In short, Board Capture theorists believe that “shareholder vote on option plans was a weak constraint on compensation arrangements.”49. Markets represent another potential check on the levels of CEOs, but according to Board Capture theorists they are also weak constraints on executive compensation.5 0.
LITIGATION'S ROLE
THE EVOLUTION OF BOARD CAPTURE THEORY While Board Capture theory and its impact on executive
In legal academia, Charles Elson identified Board Capture as a major problem in a series of articles in which he pointed to managerial dominance of the board as a major cause of excessive executive compensation. Lucian Bebchuk et al., Managerial Power and Rent Extraction in the Design of Executive Compensation, 69 U.
EXECUTIVE COMPENSATION IN THE COURTS: A SHORT HISTORY
For further discussion, see CLARK, supra note at 213-17, explaining various court decisions regarding remuneration, and 2 WASHINGTON & ROTHSCHILD, supra note 149, at 607-08, noting that ``[each person to whom a stock option is awarded] grant must, as consideration for the grant thereof, agree to remain employed by the company." It is true that the rules in the 1952 cases remained good law for the rest of the decade.178 But in 1953, Delaware's legislature amended its corporate law in response to dicta in the cases to make clear that the board's discretion regarding consideration. Notably, a number of Delaware judges began calling for the abandonment of the waste doctrine, which had long been used as a final, albeit usually unsuccessful, claim against truly egregious damages.
But the stock option cases were not lingering holdovers from the 1920s; Rather, they were granted during a period when stock options were becoming a preferred method of executive compensation, something Curbs directly notes. Waste claims are generally seen as "losers," but a study conducted by one of the authors found that plaintiffs from 2000 who brought executive compensation waste claims in Delaware courts won about forty percent of the time, with a "victory" defined as success at some point in the trial. The inability of Delaware courts to identify what a corporate director's central fiduciary duties are, let alone what the scope of those duties might be, is one of the most pressing—and from a director's point of view, troubling—issues in corporate law today.”);.
How big is the payoff for Ovitz, like . alleged, if true, imply that the director defendants knew they were making material decisions without adequate information and without adequate deliberation, and they. The Enron passage of the Sarbanes-Oxley Act,215 that Delaware courts were prepared to do more research investigating executive compensation decisions, relying on "good faith" as a legal tool to second-guess disinterested decisions.
discuss how the. rhetorical approaches of the judiciary and corporate counsel in Delaware create legal norms). discusses the course of the Delaware Supreme Court from Disney to its holding in Stone that one cannot act negligently in bad faith).
THE EMERGENCE OF OFFICERS' FIDUCIARY DUTIES A new avenue for challenges to executive compensation has
Although Gantler explicitly answered the question of what public officials' fiduciary duties were to the corporation and its shareholders, he left open at least two other important questions. It is a strange omission considering that for much of the last century, students of the corporation repeatedly advanced a version of the Board Capture Hypothesis, arguing that even though boards of directors had the legal power to capture the corporation boards, the CEO usually exercised real power.24 3 Why, then, was not the law governing the fiduciary duties of officers developed through a series of lawsuits against officers as officers? Although in recent years there has been an increase in investigations into officers' fiduciary duties.
The decline of the inner board of directors beginning in the 1970s and its replacement by a monitoring board composed largely of independent directors may have heightened awareness of the separate roles and separate duties of senior officials. Thus, if [a] section 3114 had not been amended, the ability to obtain personal jurisdiction in Delaware over some of the most important participants in corporate governance would have been impaired.251. Strine, Jr., The New Federalism of the American Corporate Governance System: Preliminary Reflections of Two Residents of One Small State, 152 U .
Gantler was a case of first impression and left a number of questions open in relation to the officers' fiduciary duties. For example, claims that officers breached their fiduciary duties to a corporation and its shareholders will be treated identically to a similar claim against directors. As we shall show below, the Court of Chancery had previously suggested how an officer's fiduciary duty should be used in an important situation - when the officer negotiates with the board of directors for an employment contract.
OFFICERS' FIDUCIARY DUTIES AND EXECUTIVE COMPENSATION CONTRACTS
Under this approach, a preliminary step is to determine whether the individual negotiating the employment agreement is an officer of the company, or merely a prospective one. In this potentially self-dealing transaction, the officer may not use tactics that would be unfair to the company.267 For example, as the plaintiffs in Disney asserted, an officer who negotiates a subsequent compensation agreement would be in breach of her fiduciary duties. if she used the fact that she was a friend of the CEO, or secretary of the compensation committee, to receive special treatment.268. One characteristic of arm's-length negotiations may be that the compensation committee treats the negotiations with the CEO like those they engage in with lower-ranking officers of the company.
Levine, 591 A.2d at 205 ("When a lack of independence is alleged, a plaintiff must show that the Board is either dominated by an officer or director who is the proponent of the challenged transaction or that the Board is under such influence as to sterilize its discretion. " (citation omitted)). The first claim would be that the board acted with gross negligence in allowing the CEO to hijack and undermine the compensation negotiation process; this claim is necessary to be acquitted.283 The second claim would be that the officer breached her fiduciary duty by undermining and manipulating the process; this claim would be at the heart of the lawsuit. We expect that the totality of the circumstances will have to show gross negligence and the withheld information will be only one element of that claim.
Under Delaware law, the board can still create a special committee of independent directors that can take control of the litigation. For example, in McPadden, the chancellor set up the board by putting the executive in charge of selling a division of the company that he knew the executive was also interested in buying. In an executive employment contract negotiation, allowing the executive to control the process of negotiating her own contract and compensation appears to be a similarly improper exercise of the board's business judgment.
Disinterested director approval would apparently not be possible because the underlying claim in this case would be that the board was not informed of the various manipulative actions taken by the CEO as part of the negotiation process. In addition to providing much-needed substance to the concept of officers' fiduciary duties in determining executive compensation, it also addresses one of the major criticisms of executive (especially CEO) compensation practices in public corporations: that too many executive compensation arrangements are products of of sweetheart deals and that the terms of these deals are influenced by the personal relationships senior managers have with each other and with the board of directors.
THEORETICAL RESPONSES
Board capture theorists would thus welcome our approach because it focuses attention on the employment contracts they believe are most likely to be tainted. More generally, Board Capture theory assumes that managers have too close ties with the directors of their companies and that these directors will be overly generous to, or even in the back pockets of, the managers.32.1 Our approach should lead to disclose such relationships. Optimal Contracting theory accepts that American boards are not completely independent.328 Although we could design a corporate governance system in which a corporate board is almost completely independent of the CEO (leaving aside imperfections such as the fact that internally promoted CEOs (will know) members and even externally hired CEOs probably know at least some board members), this may not be optimal.
Optimal Contracting theory claims that boards contract optimally given the corporate governance system's distribution of power between directors and officers.334 If we strengthen the directors' position in contract negotiations, then this belongs to the initial power of the two parties to the negotiations. If courts can cheaply and successfully identify and correct cases where insiders have abused their positions to obtain excessive compensation packages, then they will also correct flaws in the corporate governance system. This in turn should improve the underlying contracting environment that forms the background for Optimal Contracting Theory and therefore reduce contracting costs.33 6 More generally, when the legal system successfully addresses a problem in the corporate governance system, the contracting environment becomes more efficient and shareholder wealth should to increase.337 The proposal outlined in this Article should therefore be welcomed by Optimal Contracting as well as Board Capture theorists.
For Board Capture theorists, the Delaware courts' approach will provide a close examination of a situation they have decried for decades, the dominance of CEOs in the compensation process, with the promise that compensation agreements entered into through executive power will be overturned. Board Capture theorists may be skeptical, having historically held out little hope that courts would be willing or able to seriously review excessive damages. Courts have in the past imposed stricter controls on aspects of executive compensation and have sometimes warned that such controls may be used.
