Monthly Archives: October 2016

Corporate Governance Indices and Construct Validity

Bernard Black is Nicholas D. Chabraja Professor at Northwestern University Pritzker Law School and Kellogg School of Management; and B. Burcin Yurtoglu is Professor and Chair of Corporate Finance at WHU—Otto Beisheim School of Management. This post is based on a recent paper by Professor Black; Professor Yurtoglu; Antonio Gledson de Carvalho, Assistant Professor at Fundação Getúlio Vargas School of Business at Sao Paulo; Vikramaditya Khanna, the William W. Cook Professor of Law at the University of Michigan Law School; and Woochan Kim is Associate Professor of Finance at Korea University Business School (KUBS). Related research from the Program on Corporate Governance includes Related research from the Program on Corporate Governance includes What Matters in Corporate Governance? by Lucian Bebchuk, Alma Cohen and Allen Ferrell (discussed on the Forum here).

A common strategy in corporate governance research is to build a corporate governance index and then see whether the index predicts firm value or performance. These indices are imperfect, but their use is widespread because researchers lack good alternatives. A major concern with governance indices is what they actually measure. The concept of governance is abstract and latent rather than concrete and observable, and we are not sure how to proxy for this vague concept using observable measures. This raises concerns about the degree to which the proxy (a governance index) measures what it claims to be measuring. The fit between the observable proxy or “construct” (the governance index) and the underlying concept (governance) is known as construct validity. This core issue is rarely addressed in corporate governance research. Larcker, Richardson and Tuna (2007) and Dey (2008) are exceptions.

In our paper we discuss what can usefully be said about which of the many possible governance indices are sensible constructs. We conduct an exploratory analysis of how to tackle this question, using tools drawn from the causal inference, education and psychology literatures.


Do Institutional Investors Demand Public Disclosure?

Stephen A. Karolyi is Assistant Professor of Finance and Accounting and Andrew Bird is Assistant Professor of Accounting at the Tepper School of Business at Carnegie Mellon University. This post is based on their recent paper.

Do institutional investors demand corporate disclosure? A central question in finance and accounting is whether corporate transparency benefits or hurts investors. This issue is complicated by the fact that information provision could affect groups of investors differentially. Public information may crowd out the private information advantage of some institutional investors; alternatively, investors, particularly those following more passive trading strategies, may not be information sensitive. However, even passive institutional investors may benefit from an increase in monitoring by other stakeholders following improved disclosure. Further, regardless of the preferences of institutional investors, whether or not they are able to affect corporate policy on this margin is unclear. This tradeoff is reflected in mixed empirical evidence on the relationship between institutional ownership and corporate disclosure.


Key Points from Governor Tarullo’s Speech on Stress Testing and the Fed’s NPR

Dan Ryan is Leader of the Financial Services Advisory Practice at PricewaterhouseCoopers LLP. This post is based on a PwC publication by Mr. Ryan, Mike Alix, Adam Gilbert, and Armen Meyer.

The Federal Reserve (Fed) is tilting the balance of its supervisory stress testing program to drive capital requirements higher for large, systemically important Bank Holding Companies (BHCs), [1] while providing some relief for less complex institutions. In an important speech last Monday, Fed Governor Daniel Tarullo suggested several significant changes to the Fed’s annual Comprehensive Capital Analysis and Review (CCAR), which will more fully align ongoing capital requirements with stress-based capital requirements and generally raise regulatory minimum capital ratios to levels the Fed otherwise expected prudently managed firms to maintain on their own. [2] See the Appendix for a graphic depiction of this point.


Proposed Canada Business Corporations Act Amendments: A New Era?

Louis-Martin O’Neill and Jennifer Longhurst are partners at Davies Ward Phillips & Vineberg LLP. This post is based on a Davies publication by Mr. O’Neill, Ms. Longhurst, and Félix Bernard.

On September 28, 2016, the federal government introduced Bill C-25 in Parliament, proposing significant amendments to the Canada Business Corporations Act (CBCA) (the Proposed Amendments). If adopted, the Proposed Amendments will impose obligations on reporting issuers (and other distributing and prescribed corporations, defined in the CBCA) in line with current governance best practices, including the following:

  • true majority voting: requiring shareholders to cast their votes “for” or “against” each individual director’s election (rather than slate voting), and prohibiting a director who has not been elected by a majority of the votes cast from serving as a director, except in “prescribed circumstances”;
  • annual director elections: requiring corporations to hold annual elections for all directors of a company’s board, effectively prohibiting staggered boards; and
  • diversity disclosures: requiring corporations to place before shareholders, at each AGM, information respecting diversity among the directors and among the members of senior management.


The Virtuous Corporation

Shlomit Azgad-Tromer is a Research Associate at the Center on Global Legal Transformation at Columbia Law School. This post is based on her forthcoming article.

Above and beyond their traditional financial roles, contemporary corporations are increasingly assuming a normative role, promoting social agendas. According to 2015 Sustainability reports, the normative outreach of contemporary S&P 500 corporations is growing with exuberance, notwithstanding their ultimate commitment to shareholder value. Social values are embedded in every corporate decision: Corporations have always generated norms within their organizational boundaries, from employment policies to business development. Yet the social agendas assumed by contemporary corporations are open, dynamic and diverse, stretching far beyond the corporate organizational boundaries and aiming to influence society as a whole. Among other social causes, American corporations now tackle chronic malnutrition and hunger, fight disease pandemics, mitigate gender inequality and promote human rights. The myriad normative roles assumed by the corporation, from profit-centered corporate goodness, to environmental and human rights corporate agendas and to corporate philanthropy, comprise an emerging corporate social identity. This article asks what induces corporations to pursue social agendas and provides an initial taxonomy for corporate social motivation, showing that the incentives to normative corporate conduct are often rooted in the business purpose itself. Incentive analysis for corporate social agendas may shed light on the promise and the peril of corporate social identities, to be further explored in future works.

Weekly Roundup: October 7, 2016–October 13, 2016

More from:

This roundup contains a collection of the posts published on the Forum during the week of October 7, 2016–October 13, 2016.

Does Corporate Governance Matter? Evidence from the AGR Governance Rating

Inside Safe Assets

2016 CPA-Zicklin Index of Corporate Political Disclosure

What Is the Real Value of an Incentive Compensation Award When It Is Made?

Joseph E. Bachelder is special counsel in the Tax, Employee Benefits & Private Clients practice group at McCarter & English, LLP. The following post is based on a column by Mr. Bachelder which first appeared in the New York Law Journal. Andy Tsang, a senior financial analyst with the firm, assisted in the preparation of this post. Related research from the Program on Corporate Governance includes Paying for Long-Term Performance by Lucian Bebchuk and Jesse Fried (discussed on the Forum here).

The value of an incentive compensation award to an executive often is significantly less than the award’s “target value.” Target value for this purpose means the amount “targeted” for payout at the end of an award period if conditions to which the award is subject are satisfied. These conditions may be based on achievement of performance targets or simply based on continued employment during a stipulated period of time.

Delay in payment and accompanying risk factors over the period the award is to be earned out may reduce or eliminate that target value. Understanding the real value of such an award at the time it is made to the executive is very important. It impacts on the negotiation of pay packages and is reflected in executive pay information included in proxy statements and in reports in the media regarding executive pay. [1]


2016 CPA-Zicklin Index of Corporate Political Disclosure

Nanya Springer is associate director and Bruce Freed is president of the Center for Political Accountability. 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.

Even in a record-breaking year for money in politics, America’s largest publicly traded companies are steadily moving toward making disclosure and oversight of corporate political spending a common practice. The sixth annual CPA-Zicklin Index of Political Disclosure and Accountability contains this and other key findings, providing for the very first time a year-to-year comparison of the transparency and accountability policies and practices of the entire S&P 500.


The “Reasonable Investor” of Federal Securities Law

Amanda Rose is Professor of Law at Vanderbilt Law School. This post is based on a recent article by Professor Rose.

For decades public companies have complained that the enormous damage awards threatened in securities class actions renders settlement of even non-meritorious cases rational, promoting the filing of frivolous suits. This argument convinced Congress to enact the Private Securities Litigation Reform Act of 1995 (PSLRA), which includes a variety of measures designed to deter the filing of weak cases. Most importantly, the PSLRA heightened the standard for pleading scienter in securities fraud cases brought under SEC Rule 10b-5. The PSLRA did not, however, heighten the pleading requirement for materiality, a notoriously vague element of plaintiffs’ prima facie case under not only Rule 10b-5, but also Section 11 of the Securities Act of 1933, and which serves to define the scope of public companies’ disclosure obligations more generally. Today, materiality is the main fodder for merits-based critiques of securities class actions.


Significant Activity in All Sectors as Financial Institutions Innovate and Evolve

Edward D. Herlihy is a partner and co-chairman of the Executive Committee, and Richard K. Kim is a partner in the corporate department at Wachtell, Lipton, Rosen & Katz. This post is based on a Wachtell Lipton publication.

2016 began with a flurry of bank M&A activity that decelerated somewhat as fears of Brexit and an overall slowdown in global growth overtook the financial markets and dampened expectations of a near-term interest rate increase. While commodity and stock prices have gradually recovered, the yield curve is now flatter than when the year began. It remains unclear whether the Federal Reserve will increase interest rates this year, but it will likely take several rate hikes to meaningfully alleviate NIM compression. At the same time, the regulatory environment for financial institutions continues to prove very challenging and volatile, with higher capital requirements and increased compliance expenses weighing heavily on profitability. The lack of a discernible economic tailwind is gradually motivating a number of financial institutions to seize the day and find ways to adapt and thrive.


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