Executive Compensation, the Delaware Model and a Proposed Solution (Part 1)

There is a serious executive compensation problem, something obvious from the daily reportage in the business press.  The problem as we have noted often, arises from the standards (or lack of standards) adopted by the Delaware courts in connection with the approval of executive compensation.  The process used by the Delaware courts effectively allows directors to ignore the interests of shareholders and encourages directors to act in the best interest of management.  The system replaces substantive review of compensation with meaningless process.  This is discussed at length in Returning Fairness to Executive Compensation.

So what is the solution?  The only practical solution is preemption.  Delaware cannot be counted on to implement meaningful governance requirements.  It is a small state that has an economic incentive to adodpt a pro-management approach to corporate governance.  Nowhere is this more clear than in connection with executive compensation.  In effect, the system in Delaware is compensation without limits.  This is what management wants; this is what would encourage companies to incorporate in Delaware. 

The compensation process needs to be federalized and the standards set by federal law and regulation.  Moreover, the requirements need to be applied to all public companies, not just those receiving bailout money.  With that in mind, the next post will propose a solution.