Board Declassification Activism: Why Run From the Evidence?

In a recently released study, we examined the value implications of board declassifications promoted by the Harvard Law School Shareholder Rights Project (“SRP study”). In a May 2017 note, Lucian Bebchuk and Alma Cohen “contest” the results in our study. In our reply, “Board Declassification Activism: Why Run Away from the Evidence?” we show that the Bebchuk-Cohen critique is not only unwarranted, but also fails to engage with our study’s central finding: that the declassification activism of the Shareholder Rights Project (“SRP”) was followed by substantial declines in firm value of from $90 billion to $149 billion.

For three academic years (from 2011-2012 to 2013-2014), the SRP operated a clinical program that drafted, submitted, and advocated for shareholder proposals designed to prompt some of the largest publicly traded U.S. corporations to declassify their boards. The analysis in our study takes the SRP’s performance report at its word and assumes that the project had a direct, causal impact on many recent board declassifications. We further assume that investors could not have fully anticipated the substantial impact the SRP would have on board declassifications before it made its declassification activity publicly known. Using these assumptions, we argue that the SRP’s operation provides a unique quasi-experimental setting that provides causal, not just correlational, empirical evidence on the effects of board declassifications on firm value.

This evidence shows that the declassifications promoted by the SRP (“SRP declassifications”) are associated, on average, with economically and statistically significant reductions in firm value, both in absolute terms and relative to declassifications occurring at firms that were not targeted by the SRP over the same period (“non-SRP declassifications”). Economically, the negative effect of SRP declassifications corresponds to an average decline in financial value of from $960 million to $1.6 billion for each company targeted or, aggregated across the 93 SRP declassifications included in our sample, an overall decline in value of from $90 billion to $149 billion.

Bebchuk and Cohen’s note contests the results in the SRP study, arguing that “[a]ppropriately interpreted, [these] results provide some significant evidence that declassifications are beneficial and no evidence that they are value-reducing.” Their note further argues that the results of the SRP study contradict and undermine the conclusions in our prior work published in the Stanford Law Review, “The Shareholder Value of Empowered Boards” (“SLR article”). This work examined the wealth effects of staggered boards over a longer sample period (1978-2011) and documented that adopting a staggered board increases firm value, while declassifying the board decreases that value.

In our reply, we examine the various ways that Bebchuk and Cohen’s note attempts to weaken the significance of the results in the SRP study. We conclude that their critique of the evidence in the SRP study that board declassification has a negative association with firm value is unwarranted and that this evidence is consistent with the results documented in our prior staggered board studies. Those studies also include our forthcoming article in the Journal of Financial Economics, “Staggered Boards and Firm Value, Revisited” (“JFE article”), which we coauthored with Lubomir Litov. Though ignored by Bebchuk and Cohen, that paper examines the wealth effects of staggered boards over an even longer period (1978-2015), considers multiple ways to reduce endogeneity concerns and includes a plethora of robustness checks. Consistent with the results of our SLR article, our JFE article finds that firm value increases (decreases) after firms adopt (remove) a staggered board.

Most important, the Bebchuk and Cohen note remains essentially silent on the SRP study’s main finding: that firm values significantly declined, on average, after SRP declassifications. Instead, their note cherry picks the results in our study for non-SRP declassifications and fails to interpret those results in conjunction with the evidence in our prior staggered board articles, which consider a much longer time period with substantially more changes in board structure. In particular, the non-SRP declassifications considered in the SRP study are a subset of the declassifications examined in the JFE article. Accordingly, under Bebchuk and Cohen’s argument that the results for non-SRP declassifications matter separately from SRP declassifications, rather than being valuable for the purpose of comparison with the latter (as considered in our study), there is no reason to limit the analysis to the three-year period in which the SRP was active. Instead, the results in the SRP study need to be interpreted jointly with the results for the much longer 37-year sample considered in the JFE article. Performing this analysis shows that the results in the SRP study are fully consistent with the evidence in the JFE article. Therefore, the Bebchuk-Cohen note’s focus on results for non-SRP declassifications looks like an attempt to avoid the plausibly causal evidence concerning SRP declassifications, and the significant losses these declassifications triggered.

Finally, contrary to Bebchuk and Cohen’s argument, the evidence in the SRP study strengthens the case for our prior policy proposal of turning the staggered board into a default structure that is difficult to change (a “sticky default.”). In our Stanford article, we advocated for such a structure, with only the board having the power to change it, subject to shareholder approval under a supermajority two-thirds requirement. Had these constraints on board declassification been in effect, the SRP probably would have been less successful in promoting declassifications at targeted firms from 2012-2014.

Indeed, our study shows that virtually the only companies that failed to declassify their boards as the result of pressure from the SRP were those that had a supermajority requirement for dismantling the staggered board. What’s more, our study showed that these companies did not experience the same decline in value as the SRP targets that did declassify. Therefore, our proposal to turn the staggered board into a sticky default would have substantially mitigated—if not prevented—the significant decline in financial value associated with SRP declassifications.

This post comes to use from Professor Martijn Cremers at the University of Notre Dame’s Mendoza College of Business and Professor Simone M. Sepe at the University of Arizona’s James E. Rogers College of Law. It is based on their recent article, “Board Declassification Activism: Why Run Away from the Evidence?” available here.

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