Monthly Archives: June 2023

High Bar for Challenge of Business Decisions by an Independent Board

Gail Weinstein is Senior Counsel, and Philip Richter, and Steven Epstein are Partners at Fried, Frank, Harris, Shriver & Jacobson LLP. This post is based on a Fried Frank memorandum by Mr. Weinstein, Mr. Richter, Mr. Epstein, Brian T. Mangino, Andrew J. Colosimo and  Randi Lally 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 Independent Directors and Controlling Shareholders (discussed on the Forum here) by Lucian Bebchuk and Assaf Hamdani.

In City of Coral Springs Police Officers’ Pension Plan v. Jack Dorsey, Block, Inc., et al (May 9, 2023), the Delaware Court of Chancery dismissed a lawsuit against the directors of Block, Inc. (a tech company, originally called Square, Inc., led by former Twitter CEO Jack Dorsey) challenging Block’s $237.3 million acquisition in 2021 of an 86.23% stake in TIDAL, a music streaming company 27% owned by Shawn Carter (who is professionally known as Jay-Z). The court dismissed the case after finding that the plaintiffs did not establish that the independent directors of Block acted with bad faith (and that, therefore, the plaintiffs did not establish demand futility).

Key Points

  • The decision serves as a reminder of the very high bar for a finding that an independent board acted in bad faith. Even in the context of a decision to approve what was “by all accounts, a terrible deal” following a minimal and flawed process, an independent and disinterested board will not have liability unless it acted in bad faith. This decision indicates that, generally, the court will not find bad faith unless the board essentially did almost nothing to evaluate the transaction before approving it. In this case, where the directors received a presentation about the transaction, had three short meetings, and asked management questions, they had not acted in bad faith, the court found—even though, apparently, the answers to the questions they asked all strongly indicated that the deal should not be done.
  • The court continues its trend in recent years of criticizing a flawed process even when reaching a holding for the defendants. This is another case in which, although the court held that the director defendants had no liability, the court’s recitation of the background facts and other commentary made clear the court’s view that Dorsey may have been motivated by his friendship with Carter and that the directors had not done a good job and had made what was obviously a “terrible business decision.”


Weekly Roundup: June 23-29, 2023

More from:

This roundup contains a collection of the posts published on the Forum during the week of June 23-29, 2023.

Commentary: Our Proxy Advice is Apolitical

Nine Mistakes To Avoid When Transitioning CEOs

Ruling Provides Roadmap For Navigating Transactions With Fiduciary on Both Sides

Dynamic CEO-Board Cultural Proximity

Demonstrating Pay and Performance Alignment

Side Letter Governance

The Activism Vulnerability Report

2023 AGM Early Season Review

The Rise of International ESG Disclosure Standards

David A. Cifrino is Counsel at McDermott Will & Emery LLP. This post is based on his MWE 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 Tallarita; For Whom Corporate Leaders Bargain (discussed on the Forum here) by Lucian Bebchuk, Kobi Kastiel, Roberto Tallarita and Stakeholder Capitalism in the Time of COVID (discussed on the Forum here) both by Lucian Bebchuk, Kobi Kastiel, 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.; and Corporate Purpose and Corporate Competition (discussed on the Forum here) by Mark J. Roe.

New regulations expected to be adopted in 2023 will result in exponential growth in the amount of environmental, social and governance (ESG), i.e., sustainability, data generated by reporting companies and available to investors.

The US Securities and Exchange Commission (SEC) is expected to adopt final rules requiring detailed disclosure by companies of climate-related risks and opportunities by the end of 2023. The newly-formed International Sustainability Standards Board (ISSB) is expected to adopt two reporting standards in June: one on climate-related risks, and a second on other sustainability related information. Regardless of how much harmonisation there will be between these and other ESG disclosure standards, it is clear that mandatory, standardised sustainability reporting by corporations will increase significantly worldwide over the next few years.

The Data Driven and Rapidly Consolidating Global ESG Investing Ecosystem

The demand for enhanced ESG disclosure is intense. Globally, overall ESG investing is massive, having grown as much as tenfold in the last decade. Morningstar, Inc. estimated that total assets in ESG designated funds totaled more than US$3.9 trillion at the end of September 2021. The evolution in ESG investing has been accompanied by exponential growth in the amount and types of data available for ESG investors to consider. The number of public companies publishing corporate sustainability reports grew from less than 20 in the early 1990s to more than 10,000 companies today, and about 90% of the Fortune Global 500 have set carbon emission targets, up from 30% in 2009.

The world’s largest asset manager, Blackrock, Inc., noted in a comment letter to the US Department of Labor regarding pension fund regulation that, as ESG data has become more accessible, the firm has developed a better understanding of financially relevant ESG information, and ESG funds that incorporate financially relevant ESG data have become more common. BlackRock stated that its systems for ESG analysis have access to more than 2,000 categories of ESG metrics from various ESG data providers. The firm concluded that, because of the greater volume of ESG-related disclosures by companies and third party ESG vendors, together with advancements in technology, “the use of ESG data to seek enhanced investment returns and/or mitigate investment risks has become more sophisticated.”


The Bipartisan SEC Whistleblower Reform Bill: Building on Success

Allison Herren Lee is Of Counsel at Kohn, Kohn & Colapinto LLP. This post is based on her Kohn, Kohn, & Colapinto piece.

The SEC’s whistleblower program has been a resounding success – a point that has been echoed by SEC Chairs and Commissioners from both sides of the aisle. Indeed, whistleblowers have helped to take over $1.5 billion out of the pockets of fraudsters and put it back into the hands of their victims.  The program has garnered over $6.3 billion in sanctions and, importantly, awarded over $1.5 billion to the courageous women and men who helped bring misconduct to light.

It is this very success that highlights the wisdom, and anti-corruption benefits, of continually working to improve and build upon the promise of this impressive record. Fortunately, a bipartisan group of Senators agree and have put forth the SEC Whistleblower Reform Act of 2023.  Introduced by Senators Grassley (R-IA) and Warren (D-MA) on March 15, and cosponsored by Senators Collins (R-ME), Warnock (D-GA) and Cortez Masto (D-NV), this legislation is designed to make some important improvements to the SEC’s existing program.

Most notably, the legislation would address the U.S. Supreme Court’s 2018 ruling in Digital Realty Trust, Inc. v. Somers which stripped workers of protection from retaliation when they have reported corporate misconduct internally but not externally to the SEC. In addition, it would reinforce important safeguards to prevent companies from using policies or practices designed to muzzle whistleblowers.


2023 AGM Early Season Review

Amanda Buthe is a Director, Rajeev Kumar is a Senior Managing Director and Kilian Moote is a Managing Director at Georgeson LLC. This post is based on a Georgeson memorandum by Ms. Buthe, Mr. Kumar, Mr. Moote, Daniel Chang, Brigid Rosati, and Michael Maiolo. Related research from the Program on Corporate Governance includes Social Responsibility Resolutions (discussed on the Forum here) by Scott Hirst.

The 2023 Annual General Meeting (AGM) season has been a record-breaking for ESG (Environmental, Social, and Governance) shareholder proposal submissions. As of May 15, there have been 951 ESG proposals submitted, surpassing 941 submissions in the previous year.

Despite the increased number of ESG proposals, overall support for ESG initiatives has declined in the past two years, with the number of proposals receiving majority support decreased significantly. Only 24 proposals received majority support up until May 12 compared to 48 within the same timeframe in 2022.

Investors have shown a decreasing level of support for ESG proposals as they become more specific and focused on the impact of environmental, societal and political issues, including board and workforce diversity, political spending and reproductive rights.

Anti-ESG on the rise

Anti-ESG proposal submissions accounted for 10% of all ESG proposals: double the proportion last year. Despite the increase in the number of anti-ESG proposals, average support for them has nonetheless declined from 9.2% in 2022 to 6.2% in 2023.

Among the various anti-ESG proposal categories, those focused on social topics have seen a significant increase: a 46% rise in submissions (67 in 2023 to-date compared to 46 in 2022). None of these proposals have passed.

So far in 2023, proponents have filed 27 anti-ESG proposals related to diversity, equity and inclusion (DEI) issues, a number that has grown each year.


Control Expropriation via Rights Offers

Leeor Ofer is a fellow at the Harvard Law School Program on Corporate Governance, and is an S.J.D. candidate at Harvard Law School. This post is based on her recent paper, forthcoming in the American Business Law Journal. Related research from the Program on Corporate Governance includes Cheap-Stock Tunneling Around Preemptive Rights (discussed on the Forum here) by Jesse M. Fried and Holger Spamann.

Rights offers are a relatively common capital raising method. In a rights offer, the company’s existing shareholders are given the opportunity to purchase newly-issued shares in proportion to the amount of shares they already own (pro-rata) for a specific subscription price per-share. Typically, rights offers are conducted at a discount to the underlying share’s trading price.

Given that rights offers allow all shareholders to participate in the issuance in proportion to their existing shareholdings and under the same terms, the traditional view had once been that rights offers are fair to all shareholders. Previous scholarly work has shown, however, that rights offers cannot fully protect outsiders from insider expropriation. Specifically, corporate insiders can sell themselves cheap stock – a scenario coined as “cheap stock tunneling” – even when the issuance is conducted as a rights offer. First, when some shareholders are limited in their ability to participate in attractive rights offers, say for lack of sufficient funds, the formal right to participate does little to protect such shareholders. Second, Fried and Spamann have recently shown that corporate insiders can capitalize on their informational advantage to engage in cheap stock tunneling via rights offers. Namely, corporate insiders can intentionally set the subscription price within a “zone of uncertainty” – a price range for which outsiders cannot tell for sure whether the price is too high or too low. When the subscription price is set within this range, outsiders who participate risk purchasing overpriced stock, while outsiders who refrain from participating risk cheap-stock tunneling. To balance these two risks, outsiders exercise only part of their subscription rights, and some cheap-stock tunneling is facilitated.


The Activism Vulnerability Report

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 Frankl and Kushner Leo E. Strine, Jr. (discussed on the Forum here).

Introduction and Market Update

With summer just around the corner, FTI Consulting’s Activism and M&A Solutions team welcomes readers to our June 2023 Activism Vulnerability Report that highlights the findings from our Activism Vulnerability Screener for 1Q23 and discusses notable trends and themes observed in the world of shareholder activism during the 2023 proxy season.

Following the consecutive collapses of Silicon Valley Bank (“SVB”) and Signature Bank in March, other regional banks have been under pressure. Despite the U.S. Federal Reserve’s (“Fed”) efforts to prop up the banking sector, the high-profile failures coming in such close proximity undoubtedly contributed to depositors withdrawing more than $100 billion from First Republic Bank (“First Republic”) during 1Q23. This news, coupled with First Republic having a high percentage of uninsured deposits, triggered a run on the bank, causing a liquidity crisis that the bank could not quell. [1] On May 1, regulators seized First Republic, which had reported $232.9 billion in total assets on March 31, making it the largest U.S. bank failure since the 2008 financial crisis; JPMorgan Chase later agreed to buy the majority of its assets. [2]  In the weeks following the First Republic Bank collapse, PacWest Bancorp, with shares down 66.2% year-to-date and deposits likewise hemorrhaging since SVB’s loss disclosure on March 8, announced it was exploring a potential sale. [3] [4]

The U.S. government’s battle over the debt ceiling, though resolved in early June, destabilized markets in May when it appeared lawmakers might not come to a resolution. [5]  Despite the instability, investors were granted some breathing room in May as inflation continued to recede from its June 2022 peak. [6]  The Fed issued its tenth consecutive interest rate hike in May, and although recent positive macroeconomic data has left the option open to future rate increases later this summer, analysts are expecting the Fed to pause tightening for at least one meeting to determine if additional rate hikes are warranted. [7] A pause may be more beneficial to investors than a direct rate cut would be; the S&P 500 has historically climbed 16.9% on average in the 12 months following a rate pause compared to a 1.0% drop in the 12 months following a rate cut. [8]  At this point, market participants seem to believe the Fed will pause this month, but could resume rate tightening as early as July. However, additional rate hikes may carry consequences of their own, as the ever-present threat of a recession exposes risks to equity investors, just when it seemed the market was moving past a potential banking crisis. [9]

With share prices of financial institutions under pressure, shareholder activists began circling the sector. Campaigns focused on financial institutions doubled in 1Q23 relative to the same period last year. The Telecom, Media & Technology (“TMT”) and the Industrials sectors were also a focus for activists during the quarter.


Side Letter Governance

Elisabeth de Fontenay is a Professor of Law at Duke University, and Yaron Nili is a Professor of Law and the Smith-Rowe Faculty Fellow in Business Law at the University of Wisconsin Law School. This post is based on their article, forthcoming in the Washington University Law Review.

It is no exaggeration to say that over its roughly forty-year history, private equity has revolutionized both corporate finance and corporate governance.  When it first arose in the 1980s, the private equity buyout represented an entirely novel approach to owning, managing, and financing companies, and its effects on both corporate behavior and the financial markets have been profound.  Today, private equity is one of the major global asset classes, and it has attracted a truly staggering amount of capital over a relatively short period of time. It has been the driver behind major changes to, and innovations in, financial contracting.  Staffed with some of the most sophisticated financiers in the world and advised by the most elite law firms, private equity sponsors innovate at a furious pace in their mergers and acquisitions (M&A), financing, fund formation, and other contracts, and are relentless in advancing their interests in the financial markets.  Understanding how private equity funds themselves are structured and incentivized is therefore crucial for understanding how the private equity industry behaves and affects global finance.

In a leveraged buyout, a private equity fund acquires a company using a high proportion of debt (“leverage”), then seeks to optimize the company’s operations, governance and strategy before eventually exiting the investment through a sale or public offering (“buyout”).  Yet private equity buyout funds are distinct not only in their investment strategy—buying and selling whole companies—but also in the formation of the funds themselves. The sponsor that sets up and manages the buyout fund enters into a long-term agreement with investors that governs the relationship among them.  This agreement, formally a limited partnership agreement (or LPA), typically bestows on all investors in the fund the same rights and obligations. Over time, however, this simple and uniform structure has become far more complex: sponsors routinely enter into separate agreements (or “side letters”) with some or all of their investors, under which each investor in question is granted a tailored set of additional rights. Depending on the fund, the terms of any given side letter need not be disclosed to the other fund investors.


Demonstrating Pay and Performance Alignment

Mike Kesner is a Partner, Linda Pappas is Principal, and Ed Sim is a Consultant at Pay Governance LLC. This post is based on Pay Governance memorandum by Mr. Kesner, Ms. Pappas, Mr. Sim, and Ira T. Kay. Related research from the Program on Corporate Governance includes Pay without Performance: The Unfulfilled Promise of Executive Compensation (discussed on the Forum here) by Lucian Bebchuk and Jesse M. Fried.

Key Takeaways

Shareholders and companies may find the results of our comparison of Compensation Actually Paid (CAP), as presented in the new Pay Versus Performance (PVP) tables in 2023 proxy statements, and Realizable Pay (RP) of interest for the following reasons:

  • There is no perfect solution for evaluating pay for performance.
  • Summary Compensation Table (SCT) compensation values are not useful when measuring pay for performance but serve a valuable corporate governance purpose, primarily by showing Board/Compensation Committee intent when providing various compensation programs.
  • The new CAP disclosure provides a better understanding of pay for performance than SCT compensation, but the results can be distorted by the inclusion of certain mandated items such as equity awards granted prior to the performance measurement period.
  • RP generally provides a more rigorous approach to matching the time period for compensation with the performance underlying such awards.

We believe RP can provide Compensation Committees with more robust insights when evaluating pay for performance than tools based on the SCT or PVP methodologies and should be a consideration in addressing this important corporate governance issue.


Dynamic CEO-Board Cultural Proximity

Philip G. Berger is the Wallman Family Professor of Accounting at the University of Chicago, Wei Cai is an Assistant Professor of Business at Columbia University, and Lin Qiu is an Assistant Professor of Management at Purdue University. This post is based on their recent paper.

Both the academic and practitioner spheres have embraced culture as a critical factor in determining a wide range of organizational outcomes. Culture generally impacts how people communicate and interact with each other. Firms experience this same phenomenon: recent research suggests that the cultural background of executives has a lasting effect on how they communicate with other key players. These actors include the capital market, employees, and importantly, the board of directors.  Although interactions with boards of directors often determine an executive’s course of action and thus significantly impact firms, the crucial effect of culture on these interactions remains rather nebulous.

We argue that the proximity between the CEO’s and the directors’ cultural backgrounds plays a critical role in shaping the CEO-board relationship. In this study, we examine dynamic CEO-board cultural proximity – how the CEO-board cultural proximity evolves over the years after a new CEO joins the company and the implications of this evolution on corporate governance. Our definition of CEO-board cultural proximity builds off of the cultural dimensions constructed by Hofstede (2010). We hypothesize that these dimensions shape CEO-board dynamics through implicit bias and may evolve over CEO tenure. People who share the same cultural background have similar hidden assumptions, group norms, and values, reducing the need for explicit communication. These shared traits underlie the homophily phenomenon, which drives social networks, political alignment, and even friendship. In this way, culture serves as an implicit contract and an often-overlooked element of intra-firm relationships.


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