The powerful antitakeover force of staggered boards: theory, evidence, and policy.

Author:Bebchuk, Lucian Arye
 
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Staggered boards, which a majority of public companies now have, provide a powerful antitakeover defense, stronger than is commonly recognized. They provide antitakeover protection both by (i) forcing any hostile bidder, no matter when it emerges, to wait at least one year to gain control of the board and (ii) requiring such a bidder to win two elections far apart in time rather than a one-time referendum on its offer. Using a new data set of hostile bids in the five-year period 1996-2000, we find that not a single hostile bid won a ballot box victory against an "effective" staggered board (ESB). We also find that an ESB nearly doubled the odds of remaining independent for an average target in our data set, from 34% to 61%, halved the odds that a first bidder would be successful, from 34% to 14%, and reduced the odds of a sale to a white knight, from 32% to 25%. Furthermore, we find that the shareholders of targets that remained independent were made worse off compared with accepting the bid and that ESBs did not provide sufficient countervailing benefits in terms of increased premiums to offset the costs of remaining independent. Overall, we estimate that, in the period studied, ESBs reduced the returns of shareholders of hostile bid targets on the order of 8-10%. Finally, we show that most staggered boards were adopted before the developments in takeover doctrine that made ESBs such a potent defense. Our findings call for a reconsideration of takeover rules; in particular, we argue that, at least in the absence of explicit shareholder authorization, managers who lose one election over an outstanding bid should not be allowed to further block the bid with a pill-ESB combination.

  1. INTRODUCTION

    Staggered boards (SBs) are an important part of the modern U.S. corporate landscape. In a large sample of major U.S. public companies, 59% had a staggered board in 1998. (1) Among firms going public in the 1990s, the incidence of staggered boards increased from 34% in 1990 to over 70% in 2001. (2) Despite this large and growing importance in practice, the impact of staggered boards on the market for corporate control has not been adequately recognized by courts, academics, or practitioners.

    This Article analyzes the key role that staggered boards play in the antitakeover protection that U.S. public companies now enjoy. A staggered board, we argue, offers a more powerful antitakeover defense than has previously been recognized. Whereas conventional wisdom holds that a company that becomes a takeover target is unlikely to remain independent, the managers of targets with staggered boards can--and most of the time do--maintain the target's independence.

    Our work analyzes how staggered boards make it extremely difficult for a hostile bidder to gain control over the incumbents' objections. Using a new database of hostile bids against U.S. targets in the five-year period from 1996 to 2000, we provide evidence that staggered boards indeed have the powerful antitakeover force suggested by our theory. Finally, we show that the effectiveness of staggered boards reduces returns to target shareholders. The theory and evidence that we put forward have important implications for takeover regulation, and we examine the changes in takeover doctrine that they warrant.

    Staggered boards have increased in importance with the appearance and proliferation of poison pills. Takeover law allows managers to maintain a pill and thereby impede a hostile bid, as long as they are in office. As a result, when managers maintain their opposition to a hostile bid, the bidder can obtain control only if it replaces the directors with ones that will redeem the pill. This route of winning control of the board via a ballot box victory provides the safety valve on which takeover law has relied to protect shareholder interests. However, we show that when a target has an effective staggered board (ESB)--a staggered board that is appropriately designed to prevent circumvention--this safety valve is illusory.

    There are two reasons why an ESB presents such a serious impediment to a hostile bidder seeking to gain control over the incumbents' objections. First, an ESB substantially increases the delay involved in gaining control of the board and, importantly, establishes a large minimum delay. No matter when a hostile bidder emerges, gaining control of the board would take at least one year, a very long time indeed in the dynamic world of corporate acquisitions. Second, beyond the costs imposed by delay, to overcome an ESB a bidder must win two elections, far apart in time, rather than one up-or-down referendum conducted at a single point in time. We show that the two-election problem is a serious one that, combined with the delay problem, makes an ESB a powerful, even if not insurmountable, antitakeover device. Indeed, we show that an ESB provides managers with stronger protection from a hostile takeover than would an arrangement (not currently permitted under Delaware law) providing directors with guaranteed three-year terms.

    After developing our theory of staggered boards, we test it against a new database of hostile bids made against U.S. targets in the five-year period from 1996 to 2000. We find that during this period not a single hostile bidder gained control of the board of an ESB target board through a ballot box victory. The great difficulty that hostile bidders would have in gaining control of the board of a target with an ESB significantly reduces the credibility of the threat to do so, which in turn increases incumbents' power to insist on remaining independent. Specifically, we find that an ESB nearly doubles the likelihood that the average target in our data set will remain independent, from 34% to 61%; halves the likelihood that the first bidder will be successful, from 34% to 14%; and reduces the likelihood that a target will be forced to sell to a white knight or other subsequent bidder, from 32% to 25%.

    We also find that the substantial increase in the likelihood of remaining independent produced by ESBs is rather costly for target shareholders. Remaining independent makes shareholders worse off compared with the scenario in which the hostile bid is accepted. Furthermore, we find that ESBs do not provide sufficient countervailing benefits in terms of increased premiums and may even provide no such benefits at all. Overall, we find that ESBs reduced returns on the order of 8-10% for shareholders of hostile bid targets in the latter half of the 1990s. Some of the statistical tests whose results we report here are presented in greater detail in a more technical companion working paper. (3)

    These findings lend new significance to shareholder proposals demanding de-staggering of SBs, proposals that have become far more numerous and popular (with shareholders) in recent years. (4) More generally, these findings have important implications in the U.S. market for corporate control and the broader business landscape. Staggered boards play a key role in determining the extent to which managers of U.S. companies are vulnerable to a takeover threat. The theoretical arguments and empirical evidence presented here suggest that ESBs substantially increase the insulation of incumbents from takeovers and have the potential to reduce shareholder wealth.

    After analyzing the antitakeover consequences of staggered boards, we examine how we have arrived at this state of affairs. We compare the evolution of takeover law with the timing of staggered board incidence. We show that most companies that now have staggered boards adopted them before shareholders could have been fully aware of the powerful antitakeover force that was accorded to them by subsequent developments in takeover law. Specifically, shareholders that had approved staggered boards prior to 1990 found themselves in the 1990s stuck with an arrangement whose full antitakeover power they could not have earlier anticipated. In the 1990s, shareholders began to comprehend the full antitakeover force of staggered boards and, led by activist institutional investors, began voting against proposals to adopt new staggered boards and for precatory (non-binding) proposals to rescind existing ones. (5) For most companies, however, this shareholder activism amounted to "too little, too late," because the majority of large companies had already adopted staggered boards, which shareholders do not have the power to undo.

    Our conclusions concerning the special antitakeover power of staggered boards call for a reconsideration of existing takeover law. Courts have sought to strike a balance between the goals of protecting shareholders from threats that some hostile offers might present and preventing managers from entrenching themselves. Under the well-known Unocal test, managers can use defensive tactics but only to an extent that is "reasonable in relation to the threat posed." (6) Allowing managers to maintain a pill as long as they are in office, courts have believed, is a proportionate measure because of the availability of the proxy contest safety valve. Our analysis shows, however, that this safety valve on which courts have relied is largely illusory against companies with an ESB.

    Accordingly, when a target has an ESB (which is approximately half the time), courts applying the proportionality test should not permit managers to maintain a pill after they lose one election conducted over an acquisition offer. Allowing managers to maintain a pill after what was essentially a referendum on the offer would be a disproportionate and substantially entrenching measure. Therefore, we argue, preventing the use of a pill-ESB combination following defeat in one election would be consistent with the proportionality test put forward by Unocal and subsequently by Moran. In addition, our approach would preserve the nontakeover benefits that are often cited to justify staggered boards--board stability and board independence--while ensuring...

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