Corporate Purpose and the Dangers of Government-Mandated CSR

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

Do Anti-Pledging Policies Have Unintended Consequences for Corporate Governance?

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

What Comes After Shareholder Primacy? Employee Empowerment

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

Do Credit Rating Agencies Detect Accounting Frauds?

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

Nuveen Offers 2019 Proxy Season in Review

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

Blockchain-Based Corporate Governance

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, Financial Analysts, and Equity Overvaluation

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

Exequity Discusses Economic Voodoo and ISS’ Use of Economic Value Added

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:[1]

“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

How CEOs’ Experience at Buyout Targets Affects Corporate Policies

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

The Goals of the Corporation and the Limits of the Law

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

Wachtell Lipton Discusses Stakeholder Governance and the Fiduciary Duties of Directors

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

Business Roundtable’s Statement on Corporate Purposes Has Noble Aims but Creates Uncertainty

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

Richards Kibbe & Orbe Discusses Limited Legal Implications of Business Roundtable Statement

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,[1] 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

Are Audit Committees Suffering from Overload?

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

Wachtell Lipton Discusses Stakeholder Corporate Governance: Business Roundtable and CII

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

How Rank and File Equity Compensation Affects Earnings Management

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

Addressing Economic Insecurity: Why Social Insurance Is Better Than Corporate Governance Reform

The question that emerges from proposals to elevate a corporation’s “purpose,”[1] 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

Economic Consequences of Corporate Governance Disclosure

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