Editorial: Executive Compensation and Federal Intervention

In the short life of this Blog, some regular readers might think that there is a bias against state regulation of the corporate governance process.  In fact, there is no such thing.  The bias is against ineffective state regulation.  Nowhere is this more clear than in the area of executive compensation.  It is hard to imagine a better way to determine executive compensation than by informed, truly independent directors acting in the best interest of shareholders.  Unfortunately, that’s not the standard required under Delaware law, not even close.  Delaware has long replaced substance with process, then not ensured the integrity of the process.  For more on that, read here.

In the absence of meaningful standards under state law, executive compensation will remain a target for federal preemption.  In fact, recent events suggest that this may occur.  Earlier in the week, the Senate adopted the Small Business and Work Opportunity Act of 2007.  Buried in the Act was a provision that imposed limits on deferred compensation in excess of $1 million.  The provision was not meant to “correct” the problem of excessive compensation but to provide a source of funding for an accompanying tax cut for small businesses.  Nonetheless, it shows how easy it is for Congress to target executive compensation and to ignore any resulting outcry, for example from the WSJ.  As this Blog has predicted, without changes in Delaware’s standards, executive compensation remains the number one area of state law most likely to incur federal preemption.   We have already discussed that topic somewhat here. The best way to preempt (so to speak) federal preemption is for Delaware to make the standards for review of executive compensation meaningful.  The Delaware courts reacted to the threat of federal legislation before, most recently in the aftermath of the adoption of SOX.  For more on that, look at footnote 382 in the paper here.  Perhaps its time for the Delaware courts to react again.