Corporations:
A Contemporary Approach
Chapter 16
Public Shareholder Activism
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Seb Farrington, “Crankenstein” (2014)
Module VII – Fiduciary Duties
Chapter 21
Executive Compensation
• Compensation puzzle
Bar
exam
– Relation to corporate governance
– Types of pay: salary, bonuses, stock grants,
stock options
– Special issues with stock options
Corporate
practice
• Standard of review
Law
profession
• Delaware approach in Disney
Citizen of
world
– Vogelstein case
– Waste standard over time
–
–
–
–
Disney I - reject complaint / demand futile
Disney II - accept “good faith” claim
Disney III - no finding of bad faith / affirmed
Analysis:
• heightened review?
• political economy of case?
Corporations:
A Contemporary Approach
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Executive Compensation
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Fiduciary duties
(directors)
Best
interests
Oversight
Decision-making
Business Judgment Rule
Shlensky v Wrigley
Inattention
Waste
Vogelstein
102(b)(7)
Illegality Malfeasance
Caremark (bad faith)
Francis
Corporations:
A Contemporary Approach
Gross Conflict
negl interest
Illegality
Miller v AT&T
Van Gorkom Remillard
Corp
opp
Farber
102(b)(7)
Bad faith
Disney
Disinterested
independent
Benihana
Chapter 21
Executive Compensation
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Plato
“5x”
Corporations:
A Contemporary Approach
Friedman
“market - 400x”
Chapter 21
Executive Compensation
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“CEO to average worker” Ratio
(Dodd-Frank reports)
• 250 largest companies in S&P 500 index
– 331 to 1
• Highest and lowest?
– 1,795 to 1 (J.C. Penney’s Ron Johnson)
– 173 to 1 (Agilent Technologies’ William Sullivan)
• Pay for performance?
– Agilent shares: plus 49% last year
– J.C. Penney’s shares: minus 73%.
Corporations:
A Contemporary Approach
Chapter 21
Executive Compensation
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In judging whether Corporate
America is serious about
reforming itself, CEO pay remains
the acid test. To date, the results
aren’t encouraging.
Warren Buffett,
letter to shareholders of
Berkshire Hathaway, Feb. 2004
Corporations:
A Contemporary Approach
Chapter 21
Executive Compensation
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Corporations:
A Contemporary Approach
Chapter 21
Executive Compensation
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Hal and Hank
(team owners)
Public
Shareholders
Joe
(team manager)
Board of
Directors
CEO
Corporations:
A Contemporary Approach
Chapter 21
Executive Compensation
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Executive pay
• Cap of $1,000,000 (CEO and top 4
officers), unless -– performance-based pay
– set by compensation committee
(outside directors)
– approved by shareholders
Types of pay
• Salary (cash)
• Bonuses
• Plan-based
Proxy disclosure
– Stock awards
– Option grants
– Non-equity incentives
• 1992 SEC amendments
– Tabular form (CEO + top 5)
– Pay committee processes
• Deferred compensation
• 2006 SEC amendments
• 2011 “Say on Pay”
• 2012 CEO to average worker ratio
– Pension plan
– Nonqualified deferred
comp
• Other
– Executive loans (SOX!)
– Fringe benefits
Corporations:
A Contemporary Approach
Tax deductibility
Judicial review
• Waste: no relation to services
• Care: board grossly uninformed
• Loyalty: fraud or conflict
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Executive Compensation
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Corporations:
A Contemporary Approach
Chapter 21
Executive Compensation
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Corporations:
A Contemporary Approach
Chapter 21
Executive Compensation
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Stock options …
5. Companies pay employees with stock
options in order to --
1. What is a stock option?
A.The right to buy stock in the future
B.The duty to buy stock in the future
2. You have a stock option that vests in 2
years?
A.You can exercise the option any time for
next 2 years
B.You must wait 2 years before exercising
option
3. Your stock option has a strike price of
$25. Market price is $20
A.You should exercise the option
B.You should hold on to the option – it has
value though “out of the money”
4. Market price is $30. Your option (strike
= $25) expires in 5 years
A.You can wait for prices to go higher – and
defer taxes
B.You should exercise it immediately
A.Create an incentive for employees to increase
stock prices
B.To hide compensation from financial
statements
6. Stock options are impossible to value
A.True. There’s no way to know what will
happen to stock prices
B.False. Option value depends on past price
volatility and interest rates
7. Can you buy an option in General Electric
stock?
A.Yes. Options for many public companies’ stock
are bought and sold
B.No. Only employees can acquire stock options
8. If you thought GE stock would stay steady
A.You can make money by selling a “call option”
B.You can make money by buying a “put option”
1-A / 2-B / 3-B / 4-A / 5-A / 6-B / 7-A / 8-A
Corporations:
A Contemporary Approach
Chapter 21
Executive Compensation
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Option backdating
Expiration
date
Vesting
period
Exercise price
Grant
date
New exercise price
Backdated
grant date
Corporations:
A Contemporary Approach
Chapter 21
Executive Compensation
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Judicial review
Review standards - over time
Meaning of “waste” - safety valve
Disney case - duty of “good faith”
Corporations:
A Contemporary Approach
Chapter 21
Executive Compensation
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Traditional review – “waste”
Applicable standard: “If a business
payment has no relation to the
value of the services for which it is
given, it is in reality a gift.”
Rogers v. Hill (US 1933)
Applicable attitude: “Nothing is so
divergent and contentious and
inexplicable as values. Courts are
ill-equipped to solve or even to
grapple with these entangled
economic problems.”
Heller v. Boylan (NY Sup Ct 1941)
Corporations:
A Contemporary Approach
Chapter 21
Executive Compensation
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The numbers please
Randall Thomas
(Vanderbilt)
Corporations:
A Contemporary Approach
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Executive Compensation
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Thomas & Martin – Plaintiff success rates
(124 reported exec pay cases)
Delaware
Non-Delaware
Total
Waste
29%
46%
40%
Care
27%
33%
30%
Loyalty
28%
39%
35%
32%
PHC
(at least one theory)
CHC
(at least one theory)
Corporations:
A Contemporary Approach
34%
30%
(35 cases)
(27 cases)
50%
53%
(8 cases)
(47 cases)
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Executive Compensation
52%
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Evolving judicial review
in Delaware …
Corporations:
A Contemporary Approach
Chapter 21
Executive Compensation
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Delaware – evolving standards
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A Contemporary Approach
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Executive Compensation
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Lewis v. Vogelstein (Del Ch 1997)
Mattel shareholders challenge board's
stock option compensation plan for
themselves (ratified by
shareholders).
Under the plan directors received:
(1) 15,000 one-time options (exercise
price = market price on date
granted / exercisable for up to 10
years)
(2) 5,000 (or 10,000 for longerserving directors) annual options
(vest over a 4-year period /
exercise price = market price
when granted / and exercisable
for up to ten years
What’s the standard of review?
Corporations:
A Contemporary Approach
Chapter 21
Executive Compensation
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Lewis v. Vogelstein (Del Ch 1997)
Intermediate review:
Waste standard:
– sufficient
consideration
(reasonable relation
between the value of
the services and the
value of the options)
– Reviewable only if
corporation received
no consideration, the
compensation was a
gift, no person of
ordinary prudence
could possibly agree
– Plan: conditions
included to ensure
that the consideration
will pass to
corporation.
Chancellor Allen
– Defer to shareholder
ratification (in this age
when institutional
shareholders have
grown strong)
Apply?
Corporations:
A Contemporary Approach
Chapter 21
Executive Compensation
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Duty of care
Board approval of executive pay
Disney I - complaint
Disney II - amended complaint
Disney III - trial
Corporations:
A Contemporary Approach
Chapter 21
Executive Compensation
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Disney III (Del 2006)
Third category of fiduciary
conduct, between (1)
subjective bad intent and (2)
gross negligence.
This third category – intentional
dereliction of duty, a conscious
disregard for one's
responsibilities – is nonexculpable, non-indemnifiable
violation of the fiduciary duty to
act in good faith.
Corporations:
A Contemporary Approach
Chapter 21
Executive Compensation
CEO Michael Eisner with
Michael Ovitz ($140
million “pay for failure”)
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The end
Corporations:
A Contemporary Approach
Chapter 21
Executive Compensation
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