Monthly Archives: June 2020

Directors’ Fiduciary Duty in a Pandemic

Thierry Dorval is a partner and Petra Vrtkova and Charles-Étienne Borduas are associates at Norton Rose Fulbright Canada LLP. This post is based on a Norton Rose memorandum by Mr. Dorval, Ms. Vrtkova, Mr. Charles-Étienne Borduas, and Camille Provencher. 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).

COVID-19 has had and will continue to have impacts on virtually every corporation in Canada and globally. Such a disrupting chain of events, combined with freshly enacted changes to corporate legislation for federally incorporated corporations, may raise questions on the scope of directors’ fiduciary duty. If the recent legislative amendments have provided certain clarifications on a director’s fiduciary duty towards the corporation, they have had limited opportunities to be tested. The public health crisis may set the stage for such a test.

As discussed below, in discharging their fiduciary duty, directors will need to consider different factors. To benefit from the protection of the business judgement rule doctrine, directors should formulate and follow a sound protocol.

Fiduciary duty in context

Under the Canada Business Corporations Act (the CBCA), directors of a corporation have a “fiduciary duty” towards the corporation according to which they must “act honestly and in good faith with a view to the best interests of the corporation.” [1] In cases of alleged breach of such duty, courts apply the “business judgement rule,” which commands great deference to directors, to the extent directors followed a reasonable process in decision-making.


Paying by Donating: Corporate Donations Affiliated with Independent Directors

Ye Cai is Associate Professor of Finance in the Leavey School of Business at Santa Clara University; Jin Xu is Associate Professor at Virginia Tech; and Jun Yang is Associate Professor of Finance at the Indiana University Kelley School of Business. This post is based on their recent paper.

The monitoring role of independent directors on corporate boards has long been a topic of interest in the corporate governance literature. Stock-exchange rules establishing directors’ independence are typically based on transaction-based financial ties, and most empirical research classifies independent directors according to this limited assessment. However, independent directors may have other ties to top executives that interfere with their exercise of independent judgment in carrying out director responsibilities.

In our forthcoming paper in the Review of Financial StudiesPaying by Donating: Corporate Donations Affiliated with Independent Directors, we investigate a new determinant of director independence: material relationships between independent directors and top executives via corporate charitable contributions to tax-exempt organizations affiliated with independent directors (affiliated donations). Corporate donations help fulfill directors’ fundraising obligations at their affiliated charities, creating a potential conflict of interest that increases directors’ disutility in carrying out monitoring responsibilities. Because corporate charitable contributions are rarely disclosed in companies’ filings with the Securities and Exchange Commission (SEC), they have been largely overlooked in corporate governance research until very recently.


Confronting Climate Risk

Dickon Pinner, Hamid Samandari, and Jonathan Woetzel are senior partners at McKinsey & Company. This post is based on a McKinsey memorandum by Mr. Pinner, Mr. Samandari, Mr. Woetzel, Hauke Engel, Mekala Krishnan, and Brodie Boland.

After more than 10,000 years of relative stability—the full span of human civilization—the Earth’s climate is changing. Since the 1880s, the average global temperature has risen by about 1.1 degrees Celsius, driving substantial physical impact in regions around the world. As average temperatures rise, acute hazards such as heat waves and floods grow in frequency and severity, and chronic hazards such as drought and rising sea levels intensify. These physical risks from climate change will translate into increased socioeconomic risk, presenting policy makers and business leaders with a range of questions that may challenge existing assumptions about supply-chain resilience, risk models, and more.To help inform decision makers around the world so that they can better assess, adapt to, and mitigate the physical risks of climate change, the McKinsey Global Institute (MGI) recently released a report, Climate risk and response: Physical hazards and socioeconomic impact. Its focus is on understanding the nature and extent of physical risk from a changing climate over the next three decades, absent possible adaptation measures.

This post provides an overview of the report. We explain why a certain level of global warming is locked in and illustrate the kinds of physical changes that we can expect as a result. We examine closely four of the report’s nine case studies, showing how physical change might create significant socioeconomic risk at a local level. Finally, we look at some of the choices most business leaders will have to confront sooner than later.


Using ESG Tools to Help Combat Systemic Racism and Injustice

Adam O. Emmerich, David M. Silk, and Sabastian V. Niles are partners at Wachtell, Lipton, Rosen & Katz. The following post is based on a Wachtell Lipton memorandum by Mr. Emmerich, Mr. Silk, Mr. Niles, Elina Tetelbaum, and Carmen X. W. Lu. 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 Socially Responsible Firms by Alan Ferrell, Hao Liang, and Luc Renneboog (discussed on the Forum here).

Events of recent weeks and months have starkly illuminated the effects of systemic racism and injustice on Black Americans, including threats to physical safety, psychological trauma and economic disparity. CEOs worldwide and across industries have spoken out, expressing their horror and outrage, as well as their resolve to do more. Companies have announced significant financial commitments; others have referred to actions to be taken, and early movers have begun to announce or amplify business-related initiatives. Institutional investors, asset owners, asset managers, private equity fund limited partners and investor groups have also begun speaking out and considering action with respect to companies in their portfolios. The question for all is how to follow through on the sentiments expressed and drive positive change: what tools are available to address systemic racism and injustice and the threats they pose, and how can those tools be used?


ESG and the Earnings Call

Kevin Eckerle is Director of Corporate Research and Engagement at the Center for Sustainable Business at the NYU Stern School of Business; Brian Tomlinson is Director of Research, CEO Investor Forum at Chief Executives for Corporate Purpose; and Tensie Whelan is Clinical Professor for Business at the NYU Stern School of Business. This post is based on their recent report.

The information shared through quarterly reporting moves markets. Institutional investors highly value the transparency and outputs of frequent periodic reporting. Investor Relations Officers (IROs) consistently identify the earnings call as the most important venue through which to communicate their story to the capital markets. Within the C-suite, preparing for the earnings call—and its associated package of disclosures—requires a significant commitment of time and resources.

The Earnings Call and the Short-Term

Quarterly reporting has been identified as a potential source or amplifier of short-term market pressures. Management’s focus on hitting quarterly financial targets can cause overweighting by both the C-suite and equity markets of in-year or in-quarter performance benchmarked to a narrow set of financial indicators. This underweights strategic issues with a longer-term time horizon, or those that are harder to quantify in the near-term, and consequently results in insufficient analysis and reporting of these issues in the earnings call.

For example, management teams may cut research and development (R&D) or other discretionary spending in order to meet an earnings target. Chief financial officers (CFOs) report that this occurs; it is an anticipated peer-group behavior among CFOs. This expected behavior is confirmed in the literature as firms that issue and just meet near-term earnings per share (EPS) targets display discontinuous R&D spending, which illustrates the underlying pattern that planned R&D spending (and economic value) is often sacrificed to avoid a short-term earnings miss. Overall, when compared with equivalent privately held peer firms, public companies have a shorter-term focus. Concern regarding the perceived impatience of the equity markets also appears to depress listing activity.


Unanticipated Costs of Paycheck Protection Program Loans in M&A Transactions

Jennifer S. Conway and J. Leonard Teti II are partners at Cravath, Swaine & Moore LLP. This post is based on their Cravath memorandum.

Two mutually exclusive programs under the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) designed to encourage workforce retention during the COVID-19 pandemic—the Paycheck Protection Program and the Employee Retention Credit—clash in the case of an M&A deal involving a buyer that has received one benefit and a target that has received the other. This scenario could result in unanticipated costs in the form of lost tax benefits due to an acquisition, even a very small one.


The Paycheck Protection Program (PPP) is the Small Business Administration’s forgivable loan program designed to provide small businesses with a direct incentive to keep workers on their payrolls over the eight-week period after the loan is originated. The Employee Retention Credit is a payroll tax credit for certain wages paid between March 13 and December 31, 2020, by an employer of any size that has experienced significant disruption to its business due to the pandemic. A company that receives a PPP loan cannot claim the Employee Retention Credit, regardless of when the loan is received and whether it is repaid in full or forgiven (with a limited exception for loans repaid by May 18, 2020). Furthermore, ineligibility extends to all subsidiaries of the PPP loan recipient as well as all other affiliates linked by at least fifty percent (50%) common ownership or control (referred to herein as affiliates).


SEC Improves Financial Disclosure Relating to Business Acquisitions and Dispositions

Robert Meyers, Mark Metts, and Martin Wellington are partners at Sidley Austin LLP. This post is based on a Sidley memorandum by Mr. Meyers, Mr. Metts, Mr. Wellington, George Vlahakos, Jennifer F. Fitchen, and Casey Hicks.

The SEC’s long-expected reforms to Regulation S-X regarding financial disclosure for business acquisitions and dispositions were published as final amendments on May 21, 2020. Most of the final amendments are substantially in line with the SEC’s May 2019 proposing release, on which we commented in our May 2019 Sidley Update. Part of the SEC’s overall initiative to improve and streamline disclosure, the final amendments reflect a comprehensive re-thinking—and we believe substantial improvement—of a business combination disclosure system that has in many ways vexed registrants and their professional advisors for decades. The final amendments will become effective on January 1, 2021, but issuers are permitted to voluntarily comply with the final amendments in advance of the effective date.


How A Reconceived Compensation Committee Can Help Tackle Inequality

Leo E. Strine, Jr., the former Chief Justice of the Delaware Supreme Court, is the Austin Wakeman Scott Lecturer in Law and Senior Fellow at the Harvard Law School Program on Corporate Governance, as well as Of Counsel at Wachtell, Lipton, Rosen & Katz. Kirby Smith is an associate at Wachtell, Lipton, Rosen & Katz. This post is based on their recent paper. Related research from the Program on Corporate Governance includes Toward Fair and Sustainable Capitalism by Leo E. Strine, Jr (discussed on the Forum here) and The Illusory Promise of Stakeholder Governance by Lucian A. Bebchuk and Roberto Tallarita (discussed on the Forum here).

In the three decades after World War II, workers and stockholders shared equitably in the nation’s growing wealth. But, during the last several decades, this fair gainsharing has diminished as the power of the stock market, in the form of institutional investors, has grown, and the comparative voice and leverage of workers has declined. As a result of these and other factors, a much greater share of the gains from increased corporate profitability and productivity has gone to stockholders and top management, on the one hand, and much less to employees, on the other. Contributing to this divide has been a push to tie top management pay to total stockholder return and to create incentives for management to deliver returns to stockholders, even if that requires decreasing the share that the workers primarily responsible for corporate success get. The resulting economic insecurity and inequality have caused demands for serious change in corporate governance to give greater weight to the interests of workers.

This state of affairs has led to calls to reform our corporate governance system’s power dynamic to give workers more voice. And business leaders have acknowledged that an economic system that does not work for everyone is unsustainable, most prominently through the Business Roundtable’s revised statement on corporate purpose making clear that employee well-being and fair compensation are central issues for corporate management.


Boards Need to Stay Vigilant and Keep Stockholders Informed Towards Closing

Paul Tiger is partner at Freshfields Bruckhaus Deringer LLP. This post is based on his Freshfields memorandum.

It’s a natural human phenomenon. After a period of intense activity, it’s perfectly understandable to relax, take a step back and catch one’s breath. M&A deals are no different. The push to get a deal signed is often marked by long days and, sometimes, long nights for all involved. Once the deal is signed, it’s natural for the deal teams, for management, for the respective boards of directors, to go home, get a bit of sleep and go into “execution mode.” “Let’s get this closed,” they say.

But in the current environment—marked by significant volatility and radical shifts in the prospects for one or both merger parties or the combined company—that sentiment can lead to the wrong result for stockholders as circumstances change post-signing. Where a stockholder vote is required for a transaction (on either the buy-side or the target side) and has not yet been obtained and therefore the recommendation and disclosures by the board to its stockholders remain in the spotlight, the board needs to remain especially vigilant and active.

The potential has never been higher for new circumstances to arise that potentially alter the assessment of whether a transaction is still in the best interests of the stockholders that will be voting on that transaction. Directors need to remember their continuing duty to stockholders to consider this issue in the run-up to the stockholder vote.


The Forum Attracts Numerous Citations from Courts, Legislators, Regulators, and National Organizations

Tami Groswald Ozery is a co-Editor of the Forum and a Fellow at the Harvard Law School Program on Corporate Governance.

In the past fifteen years, Forum posts have had considerable influence on the corporate governance field. In an earlier post (see here), I discussed the vast number of citations that Forum posts have attracted from articles by academics and practitioners. This post, in turn focuses on the numerous citations that Forum posts have received from courts, regulators, legislators, and national organizations.

The list of such citations of Forum posts is available here. In particular, Forum posts have been cited by:

  • Court decisions, including by:
    • The Chancery Court of Delaware
    • United States District Courts in Virginia and Texas
  • Congressional bodies including:
    • The House Committee on Financial Services
    • The House Subcommittee on Investor Protection, Entrepreneurship, and Capital Markets
    • The House Subcommittee on Terrorism, Nonproliferation, and Trade
    • The House Subcommittee on Asia and the Pacific
    • The Senate Committee on Banking, Housing, and Urban Affairs
    • The Congressional Research Services
  • Regulatory agencies including:
    • Securities and Exchange Commission
    • Consumer Financial Protection Bureau
  • Public Statements and Speeches by SEC Commissioners and high-ranking officials including by:
  • Major organizations active in the field including:
    • AFL-CIO
    • American Bar Association Business Law Section
    • Council of Institutional Investors
    • Sustainability Accounting Standards Board (SABS)
    • Teachers Insurance and Annuity Association of America (TIAA)

Established in 2006 by Professor Lucian Bebchuk and the Harvard Law School Program on Corporate Governance, the Forum has become the leading online resource and the central outlet for the exchange of ideas and debate in the field of corporate governance. In an article about the Forum that was featured in the Harvard Law Bulletin a few years ago, former Chief Justice Leo Strine observed that “[i]t is amazing to see the [Forum] become required reading among the intelligentsia … of corporate governance.”

The success of the Forum has been made possible by the contribution of numerous authors, as well as by the engagement of the Forum’s ever-growing readership. We are deeply grateful for the support of our contributors and readers.

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