Mechanisms of Board Turnover: Evidence From Backdating

Abstract

Regulators and governance scholars often regard the high rates of reelection among those nominated for boards of directors (and the small percentage of nominated directors who lose elections) as persuasive evidence of limited shareholder power. To correct this perceived imbalance against shareholders, some corporate governance advocates have undertaken a number of efforts to reform the director election system, most recently by proposing “proxy access” regulation to facilitate contested board elections.The authors take a close look at the board turnover within companies implicated in stock‐option backdating to assess the effectiveness of board elections. What they find is that, despite high reelection rates among nominated directors, board turnover is in fact substantial—but it takes place almost entirely before the board elections. Because of the apparently high costs associated with losing such an election, board nominees generally are not renominated for election (or reelection) unless success is quite likely. And whereas independent directors generally leave boards by not being renominated, management directors generally resign.For this reason, reelection rates tell us very little about the effectiveness of shareholder voting. But what the authors' findings do show is that directors involved in stock‐option backdating experience reductions in both the number and prestige of their future directorships. Thus, the authors' findings suggest that the board of director election process functions more effectively than shareholder advocates typically claim, that criticism of the responsiveness of the board‐election process to shareholder interests is overstated, and that reform efforts are therefore likely to be misplaced.