Monthly Archives: February 2022

Looking for the Economy-Wide Effects of Stock Market Short-Termism

Posted by Mark J. Roe (Harvard Law School), on
Wednesday, February 16, 2022
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Mark J. Roe is David Berg Professor of Business Law at Harvard Law School. This post is based on his recent paper. Related research from the Program on Corporate Governance includes The Myth that Insulating Boards Serves Long-Term Value by Lucian Bebchuk (discussed on the Forum here);  Don’t Let the Short-Termism Bogeyman Scare You by Lucian Bebchuk (discussed on the Forum here);  Will Loyalty Shares Do Much for Corporate Short-Termism? by Mark J. Roe and Federico Cenzi Venezze (discussed on the Forum here); Stock Market Short-Termism’s Impact by Mark J. Roe (discussed on the Forum here); and Corporate Short-Termism – In the Boardroom and in the Courtroom by Mark J. Roe (discussed on the Forum here).

To investigate the widespread claim that stock market short-termism is a major drag on U.S. corporate investment, R&D, and the broad economy, I review for this paper in the Journal of Applied Corporate Finance trends in corporate capital investment, stock buybacks, and R&D that stretch back, in some cases, over the past 50 years. (I also briefly summarize firm-level data—which I analyze more extensively elsewhere—and explain limits in extrapolating strong policy recommendations from firm-level data.)

As critics of market-driven corporate short-termism have pointed out, U.S. corporate investment in capital equipment and other tangible assets has been falling steadily since the late 1970s, and buybacks have been rising, while stock market short-termism is thought to punish corporate R&D spending. This relationship is suggestive of large public firms pushing out their cash and weakening their capacity to invest, while forgoing their future by weakening R&D work. If the story of economy-wide short-termist decline due to increasing stock market pressure for immediate results were valid and strong, we would expect to see the following: (1) investment spending in the United States declining faster than in Europe and Japan, where large companies depend less on stock markets for capital and where shareholder activists are less influential; (2) cash from large share buybacks inducing a bleeding out of cash from the U.S. corporate sector; and (3) economy-wide declines in corporate R&D spending.

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IPO Readiness

Posted by Brian Lane, Joe Mallin, and Tara Tays, Pay Governance LLC, on
Wednesday, February 16, 2022
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Brian Lane, Joe Mallin and Tara Tays are partners at Pay Governance LLC. This post is based on their Pay Governance memorandum.

Executive Summary

  • 2021 marked one of the most active years in the initial public offering (IPO) market in recent memory — both among traditional IPOs as well as special purpose acquisition companies (SPACs).
  • Compensation program planning is a critical part of the comprehensive and time-consuming process necessary to transition from private to public ownership.
  • There are several facets of the compensation program to consider through the transition, such as:
    • Establishing/Updating a Compensation Philosophy
    • Reviewing/Aligning Executive Pay Levels to Business Objectives and Competitive Practice
    • Developing a Long-term Incentive (LTI) / Equity Program Strategy
    • Reviewing/Establishing Severance and Change in Control Policies
  • Advance planning, incremental decisions, and careful analysis of external and internal factors in each of the above areas can help.

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BlackRock 2022 Letter to CEOs Highlights the Importance of Sustainability

Posted by Paul A. Davies, Michael D. Green, and James Bee, Latham & Watkins LLP, on
Wednesday, February 16, 2022
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Paul A. Davies is partner, Michael D. Green is counsel, and James Bee is an associate at Latham & Watkins LLP. This post is based on their Latham 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); 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).

On 17 January 2022, Larry Fink, the founder and chief executive of BlackRock, published his annual Letter to CEOs (the Letter), titled “The Power of Capitalism”. The Letter focuses on the importance of sustainability issues to companies from a financial perspective, and seeks to highlight the economic benefits of stakeholder capitalism.

Fink’s 2020 and 2021 Letters to CEOs also drew attention to sustainability issues, noting that climate change had “become a defining factor in companies’ long-term prospects”. Given BlackRock’s status as the world’s largest asset manager by assets under management, such public statements have been and will continue to be noted by leaders of public companies throughout the US and globally.

This post examines key focus areas of the Letter.

Capital’s Shift to Sustainability

Drawing on the growth of the sustainable finance markets, the Letter notes that sustainable investments globally have now reached over US$4 trillion, and the actions and ambitions of economic actors towards decarbonisation have increased markedly over the past two years. Fink said he expects this growth in sustainable economic activity to continue at pace, stating that “every company and every industry will be transformed by the transition to a net zero world. The question is, will [companies] lead, or will [they] follow?”

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The Purpose of a Finance Professor

Posted by Alex Edmans (London Business School), on
Tuesday, February 15, 2022
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Alex Edmans is Professor of Finance at London Business School. This post is based on his recent paper, forthcoming in Financial Management.

My paper, The Purpose of a Finance Professor (forthcoming in Financial Management), is a write-up of a keynote speech that I gave at the Financial Management Association 2021 Annual Meeting. I decided to give a keynote on an unusual topic because I believe that the academic finance profession has the potential to be uniquely purposeful due to four characteristics—the freedom to take risks and work on what we’re passionate about, the loyalty to our profession rather than just our institution, the collaborative nature of the creation and dissemination of knowledge, and the magnitude of our potential impact. However, what the profession currently values, and its current social norms, are significant barriers to the fulfilment of this potential. The goal of the talk, and the accompanying article, is to highlight the special features of our profession that we often take for granted and ignore, and propose ideas to make it not only more impactful and relevant, but also more collegial and fun.

There are many generic talks on how to have a purposeful career that aim to apply across all professions. I thus focus on the above four dimensions because they are special to the academic finance profession—although some may apply to other academic disciplines beyond finance, and a few even to non-academic professions.

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CEO Compensation Increase Trends

Posted by Aubrey Bout, Perla Cuevas, and Brian Wilby, Pay Governance LLC, on
Tuesday, February 15, 2022
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Aubrey Bout is managing partner and Perla Cuevas and Brian Wilby are consultants at Pay Governance LLC. This post is based on their Pay Governance memorandum. Related research from the Program on Corporate Governance includes The CEO Pay Slice by Lucian Bebchuk, Martijn Cremers and Urs Peyer (discussed on the Forum here); and Golden Parachutes and the Wealth of Shareholders by Lucian Bebchuk, Alma Cohen, and Charles C. Y. Wang (discussed on the Forum here).

Executive Summary

  • CEO median actual pay among S&P 500 companies remained flat in 2020.
  • Overall, actual CEO pay in 2021 will potentially increase in the low- to mid-single digits due to higher bonuses and larger LTI awards (at some companies) amid strong performance coupled with conservative bonus goals set during the pandemic.
  • In the past, CEO pay increases have been supported by historical total shareholder return (TSR); in fact, annualized pay increases have been 10% lower than TSR performance.
  • We expect median CEO target pay increases in early 2022 to be in the mid-single digits as the economy and companies continue to grow; in high-growth industries, CEO increases could be greater than 10% due to a highly competitive labor market.
  • Individual CEO pay increases will continue to be closely tied to overall company performance and peer group compensation increases; it is notable that S&P 500 TSR was +18% in 2020 and 29% in 2021, primarily driven by large-cap technology companies.
  • Performance share plan usage declined slightly with 92% of S&P 500 companies employing them—likely due to the difficulty of setting multi-year goals.
  • Stock options have continued their steady decline but are still prevalent at 47% of companies.

Introduction and Summary

CEO pay continues to be discussed extensively in the media, in the boardroom, and among investors and proxy advisors. Despite strong TSR in 2020, CEO pay remained flat due to the negative impact of the COVID-19 pandemic, particularly resulting from lower bonus payouts. CEO median total direct compensation (TDC; base salary + actual bonus paid + grant value of long-term incentives [LTI]) increased at a moderate pace in the first part of the last decade: in the 2% to 6% range for 2011-2016. CEO pay accelerated with an 11% increase in 2017—likely reflecting sustained robust financial and total shareholder return (TSR) performance—before returning to 3% in 2018 and 1% in 2019, more in line with historical rates. Our CEO pay analysis is focused on historical, actual TDC, which reflects actual bonuses based on actual performance; this is different from target TDC or target pay opportunity, which uses target bonus and is typically set at the beginning of the year.

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SEC Proposes Updates to Schedule 13D/G Reporting

Posted by Andrew Freedman, Olshan Frome Wolosky LLP, on
Tuesday, February 15, 2022
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Andrew Freedman is partner at Olshan Frome Wolosky LLP. This post is based on his Olshan memorandum. Related research from the Program on Corporate Governance includes The Law and Economics of Blockholder Disclosure by Lucian Bebchuk and Robert J. Jackson Jr. (discussed on the Forum here); and Pre-Disclosure Accumulations by Activist Investors: Evidence and Policy by Lucian Bebchuk, Alon Brav, Robert J. Jackson Jr., and Wei Jiang.

On February 10, 2022, the Securities and Exchange Commission (“SEC”) published for comment proposed rules that would revise the current deadlines for Schedule 13D and Schedule 13G filings; amend Rule 13d-3 to deem holders of certain cash-settled derivative securities as beneficial owners of the reference security; clarify the SEC’s views on 13D “group” formation; and set forth the circumstances under which two or more persons may communicate and consult with one another and engage with an issuer without concern that they will be subject to regulation as a group.

The salient features of the proposed rules for our activist clients appear to be the following:

The rules, as proposed, would

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The Rise of Bankruptcy Directors

Posted by Jared Ellias (University of California Hastings), Ehud Kamar (Tel Aviv University), and Kobi Kastiel (Tel Aviv University), on
Monday, February 14, 2022
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Jared Ellias is Professor of Law and Bion M. Gregory Chair in Business Law at the University of California Hastings Law School; Ehud Kamar is Professor of Law at Tel Aviv University Buchmann Faculty of Law; and Kobi Kastiel is Associate Professor of Law at Tel Aviv University, and Lecturer on Law at Harvard Law School. This post is based on their recent paper, forthcoming in the Southern California Law Review. 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).

Over the past decade, an important new player has emerged in corporate bankruptcies: bankruptcy experts who join boards of directors shortly before or after the filing of the bankruptcy petition and claim to be independent. The new directors—typically former bankruptcy lawyers, investment bankers, or distressed debt traders—either receive the board’s power or become loud voices in the boardroom shaping the company’s bankruptcy strategy, including investigating self-dealing claims against shareholders. We call them “bankruptcy directors.”

In a new paper forthcoming in the Southern California Law Review, we study this phenomenon using a hand-collected sample of all large firms that filed for Chapter 11 between 2004 and 2019 and disclosed the identity of their directors to the bankruptcy court. To our knowledge, it is the largest sample of boards of directors of Chapter 11 firms yet studied.

We find that the percentage of firms in Chapter 11 proceedings claiming to have an independent director increased from 3.7% in 2004 to 48.3% in 2019. Over 60% of the firms that appointed bankruptcy directors had a controlling shareholder and about half were under the control of private-equity funds.

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Human Capital Management and Diversity Disclosures and Practices

Posted by Benjamin Colton, Holly Fetter and Aneta McCoy, State Street Global Advisors, on
Monday, February 14, 2022
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Benjamin Colton is Global Head of Asset Stewardship, Holly Fetter is Assistant Vice President of Asset Stewardship, and Aneta McCoy is Officer of Asset Stewardship at State Street Global Advisors. This post is based on their SSgA memorandum.

Guidance on Human Capital Management Disclosures & Practices

Our Expectations For Human Capital Management Disclosures

Human capital management is an increasingly material dimension of ESG risk and opportunity. Research suggests that intangible assets including human capital comprise 90% of market value in the S&P 500, and that effective human capital management can drive performance. The global pandemic, a heightened emphasis on gender, racial, and ethnic equity, and an increasingly tight labor market have led to a greater focus on employee recruitment, retention, and inclusion.

In 2021, State Street Global Advisors’ Asset Stewardship team sought to strengthen our perspective on human capital management. We conducted over 185 engagements with investee companies on this topic in markets across the world, including a proactive engagement campaign targeting the largest employers in our portfolios. Our team also initiated conversations with experts on the topic of human capital management, and joined Human Capital Management Coalition calls as observers to enhance our understanding of this essential topic.

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SEC’s Shadow Trading Case Survives Motion to Dismiss

Posted by Robert A. Cohen, Joseph A. Hall and Leor Landa, Davis Polk & Wardwell LLP, on
Monday, February 14, 2022
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Robert A. Cohen, Joseph A. Hall and Leor Landa are partners at Davis Polk & Wardwell LLP. This post is based on their Davis Polk memorandum. Related research from the Program on Corporate Governance includes Insider Trading Via the Corporation by Jesse Fried (discussed on the Forum here).

A novel insider trading case for trading the stock of a company that the trader did not work for and that was not the target in the M&A transaction has drawn attention for its possible implications for public companies and trading firms.

Last week, a federal judge in California denied a motion to dismiss a novel SEC action alleging what has become known as “shadow insider trading”—trading in the securities of a company other than the company the defendant knew was the target of a confidential takeover bid. The case will now proceed to discovery and perhaps trial.

The defendant in this suit, Matthew Panuwat, was an executive at Medivation, a “mid-cap, oncology-focused biopharmaceutical company.” Panuwat had signed the company’s insider trading policy, which prohibited him from using nonpublic information to trade for his personal benefit “in the Company’s securities . . . or the securities of another publicly traded company, including all significant collaborators, customers, partners, suppliers, or competitors of the Company” (emphasis added).

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Delaware Supreme Court Affirms Termination of $5.8 Billion Transaction

Posted by Charlotte K. Newell and Andrew W. Stern, Sidley Austin LLP, on
Sunday, February 13, 2022
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Charlotte K. Newell and Andrew W. Stern are partners at Sidley Austin LLP. This post is based on their Sidley 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 Deals in the Time of Pandemic, by Guhan Subramanian and Caley Petrucci (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).

The Delaware Supreme Court recently affirmed Vice Chancellor Laster’s much talked of AB Stable post-trial decision, holding that the buyer of a $5.8 billion hotel portfolio could terminate the transaction due to, among other things, the seller’s breach of an ordinary course covenant by making operational changes in response to the COVID-19 pandemic. The Supreme Court’s affirmance provides critical guidance for the interpretation and navigation of such provisions, particularly in extraordinary times.

The at-issue merger agreement was signed in September 2019, and slated to close in April 2020. Shortly before the planned closing, and without obtaining the buyer’s consent, the seller made “drastic” changes at its 15 hotels in response to COVID-19. These included: (i) closing two hotels entirely, (ii) gutting operations at 13 others, (iii) terminating or furloughing staff, and (iv) cutting spending on marketing and capital expenditures. After the buyer refused to close, the seller sued, seeking specific performance to force a closing. The buyer responded with counterclaims contending, among other things, that it had no obligation to close due to the seller’s breach of the ordinary course covenant.

Vice Chancellor Laster sided with the buyer, holding that it had validly terminated the merger agreement because the ordinary course covenant had been breached and a condition (related to issuance of title insurance) had failed. The Supreme Court did not reach the title insurance issues (and the trial court’s related harsh criticism of the seller and its advisors), but affirmed the conclusion that the buyer was permitted to walk away on the basis of the ordinary course covenant breach, and provided several pieces of guidance for participants and advisors in M&A transactions. Among them:

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