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July 15, 2004
Harvard Study Correlates Staggered Boards With Lower Shareowner Value
    by William Baue

Evidence presented in the study suggests that staggered boards do not simply reflect lower firm value, but rather that they bring about lower firm value.

Corporate governance advocates have long opposed classified boards, which stagger director re-elections to prevent the removal of the entire board. Many take action by filing shareowner resolutions year after year calling for annual board elections. These resolutions averaged 62.7 percent of the vote at the 38 companies facing the issue in the 2003 proxy season, according to the Investor Responsibility Research Center (IRRC), an impartial proxy research firm. Now, an academic study provides empirical evidence that bolsters the case against staggered boards by correlating them to lower shareowner value.

The Harvard Law School Program on Corporate Governance published the study, entitled "The Costs of Entrenched Boards," in late June. Lucian Bebchuk, a Harvard law professor and director of the corporate governance program, and Alma Cohen of the National Bureau of Economic Research (NBER) and the Analysis Group, a financial strategy consultancy, co-authored the study.

The study bolsters the case for repealing classified boards "by showing that companies with staggered boards have lower shareholder value, with the reduction in value being economically significant," Dr. Bebchuk told "Management has been taking the view that staggered boards benefit shareholders by providing stability and facilitating long-term planning--our study shows that there is no empirical basis for supporting staggered boards."

Dr. Bebchuk also believes that the study bolsters the case for granting shareowners access to the proxy to nominate board director candidates, a rule that the US Securities and Exchange Commission (SEC) is currently considering implementing in the face of staunch opposition from business.

"Evidence that impediment to shareholder removal of directors reduces corporate value provides general support for reforms aimed at making removal more viable--it thus strengthens the case for shareholder access to the ballot," said Dr. Bebchuk.

The study builds on an influential 2003 paper by Harvard economists Paul Gompers and Joy Ishii and Wharton School professor Andrew Metrick, entitled "Corporate Governance and Equity Prices," that examines how 24 governance mechanisms affect firm value. The study finds that governance mechanisms strengthening shareowner rights tend to improve share price, while mechanisms favoring management, including staggered boards, tend to erode value. However, the study considers the 24 governance mechanisms in aggregate, and does not look at any individual mechanism in isolation.

"We extend this work by finding, controlling for other governance mechanisms, that staggered have a strong effect on market value and that their effect is several times larger than the average effect of other provisions in the constructed index," write Drs. Bebchuk and Cohen.

As with the Gompers-Ishii-Metrick study, the Bebchuk-Cohen study employs an index constructed using IRRC data covering between 1,400 and 1,800 firms, which account for more than 90 percent of the total market capitalization of the US stock market. While the former study covers the decade from 1990 to 1999l, the latter study focuses on the years from 1995 (when "the legal rules that give staggered boards their protective powers were firmly in place") to 2002.

Both studies use Tobin's Q, or the ratio of the market value of assets divided by their replacement value, to calculate firm value. The Bebchuk-Cohen study finds staggered boards associated with a Tobin's Q that is lower by 17 points, which the authors characterize as not just statistically significant but also economically significant.

A few further interesting findings of the Bebchuk-Cohen study: it finds evidence suggesting that staggered boards do not simply reflect lower firm value, but rather that they bring about lower firm value. The study also finds reductions in firm value to be stronger for staggered boards established in the corporate charter (which shareholders cannot amend) than for staggered boards established in company bylaws (which can be amended by shareholders).

The study concludes with the promise that the authors are working on a subsequent study examining the effects of other governance mechanics besides staggered boards on firm value. It also praises other current research working in the same area, such as a study by Lawrence Brown and Marcus Caylor of Georgia State University (GSU) commissioned by Institutional Shareholder Services (ISS). This study finds a positive correlation between a recently introduced ISS corporate governance index and several measures of firm value.

"The [Brown-Caylor] study also reports that the sub-part of the ISS index that seems to be most important is the one based on board composition and not the one based on takeover defenses," write Drs. Bebchuk and Cohen. "Interestingly, however, the ISS incorporates the presence of staggered boards into the board composition part of its index."

"Our findings suggest that it would be worth testing whether staggered boards play an important role in the formation of whatever correlation exists between the ISS index and firm value," they add.


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