Corporate Governance

Delaware Judges, Shareholder Rights, and the Appearance of Bias (Part 5)

By J. Robert Brown

We are discussing the article recently published by VC Strine in the Journal of Corporation Law, "Toward Common Sense and Common Ground? Reflections on the Shared Interests of Managers and Labor in a More Rational System of Corporate Governance," 33 J. Corpo. Law 1 (Fall 2007).    

While VC Strine uses his article to promote reforms that will never happen, he criticizes each of the modest reforms that shareholders have managed to obtain over the last several decades.  Perhaps the most significant, although rarely used, has been the right to withhold votes for candidates and potentially prevent the reelection of a particular director.  In other words, the reform requires directors to receive a majority of the votes cast, the standard that is almost universal outside the United States.  VC Strine's view on this?

• institutional investors used their influence to obtain a less responsible and arguably more potent weapon to change the composition of the board, the conversion of a decision to "withhold authority" from a member of the management slate into an effective "no" vote.  With this weapon in hand, institutional investors can pit the incumbent board against a platform of generalized outrage, with the very real threat that generalized outrage will win. 

We have noted that this authority in reality has little real ability to influence.  Moreover, the authority, something many public companies continue to refuse to implement, is full of loopholes.  A losing director submits a letter of resignation that the board can choose to reject.  Even if the board accepts the letter and the director exits, it is the remaining directors who get to fill the vacancy.  Finally, as we have discussed on this Blog, some CEOs have used even the remote possibility of the loss of a board seat as an excuse toaccelerate compensation payments. 

The other thing he doesn't like?  The mounting campaign forsay on pay, something he calls "a steroid-fueled growth in the muscle of stockholders."  Put aside that this right exists in Austraila, Sweden Britain, and the Netherlands. And put aside that the authority would amount to an advisory vote only, providing no real substantive authority.  Moreover, so far, it has been put in place by exactly threecompanies (Par Pharmaceuticals, Aflac and Verizon).  

More importantly, VC Strine entirely ignores the role that his own court plays in the drive for "say on pay."  Shareholders want increased role in compensation because of the deplorable standards set out by Delaware courts on executive compensation matters. As we have written time and time again, the Delaware courts have largely rendered the fairness of executive compensation an irrelevant consideration.  In other words, rather than explain the movement by resort to grasping institutions, weak kneed "professional" directors, and lazy academics, VC Strine would have been on a sounder footing to shine the light back on the practices of the Delaware court.  

How out of touch is VC Strine on this issue?  The drive for "say on pay" has gone wll beyond the interests of institutional investors.  The greater threat is from Congress.  The House has already passed a say on pay bill andBarak Obama has introduced similar legislation in the Senate and will apparently give it priority if he is elected president. According to the WSJ, Hillary Clinton likewise favors the legislation.  And what is Congress reacting to?  The out of control nature of the compensation process, something arising from the standards set by the Delaware courts and the concerns of ordinary voters (those same "forced investors" mentioned by VC Strine).   

VC Strine hasrecommended that the SEC get rid of precatory shareholder proposals and instead allow shareholders to vote on, and pass, proposals that are binding.  Instead of the SEC excluding these proposals, he argues, let the Delaware courts sort them out and determine whether they interfere with the board's duties under Section 141 of the General Corporation Law.  8 Del. C. § 141 (2008).  For a chancellor who thinks an advisory "say on pay" is excessive, is there much doubt that he will interpret Section 141 in an expansive manner and strike down mandatory proposals on executive compensation or antitakeover devices?   

These views are useful.  They are a strong argument that the area of law ought not to be left to judges with predetermined views that are antagonistic towards shareholders.  It is a strong argument for federal preemption and the adoption of legislation on "say on pay."   

Full post as published by The Race to the Bottom on March 11, 2008 (boomark / email).