Monthly Archives: February 2024

Material ESG Alpha: A Fundamentals-Based Perspective

Posted by Byung Hyun Ahn (Dimensional Fund Advisors), Panos N. Patatoukas (UC Berkeley), and George S. Skiadopoulos (Queen Mary University of London and the University of Piraeus), on
Thursday, February 8, 2024
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Byung Hyun Ahn is a Senior Researcher at Dimensional Fund Advisors; Panos N. Patatoukas is a Professor and the L.H. Penney Chair in Accounting at the University of California Berkeley Haas School of Business; and George S. Skiadopoulos is a Professor at Queen Mary University of London and the University of Piraeus. This post is based on their article forthcoming in The Accounting Review. 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; How Much Do Investors Care about Social Responsibility? (discussed on the Forum here) by Scott Hirst, Kobi Kastiel, and Tamar Kricheli-Katz; and Does Enlightened Shareholder Value Add Value? (discussed on the Forum here) by Lucian A. Bebchuk, Kobi Kastiel, and Roberto Tallarita.

What is the link between changes in ESG scores and future stock performance? The question is a critical one as investors and firms are increasingly mindful that environmental, social, and governance (ESG) issues can have a material impact on corporate value creation. The need to identify material ESG issues has fostered an ecosystem of standard-setting organizations, rating agencies, and index providers. The materiality framework and industry-specific disclosure standards developed by the Sustainability Accounting Standards Board (SASB) are part of the foundation of this ecosystem.

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Financing Year in Review: Evolving Markets and New Trends

Posted by Greg Pessin, John Sobolewski, and Alana Thyng, Wachtell, Lipton, Rosen & Katz, on
Thursday, February 8, 2024
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Gregory Pessin and John Sobolewski are Partners, and Alana Thyng is a Law Clerk at Wachtell, Lipton, Rosen & Katz. This post is based on a Wachtell Lipton memorandum by Mr. Pessin, Mr. Sobolewski, Ms. Thyng, Josh Feltman, Emily Johnson, and Joel Simwinga.

Widely held concerns about inflation, rising interest rates, and a possible recession combined to slow debt financing and deal activity in the first half of 2023. Borrowers deferred new debt deals, delayed planned refinancings, and paused major corporate transactions while waiting for interest rates to top out. Private equity sponsors, in particular, held back on debt-financed leveraged buyouts while watching to see whether interest rates (or business valuations) would fall. Direct lending remained hot, continuing to fill in market gaps. But it was by no means a borrower’s market, whether in terms of pricing, terms, or leverage multiples.

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Voting on ESG: Ever-Widening Differences

Posted by Lindsey Stewart, Morningstar, Inc, on
Wednesday, February 7, 2024
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Lindsey Stewart is Director of Investment Stewardship Research at Morningstar, Inc. This post is based on his Morningstar 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, and Roberto Tallarita; How Twitter Pushed Stakeholders Under The Bus (discussed on the Forum here) by Lucian A. Bebchuk, Kobi Kastiel, and Anna Toniolo; and Corporate Purpose and Corporate Competition (discussed on the Forum here) by Mark J. Roe.

Growing Gaps in 2023

The gap between U.S. and European managers voting on ESG grew in 2023, but there’s also greater divergence among U.S. managers.

U.S. Managers’ Falling Support for Key ESG Resolutions Contrasts Sharply With Those in Europe

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Accountability of Corporate Emissions Reduction Targets

Posted by Shirley Lu (Harvard Business School), Shawn Kim (UC Berkeley), and Xiaoyan Jiang (Harvard Business School), on
Wednesday, February 7, 2024
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Shirley Lu is an Assistant Professor of Business Administration at the Harvard Business School, Shawn Kim is an Assistant Professor of Accounting at the University of California Berkeley Haas School of Business, and Xiaoyan Jiang is a Predoctoral Fellow at the Harvard Business School. This post is based on their working paper.

Companies play a vital role in achieving the Paris Agreement to limit global warming to 2 degrees Celsius above pre-industrial levels (the 2-degree scenario). As of the end of 2022, 3,904 companies have set emissions reduction targets, of which 1,859 have been approved by the Science-Based Targets Initiative to be in line with the 2-degree scenario. Announcements of these emissions targets, such as Microsoft’s claim to become carbon negative by 2030, often make media headlines. Yet it remains unclear if there are oversights of these claims and whether firms are held accountable for the target outcomes. In the absence of accountability, firms may lack sufficient incentives to pursue genuine decarbonization efforts, leading instead to opportunities for cheap talk, raising concerns about the overall credibility of these emissions reduction targets.

In this paper, we study whether there is accountability for companies’ emissions targets that ended in 2020 (i.e., targets with final target years of 2020). More specifically, we ask three questions related to such accountability. First, what are the target outcomes and can they be meaningfully interpreted? Second, what is the level of transparency (e.g., firm disclosure, media dissemination) of the target outcomes? Third, are there any consequences associated with missing emissions targets, and if so, what are they?

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Outlook for M&A and Shareholder Activism in 2024

Posted by James E. Langston and Kyle A. Harris, Cleary Gottlieb Steen & Hamilton LLP, on
Wednesday, February 7, 2024
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James E. Langston and Kyle A. Harris are Partners at Cleary Gottlieb Steen & Hamilton LLP.  This post is based on their Cleary Gottlieb memorandum.

The M&A Environment in 2024

Global deal value in 2023 fell to the lowest level seen in a decade. It was the first year since 2013 that the M&A market failed to hit the $3 trillion value mark, with continued reduced deal activity from private equity firms, which spent 36% less on acquisitions than in 2022. For boards and management teams pondering the M&A environment in 2024, a complex mix of macroeconomic, geopolitical and sector-specific headwinds and tailwinds make prognostication difficult.

Such a complex transactional environment provides challenges but also opportunities. From our vantage point, the number of transactions being actively considered is much higher than the relatively depressed 2023 metrics imply, suggesting many deal-makers are not deterred. Below are some key themes from 2023 and lessons for 2024.

Among other sources of friction, the biggest barrier to M&A has been the slowly narrowing but still lingering valuation gap between buyers and sellers in many sectors, which has been exacerbated by the increased cost of capital. In the U.S., the latter appears to be on a path to stabilizing, as a consensus emerges that interest rates have likely peaked, with Federal Reserve policymakers signaling potential rate cuts by the end of 2024. While this bodes well for acquisition financing and deal making generally, the cost of capital will remain elevated relative to pre-pandemic levels for some time and further valuation resetting is likely necessary to bridge the gap between many buyers and sellers, particularly in leveraged transactions.

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The Future of ESG: Thoughts for Boards and Management in 2024

Posted by Martin Lipton, Karessa Cain, and Carmen Lu, Wachtell, Lipton, Rosen & Katz, on
Tuesday, February 6, 2024
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Martin Lipton is a Founding Partner, Karessa Cain is a Partner, and Carmen Lu is Counsel at Wachtell, Lipton, Rosen & Katz. This post is based on a Wachtell memorandum by Mr. Lipton, Ms. Cain, Ms. Lu, Steve Rosenblum, Adam Emmerich, and Kevin Schwartz. 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; Does 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 A. Bebchuk, Kobi Kastiel, 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.; and Corporate Purpose and Corporate Competition (discussed on the Forum here) by Mark J. Roe.

The term “ESG” has steadily faded from the investor and corporate lexicon over the past year in the wake of cultural and political clashes over its meaning and purpose.  “Anti-ESG” legislation adopted by several states has created legal and financial hurdles around the term.  Institutional investors have gone quiet on ESG amid public criticism and congressional subpoenas.  BlackRock has publicly disavowed the term for having become too politicized.  The use of “ESG” in earnings calls has dropped precipitously. 

For boards and management seeking to navigate today’s environment, the declining use of the term “ESG” likely signals its evolution rather than its demise.  ESG was conceived with the purpose of focusing global attention on risks and opportunities that were not captured in financial statements or investment analysis.  But no single term could ever accurately capture the range of issues that can materially impact any particular business and its pursuit and achievement of long-term value maximization.  Without the hype and polarizing effect of the ESG mantle, companies and investors alike may have more flexibility to take a surgical approach to issues such as climate, sustainability, human capital and diversity, equity and inclusion, and pursue tailored strategies that are firmly rooted in the creation of long-term sustainable value.

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2023 Say on Pay & Proxy Results

Posted by Todd Sirras, Austin Vanbastelaer, and Justin Beck, Semler Brossy LLC, on
Tuesday, February 6, 2024
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Todd Sirras is Managing Director, Austin Vanbastelaer is Principal, and Justin Beck is a Senior Consultant at Semler Brossy LLC. This post is based on a Semler Brossy memorandum by Mr. Sirras, Mr. Vanbastelaer, Mr. Beck, Kyle McCarthy, Nathan Grantz, and Anish Tamhaney. Related research from the Program on Corporate Governance includes Executive Compensation as an Agency Problem and Pay without Performance: The Unfulfilled Promise of Executive Compensation both by Lucian A. Bebchuk and Jesse M. Fried; The Growth of Executive Pay by Lucian A. Bebchuk and Yaniv Grinstein; The CEO Pay Slice (discussed on the Forum here) by Lucian A. Bebchuk, Martijn Cremers, and Urs Peyer; and Paying for Long-Term Performance (discussed on the Forum here) by Lucian A. Bebchuk and Jesse M. Fried.

BREAKDOWN OF SAY ON PAY VOTE RESULTS

50 Russell 3000 companies (2.1%) failed Say on Pay in 2023, 12 of which are in the S&P 500 (2.5%). Four companies failed since our last report on September 28th (bolded on page 3). The 2023 failure rate was 160 basis points lower than the 2022 failure rate.

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2024 Proxy Season Considerations: Officer Exculpation for Delaware Corporations

Posted by Andrew Allen, Karen Dempsey, and Bobby Bee, Orrick Herrington & Sutcliffe LLP, on
Tuesday, February 6, 2024
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Andrew Allen is a Managing Associate, Karen Dempsey is a Partner, and Bobby Bee is a Practice Support Counsel at Orrick Herrington & Sutcliffe LLP. This post is based on their Orrick memorandum and is part of the Delaware law series; links to other posts in the series are available here.

Note: This insight, updated on January 19, 2024, now reflects the outcome of a Delaware Supreme Court case that was pending at the time of the original publication. Refer to footnote number 1 for details.

A change to DGCL Section 102(b)(7) that took effect last year permits Delaware corporations to eliminate or limit the personal liability of corporate officers for monetary damages to stockholders for breaches of their fiduciary duty of care. Given significant stockholder support for a handful of officer-exculpation proposals this year, Delaware corporations that have weighed the issue should consider asking stockholders to act during the 2024 proxy season.

Officers would still be subject to liability for breaches of their duty of care for claims brought by or in the right of the corporation, including derivative claims. Like directors, officers also remain subject to liability for breaches of the duty of loyalty, actions not in good faith, intentional misconduct, knowing violations of the law and transactions resulting in improper personal benefits for executive officers.

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Exxon proxy suit highlights divide between ESG investing and activism

Posted by Amy D. Roy and Robert A. Skinner, Ropes & Gray LLP, on
Monday, February 5, 2024
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Amy D. Roy and Robert A. Skinner are Partners at the Ropes & Gray securities litigation group in Boston. This post is based on their Ropes & Gray 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; How Much Do Investors Care about Social Responsibility? (discussed on the Forum here) by Scott Hirst, Kobi Kastiel, and Tamar Kricheli‐Katz; Does Enlightened Shareholder Value Add Value? (discussed on the Forum here) by Lucian A. Bebchuk, Kobi Kastiel, and Roberto Tallarita; and Companies Should Maximize Shareholder Welfare Not Market Value (discussed on the Forum here) by Oliver Hart and Luigi Zingales.

On January 21, Exxon Mobil Corporation initiated litigation against two activist investors, asking a Texas federal court to declare that Exxon may properly exclude the activists’ climate-related shareholder proposal from the company’s 2024 proxy statement.

The challenged proposal is co-sponsored by Arjuna Capital, a sustainability-focused U.S. wealth management firm, and Follow This, an Amsterdam-based non-profit organized to force oil company shareholder votes on climate issues.  The proposal calls for Exxon to “go beyond current plans, further accelerating the pace of emission reductions in the medium-term for its greenhouse gas (GHG) emissions across Scope 1, 2, and 3, and to summarize new plans, targets, and timetables.”

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Why did shareholder liability disappear?

Posted by John D. Turner, Queen's University Belfast, on
Monday, February 5, 2024
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John D. Turner is Professor of Finance and Financial History at Queen’s University Belfast and a Director of the Centre for Economics, Policy and History. This post is based on a recent paper forthcoming in the Journal of Financial Economics by David Bogle, Christopher Coyle, Gareth Campbell, and Professor Turner. Related research from the Program on Corporate Governance includes The Case for Increasing Shareholder Power and Letting Shareholders Set the Rules both by Lucian A. Bebchuk.

Limited liability is pervasive in modern financial systems. It can encourage investment, but it also has the potential to incentivize risk taking. Asymmetric payoffs between profits and losses can encourage financial firms to pursue more speculative projects, knowing that their shareholders will gain the full benefit of success, but a limited loss from failure. Its role in exacerbating risk taking may have played a role in the Global Financial Crisis of 2008.

Historically, banks in the United States were required to have double liability, meaning that shareholders faced additional costs beyond their initial investment if the bank became insolvent, and recent scholarship suggests that such banks were less likely to fail.

In the United Kingdom, most banks and insurance firms voluntarily chose to have extended liability, where shareholders could potentially be exposed to payouts which were much greater than the amount that they had invested. However, this is no longer the case. This raises the question: Why did shareholder liability disappear?

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