WALT DISNEY: MICHAEL OVITZ TERMINATION AND SEVERANCE PAY CASE
STUDY
TABLE OF CONTENTS
1.
Executive Summary ............................................................................................................................... 2
2.
Identification of case issues .................................................................................................................. 2
2a. Business Judgment Rule ...................................................................................................................... 3
2b. Duty of Good Faith .............................................................................................................................. 4
2c. Succession ........................................................................................................................................... 5
3.
Analysis of case issues using marketing theory .................................................................................... 5
4.
Evaluation of alternative courses of action .......................................................................................... 6
5.
Recommendations ................................................................................................................................ 7
REFERENCES .................................................................................................................................................. 9
2
1. Executive Summary
In the period that preceded the bull market in the 1990s executive compensation especially in
public companies trading in shares and stock skyrocket to unprecedented level (Agrawal &
Knoeber, 1998). In those years 1992 to 2000, the average real inflation adjusted pay of a Chief
Executive Officer (CEO) of most firms had risen to about $14.7 million up from 3.5million. It is
within the same period that Disney saw its CEO paid at least $130million as compensation for
termination without reasons.
The case study highlights the issues of excessive compensation of company executives by Walt
Disney (“Disney”). It also gives perspectives on the role of the board in making decisions that
are in the best interest of the company and protection of shareholders. In the decision made by
the courts, it identifies the loopholes within corporation law especially the link between the
directors of the company who own the corporation on behalf of shareholders and the executives
who are in control of the organization. The case also discusses the benchmark issue of succession
requires a better process that is above that of hiring.
2. Identification of case issues
The Disney case involves a decision of the Walt Disney Company concerning the hiring and
termination of Michael Ovitz (“Ovitz”)as president of the Disney Company. In 1994 Disney’s
President and Chief Operating Officer , Frank Wells (“Wells”) died in a helicopter crash
(Lederman, 2007). Shortly after Wells death, Michael Esiner (“Esiner”) underwent a quadruple
bypass surgery because of a heart disease three months after Well’s death. These events created
speculations amongst their shareholders and Esiner was convinced to hire a new President.
3
Prior to his appointment to Disney, Ovitz was running the Creative Artists Agency (“CAA”) then
its creator and partner of the Hollywood’s premier talent agency. Ovitz highly reputed and
amongst the most powerful figures in Hollywood and majority shareholder of CAA he had an
annual compensation of about $20million. Before accepting to work with Disney, he was in
negotiation with Music Corporation of Americas (“MCA”) who were offering a more lucrative
deal. The collapse of MCA and Ovitz deal, led Eisner to pursue Ovitz his long-term friend to
become the new CEO of Disney.
Ovitz’s employment agreement (OEA) was for a five-year term with a two-year renewable
option a deal that was a compromise since it could not attain MCAs offers. The deal stipulated
that upon renewal he would be entitled to additional stock options for 2million shares exercisable
at date of renewal. The OEAs alteration before approval replacing a $50million guarantee with a
reduction in the option strike price from 115% to 100% of Disney Stock price on the day of grant
upon extension, a $10 million severance pay if Disney failed to renew ha contract with the bonus
structure.
2a. Business Judgment Rule
In the business world it is trite law that the board of directors make ‘business decisions, they
ought to be informed in good faith and in honest belief that the action taken was in the best
interest of the company’ (Aronson v Lewis 473 A.2d 805, 812(Del.1984)
One of the accusations level against the board of directors was failing to decide who fitted as the
new CEO, the amount to be paid and whether they used the closeness between Eisner and Ovitz
to bring him to the company. Financial excess and waste of corporation funds are issues that fall
within the ambits of the company’s board, however, the plaintiff failed to prove that the board of
4
director’s actions were unreasonable and contrary to the business judgment rule. In the case, the
‘impression that what is not in the minutes can be as important as what is in the minutes’. In the
opinion of the court OEA that ‘ the minutes failed to highlight that the OEA discussion was
longer and substantial that that reading to myriad of issues that was brought to the committees(
Veasey & Di Gugliemo, 2012).
The impact of succession on the corporation and whether the board is required to exercise
judgment and whether the CEO is to be involved. Disney current and former directors sued for
breach of fiduciary duties in relation to hiring and no-fault termination of Ovitz (Jaclyn, 2004).
In the decision by the Chancellor ruled that the pleading failed to establish that the Disney Boar
had acted with self-interest, not independent and failed to use their business judgment rule in
approving the OEA. The decision of the court clearly stated that the court has no power to
overturn a decision rendered by the board of directors merely because the severance package was
excessive ($140 million)
2b. Duty of Good Faith
The notion of good faith is a test of ‘disingenuousness and dishonesty used in the measurement
for compensation’ (Veasey, 2003). The duty of good faith is a ‘hall mark’ in the evolving
expectations of directors, however the duty of good faith is an inspirational standard and it does
not necessarily give rise to legal liability (Veasey, 2003). It is irrelevant whether Ovitz failed
shareholder expectations of his abilities as long as he was not grossly negligent or malfeasant,
On the other hand Eisner actions though falling short of that expected from fiduciaries since he
failed to involve he board was not a legal violation.
5
2c. Succession
The case of Disney challenging the appointment and termination of Ovitz contract represents the
effects of succession to the future success of the corporation. The board in this case failed to
delineate the duties of the Esiner in influencing the appointment of the CEO and determination
of the severance pay. Esiner was unwilling to let go his Presidency at Disney and used the
termination of Ovitz to remain at the helm of the company a role he was unwilling to let go.
The failure of the board to oversee the arrangement and contract after employment to assure that
there were no obstacles to the succession process was in issue since this was derailed.
The decision of the court after a thirty-seven day of trial the court reached a conclusion that the
directors did not act in bad faith or commit corporate waste and thus protected by the business
judgment rule (Powell, 2007).
3. Analysis of case issues using marketing theory
In an organizational behavior when the executives distort business decision while engaging in
empire building, pay perk increase, compensation and private benefits, then they are in breach of
fiduciary duties (Lucian & Fried, 2006).
Russell recognized that the extraordinary compensation package of Ovitz was ‘exceptional
corporative executive’ and a ‘highly successful and unique entrepreneur’ above any corporate
CEO in America. Was the package a good deal with low risk and high returns? The perception of
outsiders in relation to the compensation was outrage, and most CEOs use ‘camouflage’ to avoid
outsiders by legitimizing the compensation (Bettis et al, 2001). Incentives that are monetary in
nature serve to market the company and instill confidence and motivate the performance of the
CEO (Ofek & Yermack, 2000).
6
The most ideal theory applicable in this case is the ‘fat cat theory’ (Murphy and Zabonik) that is
CEOs already entrenched use the board of directors as captives to deal themselves increase in
their payout the expense of the company’s shareholders. The Disney case highlights some of the
corporation scandals that arise due to market perception that awarding CEO monetary incentives
at the expense of shareholders increases the performance of the company and stocks.
The initial appointment of Ovitz as the company CEO created a wave of market stability
increasing the stock of the company by over $1billion. However, after a14 months of working
and termination, the shareholders confidence went down with numerous pullouts. In this regard,
the poor corporate governance leads to the increase in the CEO compensation on the premise that
the generous amounts would influence positively on company’s growth (Bebchuk et al, 2002).
Financial risks are normal to companies that make over a $1billion a year, and taking Ovitz on
board was a risk. The market forces shape the amount of compensation a CEO can take home ,
however the Ovitz deal was to lure in ‘an exceptional manger’ with exceptional ability that
would boost company confidence and be a successor. The impact of the deal with Ovitz saw the
rise of Disney single day stock price increase by 4.4% or a $1billion (Lederman, 2007). The
market theory dictates that the acquisition of a new CEO is a marketing strategy and the exit
especially with a huge scandal can lead to downfall of the company’s price (Lucian & Fried,
2006).
4. Evaluation of alternative courses of action
It is important for one to understand that the official perspective in executive compensation is
that ‘boards bargaining at arm’s length with CEOs negotiate pay arrangements that serve the
interest of shareholders’ (Lucian & Fried, 2006). This legitimizes the compensation
7
arrangements and informed by financial analyses. However, due care must be taken into account
linking compensation and performance of CEO.
In the management of a business, corporate law recommends a total separation of ownership and
control that is; the shareholders own the company while the managers control on how it is run. It
is important to assume that the shareholders cannot directly ensure that the agents will always act
in the principal’s best interests. This chief executives act as agents of the company and it is an
‘agency problem’ when they deviate from the shareholders strategies (Lucian & Fried,
2006).This type of behavior reduces the corporate pie and while increasing agency costs. The
creation of a company Constitution duties, powers and authority of CEOs and the Board of
Directors must outline their duties categorically.
In corporation’s law and business law, the power to run a company vested in the board of the
directors and not the CEOs. The boards of directors are to direct business and affairs of the
corporation and authorized certain causes of action. It is important to state that the precedents
and law state that directors have no consistent legal expectations. This creates a trend that each
time shareholders are unimpressed by the decision, and then they have to seek redress from the
courts (Macey, 2005). The uncertainty of the laws results in inconsistent application of the law
and hence steps taken to create legal certainty and consistent application of the law to protect
shareholders.
5. Recommendations
It is immoral to pay executives hundreds of times what other employees get is unfair and
unacceptable. It is not wrong to pay executives amounts higher than employees are, but the
8
amount ought to be pragmatic, focusing on shareholder value and the performance of
corporations.
Financial incentives are important in the, motivation of company executives however, in
enhancing shareholder value it does not call for large pay packages. It is material to state that
executives are materially already well off but they are moved b factors such as esteem, selfactualization. In this case, the motivation for a CEO is not money but the inner satisfaction that
he is doing a tough job. There is no link between performance since it does not improve
performance and is simply a waste of shareholders money.
The Board of Directors must be vigilant and always act in the best interest of the company.
Material disclosure, proper questioning of CEOs actions and powers are all necessary in ensuring
that the CEOs act according to the interests of the shareholders and company.
9
REFERENCES
Agrawal, A. & Knoeber , C.R. (1998). Managerial Compensation and the Threat of Takeover.
Journal of Financial Economics. 47 (2), pp.219-239
Aronson v Lewis 473 A.2d 805, 812(Del.1984
Bebchuk, L., Coates J. IV & Guhan, S. (2002). The Powerful Antitakeover Force of Staggered
Boards: Theory, Evidence, and Policy. Stanford Law Review 54, pp. 887-951.
Bettis, J. C., John M. B. & Michael L. L. (2001). “Managerial Ownership, Incentive Contracting,
and the Use of Zero-Cost Collars and Equity Swaps by Corporate Insiders.” Journal of
Financial and Quantitative Analysis 36, pp. 345-70.
Jaclyn, J.J. (2004). In Re Walt Disney Company Derivative Litigation : Why Stockholders
Should Not Put Too Much Faith In the Duty Of Good Faith to Enhance Director
Accountability, WIS. L.REV 1573,1777
Lederman, L. (2007). Disney Examined: A Case Study in Corporate Governance and CEO
Succession. New York Law School Law Review. 52, pp.557-582
Lorsch, J. W. & Chernak. A. (2005). "Michael Ovitz and The Walt Disney Company (A)."
Harvard Business School Case 406-065, November 2005.
Lucian, A., & Fried, J.M. (2006). Pay Without Performance: The Unfulfilled Promise of
Executive Compenastion. Harvard: Harvard University Press
Macey, J. (2005). Idea Delaware: Home of the World’s Most Expensive Raincoat. Hofstra Law
Review. 33, pp. 1131
10
Murphy, K.J. & Zabonik, J. (2004). CEO Pay and Appointments: A Market Based Explanation
for Recent Trends. The American Economic Review. 94 (2), pp. 192-196
Ofek, E. & Yermack, D. (2000). Taking Stock: Equity-Based Compensation and the Evolution of
Managerial Ownership. Journal of Finance 55(3), pp. 1367-1384.
Powell, W.J. (2007). Corporate Governance and Fiduciary Duty: The “Mickey Mouse Rule” or
Legal Consistency, Protection of Shareholder Expectations, and Balanced Director
Autonomy. George Mason Law Review.14 (3), pp. 789-829
Veasey, E.N. & Di Guglielmo, C.T. (2012). Indispensable Counsel: The Chief Legal Officer in
the New Reality. Oxford: Oxford University Press (OUP)
Veasey, E.N. (2003) Corporate Governance and Ethics in Post Enron/WorldCom Environment,
CIN.L.REV, 72 , 731, 735
Veasey, E.N. (2003). Reflections on Key Issue of Professional Responsibilities of Corporate
Lawyer’s in the Twenty-First Century. Washington University Journal. 12 (1)