Monthly Archives: June 2018

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

Anthony Garcia is a Policy Advisor at ISS Custom Research, Kosmas Papadopoulos is Managing Editor and John Roe is Head of ISS Analytics. This post is based on their publication for ISS Analytics.

Peer groups form the bedrock of many company pay-setting exercises. Benchmarking CEO pay to a target value, typically the median pay of a group of “peer” companies, is a standard practice used by compensation committees; more than 97 percent of S&P 500 companies disclose benchmarking peer groups. And while there was once significant skepticism among the investor community due to perceived peer group manipulation (typically companies selecting many larger companies or “aspirational peers,” leading to escalating executive pay), most companies seem to have reformed their peer group selection practices.

In this post, we provide an alternative look at peer groups using the “wisdom of the crowd”—that is, the network of companies formed by examining the peer selections that other companies are making (and specifically ignoring the peer selections made by the target company itself). This is not meant to be a suggestion of peers for each company to use—but rather, a comparison to see how often the “wisdom of the crowd” arrives at decisions similar to the company’s own.


The Missing Profits of Nations

Thomas R. Tørsløv and Ludvig S. Wier are PhD candidates at the University of Copenhagen; and Gabriel Zucman is Assistant Professor of Economics at UC Berkeley. This post is based on their recent paper.

Perhaps the most striking development in tax policy throughout the world over the last few decades has been the decline in corporate income tax rates. Between 1985 and 2018, the global average statutory corporate tax rate has fallen by more than half, from 49% to 24%. In 2018, most spectacularly, the United States cut its rate from 35% to 21%.

Why are corporate tax rates falling? The standard explanation is that globalization makes countries compete harder for productive capital, pushing corporate tax rates down. By cutting their rates, countries can attract more machines, plants, and equipment, which makes workers more productive and boosts their wage. This theory provides a consistent explanation for the global decline in tax rates observed over the last twenty years and offers nuanced normative insights (see Keen and Konrad, 2013, for a survey of the large literature on tax competition).

Our paper asks a simple question: is this view of globalization and of the striking tax policy changes of the last years well founded empirically? Our simple answer is “no.” Machines don’t move to low-tax places; paper profits do. By our estimates, close to 40% of multinational profits are artificially shifted to tax havens in 2015. The decline in corporate tax rate is thus the result of policies in high-tax countries—not a necessary by-product of globalization. The redistributive consequences of this process are major: instead of increasing capital stocks in low-tax countries, boosting wages along the way, profit shifting merely reduces the taxes paid by multinationals, which mostly benefits their shareholders, who tend to be wealthy.


Political and Social Issues in the Boardroom: Examples from the Gun Industry

Steven M. Haas is a partner and Meghan Garrant is an associate at Hunton Andrews Kurth LLP. This post is based on a Hunton Andrews Kurth memorandum by Mr. Haas and Ms. Garrant.

Related research from the Program on Corporate Governance includes Socially Responsible Firms by Allen Ferrell, Hao Liang, and Luc Renneboog (discussed on the Forum here) and Social Responsibility Resolutions by Scott Hirst (discussed on the Forum here).

Boards of directors are increasingly having to make difficult decisions arising from social or political issues. In today’s social media environment, companies can quickly find themselves facing consumer boycotts, targeted media campaigns, and other adverse publicity that could harm shareholder value. These threats may arise from the company’s product line or services, or more indirectly from its affiliation with another business or political organization. Companies may decide to take a stance to build consumer goodwill, avoid criticism or backlash, or even because the issue has a direct bearing on the company’s operations (e.g., immigration policy). Last year, for example, several chief executive officers resigned from the president’s American Manufacturing Council. Other times, companies may choose to do nothing or try to remove themselves from the debate. In addition to dealing with these complex business decisions, boards also are being confronted by investors who are increasingly focused on environmental, social, and governance (“ESG”) issues. This article discusses the intensifying boardroom environment of dealing with political and social issues by using gun violence as a recent example.


The Highest-Paid CEO by U.S. State

Alex Knowlton is a Senior Research Analyst at Equilar Inc. This post is based on an Equilar memorandum by Mr. Knowlton. Related research from the Program on Corporate Governance includes The Growth of Executive Pay by Lucian Bebchuk and Yaniv Grinstein.

The compensation of chief executive officers has been under the spotlight, particularly with the initial release of the CEO-to-median-worker pay ratio disclosure requirement. As a result, CEO compensation has been dissected further than ever before. However, shareholders may feel somewhat disconnected to this information due to the large, national scale. A closer-to-home, more intricate analysis of chief executive compensation can be viewed by breaking it down by the highest-paid CEO by state. A recent study Equilar conducted with the Associated Press did just that, and analyzed the total compensation of the highest-paid CEO at public companies in 46 of the 50 states. Chief executives had to have been with a company for at least two years and the Company had to have filed a proxy between January 1, 2018 and April 30, 2018 to be included in the study.


Business Groups and Firm-Specific Stock Returns

Mara Faccio is the Hanna Chair in Entrepreneurship & Professor of Finance at Purdue University Krannert School of Management; Randall Morck is the Stephen A. Jarislowsky Distinguished Chair in Finance at the University of Alberta; and M. Deniz Yavuz is Associate Professor at Purdue University Krannert School of Management. This post is based on a recent paper authored by Professor Faccio, Professor Morck, and Professor Yavuz.

Measures of general and financial development tend to correlate positively with measures of firm-specific stock return volatility at the economy level (Morck et al. 2000). Lower firm-specific stock return volatility, in turn, is associated with less efficient capital allocation (Wurgler, 2000; Durnev et al., 2004; Morck et al., 2013). Business groups, collections of separately listed firms under common control through equity blocks, are also more prevalent in lower income economies (La Porta et al., 1999; Morck, Wolfenzon, and Yeung, 2005; Khanna and Yafeh, 2007), and thought to be a second best suboptimal solution to allocatively inefficient financial markets (Khanna and Palepu, 2000; Almeida and Wolfenzon, 2006; Khanna and Yafeh, 2007). This study connects these two lines of research by showing that business group affiliated firms’ stock returns exhibit less firm-specific volatility than do the returns of unaffiliated firms in similar conditions.


Web-Delivery of Shareholder Reports

Derek N. Steingarten and Clair E. Pagnano are partners and Jon-Luc Dupuy is of counsel at K&L Gates LLP. This post is based on a memorandum by Mr. Steingarten, Ms. Pagnano, Mr. Dupuy, and Abigail P. Hemnes.

On June 4, 2018, the Securities and Exchange Commission (“SEC”) adopted Rule 30e-3 (the “Rule”) to provide mutual funds, exchange-traded funds, closed-end funds and certain registered unit investment trusts covered by the rule (“Funds”) with a new option of internet-based “notice and access” delivery of annual and semi-annual shareholder reports, conditioned on delivery to investors of a separate paper notice for each shareholder report to explain how the report can be obtained from a website or in paper form. The following is a high level summary of the Rule and its conditions, including certain differences between the final Rule and the 2015 rule proposal. The first date on which any Fund may rely on the Rule to send paper notices in lieu of shareholder reports is January 1, 2021.

In related releases, two SEC requests for public comment were announced. First, the SEC seeks public comment on additional ways to modernize fund information. Investors, academics, literacy and design experts, market observers, fund advisers, and boards of directors are invited to provide feedback on how to improve the experience of fund investors. Second, the SEC seeks comment on the framework for certain processing fees that broker-dealers and other intermediaries charge funds for delivering fund shareholder reports and other materials to investors.


The General Counsel as Key Corporate Social Responsibility Advisor

Michael W. Peregrine is a partner at McDermott Will & Emery LLP. This post is based on an article by Mr. Peregrine; his views do not necessarily reflect the views of McDermott Will & Emery or its clients.

The general counsel’s ability to incorporate moral and ethical matters within her advice, and her accepted role as “wise counselor” to management, well-position her to be an important advisor to board and executive leadership on corporate social responsibility (“CSR”) matters.

By its nature, CSR reflects the confluence of business performance; law and regulation; corporate governance; and social and environmental goals. A company’s ability to respond to CSR depends in part on soliciting a diversity of related perspectives at the executive and board levels. These should logically include the general counsel, whose portfolio extends well beyond technical legal issues, to incorporating moral and ethical considerations in her advice to the corporation.

The managerially progressive CEO, who is sensitive to CSR principles, will support and embrace the regular and active participation of the general counsel in “C-Suite” CSR discussions.


Chairman Clayton Testimony on the Oversight of the SEC

Jay Clayton is Chairman of the U.S. Securities and Exchange Commission. This post is based on Chairman Clayton’s recent testimony before the House Committee on Financial Services, available here. The views expressed in this post are those of Mr. Clayton and do not necessarily reflect those of the Securities and Exchange Commission or its staff.

Chairman Hensarling, Ranking Member Waters and members of the Committee, thank you for the opportunity to testify today [June 21, 2018] about the work of the U.S. Securities and Exchange Commission (SEC). [1]

With a workforce of over 4,500 staff in Washington and across our 11 regional offices, the SEC oversees, among other things (1) approximately $82 trillion in securities trading annually on U.S. equity markets; (2) the disclosures of approximately 4,300 exchange-listed public companies with an approximate aggregate market capitalization of $30 trillion; and (3) the activities of over 26,000 registered entities and self-regulatory organizations. These registered entities and registrants include, among others, investment advisers, broker-dealers, transfer agents, securities exchanges, clearing agencies, mutual funds and exchange-traded funds (ETFs), and employ over one million people in the United States.


REIT M&A in a Complex Market

Adam O. Emmerich and Robin Panovka are partners and leaders of the REIT M&A practice at Wachtell Lipton Rosen & Katz. This post is based on a Wachtell Lipton memorandum authored by Mr. Emmerich and Mr. Panovka.

We offer some quick observations from recent REIT deal activity, with a more fulsome discussion in our attached updated playbook:

  1. N A V are the three most misunderstood letters in the REIT lexicon, often viewed doubly incorrectly as both a floor for what a sale process should yield, and an indicator of opportunities for activists. A REIT’s so-called NAV is merely an estimate (best viewed as a range), is backward looking, typically fails to account for frictional costs, and may, in many cases, not reflect fundamental value.
  2. Activist pressure, or its threat, is often a driver, but should never be allowed to dictate results, particularly where short-termism is at play.
  3. Frictional costs can vary widely from deal to deal, depending on tax protection agreements, debt breakage, transfer taxes, severance, litigation and other issues. This should be top of the list in due diligence.
  4. Auction bidder pools vary in depth depending on the asset class and complexity involved, with some strategic buyers exercising caution, and with the larger PE firms and sovereign funds focusing rather selectively, particularly in light of unusual uncertainty around underlying value in certain asset classes. Most PE firms and sovereign funds are unwilling or unable to take down the larger or even mid-size REITs without clubbing, which obviously adds a layer of complexity and execution risk.
  5. Post-deal market checks can be an attractive tool for maximizing value, providing the benefits of an “auction with a floor.” A no-shop coupled with a two-tiered break fee (low for an initial period and then climbing to market) is sometimes a helpful compromise between go-shops and high-break-fee no-shops. Negotiating the right balance of deal protections while preserving the ability to fulfill fiduciary duties is especially important as topping bids are increasingly considered and made.
  6. Deal litigation continues to be largely inevitable, but should not be allowed to wag the dog. If a process is properly managed, the courts will afford boards wide latitude to determine how best to maximize shareholder value, with litigation/settlement costs controlled and kept to a minimum.
  7. Executive retention and termination protection issues should be considered early in the process, preferably on a clear day.


Gender Quotas on California Boards

Ron BerenblatAndrew Freedman, and Steve Wolosky are partners at Olshan Frome Wolosky LLP. This post is based on an Olshan publication by Mr. Berenblat, Mr. Freedman, and Mr. Wolosky.

California could become the first state in the nation to enact legislation promoting gender diversity in corporate boardrooms. On May 31, 2018, the State Senate of California passed a bill that would require public companies headquartered in California to comply with certain gender quota requirements with respect to board composition.

The bill, if enacted, would require any “publicly held” domestic and foreign corporation whose principal executive offices, according to the corporation’s Form 10-K, are located in California to have a minimum of one “female” on its board of directors no later than December 31, 2019. No later than December 31, 2021, the required minimum would increase to 2 female directors for corporations with 5 directors or to 3 female directors for corporations with 6 or more directors. The bill defines a “female” as “an individual who self-identifies her gender as a woman, without regard to the individual’s designated sex at birth.” A “publicly held” corporation is defined as a corporation with shares listed on “a major United States stock exchange.”


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