Corporate Governance

Executive Compensation, the Delaware Courts, and Congress (Part 2)

By J. Robert Brown

In the hearings last Friday before the House Commitee on Oversight and Government Reform, Angelo Mozilo was apparently grilled with particular ferocity. Mozilo provided ammunition, both because of the amount he was paid but also because of an email in which he apparently threatened to resign if he did not get reimbursed on taxes paid as a result of his wife's personal use of corporate aircraft, something he apologized for at the hearings.

But what was missing from the hearing were the directors who approved the compensation. They are the gatekeepers, the ones who have the obligation to watch out for the best interests of shareholders. What was their role? Under Delaware law, approval by a committee of independent directors results in the application of the business judgment rule. In applying this standard, the Delaware courts refuse to examine the actual terms of the compensation package and instead look to see if the board was informed, acted in good faith and in the best interests of shareholders. The business judgment rule is a completely inapposite standard where the board is asked to extend a financial benefit to one of its own (Mozilo was on the board). The appropriate standard is the duty of loyalty which requires that the transaction be fair. But to the Delaware courts, the fairness of the compensation no longer matters.

But the application of the business judgment rule is predicated on an independent and informed board. With respect to informed, it is common place to hire a compensation consultant to create the appearance that the board's decision was informed. The Delaware courts have never made this requirement meaningful. The consultants do not have to determine fair compensation and instead can become advocates for the CEO. This apparently occurred at Countrywide. As the memorandum distributed by the Committee noted:

• The Retention of Towers Perrin. After the board's compensation consultant, Exequity, recommended significant reductions in Mr. Mozilo's compensation, Countrywide management hired a second compensation consultant, Towers Perrin, to review the Exequity proposal. Although the company retained Towers Perrin, internal e-mails show that the consultant appeared to serve as Mr. Mozilo's personal advisor with the goal of achieving "maximum opportunity" for Mr. Mozilo. The final contract was significantly more generous to Mr. Mozilo than Exequity originally recommended.

Yet these consultants are what cause the courts to conclude that a decision of the compensation committee is informed and defer to its conclusions.  Moreover, attempts by plaintiffs in law suits to examine these circumstances are cut off by a judicial refusal to allow any discovery at the initial stages of a case, invariably preventing these facts from being uncovered.  In other words, the courts purport to require that boards be informed and that they rely on neutral experts but in fact give the obligation no real meaning. 

Full post as published by The Race to the Bottom on March 10, 2008 (boomark / email).