Staggered terms of board directors at public companies have fallen out of favor in recent years, in part because they give shareholders less influence over management, and new research suggests a staggered board structure could also hurt the effectiveness of audit committees.
Typically, with a staggered board structure, one-third of the board members are elected each year for three-year terms. But although such a structure helps ensure continuity on the board, it also tends to reinforce the entrenchment of upper management. The number of S&P-500 firms with staggered board structure (instead of one-year director terms) has declined from 300 in 2000 to fewer than 50 today.
New research adds to the evidence against the practice: Staggered board structure, it suggests, interferes with shareholder influence on the board audit committee and stymies improvements in its functioning.
The study, which appears in the May/July issue of Auditing: A Journal of Practice & Theory, published by the American Accounting Association, was written by Ronen Gal-Or and Udi Hoitash of Northeastern University and Rani Hoitash of Bentley University. "Overall our results support the recent trend to de-stagger corporate boards," they wrote. "Our results extend...evidence that staggered boards are less likely [than others] to react to low shareholder votes. This extension matters because the key difference between staggered and non-staggered boards is the ability of shareholders to promptly hold directors accountable through voting."
The study examines how audit committees' ability to carry out their responsibilities is affected by the increasing say that shareholders have come to exercise in the make-up and functioning of corporate boards.
The study asks four main questions: 1) To what extent does shareholder voting (which is nonbinding) affect the composition of the audit committee—particularly committee members with expertise in finance and accounting? 2) How does it influence the frequency of committee meetings? 3) How does it influence the overall quality of company auditing and financial reporting? and 4) How are all these impacted by whether board membership is on a staggered or non-staggered basis?
To answer these questions the researchers analyzed seven years' worth of shareholder election results along with information on director characteristics and committee memberships plus corporate auditing and financial data. They analyzed a total of 6.786 firm-years of data and 18,296 elections involving audit-committee members.
They found shareholder voting significantly influences the composition of audit committees in companies with non-staggered boards, but not those with staggered boards. This was most striking in the case of accounting financial experts, who are especially important to an audit committee’s functioning. Assessing shareholder approval by subtracting the average vote for the audit committee directors from the average for other directors, the professors found that almost half the departures from audit committees by accounting financial experts occurred when the average shareholder vote for audit committee members fell well below that for other directors (specifically, in the bottom tenth of the range from highest positive to lowest negative).
Low approval also significantly increased the likelihood that a departing expert would be replaced by another accounting financial expert, but it had no significant association with non-accounting financial expert departures.