On March 1st, Vice Chancellor Lamb made a significant contribution to the growing body of caselaw involving challenges to executive compensation decisions. The case is Valeant Pharmaceuticals v. Jerney. Fellow guest contributor Broc Romanek has already blogged about the decision, recognizing its educational value on matters of executive pay. (Broc’s post includes a nice summary of the case from Delaware lawyer J. Travis Laster of Abrams & Laster.)

The Valeant opinion is a rare example of a case in which a court awards damages against a director for having approved excessive compensation. The case is not one, however, that blazes a path for challenges to executive compensation decisions made the “kosher” way, i.e., by compensation committees whose members meet stock-exchange-prescribed criteria for independence and who rely on truly independent compensation consultants.

…continue reading: A “Valeant” Effort

Notwithstanding Chancellor Chandler’s order last month delaying a shareholder vote on the deal, CVS and Caremark successfully closed their merger last week.  The Chancellor delayed the vote until Caremark disclosed to shareholders their right to seek an appraisal and the structure of the fees paid to UBS and J.P. Morgan, which stood to gain considerably more from a consummated deal with CVS rather than a deal with Caremark’s other suitor, Express Scripts.

Edward Herlihy, Eric Roth, Craig Wasserman, and Ross Fieldston of Wachtell, Lipton, Rosen and Katz have prepared a highly insightful Memorandum offering an insider’s view of the strategic considerations that guided the Caremark board during the merger process.  The Memorandum sets forth several critical lessons boards of directors can draw from the Caremark experience, including the importance of the strategic choices that permitted CVS to improve its bid without further delaying a shareholder vote.  In light of the increased scrutiny the courts are applying to board decisions made during the auction process, the Memorandum is a must-read for directors and transaction counsel alike.

Ehud Kamar presented a fascinating new paper last night at the Law School’s Law and Economics Seminar: Going-Private Decisions and the Sarbanes-Oxley Act of 2002: A Cross-Country Analysis.  The paper, which is coauthored by Pinar Karaca-Mandic and Eric Talley, uses a difference-in-differences approach to measure whether small firms are being driven out of the U.S. capital markets by Sarbanes-Oxley.  The Abstract is as follows:

This article investigates whether the passage and the implementation of the Sarbanes-Oxley Act of 2002 (SOX) drove firms out of the public capital market.  To control for other factors affecting exit decisions, we examine the post-SOX change in the propensity of public American targets to be bought by private acquirers rather than public ones with the corresponding change for foreign targets, which were outside the purview of SOX.  Our findings are consistent with the hypothesis that SOX induced small firms to exit the public capital market during the year following its enactment.  In contrast, SOX appears to have little effect on the going-private propensities of larger firms.

Ehud’s presentation at the Seminar was followed by a lively debate with faculty and students.  Some highlights:

…continue reading: Ehud Kamar’s Study on the Consequences of SOX

Vice Chancellor Leo Strine, who teaches at Harvard Law each fall, last week issued an opinion with potentially significant implications for shareholder challenges to going-private transactions in In re Netsmart Technologies, Inc.  The opinion holds that a board may fail to meet its Revlon duties when it considers only bids from financial buyers–to the exclusion of strategic acquirers–and that a firm must disclose valuation opinions suggesting that the firm is worth more as a standalone entity in the merger proxy.

Netsmart’s board considered only bids from financial buyers before signing a merger agreement with a window shopping provision.  (Although Netsmart was prohibited from soliciting a higher bid, the window shopping clause authorized them to accept an unsolicited bid.)  In cases involving larger firms, Chancery has suggested that window shopping clauses ensure that the board accepted the highest bid, for other bidders are free to step in and pay more.  But Netsmart is quite small, and the Vice Chancellor concludes on these facts that a window shopping provision offers little market assurance for small firms because other buyers might not know that the firm is in play and the company is prohibited from actively soliciting a higher bid.

Paul Rowe, a member of the Program on Corporate Governance’s Advisory Board and a partner at Wachtell, Lipton, Rosen & Katz, has authored a Memorandum on the decision.  The Memorandum notes that the Netsmart board used an increasingly common approach to the auction, and that previous Delaware cases had approved window shopping provisions under different circumstances.  Emphasizing the fact-specific nature of the opinion, Paul concludes that Chancery will probably continue to defer to the judgment of boards in structuring the auction process, but that boards must ensure that the auction procedure they establish is appropriate in light of the particular circumstances of the merger market for the firm.

…continue reading: Chancery Addresses Deficient Board Procedures in Approving Private Equity Transactions

It has recently been suggested by some commentators on these pages that CEOs add great value and are entirely deserving of the substantial compensation they have been paid.  The example of Jim Kilts–who, it is claimed, created some $20 billion in share value at Gillette and received total compensation of $150 million for his work–was cited with approval.

I have been observing with considerable skepticism the course of CEO remuneration over a number of years, having dubbed excessive CEO pay the “mad cow disease of the North American boardroom.”  Empirically–as many who have spent much time in and around the boardroom will acknowledge–there is a point where additional tens of millions become marginal as an inducement to higher performance.  In my view, that point occurs very early in the compensation tally.

…continue reading: Just Who is Creating This Value, and at What Cost?

An article in today’s Wall Street Journal describes the continuing debate on the Securities and Exchange Commission’s rulemaking on mutual fund governance.  In 2004, the SEC adopted rules (by a split vote of 3-2) that would have required mutual funds to have a 75% independent board and would have required that the chairman of the board be independent.  The D.C. Circuit struck down that rule (for the second time) last June.  In December, the SEC released for comment two papers on mutual fund governance prepared by the Office of Economic Analysis.

At Fidelity’s request, I reviewed and commented on the OEA’s papers in this report filed with the SEC.  The report, which draws on a recent paper I coauthored with R. Glenn Hubbard, Competition and Shareholder Fees in the Mutual Fund Industry, notes that the OEA’s analysis contributes significantly to the debate on the desirability of the mutual fund governance rules.  The report also points out, however, that the OEA papers:

–Acknowledge (although underemphasize) that no empirical data supports the need for the 75% independence rule or the independent chair mandate;

…continue reading: Comments on the SEC’s Mutual Fund Governance Rules

The trial of former Qwest CEO Joe Nacchio begins next Monday, March 19, in the federal district courthouse in downtown Denver.  It is the last significant criminal case arising out of the corporate scandals that led to the adoption of Sarbanes-Oxley.  The SEC case against Nacchio is pending.  Qwest has already settled with the Commission in an agreement that included a $250 million civil penalty. 

The 42-count criminal indictment (a mere six pages long) does not revolve around financial fraud but insider trading.  It alleges that Nacchio sold shares worth more than $100 million while aware of material non-public information, with the indictment alleging that he was “specifically and repeatedly warned about the material, non-public financial risks facing Qwest and about Qwest’s ability to achieve its aggressive publicly stated financial targets.”   

TheRacetotheBottom.org will provide daily coverage of the trial.  The blog is a collaboration of students and faculty on corporate governance issues.  Faculty and students will rotate through the eight-week trial with the expectation that there will be at least two posts each day the trial is in session (the trial will not be conducted on Fridays).  Primary materials on the case can be found at the University of Denver Corporate Governance web site. 

The Wall Street Journal ran an article on the front page of today’s paper entitled How Five New Players Aid Movement to Limit CEO Pay.  The article profiles five individuals, each representing a different type of player in what the Journal calls “an unusual movement that has turned executive-pay activism into a potent mainstream force.”

The five players include Lucian Bebchuk (who the article describes as “The Professor”); Jesse Brill (”The Networker”), who brought about the use of “tally sheets” in calculating the amount of compensation a company will owe if an executive leaves the firm; pension fund activist and assistant treasurer for the State of Connecticut Meredith Miller (”The Bureaucrat”); John Hill (”The Mutual-Fund Trustee”), who is credited with the assertive stance that Putnam Investments has been taking towards executive pay; and union fund official Edward Durkin (”The Union Leader”).

…continue reading: Executive Pay Players

I thought I’d mention two items on Warren Buffett’s views on executive pay.  (Broc Romanek posted here on Buffett’s 2007 letter to shareholders.  In that letter Buffett described current pay practices as “[i]rrational and excessive.”)

First, Berkshire Hathaway does not disclose what it pays its operating executives.  I would be curious to know how much Buffett pays them.  Second, Buffett was a strong supporter of Jim Kilts at Gillette.  Kilts was paid highly for performance, created some $20 billion in value, yet was criticized in some circles for being overpaid because he received over $150 million.  I happen to agree with Buffett that Kilts should have been congratulated rather than criticized.

Steve Kaplan posted below on the hearing that the Financial Services Committee of the House of Representatives held last week on proposed legislation that would require public companies to hold each year an advisory shareholder vote on the company’s executive compensation in the preceding year.

In my written testimony, I explained: (1) the significant concerns that investors still have about existing executive pay arrangements; (2) the way in which advisory votes by shareholders could help address these concerns; (3) why the weakness of existing shareholder rights in the US makes the need for additional tools for investors greater in the US than it was in the UK (which now mandates shareholder advisory votes on compensation).  I also examined and responded to several possible objections to shareholder advisory votes.  Because I am considering developing my written statement into a piece on the subject, any comments or reactions either on the blog or directly to me would be most welcome.

…continue reading: The Hearing on Say on Pay

Chairman Barney Frank and the House Committee on Financial Services held hearings last week on CEO pay.  Lucian Bebchuk, Nell Minow and I were among those who testified.  My testimony is available here.  The testimony argues and presents evidence that the typical CEO is not overpaid. 

Two points are worth emphasizing.  First, the top 25 hedge fund managers earned more in 2004 than all 500 S&P 500 CEOs combined.  The same was true in 2005.  Second, when pay is measured by the amount of money CEOs actually receive (which includes exercised options), the typical CEO is highly paid for performance.

Last week, Bristol-Myers Squibb followed Home Depot to become the second company to reform its pay-setting process on the basis of shareholder proposals I submitted.  Last fall I submitted to Bristol-Myers Squibb a shareholder proposal to adopt a bylaw provision requiring that decisions about the CEO’s compensation be ratified by three-quarters of the company’s independent directors.  The text of the proposal and an accompanying supporting statement are available here. 

The company initially sought to exclude the proposal from the ballot, and I filed with the SEC a letter opposing the company’s request for a no-action letter.  Subsequently, however, the company and I reached an understanding under which the company agreed to adopt the proposed arrangement as a corporate governance guideline and I agreed to withdraw the proposal.

Last week the company’s Board of Directors approved the revision of the company’s corporate governance guidelines, which now state the following: “The Chief Executive Officer’s compensation must be approved by at least three-fourths of all the independent directors of the Board.”  In addition, the Board approved corresponding language changes in the charter of the Compensation and Management Development Committee.  Both the Corporate Governance Guidelines and the Compensation and Management Development Committee Charter are available on the company’s website here.

Earlier on, following my submission of a proposal to Home Depot, Home Depot and I reached an understanding under which the company amended its bylaws to implement the proposed arrangement and I withdrew my proposal.

…continue reading: Bristol-Myers Squibb Adopts My CEO Pay Proposal

At their annual meeting today, the shareholders of the Walt Disney Company voted a proposal I submitted to adopt a bylaw provision concerning board adoption of poison pills that I submitted. With 879,028,289 FOR and 626,587,117 AGAINST, and 25,884,804 abstentions, the proposal won about 57% of the votes cast.

Although the proposal failed to get the majority necessary for amending the bylaws, the majority vote in its favor reflected strong shareholder support, and Disney’s chair John Pepper announced at the meeting that the board will give the proposal a “prompt and serious consideration.”

The Disney proposal is of a similar type to the one that I submitted to CA last spring. CA had to place the proposal on the ballot following litigation in the Delaware Chancery Court. An article about this type of bylaw is available here. At the CA annual meeting, the proposal got 41% of the votes, which induced CA to adopt a new pill whose terms enable shareholders to redeem it when a qualified offer is made.

…continue reading: Pill Bylaw Proposal Gets 57% of Votes Cast at Disney

Lynn Stout (Paul Hastings Professor of Corporate and Securities Law at UCLA School of Law) today in the Wall Street Journal argues against allowing shareholder access to management’s proxy statement to elect directors, something under consideration by the Securities and Exchange Commission.  

There are plenty of pros and cons to this approach (the pros far outweighing the cons) but Professor Stout comes up with a new one: Reacting to “whiny” and “shrill” investors, more companies will eliminate public shareholders altogether and sell out to private equity firms. 

There are many many problems with the editorial, but mostly Professor Stout is wrong to attribute private equity buyouts to fatigue over shareholder demands.  In fact, management engages in these transactions for the same reason as anyone else: financial gain.  As Professor Stout herself notes, managers typically get a piece of the company and annual returns averaging 20-25% a year.  That these transactions are more common is attributable to the extraordinarily high degree of liquidity and the large number of private equity firms chasing deals.  

…continue reading: “Whiny” Shareholders and Access to Management’s Proxy Statement

Always a fascinating read, here is Warren Buffett’s 23-page 2007 letter to shareholders.  Warren always has something to say about executive compensation practices, and this year’s letter is no exception.  On page 19, he notes that he has served as a director on 19 boards and he has been the “Typhoid Mary” of compensation committees:

“At only one company was I assigned to comp committee duty, and then I was promptly outvoted on the most crucial decision that we faced.  My ostracism has been peculiar, considering that I certainly haven’t lacked experience in setting CEO pay. At Berkshire, after all, I am a one-man compensation committee who determines the salaries and incentives for the CEOs of around 40 significant operating businesses.”

…continue reading: Warren Buffett’s Frustration Over CEO Pay Practices

The Journal of Economic Perspectives recently published my article, The Goals and Promise of the Sarbanes-Oxley Act.  The article responds to criticism of Sarbanes-Oxley as a costly regulatory overreaction, arguing that Sarbanes-Oxley, while imperfect, is likely to bring net long-term benefits.  The abstract describes the article as follows:

The primary goal of the Sarbanes-Oxley Act was to fix auditing of U.S. public companies, consistent with its full, official name: the Public Company Accounting Reform and Investor Protection Act of 2002.  By consensus, auditing had been working poorly, and increasingly so.  The most important, and most promising, part of Sarbanes-Oxley was the creation of a unique, quasi-public institution to oversee and regulate auditing, the Public Company Accounting Oversight Board (PCAOB).  In controversial section 404, the law also created new disclosure-based incentives for firms to spend money on internal controls, above increases that would have occurred after the corporate scandals of the early 2000s. 

…continue reading: The Goals and Promise of the Sarbanes-Oxley Act