One question faced by companies from startup through Fortune 500 status is whether they should stagger or classify their board of directors. Staggering or classifying occurs when the corporation sets up voting for election of only a minority of members of the board every year, so it often takes several years to replace an entire board. This is viewed as a good takeover defense and also argued to be good for the corporation because frequent changes of directors can result in corporate policy and corporate governance changing more often or more dramatically. Those against it feel that it doesn’t give shareholders the ability to make major changes when problems arise with the current board’s decisions and it entrenches existing corporate policy and management to not as easily allow for necessary change. Although some would downplay trying to make this about shareholder rights versus management or existing structure, that is a major factor of the argument.
Originally, corporations would implement a simple once a year vote of shareholders for either current or new directors. These types of corporate governance decisions are put into articles of incorporation, bylaws, or state corporate law, although most commonly in the company’s bylaws. The idea of staggered boards was implemented within the last several decades as essentially a takeover defense, although they are now common for corporate stability. There is no right answer at this point, although legislative changes like SOX and Dodd-Frank continue to expand shareholder protections and rights to deal with things like “Too Big to Fail,” the Madoff Scam, and other shakeups.
The battle continues with a war of words between Harvard Law’s Shareholders Rights Project and law firm Wachtell, Lipton, Rosen, & Katz. The firm continues to argue for staggering and that it is not just about takeover defense. Harvard’s project argues that staggering needs to be eliminated to get rid of low valuations and bad corporate decision-making. Wachtell says there is no correlation between staggered boards and bad decision-making or lower company valuations. The project has gotten about a third of the Fortune 500 companies to agree to bring forward proposals to get rid of staggered boards. In addition, Dodd-Frank is implementing shareholders ability to weigh in on corporate governance and ways to provide nominations for the board of directors (instead of current management simply proposing who they recommend you vote for on their annual proxy), so the trend is definitely heading towards shareholder rights.
So what should you choose for your board? I still think staggered boards have a purpose and are not directly correlated to bad decision-making, but they are often used, whether intentionally or indirectly, to entrench current policy and management. With a startup or emerging growth company, you will be making major changes in the direction of the company on a frequent basis and need to add, remove, or change directors on the fly. This can be done with provisions in the bylaws that allow for removal or change in directors or adding directors to increase the number on the board, not having to wait for the annual shareholder meeting and proxy process. Founders should realize that as the company increases in number of shareholders during fund raising and growth that it often becomes more difficult to make major changes in things like how corporate governance is handled. For now you have the ability to stagger your board, so it is probably okay to still use them, but provide for provisions to more easily make changes in the board within your bylaws and realize that the current trend may require you to switch to annual elections for all directors.