Yearly Archives: 2020

Spotlight on Boards

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. Rosenblum, 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); 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 ever-evolving challenges facing corporate boards prompt periodic updates to a snapshot of what is expected from the board of directors of a public company—not just the legal rules, or the principles published by institutional investors and various corporate and investor associations, but also the aspirational “best practices” that have come to have equivalent influence on board and company behavior. The coronavirus pandemic and resulting economic turbulence, combined with the wide embrace of ESG, stakeholder governance and sustainable long-term investment strategies, is propelling a decisive inflection point in the responsibilities of boards of directors. The 2020 statement of corporate purpose by the World Economic Forum is a concise and cogent reflection of the current thinking of most of the leading corporations, institutional investors, asset managers and their organizations, as well as governments and regulators outside the United States:

The purpose of a company is to engage all its stakeholders in shared and sustained value creation. In creating such value, a company serves not only its shareholders, but all its stakeholders—employees, customers, suppliers, local communities and society at large. The best way to understand and harmonize the divergent interests of all stakeholders is through a shared commitment to policies and decisions that strengthen the long-term prosperity of a company.


Workplace Wellness and Employee Mental Health—An Emerging Investor Priority

Andrea K. Wahlquist, Sabastian V. Niles, and Lauren M. Kofke are partners at Wachtell, Lipton, Rosen & Katz. This post is based on a Wachtell memorandum by Ms. Wahlquist, Mr. Niles, Ms. Kofke, and Carmen X. W. Lu. Related research from the Program on Corporate Governance includes 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); Companies Should Maximize Shareholder Welfare Not Market Value by Oliver Hart and Luigi Zingales (discussed on the Forum here).

With the prospect of global vaccines on the horizon, companies worldwide continue to address the challenges of pandemic management and recovery on their businesses, the communities and constituencies they serve and especially on their employees. As companies seek to prioritize workplace and customer health and safety alongside productivity and the achievement of strategic plans, the psychological, as well as physical, well-being of employees has been brought into sharper focus this year. The urgent need to address issues of diversity, inclusion, racism and racial injustice, gender equality, and attendant financial and socioeconomic inequities has heightened attention to workplace wellness, as have pandemic-related illness and loss of life, economic and job insecurity, social isolation, lockdowns, travel restrictions and remote working and schooling.

For a long time, matters of employee wellness, mental health and emotional well-being generally had been largely only areas of internal focus for companies—and in some instances were overlooked due to unwarranted stigma attached to mental health issues within certain professions and industries and uncertainty about how to navigate stress, depression, anxiety, burnout and other conditions and illnesses and how to normalize discussion of these issues.


Sense and Nonsense in ESG Ratings

Ingo Walter is Professor Emeritus of Finance at NYU Stern School of Business. This post is based on his recent paper, forthcoming in the Journal of Law, Finance, and Accounting. 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); Socially Responsible Firms by Alan Ferrell, Hao Liang, and Luc Renneboog (discussed on the Forum here); Toward Fair and Sustainable Capitalism by Leo E. Strine, Jr (discussed on the Forum here).

Interactions between firms subject to market discipline and the environmental, social and governance (ESG) context within which they operate have proliferated to the point of influencing board and management behavior, stock prices and corporate valuations—as well as the creation of target investment funds tied to specific ESG outcomes.  In this paper we propose a heuristic to frame ESG objectives, extending from classic regulation to fuzzy signals purporting to reflect collective values—and giving rise to corporate behavior that ranges from compliance failure to conduct deemed “irresponsible” or “unethical,” with implications along the way for revenues, costs and exposure to enterprise risk.  We suggest that this heuristic is broadly consistent with the concerns of investors and the fiduciary obligations of asset managers, and forms  a constructive framework for considering interactions with an array of (often overlapping and conflicted) stakeholders.

It was inevitable that a vigorous market would develop for ESG scoring and rating services that would identify key normative targets and calibrate the  degree to which individual firms achieve those targets in the form of metrics that are transparent and defensible and that can be weighted and aggregated to generate composite scores and displayed in alphanumeric form—perhaps adjusted for industry and incorporating secondary and tertiary impacts up the supply chain. This is a heroic task compared, for example, to the mandate facing credit rating agencies (CRAs)—the likelihood of debt service “on time and in full.” The paper examines the key ESG rating issues in some detail as well as the structure, conduct and performance of the ESG rating industry itself.


The Download on Data

James Howard is a Data Management and Privacy Advisor. This post is based on an Equilar, Inc. memorandum.

Data is and continues to be a game changer for organizations across the world. Data science is evolving at an incredible pace, providing opportunities for companies to develop new, or enhance existing, products and services, and streamline operations and employee experience. Unfortunately, breaches and abuses are occurring with alarming frequency, impacting people in very real ways, driving legislators to enact complicated regulations in an attempt to create boundaries.

The use of data—and related risks—are so significant for many companies that, increasingly, boards are taking an active role in understanding how data is being managed. Many boards, however, find themselves unsure of how to evaluate the plans presented to them, which may keep them from engaging in meaningful discussions with management. This is exacerbated when events like COVID-19 occur, which impact operations and, by extension, how data risk is managed.

The following questions are intended to raise awareness among board members around issues and opportunities related to data, so they can better discharge their duties to the companies they oversee.


Statement Regarding Audit Quality in Emerging Markets and Recent Developments

Jay Clayton is Chairman of the U.S. Securities and Exchange Commission; William D. Duhnke III is Chairman of the Public Company Accounting Oversight Board; and Sagar Teotia is Chief Accountant at the U.S. Securities and Exchange Commission. This post is based on their recent public statement. The views expressed in this post are those of Mr. Clayton, Mr. Duhnke, and Mr. Teotia and do not necessarily reflect those of the Securities and Exchange Commission, the Public Company Accounting Oversight Board, or their staff.


Over the past several years, the exposure of U.S. investors and our capital markets to companies with significant operations in emerging markets, including China, has increased. [1] This increased exposure carries with it a number of significant risks and challenges, many of which we described in our statement of December 7, 2018 [2] and our more recent joint statement along with other SEC staff, Emerging Market Investments Entail Significant Disclosure, Financial Reporting and Other Risks; Remedies are Limited, on April 21, 2020. [3]

Among other relevant issues related to emerging market investments, we noted that the Public Company Accounting Oversight Board (PCAOB) continues to be prevented from inspecting the audit work and practices of PCAOB-registered audit firms in China on a comparable basis to other non-U.S. jurisdictions. This limitation on inspections also includes PCAOB access to audit work and practices of Hong Kong-based audit firms, to the extent their audit clients have operations in mainland China.


Public Thrift, Private Perks: Signaling Board Independence with Executive Pay

Pablo Ruiz-Verdú is Associate Professor of Management at the Department of Business Administration at Carlos III University; Ravi Singh is Managing Partner at Higher Moment Capital. This post is based on their recent paper, forthcoming in the Journal of Finance. Related research from the Program on Corporate Governance includes Stealth Compensation Via Retirement Benefits by Lucian Bebchuk and Jesse Fried.

Boards of directors set CEO pay. Understanding how directors’ incentives affect compensation contracts is therefore essential for understanding executive pay. In a recent paper, we contribute to this goal by proposing a model in which we analyze CEO pay explicitly as a board decision determined by director independence and by directors’ reputational concerns.  In the paper, we show that a key consequence of directors’ reputational concerns is the use of camouflaged or hidden forms of pay, which are otherwise difficult to rationalize in optimal contracting models.

Reputational concerns are widely regarded as a key determinant of director incentives and play a central role in our analysis. In our model reputational concerns arise because we assume that shareholders do not observe directors’ true independence from management and must infer the degree of independence from directors’ actions. Of course, shareholders observe formal measures of director independence (such as, for example, whether a director is a former employee of the firm). However, shareholders may be unaware of undisclosed ties between directors and the firm or the CEO, or of other attributes, such as personality traits that influence the willingness of a director to confront the CEO.


Silicon Valley and S&P 100: A Comparison of 2020 Proxy Season Results

David A. Bell is co-chair of Fenwick’s corporate governance practice and a partner in the corporate and securities group at Fenwick & West LLP. This post is based on portions of a Fenwick publication titled 2020 Proxy Season Results in Silicon Valley and Large Companies Nationwide.

In the 2020 proxy season, 146 of the technology and life sciences companies included in the Fenwick—Bloomberg Law Silicon Valley 150 List (SV 150) and 98 of the S&P 100 companies held annual meetings that typically included voting for the election of directors, ratifying the selection of auditors of the company’s financial statements and voting on executive officer compensation (“say-on-pay”).

Annual meetings also increasingly include voting on one or more of a variety of proposals that may have been put forth by the company’s board of directors or by a stockholder that has met the requirements of the company’s bylaws and applicable federal securities regulations. [1]

This companion supplement to the Fenwick survey, “Corporate Governance Practices and Trends: A Comparison of Large Public Companies and Silicon Valley Companies,” provides insight into the results of stockholder voting at annual meetings in the 2020 proxy season, [2] allowing directors, executives and practitioners to analyze company results with relevant peers.


Compensation-Related Considerations for the 2021 Proxy Season

Maj Vaseghi and Lori Goodman are partners and Sarah Ghulamhussain is a senior associate at Freshfields Bruckhaus Deringer LLP. This post is based on a Freshfields memorandum by Ms. Vaseghi, Ms. Goodman, Ms. Ghulamhussain, and Jordan Salzman. 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).

Companies poised to enter into the upcoming annual report and proxy season should start disclosure preparations early in order to address the complexities that will have inevitably resulted from an unprecedented 2020. In particular, companies will need to take proactive steps to evaluate the impact of the COVID-19 pandemic on executive compensation, the role of new human capital management disclosure requirements and continued focus on diversity and inclusion, knowing that this year’s disclosures are likely to be heavily scrutinized by investors, proxy advisors and other stakeholders given the volatility and ethos of the preceding months. This post identifies several key executive compensation and related governance issues to keep in mind:

1. Compensation discussion and analysis (CD&A) disclosure for compensation decisions made in connection with COVID-19

As has always been the case, companies should continue to strive to present the CD&A in a clear, well-detailed and balanced manner. This will be of increased importance as companies prepare to communicate executive compensation program changes prompted by the COVID-19 pandemic, and particularly the case for companies whose boards revised performance metrics or exercised discretion in determining incentive payouts. Compensation committees that have not already done so should develop a process and framework for reviewing the appropriateness of changes to compensation programs or in exercising discretion to determine 2020 annual incentive payouts. This process and framework will allow companies to explain the rationale behind the compensation committee’s decisions in the CD&A. For example, the CD&A may discuss whether the compensation committee reviewed the Company’s performance relative to its peers, its ability to meet cost cutting measures or liquidity objectives, or its ability to stage a recovery or prepare for one when approving compensation changes. A similar framework should be used in designing 2021 incentive programs and setting 2021 performance targets. For example, if an e-commerce company outperformed in 2020 due to COVID, is it appropriate to set 2021 financial targets below 2020 attainment levels? This is an issue that ISS has scrutinized in the past. Other design considerations compensation committees are assessing include using a range rather than a single target financial metric, increasing the use of relative rather than absolute performance measures and increasing the use of non-financial targets, such as strategic or sustainability goals. Moreover, while the CD&A requires only a discussion of compensation decisions related to the named executive officers, companies may choose to include a summary of the impact of COVID-19 on the broader workforce to provide context for executive pay decisions.


Innovation in the Stock Market: Exchanges and ATSs

Gabriel Rauterberg is Assistant Professor of Law at the University of Michigan Law School. This post is based on his chapter in the forthcoming book Financial Market Infrastructures: Law and Regulation (Jens-Hinrich Binder and Paolo Saguato, eds.).

Is something wrong with the structure of the stock market? Both industry participants and scholars have recently faulted the equity market for its lack of innovation. Economists at Harvard, Chicago, and elsewhere have argued that the continuous nature of modern trading bakes in a problematic arms race among high-frequency traders for speed. Stock exchanges process incoming instructions to trade in the order they arrive and as quickly as possible, which can mean in millionths of a second or less. The result, they argue, is a wasteful race for speed in order to trade first on public information. This race would be eliminated if continuous trading was replaced with discrete, periodic auctions (“frequent batched auctions”), say once per thousandth of a second. The market, these scholars also claim, will not fix itself because the nation’s stock exchanges lack robust incentives to appropriately innovate. (See, e.g., Budish, Lee & Shim, 2020).

In a forthcoming paper, I start off with the fact that there are other important markets for trading stock besides the national stock exchanges. I argue that the innovation calculus for alternative trading systems (“ATSs”) differs markedly from exchanges. ATSs, like stock exchanges, are marketplaces in which traders interact to purchase and sell stock from one another. In fact, ATSs and exchanges often function very similarly, with the same trading mechanics, technology, and participants, and both satisfy the statutory definition of a stock exchange. The defining difference between them is that exchanges choose to register as self-regulatory organizations, with closer supervision by the Securities and Exchange Commission (“SEC”), while ATSs make use of an exemption from registration as exchanges to operate in a less regulated environment.


Preparing for Shareholder Activism in the Wake of COVID-19

Keith E. Gottfried is partner at Morgan, Lewis & Bockius LLP. This post is based on his Morgan Lewis memorandum. Related research from the Program on Corporate Governance includes Dancing with Activists by Lucian Bebchuk, Alon Brav, Wei Jiang, and Thomas Keusch (discussed on the Forum here).

The shock, turmoil, uncertainty, and lack of visibility that followed the immediate onset of the coronavirus (COVID-19) pandemic in March 2020 were significant factors accounting for why shareholder activism was relatively subdued during the 2020 proxy season. However, given that activist investors have now had more than eight months to acquire their “sea legs” and recalibrate their playbook for the evolving “new normal,” it is likely that, even as the COVID-19 pandemic shows no signs of abating, activist investors will be less reluctant to wage an activism campaign in whatever “new normal” we find ourselves in during the 2021 proxy season.

Notably, unlike with respect to the 2020 proxy season, activist investors currently planning for the 2021 proxy season are making those plans aware of the existence of the COVID-19 pandemic and its evolving implications and having to anticipate and incorporate into their plans the possibility that, even if the current COVID-19 case surge is reversed and further extended lockdowns are avoided, the COVID-19 pandemic is not likely to materially subside between now and the end of the 2021 proxy season. In addition, as we will discuss below, we are likely at a point where the COVID-19 pandemic may be more of a catalyst for shareholder activism than an inhibitor. Accordingly, companies should not expect that shareholder activism during the 2021 proxy season will be as subdued as it was in 2020.


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