I recently authored a comment letter in support of the creation of a new optional listing category, designed to enable more long-term investing. Quite an interesting experiment. The other letters in support are here.
Brent J. Fields
Secretary
U.S. Securities and Exchange Commission
100 F Street, N.E.
Washington, D.C., 20549-1090
Re: Investor’s Exchange LLC Notice of Filing of Proposed Rule Change to
Establish a New Optional Listing Category on the Exchange, “LTSE Listings
on IEX” (Release No.34-82948; File No. SR-IEX-2018-06)
April 20, 2018
Dear Mr. Fields,
I appreciate the opportunity to comment on Investor’s Exchange LLC’s (“IEX”) proposed rule change to establish a new optional listing category, “LTSE Listings.” I am a law professor and faculty director of the Institute of International Economic Law at the Georgetown University Law Center, and I recently concluded a three year term as a member of the National Adjudicatory Council of FINRA. I am not a consultant or employee of IEX and do not work for them in any capacity. My research focuses on finance and global governance, public and private international law, market microstructure and international trade.
I write to express my support for IEX’s proposed rule change to adopt a new optional listing category. I believe that the proposed rules for companies listed under LTSE Listings (“LTSE Listing Rules”) offer an important listing alternative for market participants who prefer listing standards explicitly designed to promote long-term value creation.
The Long-term Value Movement
In recent years, there has been a growing movement among issuers, investors and stakeholders for corporate management to place more emphasis on long-term value creation. According to McKinsey’s 2017 discussion paper, “Measuring the Economic Impact of Short-termism,” a majority of directors and executives expressed a desire to focus more on long-term value creation.[1]In his 2017 letter to CEOs, Larry Fink, CEO of BlackRock, expressed a strong desire by shareholders who are BlackRock clients to see companies engage in more frequent and transparent long-term strategic thinking.[2]Indeed, even several current and former SEC commissioners have expressed views in favor of greater long-term strategic thinking by companies.[3]
In addition to the desires of market participants to see more opportunities for long-term value creation and investment opportunities, there is compelling evidence of economic benefits associated with long-term strategic thinking. Influential studies in the academic literature have long suggested that short-termism can lead to myopic behavior[4]—and that while short-termism can certainly have its place, long termism enables adding economic value through engagement, value investing, and returns from liquidity provision, among other things.[5] Similarly, McKinsey analysts recently found that firms emphasizing long-term strategy “exhibit stronger fundamentals” and “add more to economic output and growth.”[6]Additionally, as detailed in IEX’s rule change proposal, a long-term oriented listing alternative may energize more companies to engage in IPOs, which have the potential to add significant economic value to these companies through access to public markets and create additional opportunities for investors who cannot currently invest in these valuable but private companies.
Notably, there have been some individual efforts by U.S. companies to promote long-term corporate strategy by incentivizing longer-term share ownership through tenure voting systems. For example, The J.M. Smucker Company tenure voting program gives shareholders ten votes for each share of common stock if they have held their common shares for at least four years.[7]However, these tenure voting systems only apply to individual companies, which may have varied terms and could be rescinded.
I believe that the LTSE Listings option offers a differentiated and effective listing alternative for market participants that prefer greater emphasis on long-term value creation. In particular, the LTSE Listing Rules promoting the development and disclosure of (i) long-term growth strategies, (ii) transparency into human capital and R&D, (iii) long-term alignment of executive compensation and (iv) the long-term shareholder voting structure will create a corporate governance environment that will align the long-term strategic goals of issuers, shareholders and stakeholders and expand on existing efforts to promote long-term value creation through tenure voting systems.
(i) Long-term Growth Strategy
The LTSE Listing Rules require listed issuers to “maintain a committee specifically dedicated to overseeing the … Issuer’s strategic plans for long-term growth” (the “LTSP Committee”), whose responsibilities include oversight and approval of the issuer’s long-term growth strategy. In addition, the LTSE Listing Rules require explicit disclosures of the issuer’s long-term growth strategy, including quantitative metrics used by management to forecast and measure the effectiveness of the long-term growth strategy. I believe that requiring issuers to have a dedicated board committee focused on long-term growth strategies and the disclosure of a detailed, measurable long-term growth strategy could help foster a long-term relationship between issuers and their shareholders by providing shareholders with vital information for understanding the issuer’s long-term plans.
(ii) Transparency of Human Capital and R&D Investments
To help give investors a more complete picture of the issuer’s long-term strategy, the LTSE Listing Rules also require separate disclosure of expenses related to investment in human capital and a distinction between short- and long-term R&D spending. These disclosures, especially where accompanying narratives provide a sense of the expenditures’ aims and productivity, could provide valuable insight into how issuers are effectively investing in their long-term growth.[8]They can also provide a helpful signal for investors as to issuers’ commitment to long-term strategies and help investors feel more comfortable with short-term fluctuations in earnings.
(iii) Long-term Alignment of Executive Compensation
LTSE Listing Rules will also require that incentive-based compensation for executives be aligned with the issuer’s long-term growth strategy and prohibit such incentives from being “tied to a financial or performance metric that is measured over a time period of less than one year.” While it is important for issuers to develop and disclose long-term strategies, those actions must be implemented by management whose incentives are aligned with the same long-term horizons. I believe that the LTSE Listing Rules for executive compensation schemes could better-align management incentives with long-term corporate health.
(iv) Long-term Voting Program
Realization of the full benefits of the LTSE Listing Rules requires not only a commitment by an issuer’s management to a long-term strategy but also shareholders committed to long-term strategies. The optional tenure voting program, which over time increases the voting power of long-term shareholders opting into it, gives shareholders investing for the long-term a greater say in corporate governance matters, and long-term shareholders are more likely to exercise voting rights in ways that prioritize long-term growth strategies. By implementing tenure voting through exchange rules, the LTSE Listing Rules build on prior individual efforts to implement tenure voting by creating a set of consistent, minimum tenure voting standards that all issuers may use. When coupled with enhanced disclosure of long-term strategy and investments, investors will have both the information necessary and the power to work with issuers to pursue long-term growth strategies.
Conclusion
Market participants are increasingly expressing a desire for issuers to pursue more long-term oriented strategies. The LTSE Listing Rules, particularly those highlighted above, give them the option to do so. In doing so, the Listing Rules portend a different kind of corporate governance environment in which value-creating, long-term growth strategies can be more forthrightly pursued. For these reasons, I support IEX’s proposed rule change.
Yours sincerely,
Chris Brummer
Professor of Law
Director, International Institute Economic Law
Georgetown University Law Center
[1]McKinsey & Company, McKinsey Global Institute, Measuring the Economic Impact of Short-Termism (February 2017), available at https://www.mckinsey.com/~/media/mckinsey/global%20themes/long%20term%20capitalism/where%20companies%20with%20a%20long%20term%20view%20outperform%20their%20peers/measuring-the-economic-impact-of-short-termism.ashx.
[2]Larry Fink, Larry Fink’s Annual Letter to CEOs: A Sense of Purpose(January 16, 2018), available at https://www.blackrock.com/corporate/investor-relations/larry-fink-ceo-letter.
[3]See, e.g., Jay Clayton, Hearing before the Senate Banking Committee on the Nomination of Jay Clayton, of New York, to be a Member of the Securities and Exchange Commission (March 23, 2017), available at https://www.gpo.gov/fdsys/pkg/CHRG-115shrg24998/html/CHRG-115shrg24998.htm; Commissioner Daniel M. Gallagher, Activism, Short-Termism, and the SEC: Remarks at the 21st Annual Stanford Directors’ College (June 23, 2015), available at https://www.sec.gov/news/speech/activism-short-termism-and-the-sec.html; Commissioner Kara M. Stein, Toward Healthy Companies and a Stronger Economy: Remarks to the U.S. Treasury Department’s Corporate Women in Finance Symposium (April 30, 2015), available at https://www.sec.gov/news/speech/stein-toward-healthy-companies.html.
[4]Jeremy C. Stein, Efficient Capital Markets, Inefficient Firms: A Model of Myopic Corporate Behavior, 104 Q.J. Econ. 655, 655–56 (1989).
[5]Geoff Warren, Benefits (and Pitfalls) of Long-Term Investing, CIFR Research Working Paper, No. 40/2014, October 2014 (T003, Paper #2).
[6]McKinsey & Company, supra note 2.
[7]The J.M. Smucker Company, Registration Statement (Form S-3), at 7 (Sept. 28, 2017).
[8]See Lucian Bebchuk & Lars Stole, Do Short-Term Managerial Objectives Lead to Under- or. Over-Investment in Long-Term Projects?, 48 J. Fin. 719, 719–20 (1993) (surmising that when investors cannot observe the level of investment in along‐run project, suboptimal investment is likely, but when investors can observe investment but not its productivity, overinvestment is possible).
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