2019 Proxy Letter—Aligning Corporate Culture with Long-Term Strategy

Cyrus Taraporevala is President and CEO of State Street Global Advisors. This post is based on an SSgA letter from Mr. Taraporevala to board members, and on an additional guidance memorandum by Rakhi Kumar, SSgA Senior Managing Director and Head of ESG Investments and Asset Stewardship; Benjamin Colton, SSgA Vice President and Head of Asia Pacific; and Caitlin McSherry, SSgA Assistant Vice President and ESG Analyst.

As one of the world’s largest investment managers, we engage with companies in our investment portfolios as part of our fiduciary responsibility to maximize the probability of attractive long-term returns for our clients. Unlike our active investment strategies where we can sell a company’s stock when we disagree with management, in our index-based strategies we own the company’s stock for as long as it is included in the index. Therefore we engage as long-term investors through our asset stewardship practice on those issues that impact long-term value.

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Mergers and Acquisitions—2019

Andrew Brownstein, Steven Rosenblum and Victor Goldfeld are partners at Wachtell, Lipton, Rosen & Katz. This post is based on their Wachtell Lipton memorandum.

As a whole, 2018 proved to be another strong year for M&A. Total deal volume reached almost $4.2 trillion globally, higher than the $3.7 trillion volume of 2017, but still less than the record of over $5 trillion set in 2015. Deals involving U.S. targets totaled over $1.7 trillion, compared to approximately $1.5 trillion in 2017. The number of large deals significantly increased in 2018, with 60 deals over $10 billion announced globally (compared to 46 deals in 2017). The technology sector saw the largest deal volume, followed by healthcare, oil and gas, and real estate. Private equity firms also had a banner year. As of late December, private equity buyout volume had reached almost $384 billion, the highest since the PE boom before the financial crisis. Although hostile and unsolicited M&A remained prevalent, the volume of these deals fell globally both in absolute terms, from $575 billion in 2017 to $522 billion in 2018, and in terms of share of overall deal volume, from 15% in 2017 to less than 13% in 2018.

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Transparency in Corporate Groups

Jay L. Westbrook is the Benno C. Schmidt Chair of Business Law at the University of Texas at Austin School of Law. This post is based on an article by Professor Westbrook, forthcoming in Brooklyn Journal of Corporate, Financial & Commercial Law.

This Article addresses a remarkable blind spot in American law: the failure to apply the well-established principles of secured credit to prevent inefficiency, confusion, and fraud in the manipulation of the webs of subsidiaries within corporate groups. In particular, “asset partitioning” has been a fashionable subject in which the central problem of non-transparency has been often mentioned, but little addressed. This Article offers a concept for a new system of corporate disclosure for the benefit of creditors and other stakeholders. It would require disclosure of corporate structures and allocations of assets among affiliates to the extent the affiliates are to be treated as independent legal entities. Enforcement would follow the secured creditor model: the failure to treat each corporation as an independent entity throughout its life would sacrifice corporate independence. The approach suggested is informed by Australia’s experience with one implementation of such a system.

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Avoiding the Cliff: The Great Recession and Today’s Economy

Joe Kennedy is President of Kennedy Research, LLC. This post is based on his Kennedy Research memorandum.

Now in its 10th year, the current economic expansion is the second longest in American history, and the sustained economic growth has begot a strong economy; Gross Domestic Product will grow well above three percent in 2018, unemployment is below four percent, and wage growth is exceeding (modest) inflation.

Yet it pays to be cautious. Although most economists believe the economy will grow through 2020, continued expansion is not inevitable. In fact, an in-depth examination of the global economy reveals several weak points that could potentially threaten the current expansion.

Some of these threats have their origins in the previous downturn a decade ago. In many cases the policy responses of 2008 and 2009 merely patched over serious structural issues rather than solving them. Potential trouble spots include a collapse of the Chinese debt bubble, the long-term durability of the Eurozone and whether countries such as Italy and Greece can remain within it, and rising debt—both public and private—in the developing world as well as Western Europe.

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Corporate Governance Failures and Interim CEOs

George Mussalli is Chief Investment Officer and Head of Research and Sevinc Cukurova is an Analyst at PanAgora Asset Management. This post is based on their PanAgora memorandum.

Appointing an Interim CEO? Not surprising if you failed the corporate governance test

  • Interim CEOs are appointed by boards with shorter tenure. Board members who appoint interim CEOs have served their companies for fewer years as compared to those appointing permanent ones. This might imply lack of experience, therefore poor management. Alternatively, tenured directors might be leaving because the company is going through turmoil. In either case, we see it as a governance failure.
  • A Board’s connectedness matters. Directors who appoint interim CEOs hold fewer outside board seats. This might imply lower board quality as directors are not in demand. It might also suggest that these directors are connected to fewer CEO candidates. Permanent CEO searches take less time as connectedness increases, which is further evidence on the latter argument.
  • CEO duality implies lower likelihood of interim appointment upon departure. A CEO who also holds the Chairman title is more likely to be succeeded by a permanent one. This is consistent with an established phenomenon that successful CEOs are awarded board leadership as part of the promotion and succession process. CEO duality is one of the most controversial issues in corporate governance: activists pressure for separation of titles, whereas research shows duality has no universal impact on performance.

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Pay Now or Pay Later?: The Economics within the Private Equity Partnership

Victoria Ivashina is Professor of Finance at Harvard Business School and Josh Lerner is Jacob H. Schiff Professor of Investment Banking at Harvard Business School. This post is based on their recent article, forthcoming in the Journal of Financial Economics.

Partnerships—a business venture in which a small group of individuals shares the profits and liabilities—were the dominant organizational form of businesses for several millennia and, even today, remain critical to the way in which the professional service and investment sectors are run. Much of the existing literature and theories suggest that partnerships continue to be prevalent because they address the difficulty of attributing individual contributions to a partnership. Two dominant hypotheses emerge regarding profit sharing in partnerships. The first proposes that compensation within the same tier of partners should be compressed to provide partners an incentive to monitor each other and ensure productivity. Alternatively, compensation should correspond to performance and would therefore vary in a group with heterogeneous talent. In this article, we suggest a third possibility: that founders of partnerships may not appropriately reward other contributors, and instead claim a disproportionate share of the economics generated by the firms for themselves.

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Key 4Q 2018 Delaware Decisions

Gail Weinstein is senior counsel, and Philip Richter and Steven Epstein are partners at Fried, Frank, Harris, Shriver & Jacobson LLP. This post is based on a Fried Frank memorandum by Ms. Weinstein, Mr. Richter, Mr. Epstein, Christopher EwanSteven J. Steinman, and Warren S. de Wied. This post is part of the Delaware law series; links to other posts in the series are available here.

The major themes of the Delaware decisions issued in 2018 were (a) the continued rejection of fiduciary claims (with many fewer fiduciary cases filed than in the past), and (b) the continued emphasis on judicial interpretation of agreement provisions based on the “contractarian” approach (with more contract dispute cases filed than in the past). Notably, in the last quarter of the year, the Court of Chancery made a number of rulings of a type seen only infrequently—but these decisions at the same time reaffirmed the highly fact-specific nature of such rulings and the high bar to a plaintiff’s obtaining them.

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Corwin’s Nuance

Meredith E. KotlerRoger A. Cooper, and Mark E. McDonald are partners at Cleary Gottlieb Steen & Hamilton LLP. This post is based on a Cleary memorandum by Ms. Kotler, Mr. Cooper, Mr. McDonald, and April Collaku, and is part of the Delaware law series; links to other posts in the series are available here.

In In re Xura, Inc. Stockholder Litigation, [1] decided earlier this week, the Delaware Court of Chancery denied the target CEO’s motion to dismiss claims that he breached his fiduciary duties by “steer[ing]” the company into an allegedly unfair acquisition by a private equity firm that promised to retain him post-acquisition, while knowing that his job was in jeopardy if the target remained independent. This case is yet another example of why disclosures are so important in the post-Corwin [2] era: Vice Chancellor Slights rejected the CEO’s argument that the claims against him were extinguished by the stockholder vote approving the transaction, finding that a number of material omissions precluded a finding that the stockholders’ vote was fully informed. The vote was thus ineffective to invoke the business judgment rule at the pleading stage.

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The Board, CEO Misconduct, and Corporate Culture

Laurie Hays is Managing Director for Special Situations at Edelman. This post is based on an Edelman memorandum by Ms. Hays.

More than 400 business executives and employees including prominent CEOs have been accused of misconduct including sexual harassment in the last 18 months. In many instances, the resulting crises have fallen squarely in the lap of boards of directors. Clearly, it is time for boards to play a more active role overseeing corporate culture and conduct.

Investors increasingly view corporate culture as a risk factor. A new survey by Edelman finds that investors recognize the impact of a healthy culture and engaged employees on corporate performance. Nearly two-in-three investors surveyed believe maintaining a healthy company culture and enforcing a corporate code of conduct at all levels of the company impact their trust significantly in that company.

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Compensation Season 2019

Adam J. Shapiro, David E. Kahan and Michael J. Schobel are partners at Wachtell, Lipton, Rosen & Katz. This post is based on a Wachtell Lipton memorandum by Mr. Shapiro, Mr. Kahan, Mr. Schobel, Jeannemarie O’Brien and Andrea Wahlquist.

Boards of directors and their compensation committees will soon shift attention to the 2019 compensation season. Key considerations in the year ahead include the following:

Dodd-Frank Act Regulations

Final Hedging Disclosure Rules. New Item 407(i) of Regulation S-K requires a company to describe any employee or director hedging policies or to state that it does not have any such policies. The required disclosure covers equity securities of the company, any parent or subsidiary of the company, and any other subsidiary of the parent. Companies must comply with the new rule in proxy statements for the election of directors during fiscal years beginning on or after July 1, 2019. Now is an opportune time for a company to review and update its existing hedging policy or to consider adopting a hedging policy if it does not have one.

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