Monthly Archives: August 2020

Audit Committee Priorities in the Current Quarter and Beyond

Krista Parsons is Managing Director and Audit Committee Programs Leader and Leeann Galezio Arthur is Senior Manager at the Center for Board Effectiveness, Deloitte & Touche LLP. This post is based on their Deloitte & Touche memorandum.

Financial reporting during the first quarter of the coronavirus disease 2019 (“COVID-19”) pandemic was challenging for most companies. Reporting for the second quarter promises to be even more so given the prolonged impact of the pandemic. As companies continue to grapple with the implications of managing operations remotely, supplier disruptions, government assistance, and more, audit committee oversight will be critical to applying lessons learned thus far to the current quarter. Continued challenges around financial reporting, risk oversight, critical audit matters (“CAMs”), and compliance and fraud risk could impact the audit committee’s focus. Therefore, it may be an opportune time for audit committees to reassess their processes and practices to confirm they support the current and future demands of the committee.

Financial reporting

The SEC Division of Corporate Finance and the Chief Accountant both released statements on disclosure considerations during the COVID-19 pandemic and the importance of high-quality financial reporting, respectively. In their respective communications, both the Division of Corporate Finance and Chief Accountant continued to emphasize that forward- looking, high-quality, timely, and decision-useful information on the finances and operations of companies continue to be of utmost importance to the efficient operations of the capital markets. The statement from the Chief Accountant also underscored the importance of the audit committee’s role in oversight of internal control over financial reporting as well as the independent auditor and external audit process. The Chief Accountant also summarized the issues addressed through consultations over the last quarter and specifically highlighted the financial reporting implications of the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”), debt modifications, hedging, consolidation, business combinations, lease concessions, revenue recognition and income taxes. [1]


Was the Business Roundtable Statement on Corporate Purpose Mostly for Show? – (1) Evidence from Lack of Board Approval

Lucian Bebchuk is the James Barr Ames Professor of Law, Economics, and Finance and Director of the Program on Corporate Governance, and Roberto Tallarita is Associate Director of the Program on Corporate Governance, and Terence C. Considine Fellow in Law and Economics, both at Harvard Law School. Related program research includes The Illusory Promise of Stakeholder Governance.

Wednesday of next week marks the first anniversary of the Business Roundtable (BRT) statement on corporate purpose. The statement, which was described by the BRT as “moving away from shareholder primacy,” was heralded by observers as “an important shift… in corporate America” and a “sea change in terms of how the core purpose of business is defined.” However, in a recent Wall Street Journal op-ed, we present evidence that the statement was, more likely, a mere public-relations move rather than a signal of a significant shift in how business operates.

The op-ed, Stakeholder Capitalism Seems Mostly for Show, was based on evidence collected in our study The Illusory Promise of Stakeholder Governance. This evidence indicates that corporate leaders should not be expected to make substantial changes in the treatment of stakeholders. This conclusion will be greatly disappointing to some and quite welcome to others. But all should be clear-eyed about what corporate leaders are focused on and what they intend to deliver.

This post is the first of a series, published around the BRT statement’s first anniversary and aimed at providing Forum readers with a brief account of each of the pieces of evidence that we have collected on the expected consequences of the BRT statement. This post will focus on the lack of board approval.

Joining the BRT Statement: Who Made the Decisions?

In assessing the extent to which the BRT statement should be expected to bring about major changes, it is useful to examine whether the decision to join the statement was approved by each company’s board of directors. The most important corporate decisions (such as a major acquisition, the amendment of the by-laws, or an important change in the corporate strategy) require or at least commonly receive approval by a vote at a meeting of the board of directors. Thus, if the commitment expressed by joining the BRT statement had been expected to bring about major changes in a company’s choices and practices, it would have been expected to be approved by the board of directors.

Therefore, to examine this issue, we contacted the public relations offices of 173 companies whose CEOs signed the BRT statement. (The initial signatories of the BRT statement were 181. As of December 17, 2019, we identified 3 additional companies that publicly joined the BRT statement, for a total of 184. Of these 184 companies, we contacted all the 173 companies for which we found a public relations / media inquiries email address on the corporate website.)

We asked each company to indicate who was the highest-level decision-maker who approved the decision to join the BRT statement, whether the CEO, the board of directors, or an executive below the CEO. 48 companies responded to our inquiry. Of the responding companies, 47 companies indicated that the decision was approved by the CEO and not by the board of directors. Only one responding company indicated that the decision was approved by the board of directors. Thus, among responding companies, about 98% had no approval by the board of directors. (We also received two ambiguous responses that we did not include in the total of 48. For example, one company responded that the decision was “a collaborative effort,” declining to specify a particular decision-maker. Also, of the 48 responding companies, two added that while the decision was taken by the CEO, the CEO consulted or “usually consults” with the board.)

To be sure, a majority of the companies declined to answer even after a follow up. Still there is no reason to expect that these companies were more likely than the responding companies to have had the decision approved by the board. Thus, the strong results we obtained for our sample of 48 are telling.

What can explain the decision of CEOs to join the BRT statement without approval by the board of directors? It is implausible that CEOs chose not to seek approval for decisions that they viewed as sufficiently important to merit board consideration. Even “imperial” CEOs are unlikely to disregard the formal location of the board of directors at the top of the corporate pyramid; instead, such CEOs are likely to use their power and influence to get the board to approve the choice they favor.

Similarly, it is implausible that CEOs did not seek board approval because they viewed joining the BRT statement as a matter of personal belief rather than a statement made in their “official” capacity as corporate head. The BRT described the CEO signatories as committing “to lead their companies for the benefit of all stakeholders.” Therefore, the BRT statement did not express a shared personal belief by a group of individuals but a commitment regarding the goals that the companies led by these individuals would pursue.

In our view, the most plausible explanation for the lack of board approval has to do with the way CEOs viewed the content of the statement. According to this explanation, CEOs didn’t regard the statement as a commitment to make a major change in how their companies treat stakeholders. In the absence of a major change, they thought that there was no need for a formal board approval. Indeed, two of the companies that responded to our survey stated that joining the BRT statement reflected an affirmation that the company’s past practices have been consistent with the principles of the BRT statement rather than an expectation that the company would make major changes in its future treatment of stakeholders.

To the extent that this view was widely shared among other signatories to the statement, it can explain well why the decision to join the statement was commonly not approved by the company’s board of directors. In this case, however, the BRT statement merely reflected (i) the CEOs’ positive assessment of how their companies have been treating stakeholders thus far, as well as, importantly, (ii) the CEOs’ expectation that the statement will not lead to substantial changes in how stakeholders are treated.

Thus, the lack of board approval is consistent with and supports the conclusion that the BRT statement was not expected by signatories to bring about major changes.

The study on which this post is based, The Illusory Promise of Stakeholder Governance, is available here.

IQ from IP: Simplifying Search in Portfolio Choice

Umit G. Gurun is the Ashbel Smith Professor at the University of Texas at Dallas Naveen Jindal School of Management. This post is based on a paper, forthcoming in the Journal of Financial Economics, by Professor Gurun; Huaizhi Chen, Assistant Professor of Finance at the University of Notre Dame’s Mendoza School of Business; Lauren Cohen, the L.E. Simmons Professor in the Finance & Entrepreneurial Management Units at Harvard Business School; and Dong Lou, Associate Professor at the London School of Economics.

With the proliferation of information signals in both quantity and dimensionality in recent decades, investors face an increasingly complex portfolio choice problem. These forces create a classic signal-to-noise problem, in which an agent must dig through an ever-larger information set to decipher and to create profitable signals. In a Grossman-Stiglitz world, an agent will be happy to collect information up to their private marginal value of expected return from that activity. However, with hundreds of thousands of information signals being produced in any given day, how does an investor reduce the dimensionality of the investment problem sufficiently to know even which subset (or class) of signals have the potential to be informative and provide this return in expectation?


Exercising Business Judgment Through COVID-19

Laura Levine is counsel and William Braithwaite is senior counsel at Stikeman Elliott LLP. This post is based on their Stikeman Elliott memorandum.

As COVID-19 related restrictions begin to ease, boards and management face unique decisions as to how to return to a new normal amid evolving legal requirements, health guidelines and divergent stakeholder concerns and expectationsA focus on business judgment will assist corporate leaders in making these tough decisions and finding a path to the other side of the pandemic.

D&O Duties

The COVID-19 pandemic has forced boards and management teams to face unprecedented challenges and make quick decisions in order to guide their companies through uncharted waters. Canadian corporate law provides a well-worn framework for decision making and directors and officers should continue to bear in mind their fundamental duties as outlined in the various Canadian corporate statutes [1].

Aspects of directors’ and officers’ duties all have implications in navigating decisions related to COVID-19:


Shareholder Complaints Seek to Hold Directors Liable for Lack of Diversity

Francesca L. Odell, Victor Hou, and James Langston are partners at Cleary Gottlieb Steen & Hamilton LLP. This post is based on a Cleary memorandum by Ms. Odell, Mr. Hou, Mr. Langston, Roger Cooper, Michael Albano, and Mark McDonald. Related research from the Program on Corporate Governance includes Politics and Gender in the Executive Suite by Alma Cohen, Moshe Hazan, and David Weiss (discussed on the Forum here).

Earlier this month, three separate shareholder derivative lawsuits were filed in California federal court against the directors and officers of Oracle Corporation, Facebook, Inc., and Qualcomm, Inc., respectively. The three complaints, filed by the same lawyers, contain intentionally provocative allegations that, despite public statements emphasizing the importance of diversity within their respective organizations, the boards and executive management teams of Oracle, Facebook, and Qualcomm, remain largely white and male, and have failed to deliver on their commitments to diversity. While calls to strengthen commitments to diversity at public companies have steadily increased, these complaints go a step further and seek to reshape the boards and executive teams through litigation and hold directors and executive officers personally liable for perceived diversity shortcomings.

The plaintiffs will need to overcome a number of hurdles in order to sustain their novel claims. But the complaints touch upon serious issues at the center of a broader conversation, and similar lawsuits are likely to come. Many organizations have stated publicly that they are committed to improving racial, gender, ethnic, sexual and other forms of diversity. Last year’s Business Roundtable Statement on the Purpose of a Corporation also included a “fundamental commitment” to “foster[ing] diversity and inclusion, dignity and respect” among corporate employees. Such statements, however, have not always translated into results. The complaints against the Oracle, Facebook, and Qualcomm boards thus serve as a reminder that stakeholders of companies making public commitments to diversity are increasingly expecting those companies to follow through, and for their boards to focus on diversity and inclusion at all levels within their organizations. The recent complaints also serve as a reminder that those stakeholders—including stockholders—may pursue litigation in their attempts to hold directors and officers accountable.


Alibaba: A Case Study of Synthetic Control

Jesse M. Fried is Dane Professor of Law at Harvard Law School and Ehud Kamar is Professor of Law at Tel Aviv University Buchmann Faculty of Law. This post is based on their recent paper. Related research from the Program on Corporate Governance includes The Perils of Small-Minority Controllers by Lucian Bebchuk and Kobi Kastiel (discussed on the Forum here).

Alibaba conducted a record-breaking IPO six years ago on the New York Stock Exchange and is now valued at over $500 billion. The firm, founded by Jack Ma and others, is now the most valuable Asian public company, as well as the world’s largest ecommerce company and seventh most valuable firm. In a paper recently posted on SSRN, Alibaba: A Case Study of Synthetic Control, we explain how this giant firm is controlled.

Alibaba is known for its unique governance structure: a majority of Alibaba’s board is nominated or appointed by the so-called Alibaba Partnership, which consists of several dozen individuals. Thus, the Partnership controls Alibaba. However, as Lin and Mehaffy (2016) show, the Partnership itself is effectively controlled by a much smaller Partnership Committee that includes Ma as a perpetual member. Control of Alibaba is therefore in much fewer hands than might first appear.

Our paper digs even deeper into Alibaba’s control arrangements and reveals a surprising fact: Ma, who owns less than 5% of Alibaba, effectively controls Alibaba by himself—control that would persist even if his equity stake declined further. The reason is that Ma’s control over Alibaba is not based on his equity but rather on his control of a different firm, Ant Group.


Facing the COVID-19 Challenge in Corporate Boardrooms

Paula Loop is Governance Insights Center Leader at PricewaterhouseCoopers LLP. This post is based on a PwC memorandum authored by Ms. Loop, Leah Malone, and Paul DeNicola.

Corporate directors applaud their companies’ pandemic response thus far—but the work has only just begun

The COVID-19 pandemic and its fallout are testing companies like never before. According to our survey of directors, most board members say executives have done a great job of navigating the challenges thrown at them in the early days of the crisis. And it’s not just management. Directors are pleased with their own performance as well. Even as the boardroom goes virtual, directors say they are staying engaged and have no trouble asking hard questions of management.

Directors may be confident today, but are they ready for what comes next? The crisis is far from over. In fact, some of the biggest challenges—such as bringing employees back into the workplace—remain ahead. And boards need to ensure that the company’s strategy can carry it through, no matter how long the pandemic and economic slowdown lasts.

Confidence can be a good thing. But overconfidence can lead to complacency. By remaining focused and building on their early successes, boards can help their companies succeed—no matter how the pandemic unfolds.


ESG and Corporate Purpose in a Disrupted World

Kristen Sullivan is Partner of Sustainability and KPI Services at Deloitte & Touche LLP, Amy Silverstein is Senior Manager and Purpose Strategy Lead at the Monitor Institute, Deloitte LLP, and Leeann Galezio Arthur is Senior Manager at the Center for Board Effectiveness, Deloitte & Touche LLP. This post is based on a Deloitte memorandum by Ms. Sullivan, Ms. Silverstein, Ms. Arthur, Maureen Bujno, and Bob Lamm. 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); Socially Responsible Firms by Alan Ferrell, Hao Liang, and Luc Renneboog (discussed on the Forum here).

Even before the world was disrupted by COVID-19 and current events calling for a greater focus on social justice, corporate America was already at an inflection point with respect to its role in society, facing louder and more widespread calls for businesses to consider a broader range of stakeholders. From the groundswell of support for shareholder proposals on environmental and social matters starting in 2017, to the August 2019 statement of the Business Roundtable, to continuing pressure from prominent members of the investment community, the conversation on the purpose of the corporation has continued to gain momentum. While it remains to be seen whether we are witnessing a permanent transition from the primacy of shareholder capitalism to the inclusion of stakeholder capitalism, the above and other developments have had a profound impact on the corporate community’s approach to environmental, social, and governance (ESG) issues. In addition to increasing demands of primary stakeholders, defining and integrating corporate purpose and ESG objectives will require companies to evaluate a wide range of decisions through a multistakeholder lens, leading corporations to prioritize groups that once might have been viewed as nontraditional or secondary stakeholders: employees, customers, suppliers, communities, and other affiliations.


Blindsided by Social Risk: How Do Companies Survive a Storm of Their Own Making?

David F. Larcker is the James Irvin Miller Professor of Accounting at Stanford Graduate School of Business and Brian Tayan is a Researcher with the Corporate Governance Research Initiative at Stanford Graduate School of Business. This post is based on their recent paper.

We recently published a paper on SSRN, Blindsided by Social Risk: How Do Companies Survive a Storm of Their Own Making?, that examines how companies respond to social risk using a proprietary dataset from Marketing Scenario Analytica.

Our concept of risk continues to broaden. Historically, risk managers concerned themselves with strategic, operating, and financial breakdowns that could disrupt business activity and harm shareholder or stakeholder performance. Following the collapse of Enron, risk frameworks broadened to include financial reporting and fraud. Companies developed more rigorous internal control environments to mitigate the likelihood of these events. After the financial crisis of 2008, the scope of risk assessments expanded further, as corporate directors were asked to evaluate how compensation incentives might contribute to risk by rewarding decisions that run counter to or are in excess of the firm’s risk appetite (so-called “excessive risk taking”). Dodd-Frank required expanded analysis and disclosure of the relation between incentives and risk in the annual proxy, and shareholders were given an advisory vote on executive pay (say-on-pay).


SEC Roundtable: “Emerging Markets, Including China”

Nicolas Grabar and Shuang Zhao are partners and Robert Williams is counsel at Cleary Gottlieb Steen & Hamilton LLP. This post is based on their Cleary memorandum.

The Securities and Exchange Commission held a roundtable on July 9, 2020 on investing in emerging markets. Participants with a very wide range of perspectives addressed three concentric circles of topics:

  • At the core is the regulatory impasse between the United States and China over the ability of the Public Company Accounting Oversight Board (PCAOB) to conduct inspections and investigations of Chinese auditing firms.
  • More broadly, many participants discussed whether there are specific risks involved in investing in Chinese businesses with equity securities trading on U.S. exchanges.
  • At the most general level, the discussion addressed risks of “investing in emerging markets,” a term that participants used in different ways.

This post summarizes some themes from the discussion and identifies questions about possible future regulatory developments. [1]


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