Monthly Archives: August 2019

Index Fund Enforcement

Alexander I. Platt is the Climenko Fellow and Lecturer on Law at Harvard Law School. This post is based on his recent article, forthcoming in the UC Davis Law Review. Related research from the Program on Corporate Governance includes Index Funds and the Future of Corporate Governance: Theory, Evidence, and Policy by Lucian Bebchuk and Scott Hirst (discussed on the forum here); The Agency Problems of Institutional Investors by Lucian Bebchuk, Alma Cohen, and Scott Hirst (discussed on the Forum here); and The Specter of the Giant Three (discussed on the Forum here) by Lucian Bebchuk and Scott Hirst.

Three financial institutions now vote 25% of the stock in the largest U.S. public companies. Soon, the figure may be closer to 40%. Vanguard, BlackRock, and State Street Global Advisors—the so-called “Big Three”—dominate the market for index funds and other passively-managed investment vehicles. As passive investing has grown increasingly popular with investors, these institutions have accumulated astonishing levels of economic power.

To date, however, the debate over the rise of the Big Three has overlooked an area where this concentration of power may have a particularly significant effect: the corporate enforcement ecosystem. The analysis of some leading corporate governance scholars suggests that there is reason to worry that the Big Three’s rise could significantly undermine the current system of private and reputational mechanisms to hold companies and managers accountable for fraud and misconduct. Proponents of what I call the “Passivity Thesis” have argued that index fund managers have generally overriding incentives to refrain from meaningful corporate “stewardship”—i.e. actions to influence and enhance the value of individual portfolio companies. [See, Index Funds and the Future of Corporate Governance (discussed on the Forum here) and The Agency problems of Institutional Investors by Bebchuk, Cohen, and Hirst (discussed on the Forum here)] If that’s true, the Big Three might also be expected to use their considerable power and influence to effectively insulate managers and companies from accountability for wrongdoing.


Economic Value Added Makes a Come Back

Seymour Burchman is managing director at Semler Brossy Consulting Group, LLC. This post is based on his Semler Brossy publication.

It’s like déjà vu all over again. That’s what many directors might have thought after Institutional Shareholder Services (ISS) recently announced its new embrace of economic value added (EVA). Several decades ago, this measure of financial performance—akin to economic profit—climaxed in popularity, championed by Stern Stewart & Co. It then swooned for various reasons, even as many financial analysts lauded its advantages.

But now EVA is back. Last year, ISS acquired EVA Dimensions, a business intelligence firm that specialized in measuring economic value run by Stern Stewart cofounder Bennett Stewart. This spring, ISS began to report the EVA scores for each company in its voting recommendation reports. With ISS as the new EVA champion, directors may want to take a fresh look at the measure’s virtues and shortcomings, and prepare to respond to investors who will be comparing one company’s EVA to another’s.


Compensation Committees & Human Capital Management

Robert Newbury is Director, and Don Delves and Ryan Resch are managing directors at Willis Towers Watson. This post is based on their Willis Towers Watson memorandum.

What’s in a name? For compensation committees, it well might be a change in their identities as they take on new oversight functions for their companies’ boards.

New research from Willis Towers Watson confirms the dramatic change in the traditional role of the compensation committee as human capital management (HCM) responsibilities become more prominent.

What we found

Both the names and charters of many compensation committees have been changed to reflect how responsibilities have evolved, according to a recent study of S&P 500 companies’ charters and committee names conducted by Willis Towers Watson’s Global Executive Compensation Analysis Team. In fact, our study indicated some noteworthy findings:


Shareholder Governance and CEO Compensation: The Peer Effects of Say on Pay

Diane K. Denis is Terrence Laughlin Chair in Finance and Professor of Business Administration at the University of Pittsburgh Katz School of Business; Torsten Jochem is Assistant Professor in Finance at the University of Amsterdam Business School; and Anjana Rajamani is Assistant Professor of Finance at Erasmus University Rotterdam School of Management. This post is based on their recent article, forthcoming in the Review of Financial Studies. 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.

Growth in institutional ownership and activism combined with regulatory changes have led shareholders to play an increasingly important role in the governance of U.S. public firms. While a well-developed literature provides evidence on the direct effects of shareholder governance actions on the firms that are subject to them, there is scant evidence to date on the indirect effects for firms that are peers of the subject firms.

In our article, Shareholder Governance and CEO Compensation: The Peer Effects of Say on Pay, forthcoming in the Review of Financial Studies, we provide evidence on the spillover effects of say on pay voting. We document that firms undertake relative reductions in CEO compensation following their compensation peers’ weak say on pay votes. We define a weak say on pay vote as shareholder support in the bottom decile of Russell 3000 firms (less than 72.5%). We label firms that have weak-vote peers but do not themselves experience a weak vote as primary firms; they are the focus of our analysis. Firms that have neither a weak say on pay vote nor compensation peers that experience weak votes are our control firms. Changes in the CEO compensation of control firms serve as the counterfactual compensation change to which we compare the primary firm compensation changes.


An Implied Private Right of Action Under the Investment Company Act

Robert Skinner and Amy Roy are partners at Ropes & Gray LLP. This post is based on their Ropes & Gray memorandum.

In an August 5 holding that could open the door to a new breed of litigation claims involving mutual funds, the United States Court of Appeals for the Second Circuit ruled that the Investment Company Act of 1940 (“ICA”) creates an implied private right of action that several other courts had previously declined to recognize. Section 47(b) of the ICA provides that “[a] contract that is made, or whose performance involves, a violation of [the ICA] . . . is unenforceable by either party.” The Second Circuit concluded in Oxford University Bank v. Lansuppe Feeder, Inc. that Congress’ intent in enacting Section 47(b) was to grant contracting parties a right to sue for rescission of a contract that allegedly violates the ICA. In recent years, most courts have interpreted the ICA as providing only one private right of action—a claim for excessive advisory fees against investment advisers and their affiliates expressly granted to mutual fund shareholders under Section 36(b). While an additional private right of action under the ICA raises the prospect of expanded litigation risk for advisers and funds, the scope of new litigation might be limited in practice by the requirement that the plaintiff be a party to the allegedly violative contract.


Appraisal Claim Waivers and Deal Covenants

Katherine Henderson, Amy Simmerman and Brad Sorrels are partners at Wilson Sonsini Goodrich & Rosati. This post is based on a WSGR publication by Ms. Henderson, Ms. Simmerman, Mr. Sorrells, Ryan Greecher, Nate Emeritz, and Toni Wormald, 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 Appraisal After Dell by Guhan Subramanian and Allocating Risk Through Contract: Evidence from M&A and Policy Implications (discussed on the Forum here).

On May 15, 2019, Vice Chancellor Slights of the Delaware Court of Chancery issued a ruling addressing important issues related to private company deal litigation. Specifically, the decision addressed when a release of claims and covenant not to sue can bar ensuing appraisal and fiduciary claims by stockholders. The case, In re Altor BioScience Corporation, involved the acquisition of Altor BioScience Corporation (Altor) by an affiliate of a large stockholder of Altor by way of a merger. The plaintiffs asserted appraisal claims and breaches of fiduciary duty claims against the Altor board, including the chairman of Altor, who was also an indirect holder of 51 percent of Altor’s stock and the CEO, chairman, and 85 percent stockholder of the acquiror.


CEO Incentives Shown to Yield Positive Societal Benefits

Lars Oxelheim is Professor of International Business and Finance at the University of Agder. This post is based on a blog post by Professor Oxelheim; Rosita P. Chang, Professor of Finance at the University of Hawaii at Manoa; Jack C. DeJong, Jr., Professor of Finance at Nova Southeastern University; Robert Doktor, Professor of Management at the University of Hawaii at Manoa; and Trond Randøy, Professor of International Business and Finance at the University of Agder.

The negative aspects of large CEO pay and the associated incentives have been a hot political issue in many countries. Our research identifies some positive aspects of CEO incentives in a broader economic/societal context that have been overlooked. In a five-year longitudinal study across major free-market nations in Asia, Europe, and the Americas, we find when a higher proportion of CEOs in a nation receive incentives, that nation’s GDP increases significantly in the following years, independent of the incentives monetary value. That is, in nations where a CEO incentive compensation is more frequently employed, these nations exhibit relatively more robust economic growth in the years that follow. It appears ubiquitous CEO incentives may result in future positive societal benefits at the macroeconomic national level.


Mutual Fund Excessive Fee Claims and Market Conditions

Robert Skinner, and Amy Roy are partners at Ropes & Gray LLP. This post is based on their Ropes & Gray memorandum.

In a decisive August 5 ruling that could be the final nail in the coffin for plaintiffs’ efforts to compare advisory and subadvisory fees, a federal court in the Central District of California rejected claims of excessive mutual fund fees asserted against Metropolitan West Asset Management, LLC (“MetWest”) following a bench trial. Finding in MetWest’s favor across the board, U.S. District Judge George Wu held that the plaintiff-shareholder had failed to prove that MetWest charged excessive advisory fees to its flagship fund, the MetWest Total Return Bond Fund, which grew to become the world’s largest actively managed bond fund. The court ruled that the plaintiff’s proposed comparison of the Fund’s advisory fee to lower subadvisory fees MetWest charged to external funds was “inapt,” because MetWest “provides substantially different services and takes on substantially different risks” as adviser and sponsor of a proprietary fund. The court looked instead to mutual fund peer group fees as a more apt comparator, while also giving deference to the fee approval of the Fund’s independent trustees following a robust review process. Judge Wu further rejected the plaintiff’s theory that MetWest failed to share economies of scale merely because it did not implement breakpoints as the Fund grew in size. Throughout the decision, the court recognized important market conditions of today’s mutual fund industry, including the stiff competition among fund advisers to both attract investor assets and retain talented professionals. MetWest is represented in the case by a team of Ropes & Gray litigators.


Relative Performance and Incentive Metrics

John R. Sinkular is partner and Phil Johnson and Julia Kennedy are consultants at Pay Governance LLC. This post is based on their Pay Governance memorandum. Related research from the Program on Corporate Governance includes Paying for Long-Term Performance by Lucian Bebchuk and Jesse Fried (discussed on the Forum here).

Relative benchmarking is near-universal as companies assess historical pay-for-performance (P4P) alignment, but should relative performance be an explicit incentive plan measure? Most companies provide the majority of their long-term incentive (LTI) award opportunity to senior executives in equity-based awards, which has an underlying value directly aligned to stock price fluctuations. If companies decide this is insufficient, should they consider using Relative Total Shareholder Return (TSR) as an incentive metric? If so, should it be structured as a separate component or as a modifier? Before we address these questions, some historical context:

Performance measure selection is one of the Compensation Committee’s most important responsibilities. Performance metrics communicate to shareholders the specific measures critical to executing the business strategy and also determine the largest part of executive pay: incentive plan payouts. In order to optimize the executive pay program to achieve evolving business and talent needs while also considering external factors, companies must have the right incentive plan performance metrics.


Board Diversity Study

Ed Batts is partner, Isabella Fu is a summer associate, and Sara Gates is an associate at Orrick, Herrington & Sutcliffe LLP. This post is based on their Orrick memorandum. Related research from the Program on Corporate Governance includes Socially Responsible Firms by Alan Ferrell, Hao Liang, and Luc Renneboog (discussed on the Forum here).

On August 6, a group of three individual plaintiffs represented by Judicial Watch, Inc. filed suit in Los Angeles County Superior Court against California’s Secretary of State seeking to block the provisions of SB 826, which was signed into law in September 2018 and provides that:

  • By December 31, 2019, every publicly traded company on a major securities exchange (e.g. Nasdaq, NYSE) with its headquarters in California is required to have at least 1 female board director; and
  • By December 31, 2021, a public company board with 5 board members will need at least 2 female members, and those boards with 6 or more members will need at least 3 female members.

As the Judicial Watch lawsuit notes, at the time of the law’s enactment in September 2018, many commentators questioned its constitutionality and enforceability, irrespective of its public policy goal.

Due to the “private ordering” initiatives described below from large index and pension fund investors and proxy advisory firms, the potential incremental impact of the law itself, however, may be more limited than first appears. Almost all of these other constituencies are advocating for boards to have at least 1 female member, and many are advocating for 2 (or more).


Page 2 of 9
1 2 3 4 5 6 7 8 9