GMAC, Treasury and the Answer to the Corporate Compensation Conundrum

As we have discussed on this Blog, the bailout bill contained provisions that regulated executive compensation.  Treasury drafted regulations that implemented these provisions.  The Treasury regulations are, however, noticeable in their vagueness.  They merely require the compensation committee to make sure that the TARP requirements are met.  In other words, the regulations contain no metrics, no standards, and no meaningful guidance.

Part of the problem is that the appropriate amount of executive compensation is, in the end, company specific.  There are companies that undergo huge share price increases (which increase the compensation of CEOs with stock and options) through no significant acumen or contribution of the CEO (natural resource companies that increase in value because of a spike in natural resource prices, for example).  On the other hand, a CEO might be the most effective and work the hardest when share prices are tumbling.  In truth, as I have discussed in Returning Fairness to Executive Compensation, the answer is to leave the decision in the hands of the board but with modifications to the applicable standards. 

Right now, compensation is approved by "independent directors" on the compensation committee.  The directors are often not really independent, whether under the definition used by the NYSE or by the Delaware courts.  Nor is the process designed to ensure fairness.  The process is rife with invovlement by the CEO and with the use of consultants who often have ties to the CEO, working in his/her interest rather than that of the board and the company. 

Two things need to happen.  First, the board needs to have the obligation of showing that the process was independent.  This means truly independent directors and truly independent advisors, with little involvement of the CEO.  Second, it means imposing on the board the obligation, even if approved by independent directors, to show that the compensation was "fair."

Truly independent directors means directors not nominated by management.  This problem, therefore, screams for shareholder access to the company's proxy statement, an act that would facilitate the election of shareholder nominated directors.  But as we await Mary Schapiro and the SEC's action in this area, there is a more immediate place to show the affect of truly independent directors. 

Treasury recently agreed to bailout GMAC.  GMAC is an LLC.  Under the agreement with the government (which is attached to a current report), there are to be seven managers (aka directors).  One will be the CEO of GMAC.  Three of the remaining directors will be selected by investors, with one by Cerberus and two by a trustee of a trust holding interests in GMAC and appointed by Treasury.  The remaining three are to be approved by a majority vote of the board and must, according to the agreement, be "independent."  Moreover, one of the "independent" managers must serve as chairman. General Motors has no right to representation on the board but can designate a "board observer" to attend the meetings.

It is, therefore, Treasury (or Treasury's designated trustee) that has the right to determine the independent managers.  Treasury is in a position to ensure that the directors not only meet some technical definition of independence used by the NYSE or the emasculated definition used by the Delaware courts, but are also genuinely independent and genuinely interested in setting the compensation package that will benefit investors in GMAC (who are, in reality, the public). Moreover, the directors should receive a multi year term but agree not to stand for reelection.  In those circumstances, they will have no incentive to act in a manner that is designed to curry favor with one interest group or another.  In short, they can be truly neutral. 

There is also the issue of the applicable legal standard.  The agreement with Treasury specifically incorporates Delaware law (and GMAC is a Delaware LLC).   As a result, the anemic standards employed in Delaware apply.  Perhaps in the future this could be changed by agreement.  Rather than allow process to eliminate fairness, some burden of fairness should remain on the board even if properly approved.

Nonetheless, Treasury is in a position to ensure that the process for determining executive compensation has the the highest level of integrity, something not the case currently.  In those circumstances, it would seem appropriate for Treasury to defer to the decision of these directors, without requiring government approval of any performance based compensation decision, as the term sheet with GMAC currently requires.  See Term Sheet ("GMAC shall not pay or accrue any bonus or incentive compensation to the Senior Employees unless otherwise approved by the President’s Designee (as defined in H.R.7321)).