2012 NTU Conference on Finance1 Re-Jin Guo University of Illinois at Chicago Timothy Kruse Xavier University Tom Nohel Loyola University, Chicago

 The default law in all states requires that all directors stand for election at each annual shareholder meeting.  All states provide an exemption from this requirement if the board is staggered. Thirty-nine jurisdictions, including Delaware and California, permit a maximum of three classes. New York permits as many as four classes of directors, and Arizona allows three “or to the extent not inconsistent with cumulative voting rights.”  In all states: Installing/dismantling a staggered board through charter amendment requires both shareholder approval and board approval, while installing a staggered board in the bylaws requires either shareholder approval or board approval.  In a large sample of major U.S. public companies, 59% had a staggered board in Among firms going public in the 1990s, the incidence of staggered boards increased from 34% in 1990 to over 70% in NTU Conference on Finance2

 Old literature:  Antitakeover amendments (ATAs) protect entrenched managers.  ATAs enhance bargaining position of the incumbent board with the potential bidders to extract higher premium (Comment and Schwert, 1995).  Recent research:  Governance provisions weaken shareholder rights and are associated with inferior subsequent stock returns (Gompers, Ishii, and Metrick, 2003).  Not every governance provision is created equal.  BCF entrenchment index with 6 ATAs: staggered board; poison pill; limits to shareholder bylaw amendments; supermajority requirement for mergers; supermajority requirement for charter amendments; and golden parachutes (Bebchuk et al., 2006) NTU Conference on Finance3

 Staggered board impedes replacement of a majority of directors.  Staggered board with poison pill provides Impenetrable protection of incumbent managers.  Chancery Court (8/8/2010) and Supreme Court (11/23/2010) ruling on the takeover battle between Airgas and Air Products and Chemicals (Guo, Kruse, and Nohel, 2011; Bebchuk, Cohen, and Wang, 2012;) NTU Conference on Finance4

 October 2009: Air products expressed interest in acquiring Airgas.  February 2010: Airgas rejected Air Product’s tender offer.  September 2010: Air Products launched a proxy fight. Air Products replaced 3 directors (Airgas has a staggered board).  September 2010: Air Product obtained a majority shareholder approval for a by-law provision that the next annual meeting will be held on January 18,  October 2010: Delaware Chancery Court issued an opinion sided with Air Product.  November 2010: Supreme Court of Delaware overturned the Chancery Court ruling NTU Conference on Finance5

 Total of 506 shareholder proposal to de-stagger the board in , 479 of which went to a vote.  Average percentage of votes cast in favor of proposal to dismantle staggered board exceeds 65% in  Policies from institution investors (the Coucil of Institutional Investor, American Funds, BlackRock, CalPERS, Fidelity, TIAA-CREF and Vanguard) and leading proxy advisors (ISS and Glass Lewis) favors annual election of directors and proposal to declassify board.  Shareholder  Bristol-Myers, Host Marriott, Merck, and Proctor & Gamble received shareholder proposals to de-stagger their board for at least 16 consecutive years. The boards of those firms finally decided to de-stagger their boards in NTU Conference on Finance6

 The experience at Bausch & Lomb is typical. In 1997, shareholder activist William Steiner from the Investor Rights Association of America sponsored a proposal urging the board to de-stagger itself: [T]he Company’s classified Board of Directors maintains the incumbency of the current Board and therefore of current management, which in turn limits management’s accountability to stockholders.... I believe that [de-staggering the board] is one of the best methods available to the stockholder to insure that the Company will be managed in a manner that is in the best interests of the stockholders NTU Conference on Finance7

 The Steiner proposal received 62% approval from Bausch & Lomb shareholders, yet the company continued to maintain a staggered board.  The Bausch & Lomb board of directors argued against the proposal: In the opinion of the Board, the above reasons continue to be valid and the staggered Board remains in the best interests of the shareholders.... The staggered board does not preclude unsolicited acquisition proposals but, by eliminating the threat of imminent removal, puts the incumbent Board in a position to act to maximize value to all shareholders. In addition, the Board does not believe that directors elected for staggered terms are any less accountable to shareholders than they would be if elected annually, since the same standards of performance apply regardless of the term of service NTU Conference on Finance8

 Considerations Favoring a Classified Board:  Classification of the Board tends to balance experience, continuity and stability with the regular opportunity to add valuable, fresh perspectives.  It takes several years for a new director to become fully conversant in the complexities of the utility business model.  Classification makes it more difficult and time consuming to change majority control of the Board which reduces the vulnerability of the Company to an unsolicited takeover proposal. Thus, classification may encourage persons attempting certain types of transactions that involve an actual or threatened change of control of the Company to first seek to negotiate with the Company and may discourage pursuit of such transactions on a non-negotiated basis.  Considerations Against a Classified Board:  Classification of the Board could make more difficult or discourage the removal of incumbent directors, through a proxy contest or otherwise, and the assumption of control by a holder of a substantial block of the Company’s common stock, and could thus have the effect of entrenching incumbent management.  Classification could have the effect of discouraging a third party from making a tender offer or otherwise attempting to obtain control of the Company, even though such an attempt might be beneficial to the Company and its shareholders.  Some institutional shareholders and commentators argue that classification reduces director’s accountability to shareholders, since such a structure does not enable shareholders to express a view on each director’s performance by means of an annual vote. The Board does not agree with this argument NTU Conference on Finance9

 Staggered (classified) board is associated with lower firm valuation (Bebchuk and Cohen, 2005; Bebchuck, Cohen, and Ferrell, 2009).  Positive market reaction to board declassification announcement (Guo, Kruse, and Nohel, 2008, 2012).  Staggered board decreases firm value (Bebchuk, Cohen, and Wang, 2012) NTU Conference on Finance10

 Guo, Kruse, and Nohel (2008): Using a sample of firms declassifying their boards in , we report that:  Firms with better corporate index scores, with more independent boards, without poison pill, receiving shareholder proposals, are more likely to declassify their boards.  CARs are higher for firms with immediate board declassification, and for firms with high industry M&A volume pre-SARBOX.  Much variation among de-staggering firms before and after SARBOX NTU Conference on Finance11

 467 announcement of board declassification between 2003 and 2010, after passage of the Sarbanes- Oxley act of  Data sources: Investor Responsibility Research Center (IRRC), Riskmetrics, and searches from Factiva/Lexis-Nexis, and proxy statements.  Shareholder activism:  Shareholder proposals in prior 3 years.  Hedge fund activism from 13D filings (required for investors acquiring 5% or greater equity stake). Plans or proposals that could relate to or result in a significant change at the company disclosed in the “purpose of transaction section” of 13D filings NTU Conference on Finance12

 Activist as “an investor who tries to change the status quo through ‘voice’, without a change in control of the firm” (Gillan and Starks, 1998).  Target firms with hedge fund activism experience increases in payout, operating performance, and CEO turnover after the activism (Brav, Jiang, Partnoy, and Thomas, 2008).  Returns for firms with hedge fund activism are high for targets that are subsequently acquired, but not different from zero for those which remain independent (Greenwood and Schor, 2009) NTU Conference on Finance13

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 Mean/ Median CAR of 0.42%/0.17% (significant).  Mean/ Median CAR of 1.08%/0.90% (significant) with hedge fund activism.  Mean CAR of 0.60% (significant) prior 13D filings.  Mean/ Median CAR insignificant for other sample firms NTU Conference on Finance15

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2012 NTU Conference on Finance17 Year of first opportunity to elect entire boardTest statistic Year 0Year +1Year +2Year +30 v 30 or 1 v 2 or 3 Panel A: activism Shareholder proposal *** *** Activist event ** 1.89 Boilerplate 13D * 2.15 Any 13D filing *** 5.02 ** Panel B: ownership and defenses Proportion CEO ownership *** 2.60 *** *** 2.09 ** Proportion O&D ownership *** 3.44 *** *** 3.80 *** Firm E-index *** 4.41 *** *** 4.20 *** Adjusted E-index *** *** *** 2.20 ** 1.87 * *** 2.16 ** 2.10 ** Panel C: financial data Adjusted EBITDA to TA *** 2.97 *** 2.71 *** *** * *** 3.23 *** 2.41 ** Adjusted Leverage0.080 *** *** *** *** *** *** *** *** ** Adjusted Market to book0.195 * * Total assets *** 3.64 *** Market capitalization *** 3.32 ***

2012 NTU Conference on Finance18 (1) (2) (3) (4)(5)(6) Intercept0.976 *** *** *** *** *** *** (0.286)(0.235)(0.182)(1.48) (0.235) (0.182) Active investor ** * * (0.136)(0.167)(0.167) Investment only 13D (0.186)(0.230)(0.230) Any 13D filing ** ** ** (0.119) (0.145) (0.145) Shareholder proposal *** *** *** *** *** *** (0.105)(0.114)(0.114) (0.105) (0.114) (0.114) CEO shares * (0.602)(00.638)(0.637)(0.587) (0.636) (0.635) Median industry E-index (0.091) Firm E-index0.093 * * (0.050) (0.049) Adjusted E-index0.078 * * (0.047) Total assets ($ millions) (0.823)(0.835)(0.833)(0.824) (0.824)(0.831) Adj EBITDA/TA0.745 ** * ** * ** ** (0.363)(0.437) (0.438) (0.362) (0.434) (0.435) Adj Leverage (0.303)(0.364) (0.363)(0.301) (0.362) (0.361) Adj Market to book (0.065)(0.071) (0.071) (0.065) (0.071) (0.071) R Adj-R F-statistic

2012 NTU Conference on Finance19 (1) (2) Intercept (0.003) Active investor *** *** (0.006)(0.007) Crisis ** (0.005) Adjusted EBITDA/TA (0.005)(0.017) Adjusted Leverage (0.014)(0.011) Adjusted Capex (0.083)(0.009) Adjusted E-Index0.001 (0.002) R Adj-R F-statistic

2012 NTU Conference on Finance20 (1) (2) (3) Intercept0.097 *** *** *** (0.016)(0.017)(0.019) Active investor *** (0.050) Active investor*crisis ** (0.071) Any 13D filing0.140 *** (0.039) Any 13D filing*crisis * (0.058) Shareholder proposal (0.034) Shareholder proposal*crisis (0.046) R Adj-R F-statistic

 Significant and positive market response to board declassification announcement. The positive event returns come from those preceded by hedge fund activism.  Speed of conversion to annual director elections is higher when declassification is triggered by hedge fund activism.  Sample firms subject to hedge fund activism are more likely to be acquired within two years.  Overall, our results are consistent with that board declassification increases firm value, and hedge fund activism adds value NTU Conference on Finance21