Majority voting in board elections has become a trend in public company governance; more than two-thirds of S&P 500 Index firms now have the majority voting standard. But the bulk of evidence supports the paper tiger hypothesis: Majority voting appears to make a firm stronger, but it lacks the power to do so. It has no significant impact on director turnover, financial performance, or shareholder returns.
The authors investigate the determinants and effectiveness of majority voting proposals and adoptions. They study proposals by activist shareholders and adoptions (both voluntary adoptions and adoptions in response to proposals) and rely on data from 2004 to 2007, during which time most of the S&P 500 Index firms adopted majority voting.
Although the findings indicate that majority voting has no significant impact, two observations are worth noting. The vast majority of proposals are sponsored by labor unions targeting firms with large pension obligations, and there are positive excess returns on the proposal announcement dates.
How Is This Research Useful to Practitioners?
What the research did not find is as useful as what it did: There are no significant excess returns following the adoption of majority voting. Significant excess returns do follow proposal announcements. The authors indicate that the proposal announcements are usually part of proxy statements, which could confound the results because proxy statements include many things other than proposal announcements.
Poorly performing firms continue to perform poorly (as measured by return on assets and Tobin’s q) after adoption. Overall, the trend for voting for directors continues to be so great (an average of 90% “for” votes) that majority voting has no effect on corporate governance.
Labor unions sponsor most of the majority voting proposals, even though their average shareholdings are less than 1%, and they tend to target firms with larger accrued pension obligations. Their motivations may not be strictly aligned with those of other shareholders. In addition, Institutional Shareholder Services (ISS) and management recommendations have a significant positive influence on the outcome of the proposal votes.
The authors test several hypotheses related to majority voting and find support for one: the paper tiger hypothesis, or the idea that majority voting appears to make firms stronger but lacks the substance to do so. The director accountability hypothesis would have been supported if the authors had found positive excess returns after adoption, particularly for the firms standing to gain the most from director turnover. The disruption hypothesis would have been supported if the authors had found negative excess returns after adoption, particularly for firms whose costs of failing to elect directors would be greatest. In the end, the data show insignificant results, which is consistent with the paper tiger hypothesis: Majority voting is at best an appeasement mechanism for shareholders or simply a distraction from other corporate governance issues.
Even after the adoption of majority voting, almost all firms retained their directors. In the relatively few instances (294 out of 105,446 directors) in which directors received less than a 50% vote, most boards elected to retain them or to reject their resignations. Only three directors eventually resigned or were removed.
How Did the Authors Conduct This Research?
Two samples related to majority voting are analyzed, along with control samples. The first sample is 264 firms with proposals for majority voting; these data are obtained from ISS and verified against proxy statements filed with the US SEC. Further data verification refined the sample to 228 firms. The second sample is 481 firms that adopted majority voting (204 from proposals and 277 voluntary adoptions), with the data primarily taken from Allen (“Study of Majority Voting in Director Elections” 2007). A third dataset includes firms with neither proposals nor adoptions but that were matched across industry (Fama–French industry classification) and size (closest market value).
The authors analyze the characteristics of firms with proposals and with adoptions of majority voting and then consider the effect of proposals on director turnover and on shareholder returns.
Their findings support the conclusion that adoption of majority voting has an insignificant effect on financial performance, director turnover, and shareholder returns, which is consistent with the paper tiger hypothesis.
The authors reveal some interesting and possibly investable events or trends. But the study covers only 2004–2007, a period when many firms adopted majority voting, without it having much effect on governance. The performance of adopting firms continued to deteriorate post-adoption. What will it take for majority voting to have an impact? I believe that this step is one along the evolutionary path of the relationship between boards and shareholders. Majority voting gives activist shareholders one more pressure point, and it may start to cause real pain and response going forward. How long until this paper tiger grows some real fangs?