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Corporate transformations: the new role of proxy contests.

The proxy contest is back in vogue. Although proxy contests (also called proxy battles, fights, and wars) were infrequently used as a means of gaining control of publicly traded corporations or of influencing management policy decisions during the 1980s, recent changes in the United States business environment -- the limited availability of financing for corporate takeovers, the collapse of the junk bond market, the passage of anti-takeover statutes in 40 states and proliferation of anti-takeover defense tactics, and the active role institutional investors are now taking in the governance of American corporations -- the proxy contest has now become a very important and leading tool in battles for corporate influence and control. Indeed, many knowledgeable business leaders and observers agree that proxy contests are as serious a threat to the security of directors and corporate officers as were mergers and acquisitions during the previous decade (Skewered Shareholders, 1990). Recently published research by DeAngelo and DeAngelo (1989) supports this contention. Their analysis of proxy contests for seats on the boards of directors of 60 New York and American Stock Exchanges listed corporations found that the contests were often followed by senior management resignations, and by the sale of assets or liquidation of the firm, even when the dissidents were unsuccessful in gaining a majority of board seats. Less than 20 percent of the companies in their sample remained independent, publicly held firms, run by the same senior managers three years after the contest.

For the 30 year period ending in 1986, there were an average of only 25 proxy fights per year in American corporations which are subject to the Securities and Exchange Commission's (SEC) proxy rules. By 1990, that number had increased dramatically to 100 (Shareholder Activism, 1991). The firms which have recently had a proxy contest are both large and small, including Avon Products, Del Webb Corporation, General Motors, Honeywell, Irving Bank, K-Mart, Lockheed, NCR Corporation, Pic 'N Save, Texaco, UAL Corporation, and USX. These firms represent a cross section of American industry.

Even if proxy contests are not successful in accomplishing all their objectives, they typically result in giving dissidents some representation on the board and thus somewhat greater influence on corporate policy decisions (Shareholder Activism, 1991). For example, although their entire slate of candidates was not elected, dissidents gained representation on the boards of Armstrong World Industries, Avon Products, Del Webb Corporation, Lockheed, and NCR. At Lockheed, management agreed to dissident demands to use institutional shareholder input to select future candidates for its board of directors. The managements of American General Corporation, Dataproducts Corporation, Norton Company, Pic 'N Save, and UAL Corporation all consented to dissident demands that their companies be put up for sale. A proxy fight at Honeywell forced management to restructure the company (Fromson, 1990). Dissidents have also used their influence to restrict the use of poison pills (and other management entrenching devices) and to increase the use of confidential voting. In 1990, for example, dissident proposals to limit poison pills received majority support at Avon, Champion International Corporation, K-Mart, and Lockheed. Proposals regarding confidential voting were approved by the stockholders at Avon and Lockheed (Hanson, 1990). An important lesson from all these proxy contests is that successful use of the proxy mechanism for transforming corporations does not depend entirely on attaining more than 50 percent of the proxies voted.

Factors Which Have Increased The Use of Proxy Contests

With the collapse of the junk bond market and the limited availability of financing, corporate raiders of the 1980s have found it very difficult to mount hostile takeovers today. Thus, yesterday's raiders have increasingly turned to the proxy contest to elect their candidates to a majority of seats on a company's board. This is a relatively inexpensive means for them to gain control. Alternately, raiders who are able to raise enough capital to finance a cash tender offer often will initiate a proxy fight to help weaken management's defenses against their offer. This lactic was used recently by Georgia-Pacific Corporation to gain control of Great Northern Nekoosa Corporation and by AT&T to take over NCR Corporation (Falkowski, 1990; O'Brien, 1991).

Institutional investors (e.g., banks, insurance companies, mutual funds, private and public-sector pension funds, etc.) hold a major stake in U.S. corporations (in 1989 they owned 43 percent of all U.S. corporate stocks and more than half the stock in many Fortune 500 companies). Now, more than ever before, they are playing a significant role in initiating, sponsoring, and deciding the results of proxy contests. Institutional investors with a significant ownership position in a particular company generally do not want to sell their holdings if they become dissatisfied with the firm's financial performance or its management's polices (Falkowski, 1990). Having to quickly divest the large number of shares they own would adversely affect the price of the company 's stock. Rather than sell their shares, many institutional investors have decided to exert their right as shareholders to influence corporate policy and put pressure on mediocre managers, thereby hoping to improve a firm's financial performance, stock price, return on investment, and sometimes social responsibility. This decision has made institutional investing one of the most powerful business influences in the 1990s.

Recently, institutional investors' role in corporate governance has been extended by the SEC's widening of the range of issues which can be voted on by the use of proxies. As a result, in the first three months of 1990 alone, institutional investors introduced or sponsored 112 proposals (compared to 30 in 1987) regarding corporate governance which were to be voted on at that year's annual meetings. These included a proposal by the California Public Employees' Retirement System ("CalPers") to create a shareholder advisory committee at Avon and a proposal by the College Retirement Equities Fund to require Pfizer's stockholders to vote on any placement involving more than 10 percent of the corporation's stock (Hanson, 1990). In the future, it is even possible that large institutional investors will use proxy contests to help them limit the pay packages received by top corporate executives (Lohr, 1992). The Clinton administration may favor such action.

It might be assumed that most large American corporations have established defenses to protect themselves from proxy contests led by dissident shareholders and hostile takeovers initiated by corporate raiders. But a study of 1,297 of America's largest corporations conducted by The Analysis Group (a Belmont, Massachusetts proxy voting consulting firm) found that many companies are not as well protected as is generally assumed. In fact, the study revealed that although "about 85 percent of all firms have some form of protection against unwanted takeover bids, only 63 percent...have protections that insulate the board against proxy contests. Major corporations thus remain more vulnerable to proxy initiatives than to takeovers" (Parker, 1990, p. 21).

According to the study, the most frequent defense corporations use against proxy contests is classified boards (having staggered terms for board members). Other defenses are infrequently used by comparison. For example, only 14 percent of the firms The Analysis Group surveyed had adopted lock-in provisions, which require a super-majority of the stockholders to change a company's by-laws or charter. Such defenses as the elimination of cumulative voting, limiting the actions shareholders can take by written consent, and limiting the ability of shareholders to call special meetings are seldom used.

Very few states, however, have adopted anti-proxy contest statutes, as contrasted to the anti-takeover laws reducing the use of hostile takeovers as a means of gaining control of corporations. For example, with the exception of Massachusetts, no other state had mandated that firms which are incorporated within it have classified boards.

The most frequently used method to limit proxy contests is control-share acquisition statutes. These have been adopted by 27 states. Such statutes require stockholders who own more than a certain percentage of the outstanding shares in a firm to have their voting rights approved by stockholders who are not affiliated with them or with the current management and directors (From the Hustings, 1991). The states which have adopted control-share acquisition statutes are listed in Table 1.

Since few states have laws which restrict proxy contests and since corporations themselves generally have not established many defenses against them, the number of proxy contests is likely to continue to increase during the 1990s. If this is the case, executives who want to avoid having proxy fights in their firms must take steps now which will reduce their occurrence. Such steps include establishing multiple defenses (e.g., classified boards, lock-in provisions, etc.) appropriate for their firms, and lobbying their state legislatures to enact strong anti-proxy contest statutes. The most important and fundamental step, of course, is to attempt to eliminate the conditions in their companies which cause proxy contests.

Causes of Proxy Contests and Predicting their Outcome

With regard to the causes of proxy contests, research findings are unequivocal. The pioneering work of Duvall and Austin (1965), who studied 40 firms which had a proxy contest between 1956-1960, concluded that proxy "contests usually are begun in firms which have relatively low rates of return....Generally the worse the performance of a company, the greater the chance for the success of insurgents". In Miller's (1986) study of 93 corporations which had a proxy contest between 1964-1978, he found that the causes were primarily financial. Specifically, he found that corporations which had a proxy contest had lower rates of return on assets (ROA) and rates of return on equity (ROE) than firms which did not have a proxy fight. This finding supports Duvall and Austin's (1965) research. Miller (1986) also found that the higher the percentage of management and director ownership of their firm's common stock, the less likely insurgents were to initiate (or win) a proxy contest. This result is not surprising, of course. A more recent investigation by DeAngelo (1988) concluded that "dissident stockholders who wage a proxy contest for board seats usually cite poor earnings rather than poor stock price performance as necessitating the proposed hostile management change. Consistent with this finding, sample companies' precontest accounting returns are systematically below market, while their precontest stock returns are not". Finally, research by Hancock and Mougoue (1991), who analyzed 55 proxy contests involving U.S. corporations during the period 1970-1986, concluded that low earnings and dividend payout are likely to cause a proxy fight.

Of potential value and possible interest to executives are the discriminant functions developed independently by Duvall and Austin (1965) and Miller (1986) to predict the results of proxy contests. In 1965, Duvall and Austin developed separate functions to predict the outcomes of proxy contests for control of the board of directors and proxy contests for representation on the board. Both functions "were found to be significant, with the model for representation contests classifying them successfully in almost 90 percent of the cases and the model for control contests giving 82.5 percent correct classifications". Although these functions correctly classified nearly 90 percent and 82.5 percent, respectively, of the corporations in the samples used to construct them, their overall predictive ability is greatly exaggerated because Duvall and Austin did not test the respective functions on hold-out samples. Using the same sample to compute the coefficients of a discriminant function and to test its predictive power leads to a serious overstatement of the function's ability to correctly classify cases (Massey and Morrison, 1965).

More than 20 years after Duvall and Austin's research was reported, Miller (1986) developed a discriminant function, using a hold-out sample to test its predictive ability, to predict the results of proxy contests for control of the board. The function Miller developed correctly classified 78.26 percent of the corporations in the hold-out sample as having had a successful (the majority of the board seats were won by the dissident stockholders' slate of candidates) or an unsuccessful (the majority of the boards seats were won by management's slate of candidates) proxy contest for control. Even with a somewhat lower classification rate than the function Duvall and Austin developed (78.26% versus 82.50%), Miller's function is actually more accurate in predicting the results of control contests because it was tested on a hold-out sample. It may, therefore, be of greater value to executives (and, perhaps, dissident shareholders) in predicting the outcome of proxy contests.

There are some similarities between the discriminant function developed by Duvall and Austin (1965) and the one developed in Miller's (1986) research. First, both contain only four variables, suggesting that it is possible to differentiate between corporations which have had a successful proxy contest and corporations which have had an unsuccessful proxy contest for control on the basis of relatively few characteristics. Second, each function includes the variable rate of return on equity (ROE). Thus, ROE (or at least some measure of return on stockholders' investment) seems to be a useful discriminator.

Finally, both functions incorporate the variable percentage of common stock owned by management and directors. It appears that this characteristic is integral for differentiating between each group of firms. Unlike Duvall and Austin's function, however, the function Miller developed contains the variables rate of return on assets (ROA) and number of corporate offices, plants, and/or subsidiaries located outside the United States (a measure of company size and internationality). These variables point out the need for management to: (1) keep their firm's assets highly productive and (2) grow and internationalize their firm, if possible.

The discriminant function Miller (1986) developed suggests that management has a better chance of preventing dissidents from using a proxy contest to gain control of the board of directors (and, thus, their firm) if they own or control a significant mount of the company's common stock, if their company is both large and multinational, and if their firm's ROE and ROA are relatively high (compared to other firms in the same industry). The implications of these results for corporate strategy formulation are straight forward. First, management and directors, either directly or indirectly, should attempt to control as much of their company's stock as is economically feasible. Second, management should attempt to maximize their company's return on investment for assets and stockholders. Finally, increasing a company's size (to achieve economies of scale, market dominance, etc.) and internationalizing its operations are essential. The latter point is particularly salient for competing successfully in today's global market.

The most important contribution of Miller's (1986) research, however, is not the particular discriminant function he developed or even the information it contains for managers (and dissident stockholders). Rather, his research (and that of Duvall and Austin, 1965) focuses attention on a statistical technique which can be used to help predict the winners of proxy fights. As the proxy contest emerges as an increasingly popular means of gaining control of corporations, having the ability to predict the results of a contest would be advantageous. Perhaps, in the future more accurate and complete discriminant functions can be developed to supplant those now in use. Such functions may become essential tools in management decisions about corporate takeovers.


In times of limited availability of financing to underwrite corporate takeovers, the proxy contest is a popular and viable weapon dissident shareholders can use to exert influence on and gain control of publicly traded corporations. The popularity of proxy contests has been further increased by the proliferation of anti-takeover statutes and by the revelation that many firms have done little to protect themselves from dissidents who wage a proxy fight to gain control of their boards. Furthermore, in the past, managers often made little or no formal attempt to identify the factors which may cause a proxy contest in their companies or to implement strategies which would preclude them. Given these conditions and the fact that institutional investors are now taking a more active role in corporate governance, it can reasonably be expected that the frequency of proxy contests will continue to increase.

The international implications of proxy contests are primarily related to foreign investment in U.S. organizations. Specifically, many firms which are located abroad have substantial financial investments in U.S. corporations, and the number of foreign acquisitions of U.S. companies has increased significantly during the past decade (Growth of Cross-Border Acquisitions, 1991). Of course, proxy contests for control of a U.S. firm by foreign investors are subject to review by the President of the United States under the Exon-Florio provision, Section 721 of the Defense Production Act (Ayres, 1992). But the management of these foreign firms should be interested in understanding how potent a technique the proxy contest is for gaining control of or being able to influence policy in American corporations. As the number of U.S. companies which are recruiting foreigners to serve on their boards of directors increases (Lubin, 1992), the exposure of foreign directors to American proxy contests will rise. Their experiences with these should provide foreign directors with valuable firsthand knowledge which they may share with their colleagues abroad. This information may be useful in conducting, preventing, and dealing with future proxy fights in American corporations.

As the number of proxy contests continues to increase, corporations will, no doubt, begin lobbying for legislation to limit their use as a means of gaining corporate control or of influencing management policy decisions. It will be interesting to observe how successful corporate lobbying efforts will be in the present political climate.


1. Ayres, M. "Exon-Florio Back in Business," International Financial Law Review, January 1992, 9-10.

2. DeAngelo, L., "Managerial Competition, Information Costs, and Corporate Governance: The Use of Accounting Performance Measures in Proxy Contests," Journal of Accounting & Economics, January 1988, 10(1), 3.

3. DeAngelo, H., & DeAngelo, L., "Proxy Contests and the Governance of Publicly Held Corporations," Journal of Financial Economics, June 1989, 23(1), 29-59.

4. Duvall, R. M., & Austin, D. V., "Predicting the Results of Proxy Contests," The Journal of Finance, September 1965, 464-471.

5. Falkowski, A. J., "Proxy Battles Heat Up," Business Insurance, July 30, 1990, 20-21.

6. Frank, R. E., Massey, W. F., & Morrison, D. G., "Bias in Multiple Discriminant Analysis," Journal of Marketing Research, August 1965, 250-258.

7. Fromson, B.D., "Money & Markets: The Big Owners Roar," Fortune, July 30, 1990, 66-78.

8. "From the Hustings: The Roll of States With Takeover Control Laws," Mergers & Acquisitions, September/October 1991, 26(2), 69-72.

9. "Growth of Cross-Border Acquisitions," Mergers & Acquisitions, May/June 1991, 25(6), 47.

10. Hancock, G. D., & Mougoue, M., "The Impact of Financial Factors on Proxy Contest Outcomes," Journal of Business Finance & Accounting, June 1991, 18(4), 541-551.

11. Hanson, D. M., "Proxy Season: Victories Without Majorities," Pensions & Investments, July 23, 1990, 16.

12. Lohr, S., "Amid Layoffs and the Recession, Executives' Pay is Under Scrutiny," New York Times, January 20, 1992, A1 & C8.

13. Lublin, J. S., "More U.S. Companies Venture Overseas for Directors Offering Fresh Perspectives," Wall Street Journal, January 22, 1992, B1-B2.

14. Miller, A. N., "Two Methods of predicting the Winners of Proxy Fights: A Comparison and Applications for Corporate Strategy," Paper presented at the 46th Annual Meeting of the Academy of Management, Chicago, Illinois, 1986.

15. O'Brien, M., "AT&T Launches Proxy Battle for Control of NCR," Computer Data, January 1991, 16(1), 1-2, 10.

16. Parker, M., "Companies Not Ringed With Defensive Armor," Pensions & Investments, September 17, 1990, 21.

17. "Shareholder Activism: The End of the Casino Society?," The Economist, January 12, 1991, 60 & 62.

18. "Skewered Shareholders: Roundtable on the Time Warner Deal," Directors and Boards, Winter 1990, 30-36.

Table 1 States in the U.S. with Control-Share Acquisition Statutes

Arizona Florida Hawaii Idaho Indiana Kansas Louisiana Maryland Massachusetts Michigan Minnesota Mississippi Missouri Nebraska Nevada North Carolina Ohio Oklahoma Oregon Pennsylvania South Carolina South Dakota Tennessee Utah Virginia Wisconsin Wyoming

Source: State Takeover Laws, Responsibility Research Center, Missouri Washington D.C.

Alan N. Miller is Professor of Management at the University Ohio of Nevada, Las Vegas.
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Author:Miller, Alan N.
Publication:Review of Business
Date:Mar 22, 1994
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