Among the criticisms an activist investor leveled at Emerson recently, one of the milder ones concerned the structure of the Ferguson company’s board.
Emerson is among more than a dozen St. Louis-area companies that elect directors to staggered three-year terms, a practice that corporate governance experts say reduces accountability. Such a board structure once was common but now is used at just 13% of large companies, according to a 2018 study by Institutional Shareholder Services.
Activist hedge fund D.E. Shaw, in a letter filled with blistering allegations about Emerson’s cost structure and lagging returns, referred to the staggered board as a “director protection plan.” The two sides appear to have reached a truce on the issue this week: After Emerson agreed to appoint a director suggested by D.E. Shaw, the hedge fund said the company would urge shareholders to switch to one-year terms for directors.
Emerson’s board actually has been OK with such a change for years. After shareholders passed a 2012 resolution calling for annual election of the entire board, Emerson proposed an amendment to its articles of incorporation.
Such an amendment requires 85 percent shareholder approval, and Emerson dropped the effort after voter turnout fell short in 2013. D.E. Shaw said Emerson has committed to hiring “a leading proxy solicitation firm” to drum up votes this time.
Reinsurance Group of America, based in Chesterfield, also fell short of an 85 percent threshold in 2013, then got shareholders to approve the charter amendment in 2018. All its directors will be serving one-year terms by 2021.
That puts RGA in line with most large companies, but several leading St. Louis firms continue electing directors to three-year terms. They include Caleres, Centene, Commerce Bancshares and Spire.
Firms defend the practice by saying it guarantees continuity, but Charles Elson, director of the University of Delaware’s Weinberg Center for Corporate Governance, doesn’t buy their argument. A director serving three one-year terms provides as much continuity as someone on a three-year term, and defeats of incumbent board members are extremely rare.
What staggered terms do provide is a takeover defense. With only one-third of seats up for election each year, any outside challenger would need at least two years to win a board majority.
“Annual elections ensure accountability,” Elson says. “It’s a bad signal to your shareholders if you don’t want that.”
Research is mixed, though, on whether this particular brand of accountability boosts financial results. A 2017 study by Notre Dame finance professor Martijn Cremers and others found that staggered boards created value for firms “engaged in innovation and where stakeholder relationships matter more.”
Suppliers, customers and workers may commit more resources to a company that they know can fight off corporate raiders and stay around for the long term. So far, though, such arguments haven’t swayed firms like Institutional Shareholder Services, which advises large investors on how to vote.
“The governance groups have decided that this is a way company managements are entrenching themselves and this is bad,” says Todd Gormley, associate professor of finance at Washington University’s Olin Business School.
Smaller companies seem less attentive to such governance advice. The ISS study found that 60% of little firms, and 81% of firms that had recently gone public, had staggered boards.
Among large companies, the trend is clear. Eighty-seven percent of them had gone to one-year board terms by 2017, up from 59% in 2009.
Emerson, it appears, is finally about to join that majority.