What Is a Classified Board?
A classified board is a structure for a company's board of directors (BOD) in which some directors serve for different term lengths, typically of between one and eight years, depending on their particular classification. Under a classified system, longer terms often awarded to more senior board positions (i.e., the chairman of the board). A typical classified board will have three to five classes of positions on the board, each carrying terms of service that vary in length, allowing for a staggering of elections.
Classified boards are thus a type of staggered board, intended to promote good corporate governance and fend off hostile takeovers.
- Classified boards use multiple "class" types to categorize various positions and tenure on a board of directors.
- A classified board limits the number of board members up for re-election in any given year, thus presenting a formidable obstacle for any would-be hostile bidders.
- Such a board is beneficial because there is guaranteed continuity of the most integral board members and promotes good corporate governance.
- However, opponents have argued that this system can breed board member complacency and forces directors to develop close relations with corporate management.
How Classified Boards Work
Classified boards are divided into multiple "class" types, based on the various board positions. During each election term, only one class of positions are open to new members, thereby staggering the number of openings available within the board directorship at any one time. For example, a company with nine board members may divide into three classes—Class 1, Class 2, and Class 3. There are usually three board members per class.
Class 1 members serve a one-year term on the board, Class 2 members serve two years, and Class 3 members hold their seats for three years. This limits the board members up for re-election in any given year, thus presenting a formidable obstacle for any would-be hostile bidders that might seek to gain control of the board.
Classified Boards as an Anti-Takeover Measure
When an outside group gains control or attempts to take over a company, they may have to wait a number of years before being in a position to take over control of the board of directors when a classified board structure is in place.
With only part of the board up for election each year, this system helps to insulate a company from a hostile takeover bid by delaying the amount of time before members of the board can be replaced.
Advantages and Disadvantages of Classified Boards
The classified board structure features continuity of direction and preservation of skill but has come under harsh criticism from shareholder advocacy groups for a number of reasons. Opponents to the classified structure argue that the system breeds board member complacency and forces directors to develop close relations with corporate management.
A classified board may be in a better position to successfully prevent proxy contests from a group of stockholders or activist investors who could be pressuring the board on a set of actions. Another possible benefit of having a classified board structure is that the approach promotes stability of the board and fosters a long-term strategic vision for corporate initiatives. With a number of board members being assured of returning on a given year – since only part of the board is up for election – this structure also establishes a level of continuity in management.
On the flip side, having a set of directors locked in for a period of time can be a negative for shareholders and employees if the board makes poor decisions or is slow to react to a change in the business landscape. Failure to make good decisions or pivot strategies in enough time can sometimes lead to a significant drop in operating results, or in a worst case scenario, bankrupt the business. There is also the moral hazard of a board of directors being less accountable to the company's shareholders in a structure where their control is more protected.