Monthly Archives: August 2019

Remarks at SECs Small Business Capital Formation Advisory Committee Meeting

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’s Small Business Capital Formation Advisory Committee Meeting, 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 Carla [Garrett], members of the Small Business Capital Formation Advisory Committee, Martha [Miller], and the staff in the Office of the Advocate for Small Business Capital Formation for holding the second meeting of the Committee outside of Washington, DC. [1] It demonstrates a clear commitment to capital formation across the country. I thank you for your thoughtful and pragmatic exploration of how our rules, regulations, and policies impact small businesses and their investors, including smaller public companies. In that vein, a very big thank you to our host, Creighton University, for the warm welcome to Omaha, NE.

Your agenda today is packed with substantive topics that I believe can have a very positive impact on smaller companies and their investors. This morning you already heard from the staff in the Division of Corporation Finance about the SEC’s Concept Release on Harmonization of Securities Offering Exemptions. [2] The concept release is the first step in what I hope will be a much needed reform of our exemptive offering framework, which I have referred to before as an elaborate patchwork. [3] I understand that this morning was also the first step for the work of the Committee in this area and that you will continue to consider how we can harmonize and make more effective our exemptions from registration at a future meeting of the Committee. The opportunity for improvement is stark. Private capital raising is now outpacing capital raising in our public markets, yet our Main Street investors have no effective access to investments in private capital offerings. Further, the availability of private capital is geographically skewed and, as we discussed at your first meeting, significantly favors companies with valuations in excess of $50 million. I look forward to your work in this area. In the meantime, I encourage everyone, including small businesses and their investors, to send us their comments and share their suggestions for how we can improve the exemptive offering framework.


The Future or Fancy? An Empirical Study of Public Benefit Corporations

Michael Dorff is the Michael & Jessica Downer Endowed Chair, Southwestern Law School; James Hicks is an Academic Fellow at the University of California, Berkeley, School of Law; and Steven Davidoff Solomon is Professor of Law at University of California, Berkeley, School of Law. This post is based on their recent paper.

The public benefit corporation (“PBC”) is one of the hottest developments in corporate law. The sine qua non of this new form is that directors are permitted under their fiduciary duties to consider purposes other than profit in decision-making. The PBC has thus been described as different from the traditional corporation, which in some measure must be devoted solely to a for-profit motive. The PBC has been hailed as the “new corporate form”: one that permits a corporation to both earn money and serve a social purpose.

While there has been significant hype and theoretical consideration of this new form, to date there has been little empirical study. Critics of the PBC argue that it will be used for “purpose washing,” merely advocating a public purpose for public relations purposes while still maintaining a purely for-profit motive. Critics also argue that the current corporate form has enough latitude to serve multiple purposes. Advocates counter that the PBC will do nothing less than transform the U.S. capital markets, arguing that the profit maximization norm has contributed to a litany of preventable social ills, from global warming to income inequality, and from declining job stability to political corruption. By incorporating values other than profit-seeking into a company’s “DNA,” proponents assert, the law can tame capitalism’s worst excesses while retaining its many virtues.


Stakeholder Corporate Governance Business Roundtable and Council of Institutional Investors

Martin Lipton is a founding partner of Wachtell, Lipton, Rosen & Katz, specializing in mergers and acquisitions and matters affecting corporate policy and strategy. This post is based on a Wachtell Lipton memorandum by Mr. Lipton.

The failure of the Council of Institutional Investors to join the Business Roundtable in rejecting shareholder primacy and embracing stakeholder corporate governance is misguided. The argument that protection of stakeholders other than shareholders should be left to government regulation is an even more serious mistake. It would lead to state corporatism or socialism.

The failure to recognize the existential threats of inequality and climate change, not only to business corporations but also to asset managers, institutional investors and all shareholders, will invariably lead to legislation that will regulate not only corporations but also investors and take from them the ability to use their voting power to influence the corporations in which they invest. Inequality and climate change will not be mitigated without adherence to the BRT governance principles not just by members of the BRT, but by all business corporations.

The BRT did not dismiss shareholders as “simply” providers of capital. To the contrary, the BRT principles recognize the fundamental importance of shareholders to the company, and commit the company to transparency and engagement with its shareholders to obtain their views of the company’s strategy, operations, and prospects.


Securities Class Action Filings—2019 Midyear Assessment

Alexander “Sasha” Aganin is senior vice president and John Gould is senior vice president at Cornerstone Research. This post is based on a report by Cornerstone Research and the Stanford Law School Securities Class Action Clearinghouse.

Executive Summary

Led by a spike in core filings, federal class action securities fraud lawsuits continued at near-record levels in the first half of 2019. Plaintiffs filed more than 1,000 federal securities class actions in the last five semiannual periods—over 20 percent of all filings since 1997.

Core filings in the first half of 2019 increased to 126, one fewer than the historical high. Filings involving merger and acquisition (M&A) transactions decreased but remained well above historical levels.

Six mega DDL filings (at least $5 billion) and 11 mega MDL filings (at least $10 billion) propelled aggregate market capitalization losses to the highest and fourth-highest levels on record, respectively.


How Do Venture Capitalists Make Decisions?

Will Gornall is an Assistant Professor of Finance at the Sauder School of Business at the University of British Columbia. This post is based on a recent article, forthcoming in the Journal of Financial Economics, by Professor Gornall; Paul A. Gompers, Eugene Holman Professor of Business Administration at Harvard Business School; Steven N. Kaplan, Neubauer Family Professor of Entrepreneurship and Finance at the University of Chicago Booth School of Business; and Ilya A. Strebulaev, the David S. Lobel Professor of Private Equity at the Stanford Graduate School of Business. Related research from the Program on Corporate Governance includes Carrots & Sticks: How VCs Induce Entrepreneurial Teams to Sell Startups(discussed on the Forum here) and Do VCs Use Inside Rounds to Dilute Founders? (discussed on the Forum here), both by Jesse Fried and Brian Broughman.

Our article, How Do Venture Capitalists Make Decisions?, describes the results of a survey of almost nine hundred venture capitalists (VCs). We asked VCs about eight different topics: deal sourcing; investment selection; valuation; deal structure; post-investment value-add; exits; internal organization of firms; and relationships with limited partners.

We first consider how VCs source their potential investments—a process also known as generating deal flow. The average firm in our sample screens 200 companies and makes only four investments in a given year. Most of the deal flow comes from the VCs’ networks in some form or another. Over 30% of deals are generated through professional networks. Another 20% are referred by other investors while 8% are referred by existing portfolio companies. Almost 30% are proactively self-generated. Only 10% come inbound from company management. These results emphasize the importance of active deal generation.


SEC Proposal to Modernize Reg S-K

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

At the end of last week, the SEC voted, without an open meeting, to propose amendments to modernize the descriptions of business, legal proceedings and risk factors in Reg S-K. The proposal is another component of the SEC’s “Disclosure Effectiveness Initiative.” In crafting the proposal, the SEC took into account comments received on the 2016 Concept Release on disclosure simplification and modernization (see this PubCo post), as well as Corp Fin staff experience in review of disclosures. The changes to the rules were proposed “in light of the many changes that have occurred in our capital markets and the domestic and global economy in the more than 30 years since their adoption, including changes in the mix of businesses that participate in our public markets, changes in the way businesses operate, which may affect the relevance of current disclosure requirements, changes in technology (in particular the availability of information), and changes such as inflation that have occurred simply with the passage of time.” There is a 60-day comment period.


A Win in Proxy Fight for Universal Proxy Card

Lizanne Thomas and Robert A. Profusek are partners at Jones Day. This post is based on a Jones Day memorandum by Ms. Thomas, Mr. Profusek, Randi C. Lesnick, and James P. Dougherty. Related research from the Program on Corporate Governance includes Universal Proxies by Scott Hirst (discussed on the Forum here).

For the first time, a dissident shareholder group won board control in a proxy contest using a “universal proxy card” that included the names of both the company’s and the dissident’s slates. The battle for a majority of the board seats at EQT Corporation was waged by brothers Toby and Derek Rice, whose November 2017 sale of Rice Energy to EQT made EQT the largest natural gas producer in the United States.

Following the acquisition, EQT’s performance suffered and its share price declined—ultimately falling to less than half its value at the time of the acquisition. The Rice brothers (who with their allies had a ~3% stake in EQT) reached out privately to EQT in late 2018 to discuss their concerns but then announced that they planned to wage a proxy fight for control of EQT’s board and, if successful, to appoint Toby Rice as its CEO. Ultimately, the Rice Brothers nominated seven candidates to EQT’s 12-member board, including incumbent director Daniel Rice, who joined the EQT board after the sale.


Relative Performance Evaluation in CEO Compensation: A Talent-Retention Explanation

David De Angelis is Assistant Professor of Finance at at the Jesse H. Jones Graduate School of Business at Rice University and Yaniv Grinstein is Adjunct Professor of Finance at the Samuel Curtis Johnson Graduate School of Management at Cornell University. This post is based on their recent article, forthcoming in the Journal of Financial and Quantitative Analysis. 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).

In this article, we investigate a market-for-talent rationale for the use of relative performance evaluation (RPE) in CEO compensation. Our premise is based on Gibbons and Murphy (1990), who show RPE in CEO compensation can be used as an efficient way to compensate CEOs for their talent. In their setting, firms learn CEO talent from CEO performance relative to peer CEOs and compensate their CEOs according to their relative performance in order to retain their talent. We study the talent-retention hypothesis in two ways. First, we examine the contractual terms of RPE in CEO compensation and analyze the extent to which they are consistent with talent-retention motives. Second, using an improved empirical specification to detect RPE on a long panel of compensation data of CEOs of US firms, we test whether the transferability of CEO talent relates to a stronger use of RPE in CEO compensation.


Technology and Life Sciences IPOs

James D. Evans and Robert A. Freedman are partners at Fenwick & West LLP. This post is based on their Fenwick memorandum.

As we had predicted in our prior IPO survey, 2019 has proven to be strong for initial public offerings. Following a somewhat sluggish start to the year, technology and life sciences IPOs took off in the second quarter, making for an overall strong first half that is on par with the second half of 2018.

By the Numbers

The 59 life sciences and technology offerings completed in the first half of 2019 compared with the 57 in the second half of 2018, continuing a trend of stability. Still recovering from the effects of the federal government shutdown and stock market volatility that slowed capital markets activity in the last few months of 2018, the first quarter of 2019 saw one tech offering (Lyft) and 10 life sciences offerings. The pace picked up significantly in the second quarter, when 24 tech and 24 life sciences companies debuted. In all, 25 tech companies and 34 life sciences companies went public in H1 2019, on par with the 23 tech offerings and 34 life sciences offerings in H2 2018.

The first half of 2019 included 15 offshore companies, compared with 19 in the second half of 2018. In the United States, 20 companies went public in the San Francisco Bay Area—nine of them tech and 11 life sciences—the highest number since we started tracking the numbers in 2014. Also of note, Slack Technologies went public through a direct listing in the first half of 2019, similar to that of Spotify in the first half of the previous year.


Making Sense of Monte Carlo

Ben Burney is a Senior Advisor at Exequity, LLP. This post is based on his Exequity memorandum.

When you hear the words “Monte Carlo simulation,” do you:

  1. Scream;
  2. Pack your suitcase—Mediterranean vacation! (Simulation? Nah!); or
  3. Ponder the link between 19th century botany and modern valuation techniques? If you chose a) and would rather b), read this post to c).

For management teams and compensation committees, Monte Carlo simulations are often only marginally understood. Trying to figure out what is going on makes some want to scream (or pack their suitcases). These decision makers may know that Monte Carlo simulations are used to value awards with market conditions (like relative total shareholder return (RTSR)), but not how it works or why values are high or low.

Reviewing Monte Carlo simulation results prepared by valuation firms is not always helpful either—the materials are often filled with statistical jargon. The implication is clear: This analysis is really, really complicated.


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