The debate about the purpose of corporations seems to have heated up after Larry Fink’s annual letter to the CEOs of companies in which BlackRock invests and again after the statement from the Business Roundtable. Both Fink’s letter and the Business Roundtable statement referred to global problems and how companies should embrace a greater responsibility to address them. The statement by the Business Roundtable has been perceived variously as a major shift in corporate law or as a PR exercise to prevent government regulation.
Irrespective of its motivations, while an acknowledgement that a consideration of stakeholder interests is useful, an … Read more
Thank you Bob [Stebbins]. It is such a pleasure to be in a university town.
We drove in just after 11pm last night [September 12] and even then you could feel the energy, the energy that comes with curiosity, a thirst for knowledge and a belief that knowledge, know how, effort and community will bring us a better tomorrow.
As we drove down Mission Street this morning — past the same Buffalo Wild Wings where we got a burger late last night — I took in the health center, and other businesses. I then remarked to Bob about the strength … Read more
Stockholder representatives in class and derivative actions are supposed to share in any recovery on the same terms as other stockholders. Absent court approval, class counsel typically cannot share fee awards with their clients. Indeed, class-action litigator William Lerach famously served time in federal prison after pleading guilty to a conspiracy charge related to the payment of kickbacks to class plaintiffs.
Direct payments between class counsel and their clients are the most obvious means of encouraging plaintiffs to bring cases, but there are others. For instance, in a recent federal securities class action involving State Street Bank … Read more
The stakes for responsible corporate stewardship have never been higher.
Corporations today account for a greater proportion of our collective productivity than ever before. Of the 100 largest economies in the world, 71 are corporations, and only 29 are countries. U.S. corporations alone generated profits of $2.3 trillion in 2018 — the highest in history. Reflecting their unprecedented scale, U.S. corporations have been blamed for accelerating environmental degradation and aggravating disparities in income and wealth. Calls for the exercise of corporate social responsibility have become increasingly urgent. Recognizing this urgency, the Business Roundtable last month embraced broad stakeholder governance and … Read more
Many managers receive company stock as compensation and then pledge that stock as collateral for personal loans. The practice is increasingly common, and its potential economic impact is anything but negligible. For example, Larcker and Tayan (2010) document that pledged shares by 982 directors in 2006-2009 averaged 44 percent of the total shares received as compensation. In addition, the damage to firm value from managers’ failure to meet margin calls can be significant, as shown by lenders’ liquidation of pledged shares of Valeant Pharmaceuticals. In November 2015, Goldman Sachs sold more than $100 million of shares pledged by Valeant CEO … Read more
On September 9, 2019, the Internal Revenue Service (“IRS”) released proposed regulations (the “Proposed Regulations”) that, if finalized in their current form, would in many cases dramatically reduce the portion of a company’s net operating loss (“NOL”) carryforward that is available to be used following a so-called ownership change of the company. The Proposed Regulations would be effective for ownership changes occurring after they are finalized.
The Proposed Regulations would make other significant changes potentially applicable to distressed companies. Those aspects of the Proposed Regulations are beyond the scope of this memorandum. To learn … Read more
How do disclosure requirements influence a private firm’s decision to go public? This is an important question for regulators and corporate finance professionals, given current debate about how much information private firms should have to disclose. Conceptually, public disclosure requirements for private firms can lead to greater exposure of the firm’s confidential and proprietary information. Keeping this information out of the hands of competitors is a major factor that pushes firms to stay private. However, the introduction of laws that compel firms to disclose their private information essentially strips away this advantage. As a result, one would expect the ability … Read more
This post comes to us from John C. Coffee, Jr., the Adolf A. Berle Professor of Law at Columbia University Law School and the Director of its Center on Corporate Governance. These slides accompanied a lunch address that he gave at a Conference, entitled “Law Firms in the 21st Century,” which was held at Columbia on September 14, 2019.
… Read more
In corporate law, the U.S. academic elite stubbornly clings to shareholder primacy as the foundational principle of the field. The concept is simple, even elegant: Shareholders should be given ultimate control of the corporation because they are entitled to the residual – the leftover profits after all other contractual constituents have been paid – and they therefore have the proper incentives to maximize the overall value of the firm.
At an earlier time, shareholder primacy was more of a call to arms. As Berle and Means first identified, dispersed shareholders in the early 20th century were subject to the predations … Read more
Responding to a request by the European Parliament’s Committee on Civil Liberties, Justice and Home Affairs (LIBE), the EU’s data protection supervisory bodies released an initial joint opinion on the impact of the U.S. Clarifying Lawful Overseas Use of Data Act (“CLOUD Act”) on the EU data protection framework. The preliminary assessment by the European Data Protection Supervisor (“EDPS”) and European Data Protection Board (“EDPB”) leaves service providers facing a familiar dilemma.
Although the CLOUD Act now makes clear that U.S. disclosure orders have an extraterritorial reach, the EDPS and EDPB see very limited options for service providers to comply … Read more
Accounting fraud imposes severe costs on firms and their stakeholders. Firms at which fraud occurs often have inefficient resource allocation and face higher cost of capital and regulatory penalties. While shareholders suffer the brunt of these damages, frauds can also affect debtholders when firms miss contractual payments or declare bankruptcy. Credit rating agencies traditionally act as gatekeepers for debtholders, but their role and responsibility in detecting accounting fraud remain an open question.
On the one hand, credit rating agencies are in a unique position to detect accounting fraud. First, they have access to non-public information. While the SEC’s Regulation Fair … Read more
The frequency at which public companies must report financial information to investors has been the subject of intense debate in the European Union, Asia, and more recently the United States. For example, the Securities and Exchange Commission (SEC) is examining the pros and cons of giving U.S. companies the flexibility to report on a semi-annual basis (SEC, 2018). While previous studies have espoused the benefits of more frequent quarterly reporting in reducing information asymmetry and the cost of capital, much of the recent debate has been centered around concerns that quarterly reporting would impose significant preparation costs and encourage short-termism … Read more
Since it was enacted in July 2010, the Dodd-Frank Act’s Volcker Rule has challenged banks and their regulators alike. This is particularly the case with respect to its restrictions on proprietary trading. It has been one thing for former Federal Reserve Chairman Volcker to state that “you know it when you see it,” quite another to formulate a regulation that accurately defines proprietary trading and implements a broad statutory directive across complex business operations.
On August 20, 2019, the Office of the Comptroller of the Currency and the Board of Directors of the Federal Deposit Insurance Corporation, Director Gruenberg dissenting, … Read more
Since the 2008-2009 financial crisis, scholars, regulators, and policymakers have engaged in extensive studies to try to control excessive risk-taking by systemically important financial firms. In a recent article, available here, I argue that those studies do not fully explain the unusually excessive risks taken by financial firms as insurers of bonds and other debt securities, as sellers of protection under derivatives known as credit-default swaps (“CDS”), as providers of credit enhancement in securitization transactions, as issuers of standby letters of credit, and otherwise as guarantors of financial obligations (collectively, “financial guarantors”). Despite their sophistication, financial guarantors tend to … Read more
U.S. manufacturing employment fell by more than 40 percent over the last two decades, from 18 percent of the total U.S. workforce in 1997 to just 10 percent by 2018. Prior work identifies increased import competition from foreign competitors as a primary cause of this decline. Against this backdrop, the economics literature argues that indirect trade costs, such as information frictions, have a stronger effect on import competition than direct costs, such as tariffs and quotas. We explore the effects of a potential source of information frictions in trade that is unrelated to trade policy. Specifically, we find that the … Read more
The choice-of-law clause is now omnipresent. A recent study found that these clauses can be found in 75 percent of material agreements executed by large public companies in the United States. The popularity of such clauses in contemporary practice raises several questions. When did choice-of-law clauses first appear? Have they always been popular? Has the manner in which they are drafted changed over time? Surprisingly, the existing literature provides few answers.
In a recent paper, A Short History of the Choice-of-Law Clause, I tried to answer some of these questions. The paper sought, among other things, to determine the … Read more
The 2019 proxy season was marked by an increased willingness among shareholders to hold boards accountable on director elections, say- on-pay, and environmental, social and governance (ESG) shareholder proposals. For example, almost 5 percent of directors received less than 80 percent support for her/ his election, which is the highest proportion since the aftermath of the financial crisis.1 This suggests that investors are beginning to hold boards accountable for failing to improve governance practices and integrate ESG considerations into their overall strategy and oversight responsibilities.
Election of Directors
The most notable example of investors holding boards accountable took place at … Read more
Corporate governance is characterized by agency constructs. The agency relationship in modern finance and corporate governance is characterized by attempts to optimize incentives between principals and agents, control costs, minimize information asymmetries, control adverse selection and moral hazard, optimize risk preferences between principals and agents, and engage in monitoring. The corporate form remains the most popular form of a governance mechanism, despite the unresolved substantive agency problems associated with the division of ownership (shareholders) and control (agent) and the incomplete and suboptimal rules that govern such conflicts.
Shareholder value maximization has emerged as the dominant corporate governance solution for the … Read more
Stock-based compensation (SBC) is a significant and growing expense for many firms. From fiscal year 2006 to 2018, average SBC has increased steadily from 2.6 percent to 3.8 percent of operating expenses for publicly-traded companies. Despite its importance, however, most firms exclude SBC expense in their non-GAAP earnings, and anecdotal evidence suggests that few analysts consider the expense associated with options in their valuation models. In a recent paper, we investigate whether SBC leads to overvaluation in equity markets and the role played by analysts in the relationship between SBC and valuation.
Ignoring SBC is likely to lead to overvaluation, … Read more
Institutional Shareholder Services (ISS) recently introduced Economic Value Added (EVA) as its latest approach to measuring company performance. Recent white papers from ISS, authored by Bennett Stewart (ISS Senior Advisor), who, along with former business partner Joel Stern, developed the general EVA framework roughly 40 years ago, implicitly suggest that EVA is the solution to identifying companies creating value and therefore, the superior method for assessing pay for performance. As ISS states:
“EVA is an established standard in measuring, analyzing, projecting, valuing, and discounting a firm’s underlying economic profit rather than its accounting profit. With coverage of 16,500+ public … Read more
Private equity (PE) firms influence their buyout targets in many ways. The literature documents that PE improves target firms’ operational practices, productivity, and innovation while cutting existing jobs and creating new ones. It is far less clear whether and how these PE-created effects extend beyond target firms. In a new paper, we examine the spillover effects of PE and investigate whether and how the prior work experience of public firm chief executive officers (CEOs) in PE buyout targets helps shape corporate policies and performance of these CEOs’ current firms.
Our study is, to the best of our knowledge, the first … Read more
Antitrust treatment of no-poach agreements continues to evolve as private cases progress, state attorneys general ramp up enforcement efforts and federal regulators further contemplate the legality of no-poach agreements.
Over the past two years, private plaintiffs have filed class action lawsuits challenging the use of no-poach commitments in franchise agreements, whereby the franchisor and/or franchisees agree not to hire each other’s employees. In most cases, plaintiffs have alleged that such provisions are unreasonable restraints of trade that should be evaluated under either the strict per se rule or “quick-look” analysis because the provisions at issue are so overwhelmingly anti-competitive that … Read more
What should be the purpose of the public corporation? Over the last few years, that has become an increasingly open and contested question, as evidenced by the recent statements of the corporate sector itself, the practice of B corporations like Kickstarter or Patagonia, which pledge a concern for broader goals, and the attentions of Columbia Law Professor Jeffrey Gordon.
I wanted to use the renewed debate to take a look back at a classic defense of the shareholder value maximization model, “The End of History for Corporate Law,” published in 2000 by professors Reinier Kraakman and Henry Hansmann, then … Read more
There has recently been much debate and some confusion about a bedrock principle of corporate law – namely, the essence of the board’s fiduciary duty, and particularly the extent to which the board can or should or must consider the interests of other stakeholders besides shareholders.
For several decades, there has been a prevailing assumption among many CEOs, directors, scholars, investors, asset managers and others that the sole purpose of corporations is to maximize value for shareholders and, accordingly, that corporate decision-makers should be very closely tethered to the views and preferences of shareholders. This has created an opportunity for … Read more
The Business Roundtable’s controversial new Statement on the Purpose of a Corporation (“Statement”) is a significant corporate governance development that requires thorough board discussion. The Statement will not only affect corporate purposes generally, but also have a very uncertain impact on the fiduciary obligations of the board of directors. The discussion of it should be led, in part, by the chief legal officer.
The Statement is grounded in traditional American principles of economic equality and opportunity: the right to “an economy that allows each person to succeed through hard work and creativity and to lead a life of meaning and … Read more
How does the stock market respond to news reports about a company? Previous work has found that it takes a few days for prices to fully absorb news, and this underreaction has been attributed to investors’ limited ability to process information. We find evidence for an alternative explanation: Sophisticated institutional investors trade slowly on news to avoid tipping their hands. Once we control for this effect, we find that the market actually overreacts to news.
Academic interest in how markets process information dates back to Eugene Fama’s pioneering work in the 1960’s. Fama argued that markets are highly informationally efficient, … Read more
The embrace of shareholder activism as a tool to bring about broad social change is a welcome development. It reflects a trend of outsourcing public functions and values to private actors and stems in part from a frustration with interest group politics and existing democratic processes in the public context. However, overreliance on shareholder activism and similar private tactics may lead to an expectations gap; they are not an effective surrogate for persistent, organized, mobilized social movements that employ diverse tactics in traditional democratic venues. Lessons from the civil rights movement suggest broader systemic change will require sustained, combined pressure … Read more
The Statement on the Purpose of a Corporation by the Business Roundtable, a one-page document signed by nearly all the organization’s member CEOs, has been dramatically portrayed by the media (with the BRT’s encouragement) as a new commitment by American public companies to pursue a vision sometimes known as “stakeholder capitalism”—a model of corporate governance that explicitly recognizes the interests of non-shareholder constituencies like employees, customers, suppliers, public interest groups and local communities. This announcement of new concern for stakeholders is in turn portrayed as corporate America’s long-overdue abandonment of a myopic, shareholder-centric governance orthodoxy attributed to Milton Friedman … Read more
Audit committee responsibilities have consistently increased, and practitioners have raised concerns that audit committees may be overloaded with duties. For example, in a 2005 interview, one audit committee member noted, “It’s becoming almost excessive. We get press releases almost weekly to review. It’s becoming a burden on my email at home. Earnings releases, litigation information, and acquisition information — something seems to always be coming my way” (Beasley et al. 2009). These concerns continue today. For example, forty percent of audit committee members polled by KPMG (2015) report that it is increasingly difficult to adequately fulfill all of the audit … Read more
The most significant securities decision to be handed down in the first half of 2019 came from the Supreme Court in Lorenzo v. SEC, which clarified the scope of “scheme liability” under Rule 10b-5(a) and (c). Another significant ruling came from the Tenth Circuit in SEC v. Scoville, which held that the Dodd-Frank Act permits the SEC to bring fraud claims or claims under Section 17 of the Securities Act based on sales of securities that do not constitute domestic transactions within the meaning of Morrison v. National Australia Bank Ltd.
The second half of the Supreme Court’s … Read more
Recent advances in machine learning and natural language processing (NLP) enable machines to better understand human languages. E-mail systems now routinely warn us when an email we receive may be a spam, suggest a quick response to an email, correct our grammatical errors, and suggest words or an entire sentence to an email we are writing. The main advantage machines have over humans is that they can quickly process huge amounts of data. In a new paper, we examine the extent to which machines can help us understand the functioning of financial markets.
Public companies provide detailed information about their … Read more
The failure of the Council of Institutional Investors to join the Business Roundtable in rejecting shareholder primacy and embracing stakeholder corporate governance is misguided. The argument that protection of stakeholders other than shareholders should be left to government regulation is an even more serious mistake. It would lead to state corporatism or socialism.
The failure to recognize the existential threats of inequality and climate change, not only to business corporations but also to asset managers, institutional investors and all shareholders, will invariably lead to legislation that will regulate not only corporations but also investors and take from them the ability … Read more
Equity compensation is a beneficial tool when it motivates employees to engage more intensely in performance-enhancing activities. One negative consequence of equity compensation, however, is that it provides incentives to manage earnings (i.e., to strategically present financial reports or structure transactions in order mislead financial statement users about financial performance). Earnings management may sacrifice long-term firm value for short-term financial results, and prior research provides evidence that earnings management is more prevalent when executives have greater levels of equity compensation (e.g., Armstrong, Larcker, Ormazabal, & Taylor 2013).
Our forthcoming study in the Journal of Business Finance & Accounting extends prior … Read more
On July 30, 2019, the U.S. Court of Appeals for the District of Columbia affirmed civil contempt orders by the D.C. District Court against three Chinese banks for their failure to produce documents in response to U.S. government subpoenas relating to an investigation of North Korea’s financing of its nuclear weapons program. The 44-page opinion by D.C. Circuit Judges David S. Tatel, Patricia A. Millett and Cornelia T.L. Pillard, written for the court by Judge Tatel, was released publicly on August 6, 2019 with redactions of information that remains under seal.
The Court of Appeals concluded that there was … Read more
The U.S. Securities and Exchange Commission’s chairman and each of its commissioners issued a statement at yesterday’s open meeting on guidance about proxy voting and proxy voting advice. Chairman Jay Clayton’s statement is here. In support of the guidance, the statements of commissioners Hester M. Peirce and Elad L. Roisman are here and here. In dissent, the statements of commissioners Robert J. Jackson, Jr. and Allison Herren Lee are here and here.… Read more
The question that emerges from proposals to elevate a corporation’s “purpose,” the call for co-determination in Senator Warren’s Accountable Capitalism Act and now the Business Roundtable’s purported elevation of stakeholder interests, is whether corporate governance is capable of playing the important role in addressing social problems that some have posited. Such an approach seems to suggest that the social challenges we face can be dealt with at the level of the firm – that is, by specific corporations and their boards. This assumption seems to animate the argument for firm-specific tailoring of corporate governance in light of distinct … Read more
Recent SEC enforcement actions charging senior lawyers at Apple and SeaWorld with insider trading provide reason to dust off company insider trading policies and assess whether updates or additional training are needed. As sanctuaries for corporate America’s most valuable confidential information, law departments are among the first places that regulators look when trying to determine the source of a trader’s material nonpublic information.
Insider trading enforcement remains a cornerstone of the SEC’s enforcement program. Over the past ten years, the SEC has significantly enhanced its insider trading surveillance, detection and investigative capabilities. Through the adoption of new investigative approaches and … Read more
There are many sources of information about corporate operations, but one of the most critical is the disclosure required by the federal securities laws. Whenever a company seeks to raise capital through the public sale of securities, the U.S. Securities and Exchange Commission (“SEC”) requires that it file a detailed description of its business and financial condition, periodically updated with new information about its profits, revenues, assets, and general business activities. Regulators, competitors, employees, journalists, and members of the community have all grown to depend on securities disclosures to provide a working portrait of the country’s economic life. Yet securities … Read more
Related party transactions (RPTs) refer to a transfer of resources, services, or obligations between a reporting entity and a related party and usually offer insiders a way to expropriate wealth from other investors via self-dealing. Both the Financial Accounting Standards Board (FASB) and the Securities and Exchange Commission (SEC) require detailed disclosure of material RPTs in annual reports and proxy statements. However, none of these regulators provided specific guidance on firms’ corporate governance related to ensuring that RPTs work in the best interest of the firm and its stakeholders. Investors were often kept in the dark on whether the firm … Read more
In an important transcript ruling issued on August 14, the Delaware Court of Chancery upheld the validity and vitality of advance notice bylaw provisions, which govern the timing and disclosure requirements of stockholder nominations of board candidates. The ruling should give further comfort to boards of public corporations in enforcing reasonable and customary safeguards commonly imposed on the critical director nomination process.
The recent transcript ruling was issued in connection with the unsolicited efforts by Bay Financial Capital to acquire Barnes & Noble Education, Inc. (BNED). BNED operates physical and virtual bookstores for educational institutions, sells textbooks wholesale, and … Read more
Cryptocurrencies like Ether, DAO, Bitcoin and Facebook’s Libra are electronically generated and stored currencies by which users can trade real or virtual objects with one another, bypassing traditional central clearinghouses. Given that these cryptocurrencies are starting to replace some national currencies and financial products, should they be regulated? And, if so, how? Some countries, such as China and Russia, prohibit Initial Coin Offerings (ICOs) altogether, while others strive to reach an understanding of the currencies in order to come up with coherent regulation. As for the U.S., in April 2019 the Securities and Exchange Commission (SEC) finally issued its framework … Read more
In recent years, large asset managers have reached incredible sizes, managing trillions of dollars of assets on behalf of tens of millions of clients. The largest three – BlackRock, Vanguard, and State Street – taken together (the “Big Three”), vote about 20 percent of shares in most large companies, with the majority of these shares held in passive index funds. This concentration of financial power has ignited debates over the role of large asset managers and the effects of index fund portfolios in corporate governance. The size and composition of the portfolios of the large asset managers have significant implications, … Read more
On August 6, the United Kingdom’s Serious Fraud Office (“SFO”) published new guidance on the steps companies should take in order to receive cooperation credit in the SFO’s charging decisions. The document, titled “Corporate Co-operation Guidance” (the “SFO Guidance”), outlines similar steps to those set forth in the United States Department of Justice’s Corporate Enforcement Policy (“CEP”), indicating that SFO Director Lisa Osofsky, formerly of the FBI, is ushering in familiar U.S.-based standards in her new role leading the SFO.
Despite many similarities, the SFO Guidance differs from the CEP in a few significant respects. The most noteworthy of … Read more
In a recent paper, I review the literature on fintech and its interaction with banking. Included in fintech are innovations in payment systems (including cryptocurrencies), credit markets (including peer-to-peer or “P2P” lending), and insurance, with blockchain-assisted smart contracts playing a role. My review paper defines fintech, examines the stylized facts, and then reviews the theoretical and empirical literature. The paper summarizes our knowledge on the main research questions raised by the literature review and concludes with questions for future research.
Fintech is a hot topic, even though the interplay between information technology and financial services is not a new … Read more