Monthly Archives: September 2018

Across the Board Improvements: Gender Diversity and ESG Performance

Cristina Banahan is an Associate and Gabriel Hasson is a Senior Associate at ISS Corporate Solutions. This post is based on an ISS Corporate Solutions memorandum by Ms. Banahan and Mr. Hasson.

Proponents of more women on corporate boards have brought forth multiple arguments that have become widely acceptable in the field of corporate governance and more broadly. First, there is the normative argument based on equity and fairness, which suggests that women and men should have an equal opportunity to attain leadership positions, including corporate board memberships. Second, expanding the perceived pool of director candidates to an under-tapped population of highly qualified women leaders opens a new source of managerial talent, who are also more representative of the general workforce and society. Third, women directors are likely to bring fresh and diverse perspectives to complex issues. Finally, the economic argument for gender diversity, backed by a growing literature [1], suggests that board gender diversity can serve as a driver for better performance and increased financial returns.

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Risk Management and the Board of Directors

Martin Lipton is a founding partner of Wachtell, Lipton, Rosen & Katz, specializing in mergers and acquisitions and matters affecting corporate policy and strategy. This post is based on a Wachtell Lipton memorandum.

I. Introduction

Overview

Political, legal and economic arenas in the U.S. and around the world have continued to evolve in response to rapidly advancing technologies. Innovation, new business models and dealmaking are transforming competitive and industry landscapes and impacting companies’ strategic plans and prospects for sustainable, long-term value creation. Tax reform has created new opportunities and challenges for companies as well. Meanwhile, the severe consequences that can flow from misconduct within an organization continue to serve as a reminder that corporate operations are fraught with risk. Social and environmental issues, including the focus on income inequality and economic disparities, scrutiny of sexual misconduct issues and evolving views on climate change and natural disasters, have become increasingly salient in the public sphere, requiring companies to exercise utmost care to address legitimate issues and avoid public relations crises and liability.

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Insider Tax Effects on Acquisition Structure and Value

Michelle Hanlon is the Howard W. Johnson Professor and a Professor of Accounting at MIT Sloan School of Management; Rodrigo Verdi is the Nanyang Technological University Professor of Accounting at MIT Sloan School of Management; and Benjamin Yost is an assistant professor of accounting at Boston College Carroll School of Management. This post is based on their recent paper.

Whether firms care about shareholder-level taxes is a longstanding question in the academic literature. In the context of acquisitions, target shareholders potentially face capital gains tax liabilities upon the sale of their shares, leading early researchers to predict that investor-level taxes should influence the acquisition price as well as the deal structure (i.e., cash versus stock payment). Despite the clear theoretical predictions, it was not until fairly recently that studies found supporting empirical evidence. In particular, the findings in two papers by Ayers, Lefanowicz, and Robinson (2003, 2004) indicate that higher capital gains tax rates on individual shareholders are associated with higher acquisition premiums as well as a higher likelihood of tax-deferred deals. Although these findings represent important advancements in our understanding, it is plausible that the results would obtain even if managers do not really consider outsider shareholders’ taxes but rather consider primarily their own taxes. Motivated by recent literature examining the effects of individual executives on firm performance and activity, we expect insiders to care about shareholder-level taxes primarily when they bear those taxes themselves. In addition, we posit that tax-bearing insider shareholders are in a better position to take individual tax liabilities into account when negotiating a deal. Thus we extend upon and contribute to the earlier research by considering the impact of insiders’ tax liabilities on acquisition outcomes.

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What Does the CEO Pay Ratio Data Say About Pay?

Ben Burney is Senior Advisor at Exequity, LLP. This post is based on an Exequity memorandum by Mr. Burney. Related research from the Program on Corporate Governance includes Paying for Long-Term Performance by Lucian Bebchuk and Jesse Fried (discussed on the Forum here).

Our analysis finds company size as measured by employee count is the primary driver of the CEO Pay Ratio; company revenue and market capitalization are secondary drivers. Deeper analysis uncovers industry trends that may provide companies additional context as they compare their CEO Pay Ratios to those of their peers. Ultimately, despite some interesting trends uncovered, analysis of the CEO Pay Ratio data provides little actionable intelligence for companies and questionable, if any, value for investors. More concerning, we find potential avenues for critics of executive pay to manipulate the data to serve their interests or constituencies. The purpose of this post is to provide guidance on what the data says—and what it doesn’t.

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Shareholder Collaboration

Jill E. Fisch is Perry Golkin Professor of Law at the University of Pennsylvania Law School and Simone M. Sepe is Professor of Law and Finance at the College of Law at the University of Arizona. This post is based on a recent paper by Professor Fisch and Professor Sepe.

Legal and economics scholars have developed and debated theories of the firm since the groundbreaking work of Ronald Coase in 1937. Two models have come to dominate that discourse. Under the management-power model, the firm is a hierarchical organization, and decision-making power authority belongs to corporate insiders (officers and directors). The competing shareholder-power model de-emphasizes authority in favor of accountability and contemplates increasing shareholder decision-making power to hold insiders accountable. Both models share two key assumptions. First, they view managerial moral hazard as the central problem of corporate law. Second, they assume that insiders and shareholders are engaged in a competitive struggle for corporate power.

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The MFW Framework and Extensive Preliminary Discussions

Gail Weinstein is senior counsel, and Andrew J. Colosimo and Warren S. de Wied are partners at Fried, Frank, Harris, Shriver & Jacobson LLP. This post is based on a Fried Frank memorandum by Ms. Weinstein, Mr. Colosimo, Mr. de Wied, Randi LallyMark H. Lucas, and Maxwell Yim. This post 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).

MFW provides for judicial review of a merger between a controller and the controlled company under the deferential business judgment rule standard (rather than “entire fairness”) if, among other things, “from the outset of negotiations” (the so-called “ab initio requirement”), the controller conditioned the transaction on approval by both an independent special committee and a majority of the minority stockholders. Olenik v. Lodzinski (July 20, 2018) is notable for providing a substantial discussion of the difference between “negotiations” and “preliminary discussions” for purposes of determining whether this requirement has been met. The factual context involved an all-stock merger between two companies (one of them, a financially troubled company) that had a common purported controller; a lead negotiator for the acquiring company who was the CEO and had a financial interest in the controller; and an equity split that provided the acquiring company with a smaller equity interest in the resulting entity than was supported by the contribution analysis prepared by the special committee’s banker.

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Climate-Related Disclosures and TCFD Recommendations

Cynthia Williams is the Osler Chair in Business Law at the Osgoode Hall Law School at York University; and Ellie Mulholland is Director of the Commonwealth Climate and Law Initiative (CCLI). This post is based on a CCLI memorandum. 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).

Companies, investors and regulators are increasingly recognising that climate change is not just a social or environmental problem. It is a business problem too. The physical impacts of climate change and the economic impacts of the transition to a zero-carbon economy present foreseeable, and often material, financial risks to the performance and prospects of companies. These non-diversifiable risks affect nearly all industries and sectors within mainstream investment horizons. [1] So much so, that in 2015 Bank of England Governor and head of the G20 Financial Stability Board Mark Carney declared that climate-related financial risk threatens the very stability of the global financial system. [2]

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Board Refreshment: Finding the Right Balance

Kosmas Papadopoulos is Managing Editor at ISS Analytics. This post is based on an ISS Analytics memorandum by Mr. Papadopoulos.

For the better part of this decade, governance practitioners and investors have paid significant attention to the issue of board refreshment. Their primary concern is that a stale board—one that has not added new members for many years—may become complacent, whereby a lack of independence, new perspectives, and diversity could pose significant risks in relation to long-term performance and effective oversight of management.

The argument that board renewal practices help companies better manage risk and performance is validated by the data. In this article, we find that companies with a balanced board composition relative to director tenure tend to show better financial results and have a lower risk profile compared to their peers. At the same time, companies whose directors’ tenure is heavily concentrated (whether mostly short-tenured or mostly long-tenured) exhibit poorer performance and have a higher risk profile. Therefore, as an extension beyond practicing basic board refreshment, companies may gain significant benefits by maintaining a balance of experience and new capacity on the board.

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