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IU study: Participation matters in elections of corporate boards

As shareholders of publicly traded companies look ahead to corporate board elections this spring, new research at Indiana University's Kelley School of Business suggests that a lack of enthusiasm for slated directors can affect stock prices and lead to management turnovers.

The research, which appears in the latest issue of the Journal of Accounting and Economics, also suggests that there's merit in current regulations for uncontested director elections, which are now being examined by the Securities and Exchange Commission (SEC).

The majority of publicly traded companies approve corporate directors through uncontested elections. Combined with the widespread use of plurality rules, this system ensures that director nominees always prevail.

"Many argue that uncontested director elections are meaningless because directors up for election almost surely prevail. We provide evidence, however, that vote tallies still play a meaningful role by reflecting investor perceptions of board performance," concluded Brian Miller, an assistant professor of accounting at Kelley, and one of three co-authors in the paper.

The researchers followed firms in the Standard & Poor's 500 list over a five-year period. They chose the larger firms because they expected that shareholders would be watching them more closely. Companies that did not provide ample voter information were excluded along with those that had concerted "vote no" efforts by shareholder activists or proxy contests.

Miller and his coauthors find that board of director elections can actually serve as meaningful polls of investor perceptions of board performance, and boards appear to respond to these polls. He said the research shows that shareholders may not have to resort to replacing directors in order to influence their actions.

Among other findings, the researchers found:

  • Chief executive officers of companies where the board was approved by a lower margin were two-and-a-half times more likely to be pushed out of their jobs than at those approved by larger margin. At firms with the lowest approval levels, 5.1 percent of CEOs were forced out. "5.1 percent may seem a little low, but when you think about how many forced turnovers there are, that's a pretty big number over a year," Miller said in an interview.
  • The replacement CEOs at low-approval companies were more like to come from outside the company. Firms where the board was approved by a low margin were five times more likely to replace the CEO with an outsider than firms with higher margins.
  • The stock market reacts most negatively when CEOs leave firms where directors were approved by a high majority. Conversely, when CEOs depart a firm with directors was elected with a low majority, the market responds positively. "That evidence is consistent with the stock market's picking up the same perceptions as voters," he said.
  • In regard to CEO compensation, chief executives at companies where there has been a lower vote receive less compensation in the future than their counterparts at firms where directors have a stronger vote of confidence. Management also becomes more conservative with regard to mergers and acquisitions. as well.

The findings are applicable to recent proposals calling for majority voting in director elections. "Our evidence suggests that while uncontested votes reflect investor perceptions of board performance, such proposals will have little effect unless they significantly alter voting behavior," the professors wrote. "An approval measure of 80 percent falls into the lowest quintile of our approval measures, indicating low relative approval, but the tally still far exceeds the 50 percent-plus majority hurdle."

Miller said, "We're very careful in the paper never to say that it's the vote that's driving these decisions … We think that the vote is more of a proxy for shareholders' beliefs about how well the firm is being governed."

The SEC currently is accepting comment on its proposed proxy access rules, which would change the way boards of directors are elected at public companies. Rather than limit board candidates to a slate of directors chosen by a panel subcommittee, the reforms could give shareholders the right to place their own board candidates up for election.

While the paper does not directly address the proposed reforms, Miller said it does demonstrate that shareholders already have a major voice under the current system that can affect needed changes.

"Before making significant changes to the current system, it is worth taking a look at the effectiveness of the current system," Miller said. "Even though the system theoretically may seem to be a meaningless charade of corporate democracy, the votes do have some value as they provide a meaningful measure of investor perceptions and boards appear responsive to those perceptions."

Other authors of the paper were Paul Fischer at Pennsylvania State University; Jeffrey Gramlich, Copenhagen Business School; and Hal White, University of Michigan.