Monthly Archives: July 2019

Shareholders are Dispersed and Diverse

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. As index funds are currently growing more quickly than actively managed funds, some critics have expressed concern about increasing concentration of public company ownership in the hands of index fund managers. While it is true that assets under management (or “AUM”) in index portfolios have grown, index funds and ETFs represent less than 10% of global equity assets. [1] Further, equity investors, and hence public company shareholders, are dispersed across a diverse range of asset owners and asset managers.

As of year-end 2017, Vanguard, BlackRock, and State Street manage $3.5 trillion, $3.3 trillion, and $1.8 trillion in global equity assets, respectively. [2] These investors represent a minority position in the $83 trillion global equity market. As shown in Exhibit 1, the combined AUM of these three managers represents just over 10% of global equity assets. The largest 20 asset managers only account for 22%. Moreover, about two-thirds of all global equity investment is conducted by asset owners choosing to invest in equities directly rather than by employing an asset manager to make investments on their behalf.


Managerial Short-Termism and Investment: Evidence from Accelerated Option Vesting

Tomislav Ladika is Assistant Professor of Finance at the University of Amsterdam and Zacharias Sautner is Professor of Finance at Frankfurt School of Finance & Management. This post is based on their recent article, forthcoming in the Review of Finance. 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); Executive Compensation as an Agency Problem by Lucian Bebchuk and Jesse Fried; Short-Termism and Capital Flows by Jesse Fried and Charles C. Y. Wang (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).

Do managers sometimes take actions that boost performance in the short term, but reduce value in the long term? Financial analysts and policymakers frequently express concern about managerial short-termism. Business leaders like Jamie Dimon and Warren Buffet recently joined the fray, arguing that “companies frequently hold back on technology spending, hiring, and research and development to meet quarterly earnings forecasts.” (See “Short-Termism Is Harming the Economy”, Wall Street Journal, June 6, 2018.) Yet little clean evidence exists on the prevalence of managerial short-termism.

In our paper, Managerial Short-Termism and Investment: Evidence from Accelerated Option Vesting, forthcoming in the Review of Finance, we provide new evidence that CEOs with more short-term incentives spend less on long-term investment. We start from the insight that CEOs’ incentive horizons are determined largely by the length of the vesting periods on their equity pay grants. Short vesting periods make it more likely that CEOs pump up the stock price and then quickly sell their shares at a profit. Investment cuts are a plausible target for myopic CEOs, because investors may only realize the long-term consequences years down the road. Therefore we examine whether CEOs reduce investment when vesting periods become shorter.


Staff Statement on LIBOR Transition

William H. Hinman is Director of the Division of Corporation Finance at the U.S. Securities and Exchange Commission. This post is based on a joint statement on LIBOR transition, available here, by the SEC’s Division of Corporation Finance, Division of Investment Management, Division of Trading and Markets, and Office of the Chief Accountant. [1]

LIBOR [2] is an indicative measure of the average interest rate at which major global banks could borrow from one another. LIBOR is quoted in multiple currencies and multiple time frames using data reported by private-sector banks. [3] LIBOR is used extensively in the U.S. [4] and globally as a “benchmark” or “reference rate” for various commercial and financial contracts, including corporate and municipal bonds and loans, floating rate mortgages, asset-backed securities, consumer loans, and interest rate swaps and other derivatives. It is expected that a number of private-sector banks currently reporting information used to set LIBOR will stop doing so after 2021 when their current reporting commitment ends, which could either cause LIBOR to stop publication immediately or cause LIBOR’s regulator to determine that its quality has degraded to the degree that it is no longer representative of its underlying market. [5] As regulators and market participants seek to avoid business and market disruptions resulting from the expected discontinuation of LIBOR, implementing alternative reference rates in advance of the discontinuation has taken on urgency. As described in more detail below, the U.S. and other countries are currently working to replace LIBOR with alternative reference rates.


Statement on Opportunity Zones

Jay Clayton is Chairman of the U.S. Securities and Exchange Commission. This post is based on Chairman Clayton’s recent public statement, 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.

Today [July 15, 2019], together with our regulatory colleagues at the North American Securities Administrators Association (NASAA), our staff issued a statement explaining the potential application of state and federal securities laws to fundraising for Opportunity Zones. Separately, our staff also provided guidance regarding the ability of Main Street investors to participate in these offerings. Our staff, and our state colleagues, have my deep appreciation for their proactive and cooperative approach to this matter.

The Opportunity Zone staff statement and guidance demonstrate that Main Street investors can invest in their communities in a manner that is compliant with our securities laws. Opportunity Zones provide a community-specific incentive for long-term investment. There are well established paths for institutional investors and high net worth individuals to invest in these projects. The path for Main Street investors and, in particular those who live in the Opportunity Zone itself, to invest in these projects is often more complex and could cause those raising funds to exclude, or significantly restrict participation by, Main Street investors. I believe we should actively explore whether this complexity can be reduced in order to foster greater access to certain Opportunity Zone investments by Main Street investors, particularly those who live in or near the Opportunity Zone.


Conflicted Mutual Fund Voting in Corporate Law

Sean J. Griffith is the T.J. Maloney Chair and Professor of Law at Fordham Law School and Dorothy S. Lund is Assistant Professor of Law at the University of Southern California Gould School of Law. This post is based on their recent article, forthcoming in the Boston University Law Review. 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) and Index Funds and the Future of Corporate Governance: Theory, Evidence, and Policy by Lucian Bebchuk and Scott Hirst (discussed on the forum here).

In their challenge to Tesla’s $2.6 billion merger with SolarCity, the shareholder plaintiffs raised a novel argument. Because Tesla’s top 25 institutional investors—those holding 45.7% of Tesla’s stock—also held SolarCity stock, they stood on both sides of the transaction and therefore, the shareholder plaintiffs argued, their votes should not be treated as “disinterested.” The Delaware Court of Chancery never reached this argument, dismissing the case on other grounds, but predicted that the argument would resurface one day. We think it will too. It is an example of a paradigmatic conflict caused by the increasing intermediation of corporate shareholdings by institutional investors in general, and mutual funds in particular.

Having been steadily growing for decades, institutional investors’ share of U.S. equity markets now stands at over 80%, with mutual funds holding more than half of that amount. In the past decade, investor demand for passively managed mutual funds—index funds and exchange-traded funds (“ETFs”)—has rendered the institutions that favor passive management especially powerful: BlackRock now controls 5% blocks of more than half of U.S. publicly traded companies, and Vanguard has 5% blocks in over 40% of such companies.


Walmart’s Failure to Maintain a Sufficient Anti-Corruption Compliance Program

Alex Young K. Oh, Mark Mendelsohn, and Brad S. Karp are partners at Paul, Weiss, Rifkind, Wharton & Garrison LLP. This post is based on their Paul Weiss memorandum.

On June 20, 2019, the Department of Justice and the Securities and Exchange Commission announced long-awaited resolutions with Walmart, Inc. for violations of the books and records and internal accounting provisions of the Foreign Corrupt Practices Act (FCPA). In addition to entering into a three-year non-prosecution agreement, and agreeing to the imposition of a compliance monitor for two years, Walmart agreed to pay $137 million to settle the DOJ’s criminal charges and a further $144 million to resolve parallel civil charges brought by the SEC. Additionally, Walmart consented to the SEC’s finding that it violated the books and records and internal accounting provisions of the FCPA. Relatedly, WMT Brasilia, S.a.r.l. (“WMT”), Walmart’s wholly owned Brazilian subsidiary, pleaded guilty in connection with the resolution.

Specifically, the DOJ and the SEC alleged that from 2000 until 2011, Walmart personnel responsible for implementing and maintaining the company’s internal accounting controls were aware of certain compliance failures, including relating to potentially improper payments to government officials. The internal controls failures allowed Walmart’s foreign subsidiaries in Brazil, China, Mexico and India to hire third-party intermediaries without establishing sufficient controls to prevent those intermediaries from making improper payments to government officials in return for store permits and licenses. In a number of instances, insufficiencies in Walmart’s internal accounting controls in these foreign subsidiaries were reported to senior Walmart employees and executives. The internal control failures allowed the foreign subsidiaries to open stores faster than they would have been able to otherwise, enabling Walmart to earn additional and improper profits through these subsidiaries.


Testimony before the U.S. House of Representatives, Committee on Financial Services, Subcommittee on Investor Protection, Entrepreneurship and Capital Markets

James Andrus is an Investment Manager, Sustainable Investments, at the California Public Employees’ Retirement System (CalPERS). This post is based on his testimony before the United States House of Representatives Committee on Financial Services Subcommittee on Investor Protection, Entrepreneurship and Capital Markets hearing on Building a Sustainable and Competitive Economy: An Examination of Proposals to Improve Environmental, Social and Governance Disclosures.

Chairwoman Maloney, Ranking Member Huizenga, and other Members of the Subcommittee:

Thank you for the opportunity to testify at today’s hearing. My name is James Andrus, and I am an Investment Manager for the Sustainable Investments program for the California Public Employees’ Retirement System (“CalPERS”). I am pleased to appear before you today on behalf of CalPERS. I applaud and support the Subcommittee’s focus on building a sustainable and competitive economy. CalPERS appreciates that Environmental, Social, and Governance (“ESG”) disclosures play an important role in that work.

My testimony discusses how CalPERS benefits from a system that ensures effective, accountable and transparent corporate governance, while at the same time promoting capital formation with the objective of achieving the best returns and value for shareowners over the long-term.


Theory, Evidence, and Policy on Dual-Class Shares: A Country-Specific Response to a Global Debate

Aurelio Gurrea-Martínez is an Assistant Professor of Law at Singapore Management University. This post is based on his recent paper. Related research from the Program on Corporate Governance includes The Untenable Case for Perpetual Dual-Class Stock (discussed on the Forum here), The Perils of Small-Minority Controllers (discussed on the Forum here), and The Lifecycle Theory of Dual-Class Structures (discussed on the Forum here), all by Lucian Bebchuk and Kobi Kastiel.

Dual-class shares have become one of the most controversial issues in corporate governance and capital markets around the world. On the one hand, a tough regulatory competition to attract IPOs has led many stock exchanges, including the Singapore Exchange (SGX) and the Stock Exchange of Hong Kong (HKEX), to revise their regulatory framework to allow companies going public with dual-class shares provided that several requirements are met. On the other hand, Nasdaq and the New York Stock Exchange (NYSE) in the United States have been asked by the Council of Institutional Investors to impose time-based sunset clauses to firms going public with dual-class share structures. In the meantime, other leading financial centres, including London (premium listing) and Frankfurt, still prohibit companies from going public with dual-class shares, even though it remains to be seen whether they will keep this approach—especially in the case of the United Kingdom after Brexit—in the light of the competitive regulatory environment existing in today´s capital markets.


Director Nominations and Overbroad Questionnaires

Steve WoloskyAndrew Freedman, and Lori Marks-Esterman are partners at Olshan Frome Wolosky LLP. This post is based on an Olshan memorandum by Mr. Wolosky, Mr. Freedman, and Ms. Marks-Esterman, Ron S. Berenblat, and Kyle J. Kolb. This post is part of the Delaware law series; links to other posts in the series are available here.

On June 27, 2019, the Delaware Chancery Court entered an injunction requiring the boards of trustees (the “Boards”) of two closed-end investment funds (the “Funds”) to count the votes in favor of director candidates nominated by shareholder Saba Capital at the annual meetings scheduled for July 8, 2019. In the case captioned Saba Capital Master Fund, Ltd. v. BlackRock Credit Allocation Income Trust, et al., C.A. No. 2019-0416-MTZ, 2019 WL 2711281 (Del. Ch. Jun 27, 2019), Vice Chancellor Zurn granted Saba Capital’s request for injunctive relief, finding that the Funds’ rejection of the nominations submitted by Saba Capital violated the Funds’ bylaws. The Court’s ruling is consistent with views recently expressed by Olshan that overzealous defense advisors continue to “cross the line” by using onerous, overbroad questionnaires as traps to thwart shareholder nominations and chill activist campaigns.

Saba Capital had timely given notice of its nominations in compliance with the Funds’ advance notification bylaws. In a response weeks later, the Funds asked that the nominees complete a supplemental questionnaire, which had “nearly one hundred questions over forty-seven pages, and was due in five business days.” The Funds declared the nominations invalid after Saba Capital missed the five-day deadline for submitting the questionnaires (although Saba Capital eventually provided the completed questionnaires).


The Test of Time: Adapting to a New Era of Executive Compensation

Amit Batish is Content Manager at Equilar Inc. This post is based on an Equilar memorandum by Mr. Batish. 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 and Paying for Long-Term Performance by Lucian Bebchuk and Jesse Fried (discussed on the Forum here).

Since the passage of Dodd-Frank in 2010, there have been a number of regulations around executive compensation and performance that have left a tremendous influence on executive pay plans. The ever-evolving world of executive compensation oftentimes puts companies in a precarious predicament as decisions on pay could have an ample impact across an entire organization. There are several factors that change year-over-year, and there is no question that this leaves compensation committees in limbo on what is considered sound practice. These factors include pressure from investors to align executive pay with performance, sudden executive departures and much more.

This post examines a number of trending topics and issues across the corporate governance world that are affecting the executive compensation landscape. While the changes in the industry are indeed a conundrum to solve at times, the fact remains that corporations must adapt to these changes, regardless of the nuances in the process. Designing effective executive pay plans is not a simple task, yet once achieved, could pay significant dividends for the well-being of a corporation.


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