February 14, 2007
Board Silly or Silly Proposal? A Response to Professor Subramanian
Posted by Jeff Lipshaw
On the way to something else, I saw Ethan Leib's post over PrawfsBlawg drawing a parallel between the objections to staggered corporate boards, and possible objections to our system of staggered Senate elections. What inspired Ethan's observation was an op-ed in today's New York Times from Harvard Professor Guhan Subramanian (right) on the issue of corporate staggered boards. Professor Subramanian's clever and well-written piece is entitled "Board Silly," but to most corporate lawyers who have spent time in the real world, I'd wager its proposal seemed just plain silly. (I also commented on the analogy to the Senate over at PrawfsBlawg.)
Here's the issue. No matter which side of the issue on which you sit, it's undeniable that the combination of a so-called "poison pill" and staggered board make it very difficult to mount a successful hostile takeover. The poison pill makes it almost impossible to initiate, much less complete a tender offer (for reasons too complex to describe here) that does not have the approval of the target board. If the acquiror has the patience to wait until the next annual election of directors, it can mount a proxy contest. A proxy contest does not trigger a poison pill. But if the board is staggered, the acquiror would not be able to take control in a single election. Indeed, most M&A lawyers would tell you the staggered board is more important than the poison pill.
The standard defense of the companies, when shareholders submit their non-binding resolutions requesting that the board undertake the process of eliminating the staggered board, is that the staggering of the terms promotes stability and continuity within corporate management. (I made that argument myself, but I'm happy to say as I re-read it five years later, it was hardly the centerpiece of the defense.) As Professor Subramanian correctly observes, responsible shareholders don't oppose stability and continuity; what they oppose is the loss of the threat to incumbent management that they can be thrown out quickly if they fail to produce adequate returns to the shareholders. And there's the ironic rub. It's a crock that the form of the staggered board, as opposed to the substance of the customary practice of board nomination and renomination of its own members, is fundamentally responsible for the stability and continuity of the board (and I couldn't bring myself to say that even when I was defending it!) Boards will be stable and continuous as long as their elections, whether unitary or staggered, do not turn into political free-for-alls, which appears to be the goal of at least some portion of the shareholder activist community (primarily the union pension funds).
More below the fold.
Professor Subramanian's "compromise" is to move the staggered board from the corporate charter, where it cannot be changed (at least in Delaware) without the board's prior consent, to the bylaws, where it could be amended by the shareholders at least as easily as they could mount a successful proxy fight for control of the board. Somehow he sees this as a favor to the directors "because companies are increasingly requiring that board candidates win a majority of votes cast, [and therefore] directors would value the right to face election only every three years rather than every year."
I'm not sure what the basis is for this last empirical proposition. The question is whether competent directors are going to want to serve at all in the environment where majority vote versus consensus is the standard. By and large, as a matter of form, boards "vote" on the matters before them, but the substance of decision-making is not majority rule. (To my sociologist friends: the form is gesellschaft, but the actual operation of the board and management group is gemeinschaft.)
The flip side of the irony is this from Professor Subramanian: "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." That's precisely the argument the directors make in support of the retention of the poison pill and staggered board! To wit: "If our stock price sinks to a bargain price as a result of a short-term event, and a raider wants to acquire us on the cheap, and not in the best long-term interest of the shareholders, we need to be able to fend it off." Note also the additional empirical assertions: (1) that short-termism in boardrooms is a rampant problem in corporate America (is it? I'm agnostic on that until shown some better data); and (2) that it takes the mere window-dressing of a three-year term in the bylaws to provide a counterweight to managers focused exclusively on the short-term.
Professor Subramanian's bylaw proposal is an offer of the sleeves off his vest. Either the staggered board has a anti-takeover effect which overall benefits the shareholders, in which case it is defensible as a matter of corporate law, or it does not, in which case perhaps it should go. (By the way, I think the burden is on those advocating its elimination, but that's another subject.) But if I were a director, and the professor offered this to me as a compromise, I'd say "To what? Don't do me any favors - I can have continuity and stability as long as your constituencies refrain from making our elections into referenda about class inequalities and wealth redistribution. And don't insult me by suggesting that the only thing that keeps me from being a short-termer is the three-year election cycle. Last I checked, I still minded my fiduciary duties."
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Many thanks to Professor Lipshaw for his thoughtful critique of my NYT op-ed from a couple weeks ago. I respond briefly to clarify and respond to a few points. First, a minor issue: Professor Lipshaw mistakes my reference to majority voting to mean that I advocate majority voting within the boardroom instead of the traditional consensus approach. As I think the context of my op-ed makes clear, I am referring to majority voting for directors (not by directors), which of course is increasingly becoming the standard at U.S. public companies. Majority-voting for directors makes even uncontested board elections non-trivial, which means that directors would value standing for election every three years as I propose.
Second, a more general point: Professor Lipshaw characterizes my op-ed as advocating a bylaws-based staggered board over a charter-based staggered board. This is not correct: my op-ed clearly advocates a bylaws-based staggered board as superior to a unitary board. Most of Professor Lipshaw's commentary "below the fold" is addressing an argument that I believe is supported by the empirical evidence that I and others have compiled, but this argument is not in my op-ed, nor does my op-ed depend on it.
Finally, Professor Lipshaw asserts that my proposal is "just plain silly" to "most corporate lawyers who have spent time in the real world." All I can say in response to this attack is that I have received many e-mails and other reactions from sophisticated practitioners who are hoping that my op-ed will spur a more thoughtful dialogue on staggered boards this proxy season. I hope so too.
Posted by: Guhan Subramanian | Feb 23, 2007 9:32:12 AM
And many thanks to Professor Subramanian for his response!
Also to be clear, I don't think I've missed the point. The op-ed really turns on the empirical question whether a director would value a three year bylaw based term over a one year unitary term, because of the reality that most directors are overwhelming renominated and reelected anyway. My intuition says no - it's in fact an offer of sleeves off the vest.
Nor did I think Professor Subramanian was advocating majority voting in the board room. The point is that "voting" - period - is a dispute resolution mechanism of last resort in the business world (as opposed to, say, the political world). My point was that directors tend not to be politicians, and I'd question their stomach for engaging in regular voting campaigns, whether annual or triennal. Or worse, you might get directors who like the heat of elections!
Posted by: Jeff Lipshaw | Feb 24, 2007 7:12:32 AM