Monthly Archives: November 2021

The Limits of Portfolio Primacy

Posted by Roberto Tallarita (Harvard Law School), on
Tuesday, November 30, 2021
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Roberto Tallarita is a Lecturer on Law and Associate Director of the Program on Corporate Governance at Harvard Law School. This post is based on his recent paper. Related research from the Program on Corporate Governance includes The Agency Problems of Institutional Investors by Lucian Bebchuk, Alma Cohen, and Scott Hirst (discussed on the Forum here); Index Funds and the Future of Corporate Governance: Theory, Evidence, and Policy by Lucian Bebchuk and Scott Hirst (discussed on the forum here); and The Specter of the Giant Three by Lucian Bebchuk and Scott Hirst (discussed on the Forum here).

According to a theory that is gaining increasing support among academics and market participants (“portfolio primacy theory”), we should expect the “Big Three” (BlackRock, Vanguard, and State Street) and other index fund managers to push companies to reduce their climate externalities and thus mitigate the threat of climate change. In a new paper, The Limits of Portfolio Primacy, I question the implicit and explicit assumptions of this theory and show its significant limits. My analysis reveals that the theory’s optimistic take on the social role of index funds is grossly overstated, and suggests that climate policy should not rely on index fund stewardship as a substitute for traditional regulation.

The basic premise of the portfolio primacy theory is that the goal of index fund managers and other diversified investors is not to maximize the value of individual companies (shareholder primacy), but rather to maximize the value of their entire portfolio (portfolio primacy). Index funds, the argument goes, mirror the whole economy and therefore internalize climate externalities. Even if an individual company has no incentives to reduce its own carbon emissions, index funds have strong incentives to push for such reduction.

But to what extent can index funds be expected to undertake the role of climate stewards? And how effective can they be in mitigating global climate risk? I identify four crucial limits of portfolio primacy: portfolio biases, mispricing of climate mitigation, fiduciary failures, and insulation from index fund influence. Taken together, these four limits should dramatically lower the expectations that portfolio primacy can be a powerful weapon in our fight against global climate change.

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Important Earnout/Milestone Drafting Points Arising from Recent Pacira and Shire Decisions

Posted by Gail Weinstein, Brian T. Mangino, and Randi Lally, Fried, Frank, Harris, Shriver & Jacobson LLP, on
Tuesday, November 30, 2021
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Gail Weinstein is senior counsel, and Brian T. Mangino and Randi Lally are partners at Fried, Frank, Harris, Shriver & Jacobson LLP. This post is based on a Fried Frank memorandum by Ms. Weinstein, Mr. Mangino, Ms. Lally, David L. Shaw, Erica Jaffe, and Bret T. Chrisope, and is part of the Delaware law series; links to other posts in the series are available here. Related research from the Program on Corporate Governance includes Are M&A Contract Clauses Value Relevant to Target and Bidder Shareholders? by John C. Coates, Darius Palia, and Ge Wu (discussed on the Forum here); and Allocating Risk Through Contract: Evidence from M&A and Policy Implications by John C. Coates, IV (discussed on the Forum here).

Earnout or milestone provisions in a merger agreement provide a framework for additional merger consideration to be paid, after the closing, if specified “milestone” events occur or specified performance targets are achieved post-closing. (We use the terms “earnout” and “milestones” interchangeably in this post.) According to recent studies, earnouts are used in over 60% of private company acquisitions in the life sciences industry (where the payments usually are tied to the occurrence of specific steps in the regulatory process relating to the development and marketing of the target company’s product) and in roughly 20-30% of other private company acquisitions (where the payments typically are based on the achievement of specified levels of revenue or EBITDA). In recent years, earnouts have consistently appeared each year in almost half of all de-SPAC transactions (mergers with a SPAC acquiror).

While earnouts help to bridge the gap between a buyer and seller in the upfront negotiation of the purchase price, they often lead to post-closing disputes (and litigation) over the earnout itself. Thus, it is critical that an earnout is drafted with appropriate specificity and clarity–as underscored most recently in the Pacira and Shire decisions. In both of these cases, based on the “plain meaning” of the express language in the merger agreement at issue, the Delaware Court of Chancery rejected the buyer’s argument that an earnout payment was not due. These decisions indicate that merger agreement parties should consider certain changes to the standard formulation of earnout provisions, as discussed below.

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ISS Releases Proposed Benchmark Policy Changes for 2022

Posted by Cydney Posner, Cooley LLP, on
Tuesday, November 30, 2021
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Cydney S. Posner is special counsel at Cooley LLP. This post is based on her Cooley memorandum.

[On November 4, 2021], ISS released for public comment its proposed benchmark policy changes for 2022. If adopted, the proposed policy changes would apply to shareholder meetings held on or after February 1, 2022. The proposed changes for U.S. companies relate to board diversity, board accountability for unequal voting rights, board accountability for climate disclosure by high GHG emitters and say-on-climate proposals.

Board diversity. Currently, for companies in the Russell 3000 or S&P 1500, ISS policy is generally to vote against or withhold from the chair of the nominating committee (or other directors on a case-by-case basis) at companies where there are no women on the company’s board. ISS proposes to expand the application of that policy to companies beyond the Russell 3000 and S&P 1500, after a one-year grace period, for meetings on or after February 1, 2023. Noting the strong preference expressed by institutional investors, as well as the recent Nasdaq listing rule change on board diversity, ISS believes that this policy change “will align U.S. benchmark policy with client and market expectations on gender diversity.” One question ISS poses is whether board size should be a consideration.

SideBar

In August, the SEC approved the Nasdaq proposal for new listing rules regarding board diversity and disclosure, as well as an accompanying proposal to provide free access to a board recruiting service. The new listing rules adopt a “comply or explain” mandate for board diversity for most listed companies and require companies listed on Nasdaq’s U.S. exchange to publicly disclose “consistent, transparent diversity statistics” regarding the composition of their boards. To refute potential criticism of the board diversity proposal as a quota in disguise, Nasdaq took great pains to frame its proposal as principally “a disclosure-based framework and not a mandate.” The Nasdaq board diversity rule sets a “recommended objective” for most Nasdaq-listed companies to have at least two diverse directors on their boards; if they do not meet that objective, they will need to explain their rationales for not doing so. The proposal also requires listed companies to provide annually, in a board diversity matrix format, statistical information regarding the company’s board of directors related to the directors’ self-identified gender, race and self-identification as LGBTQ+. (See this PubCo post.)

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Recent Shareholder Activism Trends

Posted by George Casey, Scott Petepiece, and Lara Aryani, Shearman & Sterling LLP, on
Monday, November 29, 2021
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George Casey, Scott Petepiece, and Lara Aryani are partners at Shearman & Sterling LLP. This post is part of the 19th Annual Corporate Governance Survey publication prepared by Shearman & Sterling LLP, by Mr. Casey, Mr. Petepiece, Ms. Aryani, and Vita Zhu. 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); Dancing with Activists by Lucian Bebchuk, Alon Brav, Wei Jiang, and Thomas Keusch (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).

After years of growth in shareholder activist activity, the onset of COVID-19 across the world caused a decline in shareholder activism campaigns in the spring and summer of 2020. Economic recovery in the second half of the year coincided with the end-of-year proxy season and gave rise to a renewed appetite for activist campaigns in Q4 that continued through the first half of 2021. While uncertainty remains, particularly on a regional basis due to variations in vaccination rates and the impact of new variants of COVID-19, we expect to see renewed vigor in shareholder activism to continue through the second half of 2021 and into 2022.

Shareholder Activism in 2020

While shareholder activism declined sharply in the spring and summer of 2020, the overall number of campaigns was lower but did not result in a significant year-over-year decline. This was in large part due to the fact that the two annual proxy seasons book-ended the market turbulence of 2020, such that many of the activist campaigns were initiated either before COVID-19 in Q2 or after the economic recovery at the end of the year. The rebound of activism continued through the first half of 2021, with activist campaigns in the U.S. accelerating at a higher pace—large-cap United States companies experienced an approximately 30% increase in the number of activist campaigns in the first half of 2021 compared to 2020 (see chart below). Notwithstanding this renewed push, activism levels remain muted compared to the 2017–2020 averages (see chart below). Nevertheless, we expect the growing momentum to continue into the second half of 2021 and into 2022.

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Death by Committee? An Analysis of Corporate Board (Sub-) Committees

Posted by Renée B. Adams (University of Oxford), Vanitha Ragunathan (University of Queensland), and Robert Tumarkin (University of New South Wales), on
Monday, November 29, 2021
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Renée B. Adams is Professor of Finance at the University of Oxford; Vanitha Ragunathan is a Senior Lecturer in Finance at the University of Queensland; and Robert Tumarkin is a Senior Lecturer in Finance at the University of New South Wales. This post is based on their recent paper, forthcoming in the Journal of Financial Economics.

There is a long history of governance reforms that target corporate boards by mandating specific committee structures and director-type requirement. The Securities and Exchange Commission and the New York Stock Exchange first advocated for separate audit committees following the McKesson & Robbins scandal of 1938 (Birkett, 1986). In the 1970s, in response to widespread bribery by U.S. corporations in foreign countries, the SEC recommended that firms maintain an independent director majority on audit and nominating committees, and the NYSE updated its listing standards to require that firms maintain audit committees (Dundas and George, 1980). Several high-profile corporate failures in the early 1980s brought about the Treadway Commission, whose report was a factor when the major national exchanges recommended audit committee independence (Reeb and Upadhyay, 2010). In the early 2000s, the boards of Enron, Worldcom, Tyco and Parmalat, among others, were blamed for corporate malfeasance. Intending to prevent similar governance failures in the future, the Sarbanes-Oxley Act of 2002 (SOX) and the revised NYSE and NASDAQ listing standards were put in place.

Clearly, regulators believe that board structure is an important determinant of corporate governance. This has not been lost on economic and legal researchers who, for example, have found that independent audit committees can improve governance outcomes. However, corporate scandals have demonstrated a remarkable resilience to governance reforms. While reforms may appear to simply codify board characteristics, they do so by altering the nature of authority within the board.

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SEC Staff Issues New Shareholder Proposal Guidance

Posted by Marc Gerber, Ryan Adams, and Blake Grady, Skadden, Arps, Slate, Meagher & Flom LLP, on
Monday, November 29, 2021
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Marc Gerber is partner and Ryan Adams and Blake Grady are associates at Skadden, Arps, Slate, Meagher & Flom LLP. This post is based on a Skadden memorandum by Mr. Gerber, Mr. Adams, Mr. Grady, Brian Breheny, Raquel Fox, and Richard Grossman.

On November 3, 2021, the Division of Corporation Finance (Staff) of the U.S. Securities and Exchange Commission (SEC) published Staff Legal Bulletin No. 14L (SLB 14L), which explicitly rescinds Staff Legal Bulletin Nos. 14I, 14J and 14K (SLB 14I, 14J and 14K) (issued in 2017, 2018 and 2019, respectively), and effectively resets the Staff’s approach to the “ordinary business” and “relevance” exclusions for shareholder proposals to the pre-November 2017 approach.

The rescinded Staff Legal Bulletins introduced and expounded on the concept of a board analysis to support no-action requests to exclude shareholder proposals relating to the company’s “ordinary business” or lacking “relevance.” SLBs 14J and 14K also provided guidance concerning the micromanagement prong of the “ordinary business” exclusion.

The new SLB 14L also restates (with technical updates) portions of the rescinded guidance relating to the use of images in shareholder proposals and proof of ownership letters. In addition, SLB 14L provides guidance on the use of email with respect to shareholder proposals.

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Chancery Court Highlights Importance of Delivering Nomination Notices Ahead of Advance Notice Deadlines

Posted by Andrew M. Freedman, Lori Marks-Esterman, and Ron S. Berenblat, Olshan Frome Wolosky LLP, on
Sunday, November 28, 2021
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Andrew M. Freedman, Lori Marks-Esterman, and Ron S. Berenblat are partners at Olshan Frome Wolosky LLP. This post is based on an Olshan memorandum by Mr. Freedman, Ms. Marks-Esterman, Mr. Berenblat, and Theodore Hawkins, and is part of the Delaware law series; links to other posts in the series are available here.

The Delaware Chancery Court’s decision in Rosenbaum v. CytoDyn Inc., No. 2021-CV-0728-JRS (Del. Ch. Oct. 13, 2021) provides fresh insight into how courts are likely to view advance notice bylaws in the context of a shareholder activist’s nomination of a dissident slate of directors. The case arose following a push by a group of investors to nominate directors and institute changes at CytoDyn, Inc. (“CytoDyn” or the “Company”), a pharmaceutical firm in the process of developing a new drug. Litigation commenced after CytoDyn’s Board of Directors (the “Board”) rejected the investors’ director slate because of disclosure deficiencies in their Nomination Notice. Following a trial, Vice Chancellor Slights ruled that the Board properly rejected the director slate because the investor plaintiffs had “play[ed] fast and loose in their responses to key inquiries embedded in [the Company’s] advance notice bylaw.” The Court also rebuked the plaintiffs for submitting their Nomination Notice “on the eve of the deadline,” leaving no time to fix the disclosure problems highlighted by the Board.

We have written extensively about how defense law firms have been devising onerous advance notice nomination procedures and 100-plus page nominee questionnaires intended to make it more expensive for shareholders to nominate and easier for companies to allege deficiencies on frivolous technicalities. However, in this case, the Court cited legitimate substantive omissions from the investor group’s Nomination Notice and questionnaires, serving as a reminder that shareholders seeking to nominate directors should obtain guidance from advisors specializing in shareholder activism.

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Sustainability and Investing Lessons Learned in the Pandemic Era

Posted by Daniel C. Roarty, AllianceBernstein L.P., on
Saturday, November 27, 2021
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Daniel C. Roarty is Chief Investment Officer of Sustainable Thematic Equities at AllianceBernstein L.P. This post is based on his AllianceBernstein memorandum. Related research from the Program on Corporate Governance includes The Illusory Promise of Stakeholder Governance (discussed on the Forum here) and Will Corporations Deliver Value to All Stakeholders?, both by Lucian A. Bebchuk and Roberto Tallarita; For Whom Corporate Leaders Bargain by Lucian A. Bebchuk, Kobi Kastiel, and Roberto Tallarita (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 coronavirus pandemic has prompted massive changes for countries, societies, people and businesses. Interconnected environmental, social and governance issues have reinforced the role of sustainable investing strategies as an indispensable part of investor allocations for a post-COVID-19 world.

When the history of COVID-19 is written, the pandemic period will be seen as more than just a health and economic crisis. Both contributed to a social reckoning, with a growing focus on inequality around the world, while the intensifying global climate crisis has added new and unpredictable threats.

Taken together, these four pandemic-era trends have fueled a conceptual change in the purpose of investing. Before the pandemic, traditional investing viewed economic and social issues as largely distinct spheres; companies existed to enrich their owners—the shareholders. Now, those spheres are intertwined. You can’t fully understand the economics of a business without understanding how a company interacts with customers and society. Powerful social forces affect businesses and are fundamental to gaining investment insight into a company’s growth path and return potential. Here are four lessons that we think will endure long after the world has healed from COVID-19.

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2021 Board Effectiveness: A Survey of the C-Suite

Posted by Paul DeNicola and Leah Malone, PricewaterhouseCoopers LLP, and Paul Washington, The Conference Board, Inc. , on
Friday, November 26, 2021
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Paul DeNicola is Principal and Leah Malone is Director at the Governance Insights Center, PricewaterhouseCoopers LLP, and Paul Washington is Executive Director of the ESG Center at The Conference Board, Inc. This post is based on their PwC/Conference Board memorandum.

It’s rare for corporate directors to receive candid feedback from their company’s management teams. The nature of the board of directors’ oversight role makes it an uncomfortable proposition. But the view of the boardroom from the C-suite can be illuminating—and surprising. That is why PwC and The Conference Board asked more than 550 public company C-suite executives to share their perspective on their boards’ overall effectiveness, their strengths and weaknesses, and their readiness to tackle some of the biggest challenges facing companies today.

The results were clear: most executives say board performance is falling short of the mark.

This isn’t to say that executives were uniformly negative in their assessment. Many agreed that directors had a firm grasp of core matters such as the company’s strategy, the risks and opportunities before it, and the priorities of its shareholders.

Yet most executives had a less positive view of overall performance. Asked to rate the effectiveness of their boards, just 29% of executives gave directors a grade of good or excellent. Most (55%) said that they were doing a fair job overall, and a small minority (16%) graded their effectiveness as poor.

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Weekly Roundup: November 19-25, 2021

Posted by the Harvard Law School Forum on Corporate Governance & Financial Regulation, on
Friday, November 26, 2021

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This roundup contains a collection of the posts published on the Forum during the week of November 19-25, 2021.

Statement by Commissioner Roisman on Proposed Amendments Related to Proxy Voting Advice

Posted by Elad L. Roisman, U.S. Securities and Exchange Commission, on Friday, November 19, 2021
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SEC Dramatically Changes the Rules for Proxy Contests

Posted by Kai Liekefett, Derek Zaba, and Beth Berg, Sidley Austin LLP, on Friday, November 19, 2021
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BlackRock’s Move to Expand Proxy Voting Choice Creates Unknowns

Posted by Douglas Chia, Soundboard Governance, on Saturday, November 20, 2021
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ESG Global Study 2021

Posted by Jessica Ground, Capital Group, on Saturday, November 20, 2021
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2022 Glass Lewis Policy Guidelines: United States

Posted by Eric Shostal, Glass, Lewis & Co., on Sunday, November 21, 2021
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How GPs Can Compete for Capital Through ESG

Posted by Addison Holmes, Pickering Energy Partners, on Sunday, November 21, 2021
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Regulated Funds

Posted by John J. Mahon and Shaina L. Maldonado, Schulte Roth & Zabel LLP, on Monday, November 22, 2021
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Stock Investors’ Returns are Exaggerated

Posted by Jesse M. Fried (Harvard Law School), Paul Ma (University of Minnesota), and Charles C.Y. Wang (Harvard Business School), on Monday, November 22, 2021
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The World Targets Change

Posted by Karen Wong, State Street Global Advisors, on Monday, November 22, 2021
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2021 Annual Corporate Directors Survey

Posted by Maria Moats, Paul DeNicola, and Leah Malone, PricewaterhouseCoopers LLP, on Tuesday, November 23, 2021
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The Economics of Deferral and Clawback Requirements

Posted by Florian Hoffmann (KU Leuven), Roman Inderst (Goethe University Frankfurt), and Marcus Opp (Stockholm School of Economics), on Tuesday, November 23, 2021
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The Sustainability Board Report 2021

Posted by Frederik Otto, Nicolas Alexander, and Tias van Moorsel, The Sustainability Board Report, on Tuesday, November 23, 2021
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Securities Enforcement Quarterly

Posted by Charles J. Clark, Craig S. Warkol and Alex Wharton, Schulte Roth & Zabel LLP, on Wednesday, November 24, 2021
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Core Earnings: New Data and Evidence

Posted by Ethan Rouen (Harvard Business School), Eric C. So (MIT), and Charles C.Y. Wang (Harvard Business School), on Wednesday, November 24, 2021
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2021 Annual Corporate Governance Review

Posted by Hannah Orowitz, Brigid Rosati and Rajeev Kumar, Georgeson LLC, on Wednesday, November 24, 2021
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US Deputy Attorney General Signals Aggressive DOJ Focus on Corporate Crime

Posted by Ted Diskant and Julian L. Andre, McDermott Will & Emery LLP, on Thursday, November 25, 2021
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