Boards Should Use Diversity as a Defense Against Activists

Many institutional investors have made increasing the diversity of corporate boards a priority, yet activist investors that rely on the support of these institutional investors often make boards less diverse. Boards should take advantage of this divergence between the priorities of institutional investors and the actions of activist investors in resisting activist campaigns, and prepare for those campaigns by increasing board diversity.

Activists’ Effect on Board Diversity

The financial press has highlighted how activists reduce board diversity, [1] and a recent white paper by ISS and the Investor Responsibility Research Center Institute (“IRRCi”) has provided proof.[2] The ISS and … Read more

Wachtell’s Lipton Reviews the State of Play in Activism

As we approach the start of the 2018 proxy season, developments since January 2015 prompt a brief review of the state of play.

  • There has been no slowdown in the U.S.; there has been a significant increase in other countries.
  • Perhaps the most cogent description of what can be expected is contained in a must-read Bloomberg article, The World’s Most Feared Investor. “Aggressive, tenacious and litigious to a fault, Paul Singer may be the most feared activist investor in the world—by hedge fund rivals, companies and even countries. Singer’s Elliott Management Corp., which manages $34 billion of

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Settling the Staggered Board Debate

There are two starkly different sides to the heated debate over staggered boards. On one are those who argue, based in part on work by Professors Lucian Bebchuk and Alma Cohen, that the staggered board is value decreasing because it enables the entrenchment of inefficient directors and management. On the other side are proponents of the exact opposite argument, based in part on work by Professors Martijn Cremers, Lubomir Litov, and Simone Sepe and on the views of lawyer Martin Lipton, that the staggered board increases firm value because it allows directors to bargain for higher takeover premiums and to … Read more

Davis Polk Analyzes the Fed’s New Corporate Governance Guidance

The Federal Reserve’s proposed supervisory guidance on corporate governance is a breath of fresh air that should encourage banking boards to focus on their core responsibilities and avoid blurring the distinctions between executive and non-executive duties.  It is also a signal that supervisors intend to move away from the blunt “check-the-box” approach to corporate governance that has especially burdened banking boards in recent years.  We applaud this rebalancing in supervisory approach.

The following comments on this positive development are offered in the hope that the guidance, when finalized and as implemented, will avoid an overly prescriptive, “one-size-fits-all” approach.

Risk Is

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The Corporate Governance of National Security

A central goal of corporate law is to make managers accountable to shareholders. So it may come as a surprise that America’s federal government frequently compels companies to “effectively exclude the Shareholder from . . . influence over the Corporation’s business or management [.]”[1] Indeed, there is a federal agency whose principal is to ask companies to entrench the board of directors, waive the duty of loyalty, and hire individuals with little business experience to run the company.

That agency is located in the Pentagon. The managers hired and entrenched are former spies, military officers, and law enforcement officials. … Read more

Ethical Bankers

The capstone of regulatory reform in the wake of the financial crisis can be characterized as an effort to change the financial industry by getting bankers to behave more ethically. Regulators have emphasized the importance of “culture” set by a “tone at the top” that makes “ethical conduct” a primary organizational value—though they have not given much content to any of these terms.

Janet Yellen, chair of the Federal Reserve Board, has said: “[W]e expect the firms we oversee to follow the law and to operate in an ethical manner. Too often in recent years, bankers at large institutions have … Read more

Dow Jones Erred By Going Nuclear on Dual-Class Shares

In July 2017, Dow Jones, goaded by the reaction to Snapchat having gone public with a class of shares without voting rights, announced that, after extensive consultation, it had decided to henceforth eliminate companies with dual-class shares from its indices, in particular the S&P 500 Index.

Over the last 10 years, putting money in passive index funds has become a popular form of investment. An index fund is a pool of money invested in a way that is proportional to the composition of an overall index, the S&P 500 being the most popular. Already in 2016, index funds managed … Read more

How Investor Activism Affects Corporate Social Responsibility

Prominent activist investors such as hedge funds, pension funds, and influential individual shareholders and families increasingly aim to reshape corporate policies and strategy. In our paper “Shareholder Engagement on Environmental, Social, and Governance Performance”, we use a proprietary dataset covering 660 companies globally over 2005-2014 to study investor activism promoting environmental, social, and governance (ESG).

In the past two decades, socially responsible investing (SRI) has grown from niche to mainstream. The 2015 report of the UN Principles for Responsible Investing indicates that a large number of institutions (managing about $59 trillion) have endorsed these investing principles, thereby declaring … Read more

How Financial Constraints Affect Stock-Price Crash Risk

Financial crises and corporate scandals like those involving Enron, Worldcom, or Fannie Mae have triggered increased academic research into the probability of stock price crashes. Stock price crashes have a material impact on investor welfare, and so are of interest to investors making portfolio investment decisions. By understanding the factors that determine the variations in crash risk, investors can better predict and avoid future stock price crashes. In a recent paper, we examine whether and how financial constraints on companies affect the risk that their stock prices will crash. We define, per Lamont et al. (2001), financial constraints as frictions … Read more

PwC Explains Why Fraud Governance Means More Than Just Compliance

Fraud incidents have increased by over 130 percent in the past year, resulting in significant monetary and reputational losses for financial institutions. Many of these incidents — including high-profile crimes such as the Society for Worldwide Interbank Financial Telecommunication (“SWIFT”) attacks from last year — involved the exploitation of governance deficiencies and ineffective operating models.1

Maintaining proper governance for risk management has been a major point of focus for industry groups and regulators, including the Office of the Comptroller of the Currency, the Basel Committee on Banking Supervision, the Committee of Sponsoring Organizations of the Treadway Commission, and the … Read more

Law and Corporate Governance

Few research topics over the last two decades have proven as alluring and elusive as corporate governance.  Its allure is self-evident: Since the turn of the 21st century, a growing number of pundits, commentators, and scholars have argued that high quality corporate governance matters in creating and preserving firm value. And accordingly, various courts, legislatures, regulators, and boards of directors have introduced a host of governance reforms in response.  Yet the topic is also elusive, largely because corporate governance operates through a wide variety of means, including the financial structure of a company, economic incentives, monitoring, formal authority, real authority, … Read more

Were Non-Independent Boards Really Captured Before Sarbanes-Oxley?

A central question in the corporate governance literature concerns the impact of boards on performance. Some studies support the view that governance structures endogenously arise as optimal solutions to the contracting environment of the firm. Many studies support an opposing view that governance structures can be captured by CEOs in ways that reduce monitoring, promote rent seeking by executives, and exacerbate corporate wrongdoing.

Papers in this latter vein generally support Sarbanes-Oxley era reforms that changed corporate governance and mandated independent boards of directors. However, clean evidence on the average effect of requiring independent boards is limited and contested, and basic … Read more

How Irrational Actors in the CEO Suite Affect Corporate Governance

Recent news of sexual harassment and other legal controversies at Uber and throughout Silicon Valley serves as a vivid reminder that irresponsible and unethical conduct continues across the corporate landscape. Revelations of serious transgressions by senior corporate leaders belies a central assumption underlying contemporary corporate law theory. Much of corporate law is premised on rational actor theory – the idea that the law should be designed to leverage each person’s propensity to act in his rational self-interest. Corporate theorists have invoked this idea to promote a legal regime that relies on a system of incentives to cajole, but not command, … Read more

The Case Against Passive Shareholder Voting

In the past few years, investors have begun to embrace the reality that academics have been championing for decades—that a broad-based passive indexing strategy is superior to picking individual stocks or actively managed mutual funds. As a result, millions of investors have abandoned actively managed mutual funds, or “active funds,” in favor of passively managed funds, or “passive funds.” This past year alone, investors withdrew $340 billion from active funds (approximately 4 percent of the total) while investing $533 billion into passive funds (growing the total by 9 percent).

This historically unprecedented shift is good news for investors, who benefit … Read more

How Dual Class Shares in IPOs Can Create Value

The shareholder empowerment movement (the “movement”), driven primarily by public pension funds and union-related funds with over $3 billion in assets, has renewed its effort to eliminate, restrict, or at least discourage companies from creating dual class share structures in initial public offerings (IPOs).  The impetus was the issuance of non-voting stock in the recent Snap Inc. IPO.  Such advocacy, if successful, would not be trivial, as many of our most valuable and dynamic companies, including Alphabet (Google) and Facebook, have gone public by offering shares with unequal voting rights.

The movement’s vigorous response to Snap Inc.’s hugely successful IPO … Read more

Benefit Corporations and Public Markets

Benefit corporations are a new legal form of business association created to support social enterprises. Over half of U.S. states have adopted a benefit corporation statute, and over 2,000 companies have chosen the form. So far, almost all of these are closely held corporations. However, if this innovation really takes off, publicly traded companies may choose to become benefit corporations. It is instructive to consider the problems such companies may face, and what corporate governance mechanisms might help address those problems. In a recent paper I explore these questions, with a particular focus on the structure of early experiments in … Read more

Latham & Watkins Discusses How Healthcare Firms Can Prepare for the Next Cyberattack

On June 2, 2017, in the wake of the widespread cyberattack caused by the WannaCry ransomware cryptoworm, the US Department of Health & Human Services (HHS), Office for Civil Rights (OCR) added to its arsenal of cybersecurity guidance a checklist to assist HIPAA Covered Entities and Business Associates in responding to cyber-related security incidents (the Cybersecurity Checklist).1 The Cybersecurity Checklist focuses on entities’ execution of their incident response plans as well as external reporting obligations, and encourages entities to perform certain mitigating efforts, including sharing information with private-sector information-sharing and analysis organizations (ISAOs). In addition, recent OCR enforcement matters … Read more

Do Contracts for Executive Compensation Maximize Firm Value?

In a recent study, we examine whether executive compensation contracts are designed to maximize firm value. There is considerable debate regarding executive compensation in both the public arena and academia. On the one hand, proponents of the “value maximization” theories claim that executive compensation contracts are optimally designed to attract and provide incentives for executives in a competitive job market to maximize shareholder value. On the other hand, proponents of the “rent extraction” theories suggest that market forces fail in this setting, because executives are able to practically set their own compensation, therefore executive compensation contracts are set sub-optimally … Read more

The Rise of Regulatory Affairs in Innovative Startups

A few years ago, signs of change started to appear in the startup world. Media headlines began reporting battles between regulators and Uber and Airbnb. Sharing economy companies faced worker classification issues, and fintech companies bumped up against securities regulation, lending laws, and licensing requirements. Former politicians and government aides joined startup boards. A top-tier venture capital firm created the first policy and regulatory affairs group to help its portfolio companies navigate laws affecting their businesses and foster contacts with policy makers, regulators, and investors.

In a forthcoming book chapter, available here, I describe the increasing importance of regulatory … Read more

How Sarbanes-Oxley Affects Board Changes and CEO Turnover

Following the corporate governance scandals of the early 2000s, the effectiveness of board monitoring came into question. In response, Congress passed the Sarbanes-Oxley Act of 2002 (SOX) in an attempt to increase monitoring and improve corporate governance. In conjunction with SOX, exchange listing requirements required firms to have a majority of independent directors on their boards.  While firms that did not already have such a majority were forced to alter their board structures, SOX may also have prompted other firms to alter the composition of their boards.  In our recent paper, published in the Journal of Banking and Finance, … Read more