Financial press and corporate governance (Take 2)

Issues at Wirecard and Luckin Coffee had prompted me to write an earlier post about the role of financial journalists in corporate governance. One of the two companies mentioned (in case anyone needs reminding) is German. Isn’t its interesting then that the German government was going to propose discipling the press for negative coverage of pre-IPO tech companies. I say ‘going to propose’ because these proposals were contained in a position paper temporarily published on the website of Germany’s Federal Ministry of Economic Affairs. It was later claimed that the wrong version of the paper was published by mistake. In any case, the position paper did not just stop at forbidding negative press. It went on to suggest that ‘financial media should also be “obliged” to cover smaller IPOs’ and that ‘financial bloggers should legally be required to publish their full identity, and should be made liable for stating “false allegations and insults”’.

In my earlier post, I had argued that BaFin (Germany’s market regulator) should pro-actively investigate media and analyst reports. In addition to this not being possible if the press is prevented from providing negative information about pre-IPO companies, there is the obvious problem of potential subscribers to the IPO being disadvantaged.

Having send all that, I have to point out that the authors of the position paper have indeed identified a genuine concern re anonymous bloggers since the anonymity means that they are not accountable, and thus can make unverified claims. The real challenge is to ensure that investors (particularly the newer retail or wireless investors of the Gamestop variety) are able to distinguish between reliable financial media and anonymous bloggers.

Corporate participation in public policy debates

I recently read The Queering of Corporate America: How Big Business Went From LGBTQ Adversary to Ally by Professor Carlos A. Ball. It is an interesting book that describes how corporations went from being targets to sources of of LGBTQ activism. A passage [207, 208] in the conclusion of the book is interesting:

The bottom line is that there is no easy response to the question of whether corporate participation in public policy debates or harms society. Instead, the answer, like the nature of politics itself, is messy and complicated, and, by necessity, depends on the particular issues and circumstances in question.

There is little doubt that corporate engagement with issues relating to LGBTQ equality in recent years has worked to the benefit of many sexual minorities and transgender individuals.

I would agree that there is no easy answer, and will add that corporations should carefully assess the costs and benefits of engaging in public policy debates, irrespective of the issue. I discuss the costs of short-termism, both for society and the corporation in question, in this regard in a series of posts titled ‘Corporate short-termism and social media‘.

Building blocks of firm innovation

Lego is a private, family owned company which almost went bankrupt in 2003 but then later bounced back. It is currently doing very well and the latest announcement of working on a plan to use recycled bricks instead of single-use plastic seems like a great leap in current times where ESG is a prime concern. The FT editorial board has this to say about the promise of this innovation at Lego:

Lego has a reputational head-start over most businesses because parents and grandparents still associate its products with happy childhood memories. But tastes change, and attitudes to products can swing within a few tweets from unquestioning support to disapproval.

But by broadcasting its virtuous move away from oil-based plastic now, it is laying down a layer of reassurance that the box of preloved Lego bricks in the attic will still be an acceptable plaything generations hence.

While we praise how innovative Lego is currently, let’s step back to its financial troubles in 2003 for a minute. By 1993 the then profitable firm began facing challenges caused by “consolidation among some retailers and the phenomenon of big-box stores made it tougher for company leadership to negotiate prime shelf space for LEGOs”. Video and computer games also began to win over Lego. Apparently Lego’s products were perceived as being meant for boys at the time. The firm responded with an “innovation binge” which included Harry Potter and Star Wars toys which were temporarily popular but not long-term wins. Other toys completely failed and teh company was out of cash by 2003. Jorgen Vig Knudstorp, initially as management consultant and later as CEO helped Leo cut costs by selling stakes in some of its businesses and sourcing raw material from cheaper vendors. However, instead of throwing innovation out, the new management became more sensible about it. According to Professor David Robertson, the experience taught Lego the lesson of “controlled innovation”.

Professor Davidson talk’s about Lego’s innovative strategies in the period before 2003, i.e. under the former CEO Christiansen:

Kirk Christiansen and his leadership team adhered to nearly every one of the major principles that are widely prescribed by experts in launching its spate of innovation in 2000: The firm found relatively competition-free markets where LEGO could dominate. Management sought the participation of a number of different constituencies from both inside and outside the firm and hired a diverse and creative staff. It tried to create new products that disrupted existing markets, and it listened to customer feedback. Innovation became a focus of every aspect of the company, with the goal of turning it into the world’s strongest brand among families by 2005.

It is great that the near bankruptcy did not result in Lego fully giving up these innovative strategies. The most recent environment-friendly innovation seems to be a testament to this.

One question that the Lego story might give rise to is whether public companies are too hamstrung by corporate governance requirements to be innovative. Dr Roger M. Barger and Professor Iris H-Y Chiu argue that “shareholder-centred agency-based corporate governance standards may hinder firm innovation” by focusing too much on monitoring management, and in turn using financial performance as a key indicator of monitoring. They argue that this focus tends too much towards managerial short termism. While this model can motivate the “lazy manager”, they argue that holistic perspective of the organization can be more useful. they also highlight that interlocking directorships can actually bring useful industry knowledge that might help innovation. Similarly concentrated ownership might be useful for supporting investment into R&D because of their long-term commitment. Similarly dual class share structures can promote innovation by giving the founders (who have long terms interests) control over decision-making. Finally stakeholders can be a source of ideas as well. The short extract above Lego above shows that management actually did draw ideas from feedback of different stakeholders. The more recent focus on stakeholder engagement in the latest iteration UK Corporate Governance Code might also be useful for firm innovation (including in sustainable ways), if company management is so inclined.

Corporate culture

There’s an excellent line in an article in the FT today: It is difficult to assess what the culture of an organisation is from statistics. This is an important point. Even firm with more diverse employees could have a bad work culture meaning that people outside of the in-group (either based on demographic attributes or based on different viewpoints) are not promoted. The article from which I take the line is focused on equity issues for women of colour. A good corporate culture can certainly help on that count. But it can also help on a different count. Incidentally a different article also in the FT (yes, my news source of choice!) shows another issue affected by weak corporate culture. This second article is on Wirecard and mentions that its late CEO Markus Braun had little tolerance for dissenting views. I extract a little passage from the article which narrates an episode that nicely illustrates this lack of tolerance for dissenting views.

In November 2018, chief product officer Susanne Steidl took issue in an email with a draft press release which stated that new products launched by Wirecard would soon generate an additional €100m in revenue. “I don’t want to be the party pooper but this simply seems to be too high by a factor of 10,” Steidl argued, pointing out that the new products at that point generated “almost no revenue”. Braun immediately sent Steidl a terse text message: “I would be very grateful for not pursuing such discussions by mail with a large distribution list!!” One day later, the press release with the highly ambitious revenue target was published.

We know how Wirecard eventually went down.

Anyway, my point in linking these two articles – one on equity and diversity issues, another on Wirecard’s problematic management is to show how effective corporate cultures can help diverse people thrive and also prevent misconduct to a large extent. I write more about these issues in my book (still a work in progress!) titled The Corporate Diversity Jigsaw. I also have an earlier post which discusses these points in the context of issues in Pinterest.

ODR heating up in India

Online dispute resolution (ODR) has been around for a while now and Covid-19 has given it a big push. It can mean any type of online dispute resolution although the focus is usually on forms of alternative dispute resolution. In April 2021, India’s Niti Ayog launched an ODR handbook which listed consumer disputes as one of the key areas amenable to ODR. The handbook was “an invitation to business leaders to adopt ODR in India”. Snapdeal has taken the leap (via a pilot study) in partnership with Sama (an ODR platform). Apparently, about a 100 cases were settled and some disputes which ordinarily take between 2 – 3 years were completed in 15 days. This is obviously an interesting development for ODR but I also found it interesting that the CEO of Sama said that the Snapdeal was “a very customer-centric approach”. One can imagine Snapdeal drawing more customers based on their option of cheaper and quicker ODR.

There are other ODR platforms being developed and tested in India. Jupitice (which has former judges on its advisory board) is another example. The ODR handbook encouraged Indian businesses to draw on international best practices. On that note, the Council of Europe’s recently released Guidelines of the Committee of Ministers of the Council of Europe on online dispute resolution mechanisms in civil and administrative court proceedings might be of interest to businesses wanting to take the Snapdeal route and to ODR platforms.

Is Australia’s class action regime available to non-resident shareholders?

Is Pt IVA of the Federal Court of Australia Act 1976 (Cth) (which contains Australia’s class action regime) not available to non-resident shareholders of a dual listed Australian company? This and some other interesting questions came up in BHP Group Limited v Impiombato [2021] FCAFC 93 (where leave was sought to appeal the decision in Impiombato v BHP Group Limited (No 2) [2020] FCA 1720). The court granted leave to appeal on this ground.

Middleton, Mckerracher and Lee JJ noted that ‘the real question is better expressed as: whether Pt IVA permits an applicant to define group membership as including claims of non-residents?’ [27]. In the ‘opt-out’ regime of the FCAA, the Cth made a choice to ‘include no provision excluding the possibility of non-resident group members’ [47]. The judges further agreed with the primary judge’s finding that there was nothing in Part IVA showing an intention to disallow claims for loss and damage by non-residents [63].

Leave to appeal has been granted on this issue of extraterritorial application of Part IVA of the FCAA because it involves ‘a point of some importance, which has not been directly considered by an intermediate court of appeal in Australia’.

That will be something to watch out for.

There is however, another interesting issue discussed in the judgement. It is titled ‘wrongful discretion contention’ in the judgement. My title for it is below.

Lack of certainty and finality

BHP’s alternative argument was that ‘even if claims were able to be made on behalf of non-resident group members, it was appropriate for the Court to exercise its discretion under ss 23 and/or 33ZF of the Act to exclude such persons from the class action’ [69]. The primary judge rejected this application. BHP then argued that ‘in deciding not to order the exclusion of non-resident group members, or to order that the proceeding on behalf of such group members be permanently stayed pending an amendment to the definition of “group member” (or even considering such a course),… the primary judge failed to take into account a material consideration which must be properly weighed in the exercise of the discretion: the interests of BHP in the proceeding and, more particularly, BHP’s interest in certainty and finality in respect of the proceeding’ [71]. They further argued that the retention of non-resident group members ‘who will retain their rights of action against BHP Plc regardless of any settlement, promotes significant uncertainty’ [75].

The primary judge seemed to agree that there is “some risk” of the issues being re-agitated in UK and South Africa [81], however, on balance, decided not to make an order under s 33ZF or s 23 [82].

Agreeing with the primary judge’s decision, Middleton, Mckerracher and Lee JJ held as follows [83]:

Australia has adopted a no provision model. If the operation of that model results in an unfairness in an individual case, Pt IVA has within it discretions to ensure that any prejudice can be ameliorated, but to do so in such a way as to not totally exclude a sub-class of group members who have claims that can be grouped. In any event, it is not as if by excluding non-residents the Court will not have to look at the question of purchases of BHP LSE Shares and/or BHP JSE Shares on foreign exchanges, because some Australian resident group members (who also purchased BHP ASX Shares) will remain group members.

However, the judges went on to acknowledge the problem of uncertainty affecting settlement efforts. Although this particular rejection of relief was not challenged by BHP, the judges went on to make some interesting comments [92, 95].

Without expressing any concluded view, in the particular circumstances of the present case, it might be argued that immediately prior to the hearing or in the context of a settlement proposal or mediation there may be some merit in an order requiring a non-resident class member to take a positive step to opt-in to the class action, although the class action is otherwise conducted on an opt-out basis.

As to any residual concerns as to power to make an order under s 33ZF, it is beyond the scope of this judgment to enter into extended debate about any form of “opt-in” or class closure orders and it is unnecessary to do so.

It will be interesting to see if this sort of thing comes up in future in Australia or in other “opt-out” jurisdictions.

Taking the Heat: (Non)Disclosure of Climate Change Risks in India

Anik Bhaduri

               Last year, the Wall Street Journal described an event that was previously unheard of – ‘a climate change bankruptcy’. A series of wildfires in California destroyed assets worth millions, pushing the Pacific Gas and Electricity (PG&E) Company into bankruptcy and causing huge losses to its investors. Later it was found that the executives of the Company knew that the wires were outdated and that there was a high risk of electricity plants catching fire. Not only did they not do anything to reduce the risk, but they also did not inform prospective shareholders of the potential fire hazard and financial risk. This raises an important practical question that had so far only been discussed in theory – should companies be made liable for failure to disclose climate change risks?

            Over the last year, numerous countries have been discussing and debating the introduction of new regulations that mandatorily require companies to disclose potential risks to their business operations from climate change. There is, however, another school of thought, particularly prominent in the US, which holds that any information regarding climate change risks are ‘material information’ and accordingly, even in the absence of any new regulation, a failure to disclose such information to potential investors amounts to securities fraud. It has also been argued that a failure to disclose such information amounts to a breach of the fiduciary duty that the management of the company owes to tits investors. Although such a reasoning is yet to be espoused by any court in the US or elsewhere, the long-drawn litigation against Exxon indicates that there is some merit in these arguments.

            In India, although the government has flagged climate change as a systemic risk that can affect the stability of the financial system, no steps have been taken in this regard by the Securities and Exchange Board of India (SEBI) or other regulatory bodies. The SEBI, like the Securities and Exchange Commission (SEC) in the US, relies on the subjective standard on materiality to determine the extent of disclosures required. No rule or regulation in India explicitly requires companies to disclose information about climate change risks. My new article in the Business Law Review argues that even in the absence of such an explicit regulation, the failure of Indian companies to disclose information about climate change risks violates the existing SEBI regulations.

Understanding materiality: In finance and in law

            Ever since mandatory disclosures were introduced in the Securities Exchange Act in 1933, they have formed a key part of securities regulation across the world, including India. The primary purpose behind mandatory disclosures is to remedy the information asymmetry between the management of the company and the investors, so as to allow the investors to make informed decisions about where to put their money, and enable them to engage meaningfully with the company management. The understanding of what counts as material information is based on two broad theories.

The first is the efficient markets hypothesis. Postulated by the Nobel economics laureate Eugene Fama, it posits that the value of securities in a market reflects all the publicly available information. If the risks to the value of a corporation are not adequately disclosed, its shares are traded on the stock exchange at a value far above their actual worth, enhancing the possibility of a bubble on the market. Fischel further developed the idea into the fraud-on-the-market theory, which argues that because the securities market effectively reflects public information in the price of stock, fraudulent disclosures that artificially inflate or depress market prices create fraud on the entire securities market, leading to economic loss for the investor. According to this theory, therefore, material information amounts to everything which, if disclosed, will affect the price of the stock on the market. The US Supreme Court explicitly endorsed the theory in Basic v Levinson, effectively laying down the financial and economic basis for securities fraud adjudication.

The second financial theory underlying mandatory disclosures is the investor suffrage theory. According to the governance theory, the purpose of disclosures is to encourage investors to police the role of corporate decision making. This theory, also described as the agency cost model, postulates that disclosures reduce the costs of monitoring an agent’s use of corporate assets and allows shareholders to monitor self-interested directors, leading to efficiency in corporate governance. The increasing emphasis on non-financial disclosures, such as environmental compliance, boardroom diversity and human rights due diligence, lend support to this theory.

In India, the SEBI (Issue of Capital and Disclosure Requirements) Regulations, (ICDR) as well as the SEBI (Listing Obligations and Disclosure Requirements) Regulations (LODR) stipulate that all publicly listed companies are to disclose material information. Although Indian courts have not adopted the fraud-on-the-market theory as the US courts have, the concept of materiality has been defined in a similar way. In DLF Limited v. SEBI, the Securities Appellate Tribunal (‘SAT’) observed, ‘Disclosure … which is required to be made in the offer documents, is one which, if concealed would have devastating effect on the decision-making process of the investors, and without which the investors could not have formed a rational and fair business decision of investment in the IPO’. In the matter of IPO of OneLife Capital Advisors Ltd., the SEBI clarified, “‘material’ means anything likely to have an impact on an investor’s investment decision … the test to determine whether a fact is ‘material’ depends on the facts and circumstances of each case.

Although the precise contours of materiality have not been laid down by the courts, it is clear that the term is to be construed liberally. The SAT further clarified in a recent decisionThe emphasis is on disclosure; not otherwise, which means disclose even when the issuer doubts whether there is materiality … ’. Given the extremely broad definition, it may be inferred that corporations may be liable for the non-disclosure of unprecedented events even if there are no guidelines from the
SEBI in that regard.

Materiality of climate change risks

            There is a huge volume of economic literature postulating that climate change can bring about the next financial crisis. The slowly increasing frequency and severity of natural calamities threatens the assets owned by firms, comprising the first category of financial risks posed by climate change. The second category involves the potential decline in stock value as the society transitions to more eco-friendly lifestyle – that is, the stock value of petroleum firms is expected to decline over the next few decades as the society moves to electric vehicles and the like. The third category of risks arises from the ever-increasing cost of complying with stringent and pervasive environmental regulations that can severely limit the profitability of firms – for instance, regulations on stricter air controls have the potential to reduce the output of a manufacturing plant by almost 5%, imposing an annual cost of
USD 21 million to the entire manufacturing sector.

 Given the financial effects of climate change, it is evident that awareness about these risks would affect the decisions of prospective investors and therefore amount to ‘material information’. Moreover, with the rapid rise of Socially Responsible Investing, nonfinancial information are playing a greater role in investment decisions. More and more investors are factoring in environmental concerns in deciding which companies to invest in – the emergence and rapid rise of companies like CDP that provide information about the environmental implications of a companies’ activities to potential investors, shows that climate change information is clearly material.

The obvious defence that most companies would resort to when charged with failure to disclose climate change risks would be that the management of the company was unaware of the degree and extent of the risks, as the financial impact of climate change is often hard to predict and take steps against. Recent investigations, however, have shown that this is not true. The ongoing lawsuits have revealed that the directors of Exxon deliberately concealed the information relating to potential damages to business operations from climate change. A study by the Center for International Environmental Law found that the entire global oil industry has been aware of climate change risks since as early as the 1980s but deliberately led efforts ‘to mislead or confuse the public about climate science … even when the industry’s own scientists were warning them about climate risks’. Even in India, shareholders of a number of public companies have expressed their discontent regarding the lack of information available to them about financial risks arising from climate change.


            While the US SEC is considering making it mandatory for listed companies to disclose their climate change risks, there is still widespread disagreement regarding the materiality of climate change disclosures. It is essential that securities regulators rethink their understanding of materiality, and recognize climate change risks as material information that ought to be disclosed.

Anik is a final year student at NALSAR University of Law, Hyderabad. The author is thankful to Rudresh Mandal and Karan Sangani for their inputs.

Corporate governance popcorn

The FT reports on AMC engaging retail investors (or meme stock owners) with free popcorn which resulted in a surge of new investors for the company:

The cinema chain’s new Investor Connect programme, which will also offers perks such as invitations to “special screenings”, underscores how the rising power of individual traders is attracting the attention of publicly listed companies and professional Wall Street investors.

As cinemas across the world struggle to attract audiences back after the pandemic, these measures seem appeal to retail investors not just as investors but also as consumers. This is reminiscent of crowdfunding and later equity crowdfunding which rely on customers or potential customers to invest in the company. As I had written (drawing from Professor Andrew Schwartz’s scholarship) in an article co-authored with Dr Nuannuan Lin:

It has been argued that CSF carries the ‘cultural promise’ of letting customers and audiences connect with content and, relatedly, allowing customers and audience to influence production decisions. There is also a case for the existence of non-financial benefits of equity crowdfunding, and these benefits include entertainment value, political expression, patronage for art, community-mindedness or simply altruism. (References omitted.)

Our article then went on to provide an example from Australia:

A recent example is that of Revvies Energy Strips Ltd (‘Revvies’), which completed the first CSF campaign in Australia. Its product was a fast-dissolving mouth strip that delivers 40 mg of caffeine. Since Revvies supplies the product to six national sports teams, some sports clubs and Olympic athletes from Australia, New Zealand and the United Kingdom, its co-founder was of the opinion that the new investors would also become endorsers and influencers. (References omitted.)

The rise of retail investors (thanks to social media use during the pandemic) might mean that companies will engage investors like AMC is doing, and like the companies raising funds through equity crowdfunding did, not only as investors but also as customers.

(While we are on the topic, Professor Christina Sautter explaining corp law concepts on tiktok!)

NZ signs the Artemis Accords – space sector in the country is set for growth

New Zealand became the latest country to sign the Artemis Accords which is a US initiative and contains a set of principles for space exploration (including, and this is the controversial part, extraction and use of space resources). Apart from New Zealand, countries that have signed the Artemis Accords thus far are Australia, Canada, Italy, Japan, Luxembourg, the Republic of Korea, the United Arab Emirates, the United Kingdom, Ukraine, and of course, the US. Brazil has announced its intention to sign and other countries might follow.

The New Zealand minister for Economic and Regional Development, Stuart Nash said that the agreement would allow New Zealand to grow its space industry, currently worth $1.7 billion. New Zealand’s Outer Space and High-altitude Activities Act, 2017 takes a performance based or tailored approach rather than a prescriptive approach, thus allowing for innovation. Since decisions of foreign licensing authorities are relied on in the initial few years of the legislation (s 51), cooperation with other countries through Artemis Accords seems like the next step. Indicative of the focus on corporate participation in this sector, Nash said:

Our space sector is worth over $1.7 billion and our space manufacturing industry generates around $247 million per annum in revenue. Signing the Artemis Accords facilitates participation in the Artemis program by New Zealand and our space sector companies.

Such collaborations are also likely to facilitate agreements and actions to address issues of sustainability (the most immediate concern being that of space debris). Foreign minister Nanaia Mahuta also added that “responsibilities of kaitiakitanga [guardinship] of the space environment” will be taken seriously.

One stakeholder’s food is another’s poison

The question giving rise to much debate recently has been whether companies (or their CEOs) should engage in political debates. An FT article (discussing current US debates and events) says:

…a shift in the politics around corporate America as chief executives used to being lambasted by the left as tax-dodging contributors to inequality and environmental degradation find themselves attacked from the right as “woke capitalists”. 

The article quotes the executive director of Consumers Research saying: “what we’re seeing is increasingly companies trying to distract from their failings by cosying up to woke politicians”. The FT describes Consumer Research as “a right-leaning group”.

Irrespective of the political leanings of the group or the type of politicians the companies in question are “cosying up to”, this should be a cause for concern. Of course, companies might also be playing to the galley i.e. stakeholders (which could include customers) but this is risky since it is not easy to discern stakeholder sentiment. Further, the more noisy voices of social media, might in fact not be a sizeable part of the stakeholder group. (I discuss these points in previous blog posts). So another reason for CEOs to refrain from engaging in these political issues is to avoid backlash from stakeholders (which is usually a diverse group). Edelman’s sage advice to CEOs therefore is ‘to stick to topics such as retraining where they have a clear mandate’.

Professor Anthony Grey has noted (in an article titled Corporations and their contributions to public debates (2020) 36 Aust Jnl of Corp Law 66):

the expertise and ability of corporate managers to properly assess community attitudes and values is highly questionable. This is not typically where the skill set of a corporate manager lies, and it is perhaps unfair and highly problematic to expect them to take on this role.

I agree with this premise (although not every corporate manager is alike). In any case, CEOs would do well to steer clear of divisive issues.