Staggered Boards and the Wealth of Shareholders: Evidence from the two Airgas Rulings

Posted by Lucian Bebchuk, Alma Cohen and Charles C.Y. Wang, Harvard Law School, on Monday February 7, 2011 at 9:19 am
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Editor’s Note: Lucian Bebchuk, Alma Cohen, and Charles C.Y. Wang are all affiliated with Harvard Law School’s Program on Corporate Governance. This post is based on their recent study, available here. This post is part of the Delaware law series, which is cosponsored by the Forum and Corporation Service Company; links to other posts in the series are available here.

The Program on Corporate Governance just issued our paper Staggered Boards and the Wealth of Shareholders: Evidence from a Natural Experiment.

While staggered boards are known to be negatively correlated with firm valuation, such association might be due to staggered boards either bringing about lower firm value or merely being the product of the tendency of low-value firms to have staggered boards. Our paper uses a natural experiment setting to identify how market participants view the effect of staggered boards on firm value.

In particular, we focus on two recent rulings, separated by several weeks, that had opposite effects on the antitakeover force of the staggered boards of affected companies: (i) an October 2010 ruling by the Delaware Chancery Court approving the legality of shareholder-adopted bylaws that weaken the antitakeover force of a staggered board by moving the company’s annual meeting up from later parts of the calendar year to January, and (ii) the subsequent decision by the Delaware Supreme Court to overturn the Chancery Court ruling and invalidate such bylaws.

We find evidence consistent with the hypothesis that the Chancery Court ruling increased the value of companies significantly affected by the rulings –namely, companies with a staggered board and an annual meeting in later parts of the calendar year – and that the Supreme Court ruling produced a reduction in the value of these companies that was of similar magnitude (but opposite sign) to the value increase generated by the Chancery Court ruling. The identified positive and negative effects were most pronounced for firms for which control contests are especially relevant due to low industry-adjusted Tobin’s Q, low industry-adjusted return on assets, or relatively small firm size.

Our findings are consistent with market participants’ viewing staggered boards as bringing about a reduction in firm value. The findings are thus consistent with institutional investors’ standard policies of voting in favor of proposals to repeal classified boards, and with the view that the ongoing process of board declassification in public firms will enhance shareholder value.


Below is a more detailed description of what our paper does:

The existence of governance provisions that weaken shareholder rights and insulate directors from removal is now well known to be negatively correlated with firm value (Gompers, Ishii, and Metrick (2003)). This correlation is partly driven by staggered board provisions, which prevent shareholders from removing a majority of directors in any given election (Bebchuk and Cohen (2005); Bebchuk, Cohen, and Ferrell (2009)). It might be suggested, however, that such correlation does not imply causation, and that it might be fully driven by the tendency of firms with low value and weak performance to have entrenching provisions in general and staggered boards in particular. In this paper we seek to contribute to resolving the causality question and determining whether staggered boards bring about (or merely reflect) a lower firm valuation.

When a board is staggered, a challenger in a proxy fight, or a hostile bidder seeking to gain control over the board to redeem a poison pill and enable its offer to proceed, would have to win votes in two consecutive shareholder meetings. Such impediments to board replacement could lead to increased slack and thereby worsen firm performance and lower firm valuation.

Over time, institutional investors have become increasingly opposed to staggered boards. While shareholders were willing to vote for the adoption of a staggered board during the 1980s, they subsequently have not been willing to do so and, furthermore, have been increasingly willing to support shareholder proposal to dismantle staggered boards. According to Georgeson Shareholder reports, there were 187 shareholder proposals to declassify boards during the five proxy seasons from 2006 through 2010, and the average percentage of votes cast in favor of proposals to declassify exceeded 65% in each of these five years. The Council of Institutional Investors, and leading institutional investors such as the American Funds, BlackRock, CalPERS, Fidelity, TIAA-CREF, and Vanguard, all have policies that support annual election of all directors and voting in favor of board declassification proposals. ISS, the leading proxy advisor, also has a policy of recommending voting in favor of proposals to dismantle staggered boards.

Facing such widespread shareholder opposition to staggered boards, many companies have declassified their board of directors. According to FactSet Research Systems, between 2000 and 2009, the number of S&P 500 companies with classified boards declined from 300 to 164. Still, the debate over staggered boards is far from being won by shareholders opposed to staggered boards. Many companies continue to oppose proposals to de-stagger their board. Moreover, about half of the publicly traded companies in the over 3,000 public companies whose takeover defenses are tracked by FactSet Research Systems still have staggered boards.

We seek to contribute to understanding the causal effects of a staggered board. Causal identification is notoriously difficult in empirical work on corporate finance and corporate governance. We use a quasi-experimental research design, focusing on the effects of two not-fully-anticipated court rulings. In particular, we focus on the Chancery Court and Supreme Court rulings on October 8, 2010 and November 23rd, 2010, respectively, in the takeover battle between Airgas Inc. (“Airgas”) and Air Products and Chemicals, Inc. (“Air Products”).

The rulings focused on the permissibility of adopting a shareholder-adopted bylaw — conceived in the course of the Airgas takeover battle – that moves up the date of the next calendar year’s annual meeting to January. Such a bylaw has the potential of shortening the tenure of directors and facilitating the process of replacing a majority of the company’s directors. For companies whose annual meetings ordinarily took place in later parts of the calendar year (as was the case with Airgas whose annual meetings have typically been held in August or September), permitting such bylaws would reduce the extent to which staggered boards can delay the replacement of a majority of directors by shareholders and thus would lower the impediments to a hostile takeover. Chancellor Chandler of the Delaware Chancery Court initially ruled that such bylaws are legally valid and may be used. Subsequently, however, the Delaware Supreme Court reversed and held such shareholder-adopted bylaws to be invalid.

Examining the cross-section of stock returns surrounding the announcements of the rulings, we find evidence consistent with the hypothesis that the value of the companies affected by the above two rulings – companies with a staggered boards whose annual meeting has been taking place in later parts of the calendar year – was increased by the first ruling, which validated the novel method for weakening the antitakeover force of companies’ staggered boards. We also find evidence consistent with the hypothesis that the second ruling, which invalidated this novel method, had a negative effect on the value of these companies that was of a similar magnitude to that of the first ruling’s (positive) effect. The initial increase in value and subsequent reduction were especially pronounced for companies for which control contests are especially relevant due to low industry-adjusted firm value (as proxied by Tobin’s Q), low industry-adjusted return on assets, or small firm size.

Overall, our findings are consistent with market participants’ expecting the weakening of the antitakeover effect of staggered boards to bring about an increase in firm value. The findings are thus consistent with the large support among institutional investors for proposals to repeal classified boards and with the view that the continued declassification of boards – an ongoing process that has been taking place over the past decade – can be expected to benefit shareholders. It should be noted that the abnormal positive returns accompanying the Chancery Court ruling and the abnormal negative returns accompanying the Supreme Court ruling are likely to understate the market’s estimate of the benefits of repealing classified boards because (i) as will be discussed, the market ascribed a positive probability to each of the ruling before they were issued, and (ii) the bylaws that were the focus of the rulings would have weakened but not eliminated the antitakeover effect of staggered boards in the companies affected by the rulings.

Comments on or reactions to our paper, which is available here, would be most welcome.

 

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