Monthly Archives: April 2019

Gender Diversity in Silicon Valley

David A. Bell and Dawn Belt are partners at Fenwick & West LLP. This post is based on a Fenwick memorandum.

Fenwick & West has released its updated study about gender diversity on boards and executive management teams of companies in the technology and life science companies included in the Silicon Valley 150 Index and very large public companies included in the Standard & Poor’s 100 Index. [1] The Fenwick Gender Diversity Survey uses 23 years of data to provide a better picture of women’s participation at the most senior levels of public companies in Silicon Valley.

The complete publication (available here) reviews public filings from 1996 through 2018 to analyze the gender makeup of boards, board leadership, board committees and executive management teams in the two groups, with special comparisons showing how the Top 15 largest companies in the SV 150 fare, as they are the peers of the large public companies included in the S&P 100.

Executive Summary

Gender diversity in corporate leadership—and diversity in the business world more broadly—continues to drive vigorous discussion across the country, with Silicon Valley and the tech industry often at the center of heightened scrutiny.

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Short-Term Investors, Long-Term Investments, and Firm Value: Evidence from Russell 2000 Index Inclusions

Martijn Cremers is Bernard J. Hank Professor of Finance at University of Notre Dame Mendoza College of Business; Ankur Pareek is Assistant Professor of Finance at University of Nevada, Las Vegas; and Zacharias Sautner is Professor of Finance at Frankfurt School of Finance & Management. This post is based on their recent article, forthcoming in Management Science.

Related research from the Program on Corporate Governance includes The Myth that Insulating Boards Serves Long-Term Value by Lucian Bebchuk (discussed on the Forum here); The Long-Term Effects of Hedge Fund Activism by Lucian Bebchuk, Alon Brav, and Wei Jiang (discussed on the Forum here); The Uneasy Case for Favoring Long-Term Shareholders by Jesse Fried (discussed on the Forum here); and Can We Do Better by Ordinary Investors? A Pragmatic Reaction to the Dueling Ideological Mythologists of Corporate Law by Leo E. Strine (discussed on the Forum here).

Survey evidence documents that many executives are willing to take short-term actions that are detrimental to long-term firm value, such as cutting long-term investment, in response to short-term pressures by investors. (See Graham, John R., Campbell R. Harvey, and Shiva Rajgopal, 2005, The economic implications of corporate financial reporting, Journal of Accounting and Economics 40, 3-73.) In our article Short-Term Investors, Long-Term Investments, and Firm Value: Evidence from Russell 2000 Index Inclusions, forthcoming in Management Science, we empirically show that an increase in equity ownership by short-horizon investors is associated with cuts to the corporation’s long-term investments and increased short-term earnings. These higher earnings lead to temporary boosts in equity valuations, but we find that these reverse over time.

Our tests are motivated by the theory in Bolton, Scheinkman, and Xiong (2006), which predicts that short-horizon investors pressure CEOs to cut investment to increase earnings, which subsequently leads to temporary boosts in stock prices. (Bolton, Patrick, José Scheinkman, and Wei Xiong, 2006, Executive compensation and short-term behavior in speculative markets, Review of Economic Studies 73, 557-610.) The model argues that CEOs, incentivized by short-horizon investors through short-term pay, take actions that increase the short-term speculative component in stock prices, at the expense of long-term firm value. Bolton, Scheinkman, and Xiong (2006) use the case of R&D cuts that boost short-term earnings as a specific example of actions that temporarily inflate stock prices. Short-term investors benefit from this by selling stocks to other investors with more optimistic beliefs. Stock prices are then driven up to the valuations of the most optimistic investors, as short-sale constraints limit rational investors from eliminating any overvaluations. CEOs also benefits from temporary overvaluations as their short-term compensation is tied to short-term stock prices. Equity overvaluations reverse only gradually as it takes time for investors to understand that the higher earnings were due to R&D cuts that are detrimental to long-term firm value.

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Recent Trends in Off-Shore Targeted US Class Actions

David H. Kistenbroker, Joni S. Jacobsen, and Angela M. Liu are partners at Dechert LLP. This post is based on their Dechert memorandum.

Despite being headquartered abroad—and in some cases having a minimal connection with the United States—companies based outside the U.S. have still become targets in securities class actions filed in the U.S., even when the crux of the allegations occurs outside the country.

Although 2018 saw a slight decrease in securities class action litigation on the whole, non-U.S. issuers—those companies with headquarters located outside of the U.S.—were popular targets of such suits.

Non-U.S. issuers should therefore take heed of last year’s decisions and securities class action filings to ensure they are aware of recent trends and to take steps to reduce and mitigate risks associated with such suits.

In 2018, plaintiffs filed a total of 54 class action securities lawsuits against non-U.S. issuers.

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Realizable Pay: Insights into Performance Alignment

Kosmas Papadopoulos is Managing Editor and Executive Director with ISS Analytics, the data intelligence arm of Institutional Shareholder Services, Inc., and John Roe is Head of ISS Analytics. This post is based on an ISS Analytics memorandum by Mr. Papadopoulos and Mr. Roe. Related research from the Program on Corporate Governance includes Paying for Long-Term Performance (discussed on the Forum here) and the book Pay without Performance: The Unfulfilled Promise of Executive Compensation, both by Lucian Bebchuk and Jesse Fried.

How much compensation does a CEO really end up with? It’s a tough question to answer—the summary compensation table is often cited as what the CEO is paid, but the ultimate value that an executive realized from those grants can differ significantly from the amounts disclosed.

For years, companies have recognized this potential discrepancy; since even before the advent of say-on-pay, companies in perilous performance positions have turned to alternative measures of pay to demonstrate that executives have shared in the pain that investors feel in their portfolio values. These alternatives have included various forms of realizable and realized pay. An early example includes the disclosure below made at least six years ago, which still reflects the types of disclosures we see today:

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Complex Compliance Investigations

Veronica Root Martinez is Associate Professor of Law at the University of Notre Dame Law School. This post is based on her recent article, forthcoming in the Columbia Law Review.

There are a variety of accepted understandings—both within industry and academic scholarship—about what is necessary for the creation of an effective compliance program. However, when one considers the many significant compliance failures—think Wells Fargo’s fraudulently opened accounts or General Motors’s faulty ignition switch—that continue to occur despite the adoption of increasingly sophisticated internal compliance programs, it suggests that it may be time to affirmatively question certain understandings and assumptions that serve as the foundation of modern-day compliance programs. This Article contributes to that effort.

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Economic Value Added: What Companies Should Know

Jim Kroll, Marc Roloson, and Jamie Teo are directors at Willis Towers Watson. This post is based on their Willis Towers Watson memorandum.

Institutional Shareholder Services (ISS) is adding Economic Value Added (EVA) metrics in its proxy research reports this year, which is causing many companies to wonder: What is EVA? Why is ISS interested in EVA, and how will it be used? And what should boards and management do about it?

What is EVA?

Simply put, EVA is a financial measure of a company’s residual profit after accounting for the cost of capital. If a company’s net operating profit exceeds its cost of capital, it is creating value. If not, it is destroying value.

EVA = net operating profit after tax – capital charge
        = [operating income X (1 – tax rate)] – (weighted average cost of capital X capital)

Proponents of EVA often claim it is highly aligned with shareholder value creation, and it holds managers accountable for generating healthy returns on an organization’s capital. It is also considered harder to game since managers cannot take on additional capital to drive returns because cost of capital is removed from profit. Despite these benefits, critics are quick to point to the measure’s lack of clarity and its “black-box” perception as reasons not to adopt the metric.

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Engaging With Your Investors

David Shammai is Corporate Governance Director—Cross Border and Kiran Vasantham is Director of Investor Engagement at Morrow Sodali. This post is based on their Morrow Sodali memorandum.

In addition to traditional Investor Relations roadshows focused on financial performance, companies and boards are now expected to conduct governance and sustainability roadshows that reach out to institutional stewardship teams as well as portfolio managers.

For issuers, these engagements require the commitment of significant resources internally, including valuable board time. For investors, the expansion of stewardship activities means that even for those who increased the internal resources (see our earlier piece on Stewardship Principles), the escalating demand on capacity is forcing them to be more selective and raise expectations on the content and quality of engagements.

Based on Morrow Sodali’s experience assisting companies with planning and organization of governance and ESG roadshows, we note factors that are key to successful engagements.

Clear objective

Starting with coherent strategic thinking internally, the company should define and communicate the objective of the engagement. It could be to showcase a new strategic direction, or developments in the business that are related to material ESG themes, or it could be part of an ongoing dialogue with investors about relevant issues. Historically, most roadshows were scheduled in anticipation of a forthcoming shareholders meeting, but we find that many shareholders are growing reluctant to take meetings—given that their voting policies are published in detail—purely on this basis, especially during the annual meeting season.

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The SEC’s Position on Digital Assets

Susan I. Gault-Brown and F. Dario de Martino are partners and Daniel R. Kahan is an associate at Morrison & Foerster LLP. This post is based on a Morrison & Foerster memorandum by Ms. Gault-Brown, Mr. de Martino, Mr. Kahan, Alfredo B. D. Silva, Mara Elyse Goodman, and Dylan Kelsey Naughton.

On April 3, 2019, the Strategic Hub for Innovation and Financial Technology (“FinHub”) of the U.S. Securities and Exchange Commission (“SEC”) published two pieces of guidance on when a blockchain-enabled digital asset will, or will not, be considered a security.

The first piece of guidance (the “TKJ No-Action Letter”) was a no-action letter issued by the SEC’s Division of Corporation Finance in response to a request from TurnKey Jet, Inc. (“TKJ”), a Florida-based air carrier and air taxi operator. The TKJ No-Action Letter represents the first time that the SEC staff has indicated that it would not recommend enforcement action to the SEC if, in reliance on counsel’s opinion that the digital assets are not securities, the subject entity offers and sells securities without registration under the Securities Act of 1933, as amended (the “Securities Act”) and the Securities Exchange Act of 1934, as amended (the “Exchange Act”).

The second piece of guidance came in the form of a “Framework for ‘Investment Contract’ Analysis of Digital Assets” that is intended to serve as “an analytical tool to help market participants assess whether the federal securities laws apply to the offer, sale, or resale of a particular digital asset.”

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2019 Compensation Committee Guide

Jeannemarie O’Brien, David Kahan, and Michael Schobel are partners at Wachtell, Lipton, Rosen & Katz. This post is based on a Wachtell memorandum by Ms. O’Brien, Mr. Kahan, Mr. Schobel, Michael J. Segal, Andrea K. Wahlquist, and Adam J. Shapiro. Related research from the Program on Corporate Governance includes the book Pay without Performance: The Unfulfilled Promise of Executive Compensation by Lucian Bebchuk and Jesse Fried.

The key challenge for compensation committees is to approve compensation programs that directors believe will promote the long-term interests of a company and its shareholders, while taking into account shareholder views and maximizing investor support for those programs.

Three notable developments affected the public company compensation landscape in 2018. First, the elimination by the Tax Cuts and Jobs Act of 2017 (the “2017 Tax Reform Act”) of the performance-based exception to the $1 million per-person annual limit on the deductibility of compensation for certain public company executives under Section 162(m) of the U.S. Internal Revenue Code (the “Code”) resulted in a significant increase in 2018 in nondeductible compensation. However, the 2017 Tax Reform Act did not result in dramatic changes in compensation design, as most companies remained committed—both for substantive reasons and due to investor relations considerations—to traditional performance-based compensation paradigms. Second, the 2018 proxy season featured the first “pay ratio” disclosure under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank”). Institutional Shareholder Services (“ISS”) and Glass Lewis have thus far not taken pay ratio disclosure into their recommendations on say-on-pay votes. However, many companies are deeply focused on the issues of perception associated with pay ratio disclosure. In some cases, the most challenging messaging is internal, to employees intensely interested in the pay of the “median” employee that is required to be disclosed in the pay ratio discussion in the proxy. Third, the SEC issued long-awaited final regulations on the Dodd-Frank statutory mandate requiring companies to disclose hedging policies that apply to executives or directors.

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The SEC’s Current End Game on Proxy Advisory Firms

Cydney S. Posner is special counsel at Cooley LLP. This post is based on a Cooley memorandum by Ms. Posner.

The newest SEC Commissioner, Elad Roisman, who has reportedly gotten the nod to head up the SEC’s efforts regarding proxy advisory firms, told the U.S. Chamber of Commerce in late March that he expects the SEC to issue new guidance, sometime after proxy season this year, regarding the use by institutional investors of proxy advisory firm recommendations, as reported in The Deal. And, according to the WSJ, Roisman has “also questioned whether it was appropriate for the SEC to exempt proxy advisers from some regulations on investment advice, including whether they can both advise a company and make recommendations to its shareholders at the same time.” However, as discussed in this PubCo post, the question of whether proxy advisory firms, such as ISS and Glass Lewis, have undue influence over the voting process and should be reined in has long been something of a political donnybrook. With the issue of proxy advisory firm regulation so politically freighted, will the SEC limit the scope of its effort to guidance to institutional investors or, more controversially, go further and impose regulation on proxy advisors, as many companies have advocated?

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