May 29, 2009
Hybrid Boards of Directors Can Lead to Increased Share Values
by Robert Kropp
Study by the Investor Responsibility Research Center Institute and PROXY Governance finds that
efforts by activist institutional shareowners to seat dissident board members correlates with
increased share prices.
At publicly traded corporations, an independent Board of Directors is seen by many investors as
essential to the responsible oversight of management activities. As such important issues of
corporate governance as executive compensation have gained unprecedented levels of public
attention, the Securities and Exchange Commission (SEC) has proposed a rule that would permit
shareowners to place director candidates on the corporate ballot.
business objections to the SEC's authority to allow shareowners to place candidates on proxy
ballots, Senator Charles Schumer of New York recently introduced legislation that explicitly grants
the SEC the authority to do so.
In the midst of such investor concerns comes a well-timed
report, issued by the Investor
Responsibility Research Center Institute (IRRCi), a New York City-based nonprofit organization
that funds environmental, social and corporate governance (ESG) research, and authored by PROXY Governance, a proxy advisory and
Jon Lukomnik, program director at IRRCi, told SocialFunds.com, "Until this
report, no one really had an idea of what happened when hybrid boards were seated by proxy
challenges. The report shows that activists have run a number of successful campaigns that for
three years at least have led to increased share values."
The report, entitled Effectiveness of
Hybrid Boards, examines whether so-called hybrid boards, created when dissident shareowners
successfully elect directors but do not gain control of boards, succeed in creating value for
shareowners. The report studied the effectiveness of 120 hybrid boards formed between 2005 and
Observing that ownership of public companies by retail investors has declined from
more than 90% in the 1950s to approximately 30% by 2009, the report found that ownership by
institutional investors has increased over the same time period, from less than 10% to more than
70%. Active ownership by institutional investors came about, according to the report, because "the
enormous level of assets controlled by institutions made efficient movement in and out of stock
positions increasingly difficult. As a result, institutional investors increasingly have a tendency
to become involved in corporate control when results do not live up to expectations."
While the report cites some studies that question the effectiveness of corporate governance
activities by institutional investors, it also refers to research that has shown that shareowner
activism on corporate governance can lead to favorable results. One such study cited in the report
found that companies named to the annual governance Focus List compiled by the California Public Employees Retirement System (CalPERS) have
outperformed their index over a subsequent five-year period.
The report found that two
developments over the last decade were responsible for increased shareowner activism on the part of
institutional investors. One was regulatory changes mandated by the SEC, one which ended the
censoring of proxy material, and another which allowed for proxy "free communication" in which
communications among shareowners would not be pre-screened by the SEC. The other was the rise in
influence of hedge funds, which "often have no conflicts of interest which would deter them from
overt or hostile activism," and have proven to be willing to launch proxy fights for corporate
Scott Fenn, Managing Director of Policy of PROXY Governance and co-author of the
report, told SocialFunds.com, "We're seeing greater willingness of companies to compromise, greater
willingness of institutions to support dissident directors, and greater willingness of proxy
advisory firms to support the formation of hybrid boards."
Of the 120 proxy contests that
led to the creation of hybrid boards, 91% were initiated by institutional investors. 76% of the
contests were resolved through engagement and subsequent settlement, while 24% were settled by
shareowner votes. The overall number of proxy contests resulting in hybrid boards increased from 18
in 2005 to 36 in 2008. On average, dissidents gained 2 seats on the boards of companies that were
Of the objectives cited by dissidents in their campaigns to gain representation
on boards, the need for improvement of corporate performance has shown the most growth, from 28% of
2005 contests to 62% of those in 2008. Other objectives cited include governance changes, strategic
changes such as changes in business strategy or operating structure, and the sale of companies.
Less easily categorized objectives, such as improving communications and transparency with
shareowners, increased from 11% of 2005 contests to 36% in 2008.
According to the report,
"The real measure of the success of a hybrid board – regardless of the particulars of the case
activists made to gain seats on the board – should be the evaluation of increased or decreased
shareholder value." The report found that the 52 companies whose hybrid boards had been seated for
at least one year, share prices increased by 5.0%, compared to 1.4% for peers. On the other hand,
when the 15 companies whose hybrid boards had been seated 3 years or more were evaluated, the
report found that share prices increased just 0.7% over the three year period following the proxy
contest, which was actually 6.6 percentage points worse than peers.
But if the three-month
period between announcement of a proxy challenge and the scheduled proxy vote are included, then
the share prices of companies whose hybrid boards had been seated 3 years or more were found to
have increased by an average of 21.5%, 17.8 percentage points more than peers over the 39-month
"Baaed on the data set we had, we did find a correlation between hybrid boards
and increased share value," said Fenn.
Asked by SocialFunds.com about the corporate
governance activities of institutional investors, Fenn again referred to the funds necessary to
mount an effective proxy campaign, and theorized that the smaller stakes that such investors have
in companies may prevent them from doing so to the extent that hedge funds can.
a lot of money to run a proxy contest," Fenn told SocialFunds.com. "It will be interesting to see
if regulatory changes on proxy access cause institutions to employ the process more broadly. If the
rules take effect, they will make it much easier for institutional investors to nominate dissident
directors to boards."
Fenn continued, "Some of the coalitions formed by activist investors
have had remarkable success in such areas as climate change, and you can be pretty sure that some
of those activist investors will be quick to utilize the proposed regulatory changes."