Monthly Archives: April 2020

The Executive Pay Dilemma

Posted by Arthur H. Kohn, Caroline F. Hayday and Michael R. Marino, on
Thursday, April 30, 2020
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Arthur H. Kohn is a partner and Caroline Hayday is counsel at Cleary Gottlieb Steen & Hamilton LLP and Michael R. Marino is Managing Director at FW Cook. This post is based on their Cleary Gottlieb 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).

Executive pay in the midst of the pandemic presents an obvious dilemma. On the one hand, it would be a stretch to blame fairly management teams for most of the adverse financial performance that will stretch across a broad range of industries. On the other, they cannot escape the consequences either.

Consider that while stock values may bounce back for many companies in the reasonably short term, it is unlikely that business will quickly return to the status quo ante. In some industries, the markets for products and services may change permanently; in other industries, supply chain and inventory management may also be permanently affected. Not least, rank and file employees and other stakeholders across the economy will suffer. Many executives will take short-term salary cuts in recognition of the hardship, but that is a preliminary and largely symbolic step and compensation committees need to find the right overall balance between reward and respect for the economic environment.

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Institutional Investors’ Overboarding Policies for Directors

Posted by Krystal Berrini, Allie Rutherford, and Eric Sumberg, PJT Camberview, on
Thursday, April 30, 2020
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Krystal Berrini is Partner, Allie Rutherford is a Managing Director, and Eric Sumberg is a Director at PJT Camberview. This post is based on their PJT Camberview memorandum.

Over the past several years, large institutional investors have addressed their growing concerns about the demands of board service by adopting or strengthening policies on a director’s total number of board commitments. This trend has resulted in significant declines in vote support for some directors considered “overboarded” according to these new or tightened guidelines. In many instances, these investor policies are stricter than those of the major proxy advisors.

Heading into the 2020 proxy season, three institutional investors, State Street Global Advisors (SSGA), T. Rowe Price and AllianceBernstein, have tightened their director commitment policies. This follows similar actions by BlackRock in 2018 and Vanguard which adopted its first overboarding policy in April 2019. Vanguard subsequently modified its policy in early 2020 to allow some flexibility to consider company-specific facts and circumstances. As a result of these strengthened investor policies, non-executive directors who serve on more than four boards and CEOs (as well as NEOs for certain investors) who sit on more than one outside board can expect to see a decrease in support as compared to prior years.

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Executive Compensation Considerations in PIPE Transactions

Posted by Adam J. Shapiro and David E. Kahan, Wachtell, Lipton, Rosen & Katz, on
Thursday, April 30, 2020
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Adam J. Shapiro and David E. Kahan are partners at Wachtell, Lipton, Rosen & Katz. This post is based on their Wachtell Lipton publication.

As companies seek to shore up their balance sheets, we expect to see an increase in private investments in public companies (often referred to as “PIPEs”). This post outlines key issues with respect to executive compensation arrangements that may arise in connection with PIPE transactions.

Review Applicable Change of Control Provisions. Parties to a PIPE transaction should carefully review target company compensation arrangements to determine whether the investment may constitute a change of control, and whether it can be structured in a manner that would avoid that result.

Share Acquisitions. The acquisition of a specified percentage of a company’s stock or voting power (often 20% or 30%) is a common change of control trigger in executive compensation arrangements. However, the share acquisition prong frequently excludes from the change of control definition acquisitions directly from a company. Assuming a plan includes a “direct investment” exception, a typical PIPE transaction would not constitute a change of control for purposes of the applicable arrangement. It is worth noting that the NYSE and Nasdaq generally require shareholder approval of issuances of company securities representing more than 20% of a company’s outstanding shares or voting power and that navigating these requirements may present additional complexity.

Board Changes. If a PIPE transaction involves a sufficiently large stake, the investor may negotiate company board representation in connection with the transaction. Typically, the board composition prong of a change of control definition requires a change in the majority of the board that is not approved by the incumbent directors. Because a PIPE investor’s board designees will typically be approved by the incumbent board and are not likely to represent a change in a majority of the board, a PIPE transaction is unlikely to activate the board change prong of a change of control provision.

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Stakeholder Principles in the COVID Era

Posted by Klaus Schwab, Brian Moynihan, Feike Sijbesma and Jim Snabe, World Economic Forum, on
Wednesday, April 29, 2020
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Klaus Schwab is Founder and Executive Chairman of the World Economic Forum; Brian Moynihan is Chief Executive Officer of Bank of America; Feike Sijbesma is Honorary Chairman of Royal DSM; and Jim Snabel is Chairman of Siemens and Maersk. They are all members of the World Economic Forum Board of Trustees. This post is based on a letter by the World Economic Forum Board of Trustee Members, available here. Related research from the Program on Corporate Governance includes The Illusory Promise of Stakeholder Governance by Lucian A. Bebchuk and Roberto Tallarita (discussed on the Forum here) and Toward Fair and Sustainable Capitalism by Leo E. Strine, Jr (discussed on the Forum here).

The business community’s contribution: to be leaders of responsiveness and stewards of resilience

As business leaders, we are experiencing how profoundly the COVID-19 emergency is affecting the world. Our employees face health risks in their daily lives, and challenges in performing their jobs. Our ecosystem of suppliers and customers is under extreme pressure. By doing all we can to coordinate our work, we can ensure that our society and economy get through this crisis and we can mitigate its negative impact on all of our stakeholders.

We accept our responsibility to address these crises. The first priority is to win the war against coronavirus. We need to do that while doing all we can to help our stakeholders now and, at the same time, to avoid a prolonged economic impact in the future. We will continue to embody “stakeholder capitalism” and do all we can to help those who are affected, and help secure our common prosperity.

To this end, we endorse the following Stakeholder Principles in the COVID Era:

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Statement on Emerging Market Investments Disclosure and Financial Reporting Risks

Posted by Jay Clayton, U.S. Securities and Exchange Commission, on
Wednesday, April 29, 2020
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Jay Clayton is Chairman of the U.S. Securities and Exchange Commission. This post is based on a recent public statement issued by Mr. Clayton; PCAOB Chairman William D. Duhnke III; SEC Chief Accountant Sagar Teotia; SEC Division of Corporation Finance Director William Hinman; and SEC Division of Investment Management Director Dalia Blass. The views expressed in this post are those of Mr. Clayton, Mr. Duhnke, Mr. Teotia, Mr. Hinman, and Ms. Blass and do not necessarily reflect those of the Securities and Exchange Commission or its staff, the PCAOB, other PCAOB Board members, or its staff.

The PCAOB’s Inability to Inspect Audit Work Papers in China Continues

Introduction [1]

Over the past several decades, the portfolios of U.S. investors have become increasingly exposed to companies that are based in emerging markets [2] or that otherwise have significant operations in emerging markets. [3] This exposure includes investments in both U.S. issuers and foreign private issuers (“FPIs”) that are based in emerging markets or have significant operations in emerging markets. During this time, China has grown to be the largest emerging market economy and the world’s second largest economy. [4]

The SEC’s mission is threefold: protect our investors, preserve market integrity and facilitate capital formation. Ensuring that investors and other market participants have access to high-quality, reliable disclosure, including financial reporting, is at the core of our efforts to promote each of those objectives. This commitment to high-quality disclosure standards—including meaningful, principled oversight and enforcement—has long been a focus of the SEC and, since its inception, the PCAOB.

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COVID-19 and Corporate Governance: Key Issues for Public Company Directors

Posted by William Kucera, Jodi Simala, and Andrew Noreuil, Mayer Brown LLP, on
Wednesday, April 29, 2020
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William Kucera, Jodi Simala, and Andrew Noreuil are partners at Mayer Brown LLP. This post is based on a Mayer Brown memorandum by Mr. Kucera, Ms. Simala, Mr. Noreuil, Paul Chen, Debra Hoffman, and Cade Cross.

For almost all U.S. public companies, COVID-19 has created unique and very profound challenges. For the board of directors, which is charged with overseeing the short-term and long-term health of the corporation and its business prospects, navigating the COVID-19 crisis requires careful consideration of a range of issues under these unprecedented circumstances. This post outlines several corporate governance issues for directors to consider as their companies respond to the challenges and risks posed by the COVID-19 pandemic.

Monitoring and Oversight Responsibilities of Directors

As a general matter, directors of a Delaware corporation have a responsibility to oversee the business and affairs of the corporation, which requires that directors make a good faith effort to put in place a reasonable board-level system of monitoring and reporting. The Delaware courts, in a line of cases beginning with In re Caremark Int’l Inc. Derivative Litig., have found that a failure of director oversight would occur (1) if directors failed to implement any corporate reporting or information systems or controls or (2) if such a system or controls were implemented, the directors consciously failed to monitor or oversee the company’s operations, thus removing themselves from being informed of material risks or problems requiring their attention.

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Codetermination: A Poor Fit for U.S. Corporations

Posted by Jens Dammann (University of Texas) and Horst Eidenmueller (University of Oxford), on
Tuesday, April 28, 2020
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Jens Dammann is the Ben H. and Kitty King Powell Chair in Business and Commercial Law at the University of Texas at Austin School of Law and Horst Eidenmueller is a Statutory Professor for Commercial Law at the University of Oxford Faculty of Law. This post is based on their recent paper. Related research from the Program on Corporate Governance includes The Illusory Promise of Stakeholder Governance by Lucian A. Bebchuk and Roberto Tallarita (discussed on the Forum here) and Toward Fair and Sustainable Capitalism by Leo E. Strine, Jr (discussed on the Forum here).

The idea that corporations should be managed primarily in the best interest of shareholders has long had its critics. However, the practical relevance of that debate has remained limited for decades. As long as shareholders retain the right to select corporate managers, corporations will ultimately be managed in their interest. Moreover, there is little reason to believe that the commitment to shareholder wealth maximization has weakened. On the contrary, over the last decades, the rise of institutional investors and legal reforms such as say-on-pay or proxy-access have arguably increased shareholders’ power over corporations.

Now, however, important voices are calling for a fundamental shift away from the shareholder primacy model and towards a more stakeholder-oriented approach to corporate governance. Two of the most influential figures on the political left, Senator Elizabeth Warren of Massachusetts and Senator Bernie Sanders of Vermont, have put forth proposals that would allow the employees of large corporations to elect 40% or even 45% of all corporate directors. These proposals essentially build on the German system of codetermination, in which employees of large companies can elect one-third or one-half of all board members, depending on the size of the company.

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Impact of COVID-19 on Executive and Director Compensation

Posted by Kathryn Neel, Olivia Voorhis, and Jake Giordano, Semler Brossy, on
Tuesday, April 28, 2020
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Kathryn Neel is a managing director, Olivia Voorhis is a senior associate, and Jacob Giordano is an associate at Semler Brossy Consulting Group, LLC. This post is based on their Semler Brossy memorandum

As the COVID-19 pandemic and stay at home orders continue to change the way we live, work, and spend, corporations have been forced to continue evolving in response. Without an obvious rebound in consumer spending in sight, workforce reductions and furloughs are an unfortunate but necessary tactic to help companies weather the drought. The impacts of dramatic shifts in consumer behavior have not been felt evenly across sectors, however, with discretionary spending—and spending related to travel and leisure—hit hardest, while necessities like consumer staples and utilities have either remained unaffected or rebounded from March lows.

As the pandemic endures, companies have continued to enact pay cuts for company leadership to demonstrate solidarity. Semler Brossy has been tracking executive and director pay actions among Russell 3000 companies announced since early March in response to the pandemic. For the week beginning April 12, 50 companies have been added to the list of identified pay actions impacting executives and/or non-employee directors, bringing our total sample to date to 296 companies, approximately 10% of the entire Russell 3000. In this volume, we take a closer look at Consumer Discretionary and Industrials companies, the two highest represented sectors in the sample.

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Addressing Underwater Stock Options and Stock Appreciation Rights Amidst COVID-19

Posted by Kyoko Takahashi Lin and David Mollo-Christensen, Davis Polk & Wardwell LLP, on
Tuesday, April 28, 2020
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Kyoko Takahashi Lin is partner and David Mollo-Christensen is counsel at Davis Polk & Wardwell LLP. This post is based on a Davis Polk memorandum.

The coronavirus (COVID-19) pandemic and the ensuing market uncertainty, as well as recently enacted legislation, have upended the compensation and benefit programs of many companies. This post is based on the third memorandum in a series of client memoranda that we are preparing regarding how companies may wish to consider addressing their programs in this context. [1]

The recent market volatility means that many companies have seen a precipitous drop in their stock prices, which has in turn reduced the value of outstanding equity awards, jeopardizing the effectiveness of such awards to reward and retain employees (at least in the near-term). In particular, some companies may find that the exercise price of their outstanding options and stock appreciations rights (SARs) substantially exceeds the company’s current stock price (for purposes of this memorandum, we refer to such options and SARs collectively as “underwater options”). This memorandum sets forth a number of considerations for companies that may find themselves in this position and provides some guidance as to possible approaches to be taken regarding underwater options so that companies can continue to incentivize and retain employees amid the ongoing market volatility, while also taking into account reaction from their shareholders and the proxy advisory firms. [2]

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2020 Proxy Season Preview

Posted by Peter Reali, Christina Gunnell, and Jennifer Grzech, Nuveen, LLC, on
Monday, April 27, 2020
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Peter Reali is Senior Director of Responsible Investing, Christina Gunnell is Senior Analyst of Responsible Investing Engagement and Jennifer Grzech is Director of Responsible Investing at Nuveen, LLC. The post is based on a publication by the Nuveen Responsible Investing Team. 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); Reconciling Fiduciary Duty and Social Conscience: The Law and Economics of ESG Investing by a Trustee by Robert H. Sitkoff and Max M. Schanzenbach (discussed on the Forum here); and Social Responsibility Resolutions by Scott Hirst (discussed on the Forum here).

Companies recognize the importance of environmental and social (E&S) factors and are giving consideration to a broader group of stakeholders to help mitigate risk. However, new regulations bring uncertainty to the future of environmental, social and governance (ESG) proposals.

The rapid spread of the coronavirus is roiling global markets and testing companies’ abilities to handle such a significant crisis. While many aspects of the current outbreak are certainly beyond issuer control, strong company ESG management plays an important role in mitigating downside risk and preserving long-term value. Conversely, poor ESG management could lead to greater negative impacts and a longer road to market recovery.

Across industries, strong corporate governance is a fundamental factor in ensuring business continuity and resiliency in the face of any major event. Board independence, oversight accountability and diversity, in addition to executive compensation that is aligned with long-term value creation, drive better operational strategies, risk mitigation frameworks and problem-solving.

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