The Efficacy of Shareholder Voting in Staggered and Non-Staggered Boards

The following post comes to us from Ronen Gal-Or and Udi Hoitash, both of the Department of Accounting at Northeastern University, and Rani Hoitash of the Department of Accountancy at Bentley University. Recent work from the Program on Corporate Governance about staggered boards includes: How Do Staggered Boards Affect Shareholder Value? Evidence from a Natural Experiment (discussed on the Forum here).

In our paper, The Efficacy of Shareholder Voting in Staggered and Non-Staggered Boards: The Case of Audit Committee Elections, which was recently made available on SSRN, we study the efficacy of audit committee member elections in staggered and non-staggered boards.

Voting in director elections and auditor ratifications is a primary mechanism shareholders can use to voice their opinion. Past research shows that shareholders cast votes against directors that exhibit poor performance, and these votes, in turn, are associated with subsequent board reaction. However, because a significant number of U.S. public companies have staggered boards, not all directors are up for election every year. Therefore, the efficacy of shareholder votes may not be uniform. Under the staggered board voting regime, shareholders and proxy advising firms can typically voice their opinion on any given director only once every three years. This election structure may increase the likelihood that directors who are not up for election following poor performance will be insulated from the scrutiny of shareholders and proxy advisors. In turn, this may influence the accountability of staggered directors and the overall efficacy of shareholder votes.

In our paper, we address two broad questions that examine the election of directors who sit on the audit committee (AC). The first question investigates the efficacy of AC members’ elections in staggered and non-staggered boards. The second question examines whether poorly performing AC members in staggered boards benefit from delayed voting. Specifically, we examine whether AC members who are not up for election immediately following restatement announcements are still held accountable, in the second and third post restatement shareholder meeting.

We address these research questions using cross-sectional time series data from Institutional Shareholder Services (ISS) and Glass Lewis (GL) on 18,296 director elections spanning the years 2004 to 2010. We provide evidence that, in non-staggered ACs, low shareholder approval is associated with:

  • The departure of AC members with the highest levels of accounting and financial reporting acumen (i.e. accounting financial experts),
  • An increase in the number of AC meetings,
  • A decrease in the willingness to purchase high levels of tax non-audit services, and
  • An increase in financial reporting quality as evidenced by a subsequent decrease in discretionary accruals.

These tests are all insignificant in staggered ACs. Thus, our results indicate that non-staggered ACs react to low shareholder votes, whereas staggered ACs do not. One plausible explanation for the lack of responsiveness of staggered ACs is that staggered members may be insulated from shareholder dissatisfaction. Alternatively, these results could potentially be attributed to the fact that proxy advisers fail to address the concern of staggered elections in their proxy voting guidelines.

To investigate whether staggered AC members are, in the long run, insulated from shareholders dismay, we examine the long-term shareholder and proxy advisor reaction to the disclosure of financial statement restatements. Consistent with prior studies, we find that in the first election following a restatement announcement, AC members in staggered and non-staggered boards are more likely to receive both a negative recommendation from proxy advising firms and low shareholder support in terms of votes compared to non-restating firms. By the second and third election, the voting on non-staggered ACs of restating firms is not different from that of non-restating firms. This evidence suggests that shareholders and proxy advisors “penalize” non-staggered AC members only once, i.e. in the first year following the restatement announcement. This finding is consistent with our results that show a prompt response of non-staggered ACs to shareholder votes.

In contrast, among staggered ACs, we find that proxy advisors and shareholders exhibit a pattern that is indicative of a limited long term voting strategy. They continue to issue negative recommendations and lower shareholder approval to AC members that are up for election in the second shareholder meeting following the restatement. However, by the third meeting, only GL continues to issue negative recommendations for these members while ISS and shareholders show no difference from non-restating firms. Thus, it appears that shareholders and proxy advisors do apply long term, albeit limited, voting and recommendation strategies to AC members in staggered boards. Nevertheless, because the third class of staggered AC members “benefit” from the delayed voting these results can potentially explain the lack of responsiveness of staggered ACs. We propose that proxy advisors discuss and explain their multi-year recommendation approach for staggered directors who represent a significant portion of public company directors.

The full paper is available for download here.

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