The Activism Vulnerability Report Q2 2021

Jason Frankl is Senior Managing Director and Brian G. Kushner is Senior Managing Director and Leader of Private Capital Advisory Services at FTI Consulting. This post is based on their FTI Consulting memorandum. 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); Dancing with Activists by Lucian Bebchuk, Alon Brav, Wei Jiang, and Thomas Keusch (discussed on the Forum here); and Who Bleeds When the Wolves Bite? A Flesh-and-Blood Perspective on Hedge Fund Activism and Our Strange Corporate Governance System by Leo E. Strine, Jr. (discussed on the Forum here).

Market Update

The more things change, the more they stay the same. Although COVID-19 remained a global concern, U.S. equity markets continued to push higher in Q2 2021. For the year, the S&P 500 Index is up 18.3%, while the Dow Jones Industrial Average has returned 14.7% and the Nasdaq Composite Index has returned 14.2%. [1]

Year-to-Date Performance (2021) [2]

While value stocks outperformed growth stocks in the Q1 2021, that style rotation appears to have been short-lived, and the longer-term trend of growth stock outperformance has continued so far in 2021. Year-to-Date, the S&P 500 Growth Index has returned 20.6% compared to the S&P 500 Value Index, which has returned 17.9%. [3]

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Investors’ Response to the #MeToo Movement: Does Corporate Culture Matter?

Mary Billings is Associate Professor of Accounting, April Klein is Professor of Accounting, and Yanting (Crystal) Shi is a PhD candidate in Accounting, all at NYU Stern School of Business. This post is based on their recent paper. Related research from the Program on Corporate Governance includes The Illusory Promise of Stakeholder Governance by Lucian A. Bebchuk and Roberto Tallarita (discussed on the Forum here); Companies Should Maximize Shareholder Welfare Not Market Value by Oliver Hart and Luigi Zingales (discussed on the Forum here); and Reconciling Fiduciary Duty and Social Conscience: The Law and Economics of ESG Investing by a Trustee by Max M. Schanzenbach and Robert H. Sitkoff (discussed on the Forum here).

Good corporate governance is a bedrock of corporate America, with a central tenet being the board of directors’ role in effectively overseeing and monitoring the firm. Recently, institutional investors have focused on changing board composition. Beginning in 2017, two of the “Big 3” institutional investors, State Street and BlackRock, began an ESG activist campaign for their portfolio firms to include women on their board of directors, voting consistently against directors on the nominating committee if the firm presented a ballot of directors with zero women. Prominent proxy advisors, including ISS and Glass Lewis, also have advanced voting policy guidelines that reflect commitments to board gender diversity. In 2020, Goldman Sachs joined this campaign by announcing it would not underwrite IPOs in the U.S for firms with all-male boards of directors.

Given the voting and financial clout of these institutions, it is not surprising that their activism wielded significant influence in this governance area. Between 2017 and 2020, the number of S&P 1500 firms having all-male boards dropped from 179 to 30, with no S&P 500 board retaining a board without at least one woman director. In 2020, of the top 25 U.S. IPOs, just one company, Dun & Bradstreet, went public with an all-male board, compared to 12 IPOs in 2018. Government and regulators also have responded. In 2018, California passed legislation mandating most publicly traded companies based there to have at least three women on their boards by the end of 2021 (California Senate Bill No. 826), and in 2020, the NASDAQ proposed a change to its corporate governance listing requirements by requiring the inclusion (or explanation of non-inclusion) of at least one woman board member.

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How the Best Boards Approach CEO Succession Planning

Maria Castañón Moats is Leader and Paul DeNicola is Principal at the Governance Insights Center, PricewaterhouseCoopers LLP. This post is based on their PwC memorandum.

Many boards aren’t fully prepared for CEO departures despite succession planning being one of their primary responsibilities. If we’ve learned anything during the pandemic, it’s that anything can happen. There are important steps directors can take to be better prepared for both planned departures and the unexpected.

Why CEO succession planning can be hard

Planning for who will be the company’s next leader has long been one of a board’s most important responsibilities. Without the right person at the top, even the best companies with the most innovative strategies will struggle. The COVID 19 crisis has accelerated the pace of digital transformation, industry consolidation, and flexible work arrangements. So, boards may need to rethink the skills they look for in a top leader in the post pandemic environment.

Businesses need strong leadership more than ever. Yet all too often, boards are caught unprepared when they need a change in leadership. Why does this happen? For a start, it can be difficult just to have the conversation. In high performing companies, directors may be concerned that broaching the topic of succession will cause the current CEO to think they are looking for a replacement. In under performing companies, directors may want to avoid doing anything to make the CEO worry about job security when they need to focus on driving strategy.

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Board Practices Quarterly: The Outspoken Corporation

Natalie Cooper is Senior Manager and Robert Lamm is an independent senior advisor, both at the Center for Board Effectiveness, Deloitte LLP; and Randi Val Morrison is Vice President, Reporting & Member Support at the Society for Corporate Governance. This post is based on a Deloitte/Society for Corporate Governance memorandum by Ms. Cooper, Mr. Lamm, Ms. Morrison, Debbie McCormack, Carey Oven, and Darla C. Stuckey.

Corporate leaders are increasingly speaking out on potentially controversial social, political, and environmental issues as a matter of principle and/or in response to changing stakeholder pressures and expectations that corporate America can influence the dialogue on these issues. As is the case with many other corporate practices, taking a stance publicly on controversial or sensitive topics poses both risks and opportunities, including alienating or appealing to key stakeholders; enhancing or damaging the corporate culture; and eroding or building trust and brand reputation. As a result of these dynamics, many corporate leaders and boards of directors are considering—in many cases, for the first time—whether and how their companies should approach public engagement on these issues.

This post looks at how companies approach public engagement on social, political, environmental, or public policy issues and the related role of the board. It presents findings from a July 2021 survey of in-house members of the Society for Corporate Governance that addressed, among other matters, designation of a company spokesperson; governing documentation; the role of management; board oversight and practices; and stakeholder engagement.

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ESG in 2021 So Far: An Update

Marc S. Gerber, Greg Norman and Simon Toms are partners at Skadden, Arps, Slate, Meagher & Flom LLP. This post is based on a Skadden memorandum by Mr. Gerber, Mr. Norman, Mr. Toms, Louise Batty, Adam M. Howard and Caroline S. Kim. Related research from the Program on Corporate Governance includes The Illusory Promise of Stakeholder Governance (discussed on the Forum here) and Will Corporations Deliver to All Stakeholders?, both by Lucian A. Bebchuk and Roberto Tallarita; For Whom Corporate Leaders Bargain by Lucian A. Bebchuk, Kobi Kastiel, and Roberto Tallarita (discussed on the Forum here); and Restoration: The Role Stakeholder Governance Must Play in Recreating a Fair and Sustainable American Economy—A Reply to Professor Rock by Leo E. Strine, Jr. (discussed on the Forum here).

The rapidly growing focus on environmental, social and governance (ESG) matters that marked 2020 continued to shape events for companies operating or based in the U.K. and Europe in 2021. Discussions of ESG are occurring at all levels, from the boardroom to investors to employees, and governments, regulators and companies are all being encouraged to take these matters into consideration. In our 1 February 2021 article (“ESG: Key Trends in 2020 and Expectations for 2021”), we set out what we thought would be the key ESG trends to watch this year. In this article, we take stock of those predictions, discuss new issues that have emerged over the year and identify the trends we think will be prominent during the remainder of 2021.

Looking Back: Correct Predictions

A number of our key expectations at the outset of the year have been borne out.

ESG Funds [1]

In the first quarter of 2021, inflows into European “sustainable” funds totalled €120 billion, 18% more than the first quarter of 2020, according to Morningstar, and that comprised slightly more than half of all fund inflows for the first time. Of that, €36.5 billion went to passive index and exchange-traded funds (ETFs). Despite the latter growth, there is concern that passive funds will struggle to match the service provided by active managers due to (i) the subjectivity involved in determining appropriate ESG credentials until there is a standardisation of ESG data and reporting and (ii) the ease with which active managers can react to controversy compared to passive ETFs, which must wait for an index committee review before changing investments.

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Vermont’s Fossil Fuel Suit Underscores Climate-Change Pressures Faced by U.S. Companies

John F. Savarese, David M. Silk, and Jeffrey M. Wintner are partners at Wachtell, Lipton, Rosen & Katz. This post is based on a Wachtell memorandum by Mr. Savarese, Mr. Silk, Mr. Wintner, William Savitt, David B. Anders, and Sabastian V. Niles. Related research from the Program on Corporate Governance includes The Illusory Promise of Stakeholder Governance (discussed on the Forum here) and Will Corporations Deliver to All Stakeholders?, both by Lucian A. Bebchuk and Roberto Tallarita; For Whom Corporate Leaders Bargain by Lucian A. Bebchuk, Kobi Kastiel, and Roberto Tallarita (discussed on the Forum here); and Restoration: The Role Stakeholder Governance Must Play in Recreating a Fair and Sustainable American Economy—A Reply to Professor Rock by Leo E. Strine, Jr. (discussed on the Forum here).

Companies in the United States and elsewhere continue to face extreme pressure to respond to climate change, with respect to both business operations and disclosures. In the most recent U.S. development on this front, the State of Vermont yesterday brought civil claims against a series of energy companies under its state consumer protection statute, alleging deceptive acts and unfair practices in connection with their marketing, sales and other operations in and outside of the state. Stopping short of seeking restitution for environmental degradation or a ban on the sale of fossil fuels, the suit seeks disgorgement of funds obtained as a result of the alleged violation of Vermont’s consumer protection law as well as substantial civil penalties. These suits are yet another reminder that regulators continue to take aggressive positions on issues related to climate change, making it all the more important that companies carefully consider how best to address those issues.

The core allegation of the suit is that the defendants misled the public about the impact of fossil fuels by advertising that their products are better for the environment than others, while omitting to disclose that their products continue to contribute to greenhouse gas emissions and climate change. With an explicit reference to the language of cigarette marketing, the suit also alleges that the defendants mislead consumers by using “green,” “clean” and similar terminology. Vermont alleges that recent “greenwashing” campaigns by these companies falsely portray the companies as responsible stewards of the environment. Notably, the state alleges that at least one of these companies admits in a sustainability report that its publicly disclosed net-zero emissions targets are not reflected in its operating plans and budgets.

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Why CEO Option Compensation Can be a Bad Option for Shareholders: Evidence from Major Customer Relationships

Claire Liu is Assistant Professor of Finance at the University of Sydney; Ronald Masulis is Scientia Professor of Finance at the University of New South Wales; and Jared Stanfield is Assistant Professor of Finance at the University of Oklahoma. This post is based on their recent paper. Related research from the Program on Corporate Governance includes Paying for Long-Term Performance by Lucian Bebchuk and Jesse Fried (discussed on the Forum here).

Option compensation is an important component of executive pay in the United States. By providing convex payoffs, option-based compensation is viewed as a standard mechanism to reduce manager risk aversion and align manager and shareholder interests by encouraging value-enhancing risk taking. In aligning manager-shareholder interests, chief executive officer (CEO) stock option compensation can also intensify conflicts of interests with other key stakeholders by encouraging potentially excessive firm risk taking (see, e.g., John and John, 1993; Opler and Titman, 1994; Kuang and Qin, 2013; Akins et al., 2019). In this study, we take a novel approach to further our understanding of the effects of these conflicts of interest by studying the impact of competitive shocks to important product market relationships and executive option compensation.

Generating sales and preserving valuable product market relationships, such as with major customers, is arguably one of the most crucial factors for a firm’s success. In the United States, nearly half of public firms depend on at least one large customer for a substantial portion of their sales, i.e., representing at least 10% of sales (Ellis, Fee, and Thomas, 2012). It is also common for firms to make relationship-specific investments (RSI) in their major customer relationships, and the health of these valuable trading relationships can significantly affect firm value. As a result, suppliers that depend on an important customer commonly state that the loss of a major customer would negatively impact their firm. For example, Scientific Atlanta Inc., a cable and telecommunications equipment manufacturer, states in its 2005 Form 10-K filing: “A failure to maintain our relationships with customers that make significant purchases of our products and services could harm our business and results of operations. A decline in revenue from one of our key customers or the loss of a key customer could have a material adverse effect on our business and results of operations.” Networking server and storage manufacturer Qlogic Corp. states in its 2005 10-K filing: “Any such reduction, delay or loss of [major customer] purchases could have a material adverse effect on our business, financial condition or results of operations.”

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Weekly Roundup: September 10–16, 2021


More from:

This roundup contains a collection of the posts published on the Forum during the week of September 10–16, 2021.

Financial Reporting and Moral Sentiments



NYSE Restores Thresholds for Related Party Transactions


SEC Continues to Scrutinize Earnings Management Through Its EPS Initiative


Boards Need to Become More Diverse. Here’s How to Do It


Boeing’s MAX Woes Reach the Boardroom


Discharging the Discharge for Value Defense


The FCA and SEC Annual Reports—A Statistical Comparison


Beyond “Market Transparency”: Investor Disclosure and Corporate Governance


ESG Disclosures in Proxy Statements: Benchmarking the Fortune 50


Uptick in Clients Seeking to Discuss ESG Investing




Going Public Report: First Half 2021



SEC Charges Kraft Heinz with Improper Expense Management Scheme

Cydney S. Posner is special counsel at Cooley LLP. This post is based on her Cooley memorandum.

On Friday, the SEC announced settled charges against Kraft Heinz Company, its Chief Operating Officer and Chief Procurement Officer for “engaging in a long-running expense management scheme that resulted in the restatement of several years of financial reporting.” According to the SEC’s Order regarding the company and the COO, as well as the SEC’s complaint against the CPO, the company employed a number of expense management strategies that “misrepresented the true nature of transactions,” including recognizing unearned discounts from suppliers, maintaining false and misleading supplier contracts and engaging in other accounting misconduct, all of which resulted in accounting errors and misstatements. The misconduct, the SEC contended, was designed to allow the company to report sham cost savings consistent with the operational efficiencies it had touted would result from the 2015 merger of Kraft and Heinz, as well as to inflate EBITDA—a critical earnings measure for the market—and to achieve certain performance targets. And, once again, charges of failure to design and implement effective internal controls played a prominent role. After the SEC began its investigation, KHC restated its financials, reversing “$208 million in improperly-recognized cost savings arising out of nearly 300 transactions.” According to Anita B. Bandy, Associate Director of Enforcement, “Kraft and its former executives are charged with engaging in improper expense management practices that spanned many years and involved numerous misleading transactions, millions in bogus cost savings, and a pervasive breakdown in accounting controls. The violations harmed investors who ultimately bore the costs and burdens of a restatement and delayed financial reporting….Kraft and its former executives are being held accountable for placing the pursuit of cost savings above compliance with the law.” KHC agreed to pay a civil penalty of $62 million. Interestingly, this case comes on the heels of an earnings management case brought by the SEC against Healthcare Services Group, Inc. for alleged failures to properly accrue and disclose litigation loss contingencies.

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The Real Effects of Mandatory CSR Disclosure on Emissions: Evidence from the Greenhouse Gas Reporting Program

Lavender Yang is a PhD candidate in Accounting, Nicholas Z. Muller is the Lester and Judith Lave Professor of Economics, Engineering, and Public Policy, and Pierre Jinghong Liang is Professor of Accounting, all at Carnegie Mellon University Tepper School of Business. This post is based on their recent paper. Related research from the Program on Corporate Governance includes The Illusory Promise of Stakeholder Governance (discussed on the Forum here) and Will Corporations Deliver to All Stakeholders?, both by Lucian A. Bebchuk and Roberto Tallarita; For Whom Corporate Leaders Bargain by Lucian A. Bebchuk, Kobi Kastiel, and Roberto Tallarita (discussed on the Forum here); and Restoration: The Role Stakeholder Governance Must Play in Recreating a Fair and Sustainable American Economy—A Reply to Professor Rock by Leo E. Strine, Jr. (discussed on the Forum here).

As economist John Kenneth Galbraith remarked in a 1994 interview, knowing someone is watching can make a difference in the behavior of the watched.  It is not surprising, then, that societies seek to use monitoring and disclosure as tools to encourage desirable business practices, especially in the area of social responsibility such as businesses’ environmental impacts. Large-scale, mandatory Corporate Social Responsibility (CSR) reporting has been gaining momentum in recent policy debates. Back in 2020, a Commissioner of the Securities and Exchange Commission (SEC)  argued for a move toward standardized Environmental, Social, and Governance (ESG) disclosures. As discussed in this forum, the Biden administration issued an executive order in January 2021 arguing for climate change-related disclosure in all economic sectors of the United States economy.

In a recent paper, we offer causal evidence regarding the impact of mandatory CSR-relevant disclosure on firms’ emission behavior. Specifically, we investigate whether a nation-wide mandatory reporting and disclosure requirement, the Greenhouse Gas Reporting Program (GHGRP), for plant level carbon dioxide (CO2) emissions, a principal greenhouse gas (GHG), affects subsequent emissions. To answer this research question, we exploit differential disclosure requirements under the GHGRP. This regulation requires all facilities in the U.S. that emit more than 25,000 tons of CO2 per year to report their CO2 emissions to EPA who, in turn, release the data to the public in a comprehensive and accessible manner under GHGRP. Our research design exploits a unique data opportunity. For the U.S. utility sector, both pre- and post-GHGRP emissions data are available for all power plants (including those emitting less than the 25,000 ton threshold). This context facilitates the use of quasi-experimental econometric designs to assess the causal effect of the GHGRP disclosure on firm behavior. Our specifications determine whether plants whose CO2 emission reports are required to be publicly disclosed through the GHGRP behave differently than those not subjected to the program.  We hypothesize a reduction in the emission rates for plants covered by the GHGRP relative to those not covered.

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