Outside the Box
Savvy investors see value in combining CEO and chairman role; staggered director terms and dual share classes
Every corporation is unique. It follows that governance arrangements should be tailored to suit. Yet many shareholders, especially indexers, roundly condemn certain governance practices as if one size fits all.
Three corporate practices illustrate this: combining the roles of chairman and chief executive; staggered director terms, and classes of stock with different voting rights. Each is derided for valid abstract reasons, but all persist because they can be suitable at particular companies.
CEO and chair
Corporate performance results show that there is no right or wrong answer, only “it depends.” Among 20 best-performing companies over the past decade, the proportion with each practice matched the overall proportion of companies using it. In other words, these practices add or subtract value depending on context, especially the chief executive’s identity and the board’s caliber, even the shareholder makeup.
Take splitting the chair/chief executive roles. Leading indexers and proxy advisers oppose combining the roles because boards appoint and oversee the CEO. Having one person wear both hats creates a conflict, they say.
Yet many corporations thrive when led by an outstanding person serving as both chair and chief, while others have failed amid split roles, as I explained some years back in the Wall Street Journal — think Enron. After all, board chairs get only one vote, so it comes down to the capability of the other directors. Good ones neutralize such a conflict.
The data supports the view that context matters. About half the S&P 500
companies split these functions while the other half combines them. Despite indexer complaints, quality shareholders — buy-and-hold stock pickers — are as likely to own stakes in companies that split these functions as those that combine them, according to data from the Quality Shareholders Initiative at George Washington University (QSI). They look past formal checklists to substantive details.
Staggered board terms
Debate over staggered boards reflects a similar substance versus form battle. At some companies, every director stands for election every year while at others only one-third do, each for three-year terms. Critics oppose such three-year terms as impairing board accountability.
Yet a staggered board may enable a company to embrace a longer time horizon than one that can turn over completely in any year. Value arises from such binding commitments to long-term strategies, according to research led by Notre Dame Business School Dean Martijn Cremers
These realities are reflected in historical company practices, which vary. Staggered boards are used at nearly half of Russell 3000 companies, although the figure among S&P 500 companies has fallen to about 60, in response to indexer pressure in recent years. Quality shareholders grasp this point too: they invest just as much in companies with staggered boards as without them, according to QSI data.
Multiple share classes
Consider companies with more than one class of stock, each with different voting rights. By convention, every corporate share has one vote; but in these setups, insiders often get more votes for their shares than outsiders, putting power in a controlling minority. Critics say that insulates controllers from accountability and market discipline. They lobbied unsuccessfully to outlaw the practice, but in 2017 prevailed upon indexers, such as S&P, to exclude newly listed dual class stock.
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Yet even after the index exclusion, dual-class companies continued to go public, joining hundreds of others that have followed the practice for decades. These include such long-term stalwarts as Aflac
, Berkshire Hathaway
, Estee Lauder Companies
and The New York Times Company
, as well as contemporary starlets like Alphabet (Google)
, and Snap
. The practice is ideal for certain company types, especially those needing quality shareholders to support long-term businesses, such as spirits (Brown Forman
or those with valuable roots in families (Tootsie Roll Industries
) or entrepreneurs (Nike
Terms also vary, from simple board seat allocations to complex control formulas. Some even protect outsiders against insider tyranny, such as at McCormick & Co.
and United Parcel Service
. It’s no wonder, yet again, that quality shareholders are not averse to owning shares in dual class companies, according to QSI data.
Why might indexers and other critics universally condemn corporate practices that quality shareholders accept and that may enhance a company’s performance? Different business models may explain: indexers address the market as a whole while quality shareholders focus on specific companies.
Indexers prescribe policies expected to benefit the overall market, on average, not particular businesses. The size and reach of indexers — commanding around one-third of public equity — give them outsized influence, and a wide critical following. But they have small stewardship staffs and minuscule budgets to address particular companies, according to research led by Harvard Law School’s Lucian Bebchuk — no more than 45 people covering well more than 3,000 U.S. companies.
Quality shareholders appreciate that indexers may present “best practices” in general. Yet without examining context, some companies will not get the governance that is best for them. The indexing business model makes one-size-fits-all governance an imperative. But that should not stop quality shareholders or companies from fashioning a tailored approach.
Lawrence A. Cunningham is a professor and director of the Quality Shareholders Initiative at George Washington University. His books include Quality Shareholders; Dear Shareholder; and The Essays of Warren Buffett. Cunningham owns stock in Berkshire Hathaway and is a shareholder, director and vice-chairman of the board of Constellation Software.