Bebchuk and Hirst, Index Funds and the Future of Corporate Governance: Theory, Evidence, and Policy (2018)—for the common ownership debate.

The claims of common ownership critics, we suggest, fail to take into account how the agency problems of investment fund managers provide them with incentives to under-invest in stewardship and to be deferential toward the corporate managers of portfolio companies. Given these problems, policymakers should be primarily concerned that investment fund managers engage too little and not that they engage too much. The measures advocated by common ownership critics are not merely unnecessary but would be counterproductive; they could well discourage investment fund managers from stewardship activities that should be encouraged.

The presentation is available here and any comments would be welcome.

The Causal Effect of Corporate Governance on Employee Satisfaction

Marco Menner and Frederic Menninger are from the University of Konstanz, Germany. This post is based on their recent paper.

Politicians, business lawyers, institutional investors, and academics in the field of finance are currently debating the corporate purpose beyond shareholder wealth maximization. United States Senator Elizabeth Warren has introduced the “Accountable Capitalism Act” in August 2018, which requires changes to the corporate governance of large corporations and forces companies to increase their focus on the well-being of their employees. Business lawyer Martin Lipton has published the corporate governance framework “The New Paradigm” (discussed on this Forum here), which promotes investments in the workforce to ensure long-term and sustainable growth. Investor Larry Fink, founder and CEO of ETF giant BlackRock, has used his annual letter to CEOs to criticize companies for underinvesting in skilled workforces (2015) and has reminded CEOs that companies must benefit all of their stakeholders, including their employees (2018). Academics have confirmed the importance of the workforce. Several empirical studies have found a positive relation between stock returns and employee satisfaction, as well as high monetary and non-monetary societal costs resulting from stress in the workplace.

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2018 Annual Corporate Governance Review

Brigid Cremin Rosati is Director of Business Development; Edward Greene is Managing Director; and John Carroll is Institutional Services Associate at Georgeson LLC. This post is based on a Georgeson/Proxy Insight publication.

We are pleased to present the 2018 Annual Corporate Governance Review. For the second year in a row, Georgeson partnered with Proxy Insight on the coordination of voting data and analytics. Proxy Insight was instrumental in sourcing the annual meeting and proxy voting data contained in this report.

New This Year

The 2018 report provides a comprehensive review of relevant corporate governance issues covering five sections: shareholder proposals on governance issues, shareholder proposals on environmental and social and issues, director elections, say-on-pay proposals and CEO pay ratio disclosure.

Based on reader feedback and trends in the current market, we have expanded our review of environmental, social and governance shareholder proposals that were the subject of a vote during the period July 1, 2017 through June 30, 2018. Consequently, this year we are providing additional information detailing voting decisions by institutional investors related to employment diversity shareholder proposals.

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Bebchuk-Hirst Study of Index Funds Wins IRRC Institute Prize

Itai Fiegenbaum is a co-Editor of the Forum and Fellow at the Harvard Law School Program on Corporate Governance.

The IRRC Institute has announced that its 2018 annual investor research prize will be awarded to a study by Lucian Bebchuk and Scott Hirst, Index Funds and the Future of Corporate Governance: Theory, Evidence, and Policy. Upon announcing the study winning the $10,000 prize, the IRRC Institute’s Executive Director Jon Lukomnik described the study as making “a substantial contribution to understanding big picture, weighty issues for investors and the global economy.”

According to the IRRC’s press release announcing the prize, the study “provides an analytical framework for understanding the incentives of index fund managers,” “provides the first comprehensive and detailed empirical account of the full range of stewardship activities that index fund managers do and do not undertake,” and “considers the significant policy implications of the  issues analyzed.”

The judges on the panel selecting the winning study were:

  • Robert Dannhauser, Head of Capital Markets Policy, CFA Institute
  • James Hawley, Professor emeritus and former Director of the Elfenworks Center for Fiduciary Capitalism at St. Mary’s College of California
  • Erika Karp, Founder, CEO and Chair of the Board of Cornerstone Capital
  • Nell Minow, Governance Expert and Huffington Post Columnist

Biographies of the judges are available here.

More information about the IRRC Institute award is available here. The Bebchuk & Hirst study for which the prize was awarded is available here, and is discussed on the Forum here.

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