Monthly Archives: April 2021

Five Facts About Beliefs and Portfolios

Stephen Utkus is Visiting Scholar at Wharton Business School and Fellow at the Center for Financial Markets and Policy at Georgetown University. This post is based on a recent paper, forthcoming in the American Economic Review, by Mr. Utkus; Stefano Giglio, Professor of Finance at Yale School of Management; Johannes Stroebel, David S. Loeb Professor of Finance at NYU Stern School of Business; and Matteo Maggiori, Associate Professor of Finance at Stanford University Graduate School of Business.

Why do investors allocate their portfolios as they do? What causes them to change their minds and trade in their portfolios? These are critical questions in the field of macro finance. And central to answering them is understanding the role of expectations: what investors believe about future market returns and risks, how their beliefs vary with time, and how those beliefs come to influence real-world portfolio choices.

Among financial economists, there has been a growing interest in measuring investor expectations in a systematic way using surveys. However, surveys have been hindered by too qualitative a set of measures or by the lack of data showing how surveyed investors actually act on their beliefs.

In order to tackle such concerns, we have created a new research initiative on investor beliefs that combines administrative and survey data for a panel of individual investors at Vanguard. Vanguard is a well-known global asset manager; it is also large provider of investment services to U.S. retail investors. The survey, conducted every other month since February 2017, asks investors about short- and long-term expected stock market returns. It also elicits the subjective distribution of expected returns, allowing us to examine beliefs about low-probability events like a market crash. We also survey expectations on economic growth. These survey results are paired with portfolio allocation, trading, demographic and digital attention data.


Moving Cautiously on ESG Incentives in Compensation

Deborah Beckmann and Blair Jones are Managing Directors and Avi Sheldon is a Consultant at Semler Brossy Consulting Group LLC. This post is based on their Semler Brossy 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); and Paying for Long-Term Performance by Lucian Bebchuk and Jesse Fried (discussed on the Forum here).

Since the Business Roundtable’s 2019 call for greater attention to all stakeholders, corporate boards have been elevating environmental, social, and governance issues in their discussions. Last summer’s widespread protests over racial injustice put extra attention to diversity, equity, and inclusion (DE&I) issues. Boards have begun the difficult work of determining which ESG goals are especially important for their company, and how to translate those goals into incentives for executive compensation where appropriate.

General Reflections

ESG has not yet become a mainstream issue for executive compensation. But the level of inquiry from our clients (predominately corporate boards) has increased dramatically. Those clients say they in turn are getting questions from investors. Often these are about ESG-oriented initiatives generally, but they frequently circle back to executive compensation.

One financial services client, for example, met with large institutional investors recently and spent almost a full hour on ESG. A consumer products client had a similar experience. The investors asked some pointed questions:


Statement by Commissioner Peirce on the Staff ESG Risk Alert

Hester M. Peirce is a Commissioner at the U.S. Securities and Exchange Commission. This post is based on her recent public statement. The views expressed in this post are those of Ms. Peirce and do not necessarily reflect those of the Securities and Exchange Commission or its staff.

On Friday, the SEC’s Division of Examinations published a risk alert, [1] describing the areas on which the staff is focusing in examinations of registered investment advisers’ and funds’ ESG offerings. [2] This alert comes as many financial firms are finding gold in the green—they are offering ESG products because it is lucrative to do so. Therefore, as I have noted previously, asset manager accountability in the ESG space is important. [3] Firms claiming to be conducting ESG investing need to explain to investors what they mean by ESG and they need to do what they say they are doing. This same rule applies no matter what label an adviser puts on its products and services. I commend the staff for seeking, through this alert, to aid firms and their compliance officers in assessing their ESG claims and practices preemptively in their own organizations.

This risk alert, however, like its companion documents on the SEC’s “Climate and ESG Risks and Opportunities” webpage, needs some context. As an initial matter, the risk alert might cause some to ask, “Is ESG different?” The answer is that the issuance of an ESG-specific risk alert should not be interpreted as a sign that ESG investment strategies are unique in the eyes of examiners. As with any other investment strategy, advisers and funds should not make claims that do not accord with their practices, and our examiners will be looking for that consistency between claims and practice. Our examiners are not—and will not be in this space—merit regulators. The SEC’s role is not to assess whether any particular strategy is a good one, but to ensure that investors know what they are getting when they choose a particular adviser, fund, strategy, or product.


Illiberal Governance and the Rise of China’s Public Firms

Tami Groswald Ozery is a Fellow of the Harvard Law School Program on Corporate Governance. This post is based on her recent paper, forthcoming in the University of Pennsylvania Journal of International Law, as well as on her recent Testimony before the U.S.-China Economic and Security Review Commission. Related research from the Program on Corporate Governance includes China and the Rise of Law-Proof Insiders (discussed on the Forum here), by Jesse M. Fried and Ehud Kamar.

Against the backdrop of current U.S.-China relations and the various pressures in favor of an “economic decoupling” from China, policymakers in the United States are trying to comprehend the various implications of China’s rising power while considering appropriate foreign policy and regulatory responses. As part of this process, the U.S. government is rethinking its approach to global financial integration.

The risks of investing in Chinese firms that participate in U.S. financial markets have attracted most of the attention in this space. Recently, however, U.S. portfolio investing in Chinese firms that trade outside the U.S. market, whether in China or through other global exchanges, entered the debate as well.

Somewhat ironically, most efforts taken so far seem to turn away from principles of free-market capitalism towards investment restrictions and isolationism. “Economic security as national security,” an approach that was advanced in recent years in the global trade and investments space, is now spilling over to global portfolio investing, pressuring institutional investors, index providers, and asset managers to shoulder geopolitical views in their overseas investment strategies.

In my paper, Illiberal Governance and the Rise of China’s Public Firms, forthcoming in the University of Pennsylvania Journal of International Law, I elaborate on China’s growing integration with global financial markets and examine the implications for U.S. portfolio investors in Chinese firms in the context of these recent policy debates.


SEC Focuses on Potential Updates to U.S. Climate Change Disclosure Requirements

Catherine M. Clarkin is partner and Sarah H. Mishkin and Samuel E. Saunders are associates at Sullivan & Cromwell LLP. This post is based on a Sullivan & Cromwell memorandum by Ms. Clarkin, Ms. Mishkin, Mr. Saunders, John Horsfield-Bradbury, Evan S. Simpson, and Marc Treviño. 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); and Restoration: The Role Stakeholder Governance Must Play in Recreating a Fair and Sustainable American Economy—A Reply to Professor Rock by Leo E. Strine, Jr. (discussed on the Forum here).


Companies subject to U.S. reporting requirements may be required to provide additional information about relevant risks, uncertainties, impacts and opportunities related to climate change, as the U.S. Securities and Exchange Commission (SEC), in the first two months of President Joseph Biden’s administration, has begun analyzing whether current disclosures by such companies adequately inform investors about the impacts of the changing climate.

Not since 2010 has the SEC provided specific guidance to U.S. reporting companies on what information concerning climate change they are required to communicate to investors. [1] The 2010 SEC guidance, which remains in effect, articulates a “principles-based” disclosure framework rooted in the concept of materiality and does not mandate disclosure of any specific climate-related metrics. The guidance requires companies to disclose information about climate change’s potential or actual impacts on the company to the extent material to investors.


How Audit Committees Can Prepare for 2021 Q1 Reporting

Steve W. Klemash is Americas Leader and Jennifer Lee is Audit and Risk Specialist at the EY Center for Board Matters. This post is based on their EY memorandum.

As companies navigate ongoing global volatility, an uneven economic recovery and changes in the US administration, audit committees continue to focus on reviewing scenario plans, stress tests and enterprise risk management (ERM) information while overseeing high-quality financial reporting.

They are working to keep pace with the uncertain and fluid business landscape and continually re-evaluating key risks while reviewing financial statements and disclosures, systems of internal controls and other regulatory filings.

Audit committees must also determine whether appropriate processes are in place to monitor macroeconomic changes and evaluate new and emerging legislative, administrative and regulatory developments for impacts on reporting and disclosure.

Additionally, they are working to keep abreast of the continued evolution of the ESG reporting landscape (including the SEC’s recent principles-based requirements around human capital disclosures).

We summarize the following matters for consideration to aid audit committees as they enhance oversight and approach the Q1 reporting period.


Will Loyalty Shares Do Much for Corporate Short-Termism?

Mark J. Roe is David Berg Professor of Business Law at Harvard Law School, and Federico Cenzi Venezze is an associate at Cleary Gottlieb Steen & Hamilton LLP. This post is based on their recent paper. 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); Don’t Let the Short-Termism Bogeyman Scare You, by Lucian Bebchuk (discussed on the Forum here); Corporate Short-Termism—In the Boardroom and in the Courtroom by Mark Roe (discussed on the Forum here); and Stock Market Short-Termism’s Impact by Mark Roe, (discussed on the Forum here).

Stock-market short-termism—stemming from rapid trading and activists looking for quick cash—is, a widespread view has it, hurting the American economy. Because stock markets will not support corporate long-term planning, the thinking goes, companies fail to invest enough, do not do enough research and development, and buy back so much of their stock that their coffers are depleted of cash for their future.

This widespread view has induced proposals for remedy. One proposal is for corporate “loyalty shares,” whereby stockholders who own their stock for longer periods would get more voting power than those who trade their stock quickly. In the proponents’ vision, executives would appeal to loyal, longer-term, stockholders for votes against activists and traders and, by investing for the long run, would obtain the loyalty share votes. The longer-run stockholders, with extra votes, would elect like-minded boards and support longer-term corporate business policies. The affected companies would profit more and the American economy would prosper.


A Living Wage: The Latest ESG Challenge For Corporate Governance

Michael Peregrine is partner at McDermott Will & Emery LLP. This post is based on his recent article, originally published in Forbes. 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 Socially Responsible Firms by Alan Ferrell, Hao Liang, and Luc Renneboog (discussed on the Forum here).

Proposals and pressures associated with payment of a “living wage” to employees may present themselves on the boardroom agenda much sooner than corporate leaders expect.

Long considered controversial from economic and shareholder perspectives, living wage concepts are receiving more attention in the context of economic policy, social responsibility and ESG investing. As progressive perspectives concerning income equality, and executive and employee compensation, are becoming more mainstream, corporate leaders should prepare for greater engagement in this important conversation.

The concept of a living wage isn’t a new concept; it’s not something that just popped up from the 2020 election cycle. It’s been around for a while, dating back in some respects to the Great Depression, and in other respects dating back to social and labor issues arising from the days of the Industrial Revolution.

There’s no specific, “one-size-fits-all” definition of a living wage. It most frequently refers to that level of income sufficient for a worker to afford the basic needs of life, such as food, housing, clothing and transportation—with a small margin to address unforeseen events. The expectation is that a living wage is a baseline for an income level that allows a worker to achieve an acceptable standard of living through employment, without reliance on government assistance programs. The formula for determining a living wage is constantly evolving based on multiple factors, including family size, location and age.


The Structure of the Board of Directors: Boards and Governance Strategies in the US, the UK and Germany

Klaus J. Hopt is former director at the Max Planck Institute for Comparative and International Private Law, Hamburg, Germany; and Patrick C. Leyens is Professor at the University of Bremen, and Professor (hon.) at the Erasmus University Rotterdam. This post is based on their recent paper. Related research from the Program on Corporate Governance includes The Elusive Quest for Global Governance Standards by Lucian Bebchuk and Assaf Hamdani.

The board of directors is the nucleus of internal corporate governance. The internationally predominant board model, as known from the US or the UK, reveals a one-tier structure. In a two-tier structure, as found in continental European countries like Germany, the management and the monitoring tasks are divided between two boards. Despite a trend of functional convergence in internal corporate governance, we observe persisting divergence in regard to board models. As known from major corporate governance reforms, most advances directly or indirectly target the board of directors. It hence appears a long overdue question whether the choice of a particular board model affects the operation of governance strategies. If it does not, private parties should be free to choose the board model that they expect to best suit their interests.

The Board Model as a Basic Governance Structure

In our recent paper on The Structure of the Board of Directors: Boards and Governance Strategies in the US, the UK and Germany we argue that a board model only provides a basic structure which serves to enable the use of more specific corporate governance strategies. The paper continues and advances our earlier research on Board Models in Europe in which we discussed convergence and divergence of internal corporate governance in the UK and Germany, as well as in France and Italy. In our earlier research, we advanced a plea for more flexibility and leaving the choice of the board model to private parties. Our recent paper supports this plea.


Executive Pay and ESG Performance

Tom Gosling is an Executive Fellow at the London Business School Centre for Corporate Governance, and Phillippa O’Connor is Partner at PricewaterhouseCoopers LLP. This post is based on a LBS/PwC report by Mr. Gosling, Ms. O’Connor, Clare Hayes Guymer, Lawrence Harris, and Annabel Savage. 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).

Environmental Social and Governance (ESG) considerations now sit at the heart of good business practice, and for some companies have become a central strategic pillar.

Society needs companies to play their role in addressing challenges ranging from social mobility to climate change. This would suggest that executives should be paid based on ESG performance. But this simple conclusion may not always be correct, and simplistically adding the wrong ESG metric into executive incentives can be unproductive, and worse, counterproductive.

A new report in partnership between The Centre for Corporate Governance at London Business School and PwC reviews what market practice and academic evidence have to say about linking executive pay to ESG. There is no single right answer, but we identify the underlying reasons why a company may (or may not) include ESG in executive pay and the consequences for measure selection. And we set out the principles and decisions required to design a good, effective and enduring ESG pay metric, if that is what a board decides to do.


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