Corporate Governance

CEO Use of Private Aircraft and the Delaware Approach to Compensation

By J. Robert Brown

One of the more interesting things included in the term sheet for the auto bailout was the ban on the ownership and lease of private aircraft.  This was a unique penalty imposed on the auto makers for having the temerity to come to Washington, ask for a $25 bllion bailout then fly back to Washington in private jets.  But in fact private jets are common.

We have pointed this out before.  But as the Associated Press has pointed out, any number of firms taking money in the financial bailout are still using private aircraft.

• Insurance giant American International Group Inc., which has received about $150 billion in bailout money, has one of the largest fleets among bailout recipients, with seven planes, according to a review of Federal Aviation Administration records.
• Five other financial companies that got a combined $120 billion in government cash injections — Citigroup Inc., Wells Fargo & Co., Bank of America Corp., JPMorgan Chase & Co. and Morgan Stanley — all own aircraft for executive travel, according to regulatory filings earlier this year and interviews.

These costs are not insignificant.  As the AP reported, a cross country trip in a medium sized plane "costs about $20,000 for fuel. Maintenance, storage and pilot fees put the cost far higher."

It is bad enough that companies use corporate jets for "business" purposes but the real abuse concerns personal use of aircraft.  The SEC requires the top five highest paid executives to report personal use as part of the disclosure of executive compensation.  Some of the amounts, at least in the past, have been spectacular, surmounting the $500,000 mark.  The company effectively absorbs this amount.  The CEO is merely obligated to pay taxes on an amount generally equal to a first class ticket (the calculations depend upon the size of the plane and the distance flown).  See Circuit City 2008 Proxy Statement ("Additionally, the Chief Executive Officer is allowed limited personal use of our aircraft and may use up to 50 hours per year. He is taxed for his personal use of the aircraft based on a standard industry fare level formula, which equates to roughly the cost of first-class airfare.").

How can this be justified? 

Because, like all compensation issues, it depends upon the standards employed by the Delaware courts.  Compensation decisions, including personal use of aircraft, are subject to the protection of the business judgment rule if approved by a board consisting of a majority of independent directors.  But the definition of independent does not ensure that in fact they are neutral decision makers.  Nor must the CEO be excluded from the process.

And, as we have noted time and time again on this Blog, directors have every reason to appease the CEO on these types of issues.  They cannot realistically be removed by shareholders.  As a result, they can only lose their well paid sinecure if they are not renominated by the board, something that is most likely to happen if they displease the CEO.  As a result, they have every incentive to maintain good relations with the CEO and to support requests for perqs such as the personal use of the corporate aircraft.

The Delaware courts cannot be counted on to impose meaningful standards with respect to compensation.  This explains why Congress has had to intervene, prohibiting loans in SOX and the acquisition of aircraft in the failed auto bailout bill (the same restriction was included in the term sheet issued by the President in its bailout). 

It is unfortunate that decisions that rightfully ought to be left to the discretion of the board are increasingly subject to federal preemption.   It wouldn't take much for state courts to impose meaningful standards and cut off this continued federal encroachment (see Returning Fairness to Executive Compensation).  But they are steps unlikely to be taken for the pro-management courts in Delaware.

Full post as published by The Race to the Bottom on December 23, 2008 (boomark / email).