In our paper, Does the Director Election System Matter? Evidence from Majority Voting, which was recently made publicly available on SSRN, we examine the economic consequences of a change in the director election system, namely, the switch from a plurality voting to a majority voting standard.
Under a plurality voting standard—until recently the default arrangement under most state laws—the candidate with the most votes “for” is elected, a system that helps avoid the disruptive effects of failed elections. In uncontested elections, the plurality voting standard means that each nominee will always be elected as long as she receives one vote “for,” irrespective of the number of votes “withheld” (under SEC rule 14a-4(b) shareholders cannot vote “against” a director nominee, they can only vote “for” or “withhold” support).
Under a majority voting (MV) standard, instead, even in uncontested elections a director would not be elected unless the majority of votes were cast in her favor. Starting in 2004, firms have begun to adopt some form of MV standard, often in response to non-binding shareholder proposals filed by activists and policy makers have debated whether to mandate a MV standard. By the end of 2007, about two thirds of the S&P 500 firms had adopted some form of MV.
Ex ante, the effect of a MV standard is not clear. On one hand, proponents of mandatory MV argue that a greater threat of replacement will result in stronger alignment of interests between directors and shareholders, with beneficial effects on firm value. On the other hand, shareholders could withhold (or threaten to withhold) votes for reasons unrelated to shareholder value maximization. In addition, failure to elect a director may cause firms to fail to comply with SEC or exchange requirements, with potentially negative net effects on firm value. A third possibility is that MV, as put into practice, is little more than “smoke and mirrors” since under most forms of MV standard currently put into practice the election outcome ultimately remains a board decision, protected by the business judgment rule.
To empirically examine the economic consequences of the adoption of MV we perform three sets of tests. First, using a regression discontinuity design that mitigates the issues commonly associated with interpreting investor response to voting results at annual meetings, we document abnormal returns of 1.43-1.60% on annual meeting dates where shareholder proposals to adopt a MV standard are voted upon. This result suggests that (at least for targeted firms) shareholders perceive the adoption of the MV standard as a value enhancing change in governance.
Second, we examine how MV affects shareholder voting behavior—an observable action aimed at influencing firms’ conduct and, thus, potentially directly influenced by this new election system designed to increase directors’ accountability to shareholders. We find that, in the presence of a withhold recommendation from ISS (a proxy for perceived problems with the director‘s performance), the percentage of votes withheld at director elections is about 3% higher at firms adopting MV relative to pre-adoption as well as to non-adopters. Similarly, the voting support for proposals to declassify the board at firms that adopted MV is substantially higher compared to the pre-adoption period and to control firms. These results are consistent with shareholders exerting greater pressure at firms adopting MV because they expect boards to be more responsive to shareholder votes under MV.
Finally, we focus on the impact of the adoption of a MV standard on board behavior, and, in particular, on board turnover. We find that the sensitivity of board turnover to votes withheld from directors at annual elections is higher subsequent to the adoption of MV, consistent with the notion that the MV election system makes boards more responsive to shareholder pressure. Our study contributes to the growing literature on the director election system and, more generally, on the economic relevance of governance arrangements.
The full paper is available for download here.