Corporate Governance Practices and the Failure of the Delaware Model: An Example

By now, the saga of AIG is familiar to almost everyone.  The Company teetered on the edge of failure until the government had to agree to a bailout in return for an almost 80% interest in the company.  Despite the need for public assistance, AIG has been in the news constantly because of its policies with respect to executive compensation and other seemingly extravagant expenditures.  It all came to a head when New York Attorney General Andrew Cuomo sent a sharp letter to the board of directors more or less directing them to reexamine these policies.  

The letter got the board's attention.  According to the WSJ, AIG agreed:

• to freeze some $19 million in payments to its former chief executive, Martin Sullivan, while New York Attorney General Andrew Cuomo reviews executive compensation and other expenditures paid out as the company neared collapse earlier this year.  The insurance giant also has agreed not to distribute any funds from its $600 million deferred-compensation and bonus pools of its AIG Financial Products subsidiary, which Mr. Cuomo has said was largely responsible for the company's near collapse. .  . The company also agreed to establish a special governance committee to institute new expense-management controls and to immediately cancel all junkets or perks that aren't strictly justified by legitimate business needs. As a result, AIG will be canceling more than 160 conferences and events for a total savings of more than $8 million.

But the broader question is why it took the intervention of the attorney general of New York before these steps were taken.  The short answer is that Delaware is the state of incorporation for AIG.  As we have noted before, the courts in Delaware refuse to interpret fiduciary obligations in a way that would impose meaningful monitoring duties on directors.  In most instances, boards have no obligation to act except when confronted with a specific problem or issue.  In other words, the directors (who are, by the way, well paid) had no obligation to revisit compensation or lavish entertainment expenditures under the Delaware model.  Only when confronted with a threatening letter from the NY attorney general was the board confronted with a matter that required action.

It is helpful that Andrew Cuomo got the board at AIG to act responsibly.  But he can only write so many letters.  There needs to be broader reform.  This means replacing the Delaware model with federal legislation that imposes more pronounced obligations on the board.  In that way, boards will take the necessary steps before receiving the dunning letters from the attorney general.