Corporate Governance

Corporate Governance Practices and the Failure of the Delaware Model: The Evidence (Part 1)

By J. Robert Brown

The current financial turmoil challenges the Delaware model of governance.  This is an approach that declines to impose meaningful standards on directors and takes a highly deferential approach to the decisions of management.  As Alan Greenspan noted in his testimony last week, this approach has not worked to protect shareholders.

Certainly the most significant manifestation of the failings of the Delaware model have to be the problem of excessive compensation.  The golden parachutes paid to departing CEOs at failed financial institutions have garnered much of the publicity (and resulted in restrictions in the Bailout Bill).  But, of course, shareholders have been expressing concern about these practices long before the current turmoil.

Sherman and Sterling conducts periodic surveys of corporate governance practices among the 100 largest companies that have shares traded on the stock exchange.  One of them examines trends in director and executive compensation.  The report examined shareholder proposals, particularly on say on pay.  The report noted the following:

• A total of 89 compensation-related shareholder proposals were up for vote at the Top 100 companies during the 2008 proxy season.  Although this repesents an increase of more than 200 percent from our 2004 survey (44 proposals), as of July 14, only four of those 89 proposals garnered enough votes to be adopted.
• Of that number, 41 were proposals calling for say on pay.
• As of June 30, 2008, shareholders at only a few companies have actually approved say-on-pay proposals, including Apple Inc., PG&E Corporation, Tech Data Corporation, Motorola, Inc., Lexmark Internaitonal Inc., H&R Block, Inc., Ingersoll rand Company, Limited, The South Financial Group, and Alaska Air Group, Inc.
• Three companies implemented say on pay during the 2008 proxy season: 
• Aflac, Inc., Risk Metrics Group Inc., and Littlefield Corporation.  As the report noted:  "Aflac put its entire executive compensaiton program up for a vote; Littlefield asked its shareholders to vote on whether executive and director compensation was 'within 20 percent of an acceptable amount'; Risk Metrics held a shareholder vote on the company overall cmpensation philosophy, 2007 comepnsation payouts and 2008 performance objectives."
• At least thee companies (Par Pharmaceutical Companies, MBIA and Blockbuster) have committed to providing an advisory vote in 2009;
• A number of companies where shareholders have approved say on pay have not implemented the practice.  The companies listed in the report included:  Apple, Clear Channel, Activision, Motorola, JC Penney, and Valero Energy.

Interestingly, the report noted that "[t]here is also speculation that the NYSE and Nasdaq may adopt rules that make say-on-pay advisory votes mandatory, similar to the votes required for the adoption of equity compensation plans."

The shareholder concern reflects a failure of the Delaware model that emphasizes the role of independent directors in ensuring adequate oversight of the compensation process.  As we have discussed often, this approach has not worked.  The Delaware courts do not rigerously enforce the definition of independent nor do they ensure that the approval process is done in a meaningful fashion.  It is the failure of the Delaware model that has caused shareholders to demand a direct role in the process, something supported by the Democratic platform and Barak Obama.

Full post as published by The Race to the Bottom on October 29, 2008 (boomark / email).