Corporate Governance

Executive Compensation Beyond the Bailout: The Delaware Problem Redux

By J. Robert Brown

Much of the current criticism about executive compensation has focused on the bonuses paid by Merrill Lynch and AIG.  They are in the eye of the storm because they have accepted public money (Merrill indirectly when Bank of America received government money to facilitate the merger).  

But, as we have long argued, the problem of executive compensation goes way beyond companies receiving public money.  The central problem is that Delaware imposed no meaningful standards in connection with the approval of executive compensation.  The courts have all but eliminated fairness from the compensation analysis (see Returning Fairness to Executive Compensation).

An article in the WSJ supports this proposition.  As the Journal reports in the table below, there are plenty of CEOs who are well paid despite rapidly declining stock prices.  Stock prices are, of course, not the only measure of performance.  Nor are the amounts paid commensurate with many of the excesses witnessed in recent years.  Finally, the article contained some explanations for the amount paid that might truly mean the CEOs were paid in an amount commensurate with the services provided.

The problem is that we cannot be sure.  As Disney showed, directors making compensation decisions need not be particularly well informed when the standard is the duty of care.  Delaware courts apply the duty of care standard even to executive compensation paid to officers who sit on the board (and therefore are in a position to influence the compensation process).  In other words, under the Delaware approach, directors determining compensation for fellow directors are essentially insulated from liability for almost any amount paid.  This system produces what any system without standards would produce:  compensation in amounts unrelated to the services provided.

It is not a problem limited to companies receiving federal monies.  If the government does not provide a systemic solution, the problem of executive compensation will continued, with the current limits a mere hiccup, that will have no permanent affect on behavior in the long term.

Full post as published by The Race to the Bottom on March 25, 2009 (boomark / email).