Do Staggered Boards Affect Firm Value?

Steven Davidoff Solomon is a Professor of Law at UC Berkeley School of Law. This post is based on a paper authored by Professor Davidoff Solomon; Yakov Amihud, Ira Rennert Professor of Entrepreneurial Finance at NYU Stern School of Business; and Markus M. Schmid, Professor of Corporate Finance at the University of St. Gallen. Related research from the Program on Corporate Governance includes The Costs of Entrenched Boards by Lucian Bebchuk and Alma Cohen; How Do Staggered Boards Affect Shareholder Value? Evidence from a Natural Experiment by Alma Cohen and Charles C. Y. Wang; and Staggered Boards and Shareholder Value: A Reply to Amihud and Stoyanov, also by Alma Cohen and Charles C. Y. Wang (discussed on the Forum here).

In Do Staggered Boards Affect Firm Value?, we examine the controversial question of the economic effect of a staggered board.

A staggered board is commonly said to insulate a company from a hostile takeover by making it significantly more difficult to acquire the company. A target’s board can adopt a shareholder rights plan, commonly known as a poison pill, requiring a hostile acquirer to replace a majority of a target’s directors by others who would remove the pill and allow the hostile bid to proceed. But a staggered board requires that a hostile bidder run successive proxy contests over a multi-year period to replace a majority of the board. The time and cost of such an uncertain endeavor can deter a hostile bidder. Research has found that a staggered board is associated with significantly lower firm value, attributed in part to the diminished likelihood of a takeover and the entrenchment of inefficient management.

Recent research, however, has presented evidence to the contrary, finding that the adoption (removal) of a staggered board increases (reduces) firm value. These findings are consistent with the view that a staggered board promotes stability and continuity within the board and enables management to pursue long-term strategic plans.

In our paper we employ different ways of estimating the effect of a staggered board on firm value and provide evidence that, contrary to earlier studies, a staggered board has no significant effect on firm value. We address two significant econometric issues with prior studies. First, there is a selection problem in this analysis because the implementation of a staggered board defense is a policy decision by a firm. It is not imposed exogenously but it is rather endogenous, being affected by firm characteristics and by the views and objectives of the firm’s decision makers. To put this issue another way, is it that the staggered board affects firm value, or is it the other way around, that the adoption of the staggered board is affected by firm value and other performance measures?

A second issue with prior empirical studies is the possible omission of variables that affect both the likelihood of having a staggered board and firm value. The omission of such variables creates a correlation between a staggered board and firm value that is a result of the independent correlation of each of these variables with omitted variables. For example, business problems may lower firm value and induce the firm to adopt a staggered board to enable it to remedy the problem without interference. Alternatively, firms that are doing well may no longer need protection from outside interference and will de-stagger the board. In both cases we observe a negative relation between staggered board and firm value, but causality runs from firm performance to staggered board rather than in the opposite direction. In this scenario, the omitted variable is the real cause of firm value change, not the staggered board adoption.

In our analysis, we first estimate the effect of staggered board on firm value in a model which includes control variables that are directly associated with firm value and are also correlated with the likelihood of a firm having a staggered board. Some of these variables have conflicting relation with firm value and with staggered board, e.g., they are negatively related to the former and positively related to the latter. Thus, their omission in earlier studies has led to an estimated negative relation between staggered board and firm value and to the belief that de-staggering of corporate boards will be value increasing. We find that with these variables added to the model, the effect of a staggered board is muted to the extent of becoming statistically insignificantly different from zero at standard levels of significance.

We further use a prominent measure of internal corporate governance, the entrenchment index or E-Index, an index of six measures of corporate governance measures including the staggered board. We create a variable called EInet, which excludes the staggered board provision. When adding EInet to our models we find no significant relation between staggered board and firm value while EInet is negatively and very significantly related to firm value. Because the incidence of staggered board across firms is positively correlated with the magnitude of EInet, it could be that the previously documented negative value effect of staggered board picks up the negative value effect of EInet, with which it is positively correlated. This provides further evidence that the value effect of a staggered board may be a symptom of other factors.

In the second part of our analysis we control for the selection and endogeneity issues associated with the adoption or deletion of a staggered board by employing the instrumental variables method to control for the determinants of a staggered board. We utilize as identification measures incorporation in California, Massachusetts, New York and Pennsylvania, past stock performance and other instrumental variables proposed by Karpoff, Schonlau, and Wehrly. In our two-stage procedure, we find that the coefficient of staggered board is insignificantly different from zero in our models, meaning that it has no effect on firm value. This is different from results of prior studies which found negative or positive effects on value of a staggered board.

Our results that a staggered board has no significant effect on firm value suggest caution in proposing that the staggered board in and of itself creates wealth effects. In some firms it may be beneficial and in others it is detrimental, depending on the firm characteristics and on the reasons for having the staggered board, and still in other firms it is non-consequential. The effect of a staggered board is rather idiosyncratic. Therefore, a policy dictum on staggered board that applies to all firms is, in our view, inappropriate.

The complete paper is available for download here.

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