Monthly Archives: July 2019

Executive Compensation: The Role of Public Company Shareholders

Barbara Novick is Vice Chairman at BlackRock, Inc. This post is based on a Policy Spotlight issued by Blackrock.

Index funds have democratized access to diversified investment for millions of savers who are investing for long term goals, like retirement. However, the popularity of index funds has drawn critics, who claim that index fund managers may wield outsized influence over corporations through their proxy voting and engagement. Executive compensation is often cited as an example because public company shareholders can participate in ‘say-on-pay’ votes. As discussed in the Policy Spotlight, Proxy Voting Outcomes: By the Numbers, index fund managers are rarely the determining factor in say-on-pay votes. That notwithstanding, the focus on say-on-pay is misplaced, since executive compensation is neither structured nor decided by shareholders. Rather, a process is undertaken by the Board of Directors, often under the advisement of the Board’s compensation committee and/or compensation consultant, to determine the amount and composition of executive pay packages. This post provides an explanation of the process by which executive compensation is determined, and the role of shareholders in that process. First, we begin by outlining the roles of the various parties that are relevant to executive compensation determinations:


Corporate Control and the Limits of Judicial Review

Zohar Goshen is the Jerome L. Greene Professor of Transactional Law at Columbia Law School and Assaf Hamdani is Professor of Law at Tel Aviv University. This post is based on their recent paper, and 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 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.

In 2012, Google’s board approved a proposal amending Google’s charter to authorize the issuance of a new class of nonvoting Class C stock. Prior to this proposed recapitalization, Google’s capital structure was comprised of one-vote-per-share Class A shares, primarily held by public shareholders, and ten-votes-per-share Class B shares, primarily held by Google’s founders, Larry Page and Sergei Brin. Under this dual-class structure, Google had the ability to raise capital, incentivize employees, and acquire other corporations, by issuing Class A shares, while preserving control over the company in the hands of Class B shareholders. However, this strategy faced an upper limit–––if enough Class A shares were issued, eventually the voting power of Class B shares would be diluted to the point of the founders losing control. The recapitalization allowed Google to issue as many Class C nonvoting shares as it deemed necessary, without ever threatening to dilute the founders’ control. This move, therefore, reallocated control rights from the public shareholders to the company founders, and enabled the founders to keep their control over the company even as it continues to issue new shares.


Blurring the Lines: “Boilerplate” Provisions in Merger Agreement Interpretation

Jason M. Halper is partner, Jared Stanisci is special counsel, and Nunu Luo is an associate at Cadwalader, Wickersham & Taft LLP. This post is based on their Cadwalader memorandum, and is part of the Delaware law series; links to other posts in the series are available hereRelated research from the Program on Corporate Governance includes M&A Contracts: Purposes, Types, Regulation, and Patterns of Practice, and Allocating Risk Through Contract: Evidence from M&A and Policy Implications (discussed on the Forum here), both by John C. Coates, IV.

In a recent decision arising out of the sale of Cablevision, [1] the Delaware Court of Chancery issued important guidance regarding the interplay between what are commonly regarded as boilerplate merger agreement provisions and “bespoke” provisions that are drafted specifically for the transaction at issue. Here, Vice Chancellor Slights found that extrinsic evidence was necessary to determine whether a provision in the merger agreement (Section 6.4(f)) was still enforceable despite agreement from all parties that: (i) Section 6.4(f) was not listed in the agreement’s provision listing clauses that survived post-closing and (ii) the Dolan family, the beneficiaries of Section 6.4(f), were not identified as third-party beneficiaries of the merger agreement, nor was Section 6.4(f) carved out of the no-third-party-beneficiaries clause. The decision underscores that contracting parties need to be careful when considering future interpretive minefields not to assume that a boilerplate provision will take second seat to a bespoke provision.


Avoiding a Toxic Culture: 10 Changes to Address #MeToo

Amy Bowerman Freed is partner and J. Nicholas Hoover is a senior associate at Hogan Lovells. This post is based on their report, previously published in C-Suite.

The visibility of sexual harassment complaints against executive officers has increased over the last 18 months as a result of the #MeToo movement. In the wake of the growing focus on executive misconduct, companies should proactively assess their workplace practices. Below are 10 steps that companies should consider to avoid an embarrassing and damaging #MeToo situation.

  1. Invest in a healthy workplace. Companies should continue to make significant investments in creating a healthy, inclusive and respectful workplace. Hiring and promoting diverse employees will help create a strong C-suite. Diversity in the workforce enables companies to organically identify deficiencies in their existing prevention programs. Holding annual trainings on corporate policies sets the right tone, especially if members of the C-suite and department heads attend and lead these sessions. Companies should also invest in procedures to ensure that complaints against executives are treated appropriately and are reported internally to the proper supervisors. These measures include establishing hotlines with appropriate considerations and safeguards to ensure that complaints are elevated quickly to the right people within the company. For executive officers, complaints should be brought to the attention of the audit committee of the board. Employing third parties to operate the hotline helps ensure that employees feel comfortable raising issues involving misconduct.


Do Index Funds Monitor?

Daniele Macciocchi is Assistant Professor of Accounting at the University of Utah Eccles School of Business; Davidson Heath is Assistant Professor of Finance at the University of Utah Eccles School of Business; Roni Michaely is Professor of Finance at the Geneva Finance Research Institute – University of Geneva; and Matthew Ringgenberg is Associate Professor of Finance at the University of Utah Eccles School of Business. This post is based on their recent paper. Related research from the Program on Corporate Governance includes The Agency Problems of Institutional Investors by Lucian Bebchuk, Alma Cohen, and Scott Hirst (discussed on the Forum here); Index Funds and the Future of Corporate Governance: Theory, Evidence, and Policy by Lucian Bebchuk and Scott Hirst (discussed on the forum here); and The Specter of the Giant Three by Lucian Bebchuk and Scott Hirst (discussed on the Forum here).

Over the last three decades, the rise of passively managed index funds has transformed how Americans invest. In 1990 less than 1% of all mutual fund assets were held by passively managed index funds. By 2017 index funds held over $6 trillion, more than 29% of all mutual fund assets. While the flow of assets continues as investors heed the call of lower fees and better average performance, the implications of this fundamental shift in investing remain unclear. The rise of passive investing may have consequences for corporate governance, regulation, and the future of the U.S. stock market.

Our paper, Do Index Funds Monitor? examines whether index funds monitor the firms in their portfolios and hold corporate managers accountable to the same extent that actively managed funds do. If a shareholder disagrees with firm management, she has three options. First, she can voice her opinion by voting against management proposals and in favor of shareholder proposals—including her own. Second, she can engage with firm management and convince them to change corporate policy. Third, she can sell her shares (the “Wall Street Walk”), which will express her lack of confidence in the firm’s future value, and possibly drive the share price down. We examine each of these three monitoring channels using comprehensive data on U.S. equity mutual funds from 2004 to 2017. We find that relative to active funds, index funds are weak monitors that cede power to firm management.


Caremark Claim for Positive Violation of Law

Gail Weinstein is senior counsel, Steven Epstein and Andrea Gede-Lange are partners at Fried, Frank, Harris, Shriver & Jacobson LLP. This post is based on a Fried Frank memorandum by Ms. Weinstein, Mr. Epstein, Ms. Gede-Lange, Brian T. Mangino, David L. Shaw, and Shant P. Manoukian, and is part of the Delaware law series; links to other posts in the series are available here.

In In re Facebook, Inc. Section 220 Litigation (May 30, 2019), the Delaware Court of Chancery held in favor of Facebook, Inc. shareholders who were seeking to review certain books and records of the company in connection with the 2016 Cambridge Analytica data breach. The shareholders were seeking inspection of the books and records to bolster breach of fiduciary duty claims that they made in pending derivative shareholder litigation. According to the court, the company knew as early as 2015 that Cambridge Analytica, a British political consulting firm, had misappropriated potentially millions of Facebook users’ data, but the company “did not disclose this security breach to its users upon discovery or at any time thereafter” and users “first learned of the breach when they read or heard about it in the news” in 2018. The company’s stock price then dropped 19% (“wiping out” $120 billion of shareholder wealth)—“one of the sharpest single-day market value declines in history,” the court noted. Vice Chancellor Slights found that the shareholders had met their burden of proof of demonstrating a “credible basis” from which the court could infer that “mismanagement, waste or wrongdoing” occurred at the board level that permitted the data breaches to occur. The court observed that the “credible basis” standard applicable in a Section 220 action “imposes the lowest burden of proof known in our law,” while a Caremark claim implicates a high burden of proof (including evidence of bad faith) and “is possibly the most difficult theory upon which a plaintiff might hope to win a judgment.” The court emphasized that the decision in this Section 220 action involved no “merits assessment” of the Caremark claim.


The Facebook Settlement

Marshall L. Miller is of counsel and Jeohn Salone Favors is an associate at Wachtell, Lipton, Rosen & Katz. This post is based on their Wachtell Lipton memorandum.

In a settlement announced by the Federal Trade Commission [July 24, 2019], Facebook agreed to a $5 billion penalty and extensive remedial requirements to resolve an investigation into violations of a 2012 consent decree related to its data privacy practices. On the same day, the Securities and Exchange Commission announced a related $100 million resolution of charges that Facebook made misleading public disclosures in connection with data privacy risks.

The FTC resolution includes not only the largest data privacy penalty in the agency’s history, but a remedial order that is broad and long-lived, requiring Facebook to restructure its privacy operations at the compliance, executive management, and board of directors levels. Though this high-profile action constitutes, by orders of magnitude, the FTC’s most aggressive privacy enforcement effort to date, it has drawn substantial criticism from some quarters for not going far enough. The Commission’s 3-2 vote in favor of the resolution, split along party lines, reflects its controversial nature.


Compensation Consultants and the Level, Composition and Complexity of CEO Pay

Kevin J. Murphy is Kenneth L. Trefftzs Chair in Finance and Professor of Finance and Business Economics at USC Marshall School of Business; and Tatiana Sandino is Associate Professor of Business Administration at Harvard Business School. This post is based on their recent article, forthcoming in The Accounting Review. Related research from the Program on Corporate Governance includes Stealth Compensation Via Retirement Benefits by Lucian Bebchuk and Jesse Fried; The CEO Pay Slice by Lucian Bebchuk, Martijn Cremers and Urs Peyer (discussed on the Forum here); Executive Pensions by Lucian Bebchuk and Robert J. Jackson Jr; and The Growth of Executive Pay by Lucian Bebchuk and Yaniv Grinstein.

Most publicly traded firms retain consultants to provide advice on executive compensation. Prior research documents, based on cross-sectional analyses, that firms retaining executive compensation consultants pay more to their CEOs (a “CEO pay premium”) than firms not using them. Among the subset of firms using executive compensation consultants, research has shown that CEOs are paid more in firms using consultants that provide other services to their client firms (such as benefits management, advice on broad-based compensation plans, etc.). Consultants providing other services could be conflicted, since the CEOs of their client firms could be more likely to offer other services to the consultants that advise their boards to pay them more.

In our study, Compensation Consultants and the Level, Composition and Complexity of CEO Pay, forthcoming in The Accounting Review, we provide new insights on the relation between the use of executive compensation consultants and CEO pay. We analyze data from 2,347 ExecuComp firms from 2006 to 2014 (resulting in over 14,000 US firm-year observations) based on mandated disclosures introduced in 2006 and expanded in 2009 and 2012.


Global Securities Litigation Trends

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


As companies rapidly expand globally and securities markets become increasingly interconnected, multinational companies must prepare for a new era of global securities litigation. As explained in “Developments in Global Securities Litigation,” a white paper prepared by Dechert last year (“White Paper”)1, this sea change is at the forefront of potential risks for multinational companies. The U.S. Supreme Court’s 2010 decision in Morrison v. National Australia Bank Ltd. set the stage for the current legal landscape. Morrison extinguished access to U.S. courts for “F-cubed” cases (foreign investors, suing a foreign issuer, trading on foreign exchanges). But since its publication, lower courts have grappled with the scope of its holding and its effects on international law have been far reaching and substantial.

This post serves as an update to the above-mentioned White Paper addressing recent developments. In Part I, we describe recent developments in U.S. actions in a post-Morrison world, where courts continue to struggle with the application of Morrison. Part II reviews the more significant updates to shareholder rights’ litigation in the European Union, Netherlands, Germany, Italy, Spain, Canada, Australia, and Japan. Finally, Part III summarizes key findings, observations, and trends of which issuers should be aware to understand and to best position themselves to actively defend against these developments around the world.


Why Compliance (Still) Matters

John F. Savarese is a partner at Wachtell, Lipton, Rosen & Katz. This post is based on a Wachtell Lipton memorandum by Mr. Savarese,  Ralph M. Levene, David B. Anders, and Marshall Miller.

We and many other observers have noted the significant drop over the past two years in both the number of white-collar prosecutions and the scale of corporate fines and penalties. In such an environment, companies might be tempted to think that having an effective compliance program is less urgent and less important than in the past. Our experience suggests that succumbing to such temptation would be a mistake. In fact, now is arguably the best time for corporations to continue investing in their compliance programs to ensure they have in place an effective and comprehensive set of compliance policies, procedures and internal controls.

Four important developments support this view:


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