Staggered Boards and Firm Value, Revisited

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Friday March 7, 2014 at 9:02 am
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Editor’s Note: The following post comes to us from Martijn Cremers, Professor of Finance at the University of Notre Dame; Lubomir P. Litov, Assistant Professor of Finance at the University of Arizona; and Simone M. Sepe, Associate Professor of Law at the University of Arizona. Work from the Program on Corporate Governance about staggered boards includes The Costs of Entrenched Boards by Lucian Bebchuk and Alma Cohen, and How Do Staggered Boards Affect Shareholder Value? Evidence from a Natural Experiment by Alma Cohen and Charles C. Y. Wang.

Staggered boards have long played a central role in the debate on the proper relationship between boards of directors and shareholders. Advocates of shareholder empowerment view staggered boards as a quintessential corporate governance failure. Under this view, insulating directors from market discipline diminishes director accountability and encourages self-serving behaviors by incumbents such as shirking, empire building, and private benefits extraction. On the contrary, defendants of staggered boards view staggered boards as an instrument to preserve board stability and strengthen long-term commitments to value creation. This debate notwithstanding, the existing empirical literature to date has strongly supported the claim that board classification seems undesirable, finding that, in the cross-section, staggered boards are associated with lower firm value and negative abnormal returns at economically and statistically significant levels.

In our paper, Staggered Boards and Firm Value, Revisited, which was recently made publicly available on SSRN, we consider the time series evidence using a comprehensive dataset on staggered boards in 1978-2011 for a large panel of U.S. firms, and find that the negative cross-sectional association between staggered boards and firm value is reversed in the time series analysis: firm value goes up upon the adoption of a staggered board and goes down upon removal of a staggered board. In particular, staggering up (down) is associated with an increase (decrease) in Tobin’s Q of about 6.3%. We further corroborate these results using stock returns of portfolios holding stocks of firms around the time the firm staggers up or staggers down, and find that stocks that stagger up tend to have positive abnormal returns around the time they adopt a staggered board. In contrast, stocks that de-stagger tend to have no or negative abnormal returns.

How can we interpret our evidence that the adoption of a staggered board is associated with an increase in firm value? We first try to reconcile the seemingly conflicting existing cross-sectional evidence with our new time series evidence. We find that the cross-sectional results—that in the cross-section, staggered boards tend to have a lower value—could be explained by the reverse causality embedded in the choice of adopting a staggered board. In particular, our evidence suggests that firms with low firm value are more likely to adopt a staggered board.

Second, we propose a positive account of staggered boards, in which staggering up may be efficiently employed by some firms to mitigate the risk of interference by shareholders in situations of high asymmetric information between shareholders and the board. While short-term pressure from stockowners may generally provide an efficient mechanism to discipline management and the board, in contexts of high asymmetric information (or very noisy market prices) such market discipline may have adverse consequences. For example, it may be very difficult for firm insiders to credibly signal to investors that decreased short-term earnings are due to significant long-term and profitable investment programs rather than to poor managerial performance. In addition, investors with short-term investment horizons may have poor incentives to expend considerable resources to address such information problems, especially for large, complex firms.

In these contexts, a staggered board may therefore be beneficial to insulate the board from shareholder pressure and promote longer-term commitment to value creation. Consistent with this conjecture, we find that adopting a staggered board has a more positive effect on firm value for firms where such shareholder-manager problems may be more important, such as firms with higher R&D, more intangible assets, more innovative research, and firms that are larger and thus more complex.

From a broader perspective, these results cast a doubt on recent academic and regulatory proposals in favor of shareholder empowerment, suggesting that in corporate contexts where asymmetric information and long-term investments play a crucial role (as they do in many modern large firms), shareholders interference risks being detrimental rather than beneficial. To the best of our knowledge, we are also the first to challenge the claim that the empirical evidence decidedly supports the adoption of a shareholder-driven corporate governance model. In contrast to this claim, our results seem to suggest that the traditional director primacy model as enforced by the courts of Delaware (i.e., vesting the authority to run the corporation exclusively on the board of directors) can efficiently serve the interests of shareholders and society as whole.

The full paper is available for download here.

 

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