My friend Loyola law professor Mike Guttentag recently sent me a reprint of his article On Requiring Public Companies to Disclose Political Spending, 2014 Colum. Bus. L. Rev. 593 (2014), which reminded me that I wanted to flag it for my readers. It is, put simply, the single best thing I've read on corporate political contribution disclosure.
Here's the abstract:
Mandatory disclosure is a central feature of securities regulation in the United States, yet there is little agreement about how to determine precisely what public companies should be required to disclose. This lack of consensus explains much of the disagreement about whether the Securities and Exchange Commission should require public companies to disclose political spending.
To resolve the political spending disclosure debate I therefore begin by considering the more general question of how to evaluate any proposed mandatory disclosure requirement. I show why the presumption should be against adding a new disclosure requirement, and then identify the kinds of evidence that should be sufficient to overcome this presumption. Applying this new analytic framework to the political spending disclosure debate—and basing this analysis in part on previously unpublished empirical findings—shows that public companies should not be required to disclose political spending.
Here's a link to the the law review page from which you can download the article.
[William] Ackman uses stock options to control a company’s shares and agitate for change and is celebrated. A CEO is granted stock options in hopes that he or she will agitate for change and is vilified. What’s the difference? (Only one: The CEO has a contract that won’t allow him or her to pocket a short-term pop in the stock price and take off.)
Why do you notice the splinter in your brother’s eye, but do not perceive the wooden beam in your own eye? How can you say to your brother, ‘Let me remove that splinter from your eye,’ while the wooden beam is in your eye? You hypocrite, remove the wooden beam from your eye first; then you will see clearly to remove the splinter from your brother’s eye.
A few weeks ago, CalPERS’ Director of Corporate Governance, Anne Simpson, sent a letter to the Securities and Exchange Commission in support of the SEC’s proposed pay for performance disclosure rule. Her letter notes CalPERS’ belief that “Compensation of executives in publicly listed companies should be driven predominantly by performance.” ...
As noted last week, CalPERS’ Chief Investment Officer is California’s highest paid civil servant (excluding the UC system). According to the Sacramento Bee’s state worker salary database, the CIO’s total pay for 2014 was $745,000, up over 36% from $547,000 for the year before. According to Pensions & Investments, CalPERS is reporting preliminary and very anemic investment returns of 2.4% for its fiscal year ended June 30. According to the same article, this is 5.1% below CalPERS’ assumed return.
In another post, Bishop takes a look at pay inequality at CalPERS and finds still more hypocrisy.
We use a unique setting to study the tradeoffs between universal regulatory mandates and private contracting in the field of corporate governance. Events surrounding the legal challenge of a 2010 proxy access rule allow us to benchmark the market’s expectation of the benefits of universally mandated proxy access even though this rule never came into effect. At the same time, a 2010 rule amendment facilitating shareholder proposals for proxy access opened a new channel for proxy access through "private ordering." We document that this private channel has been active, spawning about 160 proxy access proposals, and use the unexpected announcement of a major private ordering initiative to identify a 0.5 percent increase in shareholder value for the targeted firms. However, our findings also underscore that private ordering may lead to a second best outcome. We find that proponents do not selectively target those firms that were expected to benefit the most from universally mandated proxy access, and that tailoring of proposal terms is limited. Moreover, management is more likely to challenge proposals at firms that stand to benefit more. Overall, we find that private ordering creates value, but it may not efficiently deliver proxy access at the firms that need it most.
Bhandari, Tara and Iliev, Peter and Kalodimos, Jonathan, Public Versus Private Provision of Governance: The Case of Proxy Access (July 24, 2015). Available at SSRN: http://ssrn.com/abstract=2635695
But what the paper does NOT prove is that SEC mandated proxy access would be superior. The SEC's effort to mandate proxy access entailed a one size fits all approach with no opportunity for tailoring to specific firm needs (except that shareholders could vote for enhanced access) and no opt out option for firms that simply don't need proxy access for effective corporate governance.
A “wolf pack” is a loose association of hedge funds (and possibly some other activists) that stop just short of forming a “group” (which would require disclosure under Section 13(d)(3) of the Williams Act once the “group” collectively held 5% or more of any class of the stock of the engaged firm). The essence of the “wolf pack” is conscious parallelism without any agreement to act in concert. The market can quickly recognize a “wolf pack” once its leader crosses the 5% threshold and files its Schedule 13D, and the market responds more enthusiastically to a “wolf pack” than to other activist investors, running up on average 14% in abnormal returns on the date of its public appearance. Also, the “wolf pack” acquires substantially more—at least 13.4% in on recent study. But this may understate, as researchers cannot know how many allies the wolf pack leader has. In the Sotheby’s proxy litigation last year, the CEO of a prominent proxy solicitor, testifying as an expert witness, estimated that hedge funds then held over 32% of Sotheby’s (a mid-cap sized firm).This is a near control block.
The key advantage of joining a “wolf pack” is that it offers near riskless profit. The hedge fund leading the pack can tip its allies of its intent to initiate an activist campaign because it is breaching no fiduciary duty in doing so (and is rather helping its own cause); thus, insider trading rules do not prohibit tipping material information in this context. If one can legally exploit material, non-public information, riskless profits are obtainable, and riskless profits will draw a crowd on Wall Street.
 For a fuller review of these tactics and the legal and market developments that made the “wolf pack” possible, as well as the concept of “group,” see John C. Coffee, Jr. and Darius Palia, “The Impact of Hedge Fund Activism: Evidence and Implications” (available at http://ssrn.com/abstract=2496518)(Oct. 2014).
 See Becht, Franks, Grant and Wagner, supra note 1, at 32. [Full cite: Marco Becht, Julian Franks, Jeremy Grant and Hammes F. Wagner, The Returns to Hedge Fund Activism: An International Study, (available at http://ssrn.com/abstract=2376271)(March 25, 2015).]
 Daniel Burch, CEO of Mackenzie Partners, so testified in the Sotheby’s litigation that hedge funds then held an estimated 32.68% of Sotheby’s. On the basis of the “threat” this constituted, the Chancery Court upheld a special “discriminatory” version of the poison pill. Third Point, LLC, the lead activist, held only 9.62% of Sotheby’s, thus showing the size of the allies that the “wolf pack” leader can assemble. See Third Point, LLC. v. Ruprecht, 2014 Del. Ch. LEXIS 64 (May 2, 2014).
It seems to me that there are several ways of responding to the wolf pack phenomenon.
First, amend Exchange Section 13(d) and the rules thereunder so that conscious parallelism requires filing a Schedule 13D. There is evidence that "wolf pack activity appears to be ostensibly uncoordinated—i.e., no formal coalition is formed—a fact that is usually attributed to an attempt by the funds to circumvent the requirement for group filing under Regulation 13D when governance activities are coalitional." Instead of requiring the SEC and/or the target to undertake the difficult task of proving that ostensibly uncoordinated activity is in fact coordinated, we should amend Section 13(d) to force wolf packs to disclose. After all, isn't sunlight the best disinfectant? In addition, as Wachtell Lipton has been urging for a long time, the 10 day window for filing Schedule 13Ds should be shortened to 2 business days.
Second, courts should be more receptive to arguments that wolf packs constitute a group that "may be liable under Section 16(b) if, in the aggregate, the group’s holdings exceed ten percent of the company’s nonexempt, registered equity securities."
... a traditional poison pill follows the federal securities laws in determining when shareholders are considered a “group” and would generally aggregate their ownership if, and only if, they entered into an agreement to act in concert with respect to their stock in the company. There is no definitive legal authority on whether a poison pill would be legally valid if it aggregated stock ownership of investors who patterned their behavior after one another, but did not have an agreement to act in concert. To avoid potential litigation, companies generally utilize the 13D definition of “group” in their shareholder rights plans although this means that their poison pill may not be an effective weapon against a wolf pack.
The Sotheby’s case may cause practitioners to rethink the desirability of adopting a wolf pack pill. Sotheby’s found that the acquisition of stock by members of a wolf pack could be a threat to the corporation based on a pattern of behavior the court described as “conscious parallelism.” The same analysis may also justify a wolf pack clause in a poison pill.
[A] recent study suggests that there may be real, but long-term, costs from hedge fund activism for the economy as a whole. These researchers took the stocks included in the Wall Street Journal’s and FactSet’s Activism Scorecard and trimmed this sample down to just those campaigns launched by activist hedge funds. Then, they followed those firms that successfully avoided a takeover. They found that these firms, even though they survived the activists’ engagement intact, were forced to curtail their investments in research and development by more than half over the next four years. Specifically, R&D expenses in this sample fell from 18% of sales to 8.12% of sales over that period. Nor was this a general secular trend, because in a random sample of firms not engaged by activists, they found that research and development expenditures rose modestly as a percentage of sales over the same period.
Although still a preliminary study, this finding should not surprise, because it confirms what activists say they are doing. Trian Fund made clear that it wanted to reduce DuPont’s expenditures on R&D. Similarly, when Pershing Square Capital and Valeant Pharmaceuticals made a bid for Allergan last year, Valeant announced that, if successful, it would cut R&D at the combined firm by 69%. Although most pharmaceutical companies typically spend about 20% of their revenues on R&D, Valeant spent only 2.7% of its revenues on R&D. Its business model was to milk acquired companies like cash cows for their cash flow.
This pattern of cutting R&D expenditures (even at companies like DuPont that have historically profited from R&D) may make sense for investors who will be long gone within a year or so.
 See Allaire and Dauphin, supra note 1, (finding an average decline in R&D expenditures as a percentage of sales from 17.34% in 2009 to 8.12% of sales in 2013). [Full cite: Yvon Allaire and Francois Dauphin, “Hedge Fund Activism: Preliminary Results and Some New Empirical Evidence” (Institute for governance of public and private corporations, April 1, 2015).]
 Id (finding a modest increase in R&D expenditures from 6.54% of sales in 2009 to 7.65% of sales in 2013).
 See Joseph Walker and Liz Hoffman, “Allergan’s Defense: Be Like Valeant,” The Wall Street Journal, July 22, 2014 at B-1.
 See Joseph Walker, “Botox Itself Aims Not to Age,” The Wall Street Journal, May 19, 2014 at B-1.
But it sucks for the rest of us.
I await a reply from the activists' academic apologists.
John Coffee observes of the recent DuPont proxy fight:
... that the governance professionals at pension funds and mutual funds now favor (or at least are open to) the idea of a divided, factionalized board. Putting Nelson Petz on DuPont’s board struck many of them as a low-cost means, with little downside risk, of keeping DuPont “in play” and signaling the shareholders’ desire for more spinoffs and less investment in long-term capital projects, including research and development.
I think that's correct, but the question is why shareholder activists and other institutional investors have developed a tolerance--if not an outright preference--for factionalized boards?
Granted, some firms might benefit from the presence of skeptical outsider viewpoints. It is well accepted, however, that cumulative voting tends to promote adversarial relations between the majority and the minority representative. The likelihood that cumulative voting results in interpersonal conflict rather than cognitive conflict thus leaves one doubtful as to whether firms actually benefit from minority representation. There will be a reduction in the trust-based relationships that cause horizontal monitoring within the board to provide effective constraints on agency costs. There also likely will be an increase in the use of pre-meeting caucuses and a reduction in information flows to the board.
So where's the evidence that short slates nominated by shareholder activists will produce better results?
Actually, the WSJ headline is somewhat misleading. What Donatiello and Pitt actually address in their provocative op-ed is the influence of proxy advisory services ISS and Glass Lewis. They argue that:
Voting decisions are often effectively controlled by proxy advisory firms—namely, Institutional Shareholder Services and Glass Lewis. There is considerable evidence that a “no” recommendation from such firms translates into about a 30% “no” vote by institutional shareholders. ...
While proxy advisory firms claim they merely advise and do not make voting decisions, their influence is unmistakable.
Donatiello and Pitt find that influence worrisome (as do I):
Proxy advisory firms have no financial interest in shareholder votes. They rarely understand the companies on which they report, their competitive situations or their strategic challenges. They use opaque processes, and they often solicit consulting fees from the same companies on whose issues they advise, without disclosing specific arrangements. Most important, proxy advisory firms claim no duty to the shareholders whose votes they effectively control. ...
The decoupling of proxy voting from the investment process, and in many cases from investor interests, might be less troublesome if it increased shareholder value, but it doesn’t. Research from 2009, also conducted by Stanford’s Rock Center, found that governance ratings by proxy advisory firms have no ability to predict future performance, and that their proxy voting policies are negatively correlated with shareholder value. Proxy advisory firms have offered no research showing that their recommendations do enhance shareholder value.
It's long since time that the government (especially the SEC but also the Department of Labor in its oversight of ERISA plans) reconsider the policies that encourage reliance on proxy advisory services. It's also long since time that the SEC start regulating proxy advisory services, especially given the rampant conflicts of interest inherent in their current business model.
In an editorial, the WSJ today opined that proxy advisory services "have enjoyed far too much influence over companies they don’t own and been subject to far too little scrutiny given their potential conflicts of interest."
U.S. businesses, feeling heat from activist investors, are slashing long-term spending and returning billions of dollars to shareholders, a fundamental shift in the way they are deploying capital.
Data show a broad array of companies have been plowing more cash into dividends and stock buybacks, while spending less on investments such as new factories and research and development.
The Journal lays much of the blame at the feet of activist investors:
An analysis conducted for The Wall Street Journal by S&P Capital IQ shows that companies in the S&P 500 index sharply increased their spending on dividends and buybacks to a median 36% of operating cash flow in 2013, from 18% in 2003. Over that same decade, those companies cut spending on plants and equipment to 29% of operating cash flow, from 33% in 2003.
At S&P 500 companies targeted by activists, the spending cuts were more dramatic. Targeted companies reduced capital expenditures in the five years after activists bought their shares to 29% of operating cash flow, from 42% the year before, the Capital IQ analysis shows. Those companies boosted spending on dividends and buybacks to 37% of operating cash flow in the first year after being approached, from 22% in the year before.
Tingle, Bryce C., Bad Company! The Assumptions Behind Proxy Advisors' Voting Recommendations (May 11, 2015). Dalhousie Law Journal, Vol. 37, No. 2 (Fall 2014) . Available at SSRN: http://ssrn.com/abstract=2605275
The corporate governance challenge for Canada is to improve the quality of its corporate performance, which has been declining relative to its international peers for decades. This is quite different from the usual assumption that corporate governance is primarily a matter of controlling managerial self-dealing. While important, board monitoring of management is only one aspect of its role in a corporation; research suggests corporate governance arrangements have a significant impact on corporate outcomes, particularly in areas such as innovation where Canada lags.
Third-party proxy advisory firms, which provide advice to institutional investors in Canada on corporate governance matters, have grown in influence over the past decade. As securities regulators consider whether (and how) to treat them, an examination of the assumptions that underlie these advisors’ voting recommendations, and the influence these assumptions have on corporate decision-making, suggest these assumptions create perverse governance incentives and are contradicted by empirical research.
Corporate political activity has become one of shareholders' top concerns. We examine whether firms targeted by shareholder proposals show different campaign contributions and lobbying activities compared to non-targeted firms. We also ask whether different sponsors of shareholder proposals target different firms depending on the firms' partisan orientation. Using data on S&P 500 companies during the period between 2007 and 2013, we find that firms that spend more on campaign contributions and lobbying are more likely to be targeted by shareholder proposals. After controlling for firms' financial performance, governance characteristics and ownership structure, we also find that public pension funds and labor unions sponsors are more likely to target Republican-leaning firms, measured by the firms' campaign contributions. This finding suggests that increasing corporate political activity can intensify a tension between management and public pension fund and labor union shareholders and lead to more activism by these shareholders.
Min, Geeyoung and You, Hye Young, Active Firms and Active Shareholders: Corporate Political Activity and Shareholder Proposals (April 30, 2015). Virginia Law and Economics Research Paper No. 15; Virginia Public Law and Legal Theory Research Paper No. 28. Available at SSRN: http://ssrn.com/abstract=2601181
My longstanding conviction that state and local government and union pension funds were using shareholder activism to advance a liberal political agenda appears to be validated, at least in part.