The Costs of Entrenched Boards

1
The Costs of Entrenched Boards

• Lucian Bebchuk and Alma Cohen
• Yale SOM, May 2004

2
Main Points

• Paper investigates empirically how the value of
  publicly traded firms is affected by protecting
  management from removal. Main findings
• Staggered boards established by company charters
  are associated with a lower market value, with
  the reduction in value being economically
  significant.
• Some evidence consistent with charter-based
  staggered boards causing, and not merely
  reflecting, a lower firm value.
• Effect stronger for charter-based staggered
  boards (which shareholders cannot amend) than for
  bylaws-based staggered boards.

3
The Key Role of Staggered Boards

• With a staggered board, directors are grouped
  into classes, with a single class of directors
  (typically, one third of directors) standing for
  election each year.
• Effective staggered board protects a board from
  removal
• in a proxy contests
• in a hostile takeover
• By-laws based staggered boards may be ineffective
  protection against removal by determined
  shareholders.

4
Evidence on the Antitakeover Power of Staggered
Boards

• Effective staggered board doubles the odds of the
  targets remaining independent.
• Other defenses, such as pre-bid poison pills,
  supermajority voting provisions, and fair price
  provisions, have much less significance.
• Bebchuk, Coates, and Subramanian (2003)

5
The Debate Over Protecting Boards From Removal

• Does protection of removal benefit or harm
  shareholders?
• Central question for
• The debate in the 1950s about proxy contests
• The debate on takeover defenses during the 1980s
  and 1990s
• The current debate on shareholder access to the
  corporate ballot.

6
Firm Value
7
Protection from Removal Affects Value in Many
Ways

• Protection can affect
• (1) The ex ante behavior and decisions of
  incumbents Manne (1965), (Stein (1988),
  Bebchuk and Stole (1992), (Arlen and Talley
  (2003).
• (2)   The probability of a hostile acquisition
  and of a negotiated acquisition
• (Easterbrook and Fischel (1981)), (Lipton
  (1979)), (Grossman and Hart (1980)), (Bebchuk
  (1982)).
• (3)   The premia obtained in the event of an
  acquisition
• Stulz (1988), (Bebchuk (2002), Subramanian
  (2003).

8
Alternative empirical strategies

• Investigate each of the different effects
• E.g., hostile bid outcomes (BCS (2002a, 2003))
  
• acquisition premia (BCS (2002b, Subramanian
  (2003))
• and then add them up.
• Investigate overall effect directly
• This paper

9
Prior Empirical Work

• Work on the effects of state antitakeover
  statutes on value (e.g., Karpoff and Malatesta
  (1989), Gartman (2000)
• Work on the effects of adoption of a poison pill
  affected stock prices (see, e.g., Ryngaert
  (1988)).
• Gompers, Ishii, and Metrick (2003) identify
  substantial correlation between firm value during
  the 1990s and a broad-based index (G) of twenty
  four corporate governance provisions.

10
The Data

• All the companies for which there was
  information in one of the volumes published by
  the Investor Responsibility Research Center
  (IRRC) (1990, 1993, 1995, 1998, 2000, and 2002.)
•  
• Each volume includes between 1,400 and 1,800
  firms, including all the firms in the SP 500 at
  the time of the volumes publication, plus
  additional firms that the IRRC viewed as
  important.
• We focus on the period 1990-2002, with special
  attention to 1996-2002.

11
Incidence of Staggered Boards
12

• Staggered Board Incidence and Market
  Capitalization

13

• Staggered Board Incidence among Different Cohorts

14
Testing for Association between Staggered Boards
and Firm Value

• Use Tobins Q as the measure of firm value.
  (Following (Demsetz and Lehn (1985), Morck,
  Shleifer and Vishny (1988), Lang and Stulz
  (1994), Yermack (1996), Daines (2001), LaPorta et
  al. (2001)).
•  
• Dependent variable is industry-adjusted Q, which
  is a firms Q minus the median Q in the firms
  industry in the observation year. Industry by the
  firms 2-digit primary SIC code.

15
Staggered Boards and Firm Value (I)

• OLS regression Independent variable
  Industry-adjusted Q

16
Staggered Boards and Firm Value (II)

• OLS regressions Independent variable
  Industry-adjusted Q

17
Exploring Causation

• Do staggered board bring about a lower firm value
  or are charter-based staggered boards simply
  adopted by firms with lower value?
• Helped by the fact that charter-based staggered
  boards cannot be adopted by the board without
  shareholder approval.
•  
• During the 1990s, the annual percentage of firms
  in which management brought a proposal to
  staggered the board was less than 0.5 (Klausner
  (2003)).

18
Pre-1990 Charter Decisions and Firm Value

• OLS regression Independent variable
  Industry-adjusted Q

19
Charter-based vs. Bylaws-based Staggered Boards
20
Conclusions

• Staggered boards are associated with a lower
  market value. The reduction in market value
  associated with them is economically meaningful.
• Staggered boards partly drive the negative
  correlation between firm value and the governance
  index.
• Some evidence consistent with staggered boards
  causing, and not merely reflecting, lower firm
  value.
• Bylaws-based staggered boards do not have the
  same effect as charter-based staggered boards.

21
Growing Shareholder Resistance

• Growing resistance from institutional investors
  during the past decade
• Shareholders generally unwilling to approve
  charter amendments establishing staggered boards.
  
• Support for precatory resolutions recommending
  the dismantling of existing staggered boards.
• But staggered boards also continue to have many
  defenders (e.g., Koppes, Ganske, and Haag
  (1999)), and boards commonly ignore precatory
  resolutions to dismantle them.