Monthly Archives: July 2018

The “Hidden” Tax Cost of Executive Compensation

Kobi Kastiel is Assistant Professor of Law at Tel-Aviv University; and Noam Noked is Assistant Professor of Law at The Chinese University of Hong Kong. This post is based on their recent essay, published in the Stanford Law Review Online.

Related research from the Program on Corporate Governance includes Executive Compensation at Fannie Mae: A Case Study of Perverse Incentives, Nonperformance Pay, and Camouflage, and Stealth Compensation Via Retirement Benefits, both by Lucian Bebchuk and Jesse Fried; and Executive Pensions by Lucian Bebchuk and Robert J. Jackson.

The sweeping tax reform enacted in December 2017 will significantly increase the tax cost of executive compensation in many publicly held corporations where the compensation for each of the top five executives exceeds $1 million. Nonetheless, it is unlikely that these corporations will reduce the executive compensation to offset the increased tax cost, which will likely be shifted to public shareholders.

In our Essay, The ‘Hidden’ Tax Cost of Executive Compensation (forthcoming in the Stanford Law Review Online) we show that this significant tax cost is not transparent to shareholders. Our analysis of a hand-collected dataset of relevant proxy statements that were filed in the first fifty days after the enactment of the tax reform reveals that companies do not provide their shareholders with sufficient information about the tax cost of executive compensation. Therefore, there is a need for a prompt regulatory response. To make the tax cost of executive compensation fully transparent, we propose that the Securities and Exchange Commission (SEC) should adopt new disclosure requirements, outlined in this Essay, as soon as practicable. The disclosure of the tax cost of executive compensation would significantly improve the accuracy of investor information regarding the overall cost of executive compensation, and it could enhance shareholders’ ability to scrutinize compensation practices, all while imposing minimal compliance costs upon companies.

Below we provide a more detailed account of our analysis:

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The Constitutionality of SEC-Appointed Judges

Margaret E. Tahyar, Linda Chatman Thomsen, and Amelia T.R. Starr are partners at Davis Polk & Wardwell LLP. This post is based on a Davis Polk memorandum by Ms. Tahyar, Ms. Thomsen, Ms. Starr, Angela T. Burgess, Martine M. Beamon and Randall D. Guynn.

The Supreme Court’s opinion in Lucia v. SEC, [1] holding that SEC ALJs qualify as Officers of the United States under the Constitution and are therefore subject to the Appointments Clause of the Constitution, is likely to have far-reaching consequences for other federal agencies that rely on ALJs. Any federal agency that appoints ALJs in a manner similar to the SEC is now vulnerable to similar constitutional challenges under the Appointments Clause. Further, while Lucia resolved one constitutional challenge to ALJs, a concurrence by Justice Breyer highlights another significant constitutional question: whether the statutory removal protections afforded to SEC ALJs are also unconstitutional. Accordingly, Lucia presents a number of open questions, including whether the decision can be used to reopen past ALJ adjudications at the SEC or elsewhere, how it will impact existing ALJs and the ALJ appointment process at other federal agencies, and whether ALJs can survive a separate constitutional challenge to their removal protections.

The Potential Implications for Retroactive and Future Challenges to ALJ Decisions Are Numerous

In this post, we first analyze the implications of the Court’s decision, then describe the Court’s reasoning and Justice Breyer’s concurrence, and, finally, address the unanswered questions raised by the Lucia decision.

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Are Merger Clauses Value Relevant to Target and Bidder Shareholders?

John C. Coates is the John F. Cogan, Jr. Professor of Law and Economics at Harvard Law School; Darius Palia is Professor of Finance at Rutgers University; and Ge Wu is a Ph.D. candidate in finance at Rutgers Business School. This post is based on their recent paper.

Related research from the Program on Corporate Governance includes Why Have M&A Contracts Grown? Evidence from Twenty Years of Deals, by John C. Coates, IV; M&A Contracts: Purposes, Types, Regulation, and Patterns of Practice, by John C. Coates, IV; and The New Look of Deal Protection by Fernan Restrepo and Guhan Subramanian (discussed on the Forum here).

A large financial economics literature has found that shareholders earn significant abnormal returns over the market on announcement of a merger and acquisition transaction. These studies have found that target shareholders earn positive abnormal returns of between 20 percent and 35 percent, whereas bidder shareholders earn zero to small negative abnormal returns. However, every merger and acquisition deal is governed by a set of contracts terms that are described in detail in the merger agreement filed with the SEC. These contract terms often called “merger clauses” are negotiated between the bidder and target in order to communicate deal terms, specify risk sharing between the parties, and describes dispute management provisions in case of litigation.

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The Inapplicability of Corwin and Section 220

Sarah T. Runnells Martin is counsel and Michelle Davis is an associate at Skadden, Arps, Slate, Meagher & Flom LLP. This post is based on their Skadden memorandum, and is part of the Delaware law series; links to other posts in the series are available here.

Since the Delaware Supreme Court decided Corwin v. KKR Financial Holdings LLC more than two years ago, there has been an open question as to whether and to what extent the principles affirmed in that decision apply in the context of a Section 220 demand to inspect books and records. In our November 2017 issue of Insights: The Delaware Edition, we discussed Salberg v. Genworth Financial, Inc., a case in which the Delaware Court of Chancery appeared to suggest, but did not explicitly hold, that the Corwin doctrine would not prevent a stockholder from obtaining books and records pursuant to Section 220 if the stockholder has stated a proper purpose. In Lavin v. West Corporation, the Court of Chancery addressed the question directly and held that it would not consider the Corwin doctrine when evaluating whether a stockholder seeking to obtain corporate documents to investigate possible wrongdoing in connection with a merger has met the proper purpose requirement of Section 220.

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SLB 14I: Impact of Board Discussion on 2018 NALs

Arthur H. Kohn is a partner and Katy Yang is an associate at Cleary Gottlieb Steen & Hamilton LLP. This post is based on a Cleary Gottlieb memorandum by Mr. Kohn and Ms. Yang. Related research from the Program on Corporate Governance includes The Case for Shareholder Access to the Ballot by Lucian Bebchuk (discussed on the Forum here), and Private Ordering and the Proxy Access Debate by Lucian Bebchuk and Scott Hirst (discussed on the Forum here).

When the staff (the “Staff”) of the Division of Corporation Finance of the Securities and Exchange Commission (“SEC”) released Staff Legal Bulletin No. 14I (“SLB 14I”) last fall, it seemed that the Staff was potentially signaling that it would be taking a more issuer-friendly approach in its review of no-action letter requests (“NALs”). In particular, the language in SLB 14I regarding the role of the board of directors suggested that the Staff may defer to the board’s determination of whether a shareholder proposal focuses on a significant policy issue, in the case of the “ordinary business” exception (Rule 14a-8(i)(7)), and whether the shareholder proposal is significantly related to the issuer’s business, in the case of the “economic relevance” exception (Rule 14a-8(i)(5)), as long as the NALs provided a sufficiently detailed discussion of the board’s analysis and the “specific processes employed by the board to ensure that its conclusions are well-informed and well-reasoned.” For example, SLB 14I stated that these types of “determinations often raise difficult judgment calls that the Division believes are in the first instance matters that the board of directors is generally in a better position to determine.” One could read that language to mean that including a well-developed board analysis could significantly influence the outcome for a NAL based on the “ordinary business” exception and/or the “economic relevance” exception.

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Metamorphosis: Digital Assets and the U.S. Securities Laws

Robert Crea is of counsel and Anthony Nolan and Eden Rohrer are partners at K&L Gates LLP. This post is based on a K&L Gates memorandum by Mr. Crea, Mr. Nolan, and Ms. Rohrer.

“When Gregor Samsa woke up one morning from unsettling dreams, he found himself changed in his bed into a monstrous vermin.”
—Franz Kafka, The Metamorphosis

In the past year, the U.S. Securities Exchange Commission (“SEC”) and Chairman Jay Clayton have repeatedly cautioned the cryptocurrency and initial coin offering (“ICO”) industries about the securities law implications for digital assets. On February 6, 2018, in testimony before the Senate Banking Committee, Chairman Clayton notably asserted that “[e]very ICO I’ve seen is ‘a security.’” [1]

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Special Purpose Acquisition Companies: An Introduction

Ramey Layne and Brenda Lenahan are partners at Vinson & Elkins LLP. This post is based on a Vinson and Elkins publication by Mr. Layne, Ms. Lenahan, Terry Bokosha, Mariam Boxwala, and Zach Swartz.

Special Purpose Acquisition Companies (“SPACs”) are companies formed to raise capital in an initial public offering (“IPO”) with the purpose of using the proceeds to acquire one or more unspecified businesses or assets to be identified after the IPO. From the beginning of 2014 through November 30, 2017, almost 80 SPAC IPOs have closed, raising approximately $19 billion in gross proceeds.

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Weekly Roundup: June 29-July 5, 2018


More from:

This roundup contains a collection of the posts published on the Forum during the week of June 29-July 5, 2018.

ESG and Sustainability: The Board’s Role



Passive Mutual Funds and ETFs: Performance and Comparison


The Directors’ E&S Guidebook



Creditor Control Rights and Board Independence


When Political Spending and Core Values Conflict


Appointments Clause & SEC Administrative Judges


Enterprise Liability and the Organization of Production Across Countries



Impact of SEC Guidance on Shareholder Proposals in the 2018 Proxy Season


Stock Option Grants and Fiduciary Duties in Ratification


Passive Investors


Spotify Case Study: Structuring and Executing a Direct Listing

Spotify Case Study: Structuring and Executing a Direct Listing

Marc D. Jaffe and Greg Rodgers are partners at Latham & Watkins LLP and Horacio Gutierrez is General Counsel at Spotify Technology S.A. This post is based on a Latham & Watkins client alert by Mr. Jaffe, Mr. Rodgers, Mr. Gutierrez, Alexander F. Cohen, Benjamin J. Cohen, Paul M. Dudek, and Dana G. Fleischman.

Spotify Technology S.A. went public on April 3, 2018 through a direct listing of its shares on the New York Stock Exchange.

Key Points:

  • A direct listing is an innovative structure that provides companies with an alternative to a traditional IPO in the path to going public.
  • Spotify had a number of important goals that it wanted to achieve along with going public, and a direct listing enabled it to do so.

If Spotify’s direct listing were a song, it would surely be at the top of the Today’s Top Hits [1] playlist for 2018. Since Spotify first announced its intention to become a public company using this groundbreaking and innovative structure, it has generated enormous interest from the financial press and market participants.

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Passive Investors

Jill E. Fisch is Perry Golkin Professor of Law at the University of Pennsylvania Law School; Assaf Hamdani is Professor of Law at Tel Aviv University; and Steven Davidoff Solomon is Professor of Law at UC Berkeley School of Law. This post is based on their recent paper. Related research from the Program on Corporate Governance includes The Agency Problems of Institutional Investors by Lucian Bebchuk, Alma Cohen, and Scott Hirst (discussed on the Forum here)

Passive investors are the new power brokers of modern capital markets. An increasing number of investors are investing through exchange traded funds and indexed mutual funds, and, as a result, passive funds—particularly the so-called big three of Blackrock, Vanguard and State Street—own an increasing percentage of publicly-traded companies. Although the extent to which index funds will continue to grow remains unclear, some estimates predict that by 2024 they will hold over 50% of the market.

In our paper, Passive Investors, we provide the first comprehensive framework of passive investment. We use this framework to explore the role of passive funds in corporate governance and the capital markets and to assess the overall implications of the rise of passive investment.

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