Bebchuk Defends Shareholder Rights Project

By Lucian Bebchuk of Harvard Law School

This article and a response by Martin Lipton of Wachtell Lipton originally posted on Harvard Law's corporate governance blog.

Note from Shareholder Rights Project: Lucian Bebchuk is the Director of the Shareholder Rights Project (SRP). The SRP, a clinical program operating at Harvard Law School, works on behalf of public pension funds and charitable organizations seeking to improve corporate governance at publicly traded companies, as well as on research and policy projects related to corporate governance. Any views expressed and positions taken by the SRP and its representatives should be attributed solely to the SRP and not to Harvard Law School or Harvard University.

This post responds to four memoranda issued by Wachtell Lipton Rosen & Katz, available on the blog here, here, here, and here.

In a memorandum issued recently by the law firm Wachtell, Lipton, Rosen & Katz (WLRK), WLRK co-founder Martin Lipton criticized me for supporting shareholder activism that allegedly has detrimental effects in the long term. The memorandum followed two earlier, strongly-worded WLRK memoranda signed by Lipton and several other prominent corporate partners at the firm, titled “The Shareholder Rights Project is Wrong” and “The Shareholder Rights Project is Still Wrong“. Those memoranda criticized the work of a program I direct, the Shareholder Rights Project (SRP), for destroying long-term value by contributing to numerous board declassifications.

I am currently carrying out research work that addresses the view held by WLRK and others that investor activism is generally detrimental to the long-term interests of companies and their shareholders. In the meantime, however, the SRP’s recent release of its 2013 results provides an appropriate opportunity to respond to WLRK claims that the SRP’s work, in particular, has contributed to the destruction of long-term value. As I explain below, these results indicate that relevant institutional investors and corporate boards have largely rejected WLRK’s views – and require that WLRK reconsider its position.

The SRP has submitted a large number of board declassification proposals on behalf of eight SRP-represented institutional investors (seven public pension funds and one foundation). The work by the SRP and SRP-represented investors has led to a large-scale movement by S&P 500 and Fortune 500 companies toward annual elections. Over 40 board declassifications have already taken place, and numerous additional agreed-upon management proposals to declassify are expected to be brought to a vote this year. In its two memoranda, WLRK denounced this work and the large-scale dismantling of classified boards that it has produced, asserting that such declassification “is harmful to companies that focus on long-term value creation.” Indeed, in a subsequent WLRK memorandum, Lipton viewed resistance to demands to dismantle staggered boards as “one of the key issues” for boards to address in 2013.

As I explained in a DealBook column, there is a significant body of empirical work that finds that classified boards are associated with negative outcomes for corporations and their shareholders. In particular, classified boards are correlated with lower company value (Bebchuk and Cohen (2005), subsequently confirmed by Faleye (2007) and Frakes (2007)), lower returns to shareholders in the event of an unsolicited offer (Bebchuk, Coates, and Subramanian (2002)), value-decreasing acquisition decisions (Masulis, Wang, and Xie (2007)), and lower sensitivity of CEO turnover to company performance (Faleye (2007)).

Although WLRK dismisses this evidence as unpersuasive, it has not backed this claim with significant empirical evidence or analysis. Instead, in promulgating the view that staggered boards are beneficial, the main basis offered by WLRK partners is their reported “experience.” It is thus unsurprising that substantial majorities of institutional investors and corporate boards have chosen to act counter to the WLRK view.

Consider first the institutional investors, including many long-term investors, which have overwhelmingly supported board declassification proposals by SRP-represented investors. For instance, BlackRock, whose approach to corporate voting was commended by Lipton in a WLRK memorandum, has consistently voted in favor of the declassification proposals put forward by SRP-represented investors. Of the 40 such proposals that went to a vote at the 2012 annual meetings of S&P 500 and Fortune 500 companies, 95% of them (38 proposals) passed, obtaining average support of 80% of votes cast. Furthermore, all of the six declassification proposals that have gone to a vote in 2013 have passed, obtaining 79% of the votes cast.

This overwhelming support for board declassification by institutional investors managing trillions of dollars should give pause to WLRK. WLRK should not maintain that it understands what is in the best interests of investors better than a substantial majority of those investors themselves.

Now consider corporate directors, a group that should be of particular importance to WLRK and to which Lipton’s memorandum on key issues for directors is specifically addressed. The boards of a large majority of the numerous companies engaged by the SRP have chosen not to heed WLRK’s suggested approach. Among the 121 companies receiving proposals for 2012 or 2013 annual meetings from SRP-represented investors, 91 companies – about three quarters of those engaged – agreed to move toward annual elections, either by entering into agreement to bring management proposals or, where companies’ classified board structures were set out in their bylaws, by declassifying through bylaw amendments.

Furthermore, the directors of almost all of the companies that have already put forward agreed-upon management proposals to declassify have recommended to shareholders that they vote to approve the dismantling of the classified boards. Such recommendations were generally accompanied by statements that the directors had considered arguments for and against classified boards and had concluded that board declassification would best serve the interests of the company and its shareholders.

If WLRK chooses to maintain its support for classified boards, it could respond to these decisions by directors in one of two ways. First, WLRK could claim that directors capitulated to pressure and chose to make proposals and recommendations that they knew to be value-decreasing in the long term; however, this would imply that the directors in question have violated their fiduciary duties. Alternatively, WLRK could claim that, even though the directors in question genuinely believed that board declassification would serve long-term value, the directors misunderstood what would actually be in their companies’ long-term interests. Either position would be inconsistent with the views for which WLRK is well-known.

For more than three decades, WLRK has contributed to the development and justification of strong takeover defenses (including classified boards) that enable boards to block acquisition offers that may be favored by a significant majority of shareholders. In advancing the case for such strong takeover defenses, WLRK has argued that the key decision whether to sell a company is best left to the discretion of the board of directors.

In supporting this argument, WLRK has taken the view that directors are in the best position to determine what course of action would be value-maximizing in the long term, and that, since they are subject to fiduciary duties, directors can be relied on to resist pressure from managers or others to make decisions that would be detrimental to long-term value. Given these long-held views, and the fact that the directors of 91 S&P 500 and Fortune 500 companies have chosen to move towards annual elections, it is inconsistent for WLRK to assert that these moves are likely to be detrimental to the long-term value of these directors’ companies.

More generally, WLRK cannot continue to maintain the following inconsistent positions:

• (1) WLRK’s long-held view that strong defensive tactics like classified boards are desirable because directors can be counted on to do what’s right for the long-term value of their companies; and
• (2) the view expressed in WLRK’s recent memoranda that moves by the directors of numerous companies toward board declassification are not right for the long-term value of their companies.

WLRK should recognize that (1) and (2) are inconsistent. I hope that its future memoranda will clarify how it will revise its positions to avoid such internal contradictions.

In particular, WLRK cannot continue to maintain – based on its “experience” – that it knows better than large majorities of institutional shareholders what is best for them and the companies in which they invest, or that it knows better than the 91 corporate boards agreeing to declassify what is best for the companies they lead and the shareholders investing in them. The time has come for WLRK to reconsider its unsupported and widely rejected position on staggered boards.