Monthly Archives: May 2018

An Investor Consensus on U.S. Corporate Governance & Stewardship Practices

Michael McCauley is Senior Officer, Investment Programs & Governance, of the Florida State Board of Administration (SBA). This post is based on a publication from the Florida SBA by Mr. McCauley; Lindsey Apple, Senior Proxy Analyst at MFS Investment Management; Jacob Williams, Florida SBA Corporate Governance Manager; and Tracy Stewart, Florida SBA Senior Corporate Governance Analyst.

The ISG, as a private initiative wholly independent of any regulatory body, was formed to bring together all types of investors to establish a framework of fundamental standards of investment stewardship and corporate governance for U.S. institutional investor and boardroom conduct. The Investor Stewardship Group (ISG) is a collective of some of the largest institutional investors and global asset managers with the goal of establishing the first ever, broad-based U.S. Stewardship and Governance Code for companies and investors. Founding members include U.S. and international institutional investors with large investments in the U.S. equity market. Since its inception in late January 2017, membership in the ISG has grown significantly, with assets under management increasing to over $22 trillion.

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Buying the Verdict

Lauren Cohen is the L.E. Simmons Professor in the Finance & Entrepreneurial Management Units at Harvard Business School and a Research Associate at the National Bureau of Economic Research (NBER); Umit G. Gurun is professor of accounting and finance at the University of Texas at Dallas. This post is based on their recent paper.

Firms are legally obligated to operate within the standards of their operating jurisdictions. Even so, and despite the fact that firms spend substantial capital in order to stay within this legal framework, infractions occur. While many of these infractions are settled privately, a large number do make it into the court system to be adjudicated. These tend to be larger stakes cases (from a value-weighted perspective) for the firms involved. Moreover, the U.S. legal system is founded upon the notion that a jury of one’s peers can conduct an arms-length review of a case adjudicating the guilt (or lack of sufficient evidence for guilt) of the alleged legal infraction. However, the moment that a party is sued, it has a clear incentive to influence the jury in its favor. Much of this convincing takes place inside the courtroom. However, one power that large, publicly facing, and well-funded organizations have at their disposal is to do so also outside of the courtroom.

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The Uncertain Role of IPOs in Future Securities Class Actions

Jeff Lubitz is Head of ISS Securities Class Action Services, Institutional Shareholder Services, Inc. This post is based on an ISS publication by Elisa Mendoza, Vice President with ISS Securities Class Action Services.

Though IPO-related class actions accounted for just four percent of all securities class actions over the past decade, according to ISS Securities Class Action Services (SCAS) data, much ink has been spilled in recent months over whether the U.S. Securities and Exchange Commission (SEC) might bar IPO-related lawsuits in lieu of arbitration. Supporters of arbitration argue that it would eliminate frivolous shareholder litigation and provide a more efficient way for investors to seek redress. [1] Treasury Department officials argue the change could be a way to “reduce costs of securities litigation for issuers in a way that protects investors’ rights and interests,” according to Bloomberg. [2] The change, proponents contend, would incentivize more companies to go public on the U.S. markets. This potential change to the SEC’s long-standing position would effectively give credence to the contention by advocates of mandatory arbitration that the burdens and expense of securities class action lawsuits are among the factors that have led to a decline in the number of IPOs in the U.S. in recent years. [3]

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The Impact of DOL Guidance on ESG-Focused Plans

Ning Chiu, Betty M. Huber, and Charles Shi are counsel at Davis Polk & Wardwell LLP. This post is based on a Davis Polk publication by Ms. Chiu, Ms. Huber, and Mr. Shi.

Related research from the Program on Corporate Governance includes The Agency Problems of Institutional Investors by Lucian Bebchuk, Alma Cohen, and Scott Hirst.

Last week the U.S. Department of Labor (DOL) issued a bulletin (the Bulletin) on its prior interpretations related to considerations of ESG factors by ERISA plan fiduciaries. Since then there has been some speculation that perhaps the positions outlined in the Bulletin would act as a speed bump to the increasing focus by investors on ESG matters at public companies.

As background, ERISA requires plan fiduciaries to act solely in the interest of plan participants and beneficiaries for the exclusive purpose of providing benefits to such persons and to discharge their fiduciary duties with the care, skill, prudence and diligence a prudent person would use under similar circumstances. Companies should be aware that the Bulletin is applicable only to fiduciaries of ERISA plans, which include private sector company-sponsored retirement plans (such as a company’s own defined benefit pension plans and 401(k) plans) and union pension plans. Managers of private investment funds are bound by the Bulletin only if their funds are subject to ERISA (many private investment funds are not). Managers of mutual funds and governmental pension funds are not bound by the Bulletin as these funds are not subject to ERISA and therefore not subject to DOL oversight.

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Bid Anticipation, Information Revelation, and Merger Gains

Wenyu Wang is Assistant Professor of Finance at Indiana University Kelley School of Business. This post is based on his recent article, published in the Journal of Financial Economics.

A large body of research documents that market reactions to takeover announcements are, on average, neutral or even slightly negative for acquirers. This evidence presents a value-creation puzzle: Why do acquirers pursue takeovers if they do not overtly benefit from the deals? The puzzle seems to contradict both the common assumption that acquirers are value-maximizers and the neoclassical theory of mergers and acquisitions (M&As).

The main goal of my article, Bid Anticipation, Information Revelation, and Merger Gains, recently published in the Journal of Financial Economics, is to reconcile the value-creation puzzle with the neoclassical theory of M&As. I evaluate how the market’s anticipation of future takeovers (i.e., the anticipation effect) and the new information revealed upon bid announcements (i.e., the revelation effect) confound traditional estimates of merger gains and lead to misinterpretation of announcement returns.

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The Future of Merger Litigation in Federal Courts?

Andrew Ditchfield and Neal A. Potischman are partners at Davis Polk & Wardwell LLP. This post is based on a Davis Polk publication by Mr. Ditchfield, Mr. Potischman, Lawrence PortnoyDana M. Seshens, and Arif H. Dhilla.

In January 2016, the Delaware Chancery Court issued its decision in In re Trulia, Inc. Stockholders Litigation, which announced that the court would approve “disclosure only” settlements that had become commonplace in M&A transactions only if the supplemental disclosures provided to a company’s stockholders in connection with those settlements were “plainly material.” Since that decision, the federal courts have seen a dramatic increase in the number of lawsuits challenging the disclosures made in connection with M&A transactions. Cornerstone reported that there were 198 M&A-related lawsuits filed in federal court in 2017, more than double the number that had been filed in 2016. The lawsuits are very similar to those that used to be filed in Delaware Chancery Court prior to Trulia. The complaints assert claims under Section 14 and 20 of the Exchange Act and allege that the disclosure documents filed in connection with M&A transactions are false and misleading because they fail to disclose various pieces of information, typically information about the issuer’s financial projections, analysis performed by the issuer’s financial advisor, and conflicts of interest. Issuers often provide supplemental disclosures to moot the claims, and plaintiffs file notices of voluntary dismissal and seek to negotiate a fee award for causing the supplemental disclosures. These types of federal disclosure lawsuits rarely lead to judicial decisions.

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CEO Attributes, Compensation, and Firm Value: Evidence from a Structural Estimation

T. Beau Page is Visiting Assistant Professor at Tulane University. This post is based on a recent article by Professor Page, forthcoming in the Journal of Financial Economics.

Researchers and regulators have long been interested in understanding chief executive officer (CEO) compensation contracts. This interest comes from the relatively large size of CEO compensation, in relation to other firm employees, and because of the important role the CEO has in running a firm. A striking finding is that variation in both the size and the makeup (equity ownership versus cash pay) of these contracts is not well-explained by the observable variables researchers routinely use to explain CEO pay. CEO-specific attributes, not firm-level variables, appear to explain most of the variation in both pay and equity ownership. What previous studies have left unanswered is “which CEO attributes explain differences across compensation contracts?” and “how important are these attributes to shareholder wealth?”
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Integrated Alpha: The Future of ESG Investing

George D. Mussalli is Chief Investment Officer and Head of Research (Equity), and Mike Chen is Portfolio Manager at PanAgora Asset Management. This post is based on a PanAgora publication by Mr. Mussalli and Mr. Chen.

When making investment choices, a company’s adherence to ESG principles is one that we believe is becoming increasingly relevant in today’s climate. Our research shows that companies which exhibit these principles not only historically outperform ones that do not incorporate them into the company’s DNA, but may experience less downside risk also.

Investors are looking more and more at adopting strategies which combine these new ESG tenets with existing methods of identifying attractive investment opportunities. Being a still evolving field, there is no well-defined process to best construct ESG portfolios which optimally combine profit-maximizing characteristics with ESG ones, all the while being mindful of client-specific requirements. At PanAgora, we believe an optimal approach to building ESG portfolios exists. An ESG portfolio can be constructed in a systematic way, with both traditional and ESG factors integrated in a manner that seeks to maximize performance based on objective measures. This may result in a portfolio which delivers alpha with ESG benefits that may accomplish both the return objectives and the values of the asset owner.

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The Business Case for Clawbacks

Kathryn Neel is managing director, Seymour Burchman is managing director, and Olivia Voorhis is an associate at Semler Brossy Consulting Group, LLC. This post is based on a Semler Brossy publication by Ms. Neel, Mr. Burchman, and Ms. Voorhis.

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).

In the world of corporate governance, a string of recent corporate scandals has highlighted the criticality of effective risk management and the potential financial and reputational harm that can result from inappropriate actions or ineffective oversight (see Figure 1).

The executives of these companies received large pay packages for their stewardship and leadership, largely provided in the form of performance-based compensation under the mantra of “pay for performance.”

This raises two questions:

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Do Women CEOs Earn More and Have More Diverse Boards?

Dan Marcec is Director of Content at Equilar, Inc. This post is based on an Equilar publication by Mr. Marcec.

As gender equity and diversity in corporate leadership continue to be critical discussions, research is regularly published showing links between these factors and company performance. Based on an analysis of Equilar 100 companies—the largest U.S.-listed firms to file proxy statements to the SEC before March 31—women CEOs had a higher representation of women on their boards on average than companies led by male counterparts. They also were awarded higher compensation on average in 2017.

Overall, Equilar 100 companies with women CEOs had an average of 24.0% representation of women on their boards, vs. 23.5% for the companies with male CEOs. Furthermore, the women in the CEO position at Equilar 100 companies were well paid in 2017 with an average pay package of $21.4 million. By comparison, the men who were on the list received an average pay package of $16.4 million. The following two questions examined this data just below the surface, finding that the complete picture is more complicated than it appears.

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