Yearly Archives: 2020

The Fear and the Bright Side of Financial Fragility

Massimo Massa is the Rothschild Professor of Banking and a Professor of Finance at INSEAD; David Schumacher is an Assistant Professor of Finance at the Desautels Faculty of Management at McGill University; and Yan Wang is an Assistant Professor of Finance at the DeGroote School of Business at McMaster University. This post is based on their recent paper, forthcoming in the Review of Financial Studies, and their recent working paper.

The global asset management industry continues to consolidate and a small number of very large asset managers play an increasingly dominant role. At the same time, one of the main folk theorems in finance posits that asset managers do not pose a risk to financial market stability because they are not levered. This lack of leverage could make concentrated stock ownership in the hands of big asset management families a source of stock price stability.

In our research, we investigate if the rise of large asset managers like BlackRock and others raises concerns about financial market stability. We ask the following questions: Does the rise of such large asset management firms induce “fear of financial fragility” in other market participants? If so, how do these other market participants respond to such fear and how does the market overall adjust as a result? Moreover, what are the corporate implications for firms with “fragile” stocks?


The Forum Wars of Section 11

Boris Feldman is a partner at Freshfields Bruckhaus Deringer LLP.

TL;DR: The battle over filing Section 11 lawsuits in state court may be approaching resolution. Multiple California courts have now upheld “Federal Forum Clauses,” which require shareholders to litigate Section 11 claims in Federal court. Judicial validation of such provisions has significant implications for companies going public and for the D&O insurance industry.

TROTS [The Rest of the Story]:

  1. Over the last decade, one of the hot topics in securities litigation has been The Forum Wars: may shareholder claims under Section 11 of the Securities Act of 1933 be brought in state and Federal courts, or only in Federal court alone?
  2. This post presumes familiarity with the basics of Section 11. For a reader innocent of such familiarity the two Supreme Court decisions cited below (one the United States Supreme Court, the other the Delaware Supreme Court) provide a useful statutory primer. The Section 11 for Dummies version is this: Section 11 gives shareholders a virtually no-fault claim against a public company for material misstatements or omissions in its IPO prospectus. The claims against the company’s directors, and against the underwriters of the offering, are nearly as potent. In the security-plaintiff bar’s armory, the Section 11 claim is a magic bullet.


Key Issues Facing Companies That Exceed Financial Expectations

Mike KesnerSandra Pace, and John Sinkular are partners at Pay Governance LLC. This post is based on their Pay Governance memorandum. Related research from the Program on Corporate Governance includes Paying for Long-Term Performance by Lucian Bebchuk and Jesse Fried (discussed on the Forum here).

We have written several posts on COVID-19’s effect on executive compensation programs at severely harmed companies and the potential actions that could be considered to mitigate some of its impact. In this post, we review companies that have exceeded initial expectations during the pandemic and the unique executive compensation challenges they may face.


A number of companies were labeled “essential services” by the Federal Government and were not required to shut down during the government-mandated lockdowns at the onset of the pandemic. In many cases, the demand for these essential businesses’ products and services soared and will likely remain in high demand for the foreseeable future, as consumer preferences and behaviors have changed across a wide range of activities including home improvements, at-home fitness, prepared meals, and ecommerce.


Real Effects of Share Repurchases Legalization on Corporate Behaviors

Zigan Wang is Assistant Professor of Finance at The University of Hong Kong; Qie Ellie Yin is Assistant Professor of Finance at Hong Kong Baptist University; and Luping Yu is a Ph.D. Candidate in Finance at The University of Hong Kong. This post is based on their recent paper, forthcoming in the Journal of Financial Economics. Related research from the Program on Corporate Governance includes Short-Termism and Capital Flows by Jesse Fried and Charles C. Y. Wang (discussed on the Forum here).


A central topic for corporations is how they manage their cash. The decision to distribute cash to shareholders is among the most important ones for corporate managers with substantial free cash flows. Although share repurchases serve as one of two major distribution methods nowadays, the practice of repurchasing shares was not largely adopted by firms until the 1980s, when major countries started to legalize it. Prior to the 1980s, even though firms could conduct private tender offers, this strategy usually involved high services fees paid to third parties or high premiums paid to tendering stockholders. These obstacles lead to the unpopularity of share repurchases before legalization. However, since major economies around the world gradually legalized open market share repurchases in their stock markets during the 1980s and 2000s, repurchasing shares has become increasingly popular for publicly listed firms. For instance, according to a report by Yardeni Research 2020, in the United States, approximately $700 billion shares were repurchased by S&P 500 companies in 2019, marking the tenth consecutive year in which share repurchases exceeded dividend payments.


2020 Director Compensation Report

Michael Ferrante and Connor Damon are consultants at FW Cook. This post is based on their FW Cook memorandum.

FW Cook’s 2020 Director Compensation Report studies non-employee director compensation at 300 companies of various sizes and industries to analyze market practices in pay levels and program structure. Year-over-year increases to total compensation, at the median, were modest among large-cap and mid-cap companies compared to small-cap companies, which had a relatively significant increase: the large-cap median increased 1.6% to $290,000, the mid-cap median increased 1.7% to $216,950, and the small-cap median increased 5.1% to $163,500. Changes were relatively stable across industries; we observe that Financial Services, Industrials, and Technology companies had no increases in median total compensation, while Energy and Retail companies had increases of 3% and 2%, respectively.

Director compensation structure remains consistent with prior years, with an average mix of 57% equity and 43% cash across the entire sample. Small-cap companies tend to have the highest cash weighting (average of 47%) and large-cap companies tend to have the lowest (average of 37%). Most companies continue to use fixed-value equity award guidelines, with full-value stock awards remaining the most common form of equity compensation and providing the most consistent means to align director pay with shareholder interests. Equity grants most commonly vest immediately, or cliff-vest after one year.


Some Thoughts for Boards of Directors in 2021

Martin Lipton is a founding partner of Wachtell, Lipton, Rosen & Katz, specializing in mergers and acquisitions and matters affecting corporate policy and strategy. This post is based on a Wachtell Lipton memorandum by Mr. Lipton, Steven A. RosenblumKaressa L. CainHannah 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); 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).

Many of the challenges that corporations and their boards have encountered in 2020 will continue to be front and center in 2021, including the COVID-19 pandemic, the movement to address racial injustice and broad-based socioeconomic inequality, an accelerating sense of urgency around climate change, technological innovation and an evolving political and regulatory climate. These trends have underscored the key themes of sustainability, resilience and corporate purpose, and are prompting new perspectives on the ways that corporations must operate to manage the multiple stakeholder interests that are critical to the health and long-term success of their businesses. And, in this environment, boards are seeking to optimize their functioning and leadership role to navigate these challenges as well as the evolving expectations of stakeholders.

Summarized below are highlights and practical suggestions for corporations and boards to consider in the new year.


Who Benefits from Analyst “Top Picks”?

René M. Stulz is Everett D. Reese Chair of Banking and Monetary Economics at The Ohio State University Fisher College of Business. This post is based on a recent paper authored by Professor Stulz; Justin Birru, Associate Professor Finance at The Ohio State University Fisher College of Business; Sinan Gokkaya, Professor of Finance at Ohio University College of Business; and Xi Liu, Assistant Professor of Finance at Miami University of Ohio Farmer School of Business.

In the early 2000s, concerns about conflicts of interest of sell-side analysts led to new regulations and eventually to the Global Analyst Research Settlement. One important byproduct of these regulations is the adoption of a new stock rating system by most leading investment banks. Before the Global Settlement, 85% of analyst recommendations are issued using a traditional five-tier rating system, but only less than 20% are afterwards.

Though a coarser three-tier rating system has the potential to reduce gains to analysts from engaging in strategic behavior, such a system also reduces the information available to investors. That is, sell-side analysts cannot fully discriminate among stocks whose performance they expect to be superior. To mitigate the costs of a coarser three-tier stock rating system, we would expect brokerage houses to attempt to increase the granularity of information available to financial market participants by devising new ways to draw attention to their best stocks. Consistently, we show that a new stock designation, “top picks,” emerges following the Global Analyst Research Settlement and its use becomes widespread mostly among three-tier brokers. A top pick is typically the stock for which the analyst has the strongest conviction of superior performance compared to other buy recommendations.


SEC Harmonizes Regulation and Improves Access to Capital in Private Markets

Adam Fleisher, Jeffrey D. Karpf, and Leslie N. Silverman are partners at Cleary Gottlieb Steen & Hamilton LLP. This post is based on a Cleary memorandum by Mr. Fleischer, Mr. Karpf, Mr. Silverman, Nina E. Bell, David Lopez, and Jeff J. Shim.

On November 2, 2020, the Securities and Exchange Commission voted 3-2 to adopt amendments to “simplify, harmonize, and improve certain aspects” of the framework for offerings exempt from Securities Act registration. The amendments largely track the March 2020 proposing release, with a few key and welcome changes, and cover a number of areas, including integration, general solicitation and offering communications, and Rule 506(c) verification requirements.

The amendments mark the second set of rule changes adopted as part of a broader SEC initiative to update the exempt offering framework, as laid out in the SEC’s 2019 concept release. The first set of rule changes, which will become effective December 8, 2020, modernize and expand the definition of “accredited investor” and “qualified institutional buyer.” Taken together, the rule changes will allow a broader range of individuals and institutions to invest in offerings under a more streamlined exempt offering framework, and clarify the rules around properly conducting private placements.

The amendments will generally become effective 60 days after the date of publication in the Federal Register. The SEC did not indicate that voluntary early adoption of the rule would be permitted.


A New Public Market Seeks to Change Capitalism by Changing the Rules

Michelle Greene is President Emeritus and a Board Member of the Long-Term Stock Exchange. Related research from the Program on Corporate Governance includes The Uneasy Case for Favoring Long-Term Shareholders by Jesse Fried (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); and The Illusory Promise of Stakeholder Governance by Lucian A. Bebchuk and Roberto Tallarita (discussed on the Forum here).

The Long-Term Stock Exchange (LTSE) was created to address a fundamental issue in today’s marketplace. As long as the public markets optimize for short-term gains, we will continue to see under-investments in workers and innovation, harmful financial engineering, and inadequate regard for the environment.  We can’t provide much-needed reforms to capitalism without urgent and sustained change to the systems that fuel mass inequality.

LTSE is a new public market that incentivizes long-term actions over the quarterly myopia of the current system. It provides capital market infrastructure that prioritizes ongoing innovation over short-term profiteering. It promotes a fundamental change in company behavior and operations through a new set of listings standards—the governance requirements imposed and enforced by stock exchanges.

While stakeholder capitalism has become a rallying cry for many companies, and sustainability funds continue to grow, the stakeholders themselves are increasingly wary of company claims.


All the President’s Friends: Political Access and Firm Value

Jeffrey R. Brown is Josef and Margot Lakonishok Professor of Business and Dean of the College of Business and Jiekun Huang is an associate professor of finance and Vernon Zimmerman Faculty Fellow at the University of Illinois at Urbana-Champaign Gies College of Business. This post is based on their recent paper, forthcoming in the Journal of Financial Economics.

Access to political decision-makers is a scarce resource because politicians and their aides have limited time and can only interact with a limited set of people. Gaining political access can be of significant value for corporations, particularly because governments play an increasingly prominent role in influencing firms. Governments affect economic activities not only through regulations but also by playing the role of customers, financiers, and partners of firms in the private sector. There is ample anecdotal evidence suggesting that firms benefit from gaining access to powerful politicians. For example, a Wall Street Journal (2015) article claims that Google executives’ frequent visits to the White House were instrumental in the Federal Trade Commission’s decision to drop its antitrust investigation of the company. Gaining and maintaining access to influential policymakers can be an important source of competitive advantage for companies. Yet despite the importance of political access for firms, the allocation of political access across firms and its effects on firm value remains underexplored.

In our paper, All the President’s Friends: Political Access and Firm Value, published in the Journal of Financial Economics, we investigate the characteristics of firms with political access as well as the valuation effects of political access for corporations. Using a data set of White House visitor logs, we identify top corporate executives of S&P 1500 firms that have face-to-face meetings with high-level federal government officials. We examine two fundamental questions associated with political access. First, how prevalent is political access—in the literal form of meetings with influential policymakers—and what are the characteristics of firms with access to politicians? Second, does political access increase firm value, and if so, through what channels?


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