Yearly Archives: 2020

Do Share Buybacks Really Destroy Long-Term Value?

Posted by Alex Edmans (London Business School), on
Thursday, October 22, 2020
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Alex Edmans is professor of finance at London Business School. This post is based on his recently published book Grow the Pie. 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); The Long-Term Effects of Hedge Fund Activism by Lucian Bebchuk, Alon Brav, and Wei Jiang (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).

Share buybacks are one of the most controversial corporate decisions today. US Senator Elizabeth Warren claimed that “buybacks create a sugar high for the corporations. It boosts prices in the short run, but the real way to boost the value of a corporation is to invest in the future, and they are not doing that.”

That quote highlights the two main reasons why share repurchases are unpopular. First, they prevent investment—in wages, in new and better products, and in reducing carbon emissions. They seem to split the pie in favour of investors and at the expense of wider society. Second, they increase the short-term stock price, allowing a CEO to benefit by opportunistically cashing out her shares. Moreover, the CEO’s personal incentives to undertake repurchases are even broader than in Senator Warren’s quote. Buybacks increase not just the stock price but also a company’s earnings per share (EPS). That allows a CEO to hit any EPS target in her bonus contract—without boosting revenues or cutting costs, which were presumably the actions that the EPS target hoped to encourage.

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The Future of Financial Fraud

Posted by Jonathan M. Karpoff (University of Washington), on
Thursday, October 22, 2020
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Jonathan M. Karpoff is Professor of Finance at University of Washington Foster School of Business. This post is based on his recent paper, forthcoming in the Journal of Corporate Finance.

Is financial fraud becoming a bigger or smaller problem over time? This paper applies two theoretical models to gain insight into this question. The first model is the Trust Triangle, which Dupont and Karpoff (2020) use to describe the forces that discipline misconduct and encourage the building of trust that is at the core of most economic transactions. The second model is Klein and Leffler’s (1981) theory of contractual enforcement in the absence of third-party enforcement. These models add content to Becker’s (1968) basic proposition that a person will commit fraud when the expected benefits exceed the expected costs, by partitioning the costs into first-party, related-party, and third-party mechanisms. These models yield comparative statics predictions about the impacts of changing technology and wealth over time.

I use theory to peer into the future because historical data do not yield a clear-cut answer to the question of whether fraud is trending up or down. One problem is that different indicators trend in different directions. For example, Cornerstone Research (2020) reports that the annual number of securities-related class action lawsuit filings that allege financial misconduct reached an all-time high in 2019. In contrast, the number of new SEC enforcement actions targeting publicly traded firms for financial misrepresentation trended up only through 2003 before turning flat or slightly downward in more recent years. Among firms facing enforcement action, the number of firms violating financial reporting rules in any given year has actually decreased since the early 2000s.

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Proxy Voting by ERISA Fiduciaries

Posted by Robert A. G. Monks and Nell Minow, ValueEdge Advisors, on
Thursday, October 22, 2020
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Robert A.G. Monks is Chairman and Nell Minow is Vice Chair of ValueEdge Advisors. This post is based on their recent comment letter to the Department of Labor. 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); Reconciling Fiduciary Duty and Social Conscience: The Law and Economics of ESG Investing by a Trustee by Max M. Schanzenbach and Robert H. Sitkoff (discussed on the Forum here); and Companies Should Maximize Shareholder Welfare Not Market Value by Oliver Hart and Luigi Zingales (discussed on the Forum here).

In the long, dismaying history of regulatory capture, when agencies set up to provide oversight instead issue rules entrenching and subsidizing corporate insiders, disregarding the public interest in transparency, accountability, and robust market forces, it is hard to think of an example as discreditable as this proposal on proxy voting by ERISA fiduciaries.

We object to this proposal in the strongest terms, both in substance and in process. We have signed the comment letter drafted by Keith Johnson and Jon Lukomnik and endorse it fully. This letter supplements it by adding our own perspective, including those of a former head of EBSA’s predecessor agency, PWBA. We note for the record that we have no financial ties to proxy advisors or ERISA fiduciaries and have not been paid by anyone to express these views. We trust EBSA will carefully scrutinize all comments for possible hidden conflicts of interest, which have been rampant in the DOL and SEC filings relating to proxy proposals and proxy voting.

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Roadmap 2030

Posted by Mindy S. Lubber, Ceres, on
Wednesday, October 21, 2020
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Mindy S. Lubber is President and CEO of Ceres, Inc. This post is based on her Ceres memorandum. 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); 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 Ceres Roadmap 2030 is a 10-year action plan that challenges companies to become sustainable business leaders, advancing the transition to a more equitable, just and sustainable economy. It provides clarity and direction in the development of credible, effective and appropriately ambitious sustainable business strategies and priorities.

To achieve this vision, the Ceres Roadmap 2030 lays out the three components of corporate action that are essential for stabilizing the climate, protecting water and natural resources and building a just and inclusive economy. The Critical Impact Actions call on companies to minimize negative environmental and social externalities and maximize positive impacts across the value chain. The Business Integration Actions guide companies as they transition core business and internal corporate systems to support long-term success and value creation in a more sustainable economy. And finally, the Systems Change Actions challenge companies to drive the systems-level transformation needed to support and enable sustainable business practice.

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

Posted by Yaron Nili (University of Wisconsin) and Megan W. Shaner (University of Oklahoma), on
Wednesday, October 21, 2020
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Yaron Nili is assistant professor at the University of Wisconsin Law School and Megan W. Shaner is professor at the University of Oklahoma College of Law. This post is based on their recent paper.

The COVID-19 global pandemic and subsequent state responses had immediate and direct impacts on annual shareholders meetings across companies large and small. In the midst of the 2020 annual meeting season, COVID-19 was declared a pandemic and a national state of emergency was declared in the United States resulting in forty-three states issuing mandatory stay-at-home orders and most major companies implementing corporate travel restrictions, forcing corporate boards to rethink their in-person annual meetings. Most companies quickly turned, for the first time, to virtual meetings as an alternative for satisfying their statutorily-required obligation to convene a meeting of their shareholders.

Despite their relatively long existence, virtual meetings garnered only modest use prior to 2020, so the en-masse transition to virtual meetings provided a natural experiment for evaluating the benefits and concerns of remote participation. More importantly, however, it thrust the annual meeting back into the corporate governance spotlight, providing an opportunity to re-think the purpose and prevailing practice of annual meetings. In our paper, Back to the Future? Reclaiming Shareholder Democracy through Virtual Annual Meetings, we offer a detailed empirical account of the impact of COVID-19 on annual meetings and shareholder voting. The paper situates virtual annual meetings within a robust historical overview of annual meetings and shareholder voting to argue that virtual meetings provide an opportunity to regain one of the core objectives and functions of annual meetings—shareholder democracy. We underscore the promise of virtual annual meetings in improving shareholder democracy, engagement, and feedback, which have largely been missing from annual meetings. Ultimately, we view the forced move to virtual meetings in 2020 as an opportunity to re-imagine annual meetings—both using the pitfalls of the 2020 season as an opportunity for growth and the benefits provided to shareholders and issuers alike as a space to learn.

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Preparing to Survive and Thrive Amidst the Next Crisis

Posted by Jonathan Ocker and Amanda Halter, Pillsbury Winthrop Shaw Pittman LLP, on
Wednesday, October 21, 2020
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Jonathan Ocker and Amanda Halter are partners at Pillsbury Winthrop Shaw Pittman LLP. This post is based on their Pillsbury memorandum.

This checklist will help boards enable their companies to anticipate, manage, and survive the next crisis, even as the novel coronavirus pandemic continues to cause unprecedented disruption and uncertainty.

Takeaways

  • Learning from the Covid-19 pandemic and the overall heightened turbulence of 2020, boards can take crisis management to the next level and oversee “foresight” or “look-around-the-corner” management teams that develop response strategies for multiple contingent scenarios.
  • Based on this planning, and to stay ahead of the next normal, boards should consistently reevaluate and update the company’s strategic and social relevance and purpose.
  • Boards should consider recalibrating their agendas and time commitment to these increased oversight responsibilities and persistent “war-like” conditions and establish a special or new contingency planning committee with additional compensation.

A novel coronavirus (COVID-19) pandemic, wildfires of unprecedented scope, numerous hurricane threats, heightened social and geopolitical unrest, increased cybersecurity breaches, asteroids, etc.—what a year! If 2020 has taught us anything, it is not “if” but “when” the next crisis will hit. It is the responsibility of the board of directors to ensure that the company is well positioned to navigate the turbulence of crisis conditions by contingency planning—proactively—at a heightened level. To that end, this post identifies 5 high-level items that can serve as a framework for sound contingency planning.

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Survey Analysis: ESG Investing Pre- and Post-Pandemic

Posted by Subodh Mishra, Institutional Investor Services, Inc., on
Tuesday, October 20, 2020
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Subodh Mishra is Managing Director at Institutional Shareholder Services, Inc. This post is based on an ISS paper by Maura Souders, Associate at ISS ESG, the responsible investment arm of Institutional Shareholder Services. 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); Reconciling Fiduciary Duty and Social Conscience: The Law and Economics of ESG Investing by a Trustee by Max M. Schanzenbach and Robert H. Sitkoff (discussed on the Forum here); and Companies Should Maximize Shareholder Welfare Not Market Value by Oliver Hart and Luigi Zingales (discussed on the Forum here).

Key Takeaways

  • A considerable proportion of respondents to the survey (62.5%) report that the Social domain of the Environmental, Social and Governance (ESG) spectrum is attracting more of their attention since the beginning of the COVID-19 pandemic.
  • Governance remains the most important ESG factor in the investment analysis and stewardship activities of 86% of respondents.
  • Respondents whose ESG engagements have grown since the outbreak of the pandemic report that the primary drivers of growth include client and stakeholder demand, racial inequality and diversity, and regulatory changes.
  • A significant share of respondents (44.1%) expect future ESG ratings to place a greater weight on workplace safety, treatment of employees, diversity and inclusion, as well as supply chain labor dynamics.
  • All these changes necessitate an increased workload, and 37.5% of respondents have either already added or intend to add new staff to manage ESG-related issues, following the onset of the pandemic.

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Are ISS Recommendations Informative? Evidence from Assessments of Compensation Practices

Posted by Ana Albuquerque (Boston University), Mary Ellen Carter (Boston College), and Susanna Gallani (Harvard Business School), on
Tuesday, October 20, 2020
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Ana M. Albuquerque is Associate Professor of Accounting at Boston University Questrom School of Business; Mary Ellen Carter is Associate Professor of Accounting at Boston College Carroll School of Management; and Susanna Gallani is Assistant Professor of Business Administration at Harvard Business School. This post is based on their recent paper.

Proxy advisors recommend to institutional investors how they should vote on the nomination of board members and other corporate governance issues, including executive compensation. The advisor with the largest US market share is Institutional Shareholder Services (ISS). ISS and other advisors do not own equity in the companies about which they provide voting advice, nor do they have any fiduciary duty to the shareholders of those companies; they don’t, in short, have skin in the game. Thus a key question is whether ISS’s voting recommendations really do inform investors and—of particular interest to us—whether ISS can identify, with its “against” recommendations, low quality compensation practices.

In a recent paper, we find it can. Specifically, we show that ISS’s “against” recommendations are associated with worse future industry-adjusted performance. However, we also find that the quality of ISS’s recommendations appears to be hurt by its workload. That is, we find that the firm’s ability to identify poor compensation practices relates only to companies with non-December fiscal year-ends. Resource constraints faced by ISS during its busy season, when it is analyzing the many firms with December fiscal year-ends, appears to influence the quality of its recommendations.

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ISS Supports Delaware Choice of Forum Provisions

Posted by Theodore N. Mirvis, William Savitt, and Sabastian V. Niles, Wachtell, Lipton, Rosen & Katz, on
Tuesday, October 20, 2020
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Theodore N. Mirvis, William Savitt, and Sabastian V. Niles are partners at Wachtell, Lipton, Rosen & Katz. This post is based on a Wachtell memorandum by Mr. Mirvis, Mr. Savitt, Mr. Niles, S. Christopher Szczerban and Anitha Reddy, and is part of the Delaware law series; links to other posts in the series are available here. The post discusses the growing acceptance of exclusive forum bylaws, which were put forward by Wachtell Lipton partner Theodore N. Mirvis and discussed on the Forum by him here, here and here.

Institutional Shareholder Services (ISS) has released its proposed 2021 voting policy updates and, for the first time, proposes expressly recognizing the benefits of Delaware choice of forum provisions for Delaware corporations and generally recommending in favor of management-sponsored proposals seeking shareholder approval of such charter or bylaw provisions. Under the new ISS policy, ISS would:

  1. generally vote for charter or bylaw provisions that specify Delaware, or the Delaware Court of Chancery, as the exclusive forum for corporate law matters for Delaware corporations, “in the absence of serious concerns about corporate governance or board responsiveness to shareholders” (and continue to decline to vote against the directors of Delaware companies who adopt such bylaw provisions “unilaterally”);
  2. continue to take a case-by-case approach with respect to votes regarding exclusive forum provisions specifying states other than Delaware; and
  3. generally vote against provisions that specify a state other than the state of incorporation as the exclusive forum for corporate law matters or a specific local court within the state (and apply withhold vote recommendations to a board’s “unilateral” adoption of such a provision).

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The Fiduciary Duties of Bank Boards

Posted by Abbott Cooper, Driver Management Company, on
Monday, October 19, 2020
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Abbott Cooper is founder and managing member of Driver Management Company LLC. Related research from the Program on Corporate Governance includes Monetary Liability for Breach of the Duty of Care? by Holger Spamann (discussed on the Forum here).

Even Bank Directors Are Not “Platonic Masters”: The fiduciary duties of bank boards extend to efforts to exploit banking regulations and manipulate bank regulators

When a board of directors takes action for the primary purpose of thwarting the effectiveness of shareholders’ election of directors, that board violates its duty of loyalty. The rationale for this rule is simple: as between shareholders and directors, shareholders are the principals and directors the agents. In a principal/agent relationship, the principal has the authority to choose the agent and in the context of directors and shareholders, it is fundamentally disloyal for the director/agent to usurp the principal/shareholders’ authority to elect directors. [1] Among non-banking, commercial corporations, this is a matter of settled law and boards are largely loathe (whether to avoid liability or predictable repercussions) to take any corporate action that would thwart the effectiveness of a shareholder vote, such as attempting to prevent a contested election of directors. Yet boards of banking organizations—almost as a matter of course when confronted with an activist investor—will shamelessly take actions with the obvious “purpose of obstructing the legitimate efforts of dissident stockholders in the exercise of their rights to undertake a proxy contest against management.” [2]

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