Effectiveness of Hybrid Boards

Abstract

This study examines whether “hybrid” boards - boards formed when activist shareholders such as hedge funds, through actual or threatened proxy contests, were able elect dissident directors but did not win full control of a board - create value for shareholders. The study reviewed the effectiveness of 120 such boards formed from 2005 through 2008. Board effectiveness was evaluated both in terms of changes in corporate governance structures and strategy, as well as through increases or decreases in shareholder value, measured in both absolute returns and relative to peers. On average, the study found that total shareholder returns at ongoing companies with hybrid boards were 19.1% - 16.6 percentage points better than peers - from the beginning of the contest period through the hybrid board’s one year anniversary. More than half of these gains came during a three-month period leading up to the formation of the hybrid board, providing strong evidence for a sizeable contest effect increase in share prices, as the market priced in its expectations of changes a hybrid board might bring. This effect is similar to the “announcement effect” - an increase in share price over a short period after the announcement, via a 13-D filing, that an activist investor has taken a significant position in a company’s stock - observed in other studies of shareholder activism. In many cases, however, the contest effect was distinct from a 13-D announcement effect, as it often came a significant period time after the initial 13-D filing, and was clearly related to a specific activist initiative - the proxy contest - rather than a general expectation of productive activism. Among the 15 ongoing businesses in the sample for which three years of performance data was available following the creation of a hybrid board, total shareholder returns averaged only 0.7% over the three-year period - 6.6 percentage points worse than peers. Total share price performance for the 39 months from the beginning of the contest period through the three year anniversary of the hybrid board, however, averaged 21.5% - 17.8 percentage points higher than peers - again largely on significant contest period share price appreciation. While most of the companies in the study continued as ongoing businesses, 18 percent were sold during the study period and 5 percent entered bankruptcy. Among the companies that were sold, the sale price premium averaged 27.1% versus the undisturbed share price. For the companies going bankrupt, in all cases more than 99.9% of shareholder value was lost. Finally, the study found that it is no longer unusual for determined shareholder activists to obtain representation on the boards or targeted companies. In fact, during the four-year period covered by the study, dissidents were able to gain representation at approximately 75% of the companies targeted. In the majority of these cases, dissidents gained board seats through settlement agreements with companies, rather than a pursuing the contest to a shareholder vote.