Earnouts Update 2023

Posted by Gail Weinstein, Warren S. de Wied, and Steven Epstein, Fried, Frank, Harris, Shriver & Jacobson LLP, on
Wednesday, November 29, 2023
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Gail Weinstein is Senior Counsel and Warren S. de Wied 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. de Wied, Mr. Epstein, Philip Richter, Randi Lally, and Erica Jaffe, and is part of the Delaware law series; links to other posts in the series are available here. Related research from the Program on Corporate Governance includes Allocating Risk Through Contract: Evidence from M&A and Policy Implications (discussed on the Forum here); Are M&A Contract Clauses Value Relevant to Bidder and Target Shareholders? (discussed on the Forum here) both by John C. Coates, Darius Palia and Ge Wu; and The New Look of Deal Protection (discussed on the Forum here) by Fernan Restrepo and Guhan Subramanian.

Since the COVID-19 pandemic began in 2020, there has been a higher proportion of M&A deals including earnouts—used, as usual, to bridge gaps in buyers’ and sellers’ views of valuation in light of economic and financial uncertainties in the marketplace generally and with respect to specific businesses. Also, earnouts have been used in some deals this year to address difficulties in upfront financing as the M&A financing environment has remained challenging. In this Briefing, we discuss (i) the prevalence of earnouts in M&A deals; (ii) the trend in litigation over earnout disputes; (iii) a change in the frequency of certain earnout-related buyer covenants; (iv) basic Delaware legal principles relating to earnouts; and (v) the recent major Delaware earnout decisions, which reflect a new judicial trend of more frequent holdings against buyers. We also offer earnout-related practice points.
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Ousted

Posted by Yifat Aran (University of Haifa) and Elizabeth Pollman (University of Pennsylvania Carey Law School), on
Wednesday, November 29, 2023
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Yifat Aran is Assistant Professor of Law at the University of Haifa School of Law and Elizabeth Pollman is Professor of Law and Co-Director of the Institute for Law and Economics at the University of Pennsylvania Carey Law School. This post is based on their symposium article, Ousted, forthcoming in Theoretical Inquiries in Law. Related research from the Program on Corporate Governance includes The Untenable Case for Perpetual Dual-Class Stock (discussed on the Forum here) by Lucian A. Bebchuk and Kobi Kastiel; and Lucky CEOs and Lucky Directors (discussed on the Forum here) by Lucian A. Bebchuk, Yaniv Grinstein, and Urs Peyer.

In an era of “founder-friendly” startup governance, dual-class stock, and technology companies dominating public markets, founder-CEOs are both admired as visionaries and feared as potential governance problems. The entrenchment of founder-CEOs’ control via dual and multi-class stock sparks concern over possible agency costs and insufficient accountability for poor performance, which leads to suspicion that these founders might retain lifetime control. This concern has spurred advocacy for the implementation of sunset provisions and equal treatment agreements, designed to mitigate the risks of enduring control and to promote equal treatment for all shareholders. Amid the twists and turns of this debate, we observe that a small but important point is missing: a substantial number of founder-CEOs have been ousted—forced or pressured to step down from the CEO role despite maintaining important indicia of control.

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Strengthening pay practices

Posted by Will Arnot, Diligent Market Intelligence, on
Tuesday, November 28, 2023
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Will Arnot is Senior Editorial Specialist at Diligent Market Intelligence (DMI). This post is based on DMI’s recent special report, Investor Stewardship 2023. Related research from the Program on Corporate Governance includes Stealth Compensation via Retirement Benefits and Paying for long-term performance (discussed on the Forum here) both by Lucian Bebchuk and Jesse M. Fried; and Share Repurchases, Equity Issuances, and the Optimal Design of Executive Pay (discussed on the Forum here) by Jesse M. Fried.

2023 marked the first time in four years S&P 500-listed issuers awarded compensation packages based on a down market. In 2022, the S&P 500 index’s total return was -19.4% and companies generally responded as investors would expect, with average granted compensation for companies in the index decreasing to $15.7 million in 2022, down from $17.5 million in 2021.

Despite these tough market conditions, investors responded positively to more modest CEO payouts. 2023 marked the first proxy season in five years where support for advisory “say on pay” proposals at S&P 500 companies increased in comparison to the previous year. Proposals of this kind received 92.1% support on average in 2017, bottoming out at 87.7% average support in 2022. 2023, however, bucked the trend, with “say on pay” resolutions winning 88.9% average support, according to Diligent Market Intelligence’s (DMI) Voting module.

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Law and Political Economy in China: The Role of Law in Corporate Governance and Market Growth

Posted by Tami Groswald Ozery (Hebrew University of Jerusalem), on
Tuesday, November 28, 2023
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Tami Groswald Ozery is Assistant Professor at the Hebrew University of Jerusalem, Israel. This post is based on her book, Law and Political Economy in China. Related research from the Program on Corporate Governance includes The Elusive Quest for Global Governance Standards (discussed on the Forum here) by Lucian A. Bebchuk and Assaf Hamdani.

Scholars have long regarded certain attributes of corporate governance, particularly legal protections of private ownership, as prerequisites for financial development, deep capital markets and economic growth. Yet, the development of the Chinese market challenges many of the underlying assumptions of this “law matters” thesis. For decades, China achieved substantial growth and developed markets while preserving market control, state ownership, and relatively weak legal institutions. Informal means and functional substitutes provided investors with credible assurances that filled in some of the voids of law by incentivizing growth and governing markets.

The enduring efficacy of these functional substitutes has left its observers puzzled and resulted in a broad intellectual and popular disregard for the role of law in China’s economic rise. Laws and legal institutions are often portrayed as window dressing or as a marginal governing tool at best. Corporate governance institutions are similarly dismissed as a political mirage. The tightening of market controls in China in recent years and the rising presence of political institutions in firms (discussed, here), in conjunction with China’s economic slowdown, further reinforce the widespread skepticism about the importance of law in China’s socialist market economy.

In my newly released book,  “Law and Political Economy in China: the Role of Law in Corporate Governance and Market Growth” (Cambridge University Press, 2023), I call to reevaluate this approach. The role of law in the Chinese market, I argue, has been wrongly undervalued.

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The Delaware-Inspired Next Step Toward Brazil Becoming the South American Leader in Corporate Law: Making Public Company Arbitrations a Matter of Public Record

Posted by Caio Machado Filho (Chediak Advogados), Francisco Rüger Antunes Maciel Müssnich (Ferro, Castro Neves, Daltro & Gomide Advogados), and Leo E. Strine, Jr (University of Pennsylvania), on
Monday, November 27, 2023

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Caio Machado Filho is a Partner at Chediak Advogados, Francisco Rüger Antunes Maciel Müssnich is a Partner at Ferro, Castro Neves, Daltro & Gomide Advogados, and Leo E. Strine, Jr. is the Michael L. Wachter Distinguished Fellow at the University of Pennsylvania Carey Law School; Senior Fellow, Harvard Program on Corporate Governance; Of Counsel, Wachtell, Lipton, Rosen & Katz; and former Chief Justice and Chancellor, the State of Delaware. This post is based on their recent paper.

One of the most important functions that corporate and securities laws play is in encouraging capital formation that can promote greater wealth for the well being of society as a whole.  At the core of this important role of law is ensuring that investors in companies are ensured that their legitimate expectations of fair treatment by corporate managers and controlling stockholders are met, that there are limits on self-dealing and opportunistic behavior, and that investors are provided with reliable information to exercise their rights and hold corporate managers accountable for fulfilling their legal and fiduciary duties.  For this role to be accomplished in companies with publicly listed shares, the regulatory system must not only function, it must do so credibly and with disclosure to the investors affected by adjudication of cases affecting their interests.  Not only that, the learning about best practices that emerge from public decisions in corporate and regulatory cases helps encourage better corporate governance and convergence toward more trustworthy approaches that encourage investment.

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2023 Annual ESG Preparedness Report

Posted by Frederik Otto, Jeannette Lichner and Adélaïde Levassor, The Sustainability Board, on
Monday, November 27, 2023
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Frederik Otto is Executive Director, Jeannette Lichner is Senior Advisor, and Adélaïde Levassor is Advisor of The Sustainability Board (TSB). This post is based on the 2023 Annual ESG Preparedness Report by Mr. Otto, Ms. Lichner, Ms. Levassor, and Vicky Moffatt. Related research from the Program on Corporate Governance includes The Illusory Promise of Stakeholder Governance (discussed on the Forum here) by Lucian Bebchuk and Roberto Tallarita; Does Enlightened Shareholder Value add Value (discussed on the Forum here) by Lucian Bebchuk, Kobi Kastiel, and Roberto Tallarita; How Twitter Pushed Stakeholders Under The Bus (discussed on the Forum here) by Lucian A. Bebchuk, Kobi Kastiel, and Anna Toniolo; and Restoration: The Role Stakeholder Governance Must Play in Recreating a Fair and Sustainable American Economy – A Reply to Professor Rock (discussed on the Forum here) by Leo E. Strine, Jr.

1. Sustainability Governance is increasing ‘On Paper’

In 2019, just over half of the businesses had a board policy for ESG oversight. This number increased to 88% globally in 2023, and almost all US companies onboard except for five.

ESG oversight is primarily measured by the presence of a board committee that addresses environmental, social, and governance (ESG) issues in its charter. We also source some of this information from proxy reports, corporate governance guidelines, and annual reports. It is important to note that we often see dramatic differences in disclosure between these documents. That means that a somewhat comprehensive approach to governance stipulated in the sustainability report might not translate into the relevant committee charter, or other documents or vice versa. READ MORE »

SEC Adopts Final Rules to Amend Beneficial Ownership Reporting Rules

Posted by Stephen Fraidin, Erica Hogan and Richard Brand, Cadwalader, Wickersham & Taft LLP, on
Sunday, November 26, 2023
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Stephen Fraidin, Erica Hogan, and Richard Brand are Partners at Cadwalader, Wickersham & Taft LLP. This post is based on their Cadwalader memorandum. Related research from the Program on Corporate Governance includes The Law and Economics of Equity Swap Disclosure (discussed on the Forum here) by Lucian A. Bebchuk; The Law and Economics of Blockholder Disclosure (discussed on the Forum here) by Lucian A. Bebchuk and Robert J. Jackson, Jr.; and Pre-Disclosure Accumulations by Activist Investors: Evidence and Policy by Lucian Bebchuk, Alon Brav, Robert J. Jackson Jr., and Wei Jiang.

Overview

On October 10, 2023, the SEC adopted rule amendments related to Section 13 beneficial ownership reporting rules (the “Final Rules”).  In brief, the Final Rules accelerate the filing deadlines for Schedules 13D and 13G, provide guidance on the formation of a “group” and provide guidance on the treatment of cash-settled derivatives.  The Final Rules adopted by the SEC addressed the concerns raised in many of the comment letters.  The final rulemaking is the culmination of a deliberative and thorough process undertaken by Chair Gensler, the other SEC Commissioners, and its staff members. We believe the end result is a final rule that balances the considerations of all market participants and achieves a principal purpose of the SEC, which is to maintain fair, orderly and efficient markets and facilitate capital formation.  Further details of the rule amendments are provided below.

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California’s Comprehensive Climate Accountability Regime: Setting an Aggressive New National Standard

Posted by William J. Stellmach, Adam Aderton and William L. Thomas, Willkie Farr & Gallagher LLP, on
Saturday, November 25, 2023
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William J. Stellmach and Adam Aderton are Partners and William L. Thomas is a Counsel at Willkie Farr & Gallagher LLP. This post is based on a Willkie memorandum by Mr. Stellmach, Mr. Aderton, Mr. Thomas, Elizabeth P. Gray, Archie Fallon, and Maria Chrysanthem. Related research from the Program on Corporate Governance includes The Illusory Promise of Stakeholder Governance (discussed on the Forum here) by Lucian A. Bebchuk and Roberto Tallarita; How Twitter Pushed Stakeholders Under The Bus (discussed on the Forum here) by Lucian A. Bebchuk, Kobi Kastiel, and Anna Toniolo; Restoration: The Role Stakeholder Governance Must Play in Recreating a Fair and Sustainable American Economy—A Reply to Professor Rock (discussed on the Forum here) by Leo E. Strine, Jr; and Corporate Purpose and Corporate Competition (discussed on the Forum here) by Mark J. Roe.

On October 7, 2023, California adopted a new set of far-reaching climate laws in the form of SB 253, the Climate Corporate Data Accountability Act (CCDAA), and SB 261, the Climate-Related Financial Risk Act (CRFRA) (collectively, the “California Climate Accountability Regime”).[1] Because of the sheer size of the California market—the world’s fifth largest economy—the new legislation effectively will re-shape the Environmental, Social and Governance (“ESG”) and climate transparency debate far beyond the state’s borders.

Under the CCDAA, companies operating within California with annual revenues exceeding $1 billion must begin publicly reporting their greenhouse gas (“GHG”) emissions, including indirect emissions impacts resulting from their activity, starting in 2026. Under the CRFRA, companies operating in California with annual revenues exceeding $500 million must publish biennial climate-related financial risk reports disclosing both climate-related financial risk and measures taken to reduce and adapt to such risk by January 1, 2026. Covered companies under both bills must pay an annual fee, the amount of which is to be determined.

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US Public Company Board Diversity in 2023: How Corporate Director Diversity Can Contribute to Board Effectiveness

Posted by Merel Spierings, The Conference Board, on
Friday, November 24, 2023
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Merel Spierings is Senior Researcher at The Conference Board ESG Center in New York. This post relates to Corporate Board Practices in the Russell 3000, S&P 500, and S&P MidCap 400: Live Dashboard, a live online dashboard published by The Conference Board and ESG data analytics firm ESGAUGE, in collaboration with Debevoise & Plimpton, the KPMG Board Leadership Center, Russell Reynolds Associates, and The John L. Weinberg Center for Corporate Governance at the University of Delaware. Related research from the Program on Corporate Governance includes The Perils and Questionable Promise of ESG-Based Compensation (discussed in the Forum here) by Lucian Bebchuk and Roberto Tallarita; Paying for long-term performance (discussed in the Forum here) by Lucian Bebchuk and Jesse Fried; and Share Repurchases, Equity Issuances, and the Optimal Design of Executive Pay (discussed in the Forum here) by Jesse Fried.

This report documents corporate governance trends and developments at US publicly traded companies—including information on board composition and diversity, the profile and skill sets of directors, and policies on their election, removal, and retirement. The analysis is based on recently filed proxy statements and complemented by the review of organizational documents (including articles of incorporation, bylaws, corporate governance principles, board committee charters, and other corporate policies made available in the Investor Relations section of companies’ websites). The report also presents key insights gained during two Chatham House Rule meetings: a focus group discussion with in-house governance leaders in which we discussed their views on current trends in corporate boardrooms, and a roundtable discussion with over 30 corporate directors, C-Suite executives, and governance professionals, in which we discussed how to harness the advantages of having a diverse board.

The reported level of diversity on US corporate boards seemed to reach a plateau even before litigation challenging corporate diversity programs in the wake of the Supreme Court’s decision in Students for Fair Admissions, Inc. v. President and Fellows of Harvard College.[1] In the current environment, it is critical for boards to have a clear consensus on how diversity and commonality among directors contribute to effectiveness. This report addresses the current state of diversity in boardrooms and provides insights on how to maximize the benefits of a diverse board.

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ConEd Is Not Dead In Delaware

Posted by Neil Q. Whoriskey and Scott Golenbock, Milbank LLP, on
Thursday, November 23, 2023
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Neil Q. Whoriskey and Scott Golenbock are Partners at Milbank LLP. This post is based on their Milbank memorandum and is part of the Delaware law series; links to other posts in the series are available here. Related research from the Program on Corporate Governance includes Are M&A Contract Clauses Value Relevant to Target and Bidder Shareholders? ( discussed on the Forum here) by John C. Coates, Darius Palia, and Ge Wu; and The New Look of Deal Protection (discussed on the Forum here) by Fernan Restrepo and Guhan Subramanian.

This is the price paid for allowing our hopes, rather than established law, to guide public merger agreement drafting for the last 18 years.  Con Edison v Northeast Utilities[1], a 2005 Second Circuit decision regarding a New York law governed merger agreement, found that, absent clear contractual language to the contrary, a target company could not collect lost shareholder premium as damages for the breach of a merger agreement. ConEd caused quite a stir in public M&A circles, with some asserting that it caused every public merger agreement to be converted into a mere option agreement, where, if the buyer did not wish to close, it had only to pay the target’s out-of-pocket costs. This may have been a bit extreme, but given how infrequently specific performance has been ordered to remedy a failure to close, it probably was not far off the mark.

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