Recent Board Declassifications: A Response to Cremers and Sepe

Lucian Bebchuk is James Barr Ames Professor of Law, Economics and Finance, and Director of the Corporate Governance Program, Harvard Law School. Alma Cohen is Professor of Empirical Practice, and Research Director of the Laboratory for Corporate Governance, at Harvard Law School. This post is based on their paper Recent Board Declassifications: A Response to Cremers and Sepe. Related program research includes The Costs of Entrenched Boards by Bebchuk and Cohen and How Do Staggered Boards Affect Shareholder Value? Evidence from a Natural Experiment by Cohen and Wang.

We recently released a short paper, Recent Board Declassifications: A Response to Cremers and Sepe. Our paper responds to a paper released earlier this month by Martijn Cremers and Simone Sepe, Board Declassification Activism: The Financial Value of the Shareholder Rights Project (“CS2017”). We show that the results of CS2017 fail to provide support for the authors’ opposition to annual elections for directors.

In their 2016 published article (“CS2016”), Cremers and Sepe focused on the effects of board declassifications (as well as classifications) that took place through 2011. In CS2016, which relied on a finance working paper written with Lubomir Litov, the authors suggested that the association between staggered boards and lower firm valuation (identified by Bebchuk and Cohen (2005) and confirmed by Faleye (2007) and Frakes (2007)) does not reflect a value-reducing effect of staggered boards. Firm-fixed-effect regressions, Cremers and Sepe argued, show that declassifications bring about a statistically and economically significant reduction in firm value.

Based on this analysis, CS2016 urged a “legal reform that would transform staggered boards into a quasi-mandatory rule.” In particular, they advocated prohibiting shareholders from seeking annual elections by submitting declassification proposals, as well as subjecting all board-initiated declassification proposals to a two-thirds supermajority requirement.

We plan to comment in detail in future work on the methodological problems that afflict the analyses of CS2016 and CS2017, and prevent these analyses from providing a basis for assessing the value effects of staggered boards. In our current paper, however, we leave aside those methodological issues, take the results of CS2017 “as is,” and provide a close reading of these results.

Appropriately interpreted, the results of CS2017 provide some significant evidence that declassifications are beneficial and no evidence that declassifications are value-reducing. Furthermore, the results presented in CS2016 regarding the consequences of declassifications during the pre-2012 period do not hold, and indeed are substantially reversed, for the 2012-2014 period considered by CS2017. On the whole, the results of CS2017 undermine the strong general endorsement of staggered boards put forward by CS2016.

It is worth highlighting that CS2017 retreats from the anti-declassification position of CS2016. Instead, CS2017 takes the position that “[the] evidence indicates that classified boards may serve a positive governance function in some companies, thus challenging the ‘one-size-fits-all’ approach to board declassification.”

Note that, in CS2016, the authors took a one-size-fits-all approach, calling for making staggered boards a “quasi-mandatory arrangement” and for changes that would make it difficult for any company to declassify. This position seems to have disappeared, with Cremers and Sepe now claiming only that classified boards “may” be positive in “some” companies. As we explain in our paper, the results in CS2017 support this retreat.

Our paper is available for download here.

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