On Enhancing Shareholder Control: A (Dodd‐) Frank Assessment of Proxy Access

• Author: JAY C. HARTZELL,STUART L. GILLAN,JONATHAN B. COHN
• DOI: http://doi.org/10.1111/jofi.12402
• Published date: 01 August 2016
• Date: 01 August 2016

THE JOURNAL OF FINANCE •VOL. LXXI, NO. 4 •AUGUST 2016

On Enhancing Shareholder Control: A (Dodd-)

Frank Assessment of Proxy Access

JONATHAN B. COHN, STUART L. GILLAN, and JAY C. HARTZELL∗

ABSTRACT

We use events related to a proxy access rule passed by the Securities and Exchange

Commission in 2010 as natural experiments to study the valuation effects of changes

in shareholder control. Wefind that valuations increase (decrease) following increases

(decreases) in perceived control, especially for firms that are poorly performing, have

shareholders likely to exercise control, and where acquiring a stake is relatively inex-

pensive. These results suggest that an increase in shareholder control from its current

level would generally benefit shareholders. However, we find that the benefits of in-

creased control are muted for firms with shareholders whose interests may deviate

from value maximization.

ACENTRAL ISSUE IN CORPORATE finance is the optimal division of control be-

tween shareholders and management. In the ongoing debate over the need for

better protection of shareholder rights, a key question is whether an increase

in shareholder control would benefit shareholders. Theory offers little guid-

ance, suggesting that more shareholder control could have positive or negative

effects on shareholder wealth (e.g., Harris and Raviv (2010)). Thus, whether

more shareholder control would benefit shareholders is ultimately an empirical

question.

This is a challenging question to answer, as exogenous variation in share-

holder control is difficult to identify. We attempt to answer this question

by studying the market’s response to events related to the evolution of the

Securities and Exchange Commission’s (SEC’s) “proxy access” rule, which

was passed in August 2010 but invalidated by a court ruling before being

implemented. The proxy access rule would have increased shareholder control

∗Cohn and Hartzell are with the University of Texasat Austin, and Gillan is with the University

of Georgia. We would like to thank Cam Harvey (the Editor), the Associate Editor,two anonymous

referees, Aydo˘

gan Altı, Daniel Bergstresser, Bernie Black, Itay Goldstein, Charles Hadlock, Ab-

hiroop Mukerjee, Stas Nikolova, Laura Starks, Anjan Thakor, Sheridan Titman, and seminar

participants at the Division of Risk, Strategy, and Financial Innovation at the U.S. SEC, NBER

Law and Economics 2011 Mid-Yearmeeting, SFS Cavalcade at the University of Michigan, Indian

School of Business Conference, University of Alberta Frontiers in Finance Conference, NYU/Penn

Conference on Law and Finance, University of Colorado, University of Michigan, University of

Florida, and University of Utah for their helpful comments. We would also like to thank Alon Brav

for sharing data on activist hedge funds, and Nick Hirschey and Mitch Towner for research assis-

tance. All remaining errors are our own. The authors have read the Journal of Finance’s disclosure

policy and have no conflicts of interest to disclose.

DOI: 10.1111/jofi.12402

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1624 The Journal of Finance R

by giving dissident shareholders the right to nominate candidates for a

company’s board of directors directly on the company’s proxy ballot. As we

discuss in more detail below, this rule was not without controversy. While some

argued that proxy access would provide unclear benefits and/or minimal cost

savings over the current rules regarding proxy contests (e.g., Kahan and Rock

(2011)), perhaps the clearest indication that market participants believe proxy

access to be important is the extent to which the proposed rules generated

vigorous and expensive debate and actions by parties on both sides of the

issue. Given the apparent importance of proxy access, the events we study

have two key features: they represent plausibly unanticipated shocks with

clear implications for expected shareholder control, and they have predictably

different implications for different types of firms. The latter feature leads to

sharp tests and allows us to conduct rich cross-sectional analysis.

Overall, our results support the view that more shareholder control tends

to benefit shareholders. Moreover, these benefits appear to be especially large

in firms that are poorly performing, have shareholders in place that are likely

to exercise control, or have relatively liquid stock (which would allow such

shareholders to obtain shares at a low cost). We find some evidence, however,

that the benefits are smaller for firms that are more likely to be targeted

by investors that may have a preference for labor-friendly policies, such as

union and pension funds. The study’s results have important implications for

regulators, corporate governance experts, and boards of directors attempting

to design governance structures, as well as for researchers studying the role of

shareholders in corporate governance.

We are careful in choosing which events to study. While the SEC made a

number of announcements when considering the proxy access rule, discussions

with current and former SEC staff indicate that, throughout its rule-making

processes, there is substantial consultation and discussion with affected par-

ties. This makes it difficult to determine whether an official announcement by

the SEC about the proxy access rule would have caused investors to raise or

lower their expectations as to the degree of shareholder control the rule would

ultimately grant. Thus, rather than study such announcements, we focus on

two events related to the evolution of the Dodd-Frank Wall Street Reform and

Consumer Protection Act that affected expectations about characteristics of

the proxy access rule that the SEC ultimately passed but are not likely to have

been anticipated by either investors or the SEC itself. In addition, we study

two other SEC events that appear to have contained surprising details about

the proxy access rule.

Our first event is the June 16, 2010 announcement of a proposal by Sena-

tor Christopher Dodd to amend the bill that would become the Dodd-Frank

Act. This proposal mandated that the SEC require an investor or group of in-

vestors to own at least 5% of a firm’s shares before gaining access to the firm’s

proxy. At the time, the SEC had proposed a tiered system, with minimum

holdings of 1%, 3%, and 5% for firms with market capitalization greater than

$700 million, between $75 and $700 million, and less than $75 million,

respectively. We refer to these as large, medium, and small firms for

On Enhancing Shareholder Control 1625

simplicity. Compared to the SEC’s proposed rule, Dodd’s proposal would have

substantially raised the hurdle to gaining proxy access for medium and large

firms, but not for small firms. The second event we study is the withdrawal of

this proposal on June 24, 2010 in last-minute negotiations over the final bill,

which presumably led to a restoration of the SEC’s proposed thresholds as the

likely outcome regarding proxy access. Based on an extensive search of news

articles, neither of these events appears to have been anticipated.1

Our third event (which occurred last, chronologically) offers similar predic-

tions in terms of cross-sectional reactions that differ across firm performance

and size. On October 4, 2010, the SEC delayed implementation of the proxy

access rule in response to a petition filed by the Business Roundtable (BRT)

with the D.C. Circuit Court of Appeals challenging the legality of the rule. As

the final rule exempted firms with market capitalization below $75 million,

this delay would have had a much smaller effect on the anticipated level of

shareholder control in these firms. While this event was important, as argued

by Becker, Bergstresser, and Subramanian (2013) in a contemporaneous pa-

per, it is possible that it may have been partially anticipated, as the BRT filed

its petition just five days earlier. Nonetheless, our results hold both with and

without this event.

We find negative (positive) stock returns associated with the first and third

(second) events for medium and large firms, which would have been most af-

fected by these events, but not for small firms, which would have been less

affected. Comparing the event returns of medium/large firms and those of

small firms allows us to filter out the effects of aggregate market movements

on the event dates. We find that the differences in event returns between

medium/large and small firms are large and statistically significant. In multi-

variate analysis, we find that the market response to the events is stronger for

firms that have low recent return on assets, sales growth, and stock returns.

As one would expect, this suggests that giving shareholders more control is

more beneficial in poorly performing firms, where shareholder intervention is

likely to be more valuable. These differences in response across performance

measures hold only for medium and large firms, and not for small firms.

We next examine how the presence of shareholders likely to utilize proxy

access affects firms’ stock price responses by focusing on the presence of such

investors at the time of the events (as every version of the proxy access rule

had a minimum holding-period requirement for gaining proxy access). We first

focus on the presence of known activist investors, both because they already

have exhibited a willingness to intervene and because, unlike other investors,

they already have access to networks of qualified director candidates through

1Regarding the Dodd proposal, one observer noted, “The sucker was like a bolt from

the heavens. It came out of nowhere” (“Frank Battling White House On Proxy Access,”

http://www.huffingtonpost.com/2010/06/17/white-house-guts-reform-t n615952.html).Themove

resulted in outrage on the part of investor groups, with suggestions that the revised threshold

would “render this important shareowner right useless,” and lobbying of White House representa-

tives in an attempt to move away from the 5% constraint (“Group Targets Obama Adviser Jarrett

On Proxy Access,” Dow Jones Newswires, 06-17-101815ET).