What type of board creates the most long-term value for US companies?

October 24, 2018 Finance

Good governance of listed companies, exercised by boards of directors, is crucial for defining appropriate strategies and thus fostering long-term value creation. However, the academic literature suggests that the impact of staggered boards – a proportion of whose members are renewed every year – is negative. Researchers turn over previous results and offer a new perspective on this question.

As well as takeover bids, pressure from activist investment funds and quarterly reporting obligations for financial communication, directors of listed companies have to contend with short-term requirements, which are not always compatible with long-term development and investment strategies. It is in this sometimes paradoxical or even ambiguous context that the members of boards of directors exercise their functions related to corporate governance. Yet corporate governance. is the subject of much debate, particularly in developed countries, as to which practices on the part of the directors are the right ones.
Admittedly, codes of governance – imposed by law and/or promoted by employer organizations and management associations – are regularly reviewed or discussed by the actors concerned,but there is no standard formula as to what constitutes good governance. In the United States, for example, corporate law is directly dependent on the federated states, with each state offering different corporate law rules. Also, most of the corporate law rules are default, meaning that contracting parties can change the legal default, including corporate governance rules, as they wish. Finally, good governance is still far from being an exact science.


There are two different board governance structures for listed companies in the United States: the unitary board, all of whose members are elected at the same time, and the staggered board, divided into two or three groups of directors, of which only one group is elected each year. “When a company has a staggered board of directors, it takes at least two elections, or two years, to renew more than 50% of the directors and thus obtain a majority. Consequently it is more difficult for the financial markets, personified by shareholders, to exert pressure on directors to improve performance in the short term. However, some academic studies have concluded that staggered boards lead to the entrenchment of directors at the expense of shareholder interests. This research topic is therefore very important in the United States, because many companies have this type of governance,” Simone Sepe says.

A 2005 empirical study by the law and economist Lucian Bebchuk, a professor at Harvard Law School, found that, as well as the risk of entrenchment of directors and administrators, staggered boards of directors tended to lower  the firm’s value, as measured by Tobin’s Q. “The paper reveals a correlation between staggered boards and lower firm values, though without proving a causal relationship. It is true that this type of governance structure is associated with lower firm valuations. This is because lower-valued companies have a greater interest in adopting a staggered board of directors in order to reduce their vulnerability to take-over bids. In our work, we wanted to clearly identify a causal link between staggered boards of directors and firms’ long-term valuations,” says Simone Sepe.

To compare the respective impact of unitary and staggered boards on the long-term valuation of companies, the researchers first collected data on more than 3,000 companies listed in the S&P 1,500 over the period 1978-2015. They then carried out various types of econometric study to obtain their results. “In our work, the negative correlation found by Bebchuk is not statistically significant. Indeed we found the reverse, combined with a clear causal link: companies with staggered boards have better valuations in the long run,” says Simone Sepe.
“The robustness of our results has been verified and tested with several econometric techniques. Our work shows that staggered boards of directors increase companies’ long-term valuation, measured by Tobin’s Q coefficient, by 3.2%.” The positive causal link found by the researchers can be explained by the bonding hypothesis, according to which directors cannot develop a long-term investment strategy when under constant pressure from shareholders and the prospect of the complete replacement of the board. On the other hand, a staggered board of directors fosters the engagement of directors and stakeholders (customers, employees, suppliers, etc.) over the long term, because it is less subject to shareholder pressure.” Shareholder oversight is very important, but in the short term – two or three years, in this case – shareholders should not intervene in companies’ investment policies,” Simone Sepe argues. Among the companies that have the greatest interest in setting up this governance structure are those with significant R&D outlay, as such investment requires time, which shareholders are not always ready to grant.
Lastly, the researchers found no evidence from their study that staggered boards create a risk of entrenchment by the company’s directors and officers. These various positive findings amount to powerful arguments for this type of governance in US listed companies.

Article published in the Cahiers Louis BACHELIER