February, 14, 2007

The following op-ed, Board Silly by Professor Guhan Subramanian, was published in The New York Times on February 14, 2007.

Slowly but surely, corporate America is giving up the staggered board.

Some businesses are responding to corporate governance rating agencies, which penalize companies that do not elect all of the directors each year. Some are responding to shareholder resolutions or to behind-the-scenes pressure from large shareholders. Georgeson Shareholder Services reports there were more than 90 resolutions among S. & P. 1500 companies in 2006 to abolish staggered boards, half proposed by the companies and half by shareholders. More are expected in the 2007 proxy season, and some corporate governance experts are urging companies not to fight the issue.

This would be a mistake. What shareholders object to is not staggered boards themselves, but how staggered boards block takeovers.

Let me explain. Most corporations have adopted or can easily adopt a “poison pill,” a takeover defense that forbids a hostile bidder from directly purchasing a controlling interest in a target company. If the target has a staggered board, a bidder must win two proxy contests, conducted more than a year apart, to gain control of the board and jettison the poison pill. No bidder in the modern era of takeovers has had the patience and persistence to do this, so the staggered board combined with the pill presents a potent roadblock to shareholders who want to accept a hostile offer.

But there is a way to give shareholders exactly what they want without eliminating the staggered board: shift the staggered board from the charter to the bylaws. That would allow a hostile bidder to dismantle the staggered board through a bylaw amendment and put its offer to shareholders in a single proxy contest. For the 99.5 percent of United States public companies that are not subject to a hostile takeover bid in a given year, directors would continue to be elected to staggered, three-year terms.

Staggered boards offer many benefits over unitary boards: greater stability, improved independence of outside directors and a longer-term perspective — things shareholders should want, too. A bylaws-based staggered board would provide directors with three-year terms but allow shareholders to “recall” them in the event of a hostile takeover bid that a majority of shareholders want to accept. This is the norm in many European countries, where directors can be elected to six-year terms but shareholders retain the right to remove them from office at any time.

Skeptics might contend that unitary boards are pretty stable too, because the vast majority of board elections are uncontested. But because companies are increasingly requiring that board candidates win a majority of votes cast, directors would value the right to face election only every three years rather than every year.

The stakes are high. If directors surrender on the question of staggered boards, we risk further short-termism in boardrooms and no internal counterweight to managers focused on quarterly earnings. But if they hold firm, approximately half of the nation’s public companies will remain heavily insulated from the socially desirable “disciplinary” effect provided by the threat of a hostile takeover. Rather than forcing an all-or-nothing showdown, boards should respond to shareholder demands to end staggering with the counter-offer of a bylaws-based staggered board.

Shareholders rightly decided that they did not like the anti-takeover effect of staggered boards, but their campaign unnecessarily casts the baby out with the bathwater. A bylaws-based staggered board meets the interests of all sides.