March 19, 2021

Corporate Governance: Back to the Drawing Board?

What if everything we’ve taken for granted about good corporate governance is wrong? According to a recent study, that just may be the case. As one of the authors, UVA Law School’s Cathy Hwang, discusses in this article, the study revisited a 2003 study that introduced the influential “Governance Index” or “G-index,” which measures how much governance rules protect shareholders.

That 2003 study has been cited nearly 10,000 times, and many other governance indices are based on the G-index it created. That study used the G-index to support its finding that stronger shareholder rights are correlated with higher value, profits & firm growth. There’s just one teensy-weensy problem with the G-index – it’s replete with errors. In fact, the authors found an astonishing 80% error rate in the G-index! What’s more, they concluded that “correcting these errors substantially weakens one of the most well-known results in law and finance, which associates good governance with higher investment returns.”

Ain’t that a kick in the head? The good news is that the authors decided to build their own dataset, called “Cleaning Corporate Governance,” that includes the 25 years of corporate charters from S&P 1500 companies that have been indexed across numerous governance metrics. This dataset will be free and open access, and hopefully will provide a better set of data for examining how governance affects shareholder value.

The governance industrial complex may find this news disconcerting, but those cynics (like me) who maintain that ideas about what constitutes “good governance” have a lot more to do with ideology than empirical data likely find it rather amusing.

Non-GAAP: Alternatives To EBITDAC

Earlier this week, I blogged about how relatively few companies are presenting adjusted EBITDA numbers that attempt to back-out expenses associated with Covid-19.  That raises the question – how are companies getting the impact of the pandemic across to investors? This excerpt from a recent Lincoln International article says that companies appear to be adopting one of three alternative approaches:

Annualizing Earnings. For some, business during Q4 2020 returned to more normal conditions than in April to June when COVID-19 was at its height. As such, for businesses disrupted by COVID-19 in the spring, annualized earnings either in the form of Last Quarter Annualized (LQA) or annualizing post June performance may be a more accurate measure of business performance than metrics from 2020.

2021 EBITDA. CFOs are more comfortable assessing 2021 EBITDA because they have better visibility into the full year’s budget, including contracted revenues and full implementation of cost-cutting measures, and as a result would prefer to focus on 2021 performance and underweight 2020 results.

The Swap Out. Another twist to LTM EBITDA is to replace the months most impacted by COVID-19 with the earnings results of those same months from 2019. Swapping out those months with 2019 performance is an easy way to reflect actual levels that were once earned.

The article says that it is critical that the particular metric chosen is as defensible as possible – and that companies should evaluate KPIs to ensure the metric they select is one that market participants would actually rely upon.

Securities Litigation: 2020 Class Action Settlements

Cornerstone Research recently released its annual report on securities class action settlements. Over on The D&O Diary, Kevin LaCroix provides an in-depth review of the report. Here’s an excerpt summarizing the numbers:

According to the report, there were 77 securities class action settlements in 2020, compared to 74 in 2019. (The settlement date). The 77 settlements in 2020 was also slightly above the 2010-2019 average number of settlements of 72.

The total value of settlements in 2020 was $4.2 billion, which is double the 2019 total settlement amount of $2.0 billion. The increase in total settlements in 2020 was largely the result of the significant number of mega settlements in 2020. (At the end of this post, I have identified the largest of these mega-settlements.) If the 2020 settlements over $1 billion are excluded, the total settlement dollars actually declined 4% in 2020 compared to 2019

As a result of the number of very large settlements in 2020, the average securities settlement in 2020 doubled to $54.5 million from $27.8 million in 2019. Though the average settlement increased in 2020 relative to 2019, the 2020 average was below the 1996-2020 average of $58.1.

There are all sorts of other interesting tidbits in Kevin’s blog, including the fact that D&O insurance covered 90% of the settlement amounts in 1933 Act claims, and that the average case took 3.3 years to resolve. Unfortunately, Cornerstone believes that relatively high settlement amounts are likely here to stay, given the significantly increased volume of class action filings in recent years.

John Jenkins