The challenges that directors of public companies face in carrying out their duties continue to grow. The end goal remains the same, to oversee the successful, profitable and sustainable operations of their companies. But the pressures that confront directors, from activism and short-termism, to ongoing shifts in governance, to global risks and competition, are many. A few weeks ago we issued an updated list of key issues that boards will be expected to deal with in the coming year (accessible at this link: The Spotlight on Boards, and discussed on the Forum here). Highlighted below are a few of the more significant issues and trends that we believe directors should bear in mind as they consider their companies’ priorities and objectives and seek to meet their companies’ goals.
Posts Tagged ‘Steven Rosenblum’
Last week, The Federalist Society’s 2014 National Lawyers Convention featured a session dedicated to the short-termism debate and the evidence put forward by Professors Lucian Bebchuk, Alon Brav, and Wei Jiang in their study, The Long-Term Effects of Hedge Fund Activism. The session began with a presentation by Professor Bebchuk that outlined the key findings and implications of the study. Three panelists then offered their reactions to the study: Jonathan Macey, Sam Harris Professor of Corporate Law, Corporate Finance, and Securities Law, Yale Law School; Robert Miller, Professor of Law and F. Arnold Daum Fellow in Corporate Law, University of Iowa College of Law; and Steven Rosenblum, a partner at Wachtell, Lipton, Rosen & Katz. The debate was moderated by E. Norman Veasey, former Chief Justice, Delaware Supreme Court.
Professor Bebchuk’s presentation slides are available here. The Bebchuk-Brav-Jiang study is available here, and posts about the study, including one published by critics of the study, are available on the Forum here.
About a year ago, Professor Lucian Bebchuk took to the pages of the Wall Street Journal to declare that he had conducted a study that he claimed proved that activist hedge funds are good for companies and the economy. Not being statisticians or econometricians, we did not respond by trying to conduct a study proving the opposite. Instead, we pointed out some of the more obvious methodological flaws in Professor Bebchuk’s study, as well as some observations from our years of real-world experience that lead us to believe that the short-term influence of activist hedge funds has been, and continues to be, profoundly destructive to the long-term health of companies and the American economy.
Corporate risk taking and the monitoring of risks have remained front and center in the minds of boards of directors, legislators and the media, fueled by the powerful mix of continuing worldwide financial instability; ever-increasing regulation; anger and resentment at the alleged power of business and financial executives and boards, including particularly as to compensation during a time of economic uncertainty, retrenchment, contraction, and changing dynamics between U.S., European and emerging market economies; and consistent media attention to corporations and economies in crisis. The reputational damage to boards of companies that fail to properly manage risk is a major threat, and Institutional Shareholder Services now includes specific reference to risk oversight as part of its criteria for choosing when to recommend withhold votes in uncontested director elections. This focus on the board’s role in risk management has also led to increased public and governmental scrutiny of compensation arrangements and their relationship to excessive risk taking and has brought added emphasis to the relationship between executive compensation and effective risk management. For the past few years, we have provided an annual overview of risk management and the board of directors. This overview highlights a number of issues that have remained critical over the years and provides an update to reflect emerging and recent developments.
We published this post last August. Since then there have been several developments that prompt us to revisit it; adding the first three paragraphs below.
First, Delaware Supreme Court Chief Justice Leo E. Strine, Jr. published a brilliant article in the Columbia Law Review, Can We Do Better by Ordinary Investors? A Pragmatic Reaction to the Dueling Ideological Mythologists of Corporate Law in which he points out the serious defects in allowing short-term investors to override carefully considered judgments of the boards of directors of public corporations. Chief Justice Strine rejects the argument of the academic activists and activist hedge funds that shareholders should have the unfettered right to force corporations to maximize shareholder value in the short run. We embrace Chief Justice Strine’s reasoning and conclusions.
In the latest instance of proxy advisors establishing a governance standard without offering evidence that it will improve corporate governance or corporate performance, ISS has adopted a new policy position that appears designed to chill board efforts to protect against “golden leash” incentive bonus schemes. These bonus schemes have been used by some activist hedge funds to recruit director candidates to stand for election in support of whatever business strategy the fund seeks to impose on a company.
In many respects, the relentless drive to adopt corporate governance mandates seems to have reached a plateau: essentially all of the prescribed “best practices”—including say-on-pay, the dismantling of takeover defenses, majority voting in the election of directors and the declassification of board structures—have been codified in rules and regulations or voluntarily adopted by a majority of S&P 500 companies. Only 11 percent of S&P 500 companies have a classified board, 8 percent have a poison pill and 6 percent have not adopted a majority vote or plurality-vote-plus-resignation standard to elect directors. The activists’ “best practices” of yesterday have become the standard practices of today. While proxy advisors and other stakeholders in the corporate governance industry will undoubtedly continue to propose new mandates, we are currently in a period of relative stasis as compared to the sea change that began with the Sarbanes-Oxley Act and unfolded over the last decade.
In other respects, however, the corporate governance landscape continues to evolve in meaningful ways. We may be entering an era of more nuanced corporate governance debates, where the focus has shifted from check-the-box policies to more complex questions such as how to strike the right balance in recruiting directors with complementary skill sets and diverse perspectives, and how to tailor the board’s role in overseeing risk management to the specific needs of the company. Shareholder engagement has been an area of particular focus, as both companies and institutional investors have sought to engage in more regular dialogue on corporate governance matters. The evolving trend here is not only the frequency and depth of engagement, but also a more fundamental re-thinking of the nature of relationships with shareholders and the role that these relationships play in facilitating long-term value creation. Importantly, this trend is about more than just expanding shareholder influence in corporate governance matters; instead, there is an emphasis on the roles and responsibilities of both companies and shareholders in facilitating thoughtful conversations instead of reflexive, off-the-shelf mandates on corporate governance issues, and cultivating long-term relationships that have the potential to curb short-termist pressures in the market.
ISS Proxy Advisory Services recently recommended that shareholders of a small cap bank holding company, Provident Financial Holdings, Inc., withhold their votes from the three director candidates standing for reelection to the company’s staggered board (all of whom serve on its nominating and governance committee) because the board adopted a bylaw designed to discourage special dissident compensation schemes. These special compensation arrangements featured prominently in a number of recent high profile proxy contests and have been roundly criticized by leading commentators. Columbia Law Professor John C. Coffee, Jr. succinctly noted “third-party bonuses create the wrong incentives, fragment the board and imply a shift toward both the short-term and higher risk.” In our memorandum on the topic, we catalogued the dangers posed by such schemes to the integrity of the boardroom and board decision-making processes. We also noted that companies could proactively address these risks by adopting a bylaw that would disqualify director candidates who are party to any such extraordinary arrangements.
Empirical studies show that attacks on companies by activist hedge funds benefit, and do not have an adverse effect on, the targets over the five-year period following the attack.
Only anecdotal evidence and claimed real-world experience show that attacks on companies by activist hedge funds have an adverse effect on the targets and other companies that adjust management strategy to avoid attacks.
Empirical studies are better than anecdotal evidence and real-world experience.
Therefore, attacks by activist hedge funds should not be restrained but should be encouraged.
Harvard Law School Professor Lucian A. Bebchuk is now touting this syllogism and his obsession with shareholder-centric corporate governance in an article entitled, “The Long-Term Effects of Hedge Fund Activism” (previously discussed here). In evaluating Professor Bebchuk’s article, it should be noted that:
A long-term oriented, well-functioning and responsible private sector is the country’s core engine for economic growth, national competitiveness, real innovation and sustained employment. Prudent reinvestment of corporate profits into research and development, capital projects and value-creating initiatives furthers these goals. Yet U.S. companies, including well-run, high-performing companies, increasingly face:
- pressure to deliver short-term results at the expense of long-term value, whether through excessive risk-taking, avoiding investments that require long-term horizons or taking on substantial leverage to fund special payouts to shareholders;
- challenges in trying to balance competing interests due to excessively empowered special interest and activist shareholders; and
- significant strain from the misallocation of corporate resources and energy into mandated activist or governance initiatives that provide no meaningful benefit to investors or other critical stakeholders.