Nejat Seyhun is the Jerome B. & Eilene M. York Professor of Business Administration and Professor of Finance at the University of Michigan Ross School of Business. This post is based on a recent paper by Mr. Seyhun; Sureyya Burcu Avci, Research Scholar at Sabanci University; Cindy A. Schipani, Merwin H. Waterman Collegiate Professor of Business Administration and Professor of Business Law at the University of Michigan Ross School of Business; and Andrew Verstein, Professor of Law at UCLA. Related research from the Program on Corporate Governance includes Lucky CEOs and Lucky Directors by Lucian Bebchuk, Yaniv Grinstein and Urs Peyer (discussed on the Forum here).
Would any of us refuse a gift? We typically do not, unless of course the gift resembles a Trojan Horse. In this blog, we hope to convince you that even if you do not refuse it, you should treat a gift from insiders with upmost care. The problem is that previous studies have shown that corporate insiders earn abnormal returns on not only open market sales and purchases of their firms’ stock, but also on their gifts. Specifically, corporate executives tend to make charitable gifts of their firms’ common stock just prior to a decline in the company’s share prices. If insiders win, who loses? The timing of these gifts is troublesome since the evidence suggests that corporate executives may be defrauding not only their shareholders but also the charities that receive the stock and possibly the taxpayers. If insiders manipulate the information flow in their companies to maximize their benefit, this can potentially hurt the shareholders. Similarly, if insiders’ actions send a wrong signal about corporate governance in their firms, this can also hurt the shareholders. If they donate overvalued stock, the donation will not benefit the charities as much as they claim. Finally, if they unfairly maximize their tax deductions, this can hurt taxpayers. Given the significant policy implications of these findings, we revisit this important issue in an attempt to clarify why insiders are able to time their gifts successfully.
A recent case that illustrates this troublesome development occurred on July 29, 2020 in Kodak stock. After surging 2,757%, a large shareholder and member of Kodak’s board of directors, George Karfunkel donated three million shares of Kodak shares on a day when stock prices fluctuated between $17.50 and $60, (or valued between $50 million and $180 million) to a charitable synagogue in New York state (See, Devine, Curt, CNN Business, “Kodak insider’s stock donation raises new concerns around the company’s government loan“.) Less than one month later, Kodak shares were trading below $6. Had the same donation taken place on August 27, 2020, it would have been worth less than $20 million. This suspicious donation contributed to concerns about unfair business practices at Kodak and jeopardized a large government loan promise to Kodak. In return, these troubling developments have contributed to a precipitous drop in Kodak stock price, thereby severely hurting Kodak shareholders.
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Comment Letter on DOL ESG Proposed Rulemaking
More from: Max Schanzenbach, Robert Sitkoff
Robert H. Sitkoff is the John L. Gray Professor of Law at Harvard Law School and Max M. Schanzenbach is the Seigle Family Professor of Law at the Northwestern University Pritzker School of Law. This post is based on their comment letter to the U.S. Department of Labor. 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 Robert H. Sitkoff and Max M. Schanzenbach (discussed on the Forum here).
We are writing in response to the proposed rulemaking [RIN 1210-AC03–Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights] by the Department of Labor (the “Department”) on prudence and loyalty in selecting plan investments and exercising shareholder rights (the “Proposal”).
This response is based on our expertise in environmental, social, and governance (“ESG”) investing, especially ESG investing by trustees and other fiduciaries. We have undertaken several years of scholarly study of ESG investing by fiduciaries. Our article, “Reconciling Fiduciary Duty and Social Conscience: The Law and Economics of ESG Investing by a Trustee,” 72 Stanford Law Review 381 (2020) (“ESG Investing by a Trustee”), is the leading scholarly study on the topic. We enclose copy of ESG Investing by a Trustee as Exhibit A. In a consulting capacity for Federated Hermes, Inc., we have prepared several white papers and videos and conducted training sessions on ESG investing for trustees and other fiduciary investors. We have also lectured widely in scholarly and industry venues on ESG investing by trustees and other fiduciaries.
We previously commented on the Department’s 2020 rulemaking on financial factors in selecting plan investments (the “2020 Rule”). [1] Our comments were critical of the position taken in the preamble and some substantive aspects of the regulatory text that implied that ESG investing was inherently suspect. We note that the final rule was substantially altered in multiple respects responsive to our criticisms. READ MORE »