Yearly Archives: 2021

Stock-Option Financing in Pre-IPO Companies

Posted by David F. Larcker (Stanford University), Brian Tayan (Stanford University), and Edward M. Watts (Yale), on
Thursday, August 26, 2021
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David Larcker is Professor of Accounting at Stanford Graduate School of Business; Brian Tayan is a researcher with the Corporate Governance Research Initiative at Stanford Graduate School of Business; and Edward Watts is Assistant Professor of Accounting at Yale School of Management. This post is based on their recent paper.

We recently published a paper on SSRN, Stock-Option Financing in Pre-IPO Companies, that examines a new industry in which specialty-finance companies provide capital to employees and executives to facilitate the exercise of stock options in pre-IPO companies.

Equity awards and stock-option grants are a central element of compensation programs in pre-IPO companies. According to the National Association of Stock Plan Professionals (NASPP), approximately three-quarters of private companies offer stock options as part of their compensation mix. In Silicon Valley, where many technology and healthcare startups are located, over 90 percent offer stock options. Stock options are not just awarded to the highest-level executives. Half of companies distribute stock options to over 80 percent of their employee base; a third distribute them to all employees.

Companies include stock options in the compensation mix for attraction, retention, and incentive purposes. Because of the leveraged nature of stock-option payouts, stock options attract highly skilled and risk-tolerant employees who are willing to sacrifice current salary for the potential of much larger future pay if the company is successful through their efforts. By paying a portion of the compensation in equity, companies in the early stage of development can reduce cash outlays. Stock options also serve as retention tools, by encouraging employees to remain with the company until granted awards are fully vested and full value realized upon completion of a liquidity event.

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SEC Approves Nasdaq “Comply-or-Explain” Proposal for Board Diversity

Posted by Cydney Posner, Cooley LLP, on
Thursday, August 26, 2021
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Cydney S. Posner is special counsel at Cooley LLP. This post is based on her Cooley memorandum. Related research from the Program on Corporate Governance includes Politics and Gender in the Executive Suite by Alma Cohen, Moshe Hazan, and David Weiss (discussed on the Forum here).

You probably remember that, late last year, Nasdaq filed with the SEC a proposal for new listing rules regarding board diversity and disclosure, accompanied by a proposal to provide free access to a board recruiting service. The new listing rules would 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. In March, after Nasdaq amended its proposal, and in June, the Division of Trading and Markets, pursuant to delegated authority, took actions that had the effect of postponing a decision on the proposal—until now. On Friday afternoon, the SEC approved the two proposals.

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,” a presentation that the SEC’s Order has clearly embraced. 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 would need to explain their rationales for not doing so. The proposal would also require 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+.

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ESG Trends and Hot Topics

Posted by Catherine Clarkin and Melissa Sawyer, Sullivan & Cromwell LLP, on
Wednesday, August 25, 2021
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Catherine M. Clarkin and Melissa Sawyer are partners at Sullivan & Cromwell LLP. This post is based on a Sullivan & Cromwell memorandum by Ms. Clarkin, Ms. Sawyer, John Horsfield-Bradbury, Marc Treviño, Sarah Mishkin, and Sam Saunders. Related research from the Program on Corporate Governance includes The Illusory Promise of Stakeholder Governance and Will Corporations Deliver Value to All Stakeholders?, both 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 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).

Key Developments

Hot topics in ESG for directors and executives to consider:

  • Regulators and investors are focused on ESG-related disclosure requirements, particularly on climate change and board and workforce diversity. Requirements are likely to be extended to US public companies and US investment funds, as well as private companies and subsidiaries operating in the EU and UK.
  • The risk of ESG-related litigation, regulatory action and shareholder proxy battles continues to grow. Companies should comprehensively review their ESG-related strategy and disclosure, including in materials not filed with authorities or used in securities offerings.
  • The global sustainable finance market is likely to be significantly boosted by new central bank and regulatory actions, but more rigorous criteria for ESG-labeled products are also being implemented. Companies should consider relevant opportunities to participate in this market.
  • Financial regulators are focusing on climate risk management and climate change’s effects on financial stability. Financial institutions should assess their current approach to climate risks and opportunities and prepare for related new requirements and supervisory expectations.

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When the Local Newspaper Leaves Town: The Effects of Local Newspaper Closures on Corporate Misconduct

Posted by Jonas Heese (Harvard Business School), Gerardo Pérez-Cavazos (UC San Diego), and Caspar David Peter (Erasmus University), on
Wednesday, August 25, 2021
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Jonas Heese is Marvin Bower Associate Professor of Business Administration at Harvard Business School; Gerardo Pérez-Cavazos is Assistant Professor of Accounting at UC San Diego Rady School of Management; and Caspar David Peter is Associate Professor of Accounting at Erasmus University Rotterdam School of Management. This post is based on their recent paper, forthcoming in Journal of Financial Economics.

Is the local press an effective monitor of corporate misconduct? Examining this question is important as over the last two decades the circulation of local newspapers in the United States has decreased by nearly 50% according to the Pew Research Center. A concern is that less local news results in less local accountability and investigative reporting, and therefore increased local corruption and crime. Yet, little is known about whether the decline in local newspapers affects corporate misconduct. We study this question by examining the effects of local newspaper closures on facility-level violations of publicly listed firms using a dataset that encompasses a wide range of violations, such as workplace safety violations, environmental violations, and securities fraud.

Effects of Local Newspaper Closures

From a theoretical standpoint, the effect of local newspaper closures on firms’ legal violations is ambiguous. On the one hand, the local press could be an effective monitor of firms and hence affect corporate misconduct via investigations or dissemination. For example, similar to the national press, the local press could undertake original investigations to detect corporate fraud. Local newspapers may be especially effective in discovering the misconduct of local firms because of their proximity to local sources such as employees and local suppliers. The local press could also affect corporate misconduct by widely disseminating information about misbehavior.

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Delaware Court Rejects Buyer’s Claim of an MAE

Posted by Roger Morscheiser, Scott Petepiece, and George Casey, Shearman & Sterling LLP, on
Wednesday, August 25, 2021
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Roger Morscheiser, Scott Petepiece, and George Casey are partners at Shearman & Sterling LLP. This post is based on their Shearman memorandum, 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).

On July 9, 2021, Vice Chancellor Slights of the Delaware Court of Chancery, in Bardy Diagnostics, Inc. v Hill-Rom, Inc. (Del. Ch. July 9, 2021), ordered specific performance to compel Hill-Rom, Inc. (“Hillrom”), a publicly held, global medical technology company, to close the acquisition of Bardy Diagnostics, Inc. (“Bardy”), a medical device startup, upon finding that Hillrom failed to prove that a significant decrease in the Medicare reimbursement rate for Bardy’s sole product offering constituted a Material Adverse Effect (“MAE”), as defined in the merger agreement.

Background

Bardy has a single product offering on the market: an ambulatory electrocardiogram device marketed as the Carnation Ambulatory Monitor (“CAM”) patch. One of Bardy’s largest sources of revenue is through Medicare reimbursements for the CAM patches. The Centers for Medicare & Medicaid Services (“CMS”), an arm of the federal Department of Health and Human Services, develops and administers Medicare’s reimbursement policy. CMS, in turn, authorizes a private entity, Novitas Solutions, Inc. (“Novitas”), to set the reimbursement rates applicable to the CAM patch, which in 2020, was approximately $365 per CAM patch.

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More Myths from Lucian Bebchuk

Posted by Martin Lipton, Wachtell, Lipton, Rosen & Katz, on
Tuesday, August 24, 2021
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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 and William Savitt. Related research from the Program on Corporate Governance includes The Illusory Promise of Stakeholder Governance and Will Corporations Deliver Value to All Stakeholders?, both by Lucian A. Bebchuk and Roberto Tallarita (discussed on the Forum here); and For Whom Corporate Leaders Bargain by Lucian A. Bebchuk, Kobi Kastiel, and Roberto Tallarita (discussed on the Forum here).

Two years ago, the Business Roundtable (BRT) issued a “Statement on the Purpose of a Corporation,” signed by the CEOs of 184 major U.S. corporations, that rejected shareholder primacy, declared “a fundamental commitment to all [corporate] stakeholders” and linked corporate purpose to advancing and protecting the interests not just of shareholders, but of all corporate stakeholders. The BRT’s statement reflected rapidly growing momentum towards a more inclusive corporate governance regime and promised to accelerate stakeholder governance by committing business leaders to the interests of employees, customers, suppliers, communities and the environment.

The BRT statement elevated the topic of stakeholder capitalism to the top of national and global policy debate. In 2020, the World Economic Forum launched the new “Davos Manifesto” in support of stakeholder capitalism. Nearly every significant asset manager—including the “big three,” BlackRock, Vanguard and State Street—now insists that the companies in which they invest adopt sustainable stakeholder governance practices. At the urging of their investors, large companies are nearly uniformly undertaking efforts to make and measure progress in achieving sustainable, socially responsible operations. The signs of the step-up in the embrace of stakeholder governance by corporations and their major investors are everywhere.

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Are CEOs Different?

Posted by Steven N. Kaplan (University of Chicago) and Morten Sorensen (Dartmouth University), on
Tuesday, August 24, 2021
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Steven N. Kaplan is the Neubauer Family Professor of Entrepreneurship and Finance at the University of Chicago Booth School of Business, and Morten Sorensen is Associate Professor of Finance at Dartmouth University Tuck School of Business. This post is based on their recent paper, forthcoming in the Journal of Finance.

Evaluating leaders and managers is a central concern for companies and their boards. A critical question is how CEOs differ from other top managers. There is much anecdotal evidence and many studies of specific companies and individual leaders, but there is very little systematic evidence about what CEOs look like, how they differ from other top managers, and which candidates are more likely to eventually be promoted to the top spot. In a recent study, drawing on unique data with personality assessments of thousands of candidates, we contrast the types of individuals that are considered for CEO, CFO, and COO positions. We examine who among the considered candidates is more likely to be hired for each position. And focusing on candidates earlier in their careers, we predict who eventually becomes a CEO, CFO, and COO.

In a data collection that has lasted several years, we have processed about 2,600 candidates. We started with candidates assessed by ghSMART, a leading HR consulting firm that has developed a rigorous process using structured interview to classify each candidate’s personality. These assessments are typically performed as part hiring or retention processes, often for the due diligence process of venture capital and private equity firms evaluating investments in the companies. We combined ghSMART’s assessments with information gathered from public searches and other data sources to track each candidate’s subsequent career. The resulting data are unique. They contain a larger number of managers, each assessed using a structured and systematic process, spanning a wide range of companies, a range of positions, and a time period lasting more than a decade.

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SEC Steps Back from Two 2020 Amendments to the Whistleblower Rules

Posted by Cydney Posner, Cooley LLP, on
Tuesday, August 24, 2021
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Cydney S. Posner is special counsel at Cooley LLP. This post is based on her Cooley memorandum.

The SEC’s whistleblower program provides for awards in amounts between 10% and 30% of the monetary sanctions collected in an SEC action based on the whistleblower’s original information. The program, which has been in place for more than ten years, is widely acknowledged to have been a resounding success. In September 2020, the SEC adopted a number of amendments to the whistleblower rules, some of which were quite controversial. In early August, SEC Chair Gary Gensler issued a statement indicating that he had directed the SEC staff to revisit the whistleblower rules, in particular, two of the amendments that had been adopted in 2020. (See this PubCo post.) Gensler observed that concerns have been raised, including by whistleblowers as well as by Commissioners Allison Herren Lee and Caroline Crenshaw, that those amendments “could discourage whistleblowers from coming forward.” Now, the SEC has issued a policy statement advising how the SEC will proceed in the interim while changes to those rules are under consideration. Commissioners Hester Peirce and Elad Roisman were none too pleased with the SEC’s action here, questioning whether it might be part of a troubling pattern of unwinding actions taken by the last Administration. They made their views known in this statement.

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The Board’s Role in Sustainable Leadership

Posted by Laura Sanderson, PJ Neal, and Emily Meneer, Russell Reynolds Associates LLP, on
Monday, August 23, 2021
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Laura Sanderson co-leads the Board and CEO Advisory Partners in Europe; PJ Neal leads the Center for Leadership Insight; and Emily Meneer leads the Social Impact and Education sector Knowledge Management team at Russell Reynolds Associates LLP. This post is based on a Russell Reynolds memorandum by Ms. Sanderson, Mr. Neal, Ms. Meneer, and Jemi Crookes. Related research from the Program on Corporate Governance includes The Illusory Promise of Stakeholder Governance and Will Corporations Deliver Value to All Stakeholders?, both 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 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).

Sustainability—both social and environmental—has quickly risen to the top of corporate agendas in recent years. This is in part because of the growing evidence that sustainable practices result in improved financial performance, and in part due to pressure from investors, employees, and the public for companies to articulate the role they play in addressing societal challenges. As one director recently told us, sustainability “has never been a higher priority for the board than it is today.”

In 2020, Russell Reynolds Associates published a study in partnership with the United Nations Global Compact examining the attributes that make executive leaders effective at driving sustainability outcomes. In this post, we study the issue from the board’s perspective, looking at how corporate directors engage with the challenges and opportunities related to sustainability, how they structure and operate the board to oversee related activities, and ultimately, how they enable sustainable in the enterprise.

 

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Obfuscation in Mutual Funds

Posted by Chloe L. Xie (MIT Sloan School of Management), on
Monday, August 23, 2021
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Chloe L. Xie is Assistant Professor of Accounting at MIT Sloan School of Management. This post is based on a recent paper, forthcoming in the Journal of Accounting and Economics, by Ms. Xie; Ed deHaan, Associate Professor of Accounting at the University of Washington Foster School of Business; Yang Song, Assistant Professor of Finance at the University of Washington Foster School of Business; and Christina Zhu, Assistant Professor of Accounting at the Wharton School of the University of Pennsylvania. Related research from the Program on Corporate Governance includes 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).

Over 9,000 mutual funds, holding $21.3 trillion in assets, were traded on U.S. exchanges during 2019. Mutual funds hold 32% of the total U.S. equity market value and comprise 58% of retirement savings (Investment Company Institute 2020). Despite the popularity of mutual funds, many studies find that they underperform and that retail investors consistently make poor choices when selecting funds. For example, retail investors could have saved $358M in 2017 alone by switching from high-fee to low-fee versions of S&P 500 mutual funds with nearly identical pre-expense returns. Investor advocates argue that poor mutual fund choices are due in part to complex financial disclosures and fee structures that make it difficult to compare funds. In a paper forthcoming in the Journal of Accounting and Economics, we investigate whether mutual funds create unnecessarily complex disclosures and fee structures to obfuscate high fees.

Academic theory suggests high-fee index funds create unnecessarily complex disclosures and fee structures so that investors find it difficult to learn from disclosures and make informed decisions (Carlin 2009). But a challenge in investigating this question is controlling for variation in non-discretionary complexity caused by differences across funds.

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