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The following report is copied with permission from Corporate Governance Highlights, a private weekly newsletter for clients of Investor Responsibility Research Center ("IRRC"), the leading source of impartial, non-advocacy research for institutional investor interests in corporate governance and proxy voting issues.


Corporate Governance Highlights

Vol. 16, No. 42

October 29, 2004




ICGN Conference Focuses on

 Board Oversight of Executive Compensation

EXECUTIVE PAY TAKES CENTER STAGE AT INTERNATIONAL GATHERING. The issue of excessive executive compensation at public corporations emerged as a leading theme at a conference held by the International Corporate Governance Network (ICGN) in Wilmington, De., on Oct. 22. Representatives from the business press, investors, judges and corporate directors offered their perspectives on the issue.


BUSINESS REPORTER CITES TROUBLING NEW TRENDS ON PAY FRONT. New York Times business reporter Gretchen Morgenson raised several problems she saw with the way companies compensate executives. First, she said, in several cases, companies have awarded high levels of incentive compensation based on financial targets, but later restated their financial reports.  In these cases, the officers who received the compensation have fiercely resisted any “claw backs” of improperly awarded compensation.  She cited the case of Computer Associates as a potential exception where compensation was awarded based on misstated financials, but where, largely due to intervention by regulators, shareholder interests may be protected by the successful claw back of corporate funds. 


   Morgenson also cited problems with current rules on how companies disclose “supplemental retirement plans.”  Currently, actual amounts of this type of compensation are not disclosed but companies provide tables that outline what executives may receive based on years of service, salary and bonus.  As a result, shareholders can be hurt by earnings reductions due to surprise payouts under these plans, she said.


   In addition, Morgenson noted that executive payouts packaged as payments in connection with mergers have become very large, often including lump sums in an amount of three times an executive’s salary. In some cases, payouts to executives can rise to 8 percent of the acquisition price in a merger transaction, Morgenson noted.  While shareholders often have the right to vote on approval of a merger, they may be reluctant to vote against a merger triggering such payments if they perceive the merger to have benefits to the company that exceed the expenses the company will incur from these golden parachute payouts.


SHAREHOLDERS MUST BE MORE ACTIVE ON ISSUE. At a panel on institutional investors, panelists said that at companies where excessive compensation is detrimental to shareholders, the fault lies not only with overreaching management but also with complacent shareholders. Companies are structured so that directors represent shareholder interests, but, said panelists, in cases where directors have proved negligent in overseeing compensation, shareholders have done little to react.


   Jack Bogle, founder of the Vanguard fund complex, commented that during his tenure at Vanguard, the firm rarely put public pressure on companies in which it invested to make changes.  He said the current era is different, however, because top executives receive compensation that is more than 300 times that of the average worker at the same company. In an earlier period, he said, executives received pay of 50 times the average worker.


   Ralph Whitworth of Relational Investors said even though institutional investors may want certain reforms, they rarely use the tools they currently have available to effect change.  Whitworth commented that an important tool shareholders fail to use is their ability to solicit other shareholders to elect a limited number of directors to a company’s board (as opposed to a more confrontational, full blown proxy contest to control the company’s entire board.)  He said that at companies where he has successfully had nominee directors elected, even the single new director made a difference by focusing other directors on problem issues.


DELAWARE JUDGES DESCRIBE NEW VIEWS ON EXECUTIVE COMPENSATION. Vice Chancellor Leo Strine of the Delaware Court of Chancery commented that recent amendments to stock exchange listing standards requiring a majority of independent directors on boards may create a structure where problems such as excessive compensation go unchecked.  He noted that greater independence often comes at the price of less expertise in the boardroom.  Independent directors may have little knowledge of the company’s business and a greater tendency to rely on management’s advice.  Strine also noted that the greater numbers of independent directors mean that there will be fewer directors with “skin in the game,” or have personal funds invested in the company.  He said where directors have their own funds at risk, they are much more inclined to oversee compensation decisions properly. 


   Former Delaware Supreme Court Chief Justice Norman Veasey said the courts are shifting to focus their judicial review on the “process” used by boards of directors to set compensation rather than evaluating absolute levels of compensation under the legal doctrine of “waste.”  He cited the Delaware Court of Chancery’s recent refusal to dismiss the plaintiffs’ complaint in the Disney case on the basis that there is the possibility it will be shown at trial that the Disney board failed to act in “good faith” in approving the 1996 severance agreement for then-Disney President Michael Ovitz.  He said that breaches of directors’ fiduciary duties to act in good faith could be understood as instances where directors consciously disregarded their duties to make informed decisions when there is the possibility the corporation could suffer a loss.


   Delaware Supreme Court Justice Jack Jacobs agreed with Veasey, noting “process [used by boards of directors] is paramount.”  He said the factors that courts will examine in deciding whether directors used a proper process when determining executive pay include: 1) whether directors had adequate information, 2) whether directors verified the reliability of the information, 3) what type of expert advice directors used, and 4) whether directors were “well-motivated’ in making their decisions. Justice Jacobs said that compensation decisions must be the product of “arms-length” bargaining or else courts will find that the process does not work.


A DIRECTOR’S ADVICE ON KEEPING PAY IN CHECK. Jack Krol, former CEO and chair of DuPont, described measures directors can take to ensure they fulfill their role of overseeing executive compensation.  He discussed his experience in reforming pay practices at Tyco International, where he serves as a lead director. Krol said the Tyco board benchmarked executive compensation at a level two times that of executives holding positions at the next lowest level of the Tyco corporate hierarchy, and the board tied incentive compensation to internal measures of financial performance that drive corporate growth rather than share price targets. 


   The Tyco board also limited severance agreements to provide for no more than two times an executive’s base salary, Krol said.  To focus executives on the long-term success of the corporation, Tyco granted restricted stock compensation rather than stock options, and to protect shareholders against excessive dilution, the board limited the company’s stock options to 1.5 percent of its outstanding shares.





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Editor: Rosemary Lally


Contributors: Benjamin Bricker and Mark Saltzburg 




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