Elect a Dissident, and You May Win a Prize
The proposal’s terms vary, based on company size, but investors who abide by a set of relatively simple rules could place director nominees on corporate proxies and put them to a shareholder vote.
Those interested in nominating directors at a large company, for example, must own a total of at least 1 percent of its shares and must have held that stake for more than a year. They must also be willing to certify that they are not trying to take over the company or gain more than a minority representation on the board.
Once these and several other requirements are met, shareholders could nominate directors to fill up to 25 percent of a board’s seats.
“The nation and the markets have recently experienced, and remain in the midst of, one of the most serious economic crises of the past century,” said Mary L. Schapiro, the chairwoman of the commission, when she announced the proposal. “This crisis has led many to raise serious questions and concerns about the accountability and responsiveness of some companies and boards of directors, to the interests of shareholders.”
If the rules go into effect, they will be a force for major change. In the past, only those shareholders with millions to spend on hard-fought proxy wars could hope to influence a board’s makeup.
For the next two months, the agency is seeking public comments on the proposal. Get ready to hear squawks and howls from those who think that shareholders should let wiser heads — like those on board nominating committees — decide who is fit to be a corporate director.
Naysayers will no doubt predict that the world will end and that stocks will fall if dissident slates of directors muscle their way into the boardrooms.
But a new study of 120 so-called hybrid boards — those formed when activist shareholders won one or more director seats from 2005 through 2008 — tells a different story. On average, these companies’ shares outperformed their peers in both short- and longer-term periods.
From the beginning of the contest period for a board seat through the first year of a hybrid board’s existence, companies’ total returns were 19.1 percent, or 16.6 percentage points better than peers’. And 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.
To be sure, much of the excess return occurs shortly after an activist announces his or her intention to battle for board seats at a company. Investors, taking their cue that the company may be undervalued, typically bid up its shares in the three months leading up to the formation of a hybrid board. Keep in mind, too, that averages mask both exceptional and disastrous outcomes.
But the study, conducted by the Investor Responsibility Research Center Institute, a nonprofit organization, and Proxy Governance, a proxy advisory firm, certainly shows that directors put in place by dissident shareholders do not generally wreak havoc at these companies. In almost 90 percent of the cases, hedge funds were the driving force behind the hybrid boards.
The degree of outperformance registered at these companies varied in surprising ways. One element that seems to affect results was the size of the stake held by the dissident shareholder. The greater the stake, the bigger the gains.
At companies at which dissidents held 5 to 10 percent of shares, for instance, results over the following 15 months moderately exceeded those of their peer groups. But for companies in which the dissidents owned 10 percent to one-quarter of the stock, price appreciation significantly outshone peers, averaging almost 68 percentage points higher over the ensuing 15 months.
Performance at the companies where dissidents held less than 5 percent of shares was only in line with peers, on average.
Here is another interesting data point from the study: A company’s share performance varied based on the number of director seats that a dissident holder won. Less is more, as it turns out. Compared with their peers, boards that seated a sole dissident moderately outperformed but those companies with three new directors significantly underperformed.
In addition to allaying fears about the impact that dissident directors may have on a company’s prospects, the study provides context on the issue of proxy access to shareholders and how broad it should be. That is the view of Jon Lukomnik, director of the I.R.R.C. Institute.
“I think what it says is there is some value to owners being able to challenge existing management and that there are also some limits to that value,” Mr. Lukomnik said. “Dissidents can clearly get the market to focus on the hidden value in these companies, but delivering on it takes hard work.”
Scott A. Fenn, managing director of policy at Proxy Governance, said the study’s findings should also help dispel the myth that those who try to shake up boards are interested only in short-term profits. “On average, anyway, when hedge funds get on boards,” he said, “at least they have a decent track record of creating some value.”