chapter 21 executive compensation
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Module VII – Fiduciary Duties. Chapter 21 Executive Compensation. Bar exam. Corporate practice. Law profession. Compensation puzzle Relation to corporate governance Types of pay: salary, bonuses, stock grants, stock options Special issues with stock options Standard of review - PowerPoint PPT PresentationTRANSCRIPT
Corporations:A Contemporary Approach
Chapter 16Public Shareholder Activism
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Seb Farrington, “Crankenstein” (2014)
Corporations:A Contemporary Approach
Chapter 21Executive Compensation
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Chapter 21Executive Compensation
• Compensation puzzle– Relation to corporate governance– Types of pay: salary, bonuses, stock grants,
stock options– Special issues with stock options
• Standard of review– Vogelstein case– Waste standard over time
• Delaware approach in Disney– Disney I - reject complaint / demand futile– Disney II - accept “good faith” claim– Disney III - no finding of bad faith / affirmed– Analysis:
• heightened review?• political economy of case?
Module VII – Fiduciary Duties
Citizen of world
Citizen of world
Law profession
Law profession
Corporate practice
Corporate practice
Bar examBar
exam
Corporations:A Contemporary Approach
Chapter 21Executive Compensation
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Fiduciary duties(directors)
OversightDecision-making
Bestinterests
Business Judgment RuleShlensky v Wrigley
Inattention Conflictinterest Remillard
Grossnegl
Van Gorkom
WasteVogelstein
Corpopp
Farber
IllegalityMiller v AT&T
Malfeasance(bad faith)
Francis
IllegalityCaremark Bad faith
Disney
Disinterestedindependent
Benihana
102(b)(7)
102(b)(7)
Corporations:A Contemporary Approach
Chapter 21Executive Compensation
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Plato“5x”
Friedman“market - 400x”
“CEO to average worker” Ratio(Dodd-Frank reports)
• 250 largest companies in S&P 500 index – 331 to 1
• Highest and lowest? – 1,795 to 1 (J.C. Penney’s Ron Johnson)– 173 to 1 (Agilent Technologies’ William Sullivan)
• Pay for performance? – Agilent shares: plus 49% last year– J.C. Penney’s shares: minus 73%.
Corporations:A Contemporary Approach
Chapter 21Executive Compensation
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Corporations:A Contemporary Approach
Chapter 21Executive Compensation
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In judging whether Corporate America is serious about reforming itself, CEO pay remains the acid test. To date, the results aren’t encouraging.
Warren Buffett, letter to shareholders of
Berkshire Hathaway, Feb. 2004
Corporations:A Contemporary Approach
Chapter 21Executive Compensation
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Corporations:A Contemporary Approach
Chapter 21Executive Compensation
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Joe (team manager)
Hal and Hank(team owners)
Public Shareholders
CEO
Board ofDirectors
Corporations:A Contemporary Approach
Chapter 21Executive Compensation
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Executive pay
Types of pay
• Salary (cash)• Bonuses• Plan-based
– Stock awards– Option grants– Non-equity incentives
• Deferred compensation – Pension plan– Nonqualified deferred
comp• Other
– Executive loans (SOX!)– Fringe benefits
Tax deductibility• Cap of $1,000,000 (CEO and top 4
officers), unless --– performance-based pay – set by compensation committee
(outside directors) – approved by shareholders
Proxy disclosure• 1992 SEC amendments
– Tabular form (CEO + top 5)– Pay committee processes
• 2006 SEC amendments • 2011 “Say on Pay”• 2012 CEO to average worker ratio
Judicial review• Waste: no relation to services• Care: board grossly uninformed• Loyalty: fraud or conflict
Corporations:A Contemporary Approach
Chapter 21Executive Compensation
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Corporations:A Contemporary Approach
Chapter 21Executive Compensation
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Corporations:A Contemporary Approach
Chapter 21Executive Compensation
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Stock options …
1. What is a stock option?A.The right to buy stock in the futureB.The duty to buy stock in the future
2. You have a stock option that vests in 2 years?
A.You can exercise the option any time for next 2 years
B.You must wait 2 years before exercising option
3. Your stock option has a strike price of $25. Market price is $20
A.You should exercise the optionB.You should hold on to the option – it has
value though “out of the money”
4. Market price is $30. Your option (strike = $25) expires in 5 years
A.You can wait for prices to go higher – and defer taxes
B.You should exercise it immediately
5. Companies pay employees with stock options in order to --
A.Create an incentive for employees to increase stock prices
B.To hide compensation from financial statements
6. Stock options are impossible to valueA.True. There’s no way to know what will
happen to stock pricesB.False. Option value depends on past price
volatility and interest rates
7. Can you buy an option in General Electric stock?
A.Yes. Options for many public companies’ stock are bought and sold
B.No. Only employees can acquire stock options
8. If you thought GE stock would stay steadyA.You can make money by selling a “call option” B.You can make money by buying a “put option”
1-A / 2-B / 3-B / 4-A / 5-A / 6-B / 7-A / 8-A
Corporations:A Contemporary Approach
Chapter 21Executive Compensation
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Option backdating
Grantdate
Vesting period
Exercise price
New exercise price
Backdatedgrant date
Expirationdate
Corporations:A Contemporary Approach
Chapter 21Executive Compensation
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Judicial review
Review standards - over timeMeaning of “waste” - safety valveDisney case - duty of “good faith”
Corporations:A Contemporary Approach
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Traditional review – “waste”
Applicable standard: “If a business payment has no relation to the value of the services for which it is given, it is in reality a gift.”
Rogers v. Hill (US 1933)
Applicable attitude: “Nothing is so divergent and contentious and inexplicable as values. Courts are ill-equipped to solve or even to grapple with these entangled economic problems.”
Heller v. Boylan (NY Sup Ct 1941)
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The numbers please
Randall Thomas(Vanderbilt)
Corporations:A Contemporary Approach
Chapter 21Executive Compensation
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Thomas & Martin – Plaintiff success rates(124 reported exec pay cases)
52%53%50%CHC(at least one theory)
32%30%34%PHC(at least one theory)
35%39%28%Loyalty
30%33%27%Care
40%46%29%Waste
TotalNon-DelawareDelaware
(35 cases) (27 cases)
(8 cases) (47 cases)
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Evolving judicial review
in Delaware …
Corporations:A Contemporary Approach
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Delaware – evolving standards19
52 –
Ker
bs v
. Cal
if Eas
tern
Airw
ays
“suf
ficie
nt c
onsid
erat
ion”
1960
– B
eard
v. E
lster
“goo
d fa
ith d
eter
min
atio
n –
prop
ben
efit”
1979
– M
ichel
son
v. D
unca
n
“exis
tenc
e of
[any
] con
sider
atio
n”
1997
– L
ewis
v. V
ogel
stei
n
“cla
ssic
waste
sta
ndar
d”
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Lewis v. Vogelstein (Del Ch 1997)
Mattel shareholders challenge board's stock option compensation plan for themselves (ratified by shareholders).
Under the plan directors received: (1)15,000 one-time options (exercise
price = market price on date granted / exercisable for up to 10 years)
(2)5,000 (or 10,000 for longer-serving directors) annual options (vest over a 4-year period / exercise price = market price when granted / and exercisable for up to ten years
What’s the standard of review?
Corporations:A Contemporary Approach
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Lewis v. Vogelstein (Del Ch 1997)
Intermediate review:
–sufficient consideration (reasonable relation between the value of the services and the value of the options)
–Plan: conditions included to ensure that the consideration will pass to corporation.
Waste standard:
– Reviewable only if corporation received no consideration, the compensation was a gift, no person of ordinary prudence could possibly agree
– Defer to shareholder ratification (in this age when institutional shareholders have grown strong)
Apply?
Chancellor Allen
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Duty of care Board approval of executive pay
Disney I - complaint
Disney II - amended complaint
Disney III - trial
Corporations:A Contemporary Approach
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Disney III (Del 2006)
Third category of fiduciary conduct, between (1) subjective bad intent and (2) gross negligence.
This third category – intentional dereliction of duty, a conscious disregard for one's responsibilities – is non-exculpable, non-indemnifiable violation of the fiduciary duty to act in good faith.
CEO Michael Eisner withMichael Ovitz ($140
million “pay for failure”)
Corporations:A Contemporary Approach
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The end