Monthly Archives: April 2019

The Perils of Pinterest’s Dual-Class Structure

Lucian Bebchuk is the James Barr Ames Professor of Law, Economics, and Finance and Director of the Program on Corporate Governance, Harvard Law School. Kobi Kastiel is Assistant Professor of Law at Tel Aviv University, and a Research Fellow at the Harvard Law School Program on Corporate Governance.

This post is the third in which they analyze the terms of dual-class IPOs by major companies, following their earlier posts on The Perils of Dell’s Low-Voting Stock and The Perils of Lyft’s Dual-Class Structure (discussed on the Forum here and here). Related research from the Program on Corporate Governance includes The Untenable Case for Perpetual Dual-Class Stock (discussed on the Forum here), and The Perils of Small-Minority Controllers (discussed on the Forum here), both by Lucian Bebchuk and Kobi Kastiel, and the keynote presentation on The Lifecycle Theory of Dual-Class Structures.

Pinterest, Inc. (“Pinterest”), the digital pin board company, is about to go public with a dual-class structure in an IPO valuating it at over $10 billion. This post focuses on the governance costs and risks that Pinterest’s public investors should expect to face down the road.

Our analysis builds on our earlier research work on multiclass structures, including The Untenable Case for Perpetual Dual-Class Stock (Virginia Law Review 2017) and The Perils of Small-Minority Controllers (Georgetown Law Journal 2019). Below we identify and analyze in turn two significant problems:

  • Tiny-minority controllers: Although Pinterest’s co-founders will hold together only a minority of voting power immediately following the IPO, the company’s IPO structure will enable them to become majority controllers over time, and to retain such a lock on control while holding only a tiny ownership stake of the company’s equity capital (less than 5%); and
  • Extremely long-lasting lock on control: Pinterest’s co-founders will be able to retain control for an extremely long period, which could well last for five or six decades, even if they become value-decreasing leaders.

Each of these governance risks can be expected to both (i) decrease the expected per share future value of Pinterest by increasing agency costs and distortions, and (ii) increase the discount to a per-share value of Pinterest at which low-voting shares of Pinterest will trade. Each of these effects would operate over time to reduce the market price at which the low-voting shares of public investors would trade. These effects should thus be taken into account by any public investors that consider holding Pinterest shares.

Expected Emergence of Tiny-Minority Controllers

Post-IPO, Pinterest will be a publicly traded dual-class company in which public investors hold low-voting shares entitling them to one vote per share. Pinterest’s three co-founders, as well as a host of venture capital investors, will hold high-voting shares entitling them to 20 votes per share. In the case of Pinterest, the design of its governance structure can be expected to produce what we define as tiny-minority controllers (see the typology we introduced in The Perils of Small-Minority Controllers).


Private Equity and Activism

Amadeus Moeser is an associate at Sidley Austin LLP. This post is based on a Sidley memorandum by Mr. Moeser and Michael Olaya.

The relationship between private equity funds and activist hedge funds has always been double-edged. While in the past, engagements of activists often led to the sale of a target company or less profitable operations of a company to private equity funds, many go-private transactions have been opposed by activists trying to improve the terms of the deal and companies brought private equity funds in as “white knights” during a hostile takeover. However, tensions seem to be slowly disappearing as the transitions between activist hedge funds and private equity funds become blurred. Private equity funds are beginning to adopt activist tactics and activists are increasingly engaging in private equity transactions.


Encouraging Smaller Entrants to Our Capital Markets

Elad L. Roisman is a Commissioner at the U.S. Securities and Exchange Commission. The following post is based on Commissioner Roisman’s recent remarks at the SEC Speaks Conference, available here. The views expressed in the post are those of Mr. Roisman and do not necessarily reflect those of the Securities and Exchange Commission, the other Commissioners, or the Staff.

I. Introduction

Good afternoon. Thank you to everyone who hurried back from lunch to hear me speak. The pressure is on for me to make it worth your while. I never imagined that I would be standing at this podium, but I am excited to be here. I recognize that many of you are here today to get insight into what we are focusing on at the Commission. I would like to take this opportunity to let you know what you can expect to hear from me in the coming year.

I will note here that my views and remarks are my own and do not necessarily represent those of the SEC or the other Commissioners.

It is hard to describe what it is like to come to the SEC as a Commissioner, but the one thing that I think every Commissioner feels, even after a day, is: “Wow. This is different than I imagined.” While I had a sense of the issues on which I planned to focus before I was sworn in last September, I also knew it had been a few years since I worked in the building and I had some catching up to do. I have used the past seven months as an opportunity to engage with the staff and assess the issues on which I could be most helpful. I am now ready to discuss a few of my priorities.


The SEC “Through the Eyes of Management”

Jay Clayton is Chairman of the U.S. Securities and Exchange Commission. This post is based on Chairman Clayton’s recent remarks at the “SEC Speaks” Conference, available here. The views expressed in this post are those of Mr. Clayton and do not necessarily reflect those of the Securities and Exchange Commission or its staff.

Thank you, Stephanie [Avakian], for that kind introduction.

Disclosure and the concepts of materiality, comparability, flexibility, efficiency and responsibility have been, and continue to be, the bedrock principles that make our public capital markets the most fair and efficient markets in the world. Today, I will take a page from our disclosure rulebook and give you a look at the Securities and Exchange Commission (“SEC”) through the “eyes of management,” similar to what public companies do in the “Management’s Discussion and Analysis,” or “MD&A” section of their SEC filings. In other words, I am going to be eating some of our own cooking.

First, some “cautionary” language:

  • the following discussion and analysis is intended to help you better understand the SEC, but you should also consider this discussion in conjunction with our four year strategic plan and our annual report for fiscal year 2018; [1]
  • some of the statements in this discussion are forward-looking statements and, as such, are subject to risks and uncertainties—actual results will almost certainly vary, and could vary materially; and
  • my words are my own and do not necessarily reflect the views of my fellow Commissioners or the SEC staff.


Enhanced Scrutiny on the Buy-Side

Afra Afsharipour is Senior Associate Dean for Academic Affairs and Professor of Law at UC Davis School of Law; The Honorable J. Travis Laster is Vice Chancellor of the Delaware Court of Chancery. This post is based on their recent article, published in the Georgia Law Review, and is part of the Delaware law series; links to other posts in the series are available here.

Empirical studies of acquisitions consistently find that public company bidders often overpay for targets, imposing significant losses on bidder shareholders. Research also indicates that the losses represent true wealth destruction in the aggregate and not simply a wealth transfer from bidder shareholders to target shareholders.

Numerous studies have connected bidder overpayment with managerial agency costs and behavioral biases that reflect management self-interest. Agency theorists in law, management, and finance argue that agency costs explain bidder overpayment—that is management pursues wealth-destroying acquisitions at the expense of shareholders. Numerous studies provide evidence that acquisitions offer significant benefits to bidder management—particularly bidder CEOs—in the form of increased compensation, power, and prestige. For example, studies have found that CEOs are financially rewarded for acquisitions in the form of large, new options and grants, but are not similarly rewarded for other types of major transactions. A second, complementary contributor to bidder overpayment is behavioral bias, such as overconfidence and ego gratification. Managers may overestimate their ability to price a target accurately or their ability to integrate its operations and generate synergies. They may also get caught up in the competitive dynamic of a bidding contest, leading to the winner’s curse. Studies have shown that social factors can undermine decision making and lead to poor acquisitions. These factors include the existence of extensive business or educational ties between the managers of the bidder and target firms, the presence of fewer independent directors on the bidder’s board, and the desire to keep up with peers.


SEC’s Amendments to Simplify Disclosure for Public Companies

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

On March 20, once again without an open meeting, the SEC adopted, with a dissent by Commissioner Robert Jackson, changes to its rules and forms designed to modernize and simplify disclosure requirements. The final amendments, FAST Act Modernization and Simplification of Regulation S-K, which were adopted largely as originally proposed in October 2017 (see this PubCo post), are part of the SEC’s ambitious housekeeping effort, the Disclosure Effectiveness Initiative. (See this PubCo post and this PubCo post.) The amendments are intended to eliminate outdated, repetitive and unnecessary disclosure, lower costs and burdens on companies and improve readability and navigability for investors and other readers. Here is the SEC’s press release.

The final amendments make a number of useful changes, such as eliminating the need to include discussion in MD&A about the earliest of three years of financial statements, permit omission of schedules and attachments from most exhibits, limiting the two-year lookback for material contracts, and streamlining the rules regarding incorporation by reference and other matters. The final amendments also impose some new obligations, such as a requirement to file as an exhibit to Form 10-K a description of the securities registered under Section 12 of the Exchange Act and a requirement to data-tag cover page information and hyperlink to information incorporated by reference.


Profiles of Selected Shareholder Activists

Jim Rossman is Head of Shareholder Advisory, Christopher Couvelier is Director, and Charles Kim is Vice President at Lazard. This post is based on a Lazard memorandum authored by Messrs. Rossman, Couvelier, Kim, and Quinn Pitcher. Related research from the Program on Corporate Governance includes The Long-Term Effects of Hedge Fund Activism by Lucian Bebchuk, Alon Brav, and Wei Jiang (discussed on the Forum here); Dancing with Activists by Lucian Bebchuk, Alon Brav, Wei Jiang, and Thomas Keusch (discussed on the Forum here); and Who Bleeds When the Wolves Bite? A Flesh-and-Blood Perspective on Hedge Fund Activism and Our Strange Corporate Governance System by Leo E. Strine, Jr. (discussed on the Forum here).

  • Lazard’s Shareholder Advisory Group analyzed activist campaign data, news sources and background information in order to profile activist hedge funds
  • The enclosed materials include abridged profiles for eight notable activists
    • The eight profiles include holdings information, strategy observations and other relevant information
    • Profiles reflect a combination of publicly available information and the Lazard Shareholder Advisory Group’s perspectives on the behavior and tactics of these investors
  • In total, Lazard’s Shareholder Advisory Group has profiled 57 activist hedge funds
    • Lazard has prepared in-depth profiles (including detailed biographies, campaign analyses and case studies) for the 16 most significant activists
    • Shorter-form profiles containing key facts have been prepared for the 41 other hedge funds
    • Those interested in receiving the full volume of activist profiles can contact Quinn Pitcher at [email protected]
  • Lazard will update this set of profiles following future 13F filings
    • The 13F filing deadline for the quarter ending on March 31, 2019 will be May 15, 2019


Hedging Climate News

Robert F. Engle is Michael Armellino Professor of Management and Financial Services at NYU Stern School of Business; Stefano Giglio is Professor of Finance at Yale School of Management; Bryan T. Kelly is Professor of Finance & Associate Director of the International Center for Finance at Yale School of Management; Johannes Stroebel is Professor of Finance at NYU Stern School of Business; and Heebum Lee is a PhD candidate in finance at NYU Stern School of Business. This post is based on their recent paper.

Despite the widespread recognition that the climate is changing, there is substantial uncertainty around the exact climate trajectory and as well as the economic consequences of climate change. As a result, financial market participants have an increasing demand for hedging themselves against future realizations of climate risk. However, hedging these risks through traditional insurance or futures contracts is difficult, both because climate risk is non-diversifiable and because it will materialize over long horizons. As a result, it would be hard for any counterparty to credibly guarantee to pay claims during a climate disaster event that might materialize in many decades. Financial market participants are therefore largely constrained to self-insure against climate risk.

In Hedging Climate Change News, we propose an easily implementable approach for constructing climate risk hedge portfolios using publicly traded assets. Our proposed methodology follows a dynamic hedging strategy using insights from asset pricing theory. In our proposed approach, rather than buying a security that directly pays off in the event of a future climate disaster, we construct portfolios that have short-term returns that hedge news about climate change over the holding period. By hedging, period by period, the innovations in news about long-run climate change, an investor can ultimately hedge her long-run exposure to climate risk. In the short run, such a portfolio differs from the Markowitz mean-variance efficient portfolio, and will thus exhibit a lower Sharpe ratio; but in the long run, the dynamic hedging approach will compensate investors for losses that arise from the realization of climate risk.


Framework for “Investment Contract” Analysis of Digital Assets

This post is based on the Framework prepared by the SEC’s Strategic Hub for Innovation and Financial Technology (“FinHub”) staff.

Framework for “Investment Contract” Analysis
of Digital Assets [1]


If you are considering an Initial Coin Offering, sometimes referred to as an “ICO,” or otherwise engaging in the offer, sale, or distribution of a digital asset, [2] you need to consider whether the U.S. federal securities laws apply. A threshold issue is whether the digital asset is a “security” under those laws. [3] The term “security” includes an “investment contract,” as well as other instruments such as stocks, bonds, and transferable shares. A digital asset should be analyzed to determine whether it has the characteristics of any product that meets the definition of “security” under the federal securities laws. In this guidance, we provide a framework for analyzing whether a digital asset has the characteristics of one particular type of security—an “investment contract.” [4] Both the Commission and the federal courts frequently use the “investment contract” analysis to determine whether unique or novel instruments or arrangements, such as digital assets, are securities subject to the federal securities laws.


Going for Gold: Global Board Culture and Director Behaviors Survey

Rusty O’Kelley III is the Global Head of the Board Consulting and Effectiveness Practice, Anthony Goodman is a member of the Board Consulting and Effectiveness Practice, and PJ Neal manages the Center for Leadership Insight at Russell Reynolds Associates. This post is based on a Russell Reynolds memorandum by Mr. O’Kelley, Mr. Goodman, Mr. Neal, and Ana Lisa Jones.

Based on our experience working with hundreds of boards each year, we know board and director performance depends on the quality of board leadership, the ability of the board to focus on the right issues and a small number of critical director behaviors. Our latest research backs this up.

The link between critical director behaviors and higher company performance was evidenced in our second Global Board Culture and Director Behaviors Survey, completed by 750 corporate (supervisory board-level) directors of large public companies worldwide. This data provides a roadmap for driving improvement in board effectiveness and, potentially, corporate performance.

This post focuses on understanding a group of boards we call “Gold Medal Boards”—those that rate themselves as operating in a highly effective manner and that oversee a high-performing company (one that has outperformed relevant total shareholder return (TSR) benchmarks for two or more years consecutively). When we look at the data for this group and compare it to the broader population of boards, the differences are clear. These boards spend the same amount of time on their work as the global peer set, but prioritize more strategic, longer-term and forward-looking discussions. Their directors are more likely to seek to understand other perspectives, focus on being present at meetings and build deep relationships with management and investors. Gold Medal Board chairs lead differently too—demonstrating behaviors that foster and facilitate higher-quality debates in the boardroom.


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