Monthly Archives: February 2019

SEC Scrutiny of Non-GAAP Financial Measures

David A. Katz is partner and Laura A. McIntosh is consulting attorney at Wachtell, Lipton, Rosen & Katz. This post is based on an article first published in the New York Law Journal.

Since 2003, when the SEC first adopted rules regarding the use of non-GAAP financial measures, there has been a constant tension between the utility of these measures and their potential to mislead investors. In recent years, the use of non-GAAP measures in public company filings has significantly increased, as has the discrepancy between these measures and their GAAP equivalents. The SEC has taken note of these trends and, since 2016, has correspondingly escalated its scrutiny of non-GAAP disclosures. In 2018, the SEC indicated that it may further intensify its enforcement in this area for the protection of investors.

Increased Use and Variance of Non-GAAP Measures

Nearly all large public companies now report non-GAAP metrics in their financial statements. In 1996, around 60 percent of S&P 500 companies reported at least one non-GAAP earnings-per-share figure. Today, according to Audit Analytics, over 97 percent of S&P 500 companies use at least one non-GAAP metric in their financial statements. Item 10(e)(1)(i)(A) of Regulation S-K states that an issuer including non-GAAP financial measures in SEC filings must present, with equal or greater prominence, the most directly comparable financial measures calculated and presented in accordance with GAAP.


The Long View: The Role of Shareholder Proposals in Shaping U.S. Corporate Governance (2000-2018)

Kosmas Papadopoulos is Managing Editor at ISS Analytics. This post is based on an ISS Analytics memorandum by Mr. Papadopoulos. Related research from the Program on Corporate Governance includes The Case for Increasing Shareholder Power by Lucian Bebchuk and Private Ordering and the Proxy Access Debate by Lucian Bebchuk and Scott Hirst (discussed on the Forum here).

Over the past three decades, shareholder proposals have transformed the corporate landscape in the U.S. by spurring the adoption of governance best practices. Annual director elections, majority vote rules for director elections, shareholder approval for poison pills, and proxy access bylaws are some of the critical governance practices that have become common practice thanks to investor support for shareholder proposal campaigns led by a wide variety of investors—some large; others small. Despite the advisory (non-binding) nature of most shareholder proposals in the U.S., successive waves of campaigns eroded boardroom entrenchment by convincing directors to respond to shareholders’ calls for accountability, transparency and stewardship.

In this second installment of our examination of long-term trends in proxy voting, we examine the impact of shareholder proposals on corporate governance practices since the turn of the century, and we forecast the potential paths forward for corporate governance changes in the future. As many of the key corporate governance practices listed above have been adopted by close to 90 percent (or more) of large market capitalization firms, proponents are turning their attention to governance topics, such as independent board chairs and written consent rights, that boards have been slower to address. Notably, voting results demonstrate that members of the investment community often have varying views on these topics, as evidenced by the declining number and percentage of governance shareholder proposals receiving majority support in recent proxy seasons.


S&P 500 CEO Compensation Increase Trends

Aubrey E. Bout is Managing Partner and Perla Cruz and Brian Wilby are Consultants at Pay Governance LLC. This post is based on their Pay Governance memorandum. Related research from the Program on Corporate Governance includes The CEO Pay Slice by Lucian Bebchuk, Martijn Cremers and Urs Peyer (discussed on the Forum here) and Paying for Long-Term Performance by Lucian Bebchuk and Jesse Fried (discussed on the Forum here).

CEO pay continues to be an extensively discussed topic in the media, in the boardroom, and among investors and proxy advisors. CEO total direct compensation (TDC; base salary + actual bonus paid + grant value of long-term incentives [LTI]) has increased at a moderate pace in recent years—in the 2-6% range for 2011-2016. However, CEO pay accelerated in 2017 at an 11% increase, likely reflecting sustained robust financial and total shareholder return (TSR) performance. Our CEO pay analysis is focused on historical actual TDC, which reflects actual bonuses; this is different from target TDC or target pay opportunity, which uses target bonus and is typically set at the beginning of the year.

As proxies come out in early 2019, we expect 2018 CEO TDC increases may be in the upper single or low double digits based on past pay trends as a result of strong earnings growth and a tight executive labor market. These likely large increases will be further supported by +22% S&P 500 TSR in 2017.


The Wells Fargo Cross-Selling Scandal

Brian Tayan is a Researcher with the Corporate Governance Research Initiative at Stanford Graduate School of Business. This post is based on a recent paper by Mr. Tayan.

Recently, attention has been paid to corporate culture, “tone at the top,” and the impact that these have on organizational outcomes. While corporate leaders and outside observers contend that culture is a critical contributor to employee engagement, motivation, and performance, the nature of this relationship and the mechanisms for instilling the desired values in employee conduct is not well understood.

For example, a survey by Deloitte finds that 94 percent of executives believe that workplace culture is important to business success, and 62 percent believe that “clearly defined and communicated core values and beliefs” are important. Graham, Harvey, Popadak, and Rajgopal (2016) find evidence that governance practices and financial incentives can reinforce culture; however, they also find that incentives can work in opposition to culture, particularly when they “reward employees for achieving a metric without regard to the actions they took to achieve that metric.” According to a participant in their study, “People invariably will do what you pay them to do even when you’re saying something different.”

The tensions between corporate culture, financial incentives, and employee conduct is illustrated by the Wells Fargo cross-selling scandal.


In Corporations We Trust: Ongoing Deregulation and Government Protections

Mark Lebovitch is partner and Jacob Spaid is an associate at Bernstein Litowitz Berger & Grossmann LLP. This post is based on their BLB&G memorandum.

Several administration priorities are endangering financial markets by reducing corporate accountability and transparency.

Nearly two years into the Trump presidency, extensive deregulation is raising risks for investors. Several of the administration’s priorities are endangering financial markets by reducing corporate accountability and transparency. SEC enforcement actions under the Administration continue to lag previous years. The Trump administration has also instructed the SEC to study reducing companies’ reporting obligations to investors, including by abandoning a hallmark of corporate disclosure: the quarterly earnings report. Meanwhile, President Trump and Congress have passed new legislation loosening regulations on the same banks that played a central role in the Great Recession. It is important for institutional investors to stay abreast of these emerging developments as they contemplate the risk of their investments amid stark changes in the regulatory landscape.


Missing Pieces Report: The 2018 Board Diversity Census of Women and Minorities on Fortune 500 Boards

Deb DeHaas is vice chairman and national managing partner at Deloitte Center for Board Effectiveness at Deloitte LLP; Linda Akutagawa is chair for the Alliance for Board Diversity and president and CEO at LEAP (Leadership Education for Asian Pacifics) at Deloitte LLP; and Skip Spriggs is president and CEO of The Executive Leadership Council at Deloitte LLP. This post is based on a Deloitte memorandum by Ms. DeHass, Ms. Akutagawa, Mr. Spriggs, Lorraine Hariton, Dale E. Jones, and Cid Wilson.

Key Findings

A critical need for inclusive leadership, the shifting US demographics, and investor pressure in the United States have increased the focus on diversity in the c-suite and on public company boards.

As demographics and buying power [1] in the United States become increasingly more diverse, forward-thinking boards are determining ways to gain more diversity of background, experience, and thought in the boardroom.

Since 2004, the Alliance for Board Diversity (“ABD” or “we”) has been striving to increase the representation of women and minorities on corporate boards. Over the past 14 years, ABD has celebrated the movement forward on diverse board representation, but the fact remains that progress has been painfully slow.

This study is the culmination of a multiyear effort organized by the Alliance for Board Diversity, collaborating with Deloitte for the 2016 and 2018 censuses, which has examined and chronicled the representation of women and minorities on public company boards of directors across America’s largest companies. Originally organized as a “snapshot” of board diversity, the data since accumulated over time has allowed for the development of information on trends relative to overall diversity as well as the comparative differences in rates of representation among minorities and women over a period of more than a decade. This 2018 Missing Pieces Report highlights the progress to date that has been made (or not) for women and minorities on corporate boards. While there have been a few gains for some demographic groups, advancement is still slow. This movement is also not representative of the broad demographic transformations that have been seen in the United States over the same period of time.


Executive Compensation, Corporate Governance, and Say on Pay

Fabrizio Ferri is Associate Professor of Accounting at University of Miami Business School; and Robert F. Göx is Professor and Chair of Managerial Accounting at the University of Zurich. This post is based on their monograph, recently published in Foundations and Trends in Accounting. Related research from the Program on Corporate Governance includes The CEO Pay Slice by Lucian Bebchuk, Martijn Cremers and Urs Peyer (discussed on the Forum here) and Paying for Long-Term Performance by Lucian Bebchuk and Jesse Fried (discussed on the Forum here).

In our monograph Executive Compensation, Corporate Governance, and Say on Pay, we provide a comprehensive summary and survey of the theoretical and empirical literature on Say on Pay. In the first part of the monograph, we study theoretically how a poor governance structure affects the level and structure of executive pay and identify conditions under which Say and Pay could help shareholders to improve it. In the second part of this monograph, we explain the origins and the cross-country differences in Say on Pay regulation and provide a detailed summary and evaluation of the empirical evidence on the subject.

The core issue among the proponents of the shareholder value view and the managerial power approach is the question of whether executive pay in public firms represents arm’s-length bargaining between managers and shareholders or rent seeking by powerful CEOs. Yet, formal models of executive pay are typically based on the shareholder value view and only a few of them explicitly study the consequences of the firm’s governance structure on its compensation decisions. In Chapter 2, we propose a conceptual framework that allows us to formalize the consequences of a poor governance structure on the board’s compensation decisions and to compare the properties of the contract proposed by a weak board to the optimal contract designed in the best interest of shareholders. This framework serves as a benchmark for studying the economic consequences of Say on Pay in Chapter 3.


Internal Forecasts and M&A

Paul M. Tiger is partner at Cleary Gottlieb Steen & Hamilton LLP. This post is based on a Cleary Gottlieb memorandum by Mr. Tiger. Related research from the Program on Corporate Governance includes M&A Contracts: Purposes, Types, Regulation, and Patterns of Practice and Why Have M&A Contracts Grown? Evidence from Twenty Years of Deals, both by John C. Coates, IV.

Uncertainties about the near and long-term future of companies at which boards are considering strategic alternatives will result in significant impediments to the ability of management teams to produce internal forecasts upon which boards may rely in good faith to support their duty of care when choosing a strategic alternative.

Often a company considering selling itself or pursuing another strategic alternative does not have an “off-the-shelf” set of long-term projections that has been vetted by management and the board in a meaningful way to support the decision to enter into a change-in-control transaction. In addition, a board does not always decide to initiate a sales process with the benefit of advance planning. In today’s era of investor activism, a company will often find itself considering a sales process on short notice—triggered by a quarter or two of weak earnings, the emergence of an activist in the stock and/or significant changes in management. In the same way, consideration of non-control transactions, such as a PIPE transaction, can often morph into a sales process.


The Risky Business of Investing in Chinese Tech Firms

Jesse Fried is Dane Professor of Law at Harvard Law School and Matthew Schoenfeld is a Portfolio Manager at Burford Capital. This post was authored by Professor Fried and Mr. Schoenfeld.

While Washington and Beijing battle over trade, a worrisome cross-border financial link has largely escaped scrutiny: Americans now collectively own most of the public equity of China’ biggest tech companies, including Alibaba, Baidu and Weibo. This relationship is strange (imagine if the Chinese owned most of Amazon, Facebook and Google). It’s also extremely risky, at least for American investors.

China’s tech darlings began tapping U.S. investors in the early 2000s, when mainland capital markets were unsophisticated and the strict profitability requirements of PRC exchanges shut out most fast-growing tech firms. To list in Shanghai, for example, a firm had to show three years of profitability. Nor was Hong Kong a viable option, as until recently it banned the use of dual-class structures favored by tech entrepreneurs. So off to New York went Baidu,, Alibaba, and dozens of other Chinese unicorns and near-unicorns thirsty for growth capital. There, they found Americans eager for exposure to China and its explosive growth. With few alternative China pure plays, investors jumped at the opportunity to invest in these Chinese tech firms’ IPOs.


Employee-Manager Alliances and Shareholder Returns from Acquisitions

Ronald Masulis is Scientia Professor of Finance at University of New South Wales Australian School of Business; Cong Wang is Professor of Finance at The Chinese University of Hong Kong, Shenzhen and the associate director of Shenzhen Finance Institute; and Fei Xie is Associate Professor of Finance at the Alfred Lerner College of Business & Economics at University of Delaware. This post is based on their recent article, forthcoming in the Journal of Financial and Quantitative Analysis.

In our recent article titled Employee-Manager Alliances and Shareholder Returns from Acquisitions, forthcoming in the Journal of Financial and Quantitative Analysis, we examine the potential for management-worker alliances when employees hold substantial voting rights due to their equity ownership, and how such alliances affect the agency relationship between managers and shareholders in the context of corporate acquisition decisions.

Employee equity ownership can provide workers with substantial cash flow and voting rights. The cash flow rights give workers residual claims to firm profits, partially aligning their interests with shareholders. Employee voting rights, on the other hand, can be a key factor in determining the likelihood of a firm becoming a takeover target as well as the outcome of such control contests (Gordon and Pound (1990), Chaplinsky and Niehaus (1994), and Rauh (2006)). Together, employee ownership of cash flow rights and voting rights makes them an important force that can affect corporate governance and firm policies.


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