Corporate Governance

Compensation without Limits

By J. Robert Brown

Does it ever stop?  Executive compensation is determined by the board of directors.  The obligations of the board of directors are determined mostly by state law.  State law in this area means Delaware.  Delaware benefits from having companies incorporate in its state, a form of tax revenue from entities that otherwise make little or no use of local services.  Free money in short.  One way to attract companies is to provide a favorable regulatory environment for determining CEO compensation.  That is what Delaware has done.  As the article, Returning Fairness to Executive Compensation, argues, the Delaware courts have eliminated fairness from any analysis of the legality of executive compensation.  Process, rather than the terms of the compensation, are the only thing that matters. 

Given this legal environment, it is no big surprise that the press keeps finding example after example of excessive compensation.  Bad enough that the overall amount of compensation is excessive, particularly for companies that have done poorly or sought government bailout.  Bad enough that companies sometimes buy the CEO's home, let his or her family use the corporate jet, and pay country club dues.  In some cases, they provide enormous payouts to the estate if the CEO dies. 

The latest, however, arises in connection with the valuation of retirement plans.  According to the WSJ, recent changes in the disclosure regime have brought to light the formulas used when converting pensions to lump some payments.  A particularly "generous" formula can "increase the value of a CEO's pension by 10% to 40%."  At the same time, the article noted that business groups "successfully lobbied Congress to be able to use a less-generous formula when it comes to paying out pensions for regular workers."

One can blame the CEO and the board for these sorts of things.  But in fact the real blame belongs with the Delaware courts.  Shareholders should have a meaningful right to challenge executive compensation as unfair, a standard that would allow shareholders to recover where the compensation exceeded industry standards without adequate justification.  This type of law suit is not typically allowed, at least when approved by a board with a majority of "independent" directors.  It is frankly time to take away from a small state with a financial incentive the authority to determine the standards for executive compensation.  Federal preemption in short.

Full post as published by The Race to the Bottom on January 26, 2009 (boomark / email).