Monthly Archives: November 2016

Including Relative Financial Results in ISS Reports

Abe Friedman is Managing Partner at CamberView Partners. This post is based on a CamberView publication by Mr. Friedman, David Martin, and Chris Wightman.

ISS announced on November 8th that proxy research reports published after February 1, 2017 will include a standardized comparison of the company’s CEO pay with a relative financial performance ranking versus peers as measured by multiple financial metrics including return on equity, return on assets, return on invested capital, revenue growth, EBITDA growth, and growth in cash flow from operations.

The relative financial metric results will be used solely in ISS’s qualitative pay-for-performance analysis, at least for 2017. The quantitative pay-for-performance screen will not change for 2017 and will continue to be based on relative and absolute total shareholder return (TSR).

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New Theory in Corporate Governance Undermines Theories Relied on by Proponents of Short-Termism and Shareholder Activism

Martin Lipton is a founding partner of Wachtell, Lipton, Rosen & Katz, specializing in mergers and acquisitions and matters affecting corporate policy and strategy. This post is based on a Wachtell Lipton memorandum by Mr. Lipton and Anna Shifflet. Earlier posts by Martin Lipton taking issue with Lucian Bebchuk’s work on hedge fund activism and shareholder rights are available here, here, and here. Recent program research on these subjects by Professor Lucian Bebchuk includes The Long-Term Effects of Hedge Fund Activism (with Alon Brav, and Wei Jiang; discussed on the Forum here), The Myth that Insulating Boards Serves Long-Term Value (discussed on the Forum here), and Toward a Constitutional Review of the Poison Pill (with Robert J. Jackson, Jr.; discussed on the Forum here).

Since the mid-1970’s the agency-cost theory, popularized by Michael Jensen, has been used and gilded by academics to justify and promote shareholder-centric corporate governance. The agency cost theory, along with Eugene Fama’s efficient market theory and Milton Friedman’s 1970 dictum that the sole purpose of the business corporation is to maximize profits for its shareholders, have been used to promote legislation, regulation and so-called “best practices” designed to limit the power of management and boards of directors to defend strategies designed to create sustainable long-term growth. So too these theories, combined with statistical studies purporting to show that attacks by activist hedge funds promote improved long-term performance and long-term shareholder value, have been used by Lucian Bebchuk to not only promote activism, but all forms of shareholder-centric governance. Indeed Bebchuk is such a fervent proponent of shareholder rights to govern corporations that he has argued that all material corporate actions should be subject to shareholder referendums, that the poison pill is unconstitutional and that the staggered board is so inimical to shareholder rights that it justified his creating a Harvard Law School group to promote proxy resolutions designed to force its abandonment.

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When Is a “Final Offer” Not Final?

Charlie Geffen is a partner in the London office of Gibson Dunn & Crutcher LLP. This post is based on a Gibson Dunn publication by Mr. Geffen, Nigel Stacey, Selina S. Sagayam, and Dennis J. Friedman.

The battle to take control of SVG Capital was a good example of how the UK’s Takeover Panel operates on a pragmatic “principles” basis rather than on a strict rules basis. And it confirmed the importance, and benefits, of participants in UK public takeover transactions discussing their tactics with the Panel prior to announcing any proposals.

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Weekly Roundup: November 18–November 24, 2016


More from:

This roundup contains a collection of the posts published on the Forum during the week of November 18–November 24, 2016.






The Law and Brexit VIII


Thoughts for Directors


Towards a New Solution to Retail Investors’ Apathy


Corporate Deleveraging





Second Circuit: Standard Lock-Up Agreements Do Not Form a “Group”


Negotiating Appraisal Conditions in Public M&A Transactions

Victor Lewkow is a partner at Cleary Gottlieb Steen & Hamilton LLP. This post is based on a Cleary Gottlieb memorandum by Mr. Lewkow and Rob Gruszecki, and is part of the Delaware law series; links to other posts in the series are available here.

Appraisal rights in public M&A transactions have recently garnered greater attention, particularly in Delaware. As a result, more attention is being paid to the possible inclusion of a closing condition protecting the acquiror against excessive use of appraisal rights, and this should lead to careful attention being paid to the negotiation and drafting of any such conditions and related provisions. Discussed below are some of the reasons for this greater attention, and suggestions regarding negotiating and drafting such provisions.

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Second Circuit: Standard Lock-Up Agreements Do Not Form a “Group”

Richard A. Rosen and Charles E. Davidow are partners in the Litigation Department at Paul, Weiss, Rifkind, Wharton & Garrison LLP. This post is based on a Paul Weiss publication by Mr. Rosen, Mr. Davidow, Daniel J. Kramer, Walter Rieman, and Raphael M. Russo.

On November 3, 2016, in an appeal arising out of the 2012 initial public offering (“IPO”) of Facebook, Inc. (“Facebook”), the Second Circuit ruled that standard lock-up agreements between lead underwriters and pre-IPO shareholders in advance of an IPO do not, without more, render those parties a “group” within the meaning of Section 13(d) of the Securities Exchange Act of 1934. Lowinger v. Morgan Stanley, No. 14-3800-cv (2d Cir. Nov. 3, 2016). As a result, a standard lock-up agreement will not be independently sufficient to trigger liability under Section 16(b) for short-swing profits.

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Exchange Traded Funds (ETFs)

Itzhak Ben-David is the Neil Klatskin Chair in Finance and Real-Estate at The Ohio State University’s Fisher College of Business. This post is based on a forthcoming article, submitted to the Annual Review of Financial Economics, by Professor Ben-David; Francesco Franzoni, Professor of Finance, University of Lugano (USI) and Senior Chair at the Swiss Finance Institute; and Rabih Moussawi, Assistant Professor of Finance at the Villanova School of Business.

Since the mid-1990s, exchange traded funds (ETFs) have become a popular investment vehicle due to their low transaction costs and intraday liquidity. ETFs issue securities that are traded on the major stock exchanges, and, for the most part, these instruments aim to replicate the performance of an index. ETFs have shown spectacular growth. By mid-2016, they represented about 10% of the market capitalization of securities traded on US stock exchanges. [1]

ETFs have similarities and differences relative to other pooled investment vehicles. ETFs either hold a basket of securities passively (physical replication) or enter into derivative contracts delivering the performance of an index (synthetic replication). They issue securities (mostly shares) that are claims on the underlying pool of securities. ETF shares are traded on stock exchanges, and investors can take either long or short positions. Two mechanisms keep ETF prices in line with those of the basket that they aim to track: primary and secondary market arbitrage. The first mechanism involves the creation and redemption of ETF shares by authorized participants (APs), which are the official market makers for a given ETF. When ETF prices and the prices of the underlying securities diverge, APs typically buy the less expensive asset (ETF shares or a basket of the underlying securities) and exchange it for the more expensive asset, leading to the creation or redemption of ETF shares. The second type of trade, consisting of long and short positions in the secondary market, retains some uncertainty with respect to the horizon over which price convergence will occur; thus, it is an arbitrage only in a loose sense.

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How the Influx of Dividend-Minded Shareholders Will Impact Shareholder Activism

Leonard Chazen is Senior Counsel of Covington & Burling LLP. This post is based on a Covington & Burling publication.

2016 has been the year of the dividend. Fixed income investors seeking higher yields have moved into dividend-paying common stocks, and dividends have replaced earnings as the primary factor determining the movement of stock prices. [1] As a result public corporations have acquired a sizeable body of new shareholders for whom increased dividends are more important than earnings growth.

This post considers how the influx of dividend-minded shareholders will impact board decision-making and shareholder activism. These dividend-minded shareholders are a potential third force in the contest for influence between institutional investors who want the corporation to be managed to enhance long-term profitability, and shareholder activists who want the board to maximize the current price of the stock. As supporters of higher dividends these new shareholders are natural allies of the activists, but unlike the typical shareholder activist, they have a long term stake in the corporation and an interest in limiting stock buy backs and dividends to a level that does not impair the ability of the corporation to continue paying dividends in the future.

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Beyond the Personal Benefit Test: The Economics of Tipping by Insiders

Jonathan R. Macey is the Sam Harris Professor of Corporate Law, Corporate Finance & Securities Law at Yale Law School. This post is based on his recent article, forthcoming in the Journal of Law and Public Affairs.

In Dirks v. SEC, the U.S. Supreme Court ruled against the Securities and Exchange Commission and exonerated securities analyst Raymond Dirks from charges that he illegally passed along insider information garnered from a tipper, Ronald Secrist. Secrist’s tip concerned the existence of a massive, ongoing fraud at his former employer, the giant insurance company Equity Funding. The fraud, which was revealed largely as a direct result of Dirks’ efforts ultimately brought the insurance giant to its knees.

The Supreme Court decision ushered in the “personal benefit” test which requires the government to show as an element of any cause of action for insider trading under SEC Rule 10b-5 that the tipper who provides material insider information to downstream tippees received a personal benefit in exchange for the information. Because Mr. Secrist, who was Mr. Dirks’ tippee, received no personal benefit in exchange for his tip, Mr. Dirks could not be guilty of insider trading.

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Corporate Deleveraging

Harry DeAngelo is Kenneth King Stonier Chair at the Marshall School of Business, University of Southern California. This post is based on a recent paper by Professor DeAngelo; Andrei S. Gonçalves, Ph.D. candidate at The Ohio State University; and René M. Stulz, the Everett D. Reese Chair of Banking and Monetary Economics at The Ohio State University and NBER.

Deleveraging is central to capital structure dynamics, yet systematic analysis of the phenomenon is limited to a handful of prior studies that examine changes in average leverage for samples of firms selected to have high and/or recently increased leverage ratios. Having a more complete understanding of the nature and extent of deleveraging is of first-order importance for corporate finance research where the Holy Grail is an empirically credible theory of capital structure. This issue is also important for macroeconomics where there is a need to understand corporate deleveraging in more normal times to have a baseline for gauging its hypothesized major role in generating periods of serious economic torpor such as the Great Depression, Japan’s Lost Decades, and the Great Recession.

In this paper, we examine corporate deleveraging using a firm-level longitudinal approach, and reach sharply different conclusions from prior studies, whose findings suggest that firms with high leverage tend to deleverage only modestly.

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