Staggered Boards and Private Benefits of Control

Our paper titled “Staggered Boards and Private Benefits of Control” adds a new perspective to the ongoing debate about whether staggered (or classified) boards of directors lead to entrenchment. The novelty of the paper is focusing directly on private benefits of control by taking advantage of a new market-based measure of the value of voting rights, which is interpreted as a lower bound for private benefits.

In a firm with a staggered board, only a fraction (usually one-third) of the board members are up for election at an annual shareholder meeting. Thus staggered boards provide a potent anti-takeover mechanism by impeding potential contenders from obtaining the majority of board seats. Critics argue that insulating firms from the market for corporate control leads to entrenchment of the incumbent managers and reduces firm value. In contrast, proponents argue that staggered boards are a value-maximizing governance choice and increase firm value through board independence, management stability and resistance to hostile or opportunistic takeovers.

Identifying the effect of staggered boards on firm value is not straightforward, because the price of common shares incorporates both the value of expected future cash flows and the value of shareholder voting rights. Consequently, any change in the stock price can be due to a change in either the value of expected future cash flows or the value of voting rights (or both). Moreover, the value of voting rights reflects the private benefits of control that may be extracted from the firm. Therefore, drawing inferences about entrenchment in a firm by looking only at stock prices is complicated. Prior studies largely overlook this issue, in part due to the lack of a broadly applicable measure of the value of voting rights, and tend to infer about entrenchment indirectly by examining firm performance or governance outcomes.

We estimate the value of voting rights from option prices (hereafter, control premium), following the method introduced in Kalay, Karakaş, and Pant (2014).[1] In essence, the method captures the control premium by synthesizing a non-voting share of common stock using the option put-call parity relation, and comparing the price of the synthetic non-voting share to that of the underlying stock. The key insight for the method is that option prices reflect the cash flows of the underlying stocks, but not the control rights. An important advantage of using this new method is that it enables us to estimate the control premium for a large sample of firms, unlike other methods of estimating the value of control such as using dual-class stocks or trades of controlling blocks. Further, and more importantly, we believe our method is more suitable for studying corporate governance issues, particularly staggered boards. This is because firms with dual-class stocks or controlling blocks are subject to selection biases, and the control in such firms is already concentrated. Thus having staggered boards is arguably less relevant in insulating these firms further from market for corporate control. Under such circumstances, the applicability and usefulness of the other methods of estimating control premium are limited.

Analyzing US public companies over the period 1996 to 2011, we find that control premium is higher for firms with staggered boards. This result holds after controlling for firm characteristics such as total assets, leverage, book-to-market ratio, firm age, insider ownership, R&D expenditures, ROA, and CAPEX, and for time invariant unobserved firm characteristics through the inclusion of firm fixed-effects. Focusing solely on the sample of 163 (33) firms de-staggering (staggering) their boards and in the years immediately before and after these changes in board structure, we find that firms de-staggering (staggering) their boards experience a 54% (11%) decrease (increase) in their control premium. These results are stronger for the de-staggering cases, compared to the staggering cases. This may be due to two possible reasons. First, we observe de-staggering of boards more often than staggering, and therefore our sample is larger for the former cases. Second, the de-staggering cases are arguably less subject to reverse causality concerns. This is because staggering the board might indicate an already entrenched management, whereas de-staggering tends to happen due to the pressure of dissenting/activist shareholders.

To mitigate the potential endogeneity concerns in the relation between staggered boards and the value of control rights, we use a quasi-natural experiment. This experiment is based on two court rulings in 2010 with opposite decisions on the effectiveness of staggered boards (Bebchuk, Cohen, and Wang (2011)).[2] These rulings were made during and in response to the takeover battle between Airgas Inc. (target) and Air Products and Chemicals, Inc. (acquirer). The Chancery Court’s ruling on October 8th, 2010 (event #1) allowed for a shareholder-adopted bylaw to move up the date of the next calendar year’s annual meeting to any date within that calendar year. This would allow the acquirer company to accelerate obtaining the majority of the board seats in the target company. The Chancery Court’s ruling weakened (but did not eliminate) the effectiveness of staggered boards. On November 23rd, 2010 (event #2), Supreme Court reversed the ruling of Chancery Court on the basis that changing the date of annual meetings would implicitly and unfairly shorten the tenure of some board members. Hence, the second ruling essentially nullified the effects of the first ruling observed on October 8th. This decision, however, was somewhat anticipated by the market, and hence the reversal of the effects could have spread before the actual announcement of the decision. Bebchuk, Cohen, and Wang (2011) document a positive (negative) stock market reaction to the first (second) ruling for firms with staggered boards.

Using the above-mentioned quasi-natural events, we find that firms with staggered boards experience a decrease (increase) in their control premium after event #1 (event #2). Note that this effect is likely to be causal due to the exogenous court decision affecting all firms with staggered boards. The changes for event #1 are statistically stronger compared to those for event #2. This is not surprising given that event #1 was much more unanticipated.

Finally, we test whether the market reaction to the court rulings is indeed associated with the control premium. We find the changes in control premium around event #1 to be significantly and negatively associated with the cumulative abnormal returns (CARs) around event #1. This further suggests that the value of control rights is a determining factor for the positive market reaction to the de-facto weakening of the effectiveness of staggered boards due to the court ruling. Our finding of a negative relation between the stock returns and the changes in control premium around event #1 is noteworthy. This is because, ceteris paribus, if the control premium of a stock increases (decreases), the stock returns would increase (decrease) as well – this would bias against us finding negative correlation between the stock returns and changes in control premium. The relation between event CARs and the change in control premium around event #2 is not significant. Again, this is not surprising given that the Supreme Court’s overruling was somewhat more anticipated.

Taken together, our results suggest that, consistent with the entrenchment view, staggered boards are perceived by the market on average as a value-reducing rather than value-maximizing corporate governance choice.


[1] See Avner Kalay, Oğuzhan Karakaş, and Shagun Pant, The Market Value of Corporate Votes: Theory and Evidence from Option Prices, 69(3) J. Fin. 1235 (2014).

[2] See Lucian A. Bebchuk, Alma Cohen, and Charles C.Y. Wang, Staggered Boards and the Wealth of Shareholders: Evidence from Two Natural Experiments, (available at (June, 2011).

The preceding post comes to us from Oğuzhan Karakaş, an Assistant Professor of Finance at Boston College and Mahdi Mohseni, an Assistant Professor of Finance at the Texas A&M University.  The post is based on their article, which is entitled “Staggered Boards and Private Benefits of Control” and available here.