Airgas and shareholder value

Larry Ribstein —  2 February 2011

Bebchuk, Cohen and Wang have posted Staggered Boards and the Wealth of Shareholders: Evidence from a Natural Experiment.  Here’s the abstract:

While staggered boards are known to be negatively correlated with firm valuation, such association might be due to staggered boards either bringing about lower firm value or merely being the product of the tendency of low-value firms to have staggered boards. In this paper, we use a natural experiment setting to identify how market participants view the effect of staggered boards on firm value. In particular, we focus on two recent rulings, separated by several weeks, that had opposite effects on the antitakeover force of the staggered boards of affected companies: (i) an October 2010 ruling by the Delaware Chancery Court approving the legality of shareholder-adopted bylaws that weaken the antitakeover force of a staggered board by moving the company’s annual meeting up from later parts of the calendar year to January, and (ii) the subsequent decision by the Delaware Supreme Court to overturn the Chancery Court ruling and invalidate such bylaws.

We find evidence consistent with the hypothesis that the Chancery Court ruling increased the value of companies significantly affected by the rulings –namely, companies with a staggered board and an annual meeting in later parts of the calendar year –and that the Supreme Court ruling produced a reduction in the value of these companies that was of similar magnitude (but opposite sign) to the value increase generated by the Chancery Court ruling. The identified positive and negative effects were most pronounced for firms for which control contests are especially relevant due to low industry-adjusted Tobin’s Q, low industry-adjusted return on assets, or relatively small firm size. Our findings are consistent with market participants’ viewing staggered boards as bringing about a reduction in firm value. The findings are thus consistent with institutional investors’ standard policies of voting in favor of proposals to repeal classified boards, and with the view that the ongoing process of board declassification in public firms will enhance shareholder value.

The paper reports on the Airgas/Air Products takeover battle.  Interestingly, it relies heavily on Steve Davidoff’s excellent reporting on this contest.

I have not studied the empirical test closely.  Taking the results at face value, I have a couple of observations.  First, although this evidence helps persuade Bebchuk et al that declassification “will enhance shareholder value,” proponents of strong boards who distrust markets driven by arbs and hedge funds would disagree.  I think the ultimate answer is best given by the corporate contract.  As interpreted by the Delaware courts in Airgas, that contract (reading the corporate charter in conjunction with the statute) favors strong board control.  See generally my venerable but still relevant article on interpreting the corporate contract in this context, Takeover Defenses and the Corporate Contract, 78 Georgetown Law Journal 71 (1989). This contract gives boards the power to, for example, maintain management continuity and long-run vision, at the possible cost of foregoing agency cost discipline. 

Second, there is, of course, another way — the uncorporation which, as I discuss in my Rise of the Uncorporation, may combine strong protection from takeovers with other mechanisms for disciplining managers.  For a recent article focusing on staggered boards in a particular type of uncorporation, see Corporate Governance and Performance in the Market for Corporate Control: The Case of REITs (no free online version available):  

We examine 132 mergers and acquisitions by Real Estate Investment Trusts (REITs) during 1997-2006 and explore the relationship between acquirer external and internal corporate governance mechanisms and announcement abnormal returns. We argue that in regulated industries with absent active takeover market, the importance of outside governance mechanisms is diminished and substituted by internal governance controls. We focus on the REIT industry. We find that bidder returns are higher for REITs with smaller boards, with more experienced CEOs, but with shorter tenure. Acquirers’ announcement returns are also significantly and positively related to higher ownership by their CEOs and board directors. We find no significant relationship between presence of staggered board and abnormal bidder returns, which supports our hypothesis that anti-takeover defense measured have reduced importance for REITs.

Larry Ribstein

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Professor of Law, University of Illinois College of Law