Monthly Archives: July 2021

CEO Compensation: Evidence From the Field

Alex Edmans is Professor of Finance at London Business School; Tom Gosling is an Executive Fellow at London Business School; and Dirk Jenter is Associate Professor of Finance at the London School of Economics. This post is based on their recent paper. Related research from the Program on Corporate Governance includes the book Pay without Performance: The Unfulfilled Promise of Executive Compensation, Executive Compensation as an Agency Problem, and Paying for Long-Term Performance (discussed on the Forum here), all by Lucian Bebchuk and Jesse Fried.

In our paper, CEO Compensation: Evidence from the Field, which was recently made available on SSRN, we survey over 200 directors of FTSE All-Share companies and over 150 investors in UK equities on how they design CEO pay packages: their objectives, the constraints they operate under, and the factors they take into account. The answers reveal several interesting results that challenge existing academic theories, which we organize into three groups:

Objective and constraints

We first ask respondents to rank the importance of three goals when setting CEO pay. 65% of directors view attracting the right CEO as most critical, while 34% prioritize designing a structure that motivates the CEO. For investors, these figures are 44% and 51% respectively. This reversal reflects a theme that recurs throughout our survey—directors view labor market forces, and thus the so-called “participation constraint”, as more important than investors, who prioritize the “incentive constraint”. Only 1% of directors and 5% of investors view keeping the level of pay down as their primary goal. This is consistent with CEO pay being a small percentage of firm value, while hiring a subpar CEO or providing suboptimal incentives has potentially large effects. READ MORE »

SEC Enforcement Action Highlights Need for Internal Communications About Cybersecurity Problems

Matthew Bacal, Robert Cohen, and Joseph Hall are partners at Davis Polk & Wardwell LLP. This post is based on a Davis Polk memorandum by Mr. Bacal, Mr. Cohen, Mr. Hall, Greg Andres, Angela Burgess and Martine Beamon.

The Securities and Exchange Commission (SEC) announced a settled enforcement action on June 15 against a company for violating the requirement that public companies have controls and procedures to ensure that they make required disclosures in SEC filings. According to the SEC’s order, a cybersecurity journalist informed the company of a vulnerability in a proprietary application that the company used to store and share document images. The vulnerability exposed more than 800 million documents that contained sensitive personal information, although the SEC’s order did not say that anyone exploited the vulnerability to access the sensitive information. The company issued a statement for the journalist’s report the same day, and filed a Form 8-K four days later.

The SEC alleged that senior executives responsible for filing the 8-K were not aware that company personnel had identified the vulnerability months before, or that the issue was not remediated as company policy required. Unaware of that history, despite attending meetings with informed personnel, the senior executives did not evaluate whether to disclose the prior detection or the failed remediation. As a result, the SEC concluded that the company violated the disclosure controls rules, which require controls and procedures “designed to ensure that information required to be disclosed by the issuer in the reports that it files or submits . . . is recorded, processed, summarized and reported, within the time periods specified” in SEC rules. Without admitting or denying the SEC’s findings, the company agreed to pay a penalty of approximately $0.5 million. Demonstrating a recent increase in interagency cooperation on cybersecurity issues, the SEC acknowledged the assistance of the New York State Department of Financial Services, which previously filed a related enforcement action against the company. [1]


A Private Fund’s Guide to ESG Compliance

Ranah Esmaili, Stephen L. Cohen, and Nader Salehi are partners at Sidley Austin LLP. This post is based on their Sidley 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); 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).

The U.S. Securities and Exchange Commission (SEC) has recently turned its attention to private fund managers that consider Environmental, Social and Governance (ESG) factors as part of their process for selecting portfolio investments. The SEC’s primary focus is on “greenwashing,” the practice of conveying a false image to investors that a product is ESG-friendly. The SEC’s Division of Examinations (EXAMS) has been examining private fund managers on ESG investment selection and portfolio management processes, use of proprietary and third-party scoring systems, marketing materials, proxy voting procedures, and policies and procedures relating to ESG.

In this post, we discuss the SEC’s recent focus on ESG, including the compliance risks associated with ESG investing, and identify concrete steps fund managers can take to ensure compliance. Those steps include conducting an internal review of ESG-related disclosures against practices, controls, and policies and procedures, and preparing for a possible SEC examination concerning ESG investing.

SEC’s ESG Developments

The SEC’s focus on ESG disclosure, which began under Acting Chair Allison Lee, continues to be a priority under Chair Gary Gensler, who was sworn into office on April 17, 2021.

On February 1, 2021, as one of her first significant public actions, Lee appointed the first-ever Senior Policy Advisor for Climate and ESG. The following month, Lee announced an Enforcement Task Force focused on climate and ESG issues and requested public input on climate change disclosures. While nearly all of the 15 questions posed in Lee’s request for public comment focused on public issuer disclosure, one item asked how the Commission’s rules should address “its oversight of certain investment advisers and funds.”


Chair Gensler’s Remarks at the Asset Management Advisory Committee Meeting

Gary Gensler is Chair of the U.S. Securities and Exchange Commission. This post is based on his recent remarks before the Asset Management Advisory Committee. The views expressed in the post are those of Chair Gensler, and do not necessarily reflect those of the Securities and Exchange Commission or the Staff.

Thank you for the kind introduction. I enjoyed chatting with you a couple of weeks ago, Ed, and it’s good to meet with the whole committee for the first time.

I’m grateful for your time and willingness to give us advice on the asset management industry. I look forward to hearing the readouts from your various subcommittees on environmental, social, and governance investing; diversity and inclusion; and private investments.

I wanted to share some thoughts on these topics—in particular, on funds that hold themselves out to the public as investing with an emphasis on sustainability, and on diversity in the asset management industry.

First, on sustainability, I’d like to discuss fund disclosure and fund names.

The basic idea is truth in advertising. We’ve seen a growing number of funds market themselves as “green,” “sustainable,” “low-carbon,” and so on.

While the estimated size of this sector varies, one estimate says there are at least 800 registered investment companies with more than $3 trillion in ESG assets last year. [1] Suffice it to say there are hundreds of funds and potentially trillions of dollars under management in this space.


Shareholder Proposal No-Action Requests in the 2021 Proxy Season

Marc S. Gerber is partner and Ryan J. Adams is an associate at Skadden, Arps, Slate, Meagher & Flom LLP. This post is based on their Skadden memorandum.

As calendar year-end companies received shareholder proposals for their 2021 annual meetings, they faced a variety of uncertainties and challenges, including navigating the COVID-19 pandemic, addressing the racial inequities brought to the fore by the killings of George Floyd and others, and steering through a hyper-partisan and unprecedented U.S. presidential transition. The shareholder proposals received by companies reflected many of these broad themes.

Unlike in the prior three years, the staff of the Division of Corporation Finance (Staff) of the U.S. Securities and Exchange Commission (SEC) did not issue new guidance regarding companies’ ability to exclude shareholder proposals from their proxy statements heading into the 2021 season. Although this may have hinted at some stability in the no-action process, that was not to be the case. The Staff issued significantly fewer no-action response letters than in previous years, opting instead to respond mostly through informal decisions that were included in a chart on the SEC’s website. Because these informal responses provided the Staff’s conclusions without additional explanation, the Staff’s reasoning in a number of decisions was unclear.

Nevertheless, whether by response letter or chart entry, there were a number of notable no-action decisions and trends. As in prior years, many of these concerned the ability to exclude proposals as relating to a company’s ordinary business. In addition, some related to procedural items that might have seemed fairly straightforward. Reviewing the guideposts provided by Staff decisions from the 2021 proxy season helps in attempting to understand the Staff’s current approach to shareholder proposals.


Ripples of Responsibility: How Long-Term Investors Navigate Uncertainty With Purpose

Matt Leatherman is Director, Ariel Babcock is Head of Research, and Victoria Tellez is Senior Research Associate at FCLTGlobal. This post is based on a FCLTGlobal memorandum by Mr. Leatherman, Ms. Babcock, Ms. Tellez, and Sam Sterling. 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); and Who Bleeds When the Wolves Bite? A Flesh-and-Blood Perspective on Hedge Fund Activism and Our Strange Corporate Governance System by Leo E. Strine, Jr. (discussed on the Forum here).

Investment organizations around the world face an array of ever-changing external expectations. These expectations go well beyond traditional notions of achieving return targets or liability matching and can create important responsibilities that are broader than fiduciary duty or asset stewardship. Ripples of Responsibility provides tools for understanding and fulfilling these responsibilities. Together with our members and others, we have piloted this publication’s toolkit in workshops focused on six different domains of responsibility: economic impact at home and abroad, equity lending and stewardship, impasses in corporate engagement, racial and gender diversity of portfolio companies, climate and environmental impact, and reputation management.

The way that investment organizations navigate existing responsibilities and new expectations that arise has a tremendous effect on their long-term success.

When an investment organization fails to fulfill true responsibilities, staff can become distracted from their long-term focus, interrupting the organization’s long-term investment strategy. Consequences also can include turnover in leadership or responses by legal or regulatory authorities that narrow the discretion of leadership. Yet positive cases of investment organizations meeting evolving expectations abound: two examples are Future Fund’s efforts to ensure that external managers steward its reputation appropriately and the New Zealand Super Fund’s participation in the national response to social media firms live streaming the Christchurch atrocity. [1] [2]


The U.S. Moving Toward Adopting New Climate Disclosures

J. Paul Forrester, Andrew Olmem, and Christina Thomas are partners at Mayer Brown LLP. This post is based on a Mayer Brown memorandum by Mr. Forrester, Mr. Olmem, Ms. Thomas, and Meicy Hui.

On June 21, 2021, US financial regulators met with US President Joe Biden to discuss the US economy and update him on their efforts to address climate-related risks. According to the White House readout of the meeting, the regulators said “they were making steady progress” on implementing President Biden’s executive order on climate-related risk. The briefing follows last week’s passage of HR 1187, the Corporate Governance Improvement and Investor Protection Act, by the US House of Representatives [1] by a vote of 215 to 214. HR 1187 would mandate that the SEC create an ESG disclosure regime for public companies and provides numerous statutory requirements for those disclosures, including climate-related disclosures. Although the bill is unlikely to become law due to expected opposition in the US Senate, which requires a 60-vote supermajority to pass legislation, the passage of the HR 1187 by the House—combined with President Biden’s focus on climate-related risks in his meeting with financial regulators—should bolster and influence the US Securities and Exchange Commission’s (SEC) ongoing development of new ESG disclosure requirements for US public companies under its existing statutory authorities. With regulators telling President Biden that they are “making steady progress,” new disclosure requirements for US public companies appear to be just around the corner.

Addressing climate change has become a central focus of US policymakers. President Biden has made addressing climate change a top domestic policy priority. As part of implementing this policy, on May 20, 2021, he signed an executive orders directing federal financial regulators to take a broad range of actions to assess and respond to climate-related financial risks, including enhancing the disclose of climate-related financial risks. [2] Concurrently, the State of California is also putting pressure on the federal government to adopt climate disclosure requirements by advancing its own legislation, the Climate Corporate Accountability Act (CCAA) [3], that would impose disclosure obligations on any California company and any company doing business in California. Whether California will ultimately adopt the CCAA once the SEC adopts its anticipated climate disclosure requirements is unclear. Nevertheless, California companies and companies doing business in California should be aware that the possibility exists for the adoption of overlapping federal and state disclosure rules.


Weekly Roundup: July 2–8, 2021

More from:

This roundup contains a collection of the posts published on the Forum during the week of July 2–8, 2021.

Shareholder Liability and Bank Failure

CEO Succession Practices in the Russell 3000 and S&P 500 2021 Edition

2021 ESG & Incentives Report

Proxy Advisory Firms and Corporate Shareholder Engagement

The Opportunity for SEC Regulation of Climate Disclosures

The Opportunity for SEC Regulation of Climate Disclosures

Lesley Hunter is Vice President of Programs and Content Strategy at the American Council on Renewable Energy (ACORE). This post is based on her ACORE memorandum.

Corporate risk exposure to climate change is becoming ever more central to companies’ bottom lines. As a result, investors, governments and the public increasingly expect information from companies on climate risks, strategies and scenario planning.

To help mitigate long-term risks, companies are adopting aggressive sustainability targets and considering environmental, social and governance (ESG) criteria to better evaluate the impact of their activities and investments. The potential allocation of ESG funds to renewable energy investment presents an opportunity to enhance the growth of climate-friendly energy resources.

However, the requirements of existing, voluntary frameworks for corporate climate disclosure are sometimes inconsistent, and the quality of reporting uneven. Sustainability investments, therefore, do not necessarily result in direct greenhouse gas (GHG) emission reductions. Investors need more consistent, comparable, transparent and forward-looking corporate disclosures they can evaluate objectively.


Proxy Advisory Firms and Corporate Shareholder Engagement

Aiyesha Dey is Høegh Family Associate Professor of Business Administration at Harvard Business School; Austin Starkweather is Assistant Professor of Finance at the University of South Carolina Darla Moore School of Business; and Joshua White is Assistant Professor of Finance at Vanderbilt University Owen Graduate School of Management. This post is based on their recent paper.

The market power of proxy advisory firms has attracted considerable attention from academics, practitioners, and regulators. A large body of research shows that recommendations by proxy advisors—such as those by Institutional Shareholder Services (ISS)—can substantially influence shareholder voting outcomes (e.g., Malenko and Shen, 2016). The academic literature, however, is mixed on whether their recommendations are value-enhancing, with some linking their advice to standardized executive pay plans and reduced company value (e.g., Larcker, McCall, and Ormazabal, 2015). Such criticisms and a decade-long review by the U.S. Securities and Exchange Commission (SEC) culminated in the promulgation of restrictive amendments to proxy advisory rules in July 2020 that SEC Chair Gary Gensler recently indicated the Commission may revisit.

In our research paper, Proxy Advisory Firms and Corporate Shareholder Engagement, we consider the role of proxy advisors through a different lens. Specifically, we examine whether and how proxy advisors influence companies’ shareholder engagement activities. Given the recent increase in demand for shareholder engagement by market participants and regulators, the findings of our research can add to our understanding of whether proxy advisors can have a disciplinary spillover effect by inducing desirable company behavior.


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