What is a Staggered Board?
Why do companies adopt a staggered board of directors?
What are the important elements you should know!
In this article, we will break down the notion of Staggered Board so you know all there is to know about it!
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Staggered Board Overview
A staggered board (also known as a classified board) is a board of directors composed of different members having different terms and are elected at different points in time during the year.
The objective of staggered boards is to reduce the possibility of board influence over the company, particularly as a safeguard against hostile takeovers.
The term “staggered” means to arrange something in an overlapping manner.
In a staggered board, what overlaps is the board member’s term of office.
One board member may be elected for one year, while another for two years and another for three years.
As a result of this uneven term of office, at any given time during the year, some board seats are up for reelection.
This makes some board seats prone to rapid changes in the board member while other seats allow longevity to the elected board member.
What’s notable is that companies employing a staggered board tend to be better protected against hostile takeovers and undue influence from external actors.
Another important reason why companies may adopt a classified board of directors is for the board to remain as independent as possible from strong shareholder activists or shareholders hostile to the corporation.
The establishing of a classified board of directors will be primarily done by updating the company’s certificate of incorporation.
In some states, like Delaware, a company may adopt the staggered board provision within its by-laws.
Non-profit organizations tend to adopt a classified board more often than private companies.
Staggered Board definition
What is the definition of a staggered board?
How do you define it?
According to Investopedia, a staggered board is defined as follows:
A staggered board of directors (also known as a classified board) is a board that is made up of different classes of directors with different service terms.
In other words, it’s a type of board composition where the board members are assigned to staggering terms of service.
Structure of Staggered Boards
The structure of a “staggered board” is quite simple.
Fundamentally, every board member must be elected by the shareholders.
However, when the board is staggered, each board member will be elected for a different term (staggered term).
Typically, you’ll find board seats having a one-year term, others having two-year term, others three-year term and even longer.
It is common to see that staggered boards will have staggered elections for different classes in the following way:
- Board Class 1 must be elected annually
- Board Class 2 must be elected every second year
- Board Class 3 must be elected every three years
This means that a board member sitting in Class 3 for a term of 3 years will see the Class 1 seat go up for election 3 times and the Class 2 go up for election once.
Hostile takeover protection
A primary reason why companies implement and adopt staggered board of directors is to protect themselves against hostile takeovers.
In other words, the objective is to ensure the company’s board remains as “independent” as possible from hostile bidders, hostile takeovers, shareholder activists and other undue influence.
The staggered board terms create a mechanism where a hostile bidder may need to wait years before being able to take control of the board.
In some cases, the wait time is so long that it dissuades the hostile bidder from even attempting to gain control of the business.
In other cases, hostile bidders may initiate their campaign to win board seats but due to the staggered nature of the board, they are unable to exercise control at any given time or for long enough to be able to achieve their goal.
Minimize cumulative voting
Another important consideration for adopting a classified board is to minimize the impact of cumulative voting.
The notion of cumulative voting is something that helps minority shareholders in exercising greater power over the company.
For example, in a standard situation where all of the board members of a company are up for election, the minority shareholders can work together to exercise their votes in a strategic way to vote for the directors of their choosing.
However, if there are only a subset of the board of director seats that are up for election, the minority shareholders’ power will be reduced as they can only work to elect fewer board members.
As such, the cumulative voting of minority shareholders are significantly reduced when they vote only for ⅓ or ¼ of the board seats.
Classified board drawbacks
There are those to criticize this type of board structure (and potentially for valid reasons).
Many consider that the staggered board of directors leads to lower profitability for the company shareholders.
Some believe that company directors should vacate their seat on a yearly basis and go up for reelection.
In the context where a board seat is taken over by a hostile bidder representative or a representative of shareholder activist, then the board members will be more concerned with their own political and strategic agenda than the best interest of the company.
As a result, the board will not have a stable management style allowing the company to move in the right direction.
Staggered Board of Directors Example
What is an example of a staggered board?
Let’s illustrate the notion using a possible scenario.
The board members in a staggered board have a staggered term and there are staggered elections held throughout the year.
Imagine that a board of directors is composed of five classes defined as follows:
- Class 1: term of office of one year
- Class 2: term of office of two years
- Class 3: term of office of three years
- Class 4: term of office of four years
- Class 5: term of office of eight years
In this example, due to the staggered terms of office, there are board members being elected in different cycles within every different class.
In Class 1, the board members are elected every year while in Class 5, they are elected every eight years.
For a company to orchestrate a hostile takeover and take control over the board, they may need to wait years before having the ability to control enough seats within each class.
So what is a classified board?
Let’s look at a summary of our findings.
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