Yearly Archives: 2019

Incentive Pay and Systemic Risk

Posted by Rui A. Albuquerque (Boston College), Luis M. B. Cabral (New York University), and José Corrêa Guedes (Catholic University of Portugal), on
Thursday, March 21, 2019
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Rui Albuquerque is Associate Professor at Boston College Carroll School of Management; Luis M. B. Cabral is the Paganelli-Bull Professor of Economics and International Business at the New York University Stern School of Business; and José Corrêa Guedes is Professor at the Católica Lisbon School of Business & Economics at the Catholic University of Portugal. This post is based on their recent article, forthcoming in the Review of Financial Studies. 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).

The SEC, the NYSE, and the U.S. government, accompanied by the actions of consultants, such as the Institutional Shareholder Services, recently have pushed to create, by means of relative performance evaluation (RPE), a tighter link between CEO pay and the factors under CEO control. This paper addresses the consequences of RPE for firm investment decisions and systemic risk in an industry model.

We propose a novel channel through which CEO incentive pay may have an effect on systemic risk. We consider the implications of relative performance evaluation, a practice that emerges in the equilibrium of our industry model. We show that RPE allows for a better alignment of interests between shareholders and managers, thereby reducing agency costs and rendering firms more productive; but it also leads managers disproportionately to choose investments that are correlated across firms, thus increasing systemic risk.

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2018 Year-End Securities Litigation Update

Posted by Brian Lutz, Monica Loseman and Jefferson Bell, Gibson, Dunn & Crutcher LLP, on
Thursday, March 21, 2019
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Brian Lutz, Monica Loseman, and Jefferson Bell are partners at Gibson, Dunn & Crutcher LLP. This post is based on a Gibson Dunn memorandum by Mr. Lutz, Ms. Loseman, Mr. Bell, Mark Perry, Shireen Barday, and Michael Kahn.

2018 witnessed even more securities litigation filings than 2017, in which we saw a dramatic uptick in securities litigation as compared to previous years. This post highlights what you most need to know in securities litigation developments and trends for the latter half of 2018, including:

  • The Supreme Court heard oral argument in Lorenzo v. Securities and Exchange Commission, and is set to answer the question of whether a securities fraud claim premised on a false statement that was not “made” by the defendant can be pursued as a “fraudulent scheme” claim even though it would not be actionable as a Rule 10b-5(b) claim under Janus Capital Group, Inc. v. First Derivative Traders, 564 U.S. 135 (2011).
  • The Supreme Court granted the petition for writ of certiorari in Emulex Corp. v. Varjabedian to consider whether Section 14(e) of the Exchange Act supports an inferred private right of action based on negligent (as opposed to knowing or reckless) misstatements or omissions made in connection with a tender offer.
  • We discuss recent developments in Delaware law, including case law exploring, among other things, (1) appraisal rights, (2) the standard of review in controller transactions, (3) application of the Corwin doctrine, and (4) when a “Material Adverse Effect” permits termination of a merger agreement.
  • We review case law implementing the Supreme Court’s decisions in Omnicare and Halliburton II.
  • We review a decision from the Third Circuit regarding the obligation to disclose risk factors, and a decision from the Ninth Circuit regarding the utilization of judicial notice and the incorporation by reference doctrine at the motion to dismiss stage.

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The Unicorn IPO Report

Posted by Alyson Clabaugh and Rob Peters, Intelligize, Inc., on
Wednesday, March 20, 2019
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Alyson Clabaugh is a Senior Product Marketing Manager and Rob Peters is a Senior Director at Intelligize, Inc. This post is based on their Intelligize memorandum.

In the process of assembling our inaugural Unicorn IPO Report, we discovered something surprising. We set out to investigate “unicorn” companies, the modern reference to private companies with valuations exceeding $1 billion (our full criteria for what constitutes a unicorn company may be found in the Methodology section of this report). While the number of unicorns has been growing over time, they are named for their scarcity. And they remain rare indeed. As 2019 began, just over 300 of them existed in the world. [1]

There’s no question, then, that these are standout operations. Which is what makes our findings—drawn from data in the Intelligize SEC compliance platform—somewhat counterintuitive. One would expect the technology unicorns, like the unicorns of myth, to be wild and independent creatures. You could say that in resisting the IPO process for so long, many of them have embodied the unicorn’s mythological ability to resist capture or taming. And yet, our examination of unicorns that went public in recent years reveals that to an unexpected degree, these singular corporations demonstrate something of a herd mentality.

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Information Intermediary or De Facto Standard Setter?: Field Evidence on the Indirect and Direct Influence of Proxy Advisors

Posted by Christie Hayne (University of Illinois) and Marshall D. Vance (Virginia Tech), on
Wednesday, March 20, 2019
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Christie Hayne is Assistant Professor at University of Illinois at Urbana-Champaign Gies College of Business and Marshall D. Vance is Assistant Professor at the Virginia Tech Pamplin College of Business. This post is based on their recent article, forthcoming in the Journal of Accounting Research.

Proxy advisory firms (PAs) are considered important and useful by some and overbearing by others. On the one hand, PAs fill an information intermediary role by processing large amounts of information and providing voting recommendations to institutional investors on matters such as executive compensation and governance. On the other hand, critics contend that PAs have outsized influence on proxy voting outcomes, which potentially allows them to exert pressure on firms to adopt PAs’ preferred practices. While these views are not mutually exclusive, examining PAs’ role(s) is important for understanding executive compensation design. If PAs primarily serve as information intermediaries, their influence on compensation practices likely occurs only indirectly through their ability to facilitate investors’ monitoring through shareholder votes. If PAs can apply pressure on firms to adopt favored compensation practices, they may be able to directly influence compensation practices. In this latter case, the effect of PA influence depends on the quality of PA recommendations.

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S&P 1500 Pay-for-Performance Update: Strong Financials, Negative Shareholder Returns

Posted by Steve Kline, Chris Kozlowski, Paige Patton, Willis Towers Watson, on
Wednesday, March 20, 2019
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Steve Kline is a director, Chris Kozlowski is a consultant, and Paige Patton is a senior analyst at Willis Towers Watson. This post is based on their Willis Towers Watson 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).

Despite strong full-year 2018 financial results, shareholder returns were dampened by investor skepticism and potential headwinds heading into 2019. This trend is no surprise given our observations through the third quarter (see “S&P 1500 pay-for-performance update: Third quarter results beg the question, “Will 2018 be the high water mark for incentive payouts?” Executive Pay Matters, December 17, 2018).

Figure 1 compares S&P1500 results in 2018 with the prior two years. While financial results across the income statement, balance sheet and cash flows are generally better than in 2017, shareholder returns declined in the fourth quarter, losing five points in 2018 following consecutive years of double-digit shareholder returns.

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Keynote Remarks at the ICI Mutual Funds and Investment Management Conference

Posted by Elad L. Roisman, U.S. Securities and Exchange Commission, on
Tuesday, March 19, 2019
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Elad L. Roisman is a Commissioner at the U.S. Securities and Exchange Commission. The following post is based on Commissioner Roisman’s recent remarks at the ICI Mutual Funds and Investment Management Conference, available here. The views expressed in the post are those of Mr. Roisman and do not necessarily reflect those of the Securities and Exchange Commission, the other Commissioners, or the Staff.

I. Introduction

Thank you, Susan [Olson], for the kind introduction. I am excited to join you here and deliver my first formal speech as a Commissioner. It has been a little over six months since I started in my new role at the Securities and Exchange Commission (“SEC”), and I can still say that it’s a very surreal feeling. Not a day goes by when I do not think about how incredible an honor it is to serve the investing public. My path to this job has not been linear. But my experiences along the way—working in private practice as an attorney, at the parent public company of a large stock exchange, in the role of counsel to an SEC Commissioner, and on the staff of the Banking Committee in the U.S. Senate—have given me a broad view of the markets that the SEC regulates and a deep commitment to the agency’s mission. I mean this, truly: it is a privilege to be serving in my role.

Today, I will talk about the proxy process. But, before I segue into any substance, this is a good time for me to provide my first standard disclaimer: My views and remarks are my own, and do not necessarily represent those of the SEC or other Commissioners.

Last year, Chairman Jay Clayton announced that the Commission would review the existing SEC rules that govern the proxy system. [1] The staff held a roundtable that raised many issues in this area and invited public comment prior to and following the event. [2] Recently, the Chairman asked me to take the lead on the Commission’s efforts to consider improvements to the proxy process. I gladly accepted and feel honored to have this opportunity. [3]

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Private Contracting, Law and Finance

Posted by Graeme Acheson (University of Stirling), Gareth Campbell (Queen's University Belfast), and John Turner (Queen's University Belfast), on
Tuesday, March 19, 2019
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Graeme Acheson is Professor at the University of Stirling; Gareth Campbell is Professor at Queen’s University Belfast; and John Turner is Professor at Queen’s University Belfast. 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 “Antidirector Rights Index” Revisited by Holger Spamann.

The Law and Finance hypothesis remains one of the most controversial theories in financial economics. In its original form, it argued that countries with higher legal protections for shareholders had wider share ownership dispersion and larger stock markets. The initial theory has been extended to consider not only protections against director self-dealing, but also the role that a myriad of other laws may have on financial outcomes. However, there has also been substantial criticism of this hypothesis. Much of the debate has focused almost exclusively on recent data. This is surprising, given that law has evolved over such a long period of time, and the emphasis placed on legal origins. There has been little systematic study looking at when and how company law originated, nor at how it evolved to create the modern system.

In our article titled Private Contracting, Law and Finance, we take the Law and Finance hypothesis back to its origins, by conducting an extensive analysis of shareholder protections in Victorian Britain. Instead of looking at the protections afforded by statutory corporate law, we examine the protections provided to shareholders by nearly 500 companies in their charters or articles of association. We argue that the experience of Victorian Britain was, in some respects, largely consistent with the Law and Finance hypothesis. Shareholders did enjoy substantial rights, there were highly developed capital markets, and there was wide dispersion of ownership.

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Dual-Track Processes: How to Turbocharge Your Exit

Posted by Michal Berkner, Josh Kaufman, and James Foster, Cooley LLP, on
Tuesday, March 19, 2019
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Michal Berkner and Josh Kaufman partners and James Foster is an associate at Cooley LLP. This post is based on their Cooley memorandum. 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.

Exiting an investment is an inherently uncertain process. Even for a thriving business with a viable equity story, committed stakeholders and the right advisers, the final deal terms and valuation are typically guided by factors beyond a company’s control. These include prevailing market sentiment, current appetite for acquisitions in a particular sector and the political and economic environment, all of which can change well within a given transaction timetable. In the face of a global economic slowdown, ongoing trade wars, Brexit, heightened market volatility and other sources of uncertainty, it is becoming increasingly important to consider how deals can be run to maximize transaction certainty and achieve optimal valuation.

Pursuing a “dual-track” process involves preparing for an initial public offering at the same time as running a private M&A process, often through an auction. Relative to choosing a single exit strategy, a dual-track process tends to be more complicated and resource-intensive, while also posing some specific risks. However, if the right dynamic is created, a dual-track process can provide visibility of relative valuation and the benefit of optionality, maximizing the chance of securing the most favorable terms. Whether there’s a looming threat of a government shutdown or a sudden stock market sell-off, or the auction bids come in below expectations, the alternative track may present a superior exit option. A dual-track process reduces the possibility that the vagaries of the stock market and industry-specific dynamics will have a detrimental effect on the overall exit by opening the investment opportunity to public markets as well as financial and strategic investors, with each influenced by the others.

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The Short-Termism Thesis: Dogma vs. Reality

Posted by Charles Nathan and Kal Goldberg, Finsbury LLC, on
Monday, March 18, 2019
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Charles Nathan is Senior Advisor and Kal Goldberg is Partner at Finsbury LLC. This post is based on their Finsbury memorandum. 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); 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); Short-Termism and Capital Flows by Jesse Fried and Charles C. Y. Wang (discussed on the Forum here); and Stock Market Short-Termism’s Impact by Mark Roe (discussed on the Forum here).

The belief that short-termism (aka quarterly capitalism) in our capital markets and in the management of our public companies is seriously (many would say fatally) damaging our economy is so widely accepted it has become a veritable truism. Countless directors and CEOs, prominent institutional investors, leading business associations, renowned lawyers and judges, prestigious academics and think tanks and politicians of all ilk (including in at least one tweet, President Trump) regularly and passionately denounce short-termism and blame it for a myriad of actual and supposed short comings of our free market economy. In short, short-termism has achieved the sanctity of dogma—a belief system that is beyond doubt and beyond question.

One of the challenges of the short-termism thesis is identifying what it encompasses. Most versions of short-termism begin with a view that it is the result of investors’ increasingly frantic trading patterns and demands for immediate profits, measured on a quarterly basis. But the asserted consequences of short-termism—that is to say, the problems it creates that need solution—are not as uniform as the perceived cause.

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Where’s the Greenium?

Posted by David F. Larcker (Stanford University) and Edward M. Watts (Stanford University), on
Monday, March 18, 2019
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David F. Larcker is James Irvin Miller Professor of Accounting at Stanford Graduate School of Business and Edward Watts is a Ph.D. student at Stanford Graduate School of Business. This post is based on their recent paper.

Environmental, Social, and Governance (ESG) measurement, Corporate Social Responsibility (CSR) activities, and Socially Responsible Investing (SRI) are increasingly important research topics in both academic and professional areas. A question of primary importance in this area is whether ESG investments have value to investors beyond the normal expected risk and return attributes of a security. For instance, if investors are presented with a high-ESG and low-ESG security whose risk and returns are identical, would investors pay more for the high-ESG security?

In our study, we focus on U.S. municipal issuers as it provides a novel quasi-natural experiment in which to investigate this issue. Municipal issuers have been one of the largest issuers of “Green bonds.” From 2013 to 2017, over $23 billion of self-labeled Green bonds have been issued in municipal markets, for more than 2,500 individual securities. This provides an extensive sample of securities and issuers for our empirical tests.

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