How Much Do We Trust Staggered Difference-in-Differences Estimates?

David F. Larcker is the James Irvin Miller Professor of Accounting at Stanford Graduate School of Business; Charles C.Y. Wang is the Glenn and Mary Jane Creamer Associate Professor of Business Administration at Harvard Business School; and Andrew Baker is a J.D. candidate at Stanford Law School. This post is based on their recent paper.

Difference-in-differences (DiD) has been the workhorse statistical methodology for analyzing regulatory or policy effects in applied finance, law, and accounting research. A generalized version of this estimation approach that relies on the staggered adoption of regulations or policies (e.g., across states or across countries) has become especially popular over the last two decades. For example, from 2000 to 2019, there were 751 papers published in (or accepted for publication by) top tier finance or accounting journals that use DiD designs. Among them, 366 (or 49%) employ a staggered DiD design. Many of the staggered DiD papers address significant questions in corporate governance and financial regulation.

The prevalent use of staggered DiD reflects a common belief among researchers that such designs are more robust and mitigate concerns that contemporaneous trends could confound the treatment effect of interest. However, recent advances in econometric theory suggest that staggered DiD designs often do not provide valid estimates of average treatment effects.

In a paper recently posted on SSRN, we find that staggered DiD designs often can, and have, resulted in misleading inferences in the literature. We also show that applying robust DiD alternatives can significantly alter inferences in important papers in corporate governance and financial regulation.

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The Activism Vulnerability Report Q4 2020

Jason Frankl and Brian Kushner are Senior Managing Directors at FTI Consulting Inc. This post is based on their FTI 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).

Introduction & Market Update

FTI Consulting’s Activism and M&A Solutions team welcomes our clients, friends and readers to our sixth quarterly Activism Vulnerability Report, documenting the results of our Activism Vulnerability Screener from the recent fourth quarter of 2020, as well as other notable trends and themes in the world of shareholder activism and engagement. Almost one year ago to the day, we sat down to write this report for the fourth quarter of 2019. Our team had just begun the shift to working from home offices and spare bedrooms, while still adjusting to full days of video conference calls due to the rapidly spreading COVID-19 coronavirus.

While it was not until the latter half of the fourth quarter of 2020, or even the start of 2021, that many of the pandemic’s biggest concerns began to subside, many areas of the market remained incredibly resilient throughout the year. The S&P 500 Index, the Dow Jones Industrial Average Index and the Nasdaq Composite Index rose 16.3%, 7.3% and 43.6%, respectively, in 2020. While the three leading indices all ended the year on solid ground, the incredible market voracity from the COVID-19 pandemic should not be overlooked. The S&P 500 Index reached an all-time peak of 3,386 on February 19, before it fell 33.9% in just 32 days to 2,237. As measured from March 23, 2020, however, the Index regained the previous high in less than five months on August 18 (an increase of 51.5%). For the S&P 500 Index and the Nasdaq Composite Index, the period of 2019 and 2020 represents the best two-year performance since 1998 and 1999, during the heart of the Dot-Com boom.

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SEC Approves NYSE’s Amended “Related Party” and “20%” Stockholder Approval Rules

Eleazar Klein is partner and Evan A. Berger is an associate at Schulte Roth & Zabel LLP. This post is based on their SRZ memorandum. Related research from the Program on Corporate Governance includes Independent Directors and Controlling Shareholders by Lucian Bebchuk and Assaf Hamdani (discussed on the Forum here).

On April 2, 2021, the Securities and Exchange Commission approved, on an accelerated basis, an amended proposal by the NYSE to amend certain of its stockholder approval rules set forth in the NYSE Listed Company Manual (“NYSE Manual”). The formal approval comes after the NYSE instituted a temporary waiver of these rules due to the challenges companies faced during the COVID-19 pandemic. See our Jan. 12, 2021 Alert and Oct. 9, 2020 Alert for more detail.

Rule 312.03(b) — As amended, the Related Party Stockholder Approval Rule:

  • No longer requires prior stockholder approval for issuances to the subsidiaries, affiliates or other closely related persons of directors, officers and substantial securityholders (“Related Party”) or to entities in which a Related Party has a substantial interest (except where a Related Party has a 5% or greater interest in the counterparty (as described below)).
  • No longer requires stockholder approval of cash sales to a Related Party if the sale meets the NYSE minimum price requirement, even where the number of shares of common stock to be issued (or the number of shares of common stock into which the securities may be convertible or exercisable) exceeds either 1% of the number of shares of common stock or 1% of the voting power outstanding before the issuance.
  • Requires stockholder approval of any transaction or series of related transactions in which any Related Party has a 5% or greater interest (or collectively have a 10% or greater interest), directly or indirectly, in the company or assets to be acquired or in the consideration to be paid in the transaction and the issuance of common stock, or securities convertible into common stock, could increase the outstanding common shares by 5% or more.
  • Deletes now irrelevant provisions relating to (i) cash sales that meet the NYSE minimum price requirement, and where the issuance does not exceed 5% of the shares of common stock or voting power before the issuance, to a Related Party where the Related Party involved in the transaction is classified as a Related Party solely because the person is a substantial security holder; and (ii) an exemption related to early stage companies.

Rule 312.03(c) — As amended, the 20% Stockholder Approval Rule:

  • Replaces the reference to “bona fide private financing” in the exception from shareholder approval for transactions relating to 20% or more of the company’s outstanding common stock or voting power with “other financing (that is not a public offering for cash) in which the company is selling securities for cash.” This would eliminate the 5% limit for any single purchaser participating in a transaction, thus permitting companies to consummate a financing to a single purchaser.
  • Requires shareholder approval if the securities in a financing are issued in connection with an acquisition of the stock or assets of another company and the issuance of the securities alone or when combined with any other present or potential issuance of common stock, or securities convertible into common stock, is equal to or exceeds either 20% of the number of shares of common stock or of the voting power outstanding before the issuance.

In addition, amendments to Section 314 of the NYSE Manual requires a company’s audit committee or other independent body of the board of directors to review related party transactions prior to any transaction and prohibit the transaction if it determines the transaction is not consistent with the interests of the company and its shareholders. For purposes of Section 314, related party transactions would mean those transactions required to be disclosed pursuant to Item 404 of Regulation S-K under the Securities Exchange Act of 1934, as amended (without giving effect to the transaction value threshold of that provision).

How Boards Can Get Human Capital Management Right in Five (Not So) Easy Steps

Paul Washington is Executive Director, ESG Center, and Rebecca L. Ray is Executive Vice President, Human Capital, at The Conference Board. This post is based on their Conference Board memorandum. Related research from the Program on Corporate Governance includes For Whom Corporate Leaders Bargain by Lucian A. Bebchuk, Kobi Kastiel, and Roberto Tallarita (discussed on the Forum here); The Illusory Promise of Stakeholder Governance by Lucian A. Bebchuk 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).

At the outset of the pandemic, employees were the top priority of boards, second only to continued liquidity. That focus intensified during the social unrest following the death of George Floyd. Now, the SEC’s new disclosure rules on human capital management (HCM) could further reinforce the focus on workers—at least temporarily.

Boards will soon face a choice, however, when it comes to their role in HCM. They can ensure that the company satisfies the new SEC reporting requirements but return to the traditional approach of providing general oversight and being deeply engaged on workforce issues on a periodic basis—as they did in response to the #MeToo movement or company-specific events such as mergers and scandals that highlighted weaknesses in corporate culture. Or they can view recent events as a catalyst to make the workforce a sustained strategic focus of the board.

Boards are struggling with how deeply to be involved in HCM, and there are risks in overstepping into a managerial role. But if companies achieve the appropriate level of board engagement and disclosure on HCM (focusing on strategy and key drivers, rather than day-to-day activity), they will not only drive long-term value, but also provide a template for how boards can tackle other ESG areas.

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Anticipating Harassment: #MeToo and the Changing Norms of Executive Contracts

Rachel Arnow-Richman is Rosenthal Chair of Labor and Employment Law at the University of Florida Levin College of Law; James Hicks is an Academic Fellow at the University of California Berkeley School of Law; and Steven Davidoff Solomon is Professor of Law at the University of California Berkeley School of Law. This post is based on their recent paper.

Two years ago, the #MeToo movement exposed the problem of sex-based misconduct by powerful employees, particularly CEOs. It also revealed, in some companies, an organizational culture seemingly permissive of such wrongdoing. In many instances, the misconduct went on for extended periods, involved numerous victims, and was an open secret among corporate officers and directors. Companies typically responded slowly and imposed few consequences on alleged perpetrators, preferring to cover up the problem with confidential settlements and cushioned exits rather than hold the accused accountable. This phenomenon, which we refer to as the ”MeToo accountability problem,” provokes serious questions. Why did companies tolerate such behavior? Why did they choose to protect rather than penalize CEOs? Most importantly, has the MeToo movement changed this culture?

In Anticipating Harassment: #MeToo and the Changing Norms of Executive Contracts, we examine these questions through an empirical study of CEO employment agreements. Unlike ordinary employees, CEOs are protected by written contracts that not only reject the default rule of employment at-will, but contain bespoke provisions that limit the companies’ ability to terminate CEOs without paying significant severance pay. These provisions typically contain a handful of narrowly drafted grounds on which a company can fire a CEO “for cause” (thereby avoiding financial liability), which rarely contemplate sex-based misconduct. Furthermore, existing law generally interprets these provisions in favor of CEOs, making it financially risky for companies to remove CEOs for behavior that—while wrongful—may turn out to fall short of the contractual or legal standard.

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Surge in SPACtivity Leads to Litigation and Regulatory Risks

Caitlyn Campbell is partner at McDermott Will & Emery LLP. This post is based on her McDermott Will & Emery memorandum.

Introduction

Not far behind the dramatic increase in the use of special purpose acquisition companies (SPACs) is a corresponding increase in the number of shareholder lawsuits and increased activity at the US Securities and Exchange Commission (SEC). In recent days, Reuters reported that the SEC opened an inquiry seeking information on how underwriters are managing the risks involved in SPACs, [1] and the SEC’s Division of Corporation Finance (Corp Fin) and acting chief accountant have issued two separate public statements on certain accounting, financial reporting and governance issues that should be considered in connection with SPAC-related mergers. [2] This increase in activity by SEC staff comes on the heels of nearly two dozen federal securities class action filings, several SEC investor alerts and earlier guidance from Corp Fin. [3] The surge in litigation and regulatory interest is likely to continue and expand throughout 2021 and beyond.

In Depth

A SPAC is a company with no operations that raises funds from public investors through an initial public offering (IPO). The proceeds from the IPO are placed in a trust or escrow account for future use in the acquisition of one or more companies. A SPAC will typically have a two-year period to identify and complete a business transaction. If the SPAC fails to do so during the specified period, then it must return the funds in the account to its public shareholders on a pro rata basis and then dissolve.

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When Disclosure Is The Better Part of Valor: Lessons From The AT&T Regulation FD Enforcement Action

Douglas Chia is Founder and President of Soundboard Governance LLC and a Fellow at the Rutgers Center for Corporate Law and Governance. This post is based on his Soundboard Governance memorandum.

On March 5, 2021, the US Securities and Exchange Commission (SEC) announced that it had charged AT&T, Inc. with “repeatedly violating” Regulation Fair Disclosure (Reg FD) in 2016. In addition to charges against the company, the SEC charged three members of AT&T’s investor relations (IR) department with “aiding and abetting” the alleged Reg FD violations.

The SEC enacted Reg FD in 2000 to prohibit selective disclosure of material nonpublic information to securities analysts, investors, and others who are likely to act on the information. Since then, the SEC has made infrequent enforcement actions, with each one giving corporate lawyers and IR professionals another datapoint to guide company communications with the investor community in what remain gray areas.

The key events, based on the SEC’s March 4, 2021 complaint filed in Federal court and AT&T’s press release on the same day to dispute the SEC’s allegations, can be summarized as follows:

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Integrating Sustainability and Long Term Planning for the Biopharma Sector

Myrto Kontaxi is Partner at the Biopharma Sustainability Roundtable (BSRT) and Brian Tomlinson is Director of Research, CEO Investor Forum at Chief Executives for Corporate Purpose (CECP). This post is based on a BSRT/CECP memorandum by Ms. Kontaxi, Mr. Tomlinson, Maggie Kohn, Thomas Scheiwiller, and Sandor Schoichet.

Executive Summary

Corporate leaders and institutional investors are looking for effective, efficient, and decision-useful information about long-term business strategy, and how it connects with the most important environmental, social, and governance (ESG) issues in each sector. This need is driven by many trends in management, capital markets, regulation, and civil society, two of which stand out:

  1. Growing evidence that a focus on ESG performance is strongly accretive to long-term value creation and financial performance, and that the elements of an effective ESG strategy are specific to each sector.
  2. Growing recognition of how valuable it can be to effectively communicate long-term plans to investors, employees, and other stakeholders.

Long-term planning is especially important for the biopharma sector right now, as we look toward a global recovery from the COVID-19 pandemic. A sustainable, long-term response by the sector is required not only to meet the direct therapeutic and diagnostic development and production challenges, but also to create new solutions and to communicate the industry’s efforts and outcomes more effectively to all stakeholders.

In response, the Biopharma Sustainability Roundtable (BSRT) and the CEO Investor Forum at Chief Executives for Corporate Purpose (CECP) have joined forces to convene the first sector-specific Biopharma CEO Investor Forum. The Forum is planned for June 7th and 8th, 2021. This report and a companion Practitioner’s Guide were created to provide practical tools for biopharma CEOs and their teams as they prepare their Sustainable Long-Term Plan presentations for the Forum. These documents combine CECP’s Long-Term Plan Framework, honed through use at previous CEO Investor Forums, with the Biopharma Investor ESG Communications Guidance, broadly validated and supported by investors to tailor the content and perspective for the biopharma sector.

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Statement by Commissioner Peirce on Rethinking Global ESG Metrics

Hester M. Peirce is a Commissioner at the U.S. Securities and Exchange Commission. This post is based on her recent public statement. The views expressed in this post are those of Ms. Peirce and do not necessarily reflect those of the Securities and Exchange Commission or its staff.

Many advocates behind the global environmental, social, and governance movement argue that prosperity alone is not a sufficient measure of society’s progress, a position that I believe is unassailable. [1] The challenge we face in addressing the ever-increasing number of issues underlying E, S, and G is daunting. The task before us is to find a way to bring about lasting, positive change to our countries on a range of issues without sacrificing in the process the very means by which so many lives have been enriched and bettered. Accordingly, a shared desire to address these and other societal problems should compel us to rethink our prescriptive approach to ESG and instead find ways to encourage our most precious resource—our people—to devise solutions to the climate-related and other challenges our societies face.

In the United States, the idea of enlisting the securities laws to achieve ESG objectives is gaining traction among activists and policy elites with a particular emphasis on requiring disclosure of specific ESG metrics. Some are urging us to closely align our rules with our European friends who long have been working on devising a comprehensive set of ESG disclosure metrics. Others would like to see us rely on standards developed and governed by an international body, such as the work being contemplated by the International Financial Reporting Standards Foundation. Indeed, there is mounting pressure to embrace a single global set of metrics, which would facilitate international capital flows and issuers’ reporting obligations.

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Interest in SPACs is Booming…and So is the Risk of Litigation

Stephen Fraidin, Gregory P. Patti, Jr. and Jason Halper are partners at Cadwalader, Wickersham & Taft LLP. This post is based on a Cadwalader memorandum by Mr. Fraidin, Mr. Patti, Mr. Halper, Jared Stanisci, Sara Bussiere and Victor Bieger.

Following these ten steps will prepare SPAC boards, sponsors, and advisors for the likely shareholder suits and potential regulatory investigations that are increasingly becoming part of the SPAC landscape.

If 2020 was the “year of the SPAC,” 2021 may be the year of SPAC litigation. SPACs—Special Purpose Acquisition Companies—are publicly traded companies launched as vehicles to raise capital to acquire a target company. Often called blank-check companies, SPACs are companies in which shareholders buy shares without knowing which company the SPAC will target and acquire. Investors place their faith in the sponsor: the entity or management team that forms the SPAC. The SPAC generally has around twenty-four months to seek out and acquire a target, or else must liquidate and return the capital.

Hundreds of new SPACs were launched in 2020 alone. Booming M&A or other transactional activity in any sector can invite litigation driven by plaintiffs’ attorneys, and SPACs are no exception. In just the first three months of 2021, more than 40 suits targeting SPACs have been filed. The nature of these claims evidence growing sophistication, as lawyers used to challenging traditional M&A transactions begin to tailor their claims to the unique characteristics of the SPAC lifecycle. And with SPACs going mainstream—and attracting attention from outside the usual financial circles—regulators are closely examining transaction disclosures and other aspects of SPAC deals. [1]

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