Agency costs and corporate governance: Evidence from proxy contests

Abstract

This thesis examines the impact of a proxy contest on the firm and the wealth of its shareholders. I find that proxy contests serve their intended purpose as an effective external disciplining mechanism, resulting in changes to the incumbent board and improvement in the firms performance.

Pre-contest and contest period abnormal returns are similar across all firms subject to a proxy contest. Over the pre-contest period, target firms experience significantly negative stock price performance. The announcement and full contest periods result in a positive stock price reaction for all firms, suggesting that the market views the initiation of a proxy contest as good news.

Agency theory suggests that a proxy contest should reduce the problems involved with a separation between principal and agent. To examine this relation, a subsample containing those firms with high free cash flow and low Tobin's Q is examined, Interesting differences in the stock price performance between firms in which dissidents 'win' seats and 'do not win' seats become apparent in the post-contest period. When dissidents 'win' seats, target firms stock prices experience a statistically significant wealth appreciation. Subsequent tests attribute such wealth gains to reduced agency problems through a reduction in capital expenditure and research and development expenditure. When dissidents 'do not win' seats, no attempt to reduce agency costs is apparent, and as a result, these firms experience a sustained wealth loss over the years surrounding a proxy contest.

The steps taken to reduce agency costs in those firms in which dissidents 'win seats' suggests that proxy contests fulfil their intended role -- to discipline the board and to improve firm performance.