Monthly Archives: May 2018

Congress Increases Pressure on Proxy Advisory Firms

David A. Katz and Trevor Norwitz are partners at Wachtell, Lipton, Rosen & Katz. This post is based on a Wachtell Lipton publication by Mr. Katz and Mr. Norwitz.

In the latest effort to enhance transparency by proxy advisory firms, six members of the Senate Banking, Housing and Urban Affairs Committee sent letters to Institutional Shareholder Services (ISS) and Glass Lewis & Co., which they noted control 97% of the proxy advisory industry, requesting information regarding their eligibility for exemption from the proxy rules, accuracy of reporting and potential conflicts of interests.

The Senators’ letters reflect many of the concerns underlying the bill passed by the House of Representatives last December, titled the Corporate Governance Reform and Transparency Act of 2017, which would require proxy advisory firms to register with the U.S. Securities and Exchange Commission, disclose potential conflicts of interest and codes of ethics, and publicize their methodologies for formulating proxy recommendations.

Why Shareholder Wealth Maximization Despite Other Objectives

S.P. Kothari is the Gordon Y. Billard Professor of Accounting and Finance at MIT Sloan School of Management. This post is based on a recent paper authored by Professor Kothari; Richard Frankel, Beverly & James Hance Professor of Accounting at Washington University in Saint Louis Olin Business School; and Luo Zuo, Associate Professor of Accounting at Cornell University SC Johnson College of Business.

The view that firms (managers) behave as if their goal is to increase shareholder wealth is the shareholder-wealth-maximization principle. While many might agree this principle governs managerial behavior, it continues to arouse intense scrutiny, adoration, and condemnation. We begin by summarizing the economic rationale behind and the welfare consequences of managers pursuing this principle. Numerous writings articulate the principle, including the influential Friedman (1970) and Jensen (2001). Friedman (1970) encapsulates the principle by imploring managers as shareholders’ agents to “conduct the business in accordance with their desires, which will generally be to make as much money as possible while conforming to the basic rules of the society, both those embodied in law and those embodied in ethical custom.”


Summary of MSCI Consultation Paper on Voting Rights and Index Inclusion

Dimitris Melas is Managing Director and Global Head of Core Equity Research at MSCI, Inc. This post is based on his MSCI publication.

Related research from the Program on Corporate Governance includes The Untenable Case for Perpetual Dual-Class Stock (discussed on the Forum here) and The Perils of Small-Minority Controllers (discussed on the Forum here), both by Lucian Bebchuk and Kobi Kastiel.

Equity indexes have evolved to fulfil multiple roles in the investment process and meet the needs of various types of investors. All institutional investors use indexes as market indicators and research tools. Asset owners employ them as policy benchmarks in their asset allocation. Active managers use them as performance benchmarks while passive investors use indexes as the basis for investment vehicles. To fulfil these multiple roles successfully, equity indexes aim to achieve comprehensive coverage of the underlying opportunity set by including all investable equity securities listed in the markets they seek to represent. In the MSCI consultation discussion paper, [1] we address the question of whether stocks of companies with multiple share classes having unequal voting rights (“unequal voting shares or stocks”) should be eligible for inclusion in equity indexes. We approach the question in two steps. First, we assess if unequal voting shares meet the definition of equity. Then, we examine the impact of unequal voting stocks from different institutional investor perspectives.


Elon Musk’s Compensation

Joseph Bachelder is special counsel and Andy Tsang is a senior financial analyst at McCarter & English LLP. This post is based on an article by Mr. Bachelder and Mr. Tsang originally published in the New York Law Journal.

Related research from the Program on Corporate Governance includes How to Tie Equity Compensation to Long‐Term Results, and Paying for Long-Term Performance (discussed on the Forum here), both by Lucian Bebchuk and Jesse Fried.

On January 21, 2018, Tesla, Inc. (Tesla), the electric car manufacturer (also in the business of sustainable energy generation and storage), granted its Chairman and Chief Executive Officer, Elon Musk, an option, subject to shareholders’ approval, to acquire 20,264,042 shares of Tesla (representing 12 percent of the then outstanding shares). Tesla’s shares are traded on NASDAQ. As of the grant date of the option, the market cap of Tesla was approximately $59 billion.

The grant-date value of the option, according to the proxy statement for the special meeting noted below, was approximately $2.6 billion, based on a so-called “Monte Carlo” option pricing model, a mathematical model used to provide an estimate for the fair value of an option at the time of grant. The option exercise price is $350.02 per share, the January 19 closing price for a share of Tesla stock. To the author’s knowledge, this is the largest stock option ever granted by a public company to an executive. According to the same proxy statement, Mr. Musk “will receive no salary, no cash bonuses and no time-based equity awards that vest solely through the passage of time (that is, simply by continuing to show up for work).”


How Valuable are Independent Directors? Evidence from External Distractions

Ronald Masulis is Scientia Professor of Finance at University of New South Wales Australian School of Business, and Emma Jincheng Zhang is a lecturer in banking and finance at Monash University. This post is based on their recent article, forthcoming in the Journal of Financial Economics.

In our article, How valuable are independent directors? Evidence from external distractions, which was recently accepted for publication in the Journal of Financial Economics, we provide new evidence on the value of independent directors by exploiting exogenous events that seriously distract independent directors.

Agency theory predicts that independent directors are valuable (Fama and Jensen, 1983). Yet, empirical assessments of the value of independent directors are decidedly mixed, leaving the value of independent directors an important unsettled question in the literature (Bhagat and Black, 1999; Gordon, 2007; Adams et al., 2010). While some studies find a positive relation between board independence and corporate outcomes (e.g., Cotter et al., 1997; Dahya et al., 2008; Aggarwal et al., 2009), others find no relation (Bhagat and Black, 2002) or changing relations depending on a firm’s information environment (Duchin et al., 2010). Recently, several studies have questioned the usefulness of independence as a primary director characteristic, with alternative director traits being proposed as superior measures of board quality, such as director co-option (Coles et al., 2014).


The Conflicted Role of Proxy Advisors

Timothy M. Doyle is Vice President of Policy and General Counsel at the American Council for Capital Formation (ACCF). This post is based on an ACCF publication by Mr. Doyle.

In an increasingly complicated investment and financial landscape, investors rely heavily on the services of data and analytics providers to support their investment-related decisions. Proxy voting is the process in which a vote is cast on behalf of a shareholder rather than that shareholder participating physically in a public shareholder meeting. The reliance on advisory services is readily apparent in the increased influence of proxy advisors like Institutional Shareholder Services (“ISS”) and Glass, Lewis & Co. (“Glass Lewis”). Due to their increasing influence, these normally private and opaque proxy advisory firms have come under fire for issues such as conflicts of interest, undue influence, privacy concerns, and the investment value their recommendations provide.

Lest readers think this is an issue with limited impact or import, proxy advisors drive major policies at most publicly traded companies. [1] They provide analysis, recommendations, and consulting services to issuers and companies alike regarding how annual and special proxies should be voted. Recommendations are made on issues ranging from Board appointments to acquisitions to environmental and social issues.


Non-Delaware Decisions on Director Nominations

David Berger and Amy Simmerman are partners and Adrian S. Broderick is an associate at Wilson Sonsini Goodrich & Rosati. This post is based on a WSGR publication by Mr. Berger, Ms. Simmerman, Ms. Broderick, William Chandler, and Doug Schnell.

Two courts recently issued significant corporate law decisions that are meaningful for corporations outside of Delaware, whose courts handle more corporate law disputes than other states because Delaware is the corporate domicile for many corporations. The first decision, In re Xerox Corporation Consolidated Shareholder Litigation, was issued by the Supreme Court of the State of New York [1] and involved a two-part injunction by the court. In particular, the court enjoined Xerox from: (i) proceeding with a business combination with Fujifilm; and (ii) enforcing its advance notice bylaw, with the result that a large stockholder who initiated a proxy contest after the corporation’s advance notice deadline could proceed with making director nominations. The second decision, Blue Lion Opportunity Master Fund, L.P. v. HomeStreet, Inc., [2] was issued by the Superior Court of the State of Washington for King County. That decision upheld a board’s decision to reject a stockholder’s nomination of a competing slate of directors on the basis that the nomination failed to comply with the company’s advance notice bylaw.


Cash Windfalls and Acquisitions

Bastian von Beschwitz is a Senior Economist on the Board of Governors of the Federal Reserve System. This post is based on his recent paper.

In my paper, Cash Windfalls and Acquisitions, forthcoming in the Journal of Financial Economics, I study the effect of large exogenous cash windfalls on a firm’s acquisition activity. The cash windfalls resulted from a German tax reform that made divestitures of equity stakes tax free. Since not all firms owned equity stakes, the tax reform provided cash windfalls only to a subset of firms. I find that firms receiving a cash windfall undertake more acquisitions and that the additional acquisitions are value-destroying.

How access to financing affects a firm’s investment policy is one of the fundamental questions in corporate finance. As Stein (2003) points out, there is convincing evidence that firms with a strong financial position invest more, but it is less clear whether this effect is driven by under- or overinvestment. Underinvestment occurs if financial frictions prevent management from making value increasing investments (e.g., Myers and Majluf, 1984). In this case, it would be optimal if firms could invest more but they lack the financial resources. In contrast, overinvestment occurs if managers engage in “empire building” (Baumol, 1959; Williamson, 1964) as predicted by the free cash flow theory (Jensen, 1986). In this case, managers use excessive financing on wasteful projects that provide them with private benefits.


Does it Pay to Pay Attention?

Alberto Rossi is Assistant Professor at the University of Maryland. This post is based on an article forthcoming in The Review of Financial Studies by Professor Rossi and Antonio Gargano, Senior Lecturer at The University of Melbourne.

Standard economic models assume that investors continuously process and incorporate all available information in their financial decisions. In reality, however, individual investors have limited information processing capacity and display limited attention. Rational economic models predict that attention-constrained investors should benefit from paying attention and should pay attention up to the point where the benefits of paying attention exceed the costs. On the other hand, a large body of behavioral literature shows that individual investors are subject to many behavioral biases and are prone to making investment mistakes. This literature suggests that paying attention may be harmful rather than beneficial to the investors.


Cryptocurrency Compensation: A Primer on Token-Based Awards

Alfredo B. D. Silva is a partner, Ali U. Nardali is Of Counsel, and Aria Kashefi is an associate at Morrison & Foerster LLP. This post is based on a Morrison & Foerster publication by Mr. Silva, Mr. Nardali, and Mr. Kashefi, which originally appeared in Bloomberg Law.

In the past year, blockchain tokens (more commonly referred to as “virtual tokens” or just “tokens”) have nudged their way into mainstream consciousness with the proliferation of “initial coin offerings,” or “ICOs,” and the blockbuster rises—and drops—in the prices of cryptocurrencies. An emerging trend sees companies and virtual organizations leveraging the value of these tokens, not only for non-dilutive capital raising purposes, but also to compensate and incentivize founders, directors, employees, consultants and other service providers. Just as with issuances of founder’s stock, stock options and other traditional equity-based compensation, token-based compensation requires significant consideration from both a securities law and a tax law perspective.


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