Monthly Archives: August 2022

Identifying Corporate Governance Effects: The Case of Universal Demand Laws

Steven Davidoff Solomon is Professor of Law at the University of California at Berkeley School of Law; Byung Hyun Ahn is a Researcher at Dimensional Fund Advisors; and Panos N. Patatoukas is Associate Professor of Finance at the University of California at Berkeley Haas School of Business. This post is based on their recent paper.

Related research from the Program on Corporate Governance includes Why Firms Adopt Antitakeover Arrangements by Lucian A. Bebchuk.

Index constructs and identifiers are regularly utilized in empirical corporate governance research. They are popular. The use of legal changes as plausibly exogenous sources of variation in the economic determinants of corporate governance is also common. State antitakeover laws, particularly business combination laws, are often used as exogenous identifiers to assess corporate governance effects. Despite their popularity, there is a growing body of literature questioning the interpretation of tests that use legal changes for identification.

In Identifying Corporate Governance Effects: The Case of Universal Demand Laws recently posted to SSRN, we contribute to the debate by examining the adoption of Universal Demand (UD) laws, an increasingly popular proxy for exogenous variation in corporate governance mechanisms. UD laws were enacted by 23 states between 1989 and 2005 and require that shareholders make a demand on the board before suing for breach of fiduciary duty or other derivative actions. Because the board can refuse the demand or otherwise prosecute the case, or decline to prosecute, academics have theorized that UD laws decrease the ability of shareholders to litigate and effectively monitor the board. Since UD laws are exogenously imposed by the state, they have the potential to address the issue of endogeneity in the relation between corporate governance and litigation risk.

In a novel paper, Appel (2019) first deployed the enactment of UD laws as a plausibly exogenous source of variation in the use of entrenchment provisions commonly opposed by shareholders. Appel’s empirical investigation zeroes in on variation in the widely-used entrenchment index (E-Index), which captures the sum of provisions restricting shareholder voting power and antitakeover provisions (Bebchuk et al. 2009). The key finding is that the enactment of UD laws across adopting states is associated with a significant increase in the E-Index. Prior work interprets this finding as prima facie evidence of a causal link between shareholder litigation rights and corporate governance. A fast-growing stream of studies in corporate finance and accounting relies on the adoption of UD laws to identify cause-and-effect links between management entrenchment and various firm outcomes. The common thread across these studies is that UD laws had a direct effect on management entrenchment.


ESG Trends and Expectations

Marc S. GerberGreg Norman and Simon Toms are partners at Skadden, Arps, Slate, Meagher & Flom LLP. This post is based on a Skadden memorandum by Mr. Gerber, Mr. Norman, Mr. Toms, Adam M. HowardKathryn Gamble, and Patrick Tsitsaros.

Related research from the Program on Corporate Governance includes The Illusory Promise of Stakeholder Governance (discussed on the Forum here) and Will Corporations Deliver Value to All Stakeholders? (discussed on the Forum here), both by Lucian A. Bebchuk and Roberto Tallarita; Restoration: The Role Stakeholder Governance Must Play in Recreating a Fair and Sustainable American Economy—A Reply to Professor Rock (discussed on the Forum here) by Leo E. Strine, Jr.; Stakeholder Capitalism in the Time of COVID (discussed on the Forum here) by Lucian Bebchuk, Kobi Kastiel, and Roberto Tallarita; and Corporate Purpose and Corporate Competition (discussed on the Forum here) by Mark J. Roe.


Environmental, social and governance (ESG) considerations continued to play a key role in the first six months of 2022, with geopolitical circumstances resulting in a reexamination of a number of ESG beliefs. In our February 2022 post “ESG: 2021 Trends and Expectations for 2022,” we set out our predictions for 2022, some of which have come to fruition but a number of which have been sidelined by unforeseen events. In this post, we discuss the ESG matters that we predicted would be key themes this year, such as new legislation in the U.K., the U.S. and Europe, criticism of ESG data, executive remuneration, and the role of ESG in the tech/cyber space, and also those ESG matters we did not expect to see, ranging from the impact of the Ukraine invasion, increased regulatory scrutiny and some impactful U.S. Supreme Court decisions. We also highlight two key topics we believe will prove central to ESG discussions in the coming months: the green energy transition and the role of sustainability advice and consulting.

Unexpected Developments

Impact of Politics and the Invasion of Ukraine [1]

Russia’s invasion of Ukraine has significantly impacted ESG trends and performance in the first six months of the year. Some have viewed the effects as a setback for the ESG movement, as oil and gas prices soared and ESG-focused funds underperformed, while others believe this could be a turning point as nations are forced to consider green energy and shift reliance on oil and gas from Russia.


BlackRock Response to the Exposure Draft Climate-Related Disclosures Issued by ISSB

Joanna Cound is Managing Director, Sarah Matthews is Director and Michelle Edkins is Managing Director at BlackRock, Inc. This post is based on BlackRock’s response to the Exposure Draft ED/2022/S2 Climate-Related Disclosures issued by the International Sustainability Standards Board.

This post is based on BlackRock’s response to The Exposure Draft ED/2022/S2 Climate-related Disclosures issued by the International Sustainability Standards Board. Below is the text of the letter with minor adjustments to eliminate the correspondence-related parts.

BlackRock manages assets on behalf of institutional and individual clients worldwide, across equity, fixed income, liquidity, alternatives, and multi-asset strategies. Our clients, the asset owners, include pension plans, endowments, foundations, charities, official institutions, insurers and other financial institutions, as well as individuals around the world. Because our clients have diverse financial objectives, we consider a variety of investment factors, risks, and opportunities, including those related to climate.

Asset managers investing on behalf of clients are not just looking for more data on climate risk; they need high-quality information that is (1) relevant to understanding climate- related risks and opportunities, and (2) reliable, timely, and comparable across jurisdictions. Investors also recognize that climate data, controls and risk methodologies are still evolving. As a fiduciary to our clients, BlackRock has engaged with public companies on climate disclosure over the past five years. We have observed these companies continually developing and adapting their climate risk management and reporting tools, improving the quality of their disclosure over time.

BlackRock strongly supports the ISSB’s goal of providing a global baseline of standards to support the disclosure of more reliable, comparable, and consistent climate-related information. We view both the ISSB Exposure Draft ED/2022/S1 on sustainability-related financial information and ED/2022/S2 on climate-related disclosure as important contributions to a multi-year, multi-jurisdictional effort towards improving the availability, quality, comparability, timeliness, and interoperability of sustainability-related disclosures.


On Index Investing

Jeffrey Coles is the Samuel S. Stewart, Jr. Presidential Chair in Business, David Eccles Chair, and Professor of Finance; Davidson Heath is an Assistant Professor of Finance; and Matthew Ringgenberg is an Associate Professor of Finance, all at the University of Utah David Eccles School of Business. This post is based on their recent paper, forthcoming in the Journal of Financial Economics.

Related research from the Program on Corporate Governance includes The Agency Problems of Institutional Investors (discussed on the Forum here) by Lucian Bebchuk, Alma Cohen, and Scott Hirst; Index Funds and the Future of Corporate Governance: Theory, Evidence, and Policy (discussed on the forum here) and The Specter of the Giant Three (discussed on the Forum here), both by Lucian Bebchuk and Scott Hirst; and The Limits of Portfolio Primacy (discussed on the Forum here) by Roberto Tallarita.

The last two decades have seen a dramatic increase in the amount of capital invested in passive index funds. While these funds help investors earn benchmark index returns for relatively low fees, the increase in passive investing is not without controversy. Passive investors, by definition, hold portfolios that simply track an index. As a result, they do not do research—they free-ride on the research and analysis of active investors. This leads to a tension: Not everyone can index, some investors must be active for prices to incorporate information. The question is, does the rise of passive investing change information production in the economy? If so, how does passive investing affect informational efficiency, that is, the link between stock prices and fundamental value?

In our paper On Index Investing (Journal of Financial Economics, 2022), we examine these questions, both theoretically and empirically. We first develop a model that is a simple extension of the classic Grossman-Stiglitz (1980) model of information acquisition by investors. We then test the model’s predictions using Russell index reconstitutions as a shock to the mix of passive and active investors. Our findings suggest that passive investing does reduce information production, but perhaps surprisingly, it does not harm informational efficiency.

Existing theories disagree on the relation between investor composition and market efficiency. Some models predict that the rise of passive investing does alter price efficiency. For example, as passive funds replace active funds, there are fewer active funds doing research which could make prices less efficient.


PE Firms Poised for Diversity Drive

Kem Ihenacho is partner, Clare Scott is counsel, and Anne Mainwaring is an associate at Latham & Watkins LLP. This post is based on a Latham memorandum by Mr. Ihenacho, Ms. Scott, Ms. Mainwaring, Catherine Campbell, and Jennifer Cadet.

Related research from the Program on Corporate Governance includes Politics and Gender in the Executive Suite (discussed on the Forum here) by Alma Cohen, Moshe Hazan, and David Weiss; Will Nasdaq’s Diversity Rules Harm Investors? (discussed on the Forum here) by Jesse M. Fried; and Duty and Diversity (discussed on the Forum here) by Chris Brummer and Leo E. Strine, Jr.

Diversity has become a key focus for every industry in recent years, and private equity, like many other parts of the financial sector, still has significant progress to make in terms of diversity and inclusion. Private equity lags behind others in the financial services industry across a range of diversity metrics—according to a report published by EY in December 2021, just 10% of private equity roles are held by women.

Amid a drive to boost diversity across the industry, PE funds are becoming more diversity focused in Europe, as investors and regulators demand change and sponsors seek a competitive advantage through diversity strategies.

LP focus

LPs are placing greater emphasis on diversity at GP manager and portfolio company level, and are asking for more information on diversity, equity, and inclusion (DEI) metrics. According to Private Equity International’s LP Perspectives 2022 survey, one in five LPs refused to invest in a PE firm due to the lack of diversity at GP level.

As PE firms strive to make progress, diversity-focused funds are now coming to market with specific mandates to select investments based on diversity criteria. Diversity criteria may be considered at both GP and portfolio level, for example, by setting minimum requirements for diversity of key people or carry recipients, or diversity of “C-Suite Executives” in portfolio companies.

Regulatory focus

EU regulation is placing greater emphasis on DEI, demonstrating growing appetite for change. For example, the EU’s Sustainable Finance Disclosure Regulation (SFDR) regime (which depending on structure, GPs are likely to be subject to, if based in Europe or marketing into Europe) requires consideration of metrics on board gender diversity and unadjusted gender pay gap in certain circumstances, including where investments are intended to meet the definition of “sustainable investments” under SFDR.


What CEOs Must Consider When Wading Into Politics and Policy Discussions

Christine DiBartolo, Jackson Dunn, and Brent McGoldrick are Senior Managing Directors at FTI Consulting. This post is based on an FTI memorandum by Ms. DiBartolo, Mr. Dunn, Mr. McGoldrick, Elly DiLeonardi, Greg Mecher and Lindsay Kunkle.

Related research from the Program on Corporate Governance includes Corporate Political Speech: Who Decides? (discussed on the Forum here) by Lucian Bebchuk and Robert J. Jackson Jr.; The Untenable Case for Keeping Investors in the Dark (discussed on the Forum here) by Lucian Bebchuk, Robert J. Jackson Jr., James David Nelson, and Roberto Tallarita; and The Politics of CEOs (discussed on the Forum here) by Alma Cohen, Moshe Hazan, Roberto Tallarita, and David Weiss.

Increasingly, Americans are turning to the private sector for leadership as the boundaries between the political, social, and business arenas blur. Viewed in the best light, this is a search for value-based leadership. At worst, the forces of polarization have now crept into companies, which makes it particularly challenging for CEOs to determine how to engage on issues—particularly ones that can be seen as political—without creating new business risks.

In this post, we use our research of two of a company’s most important stakeholders—professionals and investors—to explore what CEOs must consider when wading into politics and policy discussions.

Demands on CEOs are being driven by the belief that businesses can influence the United States’ future

Investors and professionals see large businesses having real impact. In fact, they are perceived to have influence on the future of the country equal to—or even exceeding that of—federal, state and local government. This sentiment goes one step further in current times.

Investors and professionals look to businesses to partner with the government to help manage and overcome crises and major social change. CEOs are expected by stakeholders to take their responsibility to the country, not just their business, seriously.


Should Your Company Go Private?

Mandy Wright is senior editor of Directorship magazine. This post is based on an NACD BoardTalk publication.

Twenty-six public companies have gone private this year as of mid-May, totaling more than $121 billion in value. Compare that to 47 companies that did the same in all of 2021, the highest number of such deals in more than a decade, according to Dealogic.

Dry powder is partially fueling these transactions as private equity firms compete to buy the best companies at the best prices, pushing them to look at the public markets for inspiration. In an environment of volatile stock prices, now at lows not seen for almost a year and a half, public companies are looking like especially attractive—and cheaper—bets. On the flip side, public companies have found it less and less appealing to be public, with more stringent regulatory compliance and listing requirements. This also includes a responsibility to shareholders that, to some companies, inhibits research and development as well as risk-taking for the sake of innovation.

Going private is a growing a trend, and one that more boards might wish to evaluate. For public company boards helping their organizations consider going private, below are the three main steps.

Assess the Opportunity

With many workers back in the office and life returning to a semblance of normalcy—whether or not COVID-19 has actually made its retreat—this pandemic era presents transformational opportunities for companies and entire industries to rethink how they should do business going forward, taking into consideration all that has been learned about stakeholder wants, employee needs, and consumer habits during the pandemic.


Statement by Chair Gensler on PCAOB Amendments to Strengthen Auditing Standards for Audits Involving Multiple Firms

Gary Gensler is Chair of the U.S. Securities and Exchange Commission. This post is based on his recent public statement. The views expressed in this post are those of Chair Gensler, and do not necessarily reflect those of the Securities and Exchange Commission or the Staff.

Today, the Commission approved the Public Company Accounting Oversight Board’s (PCAOB) updated standards for audits that involve multiple auditing firms. I was pleased to support the amended standards because they will strengthen the requirements for lead auditors who supervise other auditors in an audit, helping to enhance audit quality and protect investors.

Over the years, the growing complexity and international operations of public companies has led auditors increasingly to rely on other auditors — working across different firms, countries, and even languages — in completing an audit. Last year, for example, 26 percent of all issuer audit engagements used multiple auditors, and more than half of large accelerated filer audits used multiple auditors.[1] Given the challenges that such multi-firm audits present, it is important that there be robust standards for how lead auditors supervise, communicate with, and coordinate with other auditors on the audit engagement.

The PCAOB’s updated standards make enhancements across two broad areas.[2] First, the amended standards specify certain procedures for lead auditors to perform when supervising other auditors. Second, they require lead auditors to prioritize their supervisory activities around higher-risk areas in the audit.

I thank the PCAOB for their work to update this auditing standard, the first adopted since the Board was newly constituted. I look forward to the additional standard-setting work the PCAOB will undertake to live up to its founding vision under the Sarbanes-Oxley Act. If Sarbanes-Oxley, signed into law 20 years ago, meets its full potential, trust in our markets can grow — and that benefits investors and issuers alike.


1See PCAOB Release No. 2022-002, available at back)

2See “PCAOB Adopts New Requirements for Lead Auditor’s Use of Other Auditors” (June 21, 2022), available at back)

Climate Disclosures: Not Quite as Easy as (Scope) 1-2-3

Lindsey Stewart is Director of Investment Stewardship Research at Morningstar, Inc. This post is based on a Morningstar memorandum by Mr. Stewart and Hortense Bioy. Related research from the Program on Corporate Governance includes The Illusory Promise of Stakeholder Governance (discussed on the Forum here) by Lucian A. Bebchuk and Roberto Tallarita; For Whom Corporate Leaders Bargain (discussed on the Forum here) and Stakeholder Capitalism in the Time of COVID (discussed on the Forum here), both by Lucian Bebchuk, Kobi Kastiel, and Roberto Tallarita; and Restoration: The Role Stakeholder Governance Must Play in Recreating a Fair and Sustainable American Economy—A Reply to Professor Rock (discussed on the Forum here) by Leo E. Strine, Jr.

Executive Summary

Public policy advocacy is an important part of an asset manager’s active ownership strategy. Asset managers recently had a key opportunity to influence U.S. climate policy as the SEC invited comments on its proposed rule for corporate disclosures of climate-related information. Climate-related risks have increasingly become important for many companies within various industries and, as such, disclosures in this area are financially material and a key aspect of investor decision-making—a point emphasized in Morningstar’s own response to the SEC. Asset managers that have committed to addressing the climate crisis should be keen to engage with regulators like the SEC in setting guidelines for corporate disclosures on climate change, and they largely have been.

In this post, we analyze the responses of the 10 largest U.S. asset managers, including Vanguard, BlackRock, Fidelity Investments, Capital Group, State Street Global Advisors, T. Rowe Price, Invesco, JPMorgan, Dimensional, and Franklin Templeton. As our research shows, almost all of these 10 managers have engaged directly with the SEC on the proposed rule. They are generally supportive of the SEC’s efforts to mandate consistent disclosure from companies on climate risks, but they also have significant concerns in several important areas.

Key Takeaways

  • Eight out of the top 10 U.S. asset managers have responded to the SEC’s March 2022 call for comment on its proposed rule. The two exceptions are Invesco and JPMorgan.
  • Seven of the eight respondents favor mandatory climate change disclosures by all public companies. One manager, Dimensional, supports the disclosures only for public companies exposed to material climate risk.
  • All eight respondents agree on the need for mandatory disclosures of direct greenhouse gas emissions (Scope 1) and indirect greenhouse gas emissions from purchased electricity (Scope 2), where these are material.
  • Only one manager, Capital Group, favors mandatory disclosures of other indirect greenhouse gas emissions (Scope 3) at this time. The others are opposed to making such disclosures mandatory, citing a lack of maturity in measurement methods and an absence of materiality for many companies.
  • Most respondents’ support for the proposals is contingent on how materiality is defined. This is a key area of concern for most managers, who believe the SEC should clarify the definition in the proposals.
  • All respondents believe the SEC’s actions on climate disclosure should align with internationally accepted standards, particularly the Taskforce for Climate-Related Disclosures, and the emerging International Sustainability Standards Board.


CSOs Have More Impact When Aligned To The CEO

Kurt Harrison and Sarah Galloway are co-head of the Global Sustainability Practice, and Emily Meneer is a Global Knowledge Leader at Russell Reynolds Associates. This post is based on their Russell Reynolds memorandum.

Businesses are more likely to hit organizational ESG targets when their sustainability leader reports directly to a CEO with a demonstrated commitment to sustainability.

Many organizations find it challenging to know where to start when adding a new Chief Sustainability Officer (CSO) role. Our recommendation is to provide them with a direct line to the CEO.

Russell Reynolds Associates’ (RRA) 2022 survey of more than 50 global sustainability leaders found that when CSOs report directly to the CEO, they are more likely to say their company is on track to hit organizational ESG targets than those who report to other business leaders.

In fact, the survey showed reporting structure is the primary differentiator of an organization’s likelihood to meet their ESG targets. Other factors, such as P&L ownership, company tenure, or past sustainability experience are far less indicative of sustainability performance.

CSOs who report to CEOs are 50% more likely to say their company is on track to meet their ESG targets than those at organizations with other reporting structures.

The rise of the “Empowered CSO”

Our analysis shows that just 34% of CSOs report to the CEO today. The vast majority report to other C-level executives or management below.


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