Yearly Archives: 2020

From Shareholder Primacy to Stakeholder Capitalism

Frederick Alexander is Founder of The Shareholder Commons; Holly Ensign-Barstow is Director of Stakeholder Governance & Policy at B Lab; and Lenore Palladino is Assistant Professor at the School of Public Policy and the Department of Economics at the University of Massachusetts Amherst. This post is based on a recent paper authored by Mr. Alexander, Ms. Ensign-Barstow, Ms. Palladino, and Andrew Kassoy. 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); For Whom Corporate Leaders Bargain by Lucian A. Bebchuk, Kobi Kastiel, and Roberto Tallarita (discussed on the Forum here); and Toward Fair and Sustainable Capitalism by Leo E. Strine, Jr (discussed on the Forum here).

Capital Market Policies for the 21st Century

The U.S. capital markets have failed to create an inclusive and equitable economy or durable prosperity because they are built atop policies formulated over the last 150 years. These policies fail to account for (1) the injustice that naturally accrues in an unregulated free market (e.g., the lottery of birth), and (2) the planetary boundaries we are now approaching. This post proposes new legislative and regulatory reforms that promote capital stewardship to preserve market mechanisms in a more equitable economic system designed to create justice and ecological balance.

The policies we propose will create a foundation for U.S. markets that channel resources toward durable productivity and equity for workers. With these policies in place, investors will have the tools to create sustainability guardrails for company behavior that will distinguish between efficient, innovative profits that benefit us all and profits derived from negative-sum behaviors that put critical systems at risk and continue to exploit communities.


The Economics of Soft Dollars: A Review of the Literature and New Evidence from the Implementation of MiFID II

Howell E. Jackson is the James S. Reid, Jr., Professor of Law at Harvard Law School and Jeffery Zhang is an Attorney in the Federal Reserve’s Legal Division. This post is based on their recent paper. The views expressed in this post are those of the authors and do not necessarily reflect those of the Federal Reserve or the United States government.

For nearly half a century, the bundling of research services into commissions that paid for the execution of securities trades has been the focus of both policy discussion and academic debate. The practice whereby asset management firms make use of investor funds to cover the costs of research, known as “soft dollar” payments in the United States, resembles a form of kickback or self-dealing in that the payments allow asset managers to use investor funds to subsidize the cost of the asset managers’ own research expenses. On the other hand, the production of information on the value of securities arguably promotes the development of capital markets and might be understood as a public good, benefiting both investors and the economy more generally. These competing perspectives on bundled commissions have, over the decades, produced a standoff between investor advocates in favor of unbundling and financial industry interests committed to retaining a familiar, albeit opaque, business practice.


Statement by Commissioners Lee and Crenshaw on No-Action Relief for Non-Compliance with the Customer Protection Rule

Allison Herren Lee and Caroline Crenshaw are Commissioners at the U.S. Securities and Exchange Commission. This post is based on their recent public statement. The views expressed in the post are those of Commissioner Lee and Commissioner Crenshaw, and do not necessarily reflect those of the Securities and Exchange Commission, the other Commissioners, or the Staff.

Last night [October 22, 2020], a no-action letter was issued relating to apparent non-compliance by certain broker-dealers with Rule 15c3-3, [1] which is aptly named the “Customer Protection Rule.” [2] In short, certain broker-dealers’ failure to comply with the Customer Protection Rule puts retail customer funds and securities at risk, and the no-action letter purports to allow this misconduct to continue for up to six additional months. [3] The letter clearly states that these practices are not consistent with the requirements of the Customer Protection Rule. On that point we agree, and it is critical that registrants heed that message.

No-action relief, however, is not the appropriate method to communicate the message in these circumstances. No-action relief is a mechanism that allows registrants to obtain certain assurances when their conduct may touch upon a gray area of regulation, or even may be technically proscribed, but does not raise the policy concerns underlying a particular rule. It is designed to give market participants comfort in continuing a particular course of conduct in areas where clarity is lacking, or participants face potentially conflicting requirements. [4] It should not provide a grace period for compliance with clear violations of law—especially violations that put investor funds directly at risk. Here, the potential harm to customers arising from the conduct goes to the very heart of the Customer Protection Rule and should be remediated without delay. READ MORE »

Shareholder Value and Social Responsibility Are Not At Odds

The Honorable Mary K. Bush is President of Bush International LLC. This post is based on her recent article, originally published in ProMarket. 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);  For Whom Corporate Leaders Bargain by Lucian A. Bebchuk, Kobi Kastiel, 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 core of capitalism—the freedom to engage in entrepreneurial activities, to trade goods and services, and make profits for shareholders—in and of itself, is socially responsible. It is so because enterprises and the profits they generate bring many benefits to society including jobs and training, revenues for suppliers, R&D investment for innovation, among others. All potentially produce social and economic returns for individuals and businesses beyond the walls of the company. That is socially responsible.

With renewed emphasis on social responsibility, some see Milton Friedman’s dedication to increasing profits for shareholders as being at odds with social responsibility. I don’t see it that way at all. I think that friction between profits for shareholders and social responsibility arises, in many cases, when individual freedom is, in some way, compromised. Capitalism and individual freedom are joined at the hip. Friedman saw it that way and so do I. A weakened or severed link between the two frequently causes the friction.


Time to Unlock the Hidden Value in Your Board

Jeffrey Greene is a senior advisor at Fortuna Advisors and Sharath Sharma is the EY Americas leader for strategic transformations. This post is based on two articles they recently published in Corporate Board Member.

Management teams do not have to confront the pandemic’s daunting challenges alone. As they move from stabilizing cash flow and reengineering workplaces to creating a little breathing room—both financially and mentally—CEOs and directors should reflect on how to deploy their boards most effectively.

Regardless of where company performance lies on the spectrum—from distressed (physical retailers) to thriving (video conference software)—leaders can improve outcomes by:

  • Systematically involving directors in critical decisions on strategy, culture, building resilience, investor communications and compensation
  • Efficiently facilitating directors’ education about the company and its markets
  • Fully utilizing the board’s collective experience, diverse perspectives, real-time insights and extended networks

Management and shareholders cannot afford to underutilize the board in addressing this crisis, for which there are no playbooks, or its aftermath, which is unlikely to resemble any past recoveries.


The Next Frontier for Representations and Warranties Insurance: Public M&A Deals?

Igor Kirman and Ian Boczko are partners and Nicholas C.E. Walter is an associate at Wachtell, Lipton, Rosen & Katz. This post is based on their article, originally published in The M&A Lawyer. Related research from the Program on Corporate Governance includes Are M&A Contract Clauses Value Relevant to Target and Bidder Shareholders? by John C. Coates, Darius Palia, and Ge Wu (discussed on the Forum here); and The New Look of Deal Protection by Fernan Restrepo and Guhan Subramanian (discussed on the Forum here).

Recent years have witnessed a surge in the number of M&A deals that use representations and warranties insurance (“RWI”). According to a recent study, in 2018 to 2019, 52% of private company transaction agreements referred to RWI, up from only 29% in 2016 to 2017. [1] Yet, despite its dramatic growth in the private company deal market, RWI has so far been almost entirely absent from public M&A transactions (“public company deals”) in the U.S. The question is why.

One key difference between private and public company deals is the availability of post-closing recourse for the buyer. In private company deals, which typically involve the sale of a company by a small number of shareholders or the sale of a subsidiary by a large company, buyers expect sellers to indemnify them for breaches of reps. In contrast, in public company deals, where target companies are usually owned by many shareholders who trade in and out of the shares in the public markets, there traditionally has been no post-closing indemnity, in part because of the view that there would be no one left to pay it. In recent years, we have also seen a rise in a type of blank check company called a special purpose acquisition vehicle (“SPAC”), which raises money in an IPO for the purpose of acquiring other companies. [2] Most “de-SPAC” transactions, whereby the public SPAC vehicle buys a private target, thus taking the target public, do not involve a seller that provides indemnification recourse (for a number of reasons, including dispersed share ownership). Thus, SPAC deals are another category, similar in some respects to a “public deal,” where RWI can fill an indemnification gap.


COVID-19 and Inequality: A Test of Corporate Purpose

Bronagh Ward is director and Vittoria Bufalari is senior associate at KKS Advisors. This post is based on a KKS memorandum by Ms. Ward, Ms. Bufalari, Mark Tulay, Richa Joshi, Nick Cohn Martin, and Sara E. Murphy. 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); For Whom Corporate Leaders Bargain by Lucian A. Bebchuk, Kobi Kastiel, and Roberto Tallarita (discussed on the Forum here); and Toward Fair and Sustainable Capitalism by Leo E. Strine, Jr (discussed on the Forum here).

Before the onset of the COVID-19 pandemic, the world’s largest and most influential companies made promises to their stakeholders. In 2019, 181 CEOs in the Business Roundtable—a group that includes major companies such as Amazon, Apple, and Bank of America—redefined the purpose of a corporation to one that delivers value to all stakeholders, not just shareholders. The statement immediately hit the headlines and was received with equal measures of applause and skepticism.

At the 50-year anniversary of Milton Friedman’s famous statement that the one and only social responsibility of business Is to increase profits, is it possible we are witnessing a turning point in how companies view their responsibilities? If it is the dawn of a new model of purpose-driven leadership, then 2020 is a make or break year for companies to live up to their commitments. The global pandemic and the death of George Floyd have sent seismic waves through the corporate community, pushing companies to take a decisive stance on how they treat their stakeholders during a crisis and their role in addressing inequality. Against a backdrop of growing corporate commitments on purpose and a state of global crisis, we conduct a quantitative stress test of corporate purpose. Analyzing a sample of companies constituting the S&P500 and FTSEEurofirst indexes, we employ three tests of corporate purpose:


The Dangers of Buybacks: Mitigating Common Pitfalls

Sarah Keohane Williamson is CEO, Ariel Babcock is Head of Research, and Allen He is Associate Director at FCLTGlobal. This post is based on their FCLTGlobal 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); Short-Termism and Capital Flows by Jesse Fried and Charles C. Y. Wang (discussed on the Forum here); and Share Repurchases, Equity Issuances, and the Optimal Design of Executive Pay, by Jesse Fried (discussed on the Forum here).

Returning capital to shareholders is an important and legitimate goal of many corporations. Buybacks are often an effective way to distribute capital, but care must be taken to mitigate downfalls related to personal gain and enrichment, poor timing, and excess leverage.

Buybacks have experienced a meteoric rise in popularity since the turn of the twenty-first century, overtaking dividends as the preferred means to return capital to shareholders in jurisdictions like the US. In 2019 alone, corporations spent more than USD 1.2 trillion globally on buybacks.

But the rise of buybacks has been riddled with controversy. Academics, practitioners, and politicians alike have maligned the use of buybacks, taking issue with their potential contribution to income inequality, underinvestment in innovation, and use for personal enrichment. Buybacks and their implications for the long-term strength of the economy are controversial but not well understood. A deeper look at the topic reveals the following:


The Power of the Narrative in Corporate Lawmaking

Mark J. Roe is David Berg Professor of Business Law at Harvard Law School, and Roy Shapira is Associate Professor at IDC Herzliya Radzyner Law School. This post is based on their recent paper, forthcoming in the Harvard Business Law Review. Related research from the Program on Corporate Governance includes The Long-Term Effects of Hedge Fund Activism by Lucian Bebchuk, Alon Brav, and Wei Jiang (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); and Stock Market Short-Termism’s Impact by Mark Roe, (discussed on the Forum here).

The concept of how stock-market-driven short-termism damages the economy is simple and powerful: executives, confronted with a demanding stock market of traders and activists, focus too much on boosting the immediate quarterly financial statements, rather than on the business’s long-term health. Employee well-being, critical research and development, and long-run capital investment all deteriorate. As a result, the entire economy suffers. Among policymakers, the media, and executives, the consensus is that the short-termism problem is widespread and pernicious—and getting worse. Presidents and presidential candidates say so. Corporate law judges excoriate it. Stock market regulators, responding to political pressure, move combatting short-termism up on their agenda.

Yet the academic evidence for stock-market-driven short-termism as seriously damaging the economy is inconclusive and contested. Surely some companies are, as charged, excessively short-term. But the evidence of grave economy-wide damage is sparse and some of it negative. What explains this wide gap between contradictory academic evidence and assured perniciousness in the popular view?


Weekly Roundup: October 16–22, 2020

More from:

This roundup contains a collection of the posts published on the Forum during the week of October 16–22, 2020.

The Persistence of Fee Dispersion among Mutual Funds

Investing Responsibly: Company Interaction

“Bump-Up Exclusion” Bars Coverage of Settlement of Deal Litigation Claims

Key Takeaways from the New WEF/IBC ESG Disclosure Framework

Acquisition of Majority Ownership May Constitute a “Benefit”

How Executives Can Help Sustain Value Creation for the Long Term

Private Equity and COVID-19

ISS Supports Delaware Choice of Forum Provisions

Are ISS Recommendations Informative? Evidence from Assessments of Compensation Practices

Survey Analysis: ESG Investing Pre- and Post-Pandemic

Preparing to Survive and Thrive Amidst the Next Crisis

Back to the Future? Reclaiming Shareholder Democracy Through Virtual Annual Meetings

Proxy Voting by ERISA Fiduciaries

The Future of Financial Fraud

Do Share Buybacks Really Destroy Long-Term Value?

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