Yearly Archives: 2021

Tackling the Climate Crisis

Posted by Brian Sant, Ceres, on
Wednesday, August 18, 2021
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Brian Sant is Senior Director of Digital Communications and Marketing at Ceres. This post is based on his Ceres 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); Companies Should Maximize Shareholder Welfare Not Market Value by Oliver Hart and Luigi Zingales (discussed on the Forum here); and 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).

Despite the challenges, Ceres continued to expand our networks of powerful investors and companies, adding 44 new members in 2020. Just before the year began, we released the new Ceres Roadmap 2030, a 10-year action plan to help companies navigate and succeed in the accelerated transition to a just, inclusive, net zero emissions future. And our initiatives made critical advances.

Climate Action 100+ Grows in Size and Influence

The global investor-led initiative to ensure the world’s largest corporate greenhouse gas emitters take necessary action on climate change added a powerful voice to its roster just as 2020 began. BlackRock, the world’s largest asset manager with more than $6.8 trillion in assets and a member of Ceres Investor Network since 2008, joined Climate Action 100+ on January 9, 2020. Less than a week later, BlackRock’s CEO Larry Fink announced in his annual letter that sustainability is at the center of BlackRock’s investment practices and called on every government, company and shareholder to confront climate change as a unique material financial and investment risk. Blackrock’s size and influence would bring even more heft to the initiative once the U.S. proxy season began.

Proposals filed by Climate Action 100+ investor signatories calling on major oil and electric power companies to disclose lobbying activities and improve governance on climate change garnered record levels of support in 2020.

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CEO Tenure and Firm Value

Posted by Peter Limbach (University of Bielefeld), on
Wednesday, August 18, 2021
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Peter Limbach is Professor of Corporate Finance and Governance at the University of Bielefeld. This post is based on a recent paper, forthcoming in The Accounting Review, by Mr. Limbach; Francois Brochet, Associate Professor of Accounting at Boston University Questrom School of Business; Markus Schmid, Professor of Corporate Finance at the University of St.Gallen; and Meik Scholz-Daneshgari, Karlsruhe Institute of Technology.

Among academics and practitioners, there is an ongoing debate over whether CEOs stay in office too long. Empirically, a mosaic of evidence suggests that corporate outcomes – such as earnings management (Ali and Zhang, 2015), firm-customer and firm-employee relationships (Luo et al., 2014), innovation (Wu et al., 2005), net investments (Pan et al., 2016), and profitability (Henderson et al., 2006) – vary over the CEO’s time in office. Yet, this body of evidence does not provide a clear answer to a fundamental question: How does firm value vary over a CEO’s tenure?

To inform the question of whether there exists an optimal CEO tenure, we bridge this gap in the literature in two ways. First, by looking at firm value, a comprehensive and forward-looking measure that captures the realized and expected net benefits of CEOs’ actions to shareholders. Specifically, we measure firm value using Total q from Peters and Taylor (2017), who propose an adjustment to Tobin’s q that incorporates intangible assets into the denominator by capitalizing R&D and a portion of SG&A expenses. Second, by providing evidence on the determinants of the CEO tenure-firm value association.

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Effective Disclosure Controls Concerning Cybersecurity Breaches and Risks

Posted by John F. Savarese, Wayne M. Carlin, and Sabastian V. Niles, Wachtell, Lipton, Rosen & Katz, on
Wednesday, August 18, 2021
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John F. Savarese, Wayne M. Carlin, and Sabastian V. Niles are partners at Wachtell, Lipton, Rosen & Katz. This post is based on their Wachtell memorandum.

In yet another important signal of the SEC’s increasing focus on how public companies respond to, and issue disclosures concerning, significant cyber breaches, the Commission announced yesterday that it had entered into a settled administrative order with Pearson plc, finding violations of the negligence-based antifraud provisions of the Securities Act and imposing a $1 million civil penalty. Pearson neither admitted nor denied the Commission’s findings.

The Order recites that a substantial volume of personal data concerning students and school administrators was stolen by a “sophisticated threat actor” from Pearson’s academic performance assessment services that were provided to 13,000 school districts in the United States, and notes that while Pearson’s periodic filings with the Commission contained risk-factor disclosure identifying that “malicious attack[s] on our systems” could result in a “‘major data privacy or confidentiality breach,’” the Company re-issued that risk-disclosure language without disclosing that precisely such a major breach had occurred just a few months earlier. The SEC also found that Pearson’s response to media inquiries concerning the breach was materially misleading, because its press statement downplayed the scale and seriousness of the breach and implied that certain types of personal data may have been obtained, when Pearson knew that such data had, in fact, been stolen.

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Board Diversity Deliberations

Posted by Rebecca Sherratt, Insightia, on
Tuesday, August 17, 2021
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Rebecca Sherratt is Corporate Governance Editor at Insightia. This post is based on her Insightia 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).

Director support among U.S.-listed companies is dropping this year as investors expect boards to accelerate their diversity commitments for not only gender, but also racial and ethnic diversity. Average support for director elections at S&P 500 companies dropped to 96.1% in the first half of 2021, and a similar decline has also been exhibited in the U.K.

In the S&P 500, 41.6% and 38.2% of director appointments were female in 2019 and 2020 respectively, according to Activist Insight Governance data. This significant number of diverse director appointments assured investors that gender diversity issues were being sufficiently managed by boards, but now investor expectations are tightening once more.

The emphasis on racial and ethnic representation on boards has increased, in response to the 2020 Black Lives Matter protests, which highlighted to investors that minority representation on boards still leaves much to be desired.

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The Need to Validate Exogenous Shocks: Shareholder Derivative Litigation, Universal Demand Laws and Firm Behavior

Posted by Sara Toynbee (University of Texas at Austin), on
Tuesday, August 17, 2021
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Sara Toynbee is Assistant Professor of Accounting at the University of Texas at Austin McCombs School of Business. This post is based on a recent paper, forthcoming in the Journal of Accounting & Economics, by Ms. Toynbee; Dain C. Donelson, Professor of Accounting at the University of Iowa Tippie College of Business; John McInnis, Professor of Accounting at the University of Texas at Austin McCombs School of Business; and Laura Kettell, PhD Student in Accounting at the University of Texas at Austin McCombs School of Business.

As researchers in finance and accounting seek to identify causal relationships in “real-world” data, they often turn to legal changes to provide a quasi-exogenous shocks. As a recent example, a growing number of academic use the adoption of universal demand (UD) laws to examine the causal effect of litigation risk on various firm outcomes (e.g., Bourveau et al. 2018; Appel 2019; Huang et al. 2021). These studies argue that UD laws increase the procedural hurdles associated with derivative litigation; however, there is little empirical evidence that UD adoption significantly lowers derivative litigation risk. Drawing on institutional features of derivative litigation and UD laws, our paper, “The Need to Validate Exogenous Shocks: Shareholder Derivative Litigation, Universal Demand Laws and Firm Behavior” examines the validity of UD adoption as a shock to litigation risk.

UD standardizes the procedures for derivative litigation, requiring all plaintiffs to “demand” that the board bring derivative action against managers. However, even if a board refuses demand, a shareholder can still assert the refusal was improper. UD was designed to focus litigation on boards’ justifications for demand refusal, not curtail derivative litigation (see Coffee,1993). In addition, states generally passed UD laws as part of broader revisions to the Model Business Corporations Act (MBCA), which was updated in 1989 to include the UD requirement (Model Business Corporation Act, 2016). There is little evidence that legislators and attorneys viewed UD as a material part of the reforms (see, e.g., Jacobs Law LLC, 2004 discussing law passage in Massachusetts). Further, not all states enforce UD requirements (Mark and Weber, 2014). Overall, it is not clear UD significantly lowered litigation risk.

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What Boards Need to Know Before, During, and After an Acquisition

Posted by Maria Castañón Moats and Leah Malone, PricewaterhouseCoopers LLP, on
Tuesday, August 17, 2021
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Maria Castañón Moats is Leader and Leah Malone Director at the Governance Insights Center, PricewaterhouseCoopers LLP. This post is based on their PwC memorandum. 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 The New Look of Deal Protection by Fernan Restrepo and Guhan Subramanian (discussed on the Forum here).

Making an acquisition is a major step for a company. For all the possible benefits, however, there are many challenges that can derail a deal and destroy the anticipated shareholder value. Navigating those pitfalls is vital to an acquisition delivering on its potential. Here are the steps boards should take at each stage of an acquisition.

The COVID-19 pandemic and its follow-on effects have changed the economic situation for most companies. Many are experiencing financial hardship and depressed income. But others have cash. And unique opportunities may be available to those with capital to spend. Adding the right business to your arsenal can boost your customer base, increase revenue, and even reduce costs. But making an acquisition is a huge decision for a company, and executing a deal during a global pandemic poses unique challenges. Before taking the plunge you need to be confident it’s the right move with the right target. This applies not only to an individual deal, but also to how acquisitions fit into your company’s overall strategy.

Depending on the size of the target and the capabilities it brings, an acquisition can transform your company—not only what you offer customers, but how and at what cost you deliver products and services to them. Combining another company’s culture with yours also can affect company identity and raise questions about the new organization’s priorities and goals.

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Blackrock Flexes Its Muscles During the 2020-21 Proxy Period

Posted by Cydney Posner, Cooley LLP, on
Monday, August 16, 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 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).

Although BlackRock, which manages assets valued at over $9 trillion, and its CEO, Laurence Fink, have long played an outsized role in promoting corporate sustainability and social responsibility, BlackRock has also long been a target for protests by activists. As reported by Bloomberg, “[e]nvironmental advocates in cities including New York, Miami, San Francisco, London and Zurich targeted BlackRock for a wave of protests in mid-April, holding up images of giant eyeballs to signal that ‘all eyes’ were on BlackRock’s voting decisions.” Of course, protests by climate activists outside of the company’s offices are nothing new. There’s even a global network of NGOs, social movements, grassroots groups and financial advocates called “BlackRock’s Big Problem,” which pressures BlackRock to “rapidly align [its] business practices with a climate-safe world.” Why this singular outrage at BlackRock? Perhaps because, as reflected in press reports like this one in the NYT, activists have reacted to the appearance of stark inconsistencies between the company’s advocacy positions and its proxy voting record: BlackRock has historically conducted extensive engagement with companies but, in the end, voted with management much more often than activists preferred. For example, in the first quarter of 2020, the company supported less than 10% of environmental and social shareholder proposals and opposed three environmental proposals. BlackRock has just released its Investment Stewardship Report for the 2020-2021 proxy voting year (July 1, 2020 to June 30, 2021). What a difference a year makes.

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Business Groups: Panics, Runs, Organ Banks and Zombie Firms

Posted by Asli M. Colpan (Kyoto University) and Randall Morck (University of Alberta), on
Monday, August 16, 2021
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Asli M. Colpan is Professor at Kyoto University Graduate School of Management, and Randall Morck is Jarislowsky Distinguished Chair and Distinguished University Professor at the University of Alberta. This post is based on their recent paper.

Unlike in the US, large firms in many foreign stock markets come in business groups: sets of seemingly distinct firms—each with its own stock price, annual reports, public shareholders, board of directors and CEO—but all effectively controlled by on apex firm, often itself controlled by a tycoon of wealthy family. Business groups were commonplace in the economic histories of most of today’s developed economies and in today’s emerging market economies. Adolf Berle and Gardiner Means, members of Franklin Delano Roosevelt’s “brain trust” deemed large business groups undue concentrations of power and successive New Deal reforms largely expunged this mode of corporate governance from the US. Institutional reforms later marginalized business groups in in Australia, Britain and Canada.

Investors and boards of directors contemplating investments elsewhere must factor in the non-independence of firms in each business group. This is especially important where banks, near-banks and other financial firms such as pension fund portfolio managers, belong to business groups. How this plays out depends on where agency lies within the business group. This is because the apex controlling party often has a larger real investment in some group firms and a minor real stake in others, yet controls them all via super-voting shares, board appointment rights, or (most commonly) control pyramids.

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Let Your Mission Guide Your Executive Pay

Posted by Seymour Burchman and Mark Emanuel, Semler Brossy LLC, on
Monday, August 16, 2021
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Seymour Burchman is a senior advisor and Mark Emanuel is a managing director at Semler Brossy LLC. This post is based on their Semler Brossy memorandum. 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).

Many business thinkers have criticized corporate “short-termism” that discourages crucial long-term investments in intangible capabilities. Executive pay programs get much of the blame, as even “long-term incentives” last only three years, with the goals for each year’s tranche reset annually.

Those brief periods are understandable given that most company strategies in fast-paced markets require agile responses to near-term market developments. But then how can companies carry out long-term investments?

One answer is to realign pay programs to support the company’s larger mission and purpose, rather than a particular strategy. Boards can link a new set of incentives to progress toward achieving the mission, with an eye to promoting sustainable growth. Once executives are focused on and paid for long-term, mission-driven success, they’ll be more inclined to make the necessary investments.

These new incentives could replace existing three-year plans or become an entirely new set of incentives to complement the existing annual and three-year plans. Two incentive programs would be simpler to communicate and would minimize redundancy. But many boards might prefer a separate, third program to ease the transition from current incentive practices.

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DOJ Indicts Founder of Nikola for Allegedly Defrauding Retail SPAC Investors

Posted by Jonathan Kolodner, Rahul Mukhi, and Jared Gerber, Cleary Gottlieb Steen & Hamilton LLP, on
Sunday, August 15, 2021
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Jonathan Kolodner, Rahul Mukhi, and Jared Gerber are partners at Cleary Gottlieb Steen & Hamilton LLP. This post is based on a Cleary memorandum by Mr. Kolodner, Mr. Mukhi, Mr. Gerber, and JD Colavecchio.

On July 29, 2021, the U.S. Attorney’s Office for the Southern District of New York unsealed a securities and wire fraud indictment against Trevor Milton, the founder and one-time chairman of Nikola Corporation (“Nikola”), a pre-revenue electric- and hydrogen-powered vehicle company which went public through a merger with a special-purpose acquisition company (“SPAC”). [1] The Indictment alleges that Milton made deceptive, false, and misleading claims regarding Nikola’s products and technology, which were directed at retail investors through social media and television, print, and podcast interviews. The SEC also filed a parallel civil action against Milton, alleging violations of Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act, and which contends that Milton engaged in a “relentless public relations blitz” on social media and the popular press directed at “Robinhood investors” in order to inflate Nikola’s stock price.

These actions further confirm the heightened law enforcement and regulatory scrutiny of SPACs, as well as continuing interest by government authorities in protecting retail investors in so-called meme stocks. [2]

The Allegations

The Indictment alleges that from at least November 2019 through September 2020, Milton made false and misleading claims regarding the development of Nikola’s products and technology, which “addressed nearly all aspects of the business.” These alleged misstatements included: (1) claiming that the company had early success in creating a “fully functioning” semi-truck prototype, when Milton allegedly knew the prototype was inoperable; (2) falsely asserting that Nikola had engineered and built an electric- and hydrogen-powered pickup truck; (3) stating that the company was producing hydrogen at a reduced rate, when Milton allegedly knew “no hydrogen was being produced at all by Nikola”; (4) claiming Nikola had developed batteries and other components in-house, when Milton knew they were being acquired from third parties; and (5) stating that the company had binding orders representing billions in future revenue, while knowing that “the vast majority of those orders could be cancelled at any time and were for a truck Nikola had no intent to produce in the near-term.”

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