Executive Compensation, Disney and Delaware Law (Part 5)

So what is the bottom line on executive compensation?  Delaware courts will uphold executive compensation as long as it is approved by independent directors.  In so doing, Delaware courts will not examine the terms of the compensation, only the process used to approve it.  This procedural approach has a great deal to offer, at least in theory.  It allows courts to stay out of the decision making process by deferring to boards that engage in the proper process.  The theory and practice, however, diverge.  For the approach to work, the directors making the decision must really be independent. 

The Delaware courts do not ensure that this is the case, something illustrated by the Disney litigation.  That case never should have been a duty of care case.  Michael Eisner, because of his close relationship to Michael Ovitz, had an interest in the contract.  By any reasonable standard, he controlled the board of directors (the reasoning of the Chancery Court notwithstanding).  In other words, the approval process was tainted by interested influence.  Had the court examined the case in this manner, it would have imposed on the board the burden of showing that the compensation was fair.  Instead, the fairness of the contract to Ovitz was never at issue much less resolved.  By treating the matter under the duty of care, the court conducted essentially a process review and, unsurprisingly, found the process adequate.

Giving deference to executive compensation decisions by non-independent directors produces what one might expect, an explosion in executive compensation.  It is a charade, with the Delaware courts complicit in the approach.  Say on pay is a reflection of frustration over this approach and the growing sentiment for federal intervention.  In the aftermath of Super Tuesday, it is interesting to remember that Senator Obama introduced say on pay in the US Senate.