Home > Investor Participation, Staggered Boards, Trends in Corporate Governance, Voting Rights > The power of shareholders. Ballots, and the option for staggered or declassified boards

The power of shareholders. Ballots, and the option for staggered or declassified boards

The shareholder franchise, (right to vote), is the ideological support for directorial power in a company with dispersed ownership, so that whenever shareholders think directors do not deserve their trust anymore, they can use democratic tools to oust them. But, are director elections really available and adequate for this? We are going to follow the debate between Bebchuk and Lipton on this matter, as in other previous posts, (noting that they mainly refer to the US).


Why is the shareholder franchise relevant?


Boards have a role in correcting the agency problem between shareholders and managers. Given their functions, their selection is a critical decision, and compensating them so that they stay aligned with shareholders, is a must. The power to replace directors by shareholders has a role in both points, (in particular Courts do not judge directors` decisions, but shareholders need to do that). Some corporate decisions are reserved to the Board, precisely on the ground that directors can be replaced, and even director independence is not enough to provide incentives to work in favour of shareholders` interests.


When analysing Contest Solicitations, the number of directors challenged to be replaced by others still seeking to manage the company independently but differently,  is very small, (mainly in middle-sized or small companies), and a majority of them fail. When those numbers are compared to the number of public companies, the number is low. Mr Lipton considers this a fact, not a proof of difficulties to ballots. But…


The more outstanding obstacles to elections are the following, according to Mr. Bebchuk:


  1. The costs are high: sending the proxy to shareholders, and receiving it back; filing the proxy statement with the SEC, and communicating the proposed strategy, through costly proxy solicitors. But only a fraction of the eventual benefits would flow to the challenger, (according to his ownership percentage).
  2. The uncertainties under the challenger`s flag: the strategy, the Ceo that will be hired, etc.
  3. Staggered boards, where only a fraction, (usually a third) of directors comes for re-election each year. Controlling that board means winning two elections, which is more expensive, reduces the challenger`s chance, and makes shareholders reluctant to vote for, so as to avoid one year of unrest and uncertainty.


Bebchuk`s reform proposal


Consequently Mr Bebchuk proposes elections should be allowed to take place annually for all directors:


  1. The frequency would not necessarily be annual, (because of costs, short-termism being imposed on directors, etc).
  2. Access to the ballot should be opened to shareholders trespassing some ownership thresholds, and committed to keep its position for a certain time, (after the proposed director is elected).
  3. Reimbursement of funds spent in the contest, would be granted to those gaining sufficient support.
  4. Shareholders should be able to replace all directors, although unless a shareholder revolt takes place, elections could be consistent with a staggered board.
  5. Some arrangements for all elections:
    1. Directors should not remain when more votes are against than in favour. First, shareholders need to be able to cast “against” votes, and not only “withhold” ones; second, majority voting needs to be implemented, against the plurality system, because most elections are uncontested.
    2. The vote should be confidential
  6. Legislators should facilitate shareholders to initiate certain bylaws changes for introducing the proposed reform, and prevent directors from doing the same when the objective is making their ousting more difficult.


Staggered boards defendants (and Mr Lipton) concerns follow:


  1. The associated costs of annual contests,
  2. Certain major shareholders could happen to launch elections in order to pursue their own agendas,
  3. Directors would be invited to abandon their long-term focus, and the board in general would be disrupted by internal dissent and “electoral” attitudes,
  4. Director recruitment problems could arise from the permanent election forecast.
  5. Independence of Independent Directors and their stability and experience could be undermined.


The activism for the Power of Shareholders has been developed by Harvard`s Professor Bebchuk through Harvard`s “Shareholder Rights Project”, which advises some institutional investors, and in particular helps them submit proposals for declassification.


The main argument in favour of declassified boards, and against staggered or classified boards, is an empirical one, and the debate should mainly be kept in this area. There are some empirical studies which help link staggered boards with a lower firm valuation, lower returns in case of a hostile takeover bid, less pay and managers` turnover correlation with performance, and so on.


Those favoring staggered boards, attack this empirical evidence. But they also validly argue the concerns included above, and the loss of value captured by shareholders in the case of a hostile takeover bid. This last point is clear when a staggered board is combined with a poison pill. We will deal with that part of the debate in a forthcoming post, because it is critical: in fact, Professor Bebchuk`s ballot proposal is compatible with staggered boards, but not with its combination with poison pills as a hostile takeover bid defense.

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