Corporate Governance

Excessive Compensation and the Role of the Delaware Courts (Part 1)

By J. Robert Brown

The WSJ published a study of compensation paid to top executives at finance and home building companies (a number of which have since filed for bankruptcy) in the five year period preceding the current turmoil.  It is pile on in a way.  The article doesn't tell us anything new but does supply a bit more hard information.  The total amount obtained by the executives?  $21 billion.  As for individual records, there were plenty.

• Fifteen corporate chieftains of large home-building and financial-services firms each reaped more than $100 million in cash compensation and proceeds from stock sales during the past five years, according to a Wall Street Journal analysis. Four of those executives, including the heads of Lehman Brothers Holdings Inc. and Bear Stearns Cos., ran companies that have filed for bankruptcy protection or seen their share prices fall more than 90% from their peak.

The interesting thing about the data is that it is nothing new.  These amounts have been around for years, even decades.  It as in the mid-1990s that Michael Eisner at Disney earned around $500 million in one year, mostly on stock sales.  Only with the collapse of the markets and, frankly, the stark contrast between those at the top (walking away from failed companies with extraordinary golden parachutes) and those at the bottom (unable to pay their mortgage) has the compensation issue come to the forefront.

As we have long written, the source of the problem lies in Delaware.  We'll do a post after this one that illutrates how this is the case in practice.  The courts have all but insulated compensation decisions from challenge by applying an excessively high standard of review where the decision is approved by "independent" directors.  Among the many problems with the approach, the courts do not in fact ensure that the directors making the compensation decisions are independent.  Thus, they defer to decisions by director who may be beholden to or captured by the CEO.  The results are obvious.  The CEO gets what he or she wants, which translates into a compensation package that benefits management but not shareholders.

In the next post we will mention a case decided in 2006 by the Delaware Supreme Court, shortly before the bottom fell out of the markets.  The Court shut the door to the right of shareholders to examine the decision making process of directors when awarding extraordinary amounts of compensation.  It was a decision designed to further make compensation decisions off limits from challenge.  As the data in the WSJ article shows, we are seeing the consequence of the Delaware courts developing a system that has more or less prevented compensation decisions, even extraordinary ones, from becoming subject to examination and challenge by shareholders.

This is the corporate governance problem that needs to be fixed.

Full post as published by The Race to the Bottom on November 21, 2008 (boomark / email).