Corporate Governance

Executive Compensation, the Delaware Model and a Proposed Solution (Part 2)

By J. Robert Brown

So what is the solution to the executive compensation problem?

One solution is a vigorous system of access.  If shareholders can elect their own representatives to the board, they will be able to break up the cozy system for approving CEO compensation.  Matters are moving forward on that front.

In addition, Section 13 of the Exchange Act should be amended by adding a new Section 13(m).  The provision could read:

(m)   It shall be unlawful for the board of directors of any issuer reporting under section 13(a) or 15(d) to pay compensation to any executive officer deemed excessive.

1.   Excessive shall include any compensation that is significantly greater than what is ordinary for companies in the same peer group (taking into account, among other factors, the published industry or line-of-business index of the company and companies whose equity securities are traded on the same exchange or are of comparable market capitalization) and where the board of directors does not provide a substantial justification for the compensation. 

2. Safe Harbor. Executive compensation shall be presumed not excessive where:

a. The board of directors has a compensation committee. The compensation committee, in its capacity as a committee of the board of directors, shall be directly responsible for the determination of the compensation paid to executive officers of the company.

i. Independence

1. In general

Each member of the compensation committee of the issuer shall be a member of the board of directors of the issuer, and shall otherwise be independent.

2. Criteria

In order to be considered to be independent for purposes of this paragraph, a member of an compensation committee of an issuer may not, other than in his or her capacity as a member of the compensation committee, the board of directors, or any other board committee—

i. accept any consulting, advisory, or other compensatory fee from the issuer;

ii. agrees in writing to serve on the board of directors for a period of not longer than six years;

iii. has no preexisting and significant personal relationship with any executive officer of the issuer or controlling shareholder at the time the director becomes a member of the compensation committee;

iv. receive directors fees that are material to the director unless the director agrees in writing to serve not more than six years as a director of the issuer; or

v. be an affiliated person of the issuer or any subsidiary thereof.

3.  Safe Harbor:   Any director who is nominated by a shareholder or shareholders owning not less than 2% of the voting shares of the issuer and is unaffiliated with the issuer shall be considered independent for purposes of this provision.

4.  In the case of a director who has served on the compensation committee and thereafter ceases to serve on the compensation committee for any reason, the Commission shall by rule require disclosure of the reasons for the cessation. 

b. Advisers

i. Each compensation committee shall have the authority to engage independent counsel and other advisers or consultants, as it determines necessary to carry out its duties.

ii. Any advisor or consultant engaged to provide advise on or otherwise opine on the fairness of the form or amount of executive compensation shall be independent. Independent shall mean any advisor or consultant, or any affiliate of the advisor or consultant, shall have no material financial relationship with the issuer beyond the relationship with the compensation committee of the board of directors.

iii. Each issuer shall provide for appropriate funding, as determined by the compensation committee, in its capacity as a committee of the board of directors, for the proper functioning of the committee, including the payment of compensation to any person hired under this section.

c.  Rulemaking and Exemptive Authority

The Commission may prescribe rules and regulations and define terms contained in this subsection as necessary or appropriate in the public interest or for the protection of investors. 

We will discuss the provisions in a subsequent post.  By amending Section 13, the provision would be limited to reporting companies and there would be no private right of action for violations.  It would be left to the Commission to enforce the provision.  This would add an additional layer of enforcement, beyond exclusive reliance on derivative suits, which is controlled by the Delaware courts.  At the same time, it does not go so far as to create a private right of action.

Full post as published by The Race to the Bottom on April 02, 2009 (boomark / email).