Proxy Access and Hybrid Boards

The Chamber of Commerce opposes the SEC’s proposals on proxy access, claiming that such decisions reside within individual states. “No compelling reason exists to overturn the long-standing state law role in controlling the substantive rules regarding director election,” wrote the Chamber’s Richard Murray in a letter to Schapiro. “Pursuit of a federal right to access will lead to a one size fits all rule.” (Chamber Challenges SEC Over Proxy Access, Directorship, 5/1/09) “The Chamber believes that greater proxy access would not advance the financial interests of individual investors. Instead, it would allow labor unions and other special interest groups to advance their agendas at the expense of these investors.” (U.S. Chamber Calls Greater Proxy Access Good for Special Interests, Bad for Individual Investors, press release, 7/25/07)

“The potentially harmful consequences of proxy access must be considered. As
CEOs of leading U.S. companies, we are concerned about these renewed attempts to allow special and disparate interests to sidetrack corporate boards, as well as the inevitable effect these attempts will have on the ability of management and boards to focus on the long term value creation for shareholders and employees,” said John J. Castellani, President of Business Roundtable, an association of chief executive officers of leading U.S. companies with more than $5 trillion in annual revenues and nearly 10 million employees. (Business Roundtable Statement on SEC Proxy Access Proposal, press release, 5/20/09)

Rarely, however, do opponents of proxy access cite studies to support their agruments, which are more likely to be grounded in their own selfish interest to remain entrenched than in any true concern for shareowners or the US ecomony. Unions can’t hijack corporate elections if it takes a majority vote to elect directors, as it now does at most of the companies with CEOs in the BRT.

A recent study, Effectiveness of Hybrid Boards by Chris Cernich, Scott Fenn, Michael Anderson and Shirley Westcott, prepared by Proxy Governance under contract with the Investor Responsibility Research Center, looked at the effectiveness of 120 “hybrid” boards formed when shareowner activists were able to get a short slate elected and found total returns at such companies were over 19 percent — 16.6 percentage points better than peers. Total share price performance through the three-year anniversary of the hybrid boards averaged 21.5 percent — almost 18% percentage points more than their peers.

More than half of the excess return occurs within three months after an activist announces their intention to battle for board seats. Investors bid up its shares in hopes that a hybrid board will result in positive changes. Not suprisingly, performance was better where dissidents held a greater proportion of shares. They have both a better chance to get elected and more incentive to monitor. However, boards that seated a sole dissident moderately outperformed, whereas companies with three new directors significantly underperformed. Perphaps more positions being contested led to more resources being drained from the company and a greater distraction of management.

Companies whose hybrid boards were created through contest settlements averaged a sale premium of 29.6%, more than double the 13.5% average premium for companies whose hybrid boards were created by a proxy contest which went to a shareholder vote. Full blown proxy contests, like wars, can be expensive for both sides. Proxy access appears likely to bring positive changes at less cost, like the gradual transitions of democratic elections in government.

Expect to see more activist investors once proxy access becomes a reality. Like classic value investors, these firms rely on fundamental analysis showing that a company’s inherent value is greater than its trading price. Unlike most, however, they don’t wait for the market to recognize the value. They work for changes to close the gap. When they do get elected, they frequently bring much greater resources and experience to boards than most directors. Expect to see more funds like Steel Partners, Ichan Partners, Ramius Capital Group, Barington Capital Group, Breeden Capital Management, Relational Investors, Riley Investment Management, Third Point, Costa Brava Partnership, MMI Investments, Oliver Press Partners, and Lawndale Capital Management. I’ve updated our links page for such groups. If you know of others, please let me know.

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