Monthly Archives: October 2019

Weekly Roundup: October 4–10, 2019


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This roundup contains a collection of the posts published on the Forum during the week of October 4–10, 2019.

SEC Expansion of “Testing-the-Waters” Communications to All Issuers


Response to CII Proposal to Amend DGCL



Women Board Seats in Russell 3000 Pass the 20% Mark



Implied Private Right of Action Under the Investment Company Act


The Reverse Agency Problem in the Age of Compliance



Shareholder Activism and Governance in France


Self-Driving Corporations?


A Stakeholder Approach and Executive Compensation




Clear and Unambiguous Terms of Merger Agreement


Virtual Shareholder Meetings in the U.S


Corporate Control Across the World


Predicting Long Term Success for Corporations and Investors Worldwide

Predicting Long Term Success for Corporations and Investors Worldwide

Bhakti Mirchandani is Managing Director, Allen He is a senior research associate, and Victoria Tellez is a research associate at FCLTGlobal. This post is based on a FCLTGlobal memorandum by Ms. Mirchandani, Mr. He, Ms. Tellez, Steve Boxer, and Evan Horowitz. 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); The Uneasy Case for Favoring Long-Term Shareholders by Jesse Fried (discussed on the Forum here); 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); and The Long-Term Effects of Hedge Fund Activism by Lucian Bebchuk, Alon Brav, and Wei Jiang (discussed on the Forum here).

Through our research, FCLTGlobal aims to identify the key determinants of long-term success for companies and investors around the world. We then use this knowledge to encourage long-term behaviors across capital markets. This post focuses on predictors of long-term health that are grounded in rich global data going back over time. Looking across the value chain—at companies, asset managers, and asset owners—we find the following:

  • Global companies are falling short on long-term behaviors. Companies are scoring lower than they did in 2014, and well below the level reached before the financial crisis, on our overall measure of long-term behavior.
  • Overdistribution of capital can be a drain on corporate performance. Although distributing capital via buybacks and dividends makes sense in some circumstances, our analysis finds that companies taking this approach tend to generate lower five-year returns on invested capital (ROIC, our preferred measure of performance).
  • Corporate research and development (R&D) can boost returns. By looking at the marginal value of additional research spending, we show that R&D investments are linked to higher ROIC.
  • Employee ownership is linked to higher returns among global asset managers. Employee ownership is the strongest predictor of success for asset managers, particularly those in equity investing.
  • Net returns for asset owners are linked to both governance and investment strategy. Relevant factors include board diversity, active ownership, lower costs, a higher funded ratio, and higher exposure to both public and private equity. Of course, not all drivers of long-term success are easily measured or detected, and if more data were available, we could deepen our understanding of vital factors such as talent retention and customer loyalty. But even with existing data limitations, we are able to confirm some well-known predictors of long-term success and also unearth some novel ones. What follows is a fuller account of our findings, our methodology, and our thoughts on how best to extend these results in the future.

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Corporate Control Across the World

Gur Aminadav is a Finance & Research Advisor at the London Business School; and Elias Papaioannou is Professor of Economics at the London Business School and the Hal Varian Visiting Professor at MIT Department of Economics. The post is based on their recent article, forthcoming in the Journal of Finance.

Understanding the driving forces and consequences of the various types of corporate control are core inquiries of corporate finance. While most economics and legal theory distinguishes between widely-held corporations with dispersed ownership and controlled firms where a dominant shareholder exerts control, corporate structures are complex. Pyramids that allow shareholders to influence decisions over their cash-flow rights and cross-holdings of equity in business groups are pervasive. Moreover, ownership and control are often hidden behind shell companies incorporated in off-shore centers. Equity blocks—that entail some controlling rights—are commonplace, even in companies that most would coin as widely-held.

In a series of influential works Rafael La Porta, Florencio Lopez-de-Silanes, Andrei Shleifer and Robert Vishny (1997, 1998, 1999) tried to bridge economics and law research, compiling data on ownership concentration, corporate control, and legal protection of investors for a large number of countries. The subsequent voluminous literature on law and finance explores the role of the legal tradition, imposed by colonial powers, as well as corporate law, shareholder and creditor protection, securities legislation, and regulatory features on corporate control and finance (see La Porta, Lopez-de-Silanes, and Sheifer (2006) for an overview).

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Virtual Shareholder Meetings in the U.S

This post is based on an ISS Analytics publication by Marie Clara Buellingen, ISS Custom Research.

Key Findings

  • While overall the share of virtual annual meetings among Russell 3000 firms has increased to 7.7 percent, the number of new adopters has decreased in each of the last two years.
  • There does not seem to be a link between governance structure and company meeting format. Companies with virtual meetings appear no more likely to have poor governance provisions.
  • Similarly, the dissent levels on key voting items such as say-on-pay and director election appear to not vary materially for both physical and virtual meeting holders.
  • When adopting a new meeting format, companies and shareholders should evaluate key considerations to protect shareholder rights and address both concrete and perceived risks associated with a virtual meeting format.

Meeting format proliferation

Supporters of virtual shareholder meetings hail the benefits of giving more shareholders the opportunity to attend and actively participate in annual meetings, while reducing the cost to shareholders. Critics emphasize that the intangible benefits of in-person interaction could be lost, and that virtual meetings could also present problems with standard meeting procedures (such as presenting shareholder proposals). They argue that the virtual meeting format could give boards too much sway over the discussion and allow boards to avoid uncomfortable questions more easily.

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Clear and Unambiguous Terms of Merger Agreement

Jason M. Halper is partner, Jared Stanisci is special counsel, and Sara Bussiere is an associate at Cadwalader, Wickersham & Taft LLP. This post is based on a Cadwalader memorandum by Mr. Halper, Mr. Stanisci, Ms. Bussiere, William Mills, Nathan Bull, and Audrey Curtis 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 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.

The Delaware Court of Chancery’s recent decision, Genuine Parts Company v. Essendant Inc., [1] provides a helpful reminder that Delaware courts will enforce the clear and unambiguous terms of a merger agreement, and will consider contractual interpretation issues on a motion to dismiss when it finds the contractual terms to be clear and unambiguous. In Essendant, the Court denied the defendant’s motion to dismiss and found that: (i) Genuine Parts Company (“GPC”) adequately pled that the termination fee in the merger agreement was not the exclusive remedy for termination or a breach of the agreement; (ii) GPC did not waive its breach of contract claim by accepting the termination fee; and (iii) GPC pled sufficient facts to support a reasonably conceivable claim that the exclusivity provision in the merger agreement between the parties was a material term of the agreement which could be the basis for a breach of contract claim. This decision once again reinforces the need for parties to be mindful when negotiating and drafting a contract that contractual provisions reflect their understanding of the agreements they have made in the event of a breach or termination of the agreement. [2] In particular, Essendant cautions that contracting parties who want to limit recovery to the terms of the termination fee provision should carefully craft broad termination fee provisions that clearly and unambiguously state the parties’ intentions. Essendant also serves as a further reminder that a contractual party’s acceptance of a termination fee, absent specific contractual language to the contrary, will not preclude that party from pursuing a breach of contract claim. READ MORE »

Secondary Liability Risks for Private Funds—Recent Developments

Ari Berman and Tom Hill are partners and Cassie Lentchner is senior counsel at Pillsbury Winthrop Shaw Pittman LLP. This post is based on a Pillsbury memorandum by Mr. Berman, Mr. Hill, Ms. Lentchner, and Stephen Amdur.

Takeaways

  • Private funds continue to face heightened secondary liability risks arising from their portfolio investments.
  • The DOJ’s False Claims Act litigation against a private equity firm emphasizes the importance of pre-acquisition due diligence and robust compliance programs.

In an age of heightened litigation risk and a motivated Securities & Exchange Commission (SEC), private funds need to be increasingly mindful of secondary liability risks, especially when evaluating costs and benefits of potential portfolio company ownership structures. Given the uncertainties, firms must take steps to mitigate such risks—including documenting oversight, observing corporate formalities, ensuring the creation and implementation of strong internal controls, and adequately training professionals who serve as directors.

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The Role of the Creditor in Corporate Governance and Investor Stewardship

George S. Dallas is Policy Director at International Corporate Governance Network (ICGN). This post is based on an ICGN memorandum by Mr. Dallas.

As investor stewardship extends beyond equities it can be challenging for investors to consider how to adopt their stewardship practices to include fixed income and other asset classes. In the case of corporate fixed income part of this challenge lies in creditors not having formal ownership rights—as well as sometimes competing agendas with shareholders. Yet in many areas of corporate governance there can be a significant alignment of interests that supports engagement on behalf of all financial stakeholders, both creditors and shareholders.

In ICGN’s Global Stewardship Principles the role of the creditor is presented in the context of the “ecosystem” of stewardship. [1] In this context it is important to build understanding on the role of the creditor in corporate governance and to explore areas of commonality and difference with shareholders with regard to corporate governance matters. This can provide a framework for fixed income investors to factor governance related issues into investment analysis and stewardship activities.

As providers of risk capital, both creditors and shareholders are exposed to the residual risk of companies they invest in, and debt tends to be a permanent form of capital in most companies—even if individual debt issues are serviced and then reissued. Sustainable and healthy companies should seek to maintain positive relations with both creditors and shareholders to ensure cost effective access to both debt and equity capital. In turn, boards should ensure that company governance and capital allocation mechanisms reflect a fair and appropriate balancing of shareholder and creditor interests. Easier said than done?

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A Stakeholder Approach and Executive Compensation

Seymour Burchman and Mark Emanuel are Managing Directors at Semler Brossy Consulting Group, LLC. This post is based on their Semler Brossy publication. 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).

What does it mean for boards and compensation committees that 181 CEOs from the Business Roundtable amended a long-standing statement of corporate purpose last month? The CEOs declared that the purpose of companies is to serve their five key stakeholders—shareholders, customers, employees, suppliers, and the community, not shareholders alone.

In putting their signatures to that idea, these CEOs challenged the notion of shareholder primacy, a principle of business for the last fifty years. Not surprisingly, the Business Roundtable’s statement sparked a host of editorials in the business press, some arguing that the group had made a grievous error. Many writers seemed to suggest the choice is binary: You’re either with shareholders, or you’re not. The Business Roundtable, in contrast, implies the choice isn’t either/or. It’s both.

Rightly or wrongly, the question will now come up in many boardrooms and on many investor calls: What is being done to address the needs of all stakeholder groups? Some commentators may even point to academic research that shows a positive correlation between companies that promote the interests of stakeholders and better financial performance.

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Self-Driving Corporations?

John Armour is Professor of Law and Finance and Horst Eidenmueller is the Freshfields Professor of Commercial Law, both at the Faculty of Law at the University of Oxford. This post is based on their recent paper.

In a recent essay, we explore the implications of artificial intelligence (AI) for corporate law. Today, corporate law is primarily understood as a means of facilitating productive activity in business firms. On this view, it is a predominantly private endeavor, concerned with helping parties to lower the costs they encounter. Much of “core corporate law” can hence be explained as responses to agency and coordination problems arising between investors and managers. As a corollary, the impact of business activity on society at large is typically treated as outside the remit of core corporate law, in line with the theory that regulatory norms should apply equally to all actors, corporations or otherwise.

To what extent will AI change the regnant account of corporate law? The standard account is functional in its orientation; that is, it is premised on a social-scientific analysis of what actually happens in a business firm. The starting point for our inquiry is therefore to ask how AI will affect the activities of firms. As a preliminary step, we begin with a clear account of what is technically possible. The next step is then to apply standard analytic tools from social science—the economics of business organization—to explore the likely impact of these innovations on business practice. With a model of business practice in mind, we can begin to visualize how corporate law may be affected.

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Shareholder Activism and Governance in France

Adam O. Emmerich, Sabastian V. Niles, and John L. Robinson are partners at Wachtell, Lipton, Rosen & Katz. The following post is based on a Wachtell Lipton memorandum by Mr. Emmerich, Mr. Niles, Mr. Robinson, and Theodore N. Mirvis. Related research from the Program on Corporate Governance includes Against All Odds: Hedge Fund Activism in Controlled Companies by Kobi Kastiel.

The Finance Commission of the French National Assembly has announced a report that will recommend reforms to French securities market regulations to address shareholder activism and market transparency. The report’s recommendations focus on responding to the excesses of activists in the French market with enhanced disclosure, reduced asymmetry of regulation between activist investors and French public companies and enhanced regulations with respect to short selling.

Notably, the recommendations include reducing the threshold for disclosure of equity ownership (including derivatives and other synthetic ownership) from 5% to 3%. The report also recommends enhanced regulation of short trading (including negatively correlated instruments and arrangements) in excess of certain volume limits and increasing the powers of the French market regulator, the Autorité des marchés financiers (AMF), to enable it to respond more swiftly and effectively to market abuses.

We have in the past called for, and reported on proposed, changes to the U.S. disclosure requirements with respect to securities ownership and the regulation of short trading, which presents unique risks to market integrity. This is something that has interested U.S. market participants, legislators and regulators for a long time, but as to which little change has been made in the United States. We are encouraged to see other countries taking these risks seriously and taking steps to address them.

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