Staggered Boards and Firm Value, Revisited

1. Staggered Boards and Firm Value, Revisited MartijnCremers (University of Notre Dame) Lubomir P. Litov (Univ. of Arizona & WFC, Univ. of Pennsylvania) Simone M. Sepe (Univ. of Arizona & IAST-TSE) University of Nebraska, September 29th2014

2. The Staggered Board Controversy • Staggered Boards (SBs): • boards with 3 classes of directors. • one class standing for re-election each year, each serving 3-year terms. Quintessential corporate governance failure or Strengthening board commitment to long-term value creation?

3. No Controversy in Empirical Literature • Empirical literature to date documents that firms with SBs have lower financial value (e.g., Bebchuk & Cohen, 2005; Faleye, 2007; ISS, 2013; Cohen and Wang, 2013) • Purely cross-sectional result. • Literature interprets this as SBs reducing firm value. • Our paper challenges this interpretation using 1978-2011 data. • Finding that staggering up (down) is associated with increase (decrease) in financial value (proxied by Q). 3

4. Theoretical Background • The Traditional (Delaware) View • Representative Democracy model(Strine, 2006) • Director Primacy • With accountability mechanisms • Shareholders: less expertise, incentives, information II. The Shareholder Empowerment View • Direct Democracy(Bebchuk, HLR 2005) • Shareholder empowerment

5. Representative vs. Direct Democracy Governance Rome Governance vs. Athens Governance

6. Theory: Which Agency Problem? Separation of Ownership and Control • Gives rise to twin ‘Agency Problems’: • Moral Hazard (of agent) • Due to management–shareholder conflict of interest. • Addressed by Shareholder Empowerment View. • Limited Commitment of shareholders to defer judgment. • Due to asymmetric information + adverse selection. • Addressed by Director Primacy View. • Trade-off • Between market discipline and board decision making. • Not ‘one-size-fits-all’ corporate governance. 6 6

7. An Ongoing Debate • Lipton, Wachtell, Rosen & Katz, February 2013 Memo, “The Shareholder Rights Project Is Wrong”(The New York Times): • “It is surprising that a major academic institution would countenance the formation of a clinical program to advance a narrow agenda that would exacerbate the short-term pressures under which American companies are forced to operate.” • Professor Bebchuk, CLR 2013: • “None of the organizations that press for board insulation in the name of long- term value …, such as … Wachtell, Lipton, Rosen & Katz, have thus far attempted to conduct or commission research that would use the substantial data available on the financial performance of firms and shareholders to validate their myopic activists hypothesis.”

8. Shareholder Rights Project

9. Data • Staggered Boards • 1978–1989 from Cremers& Ferrell (2013) database, & hand-collected information. • 1990–2011 from Risk Metrics, previously Investor Responsibility Research Center (IRRC). • Hand-checked missing years in the 1993–2006 using proxy statements (SEC’s EDGAR). • Charter vs. Bylaws Staggered Boards. • Bebchuk and Cohen (2005); Cremers and Ferrell (2013). • Firm Value • Q (Compustat). • Stock Return (CRSP).

10. Data - Observations

11. Almost No Time-series Variation in 1990-2005

12. Variation of SB in 1978-2011

14. SBs and Firm Value • Confirm previous cross-sectional results: • Negative association between SBs and firm value. • Reversed in time-series • Controlling for firm fixed effects, association is positive (levels analysis). • Average firm value after staggering up (down) is higher (lower).

15. Cross-Sectional Analysis

16. Cross-Sectional Analysis: Controlled for Q

17. Time-Series Analysis

18. SBs and Firm Value • Confirm previous cross-sectional results: • Negative association between SBs and firm value. • Reversed in time-series: • Controlling for firm fixed effects, association is positive (levels analysis). • Average firm value after staggering up (down) is higher (lower). • In changes, association is also positive (first difference analysis). • Firm value increases (decreases) after staggering up (down).

19. First Difference Analysis

20. First Difference Analysis – Matched Sample

21. SBs and Firm Value • Confirm previous cross-sectional results: • Negative association between SBs and firm value. • Reversed in time-series: • Controlling for firm fixed effects, association is positive (levels analysis). • Average firm value after staggering up (down) is higher (lower). • In changes, association is also positive (first difference analysis). • Firm value increases (decreases) after staggering up (down). • Also, portfolio analysis has a positive alpha

22. Staggering & De-Staggering Portfolio EW Returns

23. Staggering and De-Staggering Portfolio VW Returns

24. Which Direction of Causality? • How to reconcile time-series with cross-sectional evidence? • Possible explanation is “reverse causality” • Having relatively low firm value could induces some firms to adopt a SB (rather than a SB causing low firm value). • Could explain cross-sectional result that firms with SBs tend to have low firm values. • However, reverse causality cannot explain the time series results, as this analysis shows that firm value tends to go up after the adoption of a SB

25. Predicting Models: Staggering

26. Predicting Models: De-Staggering

27. A Positive Account How to interpret positive association of SBs & firm value? • Managerial entrenchment view of SBs • Based on assumption that more shareholder power is always better (to reduce moral hazard) • However, in contexts of high asymmetric information or very noisy market prices, shareholders may not know best • Asymmetric information / adverse selection, rather than moral hazard, may be primary agency problem for some firms • SBs protect directors from shareholder pressure • Avoid myopia and promote long-term value creation

28. SBs & Firm Features • Hypothesis: If limited commitment (asymmetric info + adverse selection) is the primary problem (rather than market discipline of the board), then: • SBs may be more valuable in firms with (i) more intangible assets, firms that are (ii) more innovative, and (iii) more complex firms. • These features make valuation of corporate assets / performance more difficult, especially in the short-term • Our results confirm this hypothesis: • Value-changes associated with changes in SBs: • Stronger / driven by firms with these features

29. Value of SBs & Adverse Selection

30. Further Tests of Limited Commitment Problem • Hypothesis: If limited commitment (asymmetric info + adverse selection) is the primary problem (rather than market discipline of the board), then: • SBs may be more valuable in firms with (i) more productive labor, firms with (ii) more contractual imcompleteness (relationality), and firms with (iii) large customers. • Our results confirm this hypothesis: • Value-changes associated with changes in SBs: • Stronger / driven by firms with these features

31. Long-Term Commitment Hypothesis

32. Long-Term Commitment Hypothesis (Continued)

33. SBs & Other Governance Features • Alternative Hypotheses: • Maybe firms with SBs simultaneously decrease other pro-management governance features and this results in higher value? • Does having a SB alter the structure and level of executive compensation (increased board capture hypothesis)? • Does SB changes level of CEO turnover? • Results: • Changes in firm value before versus after the adoption of a SB independentof the level of shareholder rights at the firm. • Having a SB produces more efficient executive compensation, for example providing better risk-taking incentives. • CEO turnover is not different for firms with/without SB.

34. Governance Provisions

35. Executive Compensation

36. CEO Turnover

37. Other Robustness Checks • Separating SB provisions  Charter v. Bylaws. • Around 90% of SB are Charter-based. • Economic significance is higher. • SB bylaws based (statistically) insignificant. • Controlling for M&A activities. • Other proxies for asymmetric information (e.g., idiosyncratic volatility).

38. SB: Charter v. Bylaws Cross-Sectional Analysis

39. Conclusions • We investigate 34 years of SBs data and find that, over time, staggering up (down) is associated with increases (decreases) in firm value. • First,we challenge existing cross-sectional evidence and interpretation on staggered boards • Second, we document that in the time series, staggered boards increase firm value: • (i) SBs valuable to protect commitments to long-term value creation, especially when asymmetric information is important; • (ii) Traditional board-centric model can efficiently serve the interests of shareholders?

40. Directions for Future Legal Research • Reducing Federal intervention on Corporate Law? • How constraining managerial moral hazard? • Executive compensation? • Fiduciary duties? • Bias in shareholder advisory services?

41. Data Checks

42. Data Checks in Risk Metrics, 1996-2006 • Hand Collection, 1996-2006 • 53 cases of incomplete (late) board classification in Risk Metrics: • 128 cases of incomplete (late) board de-classification in Risk Metrics:

43. Data Consistency – Risk Metrics • Examples incomplete classification in Risk Metrics:

44. Data Consistency – Risk Metrics • Examples incomplete de-classification in Risk Metrics: