The Delaware Supreme Court is going to be hearing arguments soon in the case of Airgas vs. Air Products. In its briefs, as well as in oral argument before the Chancery Court, Airgas used our academic work on staggered board as evidence for its position. However, our academic articles, and the empirical evidence put forward in them, support the opposite position.
The case before the Delaware courts arose from Air Products’ unsolicited offer for Airgas. Facing opposition from Airgas to its offer, Air Products ran a competing slate for the August 2010 annual meeting and was able to replace one-third of the directors. (Airgas has a staggered board and thus only one-third of its directors came up for re-election at that annual meeting.) Air Products also succeeded in getting majority support for passing a bylaw moving up Airgas’ next annual meeting to January 2011, thus creating the possibility that another one-third of the directors could be replaced then.
Airgas has been arguing that the adopted bylaw is invalid as it is inconsistent with the classification of its board. In its briefs, and its oral argument before the Chancery Court, Airgas made substantial use of our academic work on staggered boards to suggest that the received academic understanding of staggered boards makes them inconsistent with shareholder ability to move up the date of the annual meeting.
Quoting our articles on The Powerful Antitakeover Force of Staggered Boards: Theory, Evidence & Policy and The Costs of Entrenched Boards, Airgas argued that they were built on the premise that, in the face of a staggered board, a hostile bidder must win two elections one year apart to gain control. Because the bylaw under consideration could enable Air Products to prevail by winning two votes just five months apart, Airgas reasoned, accepting its validity would depart from the state of affairs that, according to the literature, is supposed to prevail in the presence of a staggered board.
However, while our work suggested that classified boards force bidders to win two elections one year apart in many situations, it also explained that this is not the case in many other situations. In particular, we explained that the extent to which this is the case depends on the language of the governing documents and that those need to be carefully analyzed.
The Powerful Antitakeover Force of Staggered Boards introduced a distinction between a staggered board and an effective staggered board and uses it throughout the analysis. The article identified three ways in which, depending on a company’s governing documents, staggered boards can be rendered “ineffective” by shareholders seeking to replace a majority of the directors: (1) by removing directors without cause, when the governing documents allow shareholders to do so; (2) by increasing the size of the board and filling the vacancies created, when the governing documents allow shareholders to fix the size of the board and fill vacancies; and (3) by adopting a shareholder-adopted bylaw amendment, when the classification is established by the company’s bylaws. Furthermore, The Powerful Antitakeover Force of Staggered Boards reported that, among the takeover targets with staggered boards in our sample, about 20% had staggered boards that were not effective due to one or more of the factors (1)-(3).
While The Powerful Antitakeover Force of Staggered Boards focused on a dataset of takeover targets with staggered boards, The Costs of Entrenched Boards examined the full universe of public companies in the IRRC dataset. This article analyzed in detail the possibility that a staggered board is less effective due to factor (3) – the grounding of the board classification in the bylaws (which shareholders may amend) and not the charter (which shareholders may not amend).
Consistent with market participants’ understanding the difference between charter-based (and thus more effective) staggered boards and bylaws-based (and thus less effective) staggered boards, The Costs of Entrenched Boards reports that negative correlation with firm valuation is stronger for staggered board that are established in the corporate charter than for staggered boards established in the company’s bylaws.
Airgas has argued that many firms with a staggered board have been describing their arrangements as ones under which directors can be expected to serve three-year terms, and that allowing the considered bylaws would thus be inconsistent with settled expectations. Our work indicates that descriptions of staggered boards as involving three-year terms should be understood, and have been understood by market participants, to mean three-year terms in the ordinary course of events, but not if a majority of shareholders use any ways permitted by the governing documents to get around the board classification.
For example, in all companies where the classified board is established by the bylaws, directors can be expected to serve three-year terms only to the extent that shareholders do not amend the bylaws. The dataset of the Costs of Entrenched Boards, which lists many companies with bylaw-based staggered boards, is available here. Clearly, to the extent that these companies described their arrangements as involving three-year terms directors, such descriptions should have been reasonably understood by investors, consistent with the evidence in The Costs of Entrenched Boards, as meaning three-year terms in the absence of shareholder use of their power to amend the bylaws (or shareholder use of any other power allowed by governing documents to get around the board classification).
To be sure, while our work analyzed three ways in which shareholders may “get around” a staggered board to replace a majority of directors without two elections one year apart, we did not analyze the additional possibility used by Air Products, namely, (4) amending the bylaws to move up the date of the next annual meeting, when the governing documents do not preclude shareholders from amending that date. While our work did not analyze possibility (4) for making a staggered board less effective, the idea that some staggered boards do not force bidders to win two elections one year apart, and that one needs to study carefully the language of all the governing documents to determine the extent to which this is the case, is one that our work stressed.