Board Changes and the Director Labor Market: The Case of Mergers

Boards of directors perform the critical tasks of monitoring and advising management and it is logical to suspect that the necessary skills vary with the nature of a particular firm.  That is, a board should be chosen with consideration of the needs associated with advising and monitoring a particular business.  So what happens to boards after a merger?  After all, mergers change the nature of a firm, sometimes in dramatic ways.  Do boards change as well?  

In a recently revised working paper, David Becher, Jared Wilson and I examine this question. However, to ascertain whether board changes around mergers are significantly different from the status quo, we needed a benchmark of normal board changes.  To our surprise, there was little information available in the literature.  Consequently, our work provides evidence on changes around mergers but also provides a benchmark for normal non-merger changes.  

The abstract is below:

Board Changes and the Director Labor Market: The Case of Mergers

David Becher, Ralph Walkling and Jared Wilson

Abstract:      

We examine the stability and composition of acquirer boards around mergers, contrasting changes with the same firms in non-merger years and a sample of non-merging firms. Contrary to perceived wisdom, the post-merger board changes substantially and variation is significantly different from both non-merger years and non-merging firms. Adjustments reflect firms upgrading skills associated with executive and deal experience and bargaining between targets and acquirers rather than agency motives. Conversely, director selection in non-merger years is driven by general skills and diversity. Our analyses provide insight into the dynamic nature of board structure and characteristics valued in the director labor market.

The complete paper may be downloaded here.

All the best,

Ralph

“Board Walk or Parked Place? Acquiring Firms and the Director Labor Market”

A lot of attention has been given to the composition of a firm's board of directors.  Much less attention has been directed to changes in the board of directors, particularly around major events.  An important literature does address changes around mergers, but concentrates on target firms.  What about acquiring firms?  After all, mergers can represent dramatic shifts in the evolution of a firm.  It makes sense that monitoring and advising needs of boards should evolve as well.  The only evidence we do have on acquiring board changes around mergers suggests relative stability with few changes.  This evidence comes from the examination of target firms which finds that target directors are not often retained by the acquiring firm.  If these are the only changes, general stability of the acquiring board is implied.

In recent research with my colleagues David Becher and Jared Wilson, we find that stability is far from common with acquiring firm boards.  There are significant and substantial changes of boards over time and the changes are significantly different around mergers.  As just one indication the post-merger board typically consists of 7% target directors, but 11% of new directors unaffiliated with either target or bidder before the deal.  In addition, board size often changes either increasing or decreasing

“Board Walk or Parked Place?

Acquiring Firms and theDirector Labor Market”

Abstract

"This paper examines the stability and composition of acquirer boards around mergers.  Contrary to perceived wisdom, composition of the post-merger board changes substantially and these variations are significantly different from both non-merger years and non-merging firms.  These adjustments reflect firms upgrading skills associated with executive and deal experience.  Board changes also reflect bargaining between targets and acquirers rather than CEOs seeking a more friendly board.  Conversely, director selection in non-merger years is driven by general skills and diversity.  Overall, our analyses provide insight into the dynamic nature of board structure around mergers and characteristics valued in the director labor market."

All the best,

Ralph

When Say on Pay Becomes Binding: Australia's Two Strike Rule

Hello from Perth, Australia.  As some of you know, I am on sabbatical, currently touring Australia.  Last night I had the honor of talking to a local CPA society on Corporate Governance.  The question of Australia's two strike rule came up during the discussion.

The two strike rule is an interesting, if controversial rule in corporate governance.  If a board receives a 25%, no-vote on its compensation policy for two consecutive years, shareholders vote to decide if the the entire board must stand for re-election.  The rule, implemented in Australia in 2011, gives teeth to the previously advisory Say on Pay.

See this interesting article in The Sydney Herald.

One can imagine the pluses and minuses of such a system.  First, if directors are not responsive to shareholders a second year in a row, the shareholders get additional power to alter that situation.  It is reminiscent of the provisions in some preferred stocks, where if a firm misses dividends for say three years, the stock acquires voting rights.)

On the other hand, 25% might be a low threshold, and less than a majority could hold a firm hostage. Or, as directors often fear during a Say on Pay vote,  a low vote may be the result of something quite different from problems with compensation.  

David Trebeck, the Chairman of Penrice Soda, which recently survived a close call on the two strike rule, commented, ‘‘I think directors generally are more than capable of identifying and responding to prevailing shareholder sentiment without needing a legislative sledgehammer to do it for them."

(Source:  http://www.smh.com.au/business/axe-twostrikes-rule-penrice-directors-say-20130125-2dbam.html#ixzz2hJu9p5li)

The two strike rule isn't the case in the US but, by the way, Australia had Say on Pay, well before the United States.  It makes sense to keep track of what is happening in other venues and use that knowledge to improve practice.  This is NOT to say, I'm endorsing this idea, but it bears watching the empirical results.  

See our related post on Swiss Say on Pay.

All the best,

Ralp;h

CEO Turnover: The Grass Isn't Always Greener

As many of you know, my day job is as executive director of Drexel's Center for Corporate Governance.  The Center has it's own blog run by center director Patricia Connolly.  This week's post features one of my finance colleague's, Ed Nelling, commenting on CEO Turnover.  He gives some great examples and asks some excellent questions.  I think you will enjoy it.  The post can be found here.

Corporate Governance, A View from the Top

Last Spring Raj Gupta, Richard Jaffe and I sat down with Joe DiStefano, a leading reporter for the Philadelphia Inquirer.  Richard chairs the advisory board of our governance center of which I am executive director.  Raj, as you will see, is an important member of our center and was Chairman of Rohm and Haas leading it to a spectacular merger with Dow Chemical (spectacular for Rohm and Haas shareholders at least).   The article describes some of Raj's philosophies on governance, philosophies learned through important work on the boards of companies like Rohm and Haas, Tyco, Vanguard, Dephi and Hewlett Packard.  It is well worth reading.

The entire article can be downloaded here.

All the best,

Ralph 

Electing Directors

The board of directors is crucial to the successful governance of the modern corporation.  Directors hire and fire the CEO, monitor performance and compliance with regulations and provide crucial advice on strategic matters.  And, of course, related to this blog, the board also approves or disapproves mergers.  Until recently, however, we didn't know much about director elections.  Jay Cai, Jacqueline Garner and I studied over 2500 director elections to remedy that situation.  The abstract of the article is below.  

Electing Directors

Published in the Journal of Finance

Abstract:     

Using a large sample of director elections, we document that shareholder votes are  significantly related to firm performance, governance, director performance, and voting  mechanisms. However, most variables, except meeting attendance and ISS  recommendation, have little economic impact on shareholder votes. Even poorly  performing directors and firms typically receive over 90% of votes cast. Nevertheless,  fewer votes lead to lower 'abnormal' CEO compensation and a higher probability of  removing poison pills, classified boards, and CEOs. Meanwhile, director votes have little  impact on election outcomes, firm performance, or director reputation. These results  provide important benchmarks for the current debate about election reforms.   

The complete article, which was published in the Journal of Finance can be downloaded here.

All the best,

Ralph

Dell - Icahn: March Madness!

I have expressed fairness concerns about the proposed Dell insider LBO. See the February 8, 2013 post “The dell LBO: Existing Shareholders Lookout Below”. Until recently, it appeared that despite the resistance of minority shareholders like Southeastern, the deal would proceed at the original $13.65 per share offer price. Quite simply, no other bidder could or would challenge the Michael Dell-Silver Lake sponsored deal, which Dell’s board had blessed as the best alternative. Luckily for the minority shareholders, not so lucky for Mr. Dell, et al, Carl Ichan has entered the fray. He is proposing a special $9 per share shareholder distribution funded via use of excess cash and debt. He believes the this combined with the remaining “stub” value of $13.80 per shares offers a better value for all shareholders-not just Michael Dell-Silver Lake.

The nub of the issue is related party LBOs is always prone to abuse. The proposed Dell deal is especially suspect given its large cash position. Undoubtedly, as 4Q12 results indicate, Dell’s legacy PC business continues to decline. Nonetheless, it remains cash positive and has large liquid resources. The offer price, although representing a substantial premium over the pre-offer trading price, is at a large discount to Dell’s 52 week high price-a usual selling shareholder reference point. Furthermore, based publicly available information, a higher fundamentals based price could be reasonably crafted. Dell’s share price has increased following the mounting pressure by about $1 per share as investors sense that the offer price needs to raise to avoid Ichan’s ‘years of litigation’ threat.

Some lessons I see from this unfolding sequence of events are as follows:

1)     Honesty is still the best policy: The Dell “short sighted market doesn’t understand” the reason for going private which was never very convincing. Trying to complete a turnaround in a highly leveraged LBO structure would complicate not simplify the prospects. The real reason was to capture the upside benefits for the buyout group-in particular the large net $7.4B available cash position. Interestingly, the Dell group plans to bring the foreign cash home and pay the tax penalties after years of saying it could or would not return the cash due to tax considerations.

2)     Sharing is nice: Consider sharing the upside with Dell’s long suffering shareholders rather than trying to keep it all. A special shareholder distribution involving utilization of available net cash and a debt financed share repurchase would have allowed shareholders to participate in the transaction. Also, it could have avoided the auction requirements in a going private transaction. I would love to see the Board’s analysis in rejecting this alternative.

3)     Don’t be a pig: Absent sharing, at least offer a price that does not embarrass existing shareholders like Southeastern who has a $15-16 investment basis. Let them walk away- if not happy –at least not mad.

4)     Over disclose to increase the trust level: Provide valuation information to an independent third party like The Shareholder Forum, Inc with appropriate confidentially safeguards. This would supplement the less independent traditional fairness opinion provided by the company hired investment bank.

5)     The Michael Dell Rule: When he is buying you should not be selling. He does not appear to be minority shareholder friendly.

Ultimately, the next steps in the drama include Dell dropping the deal, increasing the price, providing more information, or letting the shareholders share in the deal. God bless Carl Ichan-he is doing God’s work here-of course for a fee, but that is ok.

J