Abstract

In this Essay, we propose a modified version of the SPAC designed to allow the public to participate in the world of corporate activism. Unlike existing SPACs, our version is designed for investments in public companies in order to change their course of action, not in private companies in order to make them go public, and overcomes many of the problems that pertain conventional SPACs. At present, direct investment in activism is reserved to affluent individuals and other professional investors of activist hedge funds. The public at large is barred from directly entering the activist arena. The current model comes at a triple price: first, critics argue that activism in its current form is slanted toward short-termed engagements, possibly neglecting potential profitable long-term engagements. Second, although loud, the current scope of activism is relatively modest. Activist engagements only reach 2.3 percent of the public companies traded on U.S. markets. Third, retail investors cannot directly share in the excess profits stemming from activism. The introduction of the Activist SPAC can change this reality. The Activist SPAC would allow interested retail investors to invest money in a corporation dedicated to Activist engagement. To ensure the success of the enterprise, the future target of the investment would not be made public at the time of the investment. Once the Activist SPAC buys a toehold position in the target and announce its plan, the investors would receive an opportunity to get their money back, should they choose to do so, or go along with the activist plan. As we show in the Essay, setting up Activist SPACs can transform the character of corporate activism by rendering it more attuned to long-term objectives, and is especially fit to pursue ESG goals. It would also give the public a voice in the future world of activism and allow it to share in its benefits directly as well as increase the scope of corporate activism. To enable these advantages, the current regulatory framework must change. We present a blueprint for the introduction of Activist SPACs, analyze the requisite key parameters and explore the legal and regulatory steps required to ensure their success. Innovation is the lifeblood of financial markets. The Activist SPAC may well mark their future path.

Abstract

The allegation that activist investors demand changes that increase short-term stock prices at the expense of long-term shareholder value (“short-termism”) has led to extensive research on interventions by hedge funds. Few studies include other private (non-hedge fund) activists, even though we find they constitute almost half of interventions. Using a 20-year sample that includes over 2,000 interventions by each type of activist, we find that short- and long-window abnormal returns are positive and economically significant around ownership announcements for each activist, and they do not reverse. Importantly, positive returns are observed for both sale and most other (non-sale) demands. Demands to sell all, or part, of the targeted firms earn especially sizable returns, and interestingly, sale demands are made more frequently by other private activists than by hedge funds. Despite the sizable returns, informed users do not regard the equity as overvalued. Analysts’ recommendations become more favorable—a reversal of the pre-announcement trend—and long-term, “dedicated” institutional investors increase their ownership. We also find post-intervention improvements in operating performance (ROA) and firm valuation (Tobin’s Q), further justifying the positive response by market participants. Our study provides new evidence that activism increases long-term shareholder value and opens an avenue for a line of research on other private activists.

Abstract

Corporate law is again taking center stage in practice, policymaking, and scholarship. Despite this, commentators have yet to adequately answer a very preliminary question: is corporate law part of private law, or is it public law? This distinction has far-reaching implications for ongoing policy discussions, including the debate between shareholder and stakeholder conceptions of the firm, epitomized by a series of recent high-profile legislative proposals and scholarly works.
As this Article demonstrates, corporate law is indeed private law. Relying on broader legal and economic theory, together with insights from the new private law (NPL) literature, this Article responds to the four main types of arguments raised by public theorists of corporate law: that the corporation’s affairs are dictated by its state-issued charter; that the requirement of registration with a state agency makes the corporation a “creature of the state”; that the mandatory, structural features of corporate law make it public law; and that corporations are required to take into account the interests of a broad array of stakeholders. Each claim is based on real-world observations, but as this Article illustrates, in every case, those facts actually point to corporate law being part and parcel of private law—just as much as contract, property, or tort law.
At the same time, this Article also explains how corporate law advances broader rule of law considerations. Corporate law is far from being the contractarian regime envisioned by some scholars since the 1980s. Instead, corporate law—like contract, property, and tort, albeit even more systemically—requires strict compliance with positive law (both public and private), and strongly upholds values of interpersonal justice and fairness. This Article expands on these points in a highly nuanced manner, not previously recognized in scholarship, or in the wider public debate about corporations in society.

Abstract

To investigate the widespread claim that stock market short-termism is a major drag on U.S. corporate investment, R&D, and the broad economy, the author examines trends in corporate capital investment, buybacks, and R&D that stretch back, in some cases, over the past 50 years. (He briefly summarizes firm-level data and explains their limits in making policy recommendations.) As critics of market-driven corporate short-termism have pointed out, U.S. corporate investment in capital equipment and other tangible assets has been falling steadily since the late 1970s, and buybacks have been rising. This relationship is suggestive of large public firms pushing out their cash and weakening their capacity to invest. But if the story of economy-wide short-termist decline due to stock market pressure were valid and strong, we would expect to see the following: (1) investment spending in the United States declining faster than in Europe and Japan, where large companies depend less on stock markets for capital and where shareholder activists are less influential; (2) cash from large share buybacks inducing a bleeding out of cash from the U.S. corporate sector; and (3) economy-wide declines in corporate R&D spending.
What the author reports, however, is U.S. corporate R&D spending, far from falling, has been rising since the 1970, and is rising faster than the economy is growing. And while corporate distributions of capital through dividends and gross buybacks have also been rising sharply for decades, corporate cash holdings (as a percentage of total assets), are at near record high levels. The best explanation for such high cash holdings together with record-high payouts—and perhaps the author’s most striking finding—is that such distributions are closely matched to new corporate borrowings. What’s more, the annual pattern of net payouts by S&P 500 companies, often mature companies, is remarkably similar to net new investment into smaller public companies outside of the S&P 500 companies.
Since capital spending by European and Japanese companies—which face neither U.S.-style quarterly-oriented stock markets nor aggressive activist investors—has been falling more rapidly than in American companies suggests that U.S. capital markets may not be a particularly powerful source of corporate shortsightedness. The author brings forward alternative explanations. These trends do not preclude the possibility that had the critics’ proposals been in place decades ago, investment, R&D, and overall performance would have been even better. But before embarking on potentially expensive reforms we should have more confidence that there is indeed a severe problem that needs addressing. For example, while critics see short-termism as damaging American R&D, the numbers show corporate R&D spending to be rising, while government support for innovation and R&D has been falling since the financial crisis. If innovation needs more support, it’s the government cutbacks that would first seem to need to be addressed.

Abstract

We examine the impact of financial disclosures’ readability on future shareholder activism, as expressed by shareholder-initiated proxy proposals. Based on a sample of 1,560 proposals made by shareholders of 818 S& P 1500 firms between 2000 and 2014, we find that the semantic complexity of the MD& A section of the 10-K filings significantly predicts future shareholder proposals. Ceteris paribus, firms with more unreadable MD& A sections are more likely to face a higher incidence of shareholder proposals, up to two years in the future. We show that our results are robust to the inclusion of several alternative readability metrics; reverse causality check, and instrumental variables approach; subsample analyses, as well as a variety of confounding events

Abstract

Despite the ever-growing influence of shareholders in corporate governance, interested voting is a topic that has not been fully explored. While the law is attentive to transactions with a controlling shareholder, such transactions hardly cover all instances in which an interested shareholder may harm the corporation by casting a pivotal vote determining the outcome of a resolution. This Paper is the first to offer a systematic mapping of interested voting based on type of shareholder resolution and type of shareholder. It describes existing approaches on interested voting, by categorizing them as bright-line rules, open-ended standards or “anything goes.” Aside from policing controlling shareholders and, to a lesser extent, acquirers in M&A transactions, the law does not offer any remedies in several other areas in which interested voting might occur, thus de facto establishing “anything goes” as the default regime.
This Paper makes several contributions to the literature. First, it reckons that in some fields “anything goes” has its merits: whenever policies to tackle interested voting are difficult to implement and adjudicate, “anything goes” limits transaction and enforcement costs, as well as litigation rents. However, in some other fields, such as M&A and other financial transactions that one way or another are subject to a shareholder vote, tailored approaches come at a premium because “anything goes” would otherwise leave investors unprotected. Regulating interested voting can curb certain market failures if voting outcomes could systematically be swayed by votes at odds with common interests of shareholders—in the long run, this would result in a reduction of wealth, if certain interest groups could organize and take advantage of such a lax approach. Moreover, if “anything goes” is really the default law of the land, we must confront with some troublesome realities: (i) nearly half of close-vote transactions pass thanks to interested voting; (ii) insiders and other repeat players like index funds and hedge funds (especially arbitrageurs) are more likely to cyclically be pivotal, undetected interested voters and take advantage of a lax regime (this is particularly problematic in our age of reconcentration of corporate ownership); and (iii) the corporate law system would have less basis to justify certain pillar doctrines (Unocal, Blasius, C & J Energy, and Corwin) on shareholders’ ability to vote for their preferred solution if in fact votes might be easily tainted by interested voting.

Abstract

The fear that business corporations have claimed unwarranted constitutional protections which have entrenched corporate power has produced a broad social movement demanding that constitutional rights be restricted to human beings and corporate personhood be abolished. We develop a critique of these proposals organized around the three salient rationales we identify in the accompanying narrative, which we argue reflect a narrow focus on large business corporations, a misunderstanding of the legal concept of personhood, and a failure to distinguish different kinds of constitutional rights and the reasons for assigning them. Corporate personhood and corporate constitutional rights are not problematic per se once these notions are decoupled from biological, metaphysical or moral considerations. The real challenge is that we need a principled way of thinking about the priority of human over corporate persons which does not reduce the efficacy of corporate institutions or harm liberal democracies.

Abstract

The allegation that activist investors demand changes that increase short-term stock prices at the expense of long-term shareholder value (“short-termism”) has led to extensive research on interventions by hedge funds. Few studies include other private (non-hedge fund) activists, even though we find they constitute almost half of interventions. Using a 20-year sample that includes over 2,000 interventions by each type of activist, we find that short- and long-window abnormal returns are positive and economically significant around ownership announcements for each activist, and they do not reverse. Importantly, positive returns are observed for both sale and most other (non-sale) demands. Demands to sell all, or part, of the targeted firms earn especially sizable returns, and interestingly, sale demands are made more frequently by other private activists than by hedge funds. Despite the sizable returns, informed users do not regard the equity as overvalued. Analysts’ recommendations become more favorable—a reversal of the pre-announcement trend—and long-term, “dedicated” institutional investors increase their ownership. We also find post-intervention improvements in operating performance (ROA) and firm valuation (Tobin’s Q), further justifying the positive response by market participants. Our study provides new evidence that activism increases long-term shareholder value and opens an avenue for a line of research on other private activists.

Abstract

ESG has rapidly become a household name leading to both confusion about what it means and creating unrealistic expectations about its effects. In this paper, I draw on more than a decade of research to dispel several myths about ESG and provide answers to important questions around theories of influence, the relation between ESG and corporate value, and the usefulness of ESG assessments and ratings.

Abstract

We explore how the Sarbanes–Oxley Act of 2002 created pressure for firms to take more visible and costly corrective action following the announcement of an earnings restatement. Building on theory about focusing events, the institutional effects of legislative change, and the agenda-setting role of the media, we propose that Sarbanes–Oxley created reactive normative pressure on firms that announce earnings restatements, increasing the likelihood of CEO replacement in their aftermath. We theorize that Sarbanes–Oxley changed the meaning—and therefore the impact—of media coverage of earnings restatements. Our findings show that firm behavior after Sarbanes–Oxley did change in ways that are consistent with the intent of the legislation: to increase executives’ accountability for the reliability of their firms’ financial statements. Moreover, we show this change is a result both of the direct effect of the legislation on increasing CEO accountability as well as through intensifying the effect of the media spotlight on misconduct

Abstract

Hedge fund activism generates persistent performance, but heterogeneity in performance suggests that some hedge fund activists are more skilled than others. We use a Markov Chain Monte Carlo Bayesian estimation algorithm to isolate a time-invariant activist-specific skill component from cumulative abnormal returns. We find considerable differences in this skill component of cumulative abnormal announcement returns of up to 13 – 20 percentage points between the top and bottom skill quintile of hedge fund activists. Out-of-sample tests confirm that our skill estimates are informative about future performance. Differences in skill are also evident in hedge fund activists’ campaign characteristics. The most skilled activists are associated with higher target firm takeover premiums and are more versatile in their use of campaign tactics.

Abstract

We identify persistent director style effects on corporate policies. Director style explains a significant amount of cross-sectional variation in firm policy variables for financing, investment, operations, and corporate governance, among others. The results are significantly different from counterfactual random assignments of directors to firms, validating the director style measures. We aggregate director styles at the firm level to create a median board style. Directors styles that deviate from board style, particularly on R\&D and executive compensation policies, are significantly more likely to leave the board or leave their appointment to key board committees. Style-divergent directors across all policies are also more likely to leave the board when the firm does well, as are those with divergent CEO compensation styles when the CEO’s salary is high. Board style has predictive power for future firm performance.

Abstract

Even against increasing interest in socially responsible investing mandates, we find that implementing ESG strategies can cost nothing. Modifying optimal portfolio weights to achieve an ESG-investing tilt negligibly affects portfolio performance across a broad range of ESG measures and thresholds. This is because those ESG measures do not provide information about future stock performance, either in relation to risk or mispricing, beyond what is provided by other observable firm characteristics. That the stock market does not reflect significant equilibrium pricing of ESG information is rationalized in a model of responsible investing wherein investors differ in which ESG-related criteria are used to weight their portfolios.

Abstract

What does it mean to be a fiduciary, and does it really matter whether the law labels a person a fiduciary or not? Until the late twentieth century Delaware corporate law could have given a singular, coherent answer to these questions; an answer that bore the deep imprint of fiduciary obligation fashioned in England in the early 19th century. Today, to its detriment, it is no longer able to provide clear answers to these questions. Through a close reading of Delaware’s early corporate fiduciary law and its contemporary going private case law, this article shows how late 20th century Delaware corporate law comingled, and then replaced, the traditional conception of what it means to be a fiduciary—which orbited the transfer and exercise of power (the power/undertaking conception)—with a conception which is power-blind and focused only on the influence and superiority that one person has over a more vulnerable other (the influence conception). The article tracks the accidental and unnoticed evolution of this conceptual shift and shows how it has altered the structure and source of Delaware fiduciary obligation, how it has significantly expanded the potential extent of fiduciary obligation, and how it has expanded the potential beneficiaries of such obligation. Delaware’s modern tool kit—including “the Duty of Loyalty”—as well as several modern fiduciary questions, uncertainties and anomalies are, the article argues, the product of this surreptitious 20th century appropriation of the conception of the “fiduciary”; without it, they would not exist.

Abstract

In a 2001 article (Function Over Form: A Reassessment of Standards of Review in Delaware Corporation Law) two of us, with important input from the other, argued that in addressing issues like hostile takeovers, assertive institutional investors, leveraged buyouts, and contested ballot questions, the Delaware courts had done exemplary work but on occasion crafted standards of review that unduly encouraged litigation and did not appropriately credit intra-corporate procedures designed to ensure fairness. Function Over Form suggested ways to make those standards more predictable, encourage procedures that better protected stockholders, and discourage meritless litigation, by restoring business judgment rule protection for transactions approved by independent directors, the disinterested stockholders, or both.

This article examines how Delaware law responded to the prior article’s recommendations, concluding that the Delaware judiciary has addressed most of them constructively, thereby creating incentives to use procedures that promote the fair treatment of stockholders and discourage meritless litigation. The continued excellence and diligence of the Delaware judiciary is one of Delaware corporate law’s core strengths.

But some recent cases have articulated standards of review that involve greater than optimal litigation intensity and less than ideal respect for decision-making in which independent directors and disinterested stockholders have potent say. Those standards also impair the integrity of Delaware’s approach to demand excusal in derivative cases and the identification of controlling stockholders. We also propose eliminating concepts like substantive coercion that do not provide a legitimate basis for resolving cases. Finally, we urge action to correct new problems such as the unfair targeting of corporate officers for negligence claims in representative actions and the frustrating state of practice under Delaware’s books and records statute.

Abstract

This Article addresses an important question in modern antitrust: when large investment funds have holdings across an industry, is competition depressed?

The question of the impact of common ownership on competition has gained much attention as the role of institutional shareholding has grown, with the funds of the three largest management companies holding in aggregate approximately 21% of the shares of a typical S&P 500 firm. It is a source of acute disagreement among scholars and policymakers, with some who believe common ownership does depress competition seeking antitrust law reforms that would significantly constrain how investment funds operate. Neglected in this vigorous debate, however, is a careful analysis of how the persons who in the first instance actually make the decisions that determine an industry’s competitiveness—firm managers— would act differently in the presence of common ownership. In essence, even if the common owners were to pressure firms to compete less, how, if at all, would that change the structure of incentives within which these managers work?

The forces that shape managerial decision-making at publicly traded firms have been the object of intense study by scholars of corporate governance for decades, primarily through use of managerial agency cost analysis. The question of how the dynamics among firms in a concentrated industry affect its level of competition has been subject to similarly intense scrutiny by industrial organization economists. We use learning from both of these fields to conclude that, at current levels, common ownership is unlikely to have a meaningful effect on the managerial structure of incentives in ways that the industrial organization theories suggest would affect competition. This conclusion thus cautions against the proposed antitrust reforms, which would solve a non-problem while adding to the costs of the investment vehicles of choice for tens of millions of ordinary
Americans.

Abstract

The animated discourse on corporate social responsibility towards stakeholders in the last two years, particularly as embodied through the terms ESG, corporate purpose and stakeholderism (which will be used in this article interchangeably) had reached a turning point even before the COVID-19 pandemic. In addition to drastically increasing ESG-related investments, corporate actors (including shareholders, other stakeholder groups, directors, officers, institutional and retail investors judges and regulators) have been making efforts to turn ideological statements into practical initiatives, emerging one after another at a dizzying pace. Without a doubt, the fields of ESG and purpose-based stakeholderism have become mainstream in the academic and practical discourse of business, finance and law.

Indeed, as is natural for changes that are perceived as paradigmatic and still in progress, there is not necessarily any consensus on such changes’ meaning, especially due to the absence of a theory that comprehensively describes, explains and justifies the increased discourse surrounding ESG issues.

This study aims to bridge the gap between the idealistic vision of stakeholder capitalism, as manifested today in ESG risks and opportunities, and the shareholder-focused history of corporate law. The main thesis of the article is that the new view of corporate purpose and stakeholder capitalism is closely related to the concept of fairness, and hypothesizes that certain foundational concepts developed in the realm of behavioral economics, rather than traditional economic theory, can help describe and justify the newfound prominence of the stakeholder approach and the rejuvenated discourse around the framing of corporate purpose.

The first two parts of the article are devoted to key insights from the world of behavioral economics and to the claim that the proliferation of declarative and practical ESG initiatives demonstrate powerfully how critical the idea of fairness is in human decision-making, in a manner that supports the findings of behavioral economics and which contradicts several basic assumptions of neoclassical economics. Based on these two parts, the article considers in its third part, the interrelationship between behavioral economics and the legal regulation of stakeholders and corporate purpose. This part opens with a descriptive review of the legal mechanisms – most of which are found within the basic doctrines of corporate law itself (such as separate legal personality, piercing the corporate veil and directors’ oversight duties) and not only in non-corporate fields (such as specific legislative acts, the contract law principles of good faith and public policy, class action and taxes), which impose obligations towards stakeholders, and liability for failing to meet those obligations – as an integral part of the evolving broader conception of corporate purpose. The third part also makes a normative claim through exploring the competitive advantage offered by “early adopters” of fair corporate behavior– a natural consequence of the fall of “will theory” in modern contract law and the related weakening of the “nexus of contracts” conception of the corporation.

The article concludes with the idea that the need to cope with the fairness bias, as emphasized by behavioral economics research, provides a solid foundation for legally implementing considerations of fairness into the modern corporation’s DNA by reframing the underlying approach towards the Companies Law, the primary legislation which regulates business sector activities. Such legal reframing of corporate purpose as one based on fairly considering stakeholder interests alongside profit-maximizing interests brings forth the expressive function of the law in integrating desired social and business norms based on an alternative culture of fairness and trust and serve as a significant and consistent keystone towards intrinsically implementing fairness and loyalty considerations into one of the most crucial economic (and social) institutions of our time.

Abstract

We propose a strategic theory of Corporate Social Responsibility (CSR). Shareholder maximizers commit to a mission statement that extends beyond firm value maximiza- tion. This commitment leads firms (either product market competitors or complementors along the value chain) to change their actions in ways that ultimately favor shareholders. We thus provide a formal analysis of the “doing well by doing good” adage. We also pro- vide conditions such that the mission statement game has the nature of a pure coordination game. Our framework thus provides a natural theory of firm leadership in a CSR context: by selecting a CSR mission statement, a first mover effectively leads the industry to a Pareto optimal equilibrium.

Abstract

Special Note: This Publication is part of The Quality Shareholder Initiative at the Center for Law, Economics and Finance (C-LEAF), at The George Washington University Law School, Prof. Lawrence A. Cunningham, Faculty Director.

This Article presents original data and analysis addressing an understudied force in corporate America: the most patient and focused shareholders. Great attention has been devoted to short-term trading on the one hand and diversified index funds on the other, but scant attention has been focused on long-term concentrated investors. The George Washington University has been redressing this problem through a research initiative focused on such buy-and-hold stock pickers, whom Warren Buffett long ago dubbed ‘quality shareholders’. GW’s Quality Shareholders Initiative (‘QSI’) is pleased to present highlights of the initial installment of this work in this Article in the Business and Finance Law Review at the George Washington University’s Center for Law, Economics, and Finance.

Abstract

According to a theory that is gaining increasing support, we should expect large asset managers (and, in particular, index fund managers) to become “climate stewards” and force companies to reduce their impact on climate change. According to this theory, by maximizing the value of their entire portfolio (portfolio primacy) rather than the value of the individual company (shareholder primacy), index fund managers are incentivized to reduce climate externalities and therefore to steer companies toward decarbonization.

This Article offers the first systematic critique of this theory and identifies four crucial limits that undermine its practical impact: mispricing of climate mitigation, portfolio biases, fiduciary conflicts, and insulation from index funds stewardship.

First, the stock market underestimates the social benefits of climate mitigation. In particular, stock prices do not accurately incorporate climate risk, and private investors discount the distant future at a much higher rate than the social discount rate.

Second, index funds are not real “universal owners”; rather, they invest in subsets of the economy that are relatively less vulnerable to climate change. Many of the Big Three index funds with the largest holdings in the top U.S. oil companies have incentives to oppose aggressive carbon mitigation measures, and even index funds with the broadest market bases internalize global climate externalities in a very limited way.

Third, climate stewardship would create unsolvable fiduciary conflicts on multiple levels: between fund managers and fund investors; between large asset managers and undiversified shareholders; and between corporate directors and the individual company.

Fourth, even if index fund managers undertook the role of climate stewards, most firms across the world would be partially or totally insulated from index fund stewardship, because they are privately held, are owned by state governments, or have a controlling or influential shareholder.

The analysis of this Article reveals the serious limits of portfolio primacy and shows that this approach offers no adequate answer to the crucial threat of climate change. Policymakers should not rely on portfolio primacy as an effective substitute for climate regulation.

Abstract

This Essay argues that shareholder activism in the United States is a social movement in which middle- and working-class shareholders, and the institutional investors that represent them, are mobilizing to reshape the distribution of power in corporate governance. Across various stages stretching over the last century, the shareholder activism movement has been defined by bursts of collective action challenging the structures of corporate power and the elites atop the corporate hierarchy. Americans have come to view shareholding and stock trading as important modes of resistance to the economic and political status quo and, as a consequence, shareholder mobilization is intensifying.

The social movements approach widens the aperture on corporate governance law as a field of study. The modern American corporate law academy, which has examined shareholder activism mainly through the lens of efficiency and agency costs, has failed to recognize shareholder activism as an evolving process of disruption. The mainstream approach has inhibited corporate law scholars from studying corporate governance as a dynamic system for reconciling economic and socio-political power. That inhibition, in turn, has caused scholars to miss an important process that is currently underway. A social-movements approach suggests that the current surge of activism—led by elite asset managers, with a young, tech-enabled class of retail investors visible on the horizon—is one stage in a sustained movement that stretches back more than a century.

Abstract

Controlling shareholders are subject to distinct legal obligations under Delaware law, and thus Delaware courts are routinely called upon to distinguish “controlling shareholders” from other corporate actors. That is an easy enough task when a person or entity has more than 50% of the corporate vote, but when a putative controller has less than 50% of the vote – and is nonetheless alleged to exercise control over corporate operations via other means – the law is shot through with inconsistency.

What is needed is a contextual approach that recognizes that the meaning of control may vary depending on the purpose of the inquiry. Under Delaware doctrine, the controlling shareholder label subjects that entity to unique legal treatment along three distinct dimensions. First, controlling shareholders – unlike minority shareholders – have fiduciary duties to the corporation. Second, interested transactions with controlling shareholders – unlike interested transactions with other fiduciaries – are subject to a unique cleansing regime in order to win business judgment deference from reviewing courts. Third, when certain transactions involving sales of control are challenged in court, they may be treated as direct rather than derivative actions, even when similar transactions that do not involve control sales would be treated as purely derivative.

By teasing out these three aspects of the legal framework and analyzing them separately, courts can more closely attend to the reasons why control carries special significance, and ultimately develop a more rational and consistent set of definitions. Most critically, courts may properly designate someone a controlling shareholder for some purposes, but not others.

Abstract

Directors are integral participants and stakeholders in outsider CEO succession events. This study examines the impact of professional director/CEO relationships in 1,173 outsider CEO successions on a range of fixed and short- and long-term, performance-related CEO compensation ratios. Results show that these relationships matter in determining the structure and composition of CEO compensation but that there are significant international differences, reflecting varying approaches to corporate governance, including board monitoring, in unique national institutional environments. Results also show that in the United States and other Anglo-Saxon capital markets, where institutional transparency is highly regarded, professional director/CEO relationships are associated with a restructuring of CEO compensation in favour of CEOs and against the interests of investors.

Abstract

In a 2001 article (Function Over Form: A Reassessment of Standards of Review in Delaware Corporation Law) two of us, with important input from the other, argued that in addressing issues like hostile takeovers, assertive institutional investors, leveraged buyouts, and contested ballot questions, the Delaware courts had done exemplary work but on occasion crafted standards of review that unduly encouraged litigation and did not appropriately credit intra-corporate procedures designed to ensure fairness. Function Over Form suggested ways to make those standards more predictable, encourage procedures that better protected stockholders, and discourage meritless litigation, by restoring business judgment rule protection for transactions approved by independent directors, the disinterested stockholders, or both.

This article examines how Delaware law responded to the prior article’s recommendations, concluding that the Delaware judiciary has addressed most of them constructively, thereby creating incentives to use procedures that promote the fair treatment of stockholders and discourage meritless litigation. The continued excellence and diligence of the Delaware judiciary is one of Delaware corporate law’s core strengths.

But some recent cases have articulated standards of review that involve greater than optimal litigation intensity and less than ideal respect for decision-making in which independent directors and disinterested stockholders have potent say. Those standards also impair the integrity of Delaware’s approach to demand excusal in derivative cases and the identification of controlling stockholders. We also propose eliminating concepts like substantive coercion that do not provide a legitimate basis for resolving cases. Finally, we urge action to correct new problems such as the unfair targeting of corporate officers for negligence claims in representative actions and the frustrating state of practice under Delaware’s books and records statute.

Abstract

Hedge fund activism refers to the phenomenon where hedge fund investors acquire a strict minority block of shares in a target firm and then attempt to pressure management for changes in corporate policies and governance with the aim to improve firm performance. This study provides an updated empirical analysis as well as a comprehensive survey of the academic finance research on hedge fund activism. We review the development, current state, and potential future trends beginning with the institutional background in which hedge fund activists operate, activists’ objectives, tactics, and the selection of target companies. Various firm outcomes are also discussed, with a focus on the financial and operating performance of targeted firms, the dynamics of engagement with fellow investors, and the impact on other stakeholders.

Beginning in the early 1990s, shareholder engagement by activist hedge funds has evolved to become both an investment strategy and a remedy for poor corporate governance. Hedge funds represent a group of highly incentivized, value-driven investors who are relatively free from regulatory and structural barriers that have constrained the monitoring by other external investors. While traditional institutional investors have taken actions ex post to preserve value or contain observed damage (such as taking the “Wall Street Walk”), hedge fund activists target under-performing firms in order to unlock value and profit from the improvement. Activist hedge funds also differ from corporate raiders that operated in the 1980s, as they tend to accumulate strict minority equity stakes and do not seek direct control. As a result, activists must win support from fellow shareholders via persuasion and influence, representing a hybrid internal-external role in a middle-ground form of corporate governance.

Research on hedge fund activism performed and reviewed in this study centers on how it impacts the target company, its shareholders, other stakeholders, and the capital market as a whole. Opponents of hedge fund activism argue that activists focus narrowly on short-term financial performance, and such “short-termism” may be detrimental to the long-run value of target companies. The empirical evidence, however, supports the conclusion that interventions by activist hedge funds lead to improvements in target firms, on average, in terms of both short-term metrics, such as stock value appreciation, and long-term performance, including productivity, innovation, and governance.

Overall, the evidence from the full body of the literature generally supports the view that hedge fund activism constitutes an important venue of corporate governance that is both influence-based and market-driven, placing activist hedge funds in a unique position to reduce the agency costs associated with the separation of ownership and control.

Abstract

Recent years have witnessed a significant upsurge of interest in alternatives to shareholder-centric corporate governance, driven by a growing sustainability imperative – increasingly widespread recognition that business as usual, despite the short-term returns generated, could undermine social and economic stability, and even threaten our long-term survival, if we fail to grapple with associated costs. We remain poorly positioned to assess corporate governance reform options, however, because prevailing theoretical lenses effectively cabin the terms of the debate in ways that obscure many of the most consequential possibilities. According to prevailing frameworks, our options essentially amount to board versus shareholder power, and shareholder versus stakeholder purpose. This narrow perspective obscures more fundamental corporate dynamics and potential reforms that might alter the incentives giving rise to corporate excesses in the first place.
This Feature argues that promoting sustainable corporate governance will require reforming fundamental features of the corporation that incentivize excessive risk-taking and externalization of costs, and presents an alternative approach more conducive to meaningful reform. The Feature first reviews prevailing conceptions of the corporation and corporate law to analyze how they collectively frame corporate governance debates (Part I), and then presents a more capacious and flexible framework for understanding the corporate form and evaluating how corporate governance might be reformed (Part II). This includes analysis of the features of the corporate form that strongly incentivize risk-taking and externalization of costs, discussion of the concept of sustainability and its implications for corporate governance, and assessment of how the corporate form and corporate law might be re-envisioned to produce better results.

The remainder of the Feature utilizes this framework to evaluate the proposals garnering the most attention today, and to direct attention toward the broader landscape of reforms that become visible through this wider conceptual lens (Part III). Recent reform initiatives typically rely heavily on disclosure, which may be an essential predicate to meaningful reform, yet too often substitutes for it as a practical matter. The Feature then assesses more ambitious reform initiatives that re-envision the board of directors, and re-think underlying incentive structures – including by imposing liability on shareholders themselves, in limited and targeted ways, to curb socially harmful risk-taking while preserving socially valuable efficiencies of the corporate form.

There is much to be said for and against such reform initiatives. The Feature concludes that this is the conversation we need to have, however, and proposes a sustainability-oriented conceptual framework to foster it. Until we scrutinize the fundamental attributes of the corporate form and the decision-making incentives they produce by reference to long-term sustainability, effective responses to the interconnected environmental, social, and economic crises we face today will continue to elude us.

Abstract

The negative effects of common ownership on competition have received significant attention, but many proposed mechanisms for institutional investor influence seem implausible. We develop and test an analytical model of optimal compensation in an oligopoly with common ownership, focusing on revenue-based pay as a plausible channel through which institutional investors might influence competition. Our model implies a negative effect of common ownership on firms’ use of revenue-based pay. Using both associative analyses and an event study difference-in-differences design based on plausibly exogenous institutional mergers, we find that common ownership has zero (or a marginally positive) effect on the use of revenue-based pay. Results involving relative performance incentives are similar. Collectively, our results provide no support for the notion that cross-owning block-holders influence compensation contracts in order to soften executives’ incentives to compete aggressively.

Abstract

While prior research on shareholder activism has highlighted how such activism can economically benefit the shareholders of targeted firms, recent studies also suggest that shareholder activism can economically disadvantage non-shareholder stakeholders, notably employees. Our study extends this research by exploring whether shareholder activism by institutional investors (i.e., institutional investor activism) can adversely affect employee health and safety through increased workplace injury and illness. Further, deviating from the assumption that financially-motivated institutional investor activists are homogeneous in their goals and preferences, we investigate whether the influence of institutional investor activism on employee health and safety hinges on the political ideology of the shareholder activist and of the board of the targeted firm. Using establishment-level data, we find that institutional investor activism adversely influences workplace injury and illness at targeted firms, and that this influence is stronger for non-liberal shareholder activists and for firms with a non-liberal board. Our study contributes to shareholder activism research by highlighting how the political ideology of shareholder activists and boards affects the impact of shareholder activism on stakeholders, and how shareholder activism can adversely affect the health and safety of employees. Further, our paper also contributes to research on workplace safety and the management of employee relations and human capital resources by highlighting the detrimental effect of a firm’s ownership by investor activists on its employees, and how the board’s political ideology may enable a firm to reduce this risk.

Abstract

This Article argues that the conventional wisdom about corporate raiders and activist hedge funds—raiders break things, and activists fix them—is wrong. Because activists have a higher risk of mistargeting—mistakenly shaking things up at firms that only appear to be underperforming—they are much more likely than raiders to destroy value and, ultimately, social wealth.

As corporate outsiders who challenge the incompetence or disloyalty of incumbent management, raiders and activists play similar roles in reducing “agency costs” at target firms. The difference between them comes down to a simple observation about their business models: raiders buy entire companies, while activists take minority stakes. This means that raiders are less likely to mistarget firms underperforming by only a slight margin, and they are less able to shift the costs of their mistakes onto other shareholders. The differences in incentives between raiders and activists only increase after the acquisition of their stake. Raiders have unrestricted access to nonpublic information after acquiring ownership of a target company, which allows them to look under the hood to determine whether changing the target’s business strategy is truly warranted. Activists, by contrast, have limited information and face structural conflicts of interest that impair their ability to objectively evaluate what’s best for the target company.

This insight has profound implications for corporate law and policy. Delaware and federal law alike have focused on building walls to keep raiders outside the gates, but they ignore the real threat—shareholder activists—that are already inside. We propose reforms to both state and federal law that would equalize the regulation of raiders and activists.

Abstract

For decades, private companies planning to enter public markets have used bankers operating as intermediaries, helping them decide on issue timing and pricing, and in meeting disclosure requirements. That banker-led process has always had inefficiencies, but without clear alternatives, companies had to accept the high costs and the money left on the table on the offering date, as bankers set offering prices well below market prices, and rewarded preferred clients. The IPO process is being disrupted by three major changes. First, companies are waiting longer to go public, and are focusing more on scaling up revenues than on building business models that deliver profits, while private. Second, the investor base for IPOs is shifting, from primarily institutional, to include more retail investors, many of whom are young, and get their investing cues more from social media than from roadshows. Third, there are alternatives emerging to the banker-led process, with a few turning to direct listings and many more, especially in the last two years, using special purpose acquisition companies (SPACs). These alternatives clearly are works in progress, and need improvement, but change is coming. In the final part of the paper, we look at disclosures that companies are required to make when they go public, and argue that they not only suffer from bloat, but are not in sync with changes that have occurred in both the companies going public, and those who trade their shares in the immediate aftermath of going public. We argue for reducing disclosure bulk and an easing of restrictions on companies making projections about the future, since these restrictions actually make it easier for companies to sell pie-in-the-sky stories.

Abstract

Stakeholder capitalism dominates the public debate about the future of the corporation. Business leaders and policymakers are calling for companies to abandon their stern adherence to profit maximization and take into consideration a broader set of stakeholder interests, on issues ranging from workplace equity to to climate change. Critics worry that managers can easily manipulate such lofty rhetoric to promote their own agenda and weaken constraints on their conduct that are typically benchmarked exclusively against financial performance. We argue instead that companies turn to stakeholders in order to derive information about the implications of their choices over a wider array of social issues that are outside the regular scope of corporate monitoring systems.

The arrival of COVID in early 2020 provides a unique setting that allows us to test in practice how companies understand and utilize stakeholder governance. Forced to adjust swiftly to a new reality, companies might choose to economize and redirect resources away from peripheral stakeholder programs, as critics predict. Alternatively, COVID could help underscore how closely companies depend on their stakeholders, such as their employees, their communities, and their governments, leading to greater efforts to address these broader needs. To explore how companies viewed stakeholders under mounting pressure brought about by COVID, we conducted interviews with CEOs, general counsel, and other top executives from large, well-known publicly traded companies with an established stakeholder governance presence. Our sample includes companies from various industries, including some that fared particularly well during COVID such as technology, and others whose businesses were hit hard, such as travel and hospitality.

Our findings suggest that companies turned to stakeholders during the pandemic with increasing frequency and asked for input on issues that are central to their business. Companies relied on stakeholder communications with employees to negotiate the remote working environment and arrange for continuous operation and reopenings, and with suppliers under immense strain as global trade contracted. Through stakeholder governance, companies understood better the needs of consumers in financial difficulty and the concerns of local authorities about unnecessary population movements, springing into action to support them. But stakeholders were not always successful in persuading managers and directors to follow their suggestions, particularly when stakeholders were themselves divided or where managers faced other critical hardships concurrently.

Stakeholder governance emerges from our interviews as a systematic framework that companies are developing in order to obtain information about the social impact of their practices. In the past, companies communicated with their stakeholders about specific issues as the need arose. Today, stakeholder governance seeks to proactively cover the company’s social profile as comprehensively as possible, collecting information in a regular and standardized manner. To achieve this goal, stakeholder governance has established an institutional footprint within many corporations, with specialized executive teams, direct oversight by the board, and external monitoring by investors and specialized professionals. This systematic framework, which has been overlooked by the corporate purpose debate, can help alleviate concerns about accountability, and offers a blueprint for dealing with future global challenges.

Abstract

We examine the changes in the board’s dual roles of monitoring and advising in times of fluctuating economic policy uncertainty (EPU). We find that a rise in EPU leads boards to reduce the size and increase independence and the proportion of female directors. They also decrease the involvement of insiders and outside executives. There is also a drop in the busyness of the directors. Overall, we find that boards enhance their monitoring power to deal with greater EPU.

Abstract

This Article seeks to shed light on the nature, purpose and prospects of ESG investing. Along the way, it develops an explanation for why so-called “ESG” or Environmental, Social and Governance principles suddenly have emerged to dominate the corporate governance and investing landscape. Clearly, the real and existential threat of climate change has galvanized the investing public into taking some sort of action. As such, I argue that the ESG movement reflects a significant libertarian turn in the history of American politics. This is because one naturally would think that government rather than the private sector would be the place to look for solutions to broad societal problems like social injustice and protecting the environment. The emergence of ESG investing and governance demonstrates a consensus that government lacks credibility and is not viewed by rational citizens as a likely source of solutions to these broad problems. In simple terms, government unresponsiveness and ineptitude have created a vacuum, and the ESG movement reflects a broad shift from primary reliance on government to primary reliance on the private sector as the source of solutions to broad social problems.

Thus, ESG investing and governance can be explained, at least in part, as a response to the failure of government. People are turning to corporations for solutions to problems that are in the proper domain of government because government has failed. This explains the “E” and the “S” in ESG. But it does not explain the “G” or governance component. Besides lack of faith in government, the emergence of ESG is attributable to the fact that the ESG movement focuses intensely on allowing management to govern for the “long term,” and this serves the private interests of important political groups such as organized labor and corporate management because it takes pressure off of management to focus on profit maximization or on objective criteria such as share prices for evaluating managerial performance. In addition, ESG governance is a new form of antitakeover device and a convenient tool for enabling ineffective management to escape accountability. Thus the recent success of the ESG movement is attributable to the confluence of the private interests of management with a secular loss of confidence in the ability of government even to address, much less to solve, the important environmental and social problems of the day. This loss of confidence has played conveniently into the hands of corporate managers who wish to avoid accountability.

While the ESG movement has found success in attracting investors, I argue that it will not be successful in ameliorating the fundamental problems of global warming and income inequality that it purports to address. In fact, much, if not most of ESG investing is “cheap talk” in light of three fundamental realities: (a) corporate managers are overwhelmingly compensated by bonuses, stock and stock options, all of which are forms of compensation that reward strong shareholder performance rather than the achievement of ESG objectives; (b) activist investors, particularly activist hedge funds and other elements of the market for corporate control post an existential threat to managers who ignore the shareholder wealth maximization paradigm; and (c) corporations are run by or under the direction of their boards of directors, who are elected exclusively by shareholders.

Abstract

An important piece of the capital structure puzzle has been missing, and it is not a contracting friction. It is recognition that managers do not have sufficient knowledge to optimize capital structure with any real precision. The literature critique in this paper (i) identifies the conceptual sources of the main empirical failures of the leading models of capital structure and (ii) shows how those failures can be repaired by taking into account imperfect managerial knowledge and several other factors. The analysis yields a compact set of principles for thinking about capital structure in an empirically supported way.

Abstract

We examine ballot order effects in the proxy voting process. Our results show that investors and proxy advisors, confronted with repeated decision making across multiple proxy votes, are subject to choice fatigue that affects their voting patterns when electing (independent) corporate directors. Down-the-ballot directors receive considerably less shareholder opposition and are less likely to receive negative recommendations from the proxy advisor, Institutional Shareholder Services. The results show that the ballot order effect is strongest when the voter is less attentive and the ballot items are more complex. Our analysis focuses on a sample where directors are positioned alphabetically on the proxy ballot. This setting allows for a causal interpretation of our results as alphabetical positions are independent of the directors’ ability or position on the board. The results are also robust to firm-level and director-level controls, as well as fixed-effects that control for unobservable time-varying factors related to the firm and voter. Our findings contribute to recent discussion in the media and among regulators about the use of the proxy voting process as an effective mechanism of shareholder voice. If proxy votes and recommendations suffer systematic bias, then recent regulation aimed at transparency might not help to improve the mechanism.

Abstract

Corporate law is on the cusp of a paradigm shift—a revolution in the definition of the stockholder’s entitlement. For a century, a simple proposition sat at the heart of corporate law: a share of stock may have some trading price, but in an intracorporate dispute that trading price has no necessary bearing on the value of an individual stockholder’s entitlements. Instead, the stockholder’s entitlement is determined by inquiring into the value of the corporate enterprise as a whole, not the individual fractionalized share. First articulated in the context of appraisal rights, this proposition has served as the Atlas of Delaware’s corporate law, providing the theoretical underpinnings of its entire doctrinal universe. It’s the centerpiece of the fairness standard, and it serves as a measure of damages for stockholders who suffer from unfaithful conduct by corporate managers. This traditional paradigm is foundational in the merger context, animating landmark decisions like Unocal and Revlon, for the powers and obligations of boards of directors make little sense if trading prices are the measure of the stockholders’ entitlement.

A new paradigm is emerging, however. In a series of important decisions, the Delaware Supreme Court has thoroughly refashioned the appraisal remedy, elevating the role of trading prices in delineating the stockholder’s entitlement. These decisions have unfortunate consequences even in their native appraisal rights context. But they portend a far broader change that has thus far escaped the attention of commentators, one that goes to the very foundation of Delaware’s corporate law.

As we show in this Article, the Delaware Supreme Court has redefined the nature of the stockholders’ entitlement, and the implications are potentially revolutionary. Most notably, the new paradigm calls into question the power of corporate directors to fight off a hostile bid. In concrete terms, it directly undermines the high-profile line of cases that culminates in the controversial 2011 Airgas v. Air Products decision. In Airgas, which has stood for a decade as the high-water mark of board power under Delaware law, the court allowed directors to repel a bidder offering a large premium to the market price by crediting the board’s view that the corporation’s value—and the value to which the stockholders were entitled—exceeded both the unaffected trading price and the bidder’s offer. If, as the Delaware Supreme Court suggests in its recent appraisal cases, the legal position of stockholders entitles them to nothing more than the trading price of their shares, then the justification for the board’s sweeping powers in Airgas to defend the corporation against hostile suitors has been swept away.