Yearly Archives: 2019

Corporate Governance by Index Exclusion

Posted by Scott Hirst (Boston University) and Kobi Kastiel (Tel Aviv University), on
Wednesday, June 12, 2019
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Scott Hirst is an Associate Professor of Law at the Boston University School of Law, and Director of Institutional Investor Research at the Harvard Law School Program on Corporate Governance. Kobi Kastiel is Assistant Professor of Law at Tel Aviv University, and a Research Fellow at the Harvard Law School Program on Corporate Governance. 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 Untenable Case for Perpetual Dual-Class Stock (discussed on the Forum here), and The Perils of Small-Minority Controllers (discussed on the Forum here), both by Lucian Bebchuk and Kobi Kastiel, and the keynote presentation on The Lifecycle Theory of Dual-Class Structures.

Investors have long been unhappy with certain governance arrangements adopted by companies undertaking IPOs, such as dual-class voting structures. Traditional sources of corporate governance rules—the Securities and Exchange Commission, state law, and exchange listing rules—do not constrain these arrangements. As a result, investors have turned to a new source of governance rules: index providers.

Our recent article, forthcoming in the Boston University Law Review, provides a comprehensive analysis of index exclusion rules, their likely effects on insider decision-making, and their ability to serve as investors’ new gatekeepers. We show that efforts to portray index providers as the new sheriffs of the U.S. capital markets are overstated. Index providers face complex and conflicting interests, which make them reluctant regulators, at best. This reluctance to regulate is clearly reflected in the dual-class exclusion rules they adopted. We also analyze, theoretically and empirically, the efficacy of index exclusions in preventing disfavored arrangements and show that their efficacy is likely to be limited, but not zero (as some scholars argue). We conclude by examining the lessons from this important experiment and the way forward for corporate governance.

A more detailed overview of our analysis follows:

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What’s New on the SEC’s new RegFlex Agenda?

Posted by Cydney Posner, Cooley LLP, on
Wednesday, June 12, 2019
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Cydney S. Posner is special counsel at Cooley LLP. This post is based on a Cooley memorandum by Ms. Posner.

SEC Chair Jay Clayton has repeatedly made a point of his intent to take the Regulatory Flexibility Act Agenda “seriously,” streamlining it to show what the SEC actually expected to take up in the subsequent period. (Clayton has previously said that the short-term agenda signifies rulemakings that the SEC actually planned to pursue in the following twelve months. See this PubCo post and this PubCo post.) The SEC’s Spring 2019 short-term and long-term agendas have now been posted, reflecting the Chair’s priorities as of March 18, when the agenda was compiled. What stands out is not so much the matters that show up on the short-term agenda—although there are plenty of significant proposals to keep us all busy—but rather the legislatively mandated items that have taken up protracted residency on the long-term (i.e., the maybe never) agenda.

On the short-term agenda:

Extending the Testing the Waters Provision to Non-Emerging Growth Companies—Corp Fin is considering recommending that the SEC adopt amendments to extend the test-the-waters provision to non-emerging growth companies. These amendments were proposed in February and are now considered to be in the final rule stage. New Rule 163B would allow a company (and its authorized representatives, including underwriters) to engage in oral or written communications, either prior to or following the filing of a registration statement, with potential investors that are, or are reasonably believed to be, qualified institutional buyers (QIBs) or institutional accredited investors to determine whether they might be interested in the contemplated registered offering. The proposed new rule was designed to allow the company to gauge market interest in the deal before committing to the time-consuming prospectus drafting and SEC review process or incurring many of the costs associated with an offering. (See this PubCo post.)

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Help! I Settled With an Activist!

Posted by Kai Haakon E. Liekefett and Leonard Wood, Sidley Austin LLP, on
Tuesday, June 11, 2019
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Kai Haakon E. Liekefett is a partner and Leonard Wood is an associate at Sidley Austin LLP. This post is based on their recent publication in the 2019 Spring Edition of Ethical Boardroom. Related research from the Program on Corporate Governance includes The Long-Term Effects of Hedge Fund Activism by Lucian Bebchuk, Alon Brav, and Wei Jiang (discussed on the Forum here); Dancing with Activists by Lucian Bebchuk, Alon Brav, Wei Jiang, and Thomas Keusch (discussed on the Forum here); and Who Bleeds When the Wolves Bite? A Flesh-and-Blood Perspective on Hedge Fund Activism and Our Strange Corporate Governance System by Leo E. Strine, Jr. (discussed on the Forum here).

Public companies in the US and around the world are increasingly signing settlement agreements as a means to put shareholder activist campaigns to rest.

While companies are allured by the prospect of a quick end to the public side of an activist campaign, settlement agreements often invite new disruptions inside the boardroom and interrupt a board’s ability to concentrate on executing a long-term strategy. Moreover, settlement agreements are of increasingly shorter duration, meaning that the peace boards bargained for often becomes merely a fleeting respite from what is, in fact, a multi-year campaign of the activist.

The anatomy of a settlement agreement

At first sight, settlement agreements with activists have much to offer. The downside for the incumbent board is nearly always that one or more activist designees will join the board, often immediately. If the activist had leverage in the negotiations, it will have successfully pushed for “replacement rights”—the right of the activist to designate a replacement for any of its designees on the board who leave for ostensibly unforeseen reasons. Replacement rights create the possibility that an activist can replace a “good cop” that it first designated to the board with a “bad cop” who will push his or her agenda harder in the boardroom. Often, the activist designees are principals or employees of the activist fund. Regularly, settlement agreements provide that activist designees on the board will occupy seats on key committees.

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CFO Gender and Financial Statement Irregularities

Posted by Vishal Gupta (University of Alabama) and Sandra Mortal (University of Alabama), on
Tuesday, June 11, 2019
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Vishal Gupta is associate professor and Sandra Mortal is associate professor of Economics, Finance, & Legal Studies at the University of Alabama Culverhouse College of Commerce. This post is based on an article, forthcoming in Academy of Management Journal, by Professor Gupta; Professor Mortal; Bidisha Chakrabarty, Edward Jones Endowed Professor of Finance at St. Louis University; Xiaohu Guo, PhD Candidate in Finance at The University of Alabama; and Daniel B. Turban, Emma S. Hibbs/Harry Gunnison Brown Chair of Business and Economics at the University of Missouri.

Our research examines whether CFO gender affects the likelihood of irregularities in a firm’s financial statements. In the current climate of increased focus on women leaders, especially in corporate positions, an intriguing question of academic and popular interest is whether male and female managers are associated with different firm decisions and behaviors. We examine this in the context of financial statements, which are an important part of the firm’s communications with its stakeholders. Because information presented in financial statements informs the investment decisions of capital market participants, the accuracy of said statements is critical to the effective functioning of the economy. Unfortunately, irregularities in financial statements are commonplace, with some estimates suggesting that at least 5% of the annual revenues of US-based firms are lost to fraud.

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EVA, Not EBITDA: A Better Measure of Investment Value

Posted by Bennett Stewart, Institutional Shareholder Services, Inc., on
Tuesday, June 11, 2019
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Bennett Stewart is a Senior Advisor at Institutional Shareholder Services, Inc. This post is based on his ISS memorandum.

There’s no doubting the popularity of EBITDA—earnings before interest taxes depreciation and amortization—as a measure of investment value. Analysts like EBITDA because it removes the vagaries of depreciation and taxes and is unaffected by company leverage ratios. EBITDA is certainly a useful indicator of the gross cash operating profit performance of a business. But is it a reliable way to measure the value of a company?

The short answer is, no, not at all. EBITDA is far less correlated to market value than is commonly thought, and it is riddled with omissions and distortions that make it a highly unreliable guide to how well a company is performing. There also is a much better valuation and performance assessment metric, so much better that investment managers should consider adopting it to replace—or at a minimum, augment—EBITDA in their equity evaluation processes.

In this post, we explore the shortcomings of EBITDA by comparing it with EVA (Economic Value Added), which measures a firm’s true economic profit after deducting a full, weighted-average cost-of-capital interest charge on the net assets used in the business.

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Climate Change Risk Oversight Framework for Directors

Posted by Rakhi Kumar, State Street Global Advisors, on
Monday, June 10, 2019
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Rakhi Kumar is Senior Managing Director and Head of ESG Investments and Asset Stewardship at State Street Global Advisors. 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).

Key Takeaways

  • The COP21 Paris Climate Accord signals the turning point of a global effort to address climate change. As nations begin to pursue their emission reduction strategies, directors should evaluate the climate-related risks facing their companies.
  • State Street Global Advisors believes that boards should regard climate change as they would any other significant risk to the business and ensure that a company’s assets and its long-term business strategy are resilient to the impacts of climate change.
  • State Street Global Advisors has developed a framework to help directors evaluate potential climate-related risks that may impact companies within a sector.
  • The three primary climate-related risks we have identified are physical risk, regulatory risk and economic risk.
  • Climate change will continue to be a priority for our asset stewardship and company engagement program in 2016 as we seek to promote effective environmental and sustainability practices and better company performance on behalf of our clients and other stakeholders.
  • Our guidance for directors is based on over 160 climate-related engagements we have had with companies over the past three years.

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Board Diversity by Term Limits?

Posted by Yaron Nili (University of Wisconsin) and Darren Rosenblum (Pace University), on
Monday, June 10, 2019
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Yaron Nili is Assistant Professor of Law at the University of Wisconsin-Madison Law School; and Darren Rosenblum is Professor of Law at Pace University Elisabeth Haub School of Law. This post is based on their recent article, forthcoming in the Alabama Law Review.

Gender diversity in the U.S. corporate world is shockingly low. As The New York Times reported, fewer women run large corporations than CEOs named John. Boardrooms also lack diversity. While 86% of directors participating in PwC’s annual director survey stated they felt that women should comprise between 21% and 50% of the board, only 28% of Russell 3000 boards have more than one-fifth of their board comprised of women. Some U.S. boards do not even try to include women: 76 of the largest 1,500 Russell 3000 companies have not had any female directors in the past decade.

The investor community has made board diversity a recent point of emphasis. State Street, Vanguard, and Blackrock have all voiced their commitment to gender diversity, followed by recent support from proxy advisors. California has ventured even further, passing legislation that mandates specific quotas for women on Californian corporations. New Jersey and Illinois may soon follow suit. Diversity mandates, however, confront substantial legal, economic and societal challenges.

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New DOJ Compliance Program Guidance

Posted by John Nassikas, John Tan, and Lindsey Carson, Arnold & Porter Kaye Scholer LLP, on
Monday, June 10, 2019
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John Nassikas and John Tan are partners and Lindsey Carson is senior associate at Arnold & Porter Kaye Scholer LLP. This post is based on an Arnold & Porter memorandum by Mr. Nassikas, Mr. Tan, Ms. Carson, Douglas F. Curtis, Mahnu V. Davar, and Wilson D. Mudge.

On April 30, 2019, the Department of Justice (DOJ) Criminal Division published new guidance for corporate compliance programs. The new guidance (Updated Compliance Guidance) updates a prior guidance document providing factors that prosecutors should consider when evaluating the effectiveness of compliance programs for determining how to prosecute or resolve corporate criminal enforcement actions. Compliance program effectiveness is a key variable DOJ takes into consideration when (1) making charging decisions and exercising prosecutorial discretion; (2) making sentencing recommendations, including calculating recommended fines; and (3) deciding whether to impose reporting requirements or appoint an outside compliance monitor as part of a corporate resolution. The Updated Compliance Guidance provides useful additional insights into prosecutors’ assessment criteria when making such decisions.

Expansion on the 2017 Compliance Guidance

The new guidance, entitled: “Evaluation of Corporate Compliance Programs,” updates and expands a prior version that the Criminal Division’s Fraud Section released in February 2017 (2017 Compliance Guidance).

While the Updated Compliance Guidance incorporates and addresses the same general issues and topics as the 2017 Compliance Guidance, the new document provides additional factors, in the form of questions, that prosecutors may consider when assessing cases, and an overall framework for that evaluation.

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Ten Years of Say-on-Pay Data

Posted by Terry Newth and Dean Chaffee, Pearl Meyer & Partners, LLC, on
Sunday, June 9, 2019
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Terry Newth is a managing director and Dean Chaffee is a consultant at Pearl Meyer & Partners, LLC. This post is based on their Pearl Meyer memorandum.

We researched 10 years of say-on-pay proxy advisory recommendations and results to understand how common it has been for a company to receive an “Against” vote recommendation or low say-on-pay support in a given year. The results are illuminating; more than 40% of Russell 3000 companies have received an “Against” vote recommendation from ISS, and almost half have received low say-on-pay support. The trend also suggests that these percentages will continue to increase each year.

Therefore, we believe companies would be well served to conduct regular, proactive stockholder outreach and engagement to mitigate the impact of a future negative vote recommendation.

The end of 2018 marked the 10-year anniversary of mandatory say-on-pay (SOP). Admittedly, the first two years were limited to financial institutions that received capital under the Troubled Asset Relief Program (TARP), but nonetheless this is an opportune time to evaluate how things have transpired over the past decade.

Say-on-pay first entered corporate America when, in early 2009, Treasury Secretary Timothy Geithner stated that recipient banks of TARP relief must hold SOP votes. By 2011, a vast majority of public companies across all industries became subject to these votes, triggered by President Obama’s signing of The Dodd-Frank Wall Street Reform and Consumer Protection Act on July 21, 2010. Today, SOP votes are as routine as the annual meetings in which they take place.

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A New Era of Extraterritorial SEC Enforcement Actions

Posted by Joshua D. Roth and Alexander R. Weiner, Fried, Frank, Harris, Shriver & Jacobson LLP., on
Sunday, June 9, 2019
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Joshua D. Roth is partner and Alexander R. Weiner is an associate at Fried, Frank, Harris, Shriver & Jacobson LLP. This post is based on their Fried Frank memorandum and is based on their article, recently published in the Banking Law Journal.

In a recent decision, U.S. Securities and Exchange Commission v. Scoville, the United States Court of Appeals for the Tenth Circuit became the first Circuit Court to opine on the scope of the SEC’s extraterritorial enforcement authority under the Dodd-Frank Act. Departing from the United States Supreme Court’s 2010 opinion in Morrison v. National Australia Bank Ltd., the Tenth Circuit held that Congress, in enacting the Dodd-Frank Act, “affirmatively and unmistakably” expressed its intent to apply the SEC’s enforcement authority under Section 17(a) of the Securities Act of 1933 (“Section 17(a)”) and the antifraud provisions of the Securities and Exchange Act of 1934, including Section 10(b) (“Section 10(b)”), extraterritorially.

SEC v. Scoville expands the scope of the SEC’s enforcement authority beyond the limitations imposed by Morrison, returning to the so-called “conduct-and-effects” test to determine extraterritoriality. This departure creates uncertainty about the scope of the SEC’s enforcement authority and additional risk for foreign entities and individuals.

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