Monthly Archives: September 2018

Employee Voice

Benjamin Colton is the Head of Asia-Pacific, Asset Stewardship at State Street Global Advisors. This post is based on his recent paper as a graduate student at the London School of Economics and Political Science.

Levels of engagement between public corporations and certain stakeholders have increased in recent decades. Shareholders more frequently address environmental, social, and governance matters and customers express their viewpoints at lower costs and with higher amplitude than ever before. Although companies are more regularly considering the perspectives of key external stakeholders, it is important that they also listen to the voice of their own employees.

Employees and the human capital they provide are central to the sustained success of a company. Whether they work in business lines, interact with end customers, or develop products, employees possess insights about their company that can be difficult for management to ascertain. The perspectives of employees can provide leadership with information valuable for improved decision-making and organizational efficiency. When silenced, employees may become unsatisfied and leadership may not receive critical information, thereby increasing the organization’s exposure to high impact risks.

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IRS Guidance on Section 162(m) Tax Reform

Jean M. McLoughlin is partner and Ron M. Aizen is counsel at Davis Polk & Wardwell LLP. This post is based on a Davis Polk memorandum by Ms. McLoughlin and Mr. Aizen.

On August 21, 2018, the IRS issued Notice 2018-68, which provides initial guidance on two aspects of the amendments to Section 162(m) of the Internal Revenue Code made by the Tax Cuts and Jobs Act (TCJA):

  • how to identify the expanded group of employees who are covered by new Section 162(m); and
  • how a plan or agreement can qualify as grandfathered from new Section 162(m).

This post summarizes this guidance, as well as the additional aspects of new Section 162(m) on which the IRS is seeking comment.

Key takeaways from the notice include the following:

  • Umbrella plans or agreements that provide for negative discretion to reduce compensation do not qualify as grandfathered from new Section 162(m); and
  • A grandfathered employment agreement that provides for auto-renewal at the end of the term, unless either party elects not to renew, loses its grandfathered status for amounts earned after the renewal date.

The notice applies to any taxable year ending on or after September 10, 2018.

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Freeze-Out Mergers

Elif Dalkir is Associate Professor of Economics at the University of New Brunswick; Mehmet Dalkir is Associate Professor of Economics at the University of New Brunswick; and Doron Levit is Assistant Professor of Finance at The Wharton School of the University of Pennsylvania. This post is based on their recent article, forthcoming in the Review of Financial Studies.

Do freeze-out mergers mitigate the free-rider problem of corporate takeovers? We revisit this fundamental question in our article Freeze-Out Mergers, which is forthcoming in the Review of Financial Studies.

The ability of the market for corporate control to efficiently allocate resources is much debated. A seminal paper by Grossman and Hart (1980) argued that there is a free-rider problem that prevents acquirers from successfully taking over companies that are widely held. The crucial assumption in this argument is that target shareholders do not view themselves as pivotal in the success of the takeover. Therefore, each shareholder refuses to tender his share whenever he expects the post-takeover value to be higher than what is being offered. If all shareholders behave that way, then a value-increasing acquirer cannot convince shareholders to tender their shares and at the same time make a profit on the purchased shares. Without any private benefits of control, free-riding precludes efficient takeovers, leading to an inefficient market for corporate control.

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My Beef with Stakeholders: Remarks at the 17th Annual SEC Conference, Center for Corporate Reporting and Governance

Hester M. Peirce is a Commissioner at the U.S. Securities and Exchange Commission. This post is based on her recent remarks at the 17th Annual SEC Conference, Center for Corporate Reporting and Governance, available here. The views expressed in this post are those of Ms. Peirce and do not necessarily reflect those of the Securities and Exchange Commission or its staff.

Good morning and thank you, Fram, for the kind introduction. Before I begin my remarks, I have to give my standard disclaimer, which is that my remarks reflect only my own views and not those of the Commission or my fellow Commissioners.

I greatly appreciate the opportunity to be part of this conference. Last time I flew to California, the skies were so clear that I was able to keep an eye on the changing landscape below all the way across the country. The vastness and great variety was striking. Having grown up in Ohio, I can attest to the fact that the magnificence of the landscape is just one of the features that makes so-called flyover country remarkably beautiful. The wealth of talent and ingenuity in the people of the heartland is where the real beauty lies.

Indeed, one of the issues on which I am committed to working with Chairman Clayton and my fellow commissioners is ways to unlock the deep potential of the middle of the country by ensuring that our securities laws do not inadvertently prevent people from investing in their own communities. Accredited investor rules, for example, have a different effect in Ohio, where incomes pale in comparison to lofty coastal paychecks. We also can work with states to ensure that the SEC does not stand in the way of state efforts to create innovation-friendly regulatory regimes. As the Chairman said when he spoke in Nashville several weeks ago, “There are obviously a lot of miles, many good, talented people, and many promising companies between the coasts,” and I agree with the Chairman that we should “make sure our regulation of capital formation enables capital to flow to the areas in between.” [1]

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California Law Awaiting Governor’s Signature Exceeds State’s Jurisdiction

Theodore N. Mirvis and Kevin S. Schwartz are partners at Wachtell, Lipton, Rosen & Katz. This post is based on a Wachtell Lipton firm memorandum by Mr. Mirvis and Mr. Schwartz.

We previously reported that California made headlines this summer with legislative action that would institute gender quotas for boards of directors of public companies headquartered in the state. This first-of-its-kind measure has now been approved by both legislative chambers and may be signed by the Governor in the coming week. California’s commitment to increasing diversity in the boardroom is laudable, but this proposed law would unconstitutionally sweep within its scope all publicly traded corporations with headquarters in California, even if those corporations are chartered outside of California. This constitutional infirmity warrants immediate reconsideration.

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Audit Committee Disclosures

Steve W. Klemash is Americas Leader, Kellie C. Huennekens is Associate Director, and Jennifer Lee is Senior Manager, all at the EY Center for Board Matters. This post is based on their EY memorandum.

The EY Center for Board Matters has reviewed voluntary proxy statement disclosures by Fortune 100 companies relating to audit committees and the audit since 2012. We examine and track these disclosures because of their value in informing investors about the important role that audit committees play in investor protection through their independent oversight of the external audit. This oversight, in turn, enhances investor confidence in financial reporting. Proxy disclosures in 2018 continue to show a year-over-year trend of increasing voluntary audit-related disclosures.

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From Duty to Power

Brett McDonnell is the Dorsey & Whitney Chair and Professor of Law University of Minnesota Law School. This post is based on a recent article by Professor McDonnell, forthcoming in the Alabama Law Review. Related research from the Program on Corporate Governance includes Socially Responsible Firms by Alan Ferrell, Hao Liang, and Luc Renneboog (discussed on the Forum here) and Social Responsibility Resolutions by Scott Hirst (discussed on the Forum here).

A growing number of businesses aspire to be social enterprises, adopting a dual mission of generating profits for investors while also pursuing a greater good. Entrepreneurs and investors, especially younger millennials, want to make a decent living but in an organization they think makes the world a better place. New statutes, especially those creating an entity called the benefit corporation, attempt to help social enterprises credibly commit to this dual mission using the governance tools of fiduciary duty and disclosure. There is much doubt, though, whether those tools are strong enough. In a new article I argue that voting power for stakeholders is a stronger tool that more social enterprises should use. In this my argument resembles Senator Elizabeth Warren’s proposed new Accountable Capitalism Act, but with a crucial difference.

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Machine Learning and Artificial Intelligence in Financial Services

Pamela L. Marcogliese and Colin D. Lloyd are partners and Sandra M. Rocks is counsel at Cleary Gottlieb Steen & Hamilton LLP. This post is based on a Cleary memorandum by Ms. Marcogliese, Mr. Lloyd, Ms. Rocks, and Lauren Gilbert.

Artificial intelligence and machine learning (for simplicity, we refer to these concepts together as “AI”) [1] have been hot topics in the financial services industry in recent years as the industry wrestles with how to harness technological innovations. In its report on Nonbank Financials, Fintech, and Innovation released on July 31st, the Treasury Department (“Treasury”) generally embraced AI and recommended facilitating the further development and incorporation of such technologies into the financial services industry to realize the potential the technologies can provide for financial services and the broader economy.

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Unicorn Stock Options—Golden Goose or Trojan Horse?

Anat Alon-Beck is the 2017-2019 Jacobson Fellow in Law and Business at New York University School of Law. This post is based on a recent paper by Dr. Alon-Beck.

Eight years ago, the idea that a venture capital (VC) backed startup could reach an aggressive valuation of over $1 billion without going public was inconceivable. But today the Wall Street Journal, Fortune Magazine, CNNMoney and CB Insights, each keeps a list of such companies and their valuations, and the list keeps growing. With the decline in the U.S. market for initial public offerings (“IPOs”), which is caused in part by the availability of new private capital sources, there is a rise in the number of privately held firms that are valued at $1 billion or more (“unicorns”).

The U.S. has the largest concentration of unicorns in the world. Whereas, in the recent past, startups tended to go public or be sold approximately four years after founding, today the average time to IPO or sale is eleven years. In a recent paper, Unicorn Stock Options—Golden Goose or Trojan Horse?, I argue that by staying private and not pursuing an IPO or sales transaction, the unicorns are delaying liquidity events for their shareholders, including employees. In the new economy, knowledgeable employees contribute to the firm’s intangible assets.

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Fake News: Evidence from Financial Markets

Shimon Kogan is Associate Professor of Finance at IDC Herzliya; Tobias J. Moskowitz is the Dean Takahashi ’80 B.A., ’83 M.P.P.M. Professor of Finance at the Yale School of Management; and Marina Niessner is Vice President at AQR Capital Management. This post is based on their recent paper.

An increasing number of professional and retail investors obtain information about financial markets from knowledge sharing platforms. For example, a 2015 study by Greenwich Associates found that 48% of institutional investors use social media to “read timely news.” While crowd-sourced outlets can lower the cost of information acquisition and speed its dissemination, they also provide a venue for interested parties to spread fake information in an attempt to manipulate the markets. In this paper, we employ a methodology developed by linguistic psychologists to identify a large set of fake articles on financial knowledge sharing platforms. We document their prevalence on these platforms, and examine the effect of fake news on volume, volatility, and prices. We further document a broader spill-over effect of fake articles on all news posted on knowledge sharing platforms. Using a clean natural experiment, we show that after investors are made aware of the presence of fake news on knowledge sharing platforms, the effect that fake and non-fake articles have on the trading volume and volatility goes down substantially.

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