Monthly Archives: May 2023

Seven Gaping Holes in Our Knowledge of Corporate Governance

Brian Tayan is a researcher with the Corporate Governance Research Initiative and David F. Larcker is the James Irvin Miller Professor of Accounting, Emeritus, at Stanford Graduate School of Business. This post is based on their recent piece. Related research from the Program on Corporate Governance includes What Matters in Corporate Governance? (discussed on the Forum here) by Lucian Bebchuk, Alma Cohen and Allen Ferrell.

We recently published a paper on SSRN (“Seven Gaping Holes in our Knowledge of Corporate Governance”) that reexamines foundational assumptions within corporate governance.

Nine decades after Berle and Means proposed a theory of corporate governance, our knowledge of its “best practices” remains woefully incomplete. Corporate governance is a social science, which means that while the factors that determine its effectiveness are complex, they are at their core subject to theory, measurement, and analysis. From the conversation today, however, one would hardly recognize this fact. Instead, the dialogue about corporate governance is dominated by rhetoric, assertions, and opinions that—while strongly held—are not necessarily supported by either applicable theory or empirical evidence. Having to choose between the results of the scientific record and their gut, many “experts” prefer their gut.

While some of the blame for this state of affairs lies with these experts, the academic and institutional research literature itself is not above reproach. Although many aspects of governance have been the subject of empirical study, our knowledge of its central characteristics is incomplete. Organizations are complex entities, and the ability of social scientists to distill their effectiveness to prescriptive best practices is limited. Many studies involve large samples of data. Large samples enable a researcher to identify patterns across many companies, but generally do not tell us how corporate governance choices would impact a specific company. Case studies or field studies can help answer firm-specific questions, but the results tend to be highly contextual and difficult to generalize. Most observational social science studies suffer from the challenges of measuring variables and demonstrating causality based on data. Empirical tests can identify associations and correlations between variables, but it is exceedingly difficult to prove that a variable caused an outcome. And in the case of corporate governance, many important variables are not publicly observable to outside researchers—forcing them to develop proxies to estimate the variable they want to measure. It is extremely difficult to produce high-quality, fundamental insights into corporate governance because of these limitations.


The Activism Vulnerability Report – Q4 2022

Jason Frankl and Brian G. 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 A. Bebchuk, Alon Brav, and Wei Jiang (discussed on the Forum here); Dancing with Activists by Lucian A. 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).

Introduction and Market Update

With proxy season underway, FTI Consulting’s Activism and M&A Solutions team welcomes readers to our quarterly Activism Vulnerability Report, which highlights the findings of our Activism Vulnerability Screener for 4Q22 and discusses other notable themes and trends in the world of shareholder activism.

The U.S. stock market in 2022 experienced increased volatility relative to 2021. Persistently high inflation, coupled with the fastest Fed tightening cycle seen since 1988, contributed to making 2022 the worst performing year for the S&P 500 Index since 2008, thrashing growth and technology stocks in particular. [1] Geopolitical concerns added to poor investor sentiment approaching the new year.[2]  However, as 2023 began, stocks and bonds each rallied in January, partly due to reported fourth quarter growth in real GDP for the United States, even while various economic factors were flashing warnings signs.[3]  However, these gains quickly eroded in February, as economic data on the labor market and consumer spending remained stronger than expected, prompting investors to reassess their expectations for inflation and further monetary policy. [4] Silicon Valley Bank’s (“SVB”) recent collapse, along with troubles at several other prominent banks, has called into question the frequency of further interest rate increases, amid concerns of contagion spreading through the wider global banking industry. [5] Though the Fed subsequently announced a quarter-percentage-point interest-rate increase following the turmoil, officials signaled that rate hikes are nearing an end in their post-meeting policy statement.[6]


The New Unocal

Robert B. Thompson is the Peter P. Weidenbruch, Jr. Professor of Business Law at Georgetown University Law Center. This post is based on his recent paper 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 The Case against Board Veto in Corporate Takeovers by Lucian Bebchuk; and Toward a Constitutional Review of the Poison Pill (discussed on the Forum here) by Lucian Bebchuk, and Robert J. Jackson Jr.

American corporate law has remained remarkably stable for decades. The stakeholder movement of recent years has unleashed extensive discussions about ESG, corporate purpose, diversity, and benefit corporations. Yet change in actual legal rules has been slow to appear. Against that backdrop, the decisions by the Delaware courts in the Williams Companies Stockholder Litigation suggest a significant adaptation. (In re the Williams Cos. S’holder Litig., 2021 WL 754593, (Del. Ch. Feb. 26, 2021) aff’d The Williams Companies, Inc. v. Wolosky, (Del. Nov. 3, 2021)). The Williams decisions reinterpret parts of Unocal Corp. Inc. v. Mesa Petroleum Co., a key case in the current corporate law paradigm. In doing so, they shifted Delaware law as to several key Unocal elements as developed over the last four decades in ways that increase the likelihood of some director governance decisions, such as a poison pill, failing judicial review. The ideological underpinning for this change is not, however, the reasoning of the stakeholder movement, which likewise has sought to alter the exercise of director power. Rather, this shift reflects Delaware’s embrace of technological innovations and market changes, particularly those reshaping the role of shareholders.

This article makes three contributions to understanding this evolution. First, it resets the frame for viewing the current Delaware governance paradigm that arose in response to the tight spot in which corporate management found themselves in the 1980s as hostile takeovers accelerated. Unocal (and two other Delaware decisions shortly thereafter—Revlon and Blasius) are at the core of what was a fundamental change. In those decisions Delaware judges expressed dissatisfaction with the capacity of their traditional frame for judicial review to adequately deal with director decisions in takeovers: “Our corporate law is not static. It must grow and develop in response to, indeed in anticipation of, evolving concepts and needs” the Court said as it inserted a third, enhanced, level of scrutiny between the two existing standards of business judgement deference and entire fairness. The focus in each of these new cases was on giving room for shareholders to check the extensive power that corporate law traditionally has provided to directors. Blasius explicitly sets out the ideological foundation for this change—the shareholder franchise is “critical to the theory that legitimates the exercise of power by some (directors and officers) over vast aggregations of property that they do not own.”


What to Watch for this Proxy Season: Say on Climate

Courteney Keatinge is Senior Director of Environmental, Social & Governance Research at Glass, Lewis & Co. This post is based on her Glass Lewis memorandum. 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 TallaritaDoes Enlightened Shareholder Value add Value (discussed on the Forum here) and Stakeholder Capitalism in the Time of COVID (discussed on the Forum here) both by Lucian Bebchuk, Kobi Kastiel, 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.

For the last two years, a growing number of companies have held votes asking investors to approve their climate transition strategies. Often referred to as Say on Climate, the trend has taken very different paths across different global markets. That said, investor scrutiny of Say on Climate appears to be increasing globally, both in terms of willingness to support what is proposed, and the overall level of interest in the proposals.

United States

The most stark example of investor skepticism is in the United States. While shareholders of U.S. companies were among the first to propose a Say on Climate vote via the shareholder resolution process in 2021, none of these proposals were approved, with support ranging from 7% to 39%. That skepticism appears to have turned to indifference, as there were no shareholder proposals on this topic at U.S. companies in 2022. It is likely that the momentum around this issue has essentially ceased for the time being at North American companies.

Some U.S. institutional investors, including some with extensive track records of climate-related stewardship, were cautious from the start. When Say on Climate first appeared, Vanguard stated that it would review each proposal independently, while State Street said that companies with strong environmental track records should not have their carbon emissions plans put to a shareholder vote. State Street also expressed concerns that, if these plans become routine, investors may become passive and approve practices of substandard companies. Many pension giants were concerned that the votes would limit board accountability for companies’ climate strategies.


Accounting for Bank Failure

Prasad Krishnamurthy is a Professor of Law at the U.C. Berkeley School of Law.

Could better accounting rules have saved Silicon Valley Bank (SVB)? The answer is a resounding maybe.

On the one hand, fair-value accounting for securities would have caused SVB to recognize its losses earlier and, perhaps, to have avoided those losses in the first place. On the other hand, greater accounting transparency can unnecessarily cause bank depositors to panic at the first sign of trouble, threatening the stability of the banking system.

Because of these conflicting effects, any change to accounting rules that causes banks to record securities or other assets at fair market value has to be accompanied by more fundamental reforms that limit depositor incentives to panic, such as enhanced deposit insurance.

As is now familiar, SVB was done in by a fall in the value of its bond portfolio, which made up 55% of its total assets at the end of 2022. When tech investment dried up, SVB’s business customers spent down their cash. The resulting deposit withdrawals forced SVB to sell its bonds at a loss. Depositors’ fear of further losses resulted in a classic run on SVB.


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