Returning Fairness to Executive Compensation

The current waive of turmoil in the financial markets has cast attention on the problem of executive compensation. Companies that have failed or disappeared in shot-gun mergers have nonetheless paid exorbitant sums to officers who arguably played a substantial role in their demise. In response, Congress for the first time established federal standards for determining compensation, including clawbacks and limits on golden parachutes.

The congressional efforts, although mild, represent a deep frustration with the system used by the Delaware courts in assessing executive compensation. With the CEO on the board, executive compensation has traditionally been examined under the duty of loyalty. Through legal legerdemain, the Delaware courts have accorded the decisions the all but insurmountable protection of the business judgment rule, requiring only that the board contain a majority of "independent directors." By largely reducing the test to a rote head count, the courts did little to ensure that compensation decisions were unaffected by the interested influence. At the same time, the courts did little to ensure that independent directors were in fact independent.

The paper, Returning Fairness to Executive Compensation, provides some suggested reforms. The efficacy of the process must be improved. Most importantly, however, fairness needs to be returned to the analysis. Only with some obligation to show the fairness of the compensation decision with the interests of shareholder be adequately protected.

The article is posted on SSRN.  We will post more on the contents of the paper later.

Comments

[Bill Kelm]

First, I sincerely appreciate the ethical goals of this website (that I just found in my research). But, I wish the editors would make it more "user friendly" by having a more clear, conspicuous, complete and comprehendable way for potential commentors like myself to know if their email addresses will be made public with their comments (put in " Commentor Policies"). Since I didn't know if my email address would be made public, I didn't offer it. Thank you, and keep up the good work.

My comment is this:
Dear Mr. Brown,

I believe we both would like to see an improvement in the United States we both love. Therefore, while I sincrerely enjoyed your post on the above subject, I would like you to add to your stated concerns the consumers of the products and services these CEO's are in charge of. As a consumer yourself, you are being affected.

I think you said: "Only with some obligation to show the fairness of the compensation decision will the interests of shareholders be adequately protected." If the consumer is forced to deal with unreasonable cost controls and very high profit margins so that shareholders benefit way more than the consumer, then the short term thinking that is hurting (IMO) many large corporations will continue. With the Internet causing "Word of Mouth" to be much more "viral" these days, the stock prices of some of these corporations could be negatively affected in a much shorter period of time than pre-Internet times.

[J. Robert Brown]

Bill:

Thanks for the comment. I will look into the issue of the policy surrounding the email address.

I don't disagree with your views about consumers. But the first step is to get the board to truly consider the interests of someone other than top management. For that, the Blog focuses on the rights of shareholders since state law imposes on directors an obligation to look out for shareholders.

Jay

[Bill Kelm]

Jay,

When I click on my name under my comment, it takes me to a page that could show my email address and URL. I strongly suggest that the commentor be given the option of privacy on both. But, if they do want to make their email address public, then the "reader" should allow "at" vs. "@" and "dot" vs. "." (which it doesn't now), so that automatic web crawlers can't generate the collection of commentor's email addresses for spam purposes.

I understand and agree with the statement "..., the Blog focuses on the rights of shareholders since state law imposes on directors an obligation to look out for shareholders." It is a shame that from a consumer perspective, the FTC and the law mainly say "Buyer Beware", unless outright and intentional deception, misrepresentation or fraud of any kind can be legally proved which I'm sure you know is difficult to do as they go to the defendent's motives.

Godspeed,
Bill