Yearly Archives: 2022

E&S Shareholder Proposals

Posted by Will Collins-Dean and Kristin Drake, Dimensional Fund Advisors, on
Thursday, June 16, 2022
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Will Collins-Dean is Vice President, Senior Portfolio Manager, and Chairman of the Investment Stewardship Committee, and Kristin Drake is Vice President, Head of Investment Stewardship, and Member of the Investment Stewardship Committee at Dimensional Fund Advisors. This post is based on their Dimensional Fund Advisors memorandum.

A manager’s voting record on environmental and social (E&S) shareholder proposals is sometimes equated with a manager’s overall commitment to environmental, social, and governance (ESG) issues. But such an assessment does not consider a manager’s broader stewardship activities and the effectiveness of shareholder proposals at improving portfolio company governance. Dimensional’s [1] stewardship approach includes engagement, [2] proxy voting, and other advocacy efforts and is focused on maximizing shareholder value on behalf of our clients. Through these efforts, we consider how portfolio companies’ E&S policies and practices may impact company performance and valuations.

Landscape and Limitations of Shareholder Proposals for US Companies

Shareholder proposals are proposals submitted by a shareholder or group of shareholders requesting the company take a specific action, such as publishing a report or disclosing a policy on a given issue. Public companies in the US must submit a proposal that they receive from an eligible shareholder to a shareholder vote at a meeting of the company’s shareholders, subject to certain exceptions. While these proposals can be used for a variety of recommendations and requests, shareholder proposals are often put forward by shareholders with a specific issue-oriented agenda. E&S shareholder proposals, while increasing, continue to represent a very small percentage of overall votes, typically less than 1% of all voting matters at US public companies. [3] Institutional Shareholder Services (ISS) noted that the majority (507 or 60%) of the total shareholder proposals filed at US companies were E&S-related. However, after omissions and withdrawals, only 182 of these proposals went to a vote. [4]

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Policy Insights on Executive Compensation

Posted by John Galloway, Vanguard, Inc., on
Wednesday, June 15, 2022
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John Galloway is Global Head of Investment Stewardship at Vanguard, Inc. This post is based on a publication by Vanguard Investment Stewardship. Related research from the Program on Corporate Governance includes The Perils and Questionable Promise of ESG-Based Compensation by Lucian A. Bebchuk and Roberto Tallarita (discussed on the Forum here); and Paying for Long-Term Performance by Lucian Bebchuk and Jesse Fried (discussed on the Forum here).

Executive summary

  • On behalf of the Vanguard funds, we advocate for well-structured executive compensation plans that drive relative pay and performance alignment, are fair to long-term shareholders, and are flexible through uncertain times.
  • We look for compensation programs that drive sustainable value for a company’s investors in a way that links pay with performance relative to peers. To do so, compensation plans must be rigorously designed with thoroughly disclosed rationale.
  • Vanguard does not expect nonfinancial metrics (such as ESG metrics) to be a standard component of all compensation plans. When compensation committees choose to include nonfinancial metrics, we look for the same qualities we do with more traditional metrics, such as rigor, disclosure, and alignment with key strategic goals and/or material risks.

Our compensation philosophy endures

Executive compensation is one of the fundamental principles of Vanguard’s Investment Stewardship program. We believe that well-structured, transparent, performance-linked executive compensation policies and practices are fundamental drivers of sustainable, long-term value. We encourage portfolio companies to adopt pay plans that incentivize outperformance versus industry peers over the long term, aligning executive compensation outcomes with shareholder outcomes.

This post highlights our main compensation principles and key parts of our executive compensation analysis process, and we discuss the rise of nonfinancial metrics—often referred to as environmental, social, and governance (ESG) metrics—in executive compensation plans to share our perspectives on best practices.

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Do Equity Markets Care About Income Inequality? Evidence from Pay Ratio Disclosure

Posted by Stephan Siegel (University of Washington), on
Wednesday, June 15, 2022
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Stephan Siegel is Professor of Finance and Business Economics at the University of Washington. This post is based on a recent paper, forthcoming in the Journal of Finance, by Professor Siegel; Yihui Pan, Associate Professor of Finance at the University of Utah; Elena S. Pikulina, Assistant Professor of Finance at the University of British Columbia Sauder School of Business; and Tracy Wang, John Spooner Professor of Finance at the University of Minnesota Carlson School of Management.

Stagnant middle-class wages but rapidly-increasing incomes by high earners have led to a growing debate about income inequality in the U.S. However, it is largely unknown how U.S. financial markets and shareholders assess the dispersion in pay between a firm’s top executives and rank-and-file employees. Understanding equity markets’ assessment of income inequality is important because equity markets allocate capital and send valuation signals to firms, informing and possibly shaping corporate policies that contribute to or mitigate income inequality. In this paper, we address this question by exploiting a new rule that required U.S. publicly traded companies to report the ratio between CEO pay and median worker pay for the first time in 2018.

Experimental and survey evidence suggests that many individuals are averse to pronounced income inequality. Aversion to inequality could be self-centered or reflect concerns about future economic growth or stability in broader society. For some individuals, high income inequality could violate their views about a fair allocation of resources. Whether such attitudes are important among financial market participants is an open question, especially as wealthy Americans, who are more likely to be equity investors, have been found to be more accepting of inequality than the rest of the population (Cohn et al. (2019)).

The average pay ratio across the approximately 2,300 U.S. firms that reported their pay ratios for the first time in 2018 is 145, while the median is 65. We find that firms reporting a higher pay ratio experience a significantly lower market reactions than firms reporting a lower pay ratio. Specifically, a one-standard-deviation increase in pay ratio decreases a firm’s seven-day cumulative abnormal return by about 42 basis points (bps). The negative market reaction persists at least several months after the initial pay ratio disclosure. It is also robust to controlling for contemporaneously disclosed CEO or worker pay, suggesting that financial markets react to within-firm pay disparity independently of pay levels. The U.S. market reaction to high pay ratios therefore seems to be at odds with earlier findings from the UK that higher pay inequality is primarily a reflection of better managerial talent (Mueller, Ouimet, and Simintzi (2017)).

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The SEC and Messaging Apps

Posted by William J. Stellmach, Elizabeth P. Gray and Sean Sandoloski, Willkie Farr & Gallagher LLP, on
Wednesday, June 15, 2022
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William J. Stellmach and Elizabeth P. Gray are partners and Sean Sandoloski is counsel at Willkie Farr & Gallagher LLP. This post is based on a Willkie memorandum by Mr. Stellmach, Ms. Gray, Mr. Sandoloski, Amelia A. Cottrell, Randall Jackson and Michael S. Schachter.

The government’s ongoing effort to crack down on the use of ephemeral messaging platforms at financial institutions appears to have entered a new phase. According to press reports, the Securities and Exchange Commission (the “Commission” or the “SEC”) is requiring Wall Street banks to undertake an unprecedented review of dozens of their top executives’ and traders’ personal cell phones to determine the frequency with which these platforms are used to conduct bank business.

Apps like WhatsApp, Signal, and Telegram allow users to send messages using end-to-end encryption, which prohibits third parties from accessing data, allowing it to be read by no one other than the sender and recipient. Users can also send ephemeral or “self-destructing” messages that are deleted automatically after they are viewed or some set amount of time after they are sent.

These apps are very popular and in wide use, but their use to conduct securities trading-related business violates laws and regulations that require banks and broker-dealers to maintain and preserve communications—not to mention banks’ own policies. These rules enable the review of records by the Commission and other regulators (such as the Commodity Futures Trading Commission (the “CFTC”)), in the course of their examination and enforcement duties. Indeed, the Commission views these rules as “an integral part of the investor protection function of the Commission, and other securities regulators” because these “records are the primary means of monitoring compliance with applicable securities laws, including antifraud provisions and financial responsibility standards.” [1] This isn’t empty rhetoric. Informal messages have formed the backbone of many high-profile corporate enforcement actions over the years. [2] If communications are migrating to platforms where those messages are neither surveilled nor retained, it becomes materially more challenging for the government to bring all manner of cases.

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Socially Responsible Divestment

Posted by Alex Edmans (London Business School), Doron Levit (University of Washington), and Jan Schneemeier (Indiana University), on
Tuesday, June 14, 2022
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Alex Edmans is Professor of Finance at London Business School, Doron Levit is Associate Professor of Finance and Business Economics at the University of Washington, and Jan Schneemeier is an Assistant Professor of Finance at Indiana University. This post is based on their 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); 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); and Exit vs. Voice by Eleonora Broccardo, Oliver Hart and Luigi Zingales (discussed on the Forum here).

Responsible investing is becoming increasingly mainstream. In 2006, the United Nations established the Principles for Responsible Investment (“UN PRI”), a commitment to invest responsibly, which was signed by 63 investors managing a total of $6.5 trillion. By the end of 2021, this had grown to 4,375 investors, representing $121 trillion.

Blanket exclusion of “brown” industries, such as tobacco, gambling, and fossil fuels, is often seen as the purest and most effective form of responsible investing. Divesting starves them of capital, the argument goes, preventing them from creating further harm. Accordingly, practitioners and the public hold investors accountable for their holdings of brown firms. In 2020, Extinction Rebellion protesters dug up a lawn outside Trinity College, Cambridge to protest at its investment in fossil fuel companies, and many asset owners evaluate asset managers according to whether they manage a “net zero” portfolio. Beyond climate, Morningstar’s “globe” ratings of funds are based on the Sustainalytics ESG ratings of the stocks they hold and are thus boosted by divesting from brown stocks. Those with low ratings are often accused of greenwashing.

However, this argument considers only one channel through which divestment can affect a company’s real actions—the primary markets channel, whereby divestment affects the terms at which a company raises new capital. As the survey of Bond, Edmans, and Goldstein (2012) points out, stock market trading—and thus divestment strategies—can also have real effects through a secondary markets channel. Specifically, trading leads to the stock price reflecting a manager’s real actions, thus rewarding or punishing him for taking them. Even if a firm is in an irremediably brown sector, which unavoidably produces negative externalities, the manager may be able to take corrective actions to mitigate these externalities. Blanket exclusion fails to reward such actions because the firm is divested no matter what. Thus, it may be optimal for a responsible investor to pursue a “tilting” strategy, where she tilts away from a brown industry but is willing to hold firms that are best-in-class, i.e. take corrective actions.

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Diversity, Experience, and Effectiveness in Board Composition

Posted by Merel Spierings, The Conference Board, Inc., on
Tuesday, June 14, 2022
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Merel Spierings is a Researcher at The Conference Board ESG Center. This post is based on her recent publication, which was released by The Conference Board and ESG analytics firm ESGAUGE, in collaboration with Debevoise & Plimpton, the KPMG Board Leadership Center, Russell Reynolds Associates, and The John L. Weinberg Center for Corporate Governance at the University of Delaware.

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); Will Nasdaq’s Diversity Rules Harm Investors? by Jesse M. Fried (discussed on the Forum here); and Duty and Diversity by Chris Brummer and Leo E. Strine, Jr. (discussed on the Forum here).

Investor and regulator focus on board composition and practices has evolved significantly over the past 20 years. In the wake of the Enron and WorldCom collapses, these stakeholders initially focused on strengthening board independence and oversight. [1] After the financial crisis of 2008, that gave way to a greater focus on whether boards have the right mix of skills and experience to guide business strategy—as well as mechanisms for shareholders to hold boards accountable for business performance. [2] More recently, the focus on board diversity has not only accelerated, but also expanded to the broader question of how boards are overseeing environmental, social, and governance (ESG) matters. For example, in early 2022, investors raised the bar for board diversity, [3] and the US Securities and Exchange Commission (SEC) proposed rules seeking greater disclosure of the board’s role in climate change and cybersecurity, with rules on human capital management to come.

These trends have significant implications for board composition, size, and education. Companies need boards with directors who have a diversity of backgrounds, as well as the skills and experience to oversee the expanding list of priorities. They also need boards of sufficient size to accommodate these individuals, as well as to populate the (new) board committees that address ESG topics. And they need to have more robust onboarding programs for these new directors, as well as ongoing board education programs to ensure the entire board is not relying on the expertise of a few directors but is fluent in the growing list of issues that boards are expected to oversee.

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California Bill Would Prohibit Settlement Agreements Keeping Certain Information Secret

Posted by Jason Russell, Hillary Hamilton, and Candace Ross Phoenix, Skadden, Arps, Slate, Meagher & Flom LLP, on
Tuesday, June 14, 2022
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Jason Russell is Partner and Hillary Hamilton and Candace Ross Phoenix are Associates at Skadden, Arps, Slate, Meagher & Flom LLP.  This post is based on their Skadden memorandum.

The California Senate will soon consider a bill prohibiting settlement agreements that prevent disclosing information about defective products or environmental hazards.

The Public Right To Know Act of 2022, SB 1149, would impact actions involving a “defective product or environmental hazard that poses a danger to public health or safety.” The bill would, if passed, prohibit both settlement agreements that restrict the disclosure of factual information and court orders that do not allow public disclosure of the covered information.

The bill allows any person, including a news media representative, “for whom it is reasonably foreseeable that the person will be substantially affected by a” violation of the act to challenge such a provision, agreement or order by filing a motion in the action or bringing a separate action for declaratory relief.

The act does not apply to certain categories of information: (1) medical or personal identifying information regarding an injured person; (2) the settlement amount; (3) a current customer list or trade secret if a party moves for an order of nondisclosure in good faith and demonstrates that the presumption is “clearly outweighed by a specific and substantial overriding confidentiality interest”; and (4) the citizenship or immigration status of any individual.

Under the bill, an attorney’s failure to comply could be grounds for professional discipline and a potential investigation by the State Bar of California. Violations under the act include: (1) requesting a settlement provision preventing disclosure of factual information; (2) advising a client to sign an agreement including such a provision; and (3) moving for an order of nondisclosure without good faith.

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Boards Are Tying Goals to ESG Metrics

Posted by Molly Stutzman, Laura Thornton, and Matthew Nestler, JUST Capital, on
Monday, June 13, 2022
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Molly Stutzman is Analyst of Corporate Research, Laura Thornton is Junior Analyst, and Matthew Nestler is Senior Manager of Workplace Policies Research at JUST Capital. This post is based on their JUST Capital memorandum. Related research from the Program on Corporate Governance includes The Perils and Questionable Promise of ESG-Based Compensation by Lucian A. Bebchuk and Roberto Tallarita (discussed on the Forum here); and Paying for Long-Term Performance by Lucian A. Bebchuk and Jesse Fried (discussed on the Forum here).

Key Findings

Customers, employees, shareholders, and other stakeholders, are increasingly expecting companies to tackle environmental, social, and governance (ESG) issues. That includes the American public. In our 2021 survey of the People’s Priorities, “The board of directors holds executives accountable to the interests of its workers, customers, communities, and the environment, as well as shareholders,” emerged as the third-most important Issue to the public, representing over 10% of our Rankings model.

And, as pressure has increased, so have corporate disclosures showing board oversight of ESG efforts. Our analysis of three data points on board oversight of ESG issues, covered under the Shareholders and Governance stakeholder, has led to two key findings. First, disclosure on these data points is steadily increasing. Almost a fifth of companies in the Russell 1000 Index report all three ESG governance data points we measure in 2022—up from around a tenth in 2020. Second, the Oil & Gas, Utilities, Energy Equipment & Services, and Chemicals industries have a much larger percentage of companies disclosing on all three ESG governance data points than other industries.

Board Oversight of ESG from 2020-2022: Unpacking the Rise in Disclosure

As proxy season kicked off last month, Mastercard made headlines with a decision to link ESG goals with bonus calculations for employees at all levels. The company had previously tied these metrics to compensation for senior-level executives, incentivizing leaders to be accountable to all their stakeholders and not merely shareholders. And while this remains a growing trend as median CEO pay sees another record-setting year, this latest move marks a deeper degree of incorporating ESG into how the company operates. Mastercard’s shift also comes as corporate America faces challenges from investors over policies and practices related to climate change, racial equity, political contributions, and other ESG issues.

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Holding Foreign Insiders Accountable

Posted by Robert Jackson (NYU), Daniel J. Taylor (The Wharton School), and Bradford Lynch (The Wharton School), on
Monday, June 13, 2022
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Robert J. Jackson, Jr. is the Pierrepont Family Professor of Law, Co-Director of the Institute for Corporate Governance and Finance at NYU School of Law, and a former Commissioner at the U.S. Securities and Exchange Commission; Daniel Taylor is Associate Professor of Accounting at the Wharton School of the University of Pennsylvania; and Bradford Lynch is a PhD student at The Wharton School of the University of Pennsylvania. This post is based on their recent paper.

Related research from the Program on Corporate Governance includes Insider Trading Via the Corporation by Jesse Fried (discussed on the Forum here); and China and the Rise of Law-Proof Insiders by Jesse M. Fried and Ehud Kamar (discussed on the Forum here).

1. Introduction

In October 2020, Ant Group, an affiliate of the Nasdaq-listed Chinese firm Alibaba, was preparing for its initial public offering (IPO). But on October 24, Alibaba CEO Jack Ma publicly criticized Chinese regulators and Communist Party officials (Zhai et al., 2020). Chinese leaders responded forcefully, and on November 3 the Ant IPO was suddenly suspended, leading Alibaba shares to fall more than 8% (Yang & Ng, 2020). Unbeknownst to most investors, however, the day before that announcement Skyscraper Limited, an entity controlled by Alibaba insiders, sold more than $150 million in Alibaba shares, avoiding millions in losses (McMorrow et al., 2021). Disclosure of that transaction was provided not in the widely-watched form that U.S. insiders must provide (Jackson, 2012) but rather on a little-known paper filing stored in file cabinets in the SEC’s reference room known as Form 144 (see e.g., Figure 1).

Figure 1. Form 144 Paper Filing by Foreign Insiders.

Below is an image of a paper filing on Form 144 associated with the sale by Sky Scraper Enterprises of over $155 million worth of shares in Alibaba, a foreign firm with American Depository Shares traded on Nasdaq. There is no corresponding Form 4. The day after this filing, shares of Alibaba fell more than 8%.

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What Boards Should Know About Digital Assets

Posted by Tim Davis, Robert Massey, and Carey Oven, Deloitte LLP, on
Monday, June 13, 2022
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Tim Davis is a Principal, Robert Massey is a Partner, and Carey Oven is a National Managing Partner at Deloitte LLP.  This post is based on their Deloitte memorandum.

The proliferation of digital assets has accelerated rapidly, generating a level of market interest sufficient to influence strategy at many major financial institutions and other corporations. Digital assets are disrupting the entire financial market, driving changes in the financial ecosystem. Blockchain, the underlying distributed ledger technology (DLT) for managing digital assets, is also gaining considerable traction, providing companies with the ability to transform some aspects of how they do business.

Digital assets—including cryptocurrencies, stablecoins, tokens, and non-fungible tokens (NFTs)—are items of value that exist only in digital form. Using cryptographic technology, digital assets are secured, exchanged, and verified in decentralized digital ledgers.

Cryptocurrencies roughly quadrupled in value from the end of 2020 to late 2021, when the market was worth more than $3 trillion. [1] In early April 2022, market capitalization for the thousands of cryptocurrencies tracked by CoinGecko was valued at $2.26 trillion. [2] Thousands of major companies have begun accepting cryptocurrencies as payments and are using crypto for a variety of investment, operational, and transactional purposes.

According to Deloitte’s 2021 Global Blockchain Survey, leaders at financial services institutions globally regard digital assets and blockchain technologies as a strategic priority. Nearly 80% of survey respondents said digital assets will be very or somewhat important to their respective industries in the coming two years. [3] More than three-quarters of respondents (76%) said they believe digital assets will serve as a strong alternative to or replacement for fiat currencies in the next five to 10 years. [4]

Explosive growth in digital assets prompted President Biden to sign an executive order on March 9, 2022, to establish a national policy for digital assets, focused on priorities such as consumer and investor protection, financial stability, financial inclusion, responsible innovation, illicit finance, and US leadership in the global financial system. According to the White House, the significant rise in popularity of digital assets creates an important opportunity for the United States to play a leading role in global governance consistent with the values of democracy and US global competitiveness. [5] In addition, more than 100 countries, including the United States, are exploring or piloting central bank digital currencies, which are digital forms of a country’s sovereign currency. [6]

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