ESG in 2023: Politics and Polemics

David N. Katz is a Partner and Laura A. McIntosh is a Consulting Attorney at Wachtell, Lipton, Rosen & Katz. This post is based on their Wachtell memorandum. Related research from the Program on Corporate Governance includes The Illusory Promise of Stakeholder Governance (discussed on the Forum here) and For Whom Corporate Leaders Bargain (discussed on the Forum here) both by Lucian A. Bebchuk and Roberto TallaritaRestoration: 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 Stakeholder Capitalism in the Time of COVID (discussed on the Forum here) by Lucian Bebchuk, Kobi Kastiel, and Roberto Tallarita.

ESG is poised to become a major element of nonfinancial reporting at the very moment that it is becoming highly controversial and politicized.  New European Union rules regarding mandatory ESG reporting will affect public and private U.S. companies that meet certain EU-presence thresholds or—significantly—are part of the value chain of an entity that is required to make the mandatory disclosures.  This development represents a significant departure from past practices and will reach much farther than many companies may have anticipated.  In the United States, the Securities and Exchange Commission is on the verge of adopting climate-related disclosure rules, possibly heralding the start of increasingly onerous ESG reporting obligations.  These regulatory developments are supported by many, though not all, institutional investors, and the extent of such support going forward is likely to influence the future direction of ESG disclosure.

Over the past year, an anti-ESG backlash has flourished in the United States, led by conservative politicians and investors.  Florida governor Ron DeSantis summarized the thesis of the backlash in a recent statement:  “Corporate power has increasingly been utilized to impose an ideological agenda on the American people through the perversion of financial investment priorities under the euphemistic banners of environmental, social, and corporate governance and diversity, inclusion, and equity.”  At the World Economic Forum summit in Davos last week, a number of executives expressed frustration and concern over the intensifying drama around ESG.  Like it or not, however, executives and investors will have to contend with ESG controversies and disclosure obligations for the foreseeable future while staying focused on their strategic priorities.  Proactive board oversight—of both ESG disclosure practices and ESG-related controversies—will be essential to managing companies’ reputational risk strategy around ESG.

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Does Greater Public Scrutiny Hurt a Firm’s Performance?

Benjamin Bennett is Assistant Professor at the Tulane University A.B. Freeman School of Business; René M. Stulz is the Everett D. Reese Chair of Banking and Monetary Economics at the Fisher College of Business at The Ohio State University; and Zexi Wang is an Associate Professor at the Lancaster University School of Management. This post is based on their recent paper.

CEOs are often concerned about the public scrutiny that comes with leading a public firm. Founders want their firm to stay private to avoid that scrutiny. Public scrutiny can be valuable, however, as it can lead to more monitoring of firms, which may improve performance. At the same time, greater attention can have adverse effects. For instance, it can distract managers, preventing them from spending their time on issues internal to the firm, and can make it difficult for firms to stand out and implement policies that may be unpopular with the public. Consequently, while public attention may have a positive side, it may also have a dark side. In this paper, we investigate whether public scrutiny benefits firm performance. We find evidence that an increase in public scrutiny has an adverse effect on firm performance.

Public attention varies among public firms. Some firms consistently receive more attention because they are more prominent or salient. For firms subject to more scrutiny, mistakes may have larger consequences as they are noticed more. Policy differences with comparable firms will be better known and raise more questions. Firm actions may be more likely to be noticed and criticized by politicians. The firm may become more exposed to legal and regulatory actions. As a result, greater attention could affect performance negatively and may force firms to take actions they would not take absent the greater attention. For instance, greater public attention might cause management to choose policies more similar to those of peers even if it would not do so in the absence of greater public scrutiny. Management might do so because it does not want its policies to stand out, because sectors of the public push for such policies, or because these policies are optimal given the heightened attention. We therefore investigate whether one channel through which greater public attention affects performance is in causing firms with greater attention to have policies more similar to their peers.

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Expanding and Diversifying Director Candidate Pools through Subsidiary Board Service

Michael Rossen is a Managing Director and Kay Brkic is a Senior Manager at Deloitte LLP. This post is based on a Deloitte LLP memorandum by Mr. Rossen, Ms. Bkic, Richard Levine, and Ian MacDonald. Related research from the Program on Corporate Governance includes Politics and Gender in the Executive Suite (discussed on the Forum here) by Alma Cohen, Moshe Hazan, and David Weiss; Will Nasdaq’s Diversity Rules Harm Investors? (discussed on the Forum here) by Jesse M. Fried; and Duty and Diversity (discussed on the Forum here) by Chris Brummer and Leo E. Strine, Jr.

The business case for board diversity is not new and may no longer be forward-thinking.[1] While organizations – and other parties – have introduced initiatives to encourage boardroom diversity, developing the next generation of board members is a persistent challenge for many business leaders.

Beyond current initiatives to increase boardroom diversity, organizations with subsidiaries are uniquely positioned to further diversify the board candidate pool.

As an example, organizations can place diverse executives onto their subsidiary boards. By providing this opportunity to their executives through a formalized policy, organizations can fill subsidiary boards with those that are interested in board service, and the executives can gain valuable experience of serving on a board that can be used as a steppingstone for longer-term board service aspirations should they wish. Putting such a policy in place also sets the stage to infuse diverse candidates into future parent board refreshment initiatives. However, this approach may not be as simple for listed subsidiaries that will have their own requirements for outside, independent directors.

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Global Corporate Credit ESG Engagement Report

Jonathan Bailey is a Managing Director and Head of ESG Investing, and Savannah Irving is an Associate at Neuberger Berman LLC. This post is based on their Neuberger Berman memorandum.

In recent years a variety of market disrupting events have underscored the importance of active ownership and the analysis of material environmental, social and governance (ESG) factors in fundamental credit research as well as investment decision-making. In our view, asset managers who leverage their relationships with issuers are best positioned to manage these ESG risks and take advantage of ESG opportunities. As highlighted in our prior ESG engagement reports, Neuberger Berman views direct issuer engagement as a critical tool to mitigate portfolio risks while generating long-term sustainable returns.

During the past year our established relationships with issuers in developed and emerging markets enabled us to have meaningful engagements with a number of management teams. We engaged on key ESG issues such as climate change, community relations and human capital management. While these ESG issues present varying challenges and complexities, both transparency and accountability are key determinants of the success of our engagements with corporate credit issuers. We encourage issuer alignment with external frameworks such as the United Nations Sustainable Development Goals (UN SDGs), the Task Force on Climate-Related Financial Disclosures (TCFD) and the SASB Standards to improve the transparency of issuers’ credit profiles. We also assess the capability of management teams to set and successfully execute sustainability targets, as evidenced in the emerging practice of linking ESG Key Performance Indicators (KPIs) to executive variable compensation with a focus on enhancing accountability.

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Investing in Influence: Investors, Portfolio Firms, and Political Giving

Raymond Fisman is Slater Family Professor in Behavioral Economics at Boston University. This post is based on a recent paper by Professor Fisman, Marianne Bertrand, Matilde Bombardini, Francesco Trebbi, and Eyub Yegen. Related research from the Program on Corporate Governance includes The Agency Problems of Institutional Investors (discussed on the Forum here) by Lucian Bebchuk, Alma Cohen, and Scott Hirst; Index Funds and the Future of Corporate Governance: Theory, Evidence, and Policy (discussed on the Forum here) and The Specter of the Giant Three (discussed on the Forum here) both by Lucian Bebchuk and Scott Hirst; and The Limits of Portfolio Primacy (discussed on the Forum here) by Roberto Tallarita.

Over the past seventy years, institutional investors’ ownership of publicly traded U.S. companies has increased dramatically, from just 6 percent in 1950 to 65 percent in 2017. As a result, a large fraction of the U.S. economy is now in the hands of a relatively small number of asset management companies. The “Big Three” of BlackRock, Vanguard, and State Street Global Investors, for example, held more than 20 percent of S&P 500 shares in 2017 as compared to 5 percent in 1998.

This sea change in the ownership of U.S. corporations has given rise to a discussion among academics and policymakers over its consequences. In “Investing in Influence,” we focus on a particular concern over the rise of institutional shareholders: has the concentration of ownership also led to a concentration of political influence?

Researchers – including ourselves – have traditionally assumed that companies’ political strategies were simply an extension of their profit-maximizing business strategies. Under this view of the world, firms make campaign donations or lobby regulators to secure laws and regulations that are good for company profits. Yet a vast body of research on corporate governance has shown that companies’ goals are driven not by a single-minded focus on corporate profits, but rather a collection of disparate interests of those who wield control over the firm’s resources.

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Weekly Roundup: January 27-February 2, 2023


More from:

This roundup contains a collection of the posts published on the Forum during the week of January 27-February 2, 2023

Preparing for the 2023 Proxy Season


Update on ESG, Stakeholder Governance, and Corporate Purpose


Delaware Courts Provide Guidance on Incumbent Board Enforcement of Advance Notice Bylaws


EU Finalizes ESG Reporting Rules with International Impacts


The controversy over proxy voting: The role of asset managers and proxy advisors


Voting Rights in Corporate Governance: History and Political Economy


​Antitrust and ESG


Conflicting Fiduciary Duties and Fire Sales of VC-backed Start-ups


Where is the World Going in 2023 and Beyond?


​Delaware M&A Updates


ESG Investing After the DOL Rule on “Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights”


ESG Investing After the DOL Rule on “Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights”

Robert H. Sitkoff is Austin Wakeman Scott Professor of Law and John L. Gray Professor of Law at Harvard Law School, and Max M. Schanzenbach is Seigle Family Professor of Law at Northwestern Pritzker School of Law. 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; Companies Should Maximize Shareholder Welfare Not Market Value (discussed on the Forum here) by Oliver D. Hart and Luigi Zingales; and Reconciling Fiduciary Duty and Social Conscience: The Law and Economics of ESG Investing by a Trustee (discussed on the Forum here) by Robert H. Sitkoff and Max M. Schanzenbach.

Summary of the Rule

In late 2022, the Department of Labor under President Biden promulgated a new rule on “Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights,” superseding the Department’s 2020 rule promulgated under President Trump. Numerous media reports suggested that the 2022 Biden Rule permits or even encourages ESG investing, in contrast to the 2020 Trump Rule, which was reported to be hostile to ESG investing. These reports are wrong. This summary aims clarify the effect of the Biden Rule and what has changed from the Trump Rule.

In brief, the 2022 Biden Rule largely reaffirms the Department of Labor’s longstanding position, compelled by binding Supreme Court precedent, that an ERISA fiduciary may use ESG investing to improve risk-adjusted returns but not to obtain collateral benefits. Subject to a few nuanced changes of limited practical import, the Biden Rule is largely consistent with the 2020 Trump Rule and earlier regulatory guidance.

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​Delaware M&A Updates

Andrew G. Gordon, Ross A. Fieldston and Laura C. Turano are Partners at Paul, Weiss, Rifkind, Wharton & Garrison LLP. This post is based on a Paul, Weiss memorandum by Mr. Gordon, Mr. Fieldston, Ms. Turano, and Jaren Janghorbani. This post is part of the Delaware law series; links to other posts in the series are available here.

Court of Chancery Holds Stockholder Is Not Third-Party Beneficiary Under Merger Agreement and Buyer Was Not Controller

In Crispo v. Musk, the Delaware Court of Chancery, in an opinion by Chancellor McCormick, held that the plaintiff stockholder of Twitter, Inc. was not a third-party beneficiary under the company’s merger agreement with Elon Musk and therefore lacked standing to sue for specific performance ordering Musk to close the merger. In so holding, the court emphasized that Delaware courts are reticent to recognize stockholders as third-party beneficiaries to corporate contracts due to Delaware law’s deference to the board’s authority to manage the corporation and its litigation assets and that other, limited circumstances where the courts have found stockholders to be third-party beneficiaries to merger agreements were clearly distinguishable. In addition, the court dismissed fiduciary duty claims against the buyers, Elon Musk and his affiliates, holding that they did not constitute a control group where Musk individually owned less than 10% of the company’s stock, the alleged group owned 26.8% of the stock, Musk did not exercise his rights under the merger agreement to veto board action and only had an alleged personal relationship with one of the 11 board members.

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Where is the World Going in 2023 and Beyond?

Paul Keary is CEO, Ursula Burns is Chair, and Sparky Zivin is a Senior Managing Director at Teneo. This post is based on their Teneo report.

Foreword

The role of today’s CEO is evolving, paralleling the shifting global financial, geopolitical and social landscapes in which they operate. Teneo is fortunate to work with and advise leading CEOs around the world as they navigate this environment.

As the calendar turns from a tumultuous 2022 to the uncertainties of 2023, we surveyed more than 300 global public company CEOs and institutional investors representing approximately $3 trillion USD of combined company and portfolio value to capture views on key issues for the coming year. From the global macroeconomic outlook to innovation and emerging technologies, deglobalization and its knock-on effects, ESG and talent, perspectives are, in many ways, aligned. For example, 86% of CEOs and investors believe that deglobalization is a reality, with almost half of CEOs acknowledging that this will have a significant impact on their companies.

However, tensions appear in several key—and perhaps unexpected—areas, highlighting possible vulnerabilities and opportunities for business leaders in the year ahead. For instance, CEOs and investors have widely divergent views on the economic outlook for the first half of 2023. While 73% of leading CEOs expect worsening conditions in 2023, 76% of investors expect conditions to improve.

This represents just a sampling of the insights highlighted in this report. We hope that the findings prove useful as you plan your strategy for 2023 and beyond.

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Conflicting Fiduciary Duties and Fire Sales of VC-backed Start-ups

Bo Bian is an Assistant Professor in Finance at the University of British Columbia; Yingxiang Li is a PhD Candidate in Finance at the University of British Columbia; and Casimiro A. Nigro is an Assistant Professor in Law and Finance at Goethe University. This post is based on their recent paper and is part of the Delaware law series; links to other posts in the series are available here.

Introduction

In 2013 the Delaware Court of Chancery’s came to a final decision regarding the by-now-famous Trados case. Trados involved claims against the board of a startup company that was sold in a merger transaction.  Plaintiffs, who held common stock of the company, alleged that board members affiliated with the company’s VC investors were conflicted in approving the transaction.  The VC investors held preferred stock that provided for a “liquidation preference” in the event of a company sale.  Because of that liquidation preference, the VC investors received all the merger consideration while common shareholders received nothing. In an initial opinion, the court denied defendants summary judgment and determined that the claims should be evaluated under the plaintiff-friendly fairness standard. (See In Re Trados Inc. Shareholder Litigation, 2009 WL 2225958 (Del Ch. 2009.)) In a subsequent trial court opinion, the court confirmed the applicability of the fairness standard, but ultimately ruled in favor of the defendants because the common stock were likely to have no value – making zero a fair price. (See In re Trados Incorporated Shareholder Litigation, 73 A.3d 17 (Del. Ch. 2013.)

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