2019 Say on Pay & Proxy Results

Todd Sirras is Managing Director and Austin Vanbastelaer is a Consultant at Semler Brossy. This post is based on their Semler Brossy memorandum. Related research from the Program on Corporate Governance includes Executive Compensation as an Agency Problem by Lucian Bebchuk and Jesse Fried.

Average Say on Pay support in 2018 declined to the lowest level observed since 2012, driven by an increase in the number of companies receiving vote support below 70%. Shareholder engagement increased on environmental proposals; other environmental, social, and governance (ESG) topics; Board diversity; and the use of GAAP versus non-GAAP performance metrics in compensation program design. Shareholders will continue pushing companies to adopt and disclose formal policies on these topics in 2019 and may vote critically in Say on Pay and Director elections if they feel companies are not sufficiently responsive. A politicized external environment and the growing attention to wealth inequality will also influence companies and introduce further messaging challenges during the second year of the CEO Pay Ratio disclosures.

Prediction 1: Russell 3000 average Say on Pay vote support will continue to decline.

Shareholders will vote more critically when casting Say on Pay votes in 2019, and average vote support will decline for a second consecutive year. Shareholders will continue to push company leadership on a broader range of governance issues this year, and we expect that Say on Pay voting will be used as an indirect mechanism for shareholder activism.

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Communicating Culture Consistently: Evidence from Banks

Jillian Grennan is Assistant Professor of Finance at the Duke University Fuqua School of Business. This post is based on her recent paper.

Corporate culture is integral to business success, and its role in banking has attracted considerable attention since the financial crisis of 2007 and 2008. For example, Fahlenbrach, Prilmeier and Stulz (2012) found banks that performed poorly in the 1998 crisis also performed poorly in the recent crisis. This persistence is consistent with a culture explanation. Egan, Matvos, and Seru (2018) found many financial advisors repeatedly engage in misconduct, but they seem to suffer little career consequences because some firms don’t seem to mind.

As a finance professor at Duke University, I study how culture affects firms and what they can do to shape it. In a research study with John Graham, Campbell Harvey, and Shiva Rajgopal, we surveyed 1,348 corporate executives and found that 90 percent believed that culture was important at their firms while 92 percent said improving their firm’s culture would increase the value of the company. But only 16 percent of firms said their culture was where it needed to be, and it wasn’t clear that these executives even knew how to change that.

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Bill Proposal—Corporate Executives Criminally Accountable for Negligent Conduct

Lev L. Dassin and Jennifer Kennedy Park are partners, and David E. Wagner is an associate at Cleary Gottlieb Steen & Hamilton LLP. This post is based on their Cleary memorandum.

On April 3, 2019, Senator (and Democratic Presidential contender) Elizabeth Warren announced proposed legislation—dubbed the “Corporate Executive Accountability Act”—that would effect a dramatic change in white collar criminal law by permitting prosecution of corporate executives for negligent conduct. Under traditional criminal law principles, defendants must typically have at least knowledge with respect to the conduct that constitutes the crime. However, under Senator Warren’s proposed law, executives of large companies could be criminally prosecuted (and fined and/or jailed if convicted) if they are found to have acted negligently in failing to prevent criminal acts committed by the companies they supervise. The bill is unlikely to be enacted, but it nonetheless represents a significant policy indication from a Presidential candidate.

In an op-ed published in The Washington Post in parallel to the bill’s announcement, Senator Warren expressed the view that “[i]t’s time to reform our laws to make sure that corporate executives face jail time for overseeing massive scams.” [1] In her words, the bill would “expand[] criminal liability to any corporate executive who negligently oversees a giant company causing severe harm to U.S. families.” She predicts that “[i]f top executives knew they would be hauled out in handcuffs for failing to reasonably oversee the companies they run, they would have a real incentive to better monitor their operations and snuff out any wrongdoing before it got out of hand.”

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What’s the Problem with Dual Class Stock? A Brief Response to Professors Bebchuk and Kastiel

David Berger is a partner at Wilson Sonsini Goodrich & Rosati. This post is based on a response by Mr. Berger to two recent posts published on the Forum.

Related research from the Program on Corporate Governance includes The Untenable Case for Perpetual Dual-Class Stock (discussed on the Forum here), The Perils of Small-Minority Controllers (discussed on the Forum here), the keynote presentation on The Lifecycle Theory of Dual-Class Structures, and the Forum posts on The Perils of Dell’s Low-Voting StockThe Perils of Lyft’s Dual-Class Structure and The Perils of Pinterest’s Dual-Class Structures, all by Lucian Bebchuk and Kobi Kastiel.

The distinguished scholars Professors Lucian Bebchuk and Kobi Kastiel (both of whom I am proud to call my friends) are once again targeting technology companies with dual class stock. In two posts published in the past two weeks and based on a similar analysis, the subject of their ire has been Lyft and Pinterest, respectively. [1] The Bebchuk/Kastiel posts focus on the “governance costs” facing investors in both companies at some point “down the road” as a result of their dual class structures. In particular, and based upon their earlier research on what they call “small-minority controllers” and “perpetual dual-class stock,” Bebchuk and Kastiel conclude that the dual class structures of both companies will eventually pose “substantial risks” for investors, and as a result can be expected to “significantly decrease the economic value of [each company’s] low-voting shares that public investors will hold.”

The day before Lyft’s IPO I was invited by Nasdaq’s Listing Council to speak on dual class stock. Specifically, the Council asked that I respond to the petition submitted by the Council of Institutional Investors (“CII”) that companies going public with dual class shares include mandatory sunset provisions in their charters, effectively terminating the dual class structure after seven (7) years (my remarks are available on SSRN). [2] CII’s Petition relied upon the same scholarship by Professors Bebchuk and Kastiel that they now use to criticize the dual class governance structures adopted by Lyft and Pinterest.

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Uncorporate Insider Trading

Peter Molk is associate professor of law at the University of Florida Levin College of Law. This post is based on a recent article by Professor Molk, forthcoming in the Minnesota Law Review. Related research from the Program on Corporate Governance includes Insider Trading Via the Corporation by Jesse Fried (discussed on the Forum here).

Insider trading has long been restricted by federal law. Corporate executives owe fiduciary duties of loyalty and care to their companies and shareholders, duties that are breached when those insiders trade in company stock or with company information. Because these fiduciary duties are a mandatory feature of corporate law, quintessential insider trading cases fall squarely within the prohibition.

Now, long after the fiduciary theory of insider trading liability was developed, “uncorporate” LLC and LP substitutes to corporations have emerged as alternative ways to organize businesses. Unlike corporations, these entities can, and often do, completely waive all management fiduciary duties owed to the entities or shareholders. In my article Uncorporate Insider Trading, I analyze the implication that, through these fiduciary duty waivers, these entities can effectively waive core insider trading liability.

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Recent Developments in Human Capital Management Disclosure

Betty M. Huber is counsel and Paula H. Simpkins is an associate at Davis Polk & Wardwell LLP. This post is based on their Davis Polk memorandum.

IAC Meeting

[In late March, 2019], the Investor Advisory Committee (IAC or Committee) to the Securities and Exchange Commission (SEC) voted to ask the SEC to further investigate and evaluate whether public companies should be required to disclose information related to human capital management (HCM), in other words, how companies manage workplace relationships including training, talent development and retention.

Over the last few decades, as the US economy has increasingly become based on technology and services, certain investors have expressed more interest in HCM disclosure.

Although the vote carried, close to one-third of the IAC members dissented. Some of the most controversial points centered on (i) augmenting current disclosures of executive compensation to include summaries of broader workforce compensation and incentive structures; (ii) measuring worker productivity; and (iii) disclosing the number of full-time, part-time and contingent workers. Certain commentators feared that this language was simply a blueprint for line item disclosure requirements.

The Committee recommended that the SEC consider requiring HCM disclosure and, to aid in its decision-making, seek input from a wide range of stakeholders, including investors, issuers, asset owners and academics.

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2019 U.S. Executive Compensation Trends

John Roe is Head of ISS Analytics, the data intelligence arm of Institutional Shareholder Services, Inc; and Kosmas Papadopoulos is Managing Editor and Executive Director with ISS Analytics. This post is based on an ISS Analytics memorandum by Mr. Roe and Mr. Papadopoulos. Related research from the Program on Corporate Governance includes The Growth of Executive Pay by Lucian Bebchuk and Yaniv Grinstein; and Paying for Long-Term Performance by Lucian Bebchuk and Jesse Fried.

As we enter the peak of proxy season, we review executive compensation trends in the U.S. based executive pay disclosures so far this year. Our key findings include:

  • Compensation disclosures so far suggest continued increases in CEO pay across all market segments and almost all industries.
  • The proportion of stock-based compensation as a percentage of total pay continues to increase, crossing the threshold of 50 percent of total pay for large companies for the first time this year.
  • Performance-based equity compensation also continues to increase despite concerns of a potential reversal in the aftermath of the repeal of 162(m).
  • CEO pay ratios remain relatively unchanged on aggregate, despite some fluctuations observed at individual companies.

More than two-thirds of S&P 500 companies and approximately half of all Russell 3000 companies have filed proxy statements containing executive pay information for the previous fiscal year. Same-store CEO pay levels show a healthy increase, with a median change in same-store S&P 500 CEO pay of approximately 6 percent compared to the previous fiscal year. These are companies that had the same CEO for the most recent two fiscal years. Non-S&P 1500 companies in the Russell index demonstrate the highest increase in same-store CEO pay with a median increase of 7.4 percent compared to the previous year.

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The Purposive Transformation of Company Law

David Kershaw is Professor of Law at London School of Economics and Edmund‐Philipp Schuster is an Associate Professor of corporate law at London School of Economics. This post is based on their recent paper.

In December of 2018 a potentially transformative event occurred within UK corporate law and corporate governance. In the course of its latest revision, the UK Corporate Governance Code has introduced the idea that establishing a “company purpose” is essential for the effective functioning of corporations. This may not, at first glance, seem all too revolutionary—especially to a US corporate lawyer. Within the context of UK law, however, the Code’s new requirement for the board to “establish the company’s purpose, values and strategy and satisfy itself that these and its culture are aligned”, raises a number of foundational questions about companies and the nature of their relationships with shareholders and other stakeholders.

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M&A/PE and Governance Update

Gail Weinstein is senior counsel, and Steven Epstein and David L. Shaw are partners at Fried, Frank, Harris, Shriver & Jacobson LLP. This post is based on their Fried Frank memorandum, and is part of the Delaware law series; links to other posts in the series are available here.

Court of Chancery Enjoins a Controller-Led Merger Pending Corrective Disclosures—FrontFour v. Medley Capital

In FrontFour Capital Group, LLC et al v. Brooke Taube et al [Medley Capital] (March 11, 2019), the court determined that, based on the precedent set in the Delaware Supreme Court’s 2014 C&J Energy decision, it could order only a disclosure remedy and not more substantive relief (such as ordering that the company be shopped) in the context of what it viewed as a controller-led merger of three affiliated entities in a “deeply flawed” sale process. The judicial outcome turned on the court’s finding that the plaintiff had not proved (indeed, had offered no evidence whatsoever to prove) that the acquiring entity had aided and abetted what the court viewed as fiduciary breaches by the target company’s board. Vice Chancellor McCormick indicated that if the plaintiff had proved the aiding and abetting claim, then C&J would not have precluded the court from ordering a “curative shopping process.” The decision may be expected to encourage plaintiffs to make (and try hard to substantiate) aiding and abetting claims to avoid this application of C&J.

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2019 Proxy Season Preview

Shirley Westcott is a Senior Vice President at Alliance Advisors LLC. This post is based on an Alliance Advisors publication by Ms. Westcott. Related research from the Program on Corporate Governance includes Social Responsibility Resolutions by Scott Hirst (discussed on the Forum here).

With the 2019 proxy season now underway, several trends are emerging in shareholder campaigns:

Environmental and social (E&S) topics will once again dominate the shareholder proposal landscape. For a third consecutive year, E&S issues account for a majority of all shareholder proposals filed, outpacing those related to governance and compensation. Topping the list of submissions are political spending resolutions, which proponents have ramped up in advance of the 2020 elections (see Table 1).

Withdrawals could approach last year’s record. In 2018, nearly half of E&S resolutions were withdrawn as a result of productive engagements, a trend that is likely to continue. Companies are showing more willingness to reach agreements with proponents due to shifts in investor voting, particularly among some of the largest institutional investors, notably BlackRock, Vanguard Group and Fidelity Investments. According to a recent Institutional Shareholder Services (ISS) study, more shareholders are supporting E&S proposals rather than casting abstention votes, which declined from 16% of votes cast in 2010 to 3% in 2018. This in turn translated into a record 12 majority votes on E&S resolutions in 2018, while another 20 received support in the 40% range.

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