The Advisors' Blog

– Broc Romanek, CompensationStandards.com

Here is an excerpt from this blog by recently deceased Prof. Larry Ribstein about this paper from Prof. Harwell Wells and Randy Thomas about how the courts may be the only way to rein in executive compensation:

The paper suggests a new approach to controlling executive compensation: the courts. The paper is partly historical, noting that courts have, in fact, been “surprisingly willing to second-guess decisions on executive compensation,” although after doing so they ultimately withdraw from the field to avoid becoming “entangled in setting pay.” The article says Delaware’s recent Gantler v. Stephens, which recognizes fiduciary duties of corporate officers, “opens the door for courts to monitor executive compensation by scrutinizing rigorously officers’ actions in negotiating their own compensation agreements.” Thomas & Wells also draw on Delaware holdings “that corporate officers are bound by their duty of loyalty to negotiate employment contracts in an arm’s-length, adversarial manner.”

Thomas & Wells suggest their “approach should be welcomed by the courts, which will not be required to determine whether compensation packages are fair or merited, but will instead be asked to engage in a familiar task, examining whether proper procedures were followed in setting compensation.” The abstract concludes:

This approach promises to break an impasse between the two major academic approaches to executive compensation. Advocates of “Board Capture” theory have long argued that senior executives so dominate their boards that they can effectively set their own pay. “Optimal contracting” theorists doubt this, contending that, given legal and economic constraints, executive compensation agreements are likely to be pretty good and benefit shareholders. The approach advocated here should, surprisingly, please both camps. To Board Capture theorists, it offers to cast light on pay negotiations they believe are largely a sham; to Optimal Contracting theorists, it offers a way to improve the already adequate negotiating environment.