Monthly Archives: June 2018

Passive Mutual Funds and ETFs: Performance and Comparison

Edwin J. Elton and Martin J. Gruber are Professors Emeritus and Scholars in Residence at NYU Stern School of Business, and Andre de Souza is Assistant Professor of Finance and Economics at St. John’s University Peter J. Tobin College of Business. This post is based on their recent paper.

Over 25% of the assets held by investment companies are held in the form of passive index funds and passive exchange traded funds. Furthermore, many indexes are followed by multiple passive funds. Empirical evidence shows that active funds underperform indexes by about 75 basis points. Given these facts, it is important for investors to understand how to make the choice among and between index funds and ETFs for any particular index. The purpose of this paper is to explain what affects performance and how to choose between passive vehicles.

In the first part of the paper, we examine return pre-expenses which measures management’s performance. Managers closely follow their index resulting in an average R2 above .996 and an average beta of 1 for ETFs and .998 for index funds. On average, ETFs pre-expenses slightly outperform the index they follow, while index funds slightly underperform.

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Fiduciary Duties of Buy-Side Directors: Recent Lessons Learned

Steven Haas is a partner and Richard Massony is an associate at Hunton Andrews Kurth LLP. This post is based on a Hunton Andrews Kurth memorandum by Mr. Haas and Mr. Massony, and is part of the Delaware law series; links to other posts in the series are available here.

Related research from the Program on Corporate Governance includes Independent Directors and Controlling Shareholders, by Lucian Bebchuk and Assaf Hamdani (discussed on the Forum here).

Significant acquisitions always present risks to the acquiring entity and its stockholders. These risks may arise from, among other things, integration challenges or failing to identify operational problems or liabilities during due diligence that adversely affect the price paid to the sellers. Nevertheless, in the context of an acquisition—even a significant, “bet the company” transaction—the directors of the
acquiring company are almost always protected by the business judgment rule. Two recent cases, however, show potential pitfalls when the buyer’s board of directors may have conflicts of interest. When a majority of the directors is conflicted or there is a controlling stockholder on both sides of the transaction, courts will not apply the business judgment rule unless certain procedural safeguards are in place.

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ESG and Sustainability: The Board’s Role

David M. Silk, David A. Katz, and Sabastian V. Niles are partners at Wachtell, Lipton, Rosen & Katz. This post is based on a Wachtell Lipton memorandum by Mr. Silk, Mr. Katz, Mr. Niles, and Carmen X. W. Lu.

Related research from the Program on Corporate Governance includes Socially Responsible Firms by Alan Ferrell (discussed on the Forum here).

In light of evolving—and sometimes actively debated—perspectives on the role of public companies with respect to sustainability, corporate social responsibility and other ESG matters (e.g., Barron’s recent report on Sustainable Investing), we are providing a high-level overview of how boards of directors and senior management teams may wish to approach these issues:

  • Be aware that sustainability has become a major, mainstream governance topic that encompasses a wide range of issues, including a company’s long-term durability as a successful enterprise, climate change and other environmental risks and impacts, systemic financial stability, management of human capital, labor standards, resource management, and consumer and product safety, and consider how your company presents itself with respect to these matters.
  • Recognize that the role of the board in these areas is generally one of partnership with management and appropriate oversight, rather than unilateral board-level mandates. This includes achieving internal clarity on which stakeholder interests are critical to the long-term success of the company, investors, employees, customers, communities, and the economy and society as a whole. These issues should be considered as part of a company’s annual strategy review.

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Weekly Roundup: June 22-28, 2018


More from:

This roundup contains a collection of the posts published on the Forum during the week of June 22-28, 2018.

A Public Option for Bank Accounts (or Central Banking for All)


Gender Quotas on California Boards


REIT M&A in a Complex Market




Web-Delivery of Shareholder Reports


Business Groups and Firm-Specific Stock Returns


The Highest-Paid CEO by U.S. State



The Missing Profits of Nations


Peer Selection and the Wisdom of the Crowd: Considerations for Companies and Investors


Clarifying Class Action Tolling


Trade Secrets Protection and Antitakeover Provisions



FIRRMA Is Coming: How to Get Ready


ETF Ownership and Corporate Investment


The SEC Draft Strategic Plan for 2018-2022

The SEC Draft Strategic Plan for 2018-2022

This post is based on the SEC Draft Strategic Plan for Fiscal Years 2018-2022, released for public comments on June 19, 2018.

Our Mission

To protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation.

Our Vision

To promote capital markets that inspire public confidence and provide a diverse array of financial opportunities to retail and institutional investors, entrepreneurs, public companies, and other market participants.

Our Values

Integrity: We inspire public confidence and trust by adhering to the highest ethical standards.

Excellence: We are committed to excellence in pursuit of our mission on behalf of the American public.

Accountability: We embrace our responsibilities and hold ourselves accountable to the American public.

Teamwork: We recognize that success depends on a skilled, diverse, coordinated team committed to the highest standards of trust, hard work, cooperation, and communication.

Fairness: We treat investors, market participants, and others fairly and in accordance with the law.

Effectiveness: We strive for innovative, flexible, and pragmatic regulatory approaches that achieve our goals and recognize the ever-changing nature of our capital markets.

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ETF Ownership and Corporate Investment

Constantinos Antoniou is Associate Professor of Finance and Behavioural Science at University of Warwick Business School; Avanidhar Subrahmanyam is Distinguished Professor of Finance, Goldyne and Irwin Hearsh Chair in Money and Banking at University of California Los Angeles Anderson School of Management; and Onur Tosun is Assistant Professor of Finance at University of Warwick Business School. This post is based on their recent paper.

Recent work has highlighted that exchange traded funds (ETFs) contribute to a decrease in the pricing efficiency of the underlying securities (Ben-David, Franzoni and Moussawi, 2017). This is because, due to their high liquidity, ETFs attract high-frequency traders. Moreover, since ETFs and the underlying assets are bound by no arbitrage conditions, volatility in ETFs caused by high-frequency trading can propagate to the underlying assets, as arbitrageurs trade to exploit violations of the law of one price. As a result, the stock prices of companies with high ETF ownership are more noisy.

Corporate managers rely on stock prices for information, since stock prices aggregate information about the future prospects of their companies from a large pool of outside investors, and some of this information is not known to management. This reliance on the stock price leads to the well-established positive relationship between stock prices and corporate investment, which indicates that the managers of companies with higher stock prices (which are deemed by the market to have good growth opportunities) invest more heavily.

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FIRRMA Is Coming: How to Get Ready

Randall H. Cook is Senior Managing Director, Rosanne Giambalvo is Senior Director, and Steve Klemencic is Managing Director at Ankura Consulting. This post is based on an Ankura memorandum by Mr. Cook, Ms. Giambalvo, Mr. Klemencic, Michael Garson, Mona Banerji, and Bill Bray.

On May 22, 2018, congressional committees in both the U.S. Senate and House of Representatives advanced the Foreign Investment Risk Review Modernization Act, or “FIRRMA.” This legislation, which the Senate Armed Services Committee also included in its version of the National Defense Authorization Act, likely will be enacted into law in the next few months, with significant impact on the regulatory environment concerning foreign direct investment (“FDI”) in the United States. FIRRMA will significantly expand the jurisdiction and activity of the Committee on Foreign Investment in the United States (“CFIUS”), and most likely include provisions aimed specifically at a broader set of FDI transactions involving U.S. distressed debt, real estate, and critical technology. The driver of this change is concern that foreign countries, particularly China, are deliberately utilizing foreign investment to acquire national security-critical assets, technologies, and information to their strategic advantage.

Success in this dynamic, increasingly complex investment environment requires both quality counsel and an experienced, technically expert team that understands and can effectively address the full spectrum of CFIUS’s growing authority and concerns. This post provides background on CFIUS, describes some of FIRRMA’s key provisions and what they may mean for your business and investments, and discusses the importance of an interdisciplinary approach to successfully navigating the CFIUS process.

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Surprises from the 2018 Proxy Season

Shirley Westcott is a Senior Vice President at Alliance Advisors LLC. This post is based on an Alliance Advisors publication by Ms. Westcott.

As the 2018 proxy season enters its final weeks, several notable trends have emerged which may inform post-season engagements and shape next year’s shareholder campaigns.

Calls for various types of climate action have resonated strongly with investors as have social initiatives on gun violence, sexual misconduct and the opioid epidemic. Pay programs have faced more frequent rebukes and even auditors, in isolated events, have been challenged over independence and performance. Retail proponents also stepped up their game with filings of exempt solicitations, while conservative investors countered liberals’ messages by co-opting their proposals.

In short, shareholders are increasingly flexing their muscles on everything from environmental and social (E&S) issues to executive compensation. A brief look at some of the season’s highlights is presented below.

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Trade Secrets Protection and Antitakeover Provisions

Aiyesha Dey is Høegh Family Associate Professor of Business of Administration at Harvard Business School; and Joshua T. White is Assistant Professor of Finance at Vanderbilt University Owen Graduate School of Management. This post is based on their recent paper.

Related research from the Program on Corporate Governance includes What Matters in Corporate Governance? by Lucian Bebchuk, Alma Cohen, and Allen Ferrell; The Costs of Entrenched Boards by Lucian Bebchuk and Alma Cohen; and Reexamining Staggered Boards and Shareholder Value by Alma Cohen and Charles C.Y. Wang (discussed on the Forum here).

Few topics have received more attention in the academic literature than public corporations’ use of antitakeover provisions. Despite the voluminous literature, we still do not fully understand why managers adopt antitakeover provisions, if their use represents “good” or “bad” governance, and which of the provisions, if any, offer actual protection against takeovers (Straska and Waller 2014).

Two views, each with different implications for firm value, have emerged in the literature. The first view holds that entrenched managers implement antitakeover provisions in a value-destroying way to shield themselves from the market for corporate control (e.g., Bebchuk et al. 2008). The other view argues that firms adopt antitakeover provisions to protect innovation incentives by reducing capital market pressures (Stein 1988). However, given that the decision to adopt antitakeovers is endogenous to the firm and manager, a resolution on their implications for shareholder value is challenging. Recently, scholars have also raised the possibility that the net benefits of antitakeovers are likely to vary across firms and the circumstances of their use (Johnson et al., 2015).

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Clarifying Class Action Tolling

Samuel P. Groner and Israel David are partners and Andrew B. Cashmore is an associate at Fried, Frank, Harris, Shriver & Jacobson LLP. This post is based on a Fried Frank memorandum by Mr. Groner, Mr. David, Mr. Cashmore, Scott B. Luftglass, Michael C. Keats, and James E. Anklam.

[On June 11, 2018], the Supreme Court resolved a circuit split regarding whether the filing of a class action lawsuit tolls the statute of limitations for putative class members to file their own class actions. In China Agritech, Inc. v. Resh, 584 U.S.      , 2018 WL 2767565 (June 11, 2018), the Court held that so-called American Pipe tolling—which allows a putative class member to file an individual claim upon denial of class certification, even if the statute of limitations would have by that time otherwise run out—does not permit the maintenance of a follow-on class action past the expiration of the statute of limitations.

American Pipe tolling was first recognized by the Court over forty years ago in American Pipe & Construction Co. v. Utah, 414 U.S. 538 (1974), where the Court held that the timely filing of a class action tolls the applicable statute of limitations for all persons encompassed by the class complaint. In American Pipe, the Court further ruled that, where class action status has been denied, members of the failed class could timely intervene as individual plaintiffs in the still-pending action, shorn of its class character. In 1983, the Court clarified in Crown, Cork & Seal Co. Inc. v. Parker, 462 U.S. 345 (1983) that American Pipe’s tolling rule is not dependent on intervening in or joining an existing suit; it applies as well to absent class members who, after denial of class certification, prefer to bring an individual suit once the economies of a class action are no longer available.

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