Howell E. Jackson & Steven L. Schwarcz
The COVID-19 pandemic has produced a public health debacle of the first order. But the virus has also propagated the kind of exogenous shock that can precipitate—and to a certain degree did precipitate—a systemic event for our financial system. This still not fully resolved systemic shock comes a little more than a decade after the last financial crisis. In the intervening years, much has been written about the global financial crisis of 2008 and its systemic dimensions. Considerable scholarly attention has focused on first devising and then critiquing the macroprudential reforms that ensued, both in the Dodd-Frank Act and the many regulations and policy guidelines that implemented its provisions. In this essay, we consider the coronavirus pandemic and its implications for the financial system through the lens of the frameworks we had developed for the analysis of systemic financial risks in the aftermath of the last financial crisis. While the COVID-19 pandemic differs in many critical respects from the events of 2008, systemic events in the financial sector have a common structure relevant to both crises. Reflecting back on responses to the last financial crisis also affords us an opportunity both to understand how financial regulators responded to the COVID-19 pandemic and also to speculate how the pandemic might lead to further reforms of financial regulation and other areas of public policy in the years ahead.
Mark J. Roe & Roy Shapira
The notion of stock-market-driven short-termism relentlessly whittling away at the American economy’s foundations is widely accepted and highly salient. Presidential candidates state as much. Senators introduce bills assuming as much. Corporate interests argue as much to the Securities and Exchange Commission and the corporate law courts. Yet the academic evidence as to the problem’s severity is no more than mixed. What explains this gap between widespread belief and weak evidence?
In this Article, we explore the role of narrative power. Some ideas are better at being popular than others. The concept of pernicious stock market short-termism has three strong qualities that make its narrative power formidable: (1) connotation—the words themselves tell us what is good (reliable long-term commitment) and what is not (unreliable short-termism); (2) category confusion—disparate corporate misbehavior, such as environmental degradation and employee mistreatment, are mislabeled as short-term, when they in fact primarily emanate from other misalignments, thereby making us view short-termism as more rampant and pernicious than it is; and (3) confirmation—the idea is regularly repeated, because it is easy to communicate, and often boosted by powerful agenda-setters and interests that benefit from its repetition.
The Article then highlights the real-world implications of narrative power—powerful narratives can make decisionmakers be more certain than the underlying evidence is, thereby leading policymakers astray. For example, a favorite remedy for stock-market-driven short-termism is to insulate executives from stock market pressure. If lawmakers believe that short-termism is a primary cause of environmental degradation, anemic investment that holds back the economy, employee mistreatment, and financial crises—as many state—then they are likely to support insulating corporate executives further from stock market accountability. Doing so, however, may do little to alleviate the underlying problems, which would be better handled by, say, stronger environmental regulation and more astute financial regulation. Powerful narratives can drive out good policymaking.
Jesse M. Fried & Ehud Kamar
Alibaba, the NYSE-traded Chinese e-commerce giant, is currently valued at over $700 billion. But Alibaba’s governance is opaque, obscuring who controls the firm. We show that Jack Ma, who now owns only about 5%, can effectively control Alibaba by controlling an entirely different firm: Ant Group. We demonstrate how control of Ant Group enables Ma to dominate Alibaba’s board. We also explain how this control gives Ma the indirect ability to disable (and perhaps seize) VIE-held licenses critical to Alibaba, providing him with substantial additional leverage. Alibaba is a case study of how corporate control can be created synthetically with little or no equity ownership via a web of employment and contractual arrangements.
Paul G. Mahoney & Adriana Z. Robertson
The rise of index funds has reshaped the modern American capital markets. Like mutual fund managers, indices now direct trillions of dollars of investor capital. Although it regulates mutual fund managers as investment advisers, the SEC has chosen not to treat the providers of market indices similarly.
In this Article, we argue that many index providers are not merely like investment advisers; under the relevant statutory and regulatory regimes, they are investment advisers. The SEC’s failure to recognize this fact reflects an inaccurate and antiquated view of the index fund market.
Having established that certain index providers are presently acting as unregulated investment advisers, we propose a regulatory solution. The SEC should create a nonexclusive, conditional safe harbor giving index providers guidance on what activities will and will not make them investment advisers. This would close the regulatory gap in a way that is consistent with the governing statutes and case law without unduly burdening market participants.
BROWN ASSETS FOR THE PRUDENT INVESTOR
Alon Brav† and J.B. Heaton*
Most commentary on climate-themed investment treats climate change as a one-way risk to brown assets from a hoped-for transition to a low-carbon economy. But the converse holds as well. Brown assets could turn out to be highly valuable if the world fails to transition out of the high-carbon economy. This is true both because sentiment for green assets may cause brown assets to be underpriced (generating higher expected returns) and because brown assets may provide a valuable hedge against the costs of climate change in a world that failed to transition to a low-carbon economy. Given the lack of progress to date toward transition to a low-carbon economy, we argue that institutional investors subject to fiduciary duties of prudent investment (including the duty to diversify) cannot yet justify divestment from brown assets.
† Peterjohn-Richards Professor of Finance, Fuqua School of Business, Duke University, ECGI, and National Bureau of Economic Research.
* Managing Member, One Hat Research LLC.
For helpful comments, we thank Ashish Arora, Doron Levit, Dorothy Lund, Cam Harvey, Elizabeth Pollman, Bernie Sharfman, Dan Vermeer, and Jonathan Zandberg.
WILL NASDAQ’S DIVERSITY RULES HARM INVESTORS?
Jesse M. Fried†
In August 2021, the Securities and Exchange Commission approved Nasdaq’s proposed rules related to diversity. The rules’ aim is for most Nasdaq-listed firms to have at least one director self-identifying as female and another self-identifying as an underrepresented minority or LGBTQ+. While Nasdaq claims these rules will benefit investors, the empirical evidence provides little support for the claim that gender or ethnic diversity in the boardroom increases shareholder value. In fact, rigorous scholarship—much of it by leading female economists—suggests that increasing board diversity can actually lead to lower share prices. The implementation of Nasdaq’s proposed rules thus may well generate risks for investors.
† Dane Professor of Law, Harvard Law School. Thanks to Michal Barzuza, Keith Bishop, Alex Edmans, Elisabeth de Fontenay, Joe Grundfest, Yaron Nili, and Steven Davidoff Solomon for helpful comments, and to Jake Laband for excellent research assistance. I serve on the Research Advisory Council of proxy advisor Glass Lewis, but my views here are not necessarily those of Glass Lewis. Comments are welcome and can be sent to me at firstname.lastname@example.org.
THE ILLUSION OF SUCCESS: A CRITIQUE OF ENGINE NO. 1’S PROXY FIGHT AT EXXONMOBIL
Bernard S. Sharfman†
With less than $40 million worth of Exxon Mobil Corporation common stock in hand, Engine No. 1 executed a proxy fight that succeeded in getting three of its four nominated directors elected to the board of the company. This victory was viewed as a success by environmentalists and ESG investors. However, this victory was illusionary as a closer look reveals an absence of accomplishment. The hedge fund activism of Engine No. 1 did not provide a roadmap for the company to improve its financial performance or specific recommendations on how it could transition from a global leader in oil and gas production to a global leader in the production of clean energy. Also, there is no evidence that Engine No. 1 has served as a corrective mechanism (correcting managerial inefficiencies) at the company consistent with this Article’s theory of hedge fund activism. Moreover, and perhaps most importantly, Engine No. 1 may have created a deadly distraction in our global fight against climate change, a fight that should be taken on by governments all over the world, not hedge fund activists.
† Bernard S. Sharfman is a research fellow at the Law & Economics Center at George Mason University’s Antonin Scalia Law School, a Senior Corporate Governance Fellow at the RealClearFoundation, and a member of the editorial advisory board of the Journal of Corporation Law. The research associated with this writing was funded by a generous grant from the Law & Economics Center at George Mason University’s Antonin Scalia Law School. The opinions expressed here are the author’s alone and do not represent the official position of the Law & Economics Center or any other organization with which he is currently affiliated. Mr. Sharfman would like to thank J.B. Heaton, Brian Cheffins, Andrew Jennings, Robert J. Rhee, Marc T. Moore, Alex Platt, Jeffrey N. Gordon, Andrew R. Johnston, and Leo E. Strine, Jr. for their helpful comments.