Securities Mosaic® Blogwatch
October 10, 2019
ISS Offers 2019 Overview of Virtual Shareholder Meetings in the U.S.
by Marie Clara Buellingen

Key Findings

  • While overall the share of virtual annual meetings among Russell 3000 firms has increased to 7.7 percent, the number of new adopters has decreased in each of the last two years.
  • There does not seem to be a link between governance structure and company meeting format. Companies with virtual meetings appear no more likely to have poor governance provisions.
  • Similarly, the dissent levels on key voting items such as say-on-pay and director election appear to not vary materially for both physical and virtual meeting holders.
  • When adopting a new meeting format, companies and shareholders should evaluate key considerations to protect shareholder rights and address both concrete and perceived risks associated with a virtual meeting format.

Meeting format proliferation

Supporters of virtual shareholder meetings hail the benefits of giving more shareholders the opportunity to attend and actively participate in annual meetings, while reducing the cost to shareholders. Critics emphasize that the intangible benefits of in-person interaction could be lost, and that virtual meetings could also present problems with standard meeting procedures (such as presenting shareholder proposals). They argue that the virtual meeting format could give boards too much sway over the discussion and allow boards to avoid uncomfortable questions more easily.

While physical shareholder meetings remain, by far, the most common approach for U.S. companies, the number of virtual meeting in the Russell 3000 has tripled since 2014. Given this growth and the ongoing debate on the merits of virtual meetings, understanding the potential benefits and risks of this format as well as the characteristics of companies that adopt the practice appears pivotal to forming a stance on the issue.

In the traditional physical meeting format, the board, management, and shareholders gather in a pre-arranged location. Shareholder meetings for U.S. companies take place all over the country and in certain cases even outside the U.S. Depending on the shareholder base, the location may influence how many shareholders can easily attend. Both the sheer number of annual meetings of portfolio companies as well as the cost of attending are barriers for many shareholders. Virtual meetings, where shareholders can attend meetings all over the world via a webcast, aim to address those barriers.

Shareholder meeting terminology:

Physical meeting: Shareholders and company representatives gather in a physical location. No remote attendance available.

Webcast meeting: Shareholders and company representatives gather in a physical location, and the proceedings are available to shareholders via webcast or teleconference. Certain opportunities may not be provided to remote participants, such as presenting shareholder proposals.

Virtual meeting: Shareholders and company representatives gather virtually only; no in-person attendance is available. All opportunities afforded to shareholders at a physical meeting are offered virtually.

Hybrid meeting: Shareholders have the opportunity to attend either a physical meeting or a virtual meeting. All opportunities afforded to shareholders at the physical meeting are available virtually.

Best practices specific to virtual shareholder meetings continue to develop since virtual shareholder meetings are still a relatively new phenomenon. On a fundamental level, companies adopting a virtual meeting format must comply with relevant state of incorporation regulations and applicable listing requirements as well as their own bylaws. In addition, companies must have the technical and security capabilities to ensure the meeting follows comparable standards to physical meetings (such as participant verification, record keeping etc.). Moreover, the overall shareholder base should have comparable opportunity to participate.The best meeting format for a given company depends on legal & bylaw requirements as well as best practices that emerge over time. Overall hybrid meetings may best balance meeting approaches by expanding the group of shareholders while also addressing the concerns of not losing the benefits of in person discussions. However, hybrid meetings currently account for less than 1% of annual meetings and their year-over-year growth lags considerably behind virtual meetings.

Virtual meetings considerations

As virtual meetings are still a relatively new phenomenon, best practices are still emerging. At a minimum the meeting format a company chooses must meet the respective exchange requirements. Moreover, the format must ensure that shareholders can exercise all rights granted under the state of incorporation can be fully exercised. Lastly, the format needs to meet a company’s bylaw requirements.

Beyond these minimum standards, companies and shareholders need to feel confident that the annual meeting format will afford all stakeholders a fair, complete, effective, and secure forum. Among the things that should be evaluated are:

  • Will the virtual meeting format result in broader meeting attendance?
  • Does the company have the right technical capabilities (in particular, the participant verification process and record keeping) to meet standards comparable to that a of physical meeting?
  • Does the virtual meeting platform provide all participants with adequate security?
  • Does the virtual meeting format actually save the company money, after ensuring that the right cyber and procedural safeguards are in place?
  • How will the company ensure fairness in questions that are allowed and moderated during the meeting? What criteria will be used to evaluate questions to be presented?
  • How does the company intend to address issues, including technical and procedural issues, that may arise due to the virtual meeting format?
  • Does the company intend to solicit feedback from shareholders regarding the virtual meeting format? How will that feedback be collected?
  • Does the company propose to provide an alternative forum for person-to-person interaction among the company, board, and shareholders?

Before switching the meeting format, companies may need to consult with key shareholders to understand if there are any concerns with the switch and how those concerns should be addressed. Designing the meeting structure with the specific needs of the shareholder base in mind will likely make the transition smoother.

What can happen when best practices are not followed became evident at this year’s AGM at General Motors. Shareholders filed a Notice of Exempt Solicitation urged to vote against the Chairman and CEO Mary Barra, Lead Director Tim Solso, and governance committee chair Patricia Russo due to the company’s decision to hold a virtual shareholder meeting and avoid uncomfortable discussions (“Who wants to stand in front of a live audience and explain shrinking sales, epic recalls and loss of market share? It is so much easier to explain it to a microphone.”).

Communication and IT firms lead the way in virtual meeting adoption

While virtual meetings have increased across sectors, our analysis showed no significant difference between S&P 500 companies and the rest of the Russell 3000. While most sectors have seen year-over-year increases in the adoption of the format, the Information Technology and Communications Services sectors have led the way. As discussed above, a range of factors go into choosing a meeting format. For IT and Communications Services companies, being ahead on technology trends reflects their core business. It’s unsurprising to find a higher prevalence of virtual meeting adopters in this group.

While a small group of companies seems to have experimented with different meeting formats over the past five years, a majority of companies stick to a new format once making the switch. In terms of new virtual meeting adopters, our analysis suggests that pace of adoption has slowed over the past couple of years.

Virtual meeting uptake has also slowed. This may suggest that companies value in-person interaction to communicate their vision for the company and the company’s progress. Engagement on a wider range of issues including social and environmental concerns across sectors is growing and many companies already have an ongoing dialog with a wider range of their shareholder base over the course of the year. As such virtual meetings may provide an alternative to physical meetings for a subset of companies. At present, they appear unlikely to become the norm.

Virtual meeting adopters, on average, do not have poor governance structures

Unlike several European markets, there is no requirement in the U.S. to obtain shareholder approval to switch from a physical to a virtual meeting format. Some skeptics believe that companies shifting to virtual meetings may have certain governance features that discourage them from facing shareholders in person.  With this concern in mind, we analyzed the data to determine if, in aggregate, patters exist to support this notion. The analysis looks at companies both listed and incorporated in the U.S. from July 2014 to June 2019 in the Russell 3000.1

Companies where the most recent meeting was virtual appear to have a slightly higher share of controlling shareholders and unequal voting rights. Looking at the sector distribution of companies in the virtual meeting group, the IT and Communication Services sector rank high. These sectors are known for having a higher concentration of these governance structures. In general, governance structures and practices appear comparable for both virtual and physical meeting groups.

Our analysis did not reveal significant differences in shareholder dissent as a measure of alignment of company and shareholder stances on key voting proposals – from say-on-pay to director elections.

Future of Virtual Meetings

Companies that have adopted a virtual meeting format and those who have stuck to the physical meeting format all seem to have comparable governance structures and practices. Looking at shareholder vote dissent as a proxy for alignment between companies and shareholder, our analysis found no significant difference in opposition levels on key voting items.

All meeting formats have potential drawbacks and benefits. Companies adopting virtual meetings should follow best practices that protect shareholder rights and the meeting format overall is conducive to similar interactions as physical shareholder meetings.

While overall the proportion of virtual meetings has increased, the rate of new adoption has slowed. In an age where ongoing shareholder engagement on a wide range of topics is increasingly the norm, companies appear to value the benefits of in-person interaction. Hybrid meetings, which allow both virtual and physical participation, may strike the best balance by expanding the group of shareholders while also maintaining the benefits of in-person discussions.


1: In our analysis we could only identify two bylaw amendment proposals to switch to a virtual meeting format last year – received by a Russell 3000 firm incorporated in the U.K. (Gates Industrial Corporation plc) and a non-Russell 3000 company (Achieve Life Sciences, Inc). There were two shareholder proposals filed since July 2014 asking companies to hold “In-Person Shareholder Meetings” (in 2018 American at Outdoor Brands Corporation and in 2017 at Hewlett Packard Enterprise Company). Both proposals were omitted due to either dealing with the ordinary course of business of the company or not meeting the stock ownership requirements.

This post comes to us from Institutional Shareholder Services. It is based on the firm’s memorandum, “Virtual Shareholder Meetings in the U.S.: 2019 Update,” dated September 26, 2019.

October 10, 2019
The Valuation and Governance Bubbles of Silicon Valley
by Jesse M. Fried and Jeffrey N. Gordon

The rise and fall of The We Company IPO bubble is one of those events that, like the subprime mortgage bubble that preceded the financial crisis, calls for an examination of market structures that could have produced such a precipitous turnabout.  Indeed, the two bubbles share similar features, namely, structural features that favor the expression of positive sentiments and make it difficult to express negative sentiments.  We call this “one-sided market sentiment.”

Some of the most famous moments of the financial crisis, memorialized in print and film, turned on how intrepid traders determined that impenetrably complex mortgage-backed securities were overvalued (because based on mortgages issued to parties who were unlikely to repay) and then figured out a way to bring that negative sentiment to the market.  Unless you can see how to make money on your contrarian pessimism, what’s the point of the investigation?

One of the most notorious events of the financial crisis, the so-called “Abacus” offering put together by Goldman Sachs that packaged toxic MBS tranches into a securitization sold to European institutional buyers, was actually designed as a mechanism for hedge fund manager John Paulson to short the subprime market.  Paulson bought the short side of the Abacus CDO that Goldman tailored to his specification.  The advent of the ABX index in 2007 – which reported average credit default spreads on the various tranches of MBS debt – offered perhaps the first routine channel for expressing negative sentiment about the subprime market (since a party might be able to take the short side of a derivative that used the ABX index as “the underlying” – the security or benchmark on which the derivative is based).  Economist Gary Gorton has argued that this new channel precipitated the subprime panic and repo runs of 2007.

The takeaway is this: A market that makes it difficult and costly to express negative sentiments is prone to a bubble and thus an abrupt collapse when negative fundamentals finally become too pervasive to ignore. Historically, stock markets have been bubble-prone because short-selling was mechanically difficult and expensive.  Many think that the bubble of the 1990s was exacerbated by such potent barriers to short-selling.  One decided positive about valuations in today’s public equity market is that the rise of index funds has significantly lowered the cost of short-selling because index funds are eager participants in the stock-lending market.  Short-selling apparently accounts for one-third of current public equity market trading. So, one might conjecture, today’s stock market prices may better represent the balance of negative and positive sentiment about a firm’s prospects and the general economy.

What’s the We-translation?  First, note that We’s prospective IPO underwriters were pitching an extraordinary valuation for the post-IPO company, $65 billion, for a company that lost money and burned cash at an impressive rate.  The last round of private financing for We implicitly valued the company at $47 billion.  Yet valuation estimates today in the wake of the failed IPO are closer to $20 billion, even $15 billion.  That’s a valuation bubble and a collapse!

We was also seized of a governance bubble.  The underwriters had permitted charter terms that ceded an extraordinary level of control rights to then-CEO Adam Neumann.  The contemplated equity structure called for three classes of common stock, with Neumann holding shares of a super-voting class with 20 votes per share and another class of stock with zero votes per share that could be used to raise additional equity.  The arrangement would have locked Neumann and his heirs into an unassailable control position until the end of time. Post-IPO failure, Neumann was fired as CEO, family members were excluded from the board, and his stock was reduced to 3 votes per share, stripping him of uncontestable control.  That’s a governance bubble and a collapse.

Our view is that the We bubbles of valuation and governance were in significant part the result of the one-sided sentiment that is a feature of the market for high-tech start-up finance that has evolved in Silicon Valley.  What are the economic incentives facing venture capital firms (“VCs”)? They make their money the new-fashioned way, by assembling pools of capital from institutional investors and wealthy individuals or families and using this capital to invest in promising new business ventures.  The VCs earn management fees on the collected funds and share in the value-appreciation of any investments. The VCs may also invest alongside the managed funds. The key to big time success in this world is access to the start-ups with the highest chance of home-run returns, a la Google or Facebook.

The Silicon Valley high-tech start-up market is flooded with money looking for high-end returns. VCs will naturally disagree as to which projects are most interesting.  The diversity of views naturally means that start-ups are funded by those who are most optimistic about their prospects.  If you don’t believe in the opportunity, you don’t invest.  If you think the valuation implied by the investment terms is too high, you don’t invest.  The point is that, in this financing environment, Silicon Valley start-ups will be disproportionately funded by those who are most optimistic about the firm’s prospects. This bias is true not only in the early-stage investment moment but also in successive rounds of VC finance.   The tendency to overvaluation is thus akin to models of bidder overpayment, in which winners in a competitive auction are disproportionately likely to be overly optimistic.

Except it’s worse.  Unlike in bidder overpayment models, where each bidder thinks she’s paying a reasonable price, VCs may knowingly overpay for shares in late-stage hot startups so they can “logo shop”: list them on their portfolio page. This can help the VCs raise a new, larger fund – with bigger management fees. VCs may also have an incentive to overpay for high-variance startups when their existing portfolio companies are underperforming and, absent a few big wins, the VCs are unlikely to generate carry.

There is no way in the Silicon Valley economic ecosystem to “short” an excessively valued start-up.  That is one consequence, some would think a virtue, of being a private company rather than a public company that has to contend with short sellers, who will not necessarily be pure-minded fundamental value traders. Yes, there is a secondary market in limited partnership interests, but this is not an effective way to communicate firm-specific negative sentiment.[1]

This structural feature would account for valuation bubbles.  What about governance bubbles? The dynamic is similar.  For greatest success, a VC needs access to the best opportunities. In an environment of surplus finance, the entrepreneur will have many potential funders to choose from.  Obviously there are many other elements that influence the entrepreneur’s decision about which VC is best (particularly the VC’s track record at helping other start-ups succeed), but one critical factor will be how much control the entrepreneur will retain, especially at the moment of the IPO.  In the private stage, there will be jostling between the entrepreneur and the VCs, which will be bounded by the entrepreneur’s skill and early success as well as by the VC’s desire to maintain a reputation of being helpful to entrepreneurs. When the firm goes public, the VC recedes and the entrepreneur wants raw control.  A reputation for willingness to exit on these terms may well be one important way that VCs compete for entrepreneurs’ favor.

On governance, the parties can point to Google’s success – but was that because of or despite the unusual control structure?  Microsoft/Gates and Amazon/Bezos succeeded without dual-class stock. Apple’s eventual success may have required the exile and return of Steve Jobs, a redemption story that dual-class common could have disrupted. Uber and now We present a decidedly cautionary tale, as perhaps does Facebook in its response to growing public policy concerns.

Is there a remedy for one-sided market sentiment?  The private label mortgage backed securities market has yet to recover.  Perhaps the Silicon Valley valuation bubble will be self-correcting.  The remedy for bidder overpayment in mature markets like oil leases is repeat-play by sophisticated parties, who build in internal checks against excessive optimism.  Fiascos like the We IPO withdrawal and IPOs with negative returns like Uber and recently Peleton may exert some market check.

Following a suggestion of our colleague Gabriel Rauterberg, we could also imagine the introduction of a Silicon Valley valuation index that, like the ABX, would offer a derivatives-based avenue for expressing general short interest. An index provider like IHS Markit could infer valuations of the latest funding rounds from preferred stock terms found in publicly available charters (if VCs would not provide explicit information). One could argue that such an “SVX” index vehicle could well serve the VCs’ long-term interests by reducing the risk of a boom-bust cycle that would damage the VC financing channel even if it might suppress current valuations.

One of us (Gordon) thinks that the governance bubble may provide an argument for a mandatory rule against dual-class common structures (or at least limitations on their potency; for example, the ratio of voting rights or its duration).  VCs face a collective commitment problem.  Net welfare would be better off if they could agree on limiting entrepreneurs’ governance grasping, but in the absence of the capacity to agree, the resulting equilibrium predictably produces a low-quality governance bubble.  Some regulator could produce a higher value result.  The “regulator” might well be the exchanges through a listing standard or the stock index providers, though exchanges (Hong Kong, for example) are moving towards accepting disproportionate voting structures rather than tightening standards.

The other of us (Fried) would object to such intervention, on the grounds that regulators are unlikely to know better about the desirability of a dual-class structure at a particular firm than the sophisticated players in U.S. markets.  Indeed, only a minority of VC-backed IPOs are dual-class, suggesting that investors like (or are at least willing to accept) that structure for some firms but not for others.  If dual-class structures prove to be problematic, their use will decline.

Bubbles may be easier to identify than to resolve.


[1] Although venture capital and private equity are commonly lumped together as “private” as opposed to “public” finance, these considerations help us appreciate the differences.  A PE sponsor critically depends upon third-party debt finance in its funding model.  A failed PE portfolio company could well produce a bankruptcy that imposes significant losses on creditors.  These losses – unlike equity losses – could not be recouped by a roaring success on another company, because debt payouts are fixed and because PE equity claims and PE debt claims are held in different portfolios. A successful PE firm needs repeated access to debt markets and thus would try to avoid debt defaults.  We’ve seen PE firms inject additional equity into failing firms to avoid a bankruptcy – meaning, risk throwing good money after bad despite the lack of legal obligation – to protect the on-going access to moderately priced debt finance that is critical to their business model.  Thus the PE funding model should offer a lower propensity to valuation bubbles than the VC funding model.

This post comes to us from professors Jesse M. Fried at Harvard Law School and Jeffrey N. Gordon at Columbia Law School.

October 10, 2019
Corporate Control Across the World
by Elias Papaioannou, Gur Aminadav

Understanding the driving forces and consequences of the various types of corporate control are core inquiries of corporate finance. While most economics and legal theory distinguishes between widely-held corporations with dispersed ownership and controlled firms where a dominant shareholder exerts control, corporate structures are complex. Pyramids that allow shareholders to influence decisions over their cash-flow rights and cross-holdings of equity in business groups are pervasive. Moreover, ownership and control are often hidden behind shell companies incorporated in off-shore centers. Equity blocks—that entail some controlling rights—are commonplace, even in companies that most would coin as widely-held.

In a series of influential works Rafael La Porta, Florencio Lopez-de-Silanes, Andrei Shleifer and Robert Vishny (1997, 1998, 1999) tried to bridge economics and law research, compiling data on ownership concentration, corporate control, and legal protection of investors for a large number of countries. The subsequent voluminous literature on law and finance explores the role of the legal tradition, imposed by colonial powers, as well as corporate law, shareholder and creditor protection, securities legislation, and regulatory features on corporate control and finance (see La Porta, Lopez-de-Silanes, and Sheifer (2006) for an overview).


In a recent article, we explore the role of legal origin on corporate control across the world, relying on a newly-compiled dataset that codifies control for 42,700 listed firms, incorporated in 127 countries in 2007-2012. This is a considerably larger sample than that used by earlier papers or country/regional case-studies. Given the wide use of equity blocks, we distinguish between three types of firms: widely-held corporations, widely-held corporations with one or more equity block(s), defined as voting rights in excess of 5%, and controlled firms with a dominant shareholder. We split controlled firms into state-controlled, family-controlled, and controlled by other listed or private firms. Our analysis proceeds in three steps.

Mapping Corporate Control

In the first part of our article, we provide an anatomy of corporate control with the newly compiled data that cover roughly 90% of world stock market capitalization in 2012. Figure 1 provides a mapping. The Berle and Means (1932) type of corporation with many small shareholders is almost absent in Africa (in Uganda, Ivory Coast, Ghana, Namibia, Botswana, and Kenya more than 75% of the firms are controlled) and in Eastern Europe (in the Czech Republic, Bulgaria, Lithuania, Romania, and Russia more than 75% of the firms have a controlling shareholder). In contrast, the share of controlled firms is low (below 30%) in New Zealand, Canada, US, UK, Ireland, Australia, and Taiwan. There is non-negligible variability within regions. In Western Europe, the share of controlled firms ranges from around 80% in Austria, Malta, and Greece to around 20% in the United Kingdom and Ireland with Spain and Switzerland in the middle. In Asia, corporate control ranges from 78% in Indonesia to around 20%-30% in Australia and Taiwan and around 47% in India.

Figure 1. Corporate Control across the World

We also provide mappings for the pervasiveness of family-controlled firms. The cross-country mean (median) is 17.5% (16.7%). When we add firms controlled by unidentified private owners, the cross-country average (median) doubles. Family-control is omnipresent in countries with strong family ties, such as Greece, Italy, Portugal, Argentina, and Lebanon, while there are relatively few family-controlled listed corporations in Taiwan, Ireland, and Australia. Likewise we map state control around the world. Government control is (close to) zero in 18 countries (e.g., United States, Canada, Latvia, Estonia), but it exceeds 20% in 11 countries, mostly in Africa (e.g., Uganda, Ghana), the Arab World (Oman, Qatar, UAE), and also Russia and China.

Legal Tradition and Corporate Control

In the second part of the article, we re-examine the “reduced-form” correlation between corporate control (and ownership concentration) and legal origin, as well as economic development. The large sample is useful, as most previous studies worked in smaller firm samples with limited country coverage; and they often focused on large firms. The big sample is especially helpful in examining heterogeneity with respect to firm size and age, aspects that may affect control and in turn be affected by the institutional environment. We uncover the following robust regularities.

1. There are large differences in corporate control across legal families. The share of controlled firms is the highest among French civil-law countries, followed by German and then Scandinavian civil-law countries. The share of controlled firms is the lowest in common-law countries. Similar patterns apply for ownership concentration, measured as the sum of the voting rights of the three (or five largest) shareholders (see Figure 2).

Figure 2. Ownership Concentration in French Civil Law and Common Law Countries

2. Equity blocks are commonplace, as we observe them in more than 80% of non-controlled firms; this applies across all regions, in both civil-law and common-law countries. Yet, the share of widely-held firms with blocks is the highest in French civil-law and the lowest in common-law countries (figure 3).

Figure 3. Corporate Control across Legal Families

3. Institutions and Corporate Control. In the third part of the article, we examine the correlation between corporate control and the institutional features that legal origin theories emphasize. While these correlations do not identify causal effects, they allow examining the potential role of investor protection, court efficiency, red tape, and labor market regulation on corporate control in a simple unified framework. Figure 4 gives a summary of the correlational analysis. The graph plots the univariate correlation between corporate control and institutional proxies of investor protection, courts quality, entry, and labor market regulation. The dots show the point estimate (bold red dots denoting statistically significant correlation) and the horizontal lines show 95% confidence intervals (based on clustered at the country standard errors).The significant cross-country correlation between corporate control (and ownership concentration) and legal origin applies for large, medium, and small listed firms; it also applies for young and old firms.

4. Dispersed ownership correlates with GDP per capita. But, the correlation is not particularly strong, as it masks heterogeneity. The negative correlation between income and control is significant only in the sample of above-median-size firms; it is especially strong for big corporations (top 10% of global market cap). The correlation is zero in the sample of small and medium-sized public companies. This novel finding echoes the results of Hsieh and Klenow (2014), who after showing that productivity differences between Mexico, India, and the United States (US) are pronounced for (very) large firms and muted for small firms, hypothesize that this reflects medium-sized firms’ inability to expand in emerging markets, because of financial frictions.

Institutions and Corporate Control

In the third part of the article, we examine the correlation between corporate control and the institutional features that legal origin theories emphasize. While these correlations do not identify causal effects, they allow examining the potential role of investor protection, court efficiency, red tape, and labor market regulation on corporate control in a simple unified framework. Figure 4 gives a summary of the correlational analysis. The graph plots the univariate correlation between corporate control and institutional proxies of investor protection, courts quality, entry, and labor market regulation. The dots show the point estimate (bold red dots denoting statistically significant correlation) and the horizontal lines show 95% confidence intervals (based on clustered at the country standard errors).

The key takeaways are:

  1. Corporate law provisions allowing legal action against managers who abuse their position, are systematically linked to disperse ownership. This result is consistent with the core idea of the law and finance literature that corporate control substitutes for weak shareholder protection (La Porta et al., 1997, 1999).
  2. The correlation between control and creditor rights is small and statistically insignificant. This result reaffirms the finding of La Porta et al. (1999) that shareholders’ rather than creditors’ rights matter for corporate control.
  3. Legal formalism, as reflected by various measures of the time needed to resolve disputes via courts, is weakly related to corporate control and ownership concentration.
  4. Corporate control and ownership concentration are not much related to entry barriers and red tape.
  5. There is a strong correlation between control and labor regulation. In countries with a high percentage of controlled firms, labor legislation is sclerotic, imposing restrictions for overtime and firings; and union membership and power are relatively high. This result is consistent with political theories of corporate control that emphasize the role of post-Great Depression and World War II welfare-state policies in finance (Roe, 2000, 2006; Rajan and Zingales, 2003, 2004). These theories stress the interplay between controlling shareholders (families and the state), workers, and outside investors that labor laws shape (Pagano and Volpin, 2005). Controlling shareholders and corporate insiders collaborate with employers at the expense of minority-outside shareholders in countries with stringent labor legislation.

Figure 4. Corporate Control and Institutions. Univariate Correlations. 2004-2012

Our large sample findings, therefore, support both legal origin (e.g., Glaeser and Shleifer, 2002; La Porta et al. 1998) and political theories of corporate control (Roe, 2000; Rajan and Zingales, 2003, Pagano and Volpin, 2005). In line with the law and finance literature, corporate control is systematically linked to the legal origin and the protection of minority shareholders. In line with political theories, economic development is also a strong correlate of control, though only for the (very) large firms that tend to be the most productive. Labor market (welfare state) legislation is also a strong correlate of corporate control, suggesting inter-linkages between finance and labor markets that most likely reflect the political equilibrium.

The complete article is available article.

October 10, 2019
Predicting Long Term Success for Corporations and Investors Worldwide
by Allen He, Bhakti Mirchandani, Evan Horowitz, Steve Boxer, Victoria Tellez, FCLTGlobal

Through our research, FCLTGlobal aims to identify the key determinants of long-term success for companies and investors around the world. We then use this knowledge to encourage long-term behaviors across capital markets. This post focuses on predictors of long-term health that are grounded in rich global data going back over time. Looking across the value chain—at companies, asset managers, and asset owners—we find the following:

  • Global companies are falling short on long-term behaviors. Companies are scoring lower than they did in 2014, and well below the level reached before the financial crisis, on our overall measure of long-term behavior.
  • Overdistribution of capital can be a drain on corporate performance. Although distributing capital via buybacks and dividends makes sense in some circumstances, our analysis finds that companies taking this approach tend to generate lower five-year returns on invested capital (ROIC, our preferred measure of performance).
  • Corporate research and development (R&D) can boost returns. By looking at the marginal value of additional research spending, we show that R&D investments are linked to higher ROIC.
  • Employee ownership is linked to higher returns among global asset managers. Employee ownership is the strongest predictor of success for asset managers, particularly those in equity investing.
  • Net returns for asset owners are linked to both governance and investment strategy. Relevant factors include board diversity, active ownership, lower costs, a higher funded ratio, and higher exposure to both public and private equity. Of course, not all drivers of long-term success are easily measured or detected, and if more data were available, we could deepen our understanding of vital factors such as talent retention and customer loyalty. But even with existing data limitations, we are able to confirm some well-known predictors of long-term success and also unearth some novel ones. What follows is a fuller account of our findings, our methodology, and our thoughts on how best to extend these results in the future.


Factors Associated with Long-term Performance of Corporations

Our analysis identified a range of factors associated with the long-term health of companies, which we split into two buckets: positively correlated factors that predict long-term health and negatively correlated factors that suggest weakness ahead.

The factor most strongly bound to long-term performance was actually one of those negative factors—something to avoid—namely, overdistribution of capital in the form of dividends and buybacks that exceed the free cash flow generated by the company. Naturally, efforts to return money to shareholders can and do make sense when companies do not have more attractive investments to pursue. And it is possible that the causal link actually runs in the other direction—that is, companies with limited growth potential may be more likely to return money to shareholders. But our analysis shows that capital distributions to investors in excess of free cash flow are associated with weaker ROIC.

Another factor that weighs on long-term value creation is excessive leverage—though, again, this is not a blanket dismissal, as leverage can be vital to businesses and borrowing can be an auspicious sign that a company has ideas worth pursuing. As a general tendency, though, more leverage among companies in our dataset translates into lower ROIC.

Factors Associated with Long-term Performance of Asset Managers

Asset managers with the strongest long-term gross returns tend to have a high level of employee ownership, which may help to align incentives. Having high net inflows is also a positive indicator, though this finding may reflect the ability of successful managers to attract money—rather than any tendency for growth to improve returns.

On the flip side, turnover among portfolio managers is an indicator of trouble ahead as is strategy proliferation.

Factors Associated with Long-term Performance of Asset Owners

Given the data limitations, the only discrete factor that we were able to definitively associate with long-term success is the percentage of a portfolio allocated to equities—where higher equity allocation is a statistically significant predictor of long-term value creation. Although we recognize that this finding may reflect the rising equity markets during the 2012-17 time frame that we are considering, it is consistent with research on how the risk premium affects equity returns over time. Pooling factors suggests that net returns may be connected to a suite of strategies and behaviors that include gender diversity on the board, strategic engagement, lower costs, a higher funded ratio, and higher exposure to both public and private equity.

Conclusion: More Data Means Richer Knowledge

The depth and breadth of our findings is limited by the availability of high-quality and complete global datasets. To counter these limitations, we followed a rigorous process beginning with a thorough literature review of academic and investment research to identify factors supported by existing studies. We then decided to focus on factors with rich, global data (and no more than 20 percent missing data), allowing us to measure granular change year over year. After consulting with a broad range of experts, we moved to the data analysis phase, using more than 20 million data points to distill which of the pre-vetted factors had a statistically significant impact on long-term value creation.

While we are proud of the rigor of this approach, no method is perfect. Our focus on factors with broad data prevented us from evaluating aspects of talent and culture that we know are vital to the long-term prospects of corporations, asset managers, and asset owners. These include customer satisfaction and employee engagement, both of which have been shown to be connected to long-term success.

Similarly, although our minimum 80 percent data completeness standard limited some of the biases associated with missing data, it also eliminated whole dimensions of information from our purview, such as executive compensation duration—which has been linked to long-term performance in academic work but where global data is currently incomplete. Such incomplete data create space for omitted variable issues, distorting our ability to measure the true explanatory power of the factors that we can regress (omitted variable issues plague a wide range of attempts to describe complex multidimensional issues with academic rigor). But even with imperfect data, we were able to advance the state of knowledge around long-term behaviors by isolating and identifying a number of the key factors correlated with long-term success around the world and across the value chain. In the corporate world, that includes appropriate reinvestments in the business rather than overdistributions of capital, productive R&D, and an end to quarterly guidance—to name just a few. For asset managers, it means embracing employee ownership as a paramount concern (on the equity side). And among asset owners, it means embracing the reality of the equity risk premium, among other things.

The next step—for FCLTGlobal in particular and the spread of long-term thinking in general—is to amass a richer universe of data and a broader array of methodologies to drive the research forward. We are working with our members and other business, academic, and policy leaders to accomplish just that while pursuing a more integrated approach to understanding the deepest drivers of long-term success, whether they have to do with governance, incentives, engagement, strategy, or public policy.

The complete publication is available here.

October 10, 2019
Chief Justice Strine’s “New Deal”
by Liz Dunshee

When Delaware Chief Justice Leo Strine announced that he’d be leaving the bench this fall, Broc speculated that grander things were yet to come. Now, the influential judge is kicking off his “retirement” with a bang – by publishing this proposal that would recommit to “New Deal” concepts. In particular, the proposal focuses on workers’ rights and a reformed shareholder voting/proposal process (e.g. requiring a “say-on-pay” vote only once every 4 years and changing shareholder proposal thresholds).

This isn’t a big surprise given some of Chief Justice Strine’s prior comments. But it’s more comprehensive. And while he doesn’t go as far as Senator Warren’s “Accountable Capitalism Act,” he does comment that companies are “societally chartered institutions” – notable for a Delaware judge! – and proposes requiring “workforce committees” for boards of all large companies (whether public or private). Here’s an excerpt on that point (and also see this Cooley blog):

To make sure that companies give careful consideration to worker concerns at the board level, the Proposal requires the Securities and Exchange Commission, the Department of Labor, and the National Labor Relations Board to jointly develop rules that would require the boards of companies with more than $1 billion in annual sales to create and maintain a committee focused on workforce concerns. By requiring these committees at all large corporations, not just public corporations, more accountability would be imposed on large private companies, such as those owned by private equity firms, to treat their workforce fairly.

These workforce committees would be focused on addressing fair gain sharing between workers and investors, the workers’ interest in training that assures continued employment, and the workers’ interest in a safe and tolerant workplace. These workforce committees would also consider whether the company uses substitute forms of labor—such as contractors—to fulfill important corporate needs, and whether those contractors pay their workers fairly, provide safe working conditions, and are operating in an ethical way, and are not simply being used to inflate corporate profits at the expense of continuing employment and fair compensation for direct company employees.

Offering a middle-ground between the current system and “codetermination”-style worker representation, the committees would be required to develop and disclose a plan for consulting directly with the company’s workers about important worker matters such as compensation and benefits, opportunities for advancement, and training. Finally, the National Labor Relations Act would be amended to ensure that companies can use dedicated committees to consult with their workers without running afoul of the Act’s prohibition on “dominating” labor organizations, provided that the company doesn’t interfere with, restrain, or coerce employees in the exercise of their rights to collective bargaining and self-organization. In essence, this would allow for European-style “works councils” without impeding union formation and representation.

Should the SEC Get Out of the “Stakeholder Disclosure” Business?

I think most securities practitioners can agree that it’s exhausting to shoehorn certain Congressional mandates for broader ’33 & ’34 Act reporting into the SEC’s mission to protect investors – and when these types of mandates come around, they also seem to be at odds with the Commission’s mission to facilitate capital formation. At the same time, a variety of stakeholders are clamoring for information, and the SEC runs the main disclosure game in town.

This paper by Tulane law prof Ann Lipton plays some of the same notes as Chief Justice Strine’s proposal (and it was actually published before his). For example, that it’s outdated to make disclosure requirements dependent on a company’s capital raising strategy. Here’s part of the abstract:

This Article recommends that we explicitly acknowledge the importance of disclosure for noninvestor audiences, and discuss the feasibility of designing a disclosure system geared to their interests. In so doing, this Article excavates the historical pedigree of proposals for stakeholder-oriented disclosure. Both in the Progressive Era, and again during the 1970s, efforts to create generalized corporate disclosure obligations were commonplace. In each era, however, they were redirected towards investor audiences, in the expectation that investors would serve as a proxy for the broader society. As this Article establishes, that compromise is no longer tenable.

Who would regulate this brave new world? Personally, I think that if the SEC’s mission was expanded, it would be well-suited to take on the challenge – but I’m not sure they’d want the job. Here’s what Ann suggests:

There is currently no federal agency with the skills to manage the system contemplated here. The SEC is not equipped to manage disclosures intended for noninvestors (which is another reason the securities laws should not be used for that purpose). The Federal Trade Commission has broad experience studying business activity, but has fewer disclosure mandates. That said, the SEC and the FTC both have skills and experience that would be useful in developing a new system: both study a wide range of industries, and the SEC in particular has expertise in developing standardized reporting for public audiences, balanced against the costs to businesses of complying with disclosure demands.

Therefore, it might be appropriate to create a joint initiative that draws on the resources and knowledge of both agencies. The initiative could begin its work by studying how public information about corporations is used by noninvestor audiences, including surveying local regulators, as well as advocacy and trade groups, for their input as to how existing disclosures are used and the weaknesses in the current system. Based on the results of this survey, the initiative could develop a standardized framework that would permit meaningful comparisons across reporting companies.

New! Quick Survey on Hedging Policy Disclosure

At our conference a few weeks ago a few weeks ago (which you can still register & watch via video archive), there were a lot of questions about how companies will handle the newly required hedging policy disclosure. Take a moment to participate in our 3-question “Quick Survey on Hedging Policy Disclosure” and see what others are planning to do.

Liz Dunshee

October 10, 2019
“Test-the-Waters” Rule Lets Companies Dip a Toe in IPOs
by Phil Brown

It has been a rough year for IPOs, as highly touted offerings keep flopping. Ride-sharing service Uber Technologies Inc. has seen its stock price fall more than 30% from the time it went public in May. The stock of Lyft Inc., meanwhile, is trading at less than half its price on the day it went public in March.

Other prospective go-publics have pulled the plug on their IPOs before they could even get to market. WeWork’s hyped offering fell apart last week amid concerns about the company’s corporate governance, while talent agency and media company Endeavor Group shelved its IPO at the last second in September.

Would these companies have benefited from the new version of the “test-the-waters” rule adopted by the Securities and Exchange Commission (SEC) last month? The rule allows companies to gauge interest in potential securities offerings through discussions with investors. (Basketball fans may recognize the “test the waters” parlance from the description of the process by which college basketball players can assess their NBA draft prospects while still retaining amateur status.)

Previously, testing the waters was only open to issuers that qualified as “emerging growth companies” (EGCs), including IPO issuers and new SEC registrants. The rule change expands that opportunity to all companies and their underwriters. “Investors and companies alike will benefit from test-the-waters communications, including increasing the likelihood of successful public securities offerings,” said SEC Chairman Jay Clayton.

The spirit of the rule certainly seems to fit with recent efforts by policymakers to reenergize capital-raising in U.S. public markets. According to a trio of partners at the law firm Sidley Austin LLP writing on a Harvard Law School corporate governance blog, “EGCs, especially those in the healthcare, technology, media, telecommunications and energy industries, and potential underwriters acting on behalf of EGCs find [test-the-waters] communications very useful in their efforts to raise capital.” Moreover, research conducted by Ernst & Young LLP on registration statements indicates the vast majority of IPOs recently have come from the pool of EGCs.

In February, lawyers at Sullivan & Cromwell LLP concluded that the proposal to expand the rule “would significantly change the communications landscape for many non-EGC issuers and allow them to communicate more freely with institutional investors to gather reliable information about investor interest before registered offerings.” The aforementioned Sidley Austin lawyers took a more skeptical view of new rule’s actual benefits. They noted that issuers with effective shelf registration statements can already market securities prior to launch in many cases. Additionally, they pointed out that companies mulling offerings can make use of other rules that allow them to communicate with prospective investors.

As such, although the latest iteration of the test-the-waters rule may limit the compliance burden for some companies before they make their case to investors, whether it actually leads to many conversations that weren’t already taking place is an open question.

View today's posts

10/10/2019 posts

CLS Blue Sky Blog: ISS Offers 2019 Overview of Virtual Shareholder Meetings in the U.S.
CLS Blue Sky Blog: The Valuation and Governance Bubbles of Silicon Valley
The Harvard Law School Forum on Corporate Governance and Financial Regulation: Corporate Control Across the World
The Harvard Law School Forum on Corporate Governance and Financial Regulation: Predicting Long Term Success for Corporations and Investors Worldwide Blog: Chief Justice Strine’s “New Deal”
Blog – Intelligize: “Test-the-Waters” Rule Lets Companies Dip a Toe in IPOs

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