board of directors

The introduction of Shareholder Rights Project (SRP) is changing the way boards operate in a positive way. The SRP has been pivotal in helping corporate boards convert from the historical, class-structured formation to a declassified format.

The classified format is a system whereby the entire board is categorized into classes with only one class participating in proxy voting at the end of every year: this means that it is very difficult to overhaul an existing board, or make any significant changes in control. Such formations interferes with implementation of corporate governance practices, which is why SRP is consistently advising shareholders to push for declassification of board.

According to a publication by Matteo Tonello and Melissa Aguilar, the 2012 proxy season has been marked by several declassification proposals received from shareholders. Up to 44 companies have shown interest in declassifying their boards, and 33 of those have already approved of declassification.

The proxy voting in a declassified board includes all members of the board, thereby giving the shareholders an opportunity to change things on an annual basis. Additionally, this kind of proxy voting allows shareholder friendly  policies to be implemented. One example is linking board compensation to performance. In the case of classified boards,it can take up to three years to alter the mode of operation.

On a classified board, a board member can stay at the helm between 3 to 5 years depending on the terms of the contract. Tonello and Aguilar say “classification is used as a defensive measure from hostile takeovers: when a board is staggered, hostile bidders must win more than one proxy contest at successive shareholder meetings to exercise control of the target.”

Pension fund and Activist hedge funds have shown a lot of interest in declassification since 2011. A good example is noted in our previous article where, Douglas Schaller, an activist investor, who effectively through proxy voting managed to take control of Bank of Floyd.

The majority of the large companies with assets in excess of $5 billion have declassified boards, with only 15% operating under class structured boards. On the other hand, 47% of Small companies are yet to approve declassification.

The statistic does make sense to some extent, because it would be even easier to take over the small corporations under declassified format than the classified structure; hence, classification can act as a mode of defense against hostile acquisitions as noted earlier.