How does the board of directors structure help protect shareholders? This lesson will provide definitions and examples of how a staggered board of directors is structured.
Staggered Board of Directors
Have you ever needed to make an important decision for your family? How are these decisions made? Do mom and dad sit down and talk through all decisions? Does one person have authority to make family decisions without consulting the other one?For companies there are many different individuals involved in decision making. At the highest level you will find the board of directors who represent the shareholders and investors best interest. The structure of the board, however, varies based on the company set-up.
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A staggered board of directors is one in which board members serve different terms that intentionally overlap so that not all terms expire in the same year. It’s often referred to as a ‘classified board of directors’ and is a common practice within US corporations.Under a staggered board, members are elected to one, three, or five-year terms. Board member positions are elected in part based on their classification or as a percentage, typically one-third, as opposed to all board members at one time.
First, it makes a hostile takeover much more difficult by limiting majority control. While most mergers and acquisitions occur as a result of a mutual agreement and evaluation of the full impacts to the company and their shareholders, some come about as the result of a hostile takeover bid.A hostile takeover occurs when one company seeks to acquire another company without board or management approval. This makes the acquisition riskier and could cause major a disruption to the operations of the firm.Even if a hostile bidder was able to win one seat on the board, they would have to wait at minimum another year to try and win out another seat. However, even two board member votes may not guarantee the necessary approval for the acquisition. For our decision-making family, mom or dad could make a decision without full agreement or knowledge of the other, causing a potential impact on the day-to-day family plans and activities. The board of directors provides a good balance when making company decisions, as opposed to just one individual having full decision-making authority.A staggered board is combined with what is known as a poison pill, a corporate tactic used to protect a target company from a hostile takeover. There are two types of poison pills that can be utilized.
Poison pills can be installed and removed by board authority, however, this again would be difficult and time consuming with a staggered board structure. Staggered boards grew in popularity in the 1980’s as a response to a wave of hostile takeovers.
Minimize Cumulative VotingStaggered boards are also believed to minimize the impact of cumulative voting. The U.S. Securities and Exchange Commission reports that cumulative voting is intended to help strengthen minority shareholders interest when voting to elect a director. Shareholders can cast all their votes for a single nominee if there are multiple openings on the board. With only one-half, one-third or even one-fourth of the board being up for election at any given time the likelihood that minority shareholders can use the power of cumulative voting is greatly reduced. In addition, it is reported that long-term business commitments are protected by staggered boards. Furthermore, there is little opportunity for short-term pressure to take control over management. Current State of the Economy and Staggered BoardsDespite the benefits of protecting the long-term interest in the company with a staggered board, an unstaggered board drives accountability. Some investors are concerned that a staggered board allows members to avoid accountability when not elected annually with performance expectations.This concern can be addressed if companies modify their classified board structure, promoting the expected benefits. One suggested modifications would be to measure company performance and benchmark against its peer groups, including operations and stock performance, and allow the board to become automatically declassified if the company underperforms it peers over a period of time.Recently there has been a push to ‘declassify’ or destagger board structures. The expected benefits are increased sensitivity to the firms activities and performance, improved decision making, and higher valuation of the company. Reports suggest that from 2005 to 2014 staggered boards have declined 25%. Over 300 companies in the Standard ; Poor’s 500-stock index had a staggered board in 2002, but by 2009 the number had declined to 164.The Harvard Law School Program on Institutional Investors established a project called the Shareholder Rights Project (SRP) which can from 2011-2014. During that time, the SRP worked to educate investors and improve corporate governance within publicly traded firms.Their efforts to move companies towards annual elections resulted in board declassification at about a hundred S&P 500 and Fortune 500 companies. Lesson SummaryA staggered board of directors has member terms overlap so not all board members are elected at one time. While there is a push by many companies to declassify or destagger their board structures, most new companies are still going live during their IPO with a staggered board structure.The structure of the board is intended to protect the board in two ways:
However, other factors such as company performance and member accountability can result in shareholders consideration to declassify the board in an attempt to feel more in control. Projects such as the Harvard Law School Program on Institutional Investors work to educate investors and help drive board declassification. 
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