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References
See especially M. Jensen and K.J. Murphy, ‘CEO Incentives: It’s Not How Much You Pay, But How’, 68 Harvard Business Review (1990) p. 138; and M. Jensen and K.J. Murphy, ‘Performance Pay and Top Management Incentives’, 98 Journal of Political Economy (1990) p. 225.
Between 1992 and 2000, the average real (inflation adjusted) pay of chief executive officers (CEOs) of S&P 500 firms more than quadrupled, climbing from $3.5 million to $14.7 million. This increase far outstripped that of compensation for other employees. In 1991, the average large-company CEO received approximately 140 times the pay of an average worker, while in 2003 the ratio was about 500:1. The most pronounced component of the trend has been the explosion in stock option grants, with the value of option-based compensation (on a Black-Scholes basis) increasing ninefold during the bull market of the 1990s (figures drawn from p. 1 of Pay without Performance).
Since the early 1990s, the number of studies aimed at explaining the various features of executive compensation arrangements has grown even faster than the CEO pay packages: see K.J. Murphy, ‘Executive Compensation’, in O. Ashenfelter and D. Card, eds., Handbook of Labor Economics, Vol. 3, bk. 2 (New York, Elsevier 1999).
In most US corporations, the board of directors is responsible for determining the compensation of the CEO and other top executives, following the indications of the internal ‘compensation committee’. However, corporate by-laws may grant the compensation committee full and exclusive authority on the issue.
See, among others, L.J. Barris ‘The Overcompensation Problem: A Collective Approach to Controlling Executive Pay’, 68 Indiana Law Journal (1992) p. 59; E.W. Orts, ‘Shirking and Sharking: a Legal Theory of the Firm’, 16 Yale Law and Policy Review (1996) p. 265; C.M. Yablon, ‘Bonus Questions — Executive Compensation in the Era of Pay for Performance’, 75 Notre Dame Law Review (1999) p. 271.
See L. Bebchuk, J. Fried and D. Walker, ‘Managerial Power and Rent Extraction in the Design of Executive Compensation’, 69 University of Chicago Law Review (2002) p. 751; L. Bebchuk and J. Fried, ‘Executive Compensation as an Agency Problem’, 17 Journal of Economic Perspectives (2003) p. 71.
‘Nominating committees’ tend (and are also advised by the majority of business experts) to consult with the CEO before choosing the candidates that are placed on the company’s slate submitted to a shareholders’ vote.
The factors taken into consideration by Bebchuk and Fried are: friendship and loyalty among directors, collegiality and team spirit within the board, deference towards the CEO, ‘cognitive dissonance’ that might affect independent directors who are or were executives themselves and a lack of sufficient time and information.
Moreover, in the last part of the book, Bebchuk and Fried express some concerns about the potential conflict of interests that could stem from directors’ equity-based pay.
On the one hand, the recent decision in the Disney case (In Re The Walt Disney Company Derivative Litigation, 2005 Del. Ch. LEXIS 113, 9 August 2005), currently under appeal before the Delaware Supreme Court, seems to be consistent with this assessment, since it confirms the high burden of proof imposed on the shareholder plaintiffs to rebut the ‘business judgment rule’. On the other hand, positive conclusions as regards the potential use of litigation may be drawn from another recent Delaware case (Official Committee of Unsecured Creditors of Integrated Health Services, Inc. v. Elkins, 2004 Del Ch. LEXIS 122, 24 August 2004) and from an empirical analysis of a large number of executive compensation cases, which found that in public companies plaintiffs have won significant victories in 32 per cent of the cases in that sample (R. Thomas and K.J. Martin, ‘Litigating Challenges to Executive Pay: An Exercise in Futility?’, 79 Washington University Law Quarterly (2001) p. 593).
A practice already implemented in most US public companies even before the new listing requirements of the major US stock exchanges made it mandatory in 2003.
The arrangements identified as evidence of camouflaged rents granted to executives are: gratuitous payments when executives decide (or are asked) to leave, postretirement payments and benefits that are channelled through non-transparent forms (i.e., ‘supplemental’ executive retirement pensions, deferred compensation, postretirement perks and guaranteed consulting fees) and executive company loans granted at significantly below market rates and in many cases subsequently forgiven by the company (pp. 87–117).
In particular, Bebchuk and Fried reach this conclusion focusing at length on: the lack of any kind of term that would eliminate managers’ windfalls from stock price increases that are unrelated to their own performance (such as indexing the stock options’ exercise price to market movements); the uniform practice of setting the stock options’ exercise prices equal to the company’s stock price on the date of the grant, although exercise prices should be set according to firm-specific factors; the widespread practice of ‘repricing’, that is, reducing exercise prices when the company stock price has fallen well below the exercise price and thereby reducing the ex ante incentive effect of stock options; the lack of arrangements that would limit managers’ ability to ‘unwind’ (i.e., to immediately exercise the just-vested options and sell the acquired shares) and would therefore prolong the incentive effect, while screening out the risk of excessive short-termism (.pp. 137–185).
Following the comments received and the appointment of the new SEC President, the proposal (SEC Release Nos. 34-48626) is very unlikely to be brought forward by the SEC.
S.M. Bainbridge, ‘Executive Compensation: Who Decides?’, 83 Texas Law Review (2005) p. 1615; W.B. Bratton, ‘The Academic Tournament over Executive Compensation’, 93 California Law Review (2005) p. 1557; J.E. Core, W.R. Guay and R.S. Thomas, Is U.S. CEO Compensation Inefficient Pay Without Performance?, Vanderbilt University and University of Pennsylvania Working Paper (2004); J.N. Gordon, Executive Compensation: What’s the Problem, What’s the Remedy? The Case for ‘Compensation Discussion and Analysis, Working Paper, Columbia Law School and European Corporate Governance Institute (ECGI) (2005); M.C. Jensen and K. Murphy (in collaboration with e. g. Wruck), Remuneration: Where We’ve Been, How We Got Here, What are the Problems, and How to Fix Them, ECGI Finance Working Paper (2004), all available at: http://www.ssrn.com. For further discussion of Pay without Performance, see the Columbia Law School ‘Symposium on Executive Pay’, 15 October 2004, available at: http://www.law.columbia.edu.
I.e., they ‘minimise agency costs and the cost of residual divergence’ since they anticipate and minimise the costs of managerial power and other agency costs.
Along this line of thought, see Core, Guay and Thomas, op. cit. n. 15; Bainbridge, loc. cit. n. 15; and Gordon, op. cit. n. 15, all noting that current practices may be due to favourable tax treatment or may induce and protect managers’ investments in firm-specific human capital. On the use of ‘golden parachutes’ and stock options as ‘equilibrating’ or ‘adaptive’ devices within the US corporate governance system in general, see M. Kahan and E.B. Rock, ‘How I Learned to Stop Worrying and Love the Pill: Adaptive Responses to Takeover Law’, 57 University of Chicago Law Review (2002) p. 871.
Core, Guay and Thomas, op. cit. n. 15.
Bainbridge, loc. cit. n. 15; Gordon, op. cit. n. 15; Jensen and Murphy, op. cit. n. 15.
Gordon, op. cit. n. 15; Jensen and Murphy, op. cit. n. 15.
H. Manne, ‘The Follies of Regulation’, The Wall Street Journal, 27 September 2005.
Indeed, the new listing rules have tightened the requisites for ‘independent directors’, increased the role of independent directors in the nominating process and assigned the task to hire compensation consultants exclusively to the compensation committee (Pay without Performance, pp. 26–29). The Sarbanes-Oxley has prohibited executive loans, with some exceptions, and has introduced ‘stricter disclosure rules that will reduce firms’ ability to let managers profit from trading on private information’ (ibid., p. 183).
The cases and the literature mentioned supra in n. 10 give account of the higher scrutiny that is dedicated to executive pay by shareholders and the courts.
See the US accounting standard FAS 123(R), approved by the US Financial Accounting Standards Board.
See SEC release 34-53185.
On the debate over directors’ ballot reform, see the opinions expressed at the Yale Law School Symposium ‘Reassessing Director Elections’, 7 October 2005, available at: http://www.law.yale.edu, and at the Harvard Law School ‘Symposium on Corporate Elections’, October 2003, available at: http://www.ssrn.com.
On this issue, see B. Holmström and S.N. Kaplan, The State of U.S. Corporate Governance: What’s Right and What’s Wrong?, ECGI Finance Working Paper (2003), available at: http://www.ecgi.org. For an overview of different views expressed with regard to the proposed reforms of the current US corporate governance system, see S.M. Bainbridge, ‘Director Primacy and Shareholder Disempowerment’, 119 Harvard Law Review (2006) p. 1735; L.E. Strine, ‘Toward a True Corporate Republic: A Traditionalist Response to Bebchuk’s Solution for Improving Corporate America’, 119 Harvard Law Review (2006) p. 1759; and L.A. Bebchuk ‘Letting Shareholders Set the Rules’, 119 Harvard Law Review (2006) p. 1784.
G. Ferrarini, N. Moloney and C. Vespro, Executive Remuneration in the EU: Comparative Law and Practice, ECGI Law Working Paper (2003), available at: http://www.ecgi.org; G. Ferrarini and N. Moloney, ‘Executive Remuneration and Corporate Governance in the EU: Convergence, Divergence and Reform Perspectives’, in G. Ferrarini, K.J. Hopt, J. Winter and E. Wymeersch, eds., Reforming Company and Takeover Law in Europe (Oxford, Oxford University Press 2004).
For data, see M. Becht, P. Bolton and A. Roell, Corporate Governance and Control, ECGI Finance Working Paper (2002), available at: http://www.ecgi.org; Ferrarini et al., op. cit. n. 28.
See G. Ferrarini and N. Moloney, Executive Remuneration in the EU: The Context for Reform, ECGI Working Paper (2005), available at: http://www.ecgi.org.
e. g., in Germany, where on 10 August 2005 a law was enacted that requires listed companies to disclose the compensation granted to each of the members of the Vorstand (management board) (Gesetz über die Offenlegung der Vorstandsvergütungen). However, a provision within the new German law allows companies to forgo the disclosure requirement (for a maximum period of five years) if shareholders holding 75 per cent of the voting capital agree with a management resolution limiting disclosure. In Italy, whose regulations already required a high standard of disclosure, the new version (2006) of the ‘corporate governance code’ for listed companies (required on a ‘comply or explain’ basis) and Art. 16 of the so-called ‘Law on Savings’ (L. n. 262/2005) have strengthened corporate governance checks on executive pay and further enhanced the degree of transparency. In Sweden, pay disclosure has recently been improved by a revised ‘comply or explain’ Swedish governance code (2005).
See Ferrarini and Moloney, op. cit. n. 30.
See L. Enriques, Company Law Harmonization Reconsidered: What Role for the EC?, ECGI Law Working Paper (2005), available at: http://www.ecgi.org. Specifically on the European Community’s attempt to harmonise executive pay regulation, see Ferrarini and Moloney, op. cit. n. 30.
See Ferrarini and Moloney, op. cit. n. 30.
On the drawbacks of bonus-based schemes, see, among others, Jensen and Murphy, op. cit. n. 15.
See D. Yermack, ‘Remuneration, Retention, and Reputation Incentives for Outside Directors’, 59 Journal of Finance (2004) p. 2281.
See p. 34 (and accompanying footnotes). However Bebchuk and Fried eventually express scepticism towards this solution (pp. 205–206).
The Combined Code on Corporate Governance (which is prescribed on a ‘comply or explain’ basis) requires listed companies to explain in the annual remuneration statement the reasons for granting performance-related incentives to non-executive directors, makes these grants conditional on a shareholders’ vote and allows directors to sell their shares no earlier than one year after they have left the company (§§ A.3.1 and B.1.3).
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Cappiello, S. Lucian Bebchuk and Jesse M. Fried, Pay without Performance: The Unfulfilled Promise of Executive Compensation (Cambridge, MA, and London, UK, Harvard University Press 2004) xii + 278 pp., ISBN 0-674-01665-3 doi10.1017/S1566752906217531. Eur Bus Org Law Rev 7, 753–763 (2006). https://doi.org/10.1017/S1566752906007531
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DOI: https://doi.org/10.1017/S1566752906007531