Does Your Vote Count? When Firms Bypass Shareholder Approval of Board Appointments

Abstract

Although U.S. state corporate laws require shareholders to elect the firm's directors, under certain circumstances managers can circumvent this requirement and appoint new directors without shareholder approval. The appointment of directors without shareholder approval usually occurs simultaneously with the private placement of financial securities. In this study we examine the causes and consequences of this appointment of directors without a shareholder election, a phenomenon that remains unexamined in the literature. The 'bundling' of board seats with the purchase of corporate securities that is characteristic of some private issues serves as a unique environment in which to assess the importance of shareholder voting rights. Our analysis of the effect of circumvention of shareholder approval on the nature of the directors subsequently appointed contributes to the policy controversy regarding the need for external regulation to strengthen the position of independent directors. In particular, our study is relevant to the current debate over the SEC's recent proposal to provide shareholders with the power to directly place director candidates on the corporate ballot in certain circumstances. Further, since this research examines the effects resulting from the nullification of a basic shareholder right, it helps to establish the impact that the violation of one share-one vote rules might have on the corporate governance for firms in countries with weak shareholder protection. By analyzing a sample of U.S. firms that appoint directors in combination with private offerings between 1995 and 2000, we find that firms in which agency costs are higher are more likely to nullify shareholder approval of board appointments at the time of the private placement. Firms that bypass shareholders are also less likely to appoint independent directors or to elect an independent director as chairman of the board. We also find that the stock market reacts more positively to the announcement of the private offering when the firm submits the board candidates for shareholder approval. Further, we show that firms that bypass shareholder approval significantly underperform after the private offering when compared to firms seeking shareholder approval. We conclude from our findings that the firm's decision to circumvent shareholder ratification is most consistent with the entrenchment hypothesis.