A growing number of companies seem willing to compromise on one high-profile governance issue: the declassification of the board of directors.

For example, in just the past few months, about two dozen companies proposed annual elections of directors at their annual meetings. They include Avon, BellSouth, Cendant, Merck, The Dow Chemical Co., Starwood and Weyerhaeuser.

However, even though more and more companies are moving in this direction, it is clear that they don't intellectually endorse the concept. Rather, many of the recent decisions related to this issue are more reflective of the current governance-conscious environment that has gripped corporate America by the lapel.

Passionate Shareholders

For example, earlier this year Starwood Hotels & Resorts Worldwide announced that its board of directors voted unanimously to declassify its board in favor of annual elections of all its directors. Noting that last year in a non-binding proposal a majority of Starwood's shareholders voted in favor of de-staggering the board, the hotel company bragged in its press release that the company was "already in the forefront of good corporate governance in the hotel industry."

Yet, within the same announcement, Barry S. Sternlicht, Starwood's chairman and CEO made a point of stating, "Our board of directors strongly believes that a staggered board is the best way to ensure that shareholders receive full value during a hostile takeover bid or to protect the company from an effective change in control via the replacement of a majority of the board without the payment of a premium to shareholders."

So, why declassify? "It became clear that our shareholders are passionate about this issue so we elected to respond," he added.

Avon, which announced before its May 6 annual meeting that it would submit a proposal before next year's meeting to declassify its board, reacted similarly. "Avon's board is committed to listening and responding proactively to shareholders," said Andrea Jung, Avon's chairman and CEO.

But, she too felt compelled to add, "The board believes that the current classified structure has provided the continuity of experience and perspective to facilitate long-term planning. Nonetheless, in making this move, the Board acknowledges the strong sentiment in favor of declassification, and recognizes shareholders' view that this measure will enhance board accountability."

In fact, Avon's decision was part of a compromise agreement with Walden Asset Management, an activist shareholder that has been a long-time advocate of annual elections for all directors, which subsequently withdrew its related proposal from consideration at this year's meeting.

In his statement, Walden Senior Vice President Timothy Smith was gracious, noting, "We believe this change demonstrates Avon's commitment to be a leader in corporate governance. Avon's top management and board undertook a painstaking review of this issue, and are very attuned to the views of Avon shareowners who overwhelmingly registered their support for the principle of annual election of Directors to increase board accountability."

Governance, 2004 Style

Meanwhile, last week a non-binding proposal calling for annual elections of directors at Duke Energy Corp. was approved by nearly 63 percent of common shares voted at the company annual meeting.

In an unusual and improbable reaction, Duke Chairman and Chief Executive Paul M. Anderson reportedly said the board "will abide by the will of the shareholders" even though the board opposed this policy.

Welcome to corporate governance, 2004 style. To get an idea of how much the governance environment has changed over just the past few years, the case of Cendant Corp. provides a worthwhile example. The $18 billion hotel franchisor recently announced that its shareholders approved a proposal to declassify its board of directors.

This wouldn't be surprising if it wasn't the third time the company had voluntarily submitted this type of proposal. But—believe it or not—similar proposals in 2000 and 2002 didn't pass.

So, why do governance experts and investors even care so much about this issue? They believe directors are more responsive if they must be approved each year. What's more, companies are more vulnerable to proxy fights if hostile suitors can change a majority of the directors in one year rather than wait several years. And, as in the case with companies that have poison pills or other apparent takeover defenses, companies with staggered boards are less likely to trade with a takeover premium.

In fact, Walden likes to point out in its proxy materials that a 2001 study of 1,500 firms, conducted by researchers at Harvard University and the University of Pennsylvania's Wharton School, found a significant positive relationship between greater shareholder rights, including annual election of directors as measured by a governance index, and both firm valuation and performance from 1990 to 1999.

Whether they buy it or not, many top executives seem willing to go along with this conclusion for now.

 

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