Goldman Sachs set off a new round of grumbling in Washington in February when it disclosed that Lloyd C. Blankfein, its chief executive, would receive an all-stock bonus of $9 million for 2009. Goldman Sachs had set a record for profit that year, netting $13.4 billion, a 17.5 percent increase over its previous profit record in 2007. Nonetheless, Mr. Blankfein’s announced bonus was to be 87 percent less than the bonus he received in 2007, and roughly half of what Jamie Dimon, his counterpart at JPMorgan Chase, received.
The Obama administration and some members of Congress were not impressed.
In an interview with Bloomberg News soon after the announcement of Mr. Blankfein’s bonus, Kenneth R. Feinberg, the Treasury’s special master for executive compensation, recognized that Goldman Sachs had followed his “prescriptions” regaring the mix of compensation, with an emphasis on restricted stock, but he lamented that the total compensation remained excessive. This view expressed by Mr. Feinberg (and for that matter, by certain members of Congress when discussing executive compensation) does not acknowledge that compensation, for the most part, should remain an issue for boards and managers to wrestle with, should reflect the results of operations of the company and is subject to complex and nuanced issues.
Let’s juxtapose the views of the Obama administration and Congress to those of Vice Chancellor Leo E. Strine Jr., one of the five judges on the Delaware Chancery Court. When asked by The Deal in January about the push to federalize corporate law in response to the financial crisis, Judge Strine asked his own question in return: “Do we want to send a signal internationally that when we have crisis in the U.S., we engage in a flood of new mandates regardless of whether these mandates relate to what caused the crisis?”
Despite calls for the federal government to set corporate governance standards, Judge Strine said Delaware would not respond in kind because “[o]utside of areas critical to the protection of society, such as leverage limitations and capital requirements, Delaware is trying to approach this on the merits, and we don’t want to be crisis-driven.”
Judge Strine insisted that “Delaware can’t step in front of the feds and say, ‘Every corporation ought to have X,’ without being inconsistent with its preference for company-specific private ordering.”
Note the striking differences between the views expressed by certain members of Congress and the Obama administration as compared to Judge Strine’s views concerning the proper role of government regulation. Judge Strine is concerned about the competitive global marketplace and the perceived risks of doing business in the United States relative to other countries. He wants to respond to the causes of the crisis in a measured manner. In Judge Strine’s commentary, there is a fundamental respect for the decision-making processes of each company — an understanding of the differing circumstances that each company faces when making compensation decisions — that is absent from discussions by the Obama administration and Congress on these issues.
Judge Strine’s views reflect more than 50 years of jurisprudence on executive compensation under Delaware law. In Brehm v. Eisner, the Delaware Supreme Court acknowledged that “[i]t is the essence of business judgment for a board to determine if ‘a particular individual warrant[s] large amounts of money, whether in the form of current salary or severance provisions.’ ”
As such, board decisions with regard to compensation generally receive the benefit of the business judgment rule, which, as set forth in Aronson v. Lewis and its progeny, presumes “that in making a business decision the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action was taken in the best interests of the company,” unless the presumption is rebutted by particularized facts that show the directors lacked independence, failed to act in good faith, or acted in a manner that could not be attributed to a rational business purpose.
Attacks on executive compensation in Delaware are framed as allegations of waste in which the controlling test, as set forth in Saxe v. Brady, is “whether what the corporation has received is so inadequate in value that no person of ordinary, sound business judgment would deem it worth what the corporation has paid.” The high threshold reflects an admission, as described in Lewis v. Vogelstein, that “[c]ourts are ill-fitted to attempt to weigh the ‘adequacy’ of consideration.” On the issue of executive compensation, the Brehm court said: “[t]o be sure, there are limits, but they are confined to unconscionable cases where directors irrationally squander or give away corporate assets.”
For decades, Delaware has been the most important jurisdiction in the United States for establishing the legal parameters of corporate governance, and its courts have seen it through previous recessions with consistency, even-handedness and measured interventions. Yet even if we believe that Delaware has been too deferential with respect to decisions made regarding compensation, the answer is not more federal regulation of the area.
Despite disagreements, we should agree that boards and managers face complex and nuanced issues when making compensation decisions. They must consider how to appropriately give incentives to managers, how to attract and retain talent, and how to balance short-term and long-term interests while remaining competitive in the market for top management.
If we can agree that companies face these complex issues, can we think of any other area of complex incentives where we believe less flexibility, less experimentation or less differentiation is better? Has anyone articulated or demonstrated a causal connection between executive compensation and the financial crisis? The answer to the issue cannot be for the federal government to more heavily regulate executive compensation; we require the crucible of the free market to test compensation schemes meant to benefit firms and their shareholders.
If, like the Delaware courts, we can avoid submitting to the populist anger of the 15-second sound bite, if we can keep our heads while our competitors lose theirs (see Britain’s punitive 50 percent tax on banker bonuses), we will continue to emerge from the financial crisis stronger than ever. That is our charge. If we cannot, it will be because of a failure of business and political leadership on this issue.
Manan Shah is a partner at Jones Day in New York specializing in executive compensation, employee benefits and corporate governance. Benjamin M. Grossman is an associate specializing in mergers and acquisitions. Their views do not necessarily reflect those of Jones Day or any of the law firm’s clients.