Harvard Report Finds Negative Impact of Classified Board Structure on Firm Value

Bebchuk, Cohen, and Wang of Harvard University just recently released a report examining the relationship between staggered boards and firm value. While numerous reports have found a negative correlation between classified boards and firm value, one must be cautious in determining causation. Are classified boards merely a product of low-valued firms or are they actually responsible for yielding a negative impact on firm value?

In determining causation, the researchers implemented a quasi-experiment that made use of an October 8, 2010 ruling by the "Delaware Court of Chancery… approv[ing] the legality of a shareholder-adopted bylaw that shortened the tenure of directors". The case concerned a takeover contest between Airgas, Inc. ("ARG") and Air Products and Chemicals, Inc. ("APD"), where the bylaw would move ARG's annual meeting earlier in the year to January (from August). The "January bylaw" would thus have the effect of limiting the extent to which ARG's staggered board could entrench incumbent directors.

As it turns out, following the ruling in favor of the "January bylaw", firms with staggered boards experienced positive abnormal stock returns, compared to those without staggered boards. Companies with late annual meetings, Delaware incorporation, non-supermajority voting requirements, below-industry return on assets, and small firm size, increased most notably in value. All told, five days following the ruling, firms with staggered boards increased 50 risk-adjusted basis points in value over those without staggered boards.

The study goes beyond the scope of prior research by indicating causation: staggered boards negatively impact firm value.

It is no surprise then that Georgeson reports an average of 65%+ shareholders voting in favor of the 187 shareholder proposals to de-stagger boards during the 2006 - 2010 proxy seasons. It should also be of no surprise that between 2000 and 2009, "the number of S&P 500 companies with classified boards declined from 300 to 164".  Download Georgeson's 2010 Annual Corporate Governance Review

With that said, about half of "the over 3,000 public companies whose takeover defenses are tracked by FactSet Research Systems still have staggered boards". That leaves quite a few firms vulnerable to some corporate governance criticism from their investor base.

No doubt the findings in this report will be used to help bolster support for many activist investors seeking to remove a company's classified board structure.  In our opinion, companies interested in taking a proactive approach to avoiding shareholder activism, de-staggering the board may present an attractive option and should be seriously studied in conjunction with the merits associated with the company's other defense mechanisms.  

The report can be found here.

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IMPORTANT NOTE: On November 17, 2010, ARG appealed Chancellor Chandler's decision to the Delaware Supreme Court. Just yesterday, on November 23, 2010, the Delaware Supreme Court ruled in favor of ARG (overturning Chancellor Chandler's decision) determining the shareholder-approved bylaw to be illegal. ARG fell sharply 5.92% that day to $62. Thus, (assuming no other outside influence on ARG's stock) the report's findings not only remain consistent, but also are further validated.

Posted by David Schatz

Image extracted from (1).

Wachtell Lipton Issues Annual Client Memo: "Key Issues for Directors 2011"

In light of expectations that shareholder activism will rise over the next year, WLRK has issued to its clients a rather timely memo, titled "Key Issues for Directors 2011". The memo is written by the inventor of the "poison pill" and shareholder activist critic Marty Lipton. Given Lipton's track record as a skilled lawyer, the memo provides a helpful guideline for corporations looking for defense. In providing advice, Lipton considers the financial crisis, expectations for the upcoming takeover and shareholder activist environment, as well as new government rules and regulations in the era of Dodd-Frank. 

Excerpt from the memo:

Earlier this year, in The Spotlight on Boards, I published a list of the roles and responsibilities that boards today are expected to fulfill.  Looking forward to 2011, it is clear that in addition to satisfying these expectations, the key issues that boards will need to address include:

          ·         Organizing the business of the board so that each of the increasingly time-consuming matters that the board is expected to oversee receives the appropriate attention of the directors.

          ·         Retaining and recruiting sufficient directors to meet the requirements for experience, expertise, diversity, independence, leadership ability and character, and providing compensation for directors that fairly reflects the significantly increased time and energy that they will need to spend in serving as board members. 

          ·         Developing an understanding of shareholder perspectives on the company, as well as coping with the escalating requests of union and public pension funds and other activist shareholders for meetings with the independent members of the board to discuss performance, governance, compensation and director nominations matters.

          ·         Maintaining the collegiality of the board in light of the balkanization created by the mandatory independent committee structure, and maintaining a collegial relationship with senior management that allows the board to play the important role of a strategic partner in light of the constantly increasing focus on the monitoring function of the board. 

          ·         Developing an understanding how the company and the board will function in the event of a crisis.  Most crises are handled less than optimally because management and the board have not been proactive in discussing how they would function, and the board cedes control to outside counsel and consultants. 

          ·         Most importantly, working with management to encourage entrepreneurship, appropriate risk taking, and investment to promote the long-term success of the company, despite the unrelenting pressures for short-term performance. 

Martin Lipton

Links to some previous thoughts…

Some Thoughts for Board of Directors 2010

Some Thoughts for Board of Directors 2009

Some Thoughts for Board of Directors 2008

Posted by David Schatz

Report by Schulte Roth & Zabel and Mergermarket Sheds Light on the Outlook of Shareholder Activism

Corporate law firm Schulte Roth & Zabel (SRZ), along with Mergermarket, recently released the findings of their annual survey Shareholder Activism Insight at SRZ's inaugural Shareholder Activism Conference in New York City this past week.

Here are a few survey results…

Not surprisingly, both activist and corporate respondents see a rise in shareholder activism over the upcoming 12 months.  60% of activists see a rise in shareholder activism versus 64% for corporate respondents.

This latter number is up from 39% in 2008. Only 4% of executives (and 0% of investors) actually see a decrease in shareholder activism over the upcoming 12 months.

While both activists (88%) and corporates (56%) are in agreement that the most  notable increases in shareholder activism in the next year will come from hedge funds, they disagree on the specifics. In terms of activism, excluding hedge funds, corporate respondents are most bullish on union funds; activist respondents, pension funds. All told, activists see a greater use of activism across all investor groups, except union funds, than corporate respondents do. While 46% of corporate respondents see an increased use of activism for union funds, only 35% of activists agree. Conversely, 40% of activists see a rise in activism amongst sovereign wealth funds, but only 4% of corporates expect an increase.

Perhaps most notably, respondents disagree as to which sectors will experience the greatest rise in shareholder activism over the next year and what catalysts will be responsible for this trend. Although a plurality of corporates (44%) and activists (26%) see shareholder activism rising most in the financial services industry, the latter class evidently has their eyes set on a more diversified portfolio. 22% of activists expect the greatest amount of activism to occur in the energy/utilities and technology/media/telecom industries each. 33% of corporates, not expecting a rise in technology/media/telecom targets, believe the greatest use of shareholder activism will take place in the energy/utilities industry, followed by 11% for chemicals/industrials (which activists, conversely don't expect any rise to take place in.) However, the most significant disagreements between corporates and activists arise when polled about catalysts. While 68% of activists see excessive cash on balance sheets (versus 15% for corporates) as the main driver of shareholder activism, 54% of executives see financial performance (versus 40% for activists) as the main driver. Activists see greater rises in activist investing due to every catalyst than corporates do (and quite significantly, at that), except for financial performance. Lastly, despite 50% of executives viewing activists as short-term market opportunists, nearly a majority (48%) of activists polled stated that their average holding period is in excess of a year.

With that said, there still is significant agreement between executive and activist respondents. For example, the two believe, by a substantial majority, that dialogue/negotiations is both the best strategy for activists, as well as for companies, to take in addressing shareholder activism. A plurality of activists (44%) and a majority of corporate respondents (57%) believe that investors and corporations work constructively on these negotiations most of the time, free from the limelight--which contrasts with media portrayals. Executives' views of activists have also improved over the last year, with 46% of executives viewing them as value driven co-owners and 74% of executives believing that shareholder board representation is important. Additionally, a majority of both parties believe "say on pay" rules will have the greatest impact on the extent of shareholder activism over the upcoming 12 months. 80% of activists and 72% of executives also expect investors to take advantage of proxy access, although technically in the long-term only executives (by a majority) expect this to be a long-term trend.

Despite the perceived impact of new regulations, only approximately 10% of corporates will respond by changing their composition of boards/senior management, their executive compensation structure, or their public relations strategies. Says David Rosewater, Partner at Schulte Roth & Zabel, "It is interesting to note that although more than half of the corporate executives responding state that the Dodd-Frank Act provisions will make them more responsive, very few believe it will change their behavior on relevant issues."

The report, which can be found here, is fascinating in the context of the major proxy campaigns taking place currently, the financial crisis, and the ruling going on over proxy access. Hedge Fund Solutions, LLC., as well as other consultants, have been counseling companies and investors in preparation for this increased and distinctive rise in shareholder activism.

Marc Weingarten and David Rosewater lead SRZ's shareholder activism practice.  

Marc Weingarten

David Rosewater

SRZ has a preeminent practice specialty in activist matters, with an unparalleled expertise in the applicable securities laws, proxy rules and the current state of market practice. SRZ has been counsel in many of the highest-profile activist matters in recent years. Serving both issuers and activists, the firm advises on federal securities law, state corporate law, Hart-Scott-Rodino, proxy rules and related matters, as well as handling investigations and litigations arising out of activist activity.

Charts extracted from Shareholder Activism Insight


Posted by David Schatz

HBS Research Finds Positive Market Value of Proxy Access

In a recently released study titled "Does Shareholder Proxy Access Improve Firm Value? Evidence from the Business Roundtable Challenge", the authors--Becker, Bergstresser, and Subramanian of Harvard Business School--argue "that financial markets place a positive value on shareholder access".

As published earlier, on October 4, the SEC granted a Stay of proxy access following litigation by the Business Roundtable and the US Chamber of Commerce. Consequentially, there has been some ongoing debate as to whether or not proxy access will go into effect. Should it not get into effect, and the paper's conclusions are accurate, firms will miss out in a potential source of value creation.

According to the research, as manifested in the SEC's final Rule 14a-11, shareholder access improves overall shareholder value.

"We find that firms that would have been most affected by proxy access, as measured by overall institutional ownership, lost 17 basis points of value for each standard deviation of ownership.  For firms that were owned more by historically activist institutions, the value lost was nearly four times as large." [emphasis added]

The paper can be found here.

Posted by David Schatz