Shareholder Rights and Executive Compensation: The Growing Fight Over Gross-Ups

We have noted that executive compensation is a matter of state law.  Delaware, a state that earns considerable income by attracting large corporations to form in the state, has an incentive to appeal to management to induce them to enter the jurisdiction.  For more on this topic, take a look at The Irrelevance of State Corporate Law in the Governance of Public Companies.

To induce management to incorporate in Delaware, there can be nothing more important than maximum latitude on setting executive compensation.  Managers will want to gravitate to jurisdictions that allow for the highest salaries.  In that respect, Delaware is a highly attractive jurisdiction.  It has largely put in place a system that makes compensation decision by the board unreviewable.  In other words, the fairness of the compensation and the terms are almost impossible to challenge.

The consequences of this approach is compensation without limits, something made clear by some of the  enormous payouts earned by top officials in companies that have failed or otherwise faired poorly during the current period of financial turmoil.  These payouts have focused public attention on the problem of excessive executive compensation.  But it is nothing new.

Prior to the current turmoil, reform efforts focused on "say on pay," an advisory vote by shareholders on executive compensation.  Say on pay was passed in the house and introduced by Senator now President Elect Obama in the Senate.  But while a useful devise (it exists in Great Britain and induces increased conversation between shareholders and managers), it contains no substantive limits on compensation.  Boards can still pay excessive amounts and can ignore any negative vote of shareholders.

Perhaps emboldened by the current turmoil, shareholders seem to be shifting their attention to more substantive limits on compensation.  Riskmetrics has announced that it will target an expanded category of executive compensation practices.  It will recommend that shareholder votes be withheld from directors that approve the payment of excise tax gross ups for management.  In other words, while say on pay is likely to retain strong support, shareholders want more than an advisory vote. This proxy season, expect to see even more shareholder proposals and withhold campaigns targeting lavish compensation practices.

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[jelibean]

Starbucks is also donating 5 cents from every drink sold today, Dec 1, to this same fund in honor of World Aids Day. The line at my local Starbucks was much longer today than usual.