Monthly Archives: September 2016

The Role of Proxy Advisory Firms

Nadya Malenko is an Assistant Professor of Finance at Boston College Carroll School of Management. This post is based on a forthcoming article by Professor Malenko, and Yao Shen, Assistant Professor of Finance at Baruch College Zicklin School of Business.

In our article The Role of Proxy Advisory Firms: Evidence from a Regression-Discontinuity Design, forthcoming in the Review of Financial Studies, we analyze the effect of Institutional Shareholder Services (ISS) recommendations on shareholder voting outcomes. Over time, regulators and market participants have become increasingly concerned with the influence proxy advisors allegedly have on investors’ votes and have pushed for stringent regulation of the proxy advisory industry. However, there is disagreement about whether the impact of proxy advisors’ recommendations is as strong as is sometimes claimed. On the one hand, concerns about ISS’s outsized influence are consistent with the strong positive correlation observed between ISS recommendations and voting outcomes. On the other hand, assessing the actual influence of ISS has been difficult because of the omitted variable problem: the same unobservable firm characteristics that lead ISS to give a negative recommendation can also lead shareholders to withdraw their support for the proposal, leading to an upward bias in the estimates of the ISS effect. Prior literature concludes that ISS recommendations move at least some fraction of the votes, but whether this fraction is large or small remains unclear. As a result, many observers believe that the influence of proxy advisors is significantly overstated and that stringent regulation may do more harm than good.

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Outsourcing Corporate Governance

Tao Li is Assistant Professor of Finance at Warwick Business School. This post is based on a forthcoming article by Professor Li.

With ever growing institutional shareholdings and recent regulatory reforms to enhance shareholder rights, proxy advisory firms, ISS and Glass Lewis in particular, have a large influence on shareholder votes. It is thus critical that these independent advisory firms issue unbiased recommendations and be free of potential conflicts of interest. My article, Outsourcing Corporate Governance: Conflicts of Interest within the Proxy Advisory Industry, publicly available on SSRN, provides the first study on whether and when conflicts of interest can arise from serving both shareholders and issuers.

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A Theory of Efficient Short-Termism

Richard T. Thakor is Assistant Professor of Finance at the University of Minnesota Carlson School of Management. This post is based on his recent paper. 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); The Myth that Insulating Boards Serves Long-Term Value by Lucian Bebchuk (discussed on the Forum here); The Law and Economics of Blockholder Disclosure by Lucian Bebchuk and Robert J. Jackson Jr. (discussed on the Forum here), and Pre-Disclosure Accumulations by Activist Investors: Evidence and Policy by Lucian Bebchuk, Alon Brav, Robert J. Jackson Jr., and Wei Jiang.

In the area of corporate investment policy and governance, one of the most widely-studied topics is corporate “short-termism” or “investment myopia”, which is the practice of preferring lower-valued short-term projects over higher-valued long-term projects. It is widely asserted that short-termism is responsible for numerous ills, including excessive risk-taking and underinvestment in R&D, and that it may even represent a danger to capitalism itself. Yet, short-termism continues to be widely practiced, exhibits little correlation with firm performance, and does not appear to be used only by incompetent or unsophisticated managers (e.g. Graham and Harvey (2001)). In A Theory of Efficient Short-termism, I challenge the notion that short-termism is inherently a misguided practice that is pursued only by self-serving managers or is the outcome of a desire to cater to short-horizon investors, and theoretically ask whether there are circumstances in which it is economically efficient.
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Equity Market Structure in 2016 and for the Future

Mary Jo White is Chair of the U.S. Securities and Exchange Commission. The following post is based on Chair White’s recent keynote address to the 83rd Annual Market Structure Conference. The complete publication, including footnotes, is available here. The views expressed in this post are those of Chair White and do not necessarily reflect those of the Securities and Exchange Commission, the other Commissioners, or the Staff.

The American equity markets are the strongest in the world, and one of the Commission’s most important responsibilities is to work every day to maintain their fairness, orderliness, and efficiency. Optimizing market structure is a continuous process, one that requires the Commission to act with both care and intensity, strictly guided by what is best for investors and capital formation for public companies.

I emphasized this guiding principle when I last joined you in 2013, and in 2014 when I laid out a program for enhancing equity market structure. Fulfilling our responsibility to investors and issuers, of course, demands that the Commission act quickly to address issues that are demonstrably undermining the interests of investors and issuers. But it also requires the Commission to carefully consider changes to market structure where the impact on those interests is far less clear and the data to support competing perspectives is lacking or conflicting.

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PROMESA and Puerto Rico’s Pathways to Solvency

Stephen Park is Assistant Professor of Business Law at the University of Connecticut School of Business, and Tim Samples is Assistant Professor of Legal Studies at the University of Georgia Terry College of Business. This post is based on their forthcoming article.

Facing a self-declared “death spiral” of public debt, the Governor of Puerto Rico announced a debt moratorium earlier this year, halting payments to bondholders. A series of missed payments followed, including a landmark default on constitutionally guaranteed bonds in July. At the same time, Congress passed the Puerto Rico Oversight, Management, and Economic Stability Act (PROMESA or “promise” in Spanish), which combines a debt restructuring system with federal controls over the island’s finances. But enacting PROMESA is only a first step. Coordination and engagement with creditors is the next step—and an even more complicated one—in Puerto Rico’s long journey towards solvency and fiscal stability.

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Weekly Roundup: September 9–September 15, 2016


More from:

This roundup contains a collection of the posts published on the Forum during the week of September 9–September 15, 2016.



Pay-to-Play Rules for Swap Dealers




Federal Civil Penalties Set to Increase Significantly, Many Present Retroactivity Concerns








Protecting Companies from Political Spending Peril



Crowdfunding and the Not-So-Safe SAFE


SEC Clawbacks of CEO and CFO Compensation

John F. Savarese and Wayne M. Carlin are partners in the Litigation Department of Wachtell, Lipton, Rosen & Katz. This post is based on a Wachtell Lipton memorandum. Related research from the Program on Corporate Governance includes Excess-Pay Clawbacks by Jesse Fried and Nitzan Shilon (discussed on the Forum here); and Rationalizing the Dodd-Frank Clawback by Jesse Fried (discussed on the Forum here).

Last week, the U.S. Court of Appeals for the Ninth Circuit affirmed the SEC’s interpretation of Section 304 of the Sarbanes-Oxley Act, which authorizes the SEC to seek to claw back performance-based compensation paid to CEOs and CFOs of public companies in certain circumstances. SEC v. Jensen (Aug. 31, 2016). The SEC’s power to seek clawbacks arises when an issuer has been required to restate previously issued financial statements “as a result of misconduct.” A key issue in the interpretation of this provision has been the question whether the “misconduct” must be committed by the person whose compensation the SEC is seeking to recover. The SEC has argued that personal misconduct is not required, but that any misconduct within the corporation—committed by any employee—is a sufficient predicate to claw back compensation from the CEO and CFO.

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Crowdfunding and the Not-So-Safe SAFE

Joseph Green is a Senior Legal Editor (Startups & Venture Capital) at Thomson Reuters Practical Law; John Coyle is an Associate Professor at the University of North Carolina School of Law. This post is based on their recent paper.

On May 16, 2016, the much-anticipated era of retail crowdfunding officially began in the United States. While it is far too early to pass judgment on the long-term prospects of the crowdfunding project more generally, it is possible at this juncture to assess how certain aspects of crowdfunding are developing. With respect to the menu of financing instruments being offered to prospective investors, early market participants are potentially sabotaging the crowdfunding experiment by making widespread use of a relatively new startup-financing instrument—the simple agreement for future equity (SAFE)—that may frustrate the ability of investors to share in the upside of successful crowdfunding companies.

The SAFE was developed by Y Combinator, the well-known startup accelerator based in Silicon Valley, as a means of investing in startups that expected to raise institutional venture capital at a later date. Although the SAFE resembles a classic seed-stage convertible note in most respects, it lacks the convertible note’s maturity date and does not accrue interest while it remains outstanding. It does not pay dividends, and the SAFE holder has no right to vote on matters submitted to shareholders. The SAFE is, in essence, a contractual derivative instrument that amounts to a deferred equity investment. It will prove valuable to the holder if, and only if, the company that issues it raises a subsequent round of financing or is sold.

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Do Directors Suffer External Consequences for Poor Oversight of Executive Compensation? Evidence from Say-on-Pay Votes

T. Colin Campbell is Associate Professor at the University of Cincinnati Carl H. Lindner College of Business. This post is based on a recent paper by Professor Campbell; Kelly R. Brunarski, Associate Professor at Miami University of Ohio Farmer School of Business; Yvette S. Harman, Associate Professor of Finance at Miami University of Ohio Farmer School of Business; and Mary Elizabeth Thompson, Assistant Professor at Miami University of Ohio Farmer School of Business.

The idea that directors could suffer penalties imposed by the external labor market when they fail in their oversight responsibilities is not a new one. Fama (1980) suggests that external labor market penalties could provide incentives for directors and help ensure shareholder-aligned oversight of firms. That is, ex post settling up in the directorial labor market could create ex ante incentives for directors to provide efficient monitoring of the firm and optimal contracting with managers. Levit and Malenko (2015) further suggest that without external labor market penalties, managers could easily incentivize directors to provide poor oversight. Several studies document evidence of labor market penalties for directors who fail in their duties as board members. For instance, Srinivasan (2005) and Fich and Shivdasani (2007) find that directors suffer significant reputational damage at interlocking firms when the firm issues accounting restatements or is sued for fraud. Similarly, Yermack (2004) notes that directors have reputational incentives tied to the firm’s performance.

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Protecting Companies from Political Spending Peril

Bruce F. Freed is president of the Center for Political Accountability (CPA) and Karl Sandstrom is senior counsel at Perkins Coie and counsel to the CPA. This post is based on a CPA publication. Related research from the Program on Corporate Governance includes Shining Light on Corporate Political Spending and Corporate Political Speech: Who Decides?, both by Lucian Bebchuk and Robert Jackson (discussed on the Forum here and here); and Corporate Politics, Governance, and Value Before and after Citizens United by John C. Coates.

No publicly traded company would consider a request for a sizable donation from a newly formed charity without exercising rigorous due diligence on how its money will be spent. Doing otherwise would risk its reputation and violate the managers’ fiduciary duties to the company shareholders. Good business practice requires no less of a company when it engages in political spending. Indeed, when it comes to political spending, the risks may even be greater because of the myriad of laws, federal and state, that regulate political spending and reputational challenges posed by greater media scrutiny.

This election season has seen the emergence of new political players, shadowy advocacy organizations, newly minted traded associations and Super PACs dedicated to the election of a single candidate. Some of these organizations promise that their donors will never be disclosed. Others confidently assure their donors that they operating in full compliance with all applicable laws. What is often missing from their requests is basic information about the organization’s internal governance, its actual pre- and post-election plans and any financial or reporting commitments to the donors.

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