Monthly Archives: August 2020

On the Purpose and Objective of the Corporation

Martin Lipton is a founding partner specializing in mergers and acquisitions and matters affecting corporate policy and strategy, and Steven A. Rosenblum and William Savitt are partners Wachtell, Lipton, Rosen & Katz. This post is based on a Wachtell Lipton memorandum by Mr. Lipton, Mr. Rosenblum, Mr. Savitt, Karessa L. Cain, Hannah Clark, and Bita Assad. 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).

As we approach the first anniversary of the Business Roundtable’s abandonment of shareholder primacy and embrace of stakeholder governance, and the fourth anniversary of our development for the World Economic Forum of The New Paradigm: A Roadmap for an Implicit Corporate Governance Partnership Between Corporations and Investors to Achieve Sustainable Long-Term Investment and Growth, we thought it useful to consider in broader context the key issues of corporate governance and investor stewardship today. While there is no universal consensus, the question underlying these issues can be expressed as: What is the corporation trying to achieve? What is its objective?


Contracts with (Social) Benefits: The Implementation of Impact Investing

Anne Tucker is Professor of Law at Georgia State University College of Law. This post is based on a recent paper, forthcoming in the Journal of Financial Economics by Professor Tucker; Christopher Geczy, Adjunct Professor of Finance at The Wharton School at the University of Pennsylvania; Jessica Jeffers, Assistant Professor of Finance at The University of Chicago Booth School of Business; and David Musto, the Ronald O. Perelman Professor in Finance at The Wharton School at the University of Pennsylvania.

In our paper, Contracts with (Social) Benefits (forthcoming Journal of Financial Economics), we ask how private market contracts adapt to serve social-benefit goals in addition to financial goals. In particular we consider the potential impact of these additional goals on canonical principal-agent problems: first between investors and the fund, and, later, between the fund and the portfolio companies in which the fund invests.

To examine contracting for impact, we analyze a unique set of impact fund legal documents compiled by the Wharton Social Impact Initiative (WSII). Documents include private limited partner agreements (LPAs), private placement memoranda (PPMs), term sheets, and letters of intent. These documents are a window onto the rapidly growing sector of private markets, which by 2019 exceeded 13,000 deals and $33 billion per year (GINN, 2019). In addition to contract observations summarized below, our paper provides a novel descriptive account of the impact funds contributing documents, and of the sector itself.


Analysis of Proxy Advisors’ Recommendations During the 2020 Proxy Season

Kyle Isakower is Senior Vice President of Regulatory and Energy Policy at the American Council for Capital Formation. This post is based on his ACCF report.


A new analysis of companies’ supplemental filings to their proxy materials with the U.S. Securities and Exchange Commission (SEC) during the majority of the 2020 proxy season shows at least 42 instances where proxy advisors have formulated recommendations based on errors* or analysis disputed by the companies themselves.

For example, in one supplemental filing, a proxy advisor generated a recommendation using a disputed figure for a company’s net income, a basic but critical number. Another highlighted how a proxy advisor based its recommendation on a peer group that did not include the company’s actual competitors. Other filings showed instances where proxy advisors issued recommendations that appear to be contradictory with their stated policies.


Comment Letter to DOL

Subodh Mishra is Managing Director at Institutional Shareholder Services, Inc. This post is based on a recent comment letter from ISS President & CEO Gary Retelny to the U.S. Department of Labor in response to potential amendments to the Employee Retirement Income Security Act of 1974 (ERISA). 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 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).

Institutional Shareholder Services Inc. (ISS) is pleased to submit these comments regarding the above-referenced proposal to amend the “Investment duties” rule under Title I of the Employee Retirement Income Security Act of 1974 (ERISA) [29 CFR §2550.404a-1]. Given the increasing importance of integrating environmental, social and corporate governance (“ESG”) factors into a prudent investment management strategy, ISS applauds the Department’s intent to clarify the sub-regulatory guidance in this area. Unfortunately, the proposed rule amendment adds more confusion than clarity, and would, we fear, work to the detriment of ERISA plan participants and their beneficiaries.

While the Department seems to recognize the economic relevance of ESG factors in theory, the Proposing Release nonetheless perpetuates outdated assumptions about ESG investing. As a result, the proposed amendment of Rule 404a-1 imposes unnecessary burdens on the selection of ESG investments, even where the fiduciary has found such investments to be prudent after evaluating them solely on pecuniary grounds. The permissible consideration of non-pecuniary factors under the proposed amendment is confusing as well. The Department characterizes this rulemaking as a confirmation of existing sub-regulatory guidance, but that is not the case. Whereas existing guidance employs an economic equivalence test for assessing alternative investments, the proposed rule requires that such alternatives be economically “indistinguishable.” In so doing, the proposal creates a new—and, ISS fears, unworkable—standard for ERISA fiduciaries.


The Origins and Real Effects of the Gender Gap: Evidence from CEOs’ Formative Years

Ran Duchin is the William A. Fowler Endowed Professor at the University of Washington Foster School of Business; Mikhail Simutin is Associate Professor of Finance at the University of Toronto Rotman School of Management; and Denis Sosyura is Professor of Finance at Arizona State University. This post is based on their paper, forthcoming in The Review of Financial Studies.

In the paper The Origins and Real Effects of the Gender Gap: Evidence from CEOs’ Formative Years (forthcoming in the Review of Financial Studies), we provide the first systematic evidence on the socioeconomic backgrounds of U.S. CEOs. Using individual census records for the families where the CEOs grew up, we study how CEOs’ formative experiences affect their capital allocation decisions. Our main finding is that CEOs raised in male-dominated families—those where the father was the only income earner and had more education than the mother—hire fewer women and allocate smaller capital budgets to female managers. We argue that gender effects in financial policies originate in CEO beliefs developed during formative years.

Our study is motivated by an ongoing debate about whether male managers obtain more resources, such as pay, capital, or promotion opportunities, than their female peers. If such a gender gap exists, it remains unclear whether it reflects a potential bias of the decision makers or results from economic factors correlated with gender, such as productivity or risk aversion. Similarly, the effects on economic outcomes are not fully understood.


Disclosure Regarding Director’s Conflict During Merger Negotiations

Jason M. Halper is partner, Jared Stanisci is special counsel, and Victor Bieger is an associate at Cadwalader, Wickersham & Taft LLP. This post is based on a Cadwalader memorandum by Mr. Halper, Mr. Stanisci, Mr. Bieger, Nathan M. Bull, and Sara Bussiere. This post is part of the Delaware law series; links to other posts in the series are available here.

The Delaware courts have not been shy about warning of the dangers that can arise when merger negotiations are handed over to conflicted directors who fail to keep their boards fully informed about their divided loyalties. Over the last two years, the Delaware Supreme Court has faulted a director for lining up a buyer without disclosing that he had negotiated a lucrative equity roll-over deal on the side, and the Court of Chancery chastised a director (and his hedge fund sponsor) for engineering a quick sale of a company without disclosing to the rest of the board that he had been tipped off to the price the buyer had in mind. Directors have an “‘unremitting obligation’ to deal candidly with their fellow directors,” the Delaware courts have stressed, and that is no more true than when they are entrusted to lead merger negotiations.


Blueprint for Responsible Policy Engagement on Climate Change

Veena Ramani is Senior Program Director, Capital Markets Systems at Ceres. This post is based on her Ceres report. 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)


In the last few years, expectations on whether—and how—companies should engage on climate change have evolved. Companies and investors now largely understand that climate change poses clear financial and even material risks to companies and industries across the economy. Additionally, climate change is now widely recognized as posing a systemic threat to financial markets writ large, with significant potential for disruptive impacts on overall economic stability and the lives and livelihoods of tens of millions of people across the U.S. and globally.

Recognizing the need to address the climate crisis, a growing number of companies are taking increasingly ambitious steps to address climate change across their performance and strategies. However, these efforts could be undermined if their lobbying on climate change, whether directly or through their trade associations, is not aligned with climate science. In fact, such misalignment could lead to inefficient corporate spending and reputational and financial risk. Companies that establish robust governance systems to address climate change as a systemic risk and align their lobbying efforts to support science-based climate policies will drive the creation of a regulatory environment that best positions them for resilient growth.


Corporate Culture as a Theory of the Firm

Gary B. Gorton is the Frederick Frank Class of 1954 Professor of Finance and Alexander Zentefis is Assistant Professor of Finance, both at the Yale School of Management. This post is based on their recent paper.

Business leaders have long recognized that corporate culture is vital to a company’s identity and success. In one of the more colorful descriptions of culture’s importance, the legendary management author Peter Drucker wrote: “culture eats strategy for breakfast, technology for lunch, and products for dinner, and soon thereafter everything else too.” Similarly, former IBM Chairman and CEO Louis V. Gerstner, Jr. wrote: “I came to see, in my time at IBM, that culture isn’t just one aspect of the game, it is the game.”

And yet, scholars have consistently overlooked corporate culture in their theories of the firm. For the most part, existing theories have focused on the costs and benefits of asset ownership and/or incentive contracts to explain whether a company produces parts and services in house or instead purchases them in a market (the “make-or-buy decision”). Bengt Holmström and John Roberts provide a detailed survey of numerous current theories (Holmström and Roberts 1998) and Robert Gibbons supplies an elegant synthesis of several theories (Gibbons 2005).


Legal Liability for ESG Disclosures

Connor Kuratek is Chief Corporate Counsel at Marsh & McLennan Companies, Inc., and Joseph A. Hall is a partner and Betty M. Huber is counsel at Davis Polk & Wardwell LLP. This post is based on a Davis Polk memorandum by Mr. Kuratek, Mr. Hall, Ms. Huber, and Katherine J. Brennan.

Corporate Social Responsibility and Environmental, Social & Governance (ESG) issues have become increasingly important over the past few years, and evaluating a company’s ESG disclosures has become a key tool used by many investors in making investment and engagement decisions. Many companies are, with increasing frequency, publishing ESG reports on their websites and incorporating ESG disclosure into mandatory filings with the U.S. Securities and Exchange Commission. According to a National Association of Corporate Directors Report, in 2019, 66% of companies in the Russell 3000 Index discussed and incorporated some ESG risk disclosure into their financial filings. [1] The increase in disclosure has been accompanied by an increase in shareholder litigation on ESG issues.

This post is divided into three parts: Part 1 provides a brief summary of the rise in investor pressure for increased ESG disclosures; Part 2 describes the SEC response to these trends and disclosure regimes, with a particular focus on the World Economic Forum’s 2020 frameworks; and Part 3 discusses litigation related to ESG voluntary disclosures and what companies can do to limit the risk of associated litigation.


The Dutch Stakeholder Experience

Christiaan de Brauw is a partner at Allen & Overy LLP, This post is based on his Allen & Overy memorandum. 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) and The Illusory Promise of Stakeholder Governance by Lucian A. Bebchuk and Roberto Tallarita (discussed on the Forum here).

Recently, there have been significant developments towards a more stakeholder-oriented governance model, as evidenced by, among other things, the statements from the Business Roundtable and the World Economic Forum, as well as statements from institutional shareholders like BlackRock. Simultaneously, there has been increasing interest in re-evaluating the purpose of the corporation, for example in the UK and France. The Dutch stakeholder model has evolved over time into a truly workable model in a successful market-based economy. This model has proven to be attractive to US and other foreign investors in Dutch listed companies. The Dutch experience has some important lessons for those seeking to adopt a more stakeholder-oriented governance model. We have learned that there are three key requirements to make such a model work. These are: (i) embed a clear stakeholder mission in the fiduciary duties of the board, (ii) give teeth to that stakeholder mission, while creating appropriate checks and balances, and (iii) foster a stakeholder-oriented mindset and environment. Below, I offer some further insights into these lessons learned.


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