Monthly Archives: January 2022

Interested Voting

Posted by Matteo Gatti (Rutgers), on
Thursday, January 6, 2022
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Matteo Gatti is Professor of Law at Rutgers Law School. This post is based on his recent paper. Related research from the Program on Corporate Governance includes Independent Directors and Controlling Shareholders by Lucian Bebchuk and Assaf Hamdani (discussed on the Forum here).

Despite the ever-growing influence of institutional investors and shareholders generally in corporate governance, interested voting is not fully explored. While corporate law is indisputably attentive to transactions with a controlling shareholder, such transactions hardly cover all instances in which an interested shareholder may harm the corporation by casting a pivotal vote determining the outcome of a resolution. Especially in this current phase of reconcentration of corporate ownership, a deeper investigation is long due.

In a new paper, Interested Voting, I organically analyze different types of resolutions impacted by interested voting, the most typical interested shareholders, current regimes attempting to tackle the phenomenon, and possible policy fixes in areas not covered by an existing regime.

Taxonomies of interested voting

The paper presents taxonomies of interested voting based on type of shareholder resolution and type of shareholder. On the first front, I look at M&A transactions, director elections, changes to the organizational documents, and non-binding resolutions like shareholder proposals and say-on-pay votes. On the other front, I describe several types of shareholders that can be prone to interested voting. Some, like directors, managers, and controlling shareholders, are the usual suspects. But some other shareholders can be as problematic: significant shareholders, acquirers, parties to a voting agreement, cross-owners, institutional investors, shareholder activists, arbitrageurs, employees, and various types of activists (climate, labor, and political).

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ISS Releases Benchmark Policy Updates for 2022

Posted by Cydney Posner, Cooley LLP, on
Thursday, January 6, 2022
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Cydney S. Posner is special counsel at Cooley LLP. This post is based on her Cooley memorandum.

This week, ISS issued its benchmark policy updates for 2022. The policy changes will apply to shareholder meetings held on or after February 1, 2022. The key changes for U.S. companies relate to say-on-climate proposals, board diversity, board accountability for climate disclosure by high GHG emitters, board accountability for unequal voting rights and shareholder proposals for racial equity audits, as well as the decidedly less buzzy topics of capital stock authorizations and burn rate methodology in compensation plans.

Say on climate. The policy updates distinguish between management proposals and proposals submitted by shareholders. In both cases, proposals will be evaluated on a case-by-case basis, but the factors taken into account will differ.

ISS indicates that its policy for management proposals represents a codification of the framework it developed last year, adjusted for relevant feedback. For management proposals that request shareholders to approve the company’s climate transition action plan (or variations of same), ISS will take into account a long list of factors, including the completeness and rigor of the plan, the extent to which the company’s climate-related disclosures align with the TCFD recommendations and other market standards; disclosure of the company’s scope 1, 2 and 3 GHG emissions; the completeness and rigor of the company’s short-, medium- and long-term targets for reducing GHG emissions in line with the Paris Agreement; whether the company has sought and received third-party approval that its targets are science-based; whether the company has committed to be “net zero” for Scopes 1, 2, and 3 emissions by 2050; whether the company discloses a commitment to report on the implementation of its plan in subsequent years; whether the company’s climate data has received third-party assurance; disclosure regarding how the company’s lobbying activities and its capital expenditures align with company strategy; any specific industry decarbonization challenges; and how the company’s commitment, disclosure and performance compare to its industry peers. And that list isn’t even exhaustive.

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Enforcement Again Brings Charges for Failure to Disclose Perks

Posted by Cydney Posner, Cooley LLP, on
Wednesday, January 5, 2022
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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 Stealth Compensation Via Retirement Benefits by Lucian Bebchuk and Jesse M. Fried.

Failure to disclose executive perks continues to be a flashing target for SEC Enforcement. Just last year, there were two actions against companies for disclosure failures regarding perks—Hilton Worldwide Holdings Inc. (see this PubCo post) and Argo Group International Holdings, Ltd. (see this PubCo post). And earlier this year, Enforcement brought settled charges against Gulfport Energy Corporation and its former CEO, Michael G. Moore, for failure to disclose some of the perks provided to Moore (see this PubCo post). Now, the SEC has once again filed settled charges against a company, ProPetro Holding Corp., and its co-founder and former CEO, Dale Redman, for failure to properly disclose executive perks—including, once again, personal use of aircraft at the company’s expense—as well as two stock pledges. While the topic is not new, the different types of blunders and slip-ups—which seem to be unique to each case—can be instructive. In this case, the focus was—in addition to absence of a policy regarding personal travel reimbursement, inadequate internal controls around perks and failure to disclose paid personal travel expenses—an inadequate process for completion and review of D&O questionnaires.

As you know, Reg S-K Item 402 requires identification of all perquisites and personal benefits by type, and quantification of any perquisite or personal benefit that exceeds the greater of $25,000 or 10% of total perquisites. Item 403, which provides for inclusion of the beneficial ownership table, requires disclosure of the number of shares beneficially owned that are pledged as security, usually disclosed in a footnote to the table.

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Board Responsibility for Artificial Intelligence Oversight

Posted by Robert G. Eccles (Oxford University) and Miriam Vogel (EqualAI & Georgetown University), on
Wednesday, January 5, 2022
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Robert G. Eccles is Visiting Professor of Management Practice at Oxford University Said Business School, and Miriam Vogel is President and CEO of EqualAI and Adjunct Professor at Georgetown University Law Center.

Artificial Intelligence (AI) is quickly taking over. But not in the robot-coup type of scenario that inspires multimillion dollar box office hits. Rather, AI protects our credit cards from fraudulent activity, helps employers to hire and maintain a remote workforce during a global pandemic, and enables doctors to deliver care to patients thousands of miles away. AI is and will be a powerful tool to advance our lives, economy, and opportunities to thrive, but only if it does not perpetuate and mass produce discrimination and physical harm to individuals—and massive liability to corporations. Board members are in an optimal position to ensure that companies under their purview are prepared to avoid the harms, and litigation risks that AI could invite.

In particular, environmental, social, and governance (ESG) considerations that safeguard against risks and ensure good corporate stewardship provide a natural home and framework to guard against these harms.

As focus on climate change grows through COP26 has made clear, the environment or “E” will be a future headline involving AI, as the outsized carbon footprint of AI inflicts increasing damage to our environment. In the meantime, corporate leadership must immediately turn to the “S,” or societal implications of AI, where harms are pervasive and liability is imminent. On the upside, if we get this right, AI can instead by an ally in addressing these harms and best practices for board “G” or governance. For instance, instead of blindly deploying AI systems that have been built and trained on data sets mostly populated by Caucasian male users, we can enhance user safety by operating transparently and noting when an AI program has been tested and trained on limited populations. Better yet, we can open our aperture and use AI to broaden our consumer base by ensuring that AI products are not just safe but also beneficial to broader swaths of the population. Likewise, AI is often considered a trigger for job loss, but if we are thoughtful and forward thinking, implementing measures like upskilling programs, workers can benefit, along with the companies and ultimately our economy, from providing a broader population to service and support AI deployment.

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Board Oversight: Key Focus Areas for 2022

Posted by Holly Gregory, Sidley Austin LLP, on
Wednesday, January 5, 2022
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Holly J. Gregory is partner at Sidley Austin LLP. This post is based on her Sidley memorandum.

Boards function in a complex and dynamic business setting in which stakeholder expectations and demands for board attention are expanding. The challenges of operating through the COVID-19 pandemic in an uncertain environment continue to be felt as companies anticipate a new post-pandemic normal. Companies face pressure on multiple fronts, including resistance to returning to in-person work in a highly competitive talent market, supply chain bottlenecks and inflation, the potential for a global and national economic slowdown, and increasing risk of cyberattacks, unusual climate events, and regulatory action (including antitrust enforcement and taxation), all in an atmosphere of heightened scrutiny of board oversight.

Ensuring that directors are well-positioned to satisfy their oversight responsibility requires periodic assessment of board agenda priorities and the related structures, processes, and controls that are in place to ensure that the board is well-informed on a timely basis of matters requiring attention. This post summarizes directors’ duty of oversight and highlights issues that are likely to require significant board attention in 2022, including:

  • Strategy and risk.
  • Corporate purpose and environmental, social, and governance (ESG) matters.
  • Human capital and workforce issues.
  • Shareholder engagement and activism.
  • Crisis management.
  • Board-management relationships and board culture.

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SEC Provides Interpretative Accounting Guidance

Posted by John Ellerman and Mike Kesner, Pay Governance LLC, on
Tuesday, January 4, 2022
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John Ellerman and Mike Kesner are partners at Pay Governance LLC. This post is based on their Pay Governance memorandum.

Introduction

From time to time, the Securities and Exchange Commission (SEC) provides interpretative accounting guidance, referred to as staff accounting bulletins (SABs), to public companies. On November 24, 2021, the SEC released SAB 120, which addresses the estimation of the fair value of share grants such as stock options, restricted shares, performance awards, and other equity awards when a company issues an equity award just prior to the release of positive non-public information. This type of equity award is referred to in SAB 120 as a “spring-loaded” award. If the award is spring-loaded, the SEC believes the company may need to value the award for accounting and proxy purposes at an amount greater than the reported share price at the date of grant.

It is important to note that the statements of SEC staff in accounting bulletins are not rules or interpretations of the SEC nor are they published as bearing the SEC’s official approval. Such statements represent interpretations and practices followed by the Division of Corporate Finance and the Office of the Chief Accountant in administering the disclosure requirements of the federal securities laws.

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Why We Should Trust Investors for Promoting Sustainability Goals

Posted by Wolf-Georg Ringe (University of Hamburg), on
Tuesday, January 4, 2022
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Wolf-Georg Ringe is Professor of Law & Finance at the University of Hamburg Faculty of Law. This post is based on his recent paper. 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).

ESG investing is undoubtedly on the rise. However, many contributors to this Forum and other academic commentators remain skeptical as to the incentives and genuine interests of institutional investors in pursuing sustainability goals. For example, in a recent post, Roberto Tallarita exposes the limits of portfolio primacy and explains why policymakers should revert to traditional legal instruments for furthering such policy objectives. In this spirit, regulators frequently seek to prescribe and regulate how firms may address ESG concerns by formulating conduct standards. For example, the European Union is poised to redefine directors’ duties to include sustainability and climate objectives.

Deviating from this viewpoint, my recent paper, Investor-led Sustainability in Corporate Governance, takes a more optimistic view and makes the case for the empowerment of investors to achieve greater sustainability in capital markets. Put differently, I shift the focus of ESG away from regulatory intervention to instead favor a market-led approach in ESG investments.

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Board Dialogue on DEI

Posted by Margaret Hylas and Olivia Tay, Semler Brossy, on
Tuesday, January 4, 2022
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Margaret Hylas and Olivia Tay are senior consultants at Semler Brossy. 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).

The drumbeat to add diversity, equity and inclusion (DEI) metrics to executive incentive design is growing louder. Some companies are already far along on their efforts, and incentive design may naturally extend their strategic priorities. Others are still learning, and the rush to add DEI incentives is at risk of being a “check the box” item that satisfies external audiences without meaning or impact internally. DEI incentive metrics do not unilaterally make sense for every company and are not the only lever companies can use to hold management teams accountable. How can a board member evaluate if DEI incentive metrics would be meaningful? As with any key initiative, the dialogue surrounding performance management can give clues as to what does or doesn’t make sense at a company.

Assessing the dialogue at the board level

You can tell a lot about how seriously a company takes an issue by how directors discuss it. DEI efforts are no exception. Before going straight to incentive pay, evaluate how board members assess performance management around DEI.

  • What information does the board receive on DEI? Is it primarily a report-out on key statistics, or does it go beyond the current state and include details on the company’s long-term strategy and goals?
  • Is the board aware of who leads the charge on the company’s DEI strategy? Can the board hear from those individuals and from diverse members of management?
  • Does the board have visibility on how key DEI statistics have progressed over time? Is the board aware of how progress compares to external and/or peer standards?
  • Are the definitions of success clear? Does the board know what the right goals should be? Is there sufficient room for board dialogue to test the rigor of goals?
  • Are the indicators of “something went wrong” clear to the board? For areas where the company misses the mark, is the board aware of the key drivers and needed course corrections?
  • Does the board discuss messaging and disclosure both internally and externally?

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The Activism Vulnerability Report Q3 2021

Posted by Jason Frankl and Brian Kushner, FTI Consulting, on
Monday, January 3, 2022
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Jason Frankl and Brian Kushner are Senior Managing Directors at FTI Consulting. This post is based on their FTI Consulting memorandum. 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).

Intro and Market Update

Despite the continued fluctuation of COVID-19 cases and emergence of variants, the world does seem to be returning to some semblance of normalcy. Vaccinations and testing have allowed for increased travel and a return to the office for many, including FTI’s New York City colleagues. In addition, consumer spending increased by ~0.4% from Q2 to Q3 and we witnessed strong market performance from early-July to the beginning of September. [1] In recent months, the U.S. equity markets reverted back to the winners of the initial COVID era with large-cap equities outperforming both mid- and small-cap equities and growth equities outperforming value equities. [2] [3] While year-over-year inflation reached a 30-year high of 6.2% in October and supply chain disruption worries shook investor confidence, the major indices remained resilient through the third quarter, though they have come under pressure following the emergence of the Omicron variant. [4] [5] Year-to-date through November 30th, the S&P 500 Index had returned 21.6%, while the Nasdaq Composite Index and the Dow Jones Industrial Average had returned 20.6% and 12.7%, respectively. [6]

Corporate profits have been a key catalyst for the continued strength of the equity markets; the S&P 500 Index reported the third highest year-over-year growth in earnings since Q2 2010 at 41.6%, far above the pre-pandemic Q3 2019 growth rate of -2.2%. [7] Small-cap equities, measured by the Russell 2000 Index, also demonstrated earnings strength with forward EPS forecasts reaching five-year highs. [8]

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Are All Risks Created Equal? Rethinking the Distinction between Legal and Business Risk in Corporate Law

Posted by Gideon Parchomovsky (Hebrew University of Jerusalem) and Adi Libson (Bar-Ilan University), on
Monday, January 3, 2022
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Gideon Parchomovsky is Wachtell, Lipton, Rosen & Katz Chair in Corporate Law at the Hebrew University of Jerusalem, and Adi Libson is a lecturer in the Law Faculty of Bar-Ilan University. This post is based on their recent paper.

Should corporate legal risk be treated similarly to corporate business risks? Currently, the law draws a clear-cut distinction between the two sources of risk, permitting the latter type of risk and banning the former. Business decisions, risky though they may be, fall under the duty of care and as long as they do not involve a conflict of interest, are judged under the deferential business judgment rule. Furthermore, companies can grant directors and officers exemptions from liability for negligent violations of the duty of care, as well as insure them against personal liability in such cases. Decisions that violate the law, by contrast, constitute a violation of the duty of loyalty (or an independent duty of good faith – Cede & Co. v. Techinicolor, Inc.), and hence, they are not entitled to the deferential standard of the business judgment rule. This distinction has been especially emphasized in the context of violations of oversight duty, willing to impose liability in case of the latter, but not in former (Chancellor Chandler in in re Citigroup; Pollman, 2019).

As a consequence of this distinction, corporate managements can take on high business risks, but must steer clear of decisions and policies that involve minimal legal risks, even when the potential rewards are very high. As a result, fiduciaries are shielded from personal liability in the case of business risk and are entirely exposed to civil and criminal liability that arises from legal risk taking. As corporate law theorists have underscored, the differential treatment of business and legal risk is highly problematic from the perspective of firms and shareholders (Bainbridge, 2008; Pollman, 2019). To begin with, legal risk cannot be completely averted or eliminated. More importantly, decisions involving negligible levels of legal risk might yield significant profits for firms. Thus, the outright ban on legal risk-taking harms shareholders, who would have favored a more nuanced regime to legal risk. From the shareholder point of view, there is no justification to differentiate between two similar patterns of risk, with up sides and down sides with the same magnitude and probabilities, based on the source of risk. Shareholders should be agnostic to the source of risk in of itself.

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