The New York Times, the Harvard Law School Forum on Corporate Governance and other media outlets are reporting on an increasingly heated debate over whether corporate boards of directors should all stand for election at the same time (a “declassified” board that could be analogized to the method for electing the U.S. House or Representatives) or serve staggered terms, usually with one-third of the directors standing for election each year (a “classified” board that could be analogized to the method for electing one-third of the U.S Senate every two years). Many articles and other publications address this topic, often with lots of data to support a particular position, and some academics are also soliciting shareholders with proposals based upon their research.
One question that has not been central to this debate is whether corporate law compliance is helped or harmed by having a classified or declassified board. The answer to that question is not clear, but it is important. The impact of corporate governance norms on law compliance is particularly important to lawyers who practice securities and corporate law and seek to help clients obey the law.
Declassified boards make companies more vulnerable to take over attempts as well proxy fights to replace directors and senior management. This could be a good thing if ethically minded bidders or activist shareholders were to identify ethically challenged directors and managers and then take advantage of the declassified board structure to vote them out of office. I am skeptical, but this scenario will be more believable if activist shareholders start talking more about corporate law compliance and ethics rather than being single mindedly focused on stock price.
The more intuitively likely scenario is that directors and officers in a company with a declassified board and a lackluster stock price will fear takeover attempts and proxy battles, and will do everything possible to quickly get their stock price up. When directors can all be replaced in one shareholder vote, they don’t have much time. There are legitimate ways of improving stock price (run a good business) as well as illegitimate ways (cook the books, ignore safety defects in products, make profits by violating laws, take unreasonable financial risks to increase earnings, etc.). We hope corporate officers and directors choose the legitimate ways rather than the illegitimate.
I have written and spoken (at the ABA Professional Responsibility conference among other venues) on how cognitive psychology suggests that decision makers who face two bad alternatives, a so called “loss frame”, are prone to risk taking – financial risk taking, legal risk taking and ethical risk taking – if the risk taking offers them some hope of avoiding a bad outcome. In the corporate governance context a lackluster stock price and a declassified board poses just such a “loss frame” to corporate officers and directors. The unanswered question (cognitive psychology studies don’t always predict what people actually do) is how directors and officers actually respond. Do they find good ways to increase stock price and save their jobs or do they look to the riskier and less savory alternatives?
What this debate needs is detailed empirical research on whether board classification or declassification makes any difference for law compliance. Measuring compliance is difficult but rough estimates could be made based on SEC complaints, securities fraud suits, product liability suits, attorney general investigations, and/or regulatory investigations and settlements. With respect to some or all of these rough measures of law compliance, does board classification make a difference? We should do what we can to find out.