Monthly Archives: December 2019

Corporate Purpose in Play: The Role of ESG Investing

John Gerard Ruggie is the Berthold Beitz Research Professor in Human Rights and International Affairs at Harvard Kennedy School. This post is based on his recent book chapter, forthcoming in “Sustainable Investing: A Path to a New Horizon”, Routledge. 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 19, 2019, the U.S. Business Roundtable (BR), comprising the CEOs of more than 200 of America’s largest corporations, issued a new mission statement on “the purpose of a corporation” (BR, 2019a). The press release noted that each periodic update on principles of corporate governance since 1997 had endorsed the principle of maximizing shareholder value. In contrast, the new statement commits signatory CEOs “to lead their companies for the benefit of all stakeholders—customers, employees, suppliers, communities and shareholders.” “[Milton] Friedman must be turning in his grave,” a Fortune magazine article declared.

Such shifts are not unprecedented. Indeed, Friedman bore significant intellectual responsibility for the last one. William Allen, a highly regarded former Chancellor of the Delaware Court of Chancery, authored an essay some years ago entitled “Our Schizophrenic Conception of the Business Corporation.” Allen’s thesis was that over the course of the twentieth century there were two quite different and inconsistent ways to conceptualize the public corporation and legitimate its power. I will call them the property conception and the social entity conception.” By the property conception he meant that the corporation is literally seen—in the literature and in the courts—as the property of the individuals who constitute the firm. That made perfect sense, Allen affirmed, when the main players actually were a limited number of natural persons who had come together for the purpose of capital formation. It began to make less sense, he states, as the scale and scope of the modern corporation grew massively, requiring distinctive management skills and risk sharing through widely dispersed stock holdings.


Preparing for the 2020 Reporting Season

Douglas Schnell, Lisa Stimmell, and Jose Macias are partners at Wilson Sonsini Goodrich & Rosati. This post is based on a Wilson Sonsini memorandum by Mr. Schnell, Ms. Stimmell, Mr. Macias, John Aguirre, and Courtney Mathes.

With the 2020 reporting season just around the corner, there are several compliance “musts” to focus on, as well as items that can be addressed in the remainder of 2019 to make 2020 a little easier.

Several broader themes from prior years will continue into the 2020 proxy season, together with some new areas of focus and new rules that will be applicable for Annual Reports on Form 10-K and proxy statements filed in 2020. Several themes that have emerged over the past several reporting cycles—including an increased focus on effective disclosure and analysis in the Form 10-K and proxy statement, as well as the ongoing need for effective shareholder engagement—will continue into 2020.


Purpose, Stakeholders, ESG and Sustainable Long-Term Investment

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.

This year, each of the major index fund managers, the Business Roundtable, the British Academy, the UK Financial Reporting Council, the World Economic Forum and a number of other organizations (both governmental and nongovernmental) announced that they did not support shareholder primacy and do support sustainable long-term investment and considering ESG matters. However, the initial reaction of the Council of Institutional Investors in denouncing the BRT position from both an economic and legal standpoint, although quickly moderated, has continued to echo in Wall Street trading rooms, at activist hedge funds and in corporate boardrooms. I continue to hear that the shareholders own the corporation and therefore can order the directors to maximize value solely for the shareholders. I also continue to hear that since the shareholders elect the directors, the directors have a primary fiduciary duty to the shareholders. Lastly, I continue to hear from some quarters of academia that economic theory and financial statistics “prove” that shareholder primacy and its concomitant short-termism best serve the economy and are critical elements of capitalism.


Controlling Shareholders in the Twenty-First Century: Complicating Corporate Governance Beyond Agency Costs

Mariana Pargendler is Professor of Law at Fundação Getulio Vargas Law School at São Paulo. This post is based on a recent paper by Professor Pargendler, forthcoming in the Journal of Corporation Law. Related research from the Program on Corporate Governance includes The Perils of Small-Minority Controllers (discussed on the Forum here) and The Untenable Case for Perpetual Dual-Class Stock (discussed on the Forum here), both by Lucian Bebchuk and Kobi Kastiel; and Independent Directors and Controlling Shareholders  (discussed on the Forum here); and The Elusive Quest for Global Governance Standards, both by Lucian Bebchuk and Assaf Hamdani.

By the end of the twentieth century, the then-dominant literature on “law and finance” assumed that concentrated ownership was a product of deficient legal systems that did not sufficiently protect outside investors. At the same time, commentators posited that the competitive pressures of economic globalization would push countries around the world to adopt an efficient regime of strong investor protection, which was thought to facilitate ownership dispersion. Nevertheless, at the dawn of the 2020s, ownership concentration not only persists, but appears to be on the rise among the world’s largest companies. As of 2015, there was only one controlled company under a single-class structure (Walmart) among the world’s ten largest firms by market capitalization. By 2019, four of the top ten first in the globe are controlled companies with dual-class shares (Alphabet, Facebook, Alibaba, and Berkshire Hathaway). Moreover, Amazon is a borderline case, with founder Jeff Bezos holding a sizable equity stake and outsize influence in the company.


Letter Concerning PCAOB Staff Guidance: Communications With Audit Committees Concerning Independence

Barbara Roper is Director of Investor Protection at the Consumer Federation of America. This post is based on a letter by the Consumer Federation of America, AFL-CIO, Better Markets, Center for American Progress, and Americans for Financial Reform to the SEC Chairman Jay Clayton from Ms. Roper; Brandon J. Rees, Deputy Director, Corporations and Capital Markets at the AFL-CIO; Lev Bagramian, Senior Securities Policy Advisor at Better Markets; Andy Green, Managing Director, Economic Policy at the Center for American Progress; and Marcus Stanley, Policy Director at Americans for Financial Reform.

We are writing to express our grave concerns regarding PCAOB staff guidance on Rule 3526(b), Communications with Audit Committees Concerning Independence, which was published earlier this year. The faulty interpretation of the rules contained in this staff guidance would both undermine auditor independence and deceive the investing public by permitting firms to claim an audit was independent and conducted in accordance with PCAOB standards even when violations of the auditor independence rules occurred. We therefore urge you to require the PCAOB to withdraw this guidance immediately and to affirm that the position adopted by PCAOB in this guidance is inconsistent with SEC policy and federal securities laws.

The independence of public company audits is what gives them value. It is what allows investors to rely on companies’ financial statements as accurate and reliable when making investment decisions. As such, auditor independence is critical to both the integrity and the efficiency of our capital markets. Recognizing the central importance of auditor independence, PCAOB Rule 3520 requires an audit firm and its associated persons to maintain their independence throughout the audit and professional engagement period, by satisfying the independence criteria of both the SEC and the PCAOB.


Wake Up Call for Corporate Leaders

Lex Suvanto is Global Managing Director, Financial Communications & Capital Markets and David Carey is Senior Content Advisor at Edelman This post is based on an Edelman memorandum by Mr. Suvanto, Mr. Carey, Laurie Hays, and Josh Hochberg. 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).

What it takes for public companies to pass muster with major investors is changing. Until recently, a laser-like focus on maximizing shareholder returns was singularly paramount. No longer.

A new set of guiding principles, initially set forth in an August statement from the Business Roundtable and reinforced in our survey findings, is gaining acceptance.

Today, stock performance and financial returns are increasingly joined by a new set of investment criteria for leading institutional investors. To measure up, most investors agree, companies must address the needs of a wide range of stakeholders and must implement effective environmental, social-impact and governance (ESG) practices.


Debt Buybacks and the Myth of Creditor Power

Yesha Yadav is Professor of Law at Vanderbilt Law School. This post is based on a recent paper by Professor Yadav.

In Debt Buybacks the Myth of Creditor Control, I argue that regulation fails to protect bondholders in the context of a debt buyback—when issuers repurchase outstanding claims with a view to extinguishing these claims from their books. Share buybacks have long constituted rich fodder for researchers, regulators and politicians opining on how these transactions impact investor protection, managerial behavior and national economic growth. By contrast, commentators have paid near negligible attention to debt buybacks despite their ability to radically and rapidly re-shape the bargain between an issuer and entire swath of creditors. A back-of-the-lope calculation suggests that issuers have repurchased around $1.9 trillion worth of debt between 2004-2017. A slew of corporate heavyweights like Kohl’s, Macy’s Verizon, Albertsons and SoftBank have sought to deal with their shaky piles of debt—and the problematic covenants often attaching to them—by looking to buy back billions of dollars in bond and bank claims. Where an issuer can repurchase this debt when it is trading at a discount to par value, the borrower can de-lever while also booking a notional gain on its books. Perhaps most importantly for some firms, debt buybacks—accompanied by solicitations of consent from bondholders—can strip away unwanted creditor control rights, freeing the debtor up to take on more debt, conclude mergers/acquisitions or preemptively escape likely future violations of bond indenture terms and the resulting ire of investors.


2019 Year-End Issues for Audit Committees

Steve W. Klemash is Americas Leader, Jennifer Lee is Senior Manager, and Fiona Burgess is Assistant Director at the EY Center for Board Matters. This post is based on their EY memorandum.


In this 2019 edition of our annual review of issues affecting audit committees during the year-end audit cycle, we summarize key developments for audit committees to consider. The audit committee role grows more demanding and complex amid fast-paced change, and this report will assist audit committees as they proactively address recent and upcoming developments in financial reporting, tax, the regulatory landscape and risk management.

Financial reporting

The Securities and Exchange Commission (SEC) staff has remained focused on ensuring financial reporting and disclosure reflect a changing business environment. Revenue recognition was the most frequent area of comment. This is consistently an area receiving significant comment which was anticipated this year as a result of the adoption of the Accounting Standards Codification (ASC) 606 (Revenue from contracts with customers). Revenue recognition comments were primarily focused on:


Shareholder Activism and Proxy Contests as a “Proper Purpose” for Books and Records Demands

Gail Weinstein is senior counsel and Steven Epstein and Warren S. de Wied are partners at Fried, Frank, Harris, Shriver & Jacobson LLP. This post is based on a Fried Frank memorandum by Ms. Weinstein, Mr. Epstein, Mr. de Wied, Brian T. Mangino, David L. Shaw, and Randi Lally. Related research from the Program on Corporate Governance includes Dancing with Activists by Lucian Bebchuk, Alon Brav, Wei Jiang, and Thomas Keusch (discussed on the Forum here).

The Occidental-Anadarko merger closed in August 2019 after Occidental Petroleum Inc. outbid Chevron Corporation and broke up Chevron’s deal to acquire Anadarko Inc. Entities affiliated with shareholder activist Carl Icahn (the “Icahn Entities”) began to acquire stock in Occidental during the bidding war and then advocated against the Anadarko deal, contending that Occidental (i) was vastly overpaying and (ii) had agreed to expensive financing as a byproduct of restructuring the deal to avoid an Occidental stockholder vote (by limiting the number of Occidental shares to be issued in the merger and thus maximizing the portion of the merger consideration that had to be paid in cash). Given that there was no Occidental stockholder vote on the merger, the Icahn Entities are now planning a post-closing proxy contest to take control of Occidental’s board.

The Icahn Entities filed a lawsuit to compel Occidental to permit them, under DGCL Section 220, to inspect Occidental’s books and records for the purpose of obtaining information material to their communicating with the other stockholders in the proxy contest about the merger and the related financing. In High River Limited Partnership v. Occidental Petroleum Inc. (Nov. 14, 2019), the Delaware Court of Chancery rejected the demand and held that facilitating the prosecution of a proxy contest is not a “proper purpose” for a Section 220 demand where the stockholder simply “disagreed” with board decisions and is not alleging that the board engaged in legally actionable misconduct.


Representation & Warranty Insurance—Current Market Trends

Kevin Mills and Alfred Browne are partners, and Michael Coburn is an associate at Cooley LLP. This post is based on a Cooley memorandum by Messrs. Mills, Browne, Coburn, Heidi Lawson, and Ben Beerle.

Over the last decade the use of R&W insurance in merger and acquisition transactions has grown exponentially. From 2008 to 2018, the total R&W policies bound per year in North America rose from 40 deals, providing $541 million of coverage to 1500+ R&W insurance transactions, providing aggregate coverage of $38.6 billion. [1] We are also seeing a marked increase in the percentage of deals where R&W insurance is being considered and being used. Aon estimates that over 45% of all private M&A transactions in North America had R&W insurance in 2018. [2]

Publicly reported deals also reflect increasing utilization of R&W insurance for transactions ranging in size from $35 million to $21.4 billion. [3] Based on our own experience, for the first time, both strategic and financial parties in almost every deal over $30 million are at least considering the use of R&W insurance. We are also seeing an increase in “no seller indemnity deals”, which Aon estimates to have increased from 12% to 26% of all R&W insurance deals from 2016 to 2018 and, if our experience this year is consistent with that of the broader market, we think those numbers will be even higher for 2019.


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