What is Staggered Board?
Staggered Board, popularly known as Classified Board, refers to the particular set-up of the members of the board such that it contains directors that are stratified into different classes. In such a case, out of the several classes of directors, only one class of directors have to go through the process of elections at any given point of time, which is quite different than that of a normal board where all the directors are elected at the same time.
In the US corporates, a staggered board of directors is a very well-known practice, which is usually is formed for governing the board of directors of an organization, corporation, or company. In this set-up, only a certain section of the members of the board (instead of the entire board of directors) is elected at any given time each time. Each category of directors are assigned a specific “class,” say Class I, Class II, Class III, etc.
How Does the Staggered Board Work?
In a staggered board, the members are grouped into well-defined classes. Let us assume that there are 12 members in the board of directors of XYZ Inc., and they are grouped into three classes, say Class I, Class II, and Class III. Also, 25% (3 members), 50% (6), and 25% (3) of the members are there in Class I, Class II, and Class III, respectively. Now, the terms for the members of Class I, Class II, and Class III are to expire in May 2020, May 2021, and May 2022, respectively. Therefore, on any election date, only one class of members is up for election, and this is why the name – “staggered.”
Let us take the example of XYZ Inc. and ABC Inc. to illustrate its importance. XYZ Inc. uses a staggered board while ABC Inc. uses a normal set-up for the board of directors. Both the companies have 15 members in their board of directors, who each serve for a term of 3 years.
In the case of XYZ Inc., five directors are grouped into each of the three classes. The terms for the members of Class I, Class II, and Class III are to expire in June 2020, June 2021, and June 2022, respectively. In the case of ABC Inc., the terms of all the 15 directors are to expire in June 2021.
Now, let us assume a situation of a potential hostile takeover of both XYZ Inc. and ABC Inc. by DFG Inc. in June 2021. Basically, DFG Inc. seeks to acquire either of the two companies to strengthen its market domination by having more market shareMarket ShareMarket share determines the company's contribution in percentage to the total revenue generated within an industry or market in a certain period. It depicts the company's market position when compared to that of its competitors.. However, none of the companies are willing to join DFG Inc.
The takeOver of XYZ Inc: In order to gain control of XYZ Inc., DFG Inc. will have to garner a board majority. Given the staggered nature of the board, the acquirer will be able to pocket a maximum of 5 seats in any election. So, in the election of June 2021, even if DFG Inc. acquires all the five seats, it will still fail to achieve a board majority (5 out of 15). Therefore, the acquirer will have to wait until the next election to achieve a board majority, and in the period, the target company might be able to device some other way to overcome the takeoverTakeoverA takeover is a transaction where the bidder company acquires the target company with or without the management's mutual agreement. Typically, a larger company expresses an interest to acquire a smaller company. Takeovers are frequent events in the current competitive business world disguised as friendly mergers. attempt.
The takeOver of ABC Inc: In order to gain control of ABC Inc., DFG Inc. will have to garner a board majority. Given the normal nature of the board, DFG Inc. will be able to acquire all the 15 seats in the election of June 2021 and swiftly take over ABC Inc.
The above example shows how such a classified board can be useful to avoid such attempts of a hostile takeover.
Why is the Staggered Board Important?
The importance can be acknowledged from the fact that it can be used as an effective measure to stop a hostile takeover, as has been illustrated in the above example. Because of a staggered board, a hostile bidder has to delay its attempt at least by one year of not more. In order to gain control of the majority section of the board, the hostile bidder has to acquire the required seats across several elections that are planned to happen for a specific director class. In this way, it safeguards a corporation from outside influence.
Some of the major benefits are as follows:
- Members of such boards are offered longer overall tenure, and as such, they are able to focus on major business issues. They are not bothered by-elections every year.
- The structure of a staggered board of directors is such that it inherently prevents any abusive or hostile takeover attempts.
- Long-term investors usually seek stability, and a classified board can provide that stability as there isn’t as much pressure on the board members to make uncertain decisions to make an unscrupulous profit.
Some of the major limitations are as follows:
- A company’s value might become impacted due to a staggered board as the board members are there for an extended period of time irrespective of their performance.
- In any given year, only a certain section of the board is replaced through the process of election. In such a scenario, any change that the current board members are not willing to make can’t be brought for the next couple of years until the majority of the members are changed.
This has been a guide to what is Staggered Board. Here we discuss how does it work along with examples, benefits, and limitations. You may learn more about financing from the following articles –