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Staggering findings

Companies with staggered boards have a higher ‘voting premium’ that reflects managerial inefficiencies, especially in mature firms and those in noncompetitive industries, finds a new study co-authored by Dr Oğuzhan Karakaş of Cambridge Judge Business School.

Very long board table in a uniform and symetrical board room.

The practice of ‘staggered’ terms for company boards of directors – in which only a fraction of the board is up for re-election in any year – is widely seen as a very effective antitakeover maneuver adopted by many US companies. Yet there has long been disagreement among management experts whether staggered boards harm shareholder value through entrenchment of the old guard or help through management stability and board independence.

Resolving this debate has been challenging, and that’s because a share of common stock has two components – a right to future cash flow and a right to vote. A change in stock price can therefore reflect either of these factors. It’s difficult to isolate the effect of voting rights – whose value in a well-managed company is typically low because there is limited potential for improved firm performance, but is higher when outside shareholders use voting power to exert disciplinary pressure over entrenched and/or inefficient management.

Oğuzhan Karakaş.
Oğuzhan Karakaş

A new study co-authored by Dr Oğuzhan Karakaş, University Senior Lecturer in Finance at Cambridge Judge Business School, addresses this through a novel technique of estimating the value of voting rights using option prices – which reflect cash flows of the underlying stocks but not the control rights. This is done by ‘synthesising’ a nonvoting share of common stock – so ‘voting premium’ is defined as the price difference between the stock (ie voting share) and the synthetic nonvoting share.

The study published in The Review of Corporate Finance Studies then finds that companies with staggered boards have a higher voting premium, reflecting private benefits for corporate insiders through control and associated managerial inefficiencies – and this is particularly pronounced for mature firms and those in noncompetitive industries.

“We find that voting premium is higher for firms with staggered boards. This result holds after controlling for firm and industry characteristics including total assets, leverage, book-to-market ratio, firm age, insider ownership, institutional ownership concentration, R&D expenditures, return on assets, capital expenditure, and product market competition,” the study says.

For institutional investors and other public company stakeholders, the findings “suggest that corporate votes are valuable, and that the value of voting rights may serve as an effective, market-based diagnostic tool to assess the corporate governance practices of firms,” says co-author Dr Oğuzhan Karakaş of Cambridge Judge. “Our finding that staggered boards are, on average, perceived by the market as entrenching management could make investors generally more wary of staggered boards and more willing to express opposition to them. However, investors should still be cautious about a “one-size-fits-all” approach towards staggered boards.”

The study looks at large US public companies from 1996 to 2018 that have liquid options traded on their stocks, excluding dual-class firms and companies in which insider equity ownership exceeds 50% (given that board staggering would have little effect on the already heavily concentrated control of such firms). It then focuses on 321 companies during this period that changed their board structure to destagger their boards, and 29 firms that changed to a staggering system – and found that firms that destagger their boards experience a 65% decrease in their voting premium, while firms that stagger their boards have a 169% increase in their voting premium.

“Overall, our findings portray a picture that staggered boards, which tend to be set at the early stages of public firms’ life cycle, lead to entrenchment as firm matures and particularly if the firm is not in a competitive industry,” says the study. “This suggests that managerial inefficiencies are more severe when managers are insulated from market for corporate control, and particularly when other governance mechanisms are less effective.”

The study entitled “Staggered boards and the value of voting rights” is co-authored by Dr Oğuzhan Karakaş of Cambridge Judge Business School and Mahdi Mohseni of the Tehran Institute for Advanced Studies.