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Overview

The growing spotlight on compensation of executives at public companies is not a surprising consequence of investors’ reaction to high-profile corporate accounting and management scandals that have been making headlines.  Many investors have concluded that the interests of executives are not aligned with shareholders and courts have been inclined to agree in light of the increasing importance of corporate governance and growing clout of institutional investors.

In 2004, some of the most egregious examples of corporate greed arose in the area of executive compensation.  Michael Ovitz, Disney’s former president, Michael Eisner, the chief executive, and several current and former directors of Disney were sued in the Delaware Court of Chancery because of a $140 million severance packaged awarded to Mr. Ovitz when he left Disney after only 14 months as the company’s president.  The shareholder derivative lawsuit claims Disney’s board failed in its fiduciary responsibilities by not properly scrutinizing Mr. Ovitz’s employment contract when he joined the company in 1995 and then granting him a nonfault termination that entitled him to the extraordinary severance package when he left just one year later.  

Also in 2004, Dick Grasso, the former chairman of the New York Stock Exchange, was criticized for accepting an unreasonably large compensation package, while at the same time heading one of the organizations at the forefront of establishing ever stricter corporate governance rules, including those relating to the approval of executive compensation.  Mr. Grasso was eventually dumped by the NYSE board, but not before securing a $130 million payout.  As a result, the state of New York brought an action against Grasso and charged him with violating New York’s not-for-profit law.  The state’s claim contends that the compensation package was (1) objectively unreasonable, (2) the product of a faulty compensation committee review process improperly influenced by Grasso, and (3) approved by the NYSE board based on materially incomplete, inaccurate and misleading information.

Of course, Disney is a public company and the NSYE is a not-for-profit entity, but these executive compensation suits have a common thread: public outcry and resulting litigation when a board fails to exercise fiduciary duties to a company’s shareholders or other stakeholders.  The new rules and regulations promulgated under the Sarbanes-Oxley Act of 2002 were a call to corporations and their boards for accountability and transparency.  In the area of executive compensation, that means the compensation committee must be more than a rubber stamp.  

The Securities and Exchange Commission, the NYSE and Nasdaq  have published rules and regulations for compensation committees and their charters.  In addition, executive compensation packages and the disclosure of their terms in public company filings are now subject to heightened review.  As with all guidelines, the new Sarbanes-Oxley rules and guidelines are only as good as a company’s commitment to implement and follow them.  To be more than a rubber stamp, compensation committees must demonstrate independence and diligence.  Further, effort should be made to match executive compensation to demonstrable performance measures.  Many committees are hiring their own compensation consultants to evaluate the packages recommended by management’s compensation consultants.  Studies of comparable executive compensation further bolster a committee’s efforts to link compensation to performance.

These best practices and others in the executive compensation arena are being implemented, evaluated and revised.  The risk of shareholder and government suits is real.  Companies can reduce this risk by selecting independent, competent compensation committee members and creating effective processes that address how they determine executive compensation.

For More Information

Please contact your Thompson Hine lawyer or any member of our Corporate Transactions & Securities practice group for more information.

Disclosure

This article was featured in the Cincinnati Business Courier. This publication is intended to inform clients about legal matters of current interest. It is not intended as legal advice. Readers should not act upon the information contained in it without professional counsel. This document may be considered attorney advertising in some jurisdictions. Some of the design images and photographs in this document may be of actors depicting fictional scenes.