The Disney Opinion and Executive Compensation
I had the good fortune to be asked to review Professor Telman’s Business Judgment Rule, Disclosure and Executive Compensation article, over on the ‘glom. I enjoyed the paper, both because I think Professor Telman proposes an interesting way to attack recent executive compensation scandals and because I am currently working with my sister (the nicer, funnier, smarter Professor Nowicki) on an empirical paper on executive compensation, such that the topic weighs heavily on my mind. In addition, however, it was interesting to read Professor Telman’s article on the heels of the Delaware Supreme Court’s Disney opinion and its weak review of the Disney board’s analysis of Ovitz’s vulgar pay package. Indeed, Gordon Smith poses a query to Professor Telman (and perhaps me) on the ‘glom that is partially related to something I had intended to address earlier here, on concurringopinions.com. For what it is worth, then:
Executive Compensation and the “Ovitz Fiasco”
In my view, the Disney board failed in an amazing assortment of ways with respect to the hiring and compensation of Michael Ovitz, not the least of which include
(a) the failure to sufficiently consider/review/debate (become informed about) the decision to hire Ovitz (or the “decision to elect Ovitz as Disney’s President”) and
(b) the failure to review as a board at least to some minimal degree the OEA.
The Delaware Supreme Court, in its recent Disney opinion, did not do a strong job with addressing these failures, both in the collective and as the bevy of very distinct issues that they were. In its opinion, the court inappropriately collapses and poorly addresses four inquiries:
(1) Did Eisner have the authority to hire Ovitz into a senior-level position – e.g. delegate board authority to an officer ala normal agency principles and DGCL § 141 – without first securing official board approval?
(2) Did the board *as a group* have to debate/consider/review/become-informed-about the decision to elect Ovitz as Disney’s President?
(3) Was a full board vote needed when approving a very costly senior executive compensation package or could that sort of matter be finalized without full board ratification?
(4) If a full board vote was needed on the compensation package, was it permissible for the board to delegate the discussion and deliberation on the entirety of the Ovitz compensation issue to the compensation committee, such that all the full board needed to do is hear the comp. committee say “yep, fine with us” and the rest of the board could sign-off on the package? (Francis v. Smith?)
Let’s begin on pages 41-44 of the Disney slip opinion, where the court discusses the lower court’s “ruling that the full Disney Board was not required to consider and approve the OEA.” On page 42 of the slip. op., the court concludes that “The Chancellor’s ruling – that executive compensation was to be fixed by the compensation committee – is legally correct.” The court, with that statement, appears to be saying one of two things:
1. The Chancellor correctly concluded that Disney’s internal governance documents delegate – unquestionably- the issue of executive compensation to the compensation committee *or*
2. The Chancellor correctly concluded both that the internal governance documents so delegate and that the delegation is valid as a matter of law (e.g. “is legally permissible” or “is allowable by law”).
If the court is taking the first position, my response is “is that enough?” If the court is taking the second position, my response is “are you kidding?”
For the past four years, I have been teaching my students that, with respect to some matters of corporate governance, even when the issue at hand is delegated in the first instance to a Board sub-committee, the ENTIRE Board must review the matter at least to a degree before it is officially resolved. For example, if a Board’s Nominating Committee decides after much debate to slate a Board nominee who was once accused (seemingly on strong facts) of embezzling a significant amount of money (the charges never materialized and the case was never brought (perhaps because the accused was a political figure at the time)), my position is that the entire Board must be informed of the issue, appraised of the Nominating Committee’s concerns and ultimate reasoning which led to the nominee making it to the slate, and allowed, if so needed, to discuss the issue as a body. Contrariwise, is the Delaware Supreme Court in the Disney opinion saying that, by delegating matters to a committee, a big-ticket concern can be DELEGATED AWAY to *never* return for a full Board discussion, such that the Board as a whole can just rubber-stamp the committee’s decision without any sort of later full-board deliberation (on the accused embezzler and the propriety of putting him in a position to potentially be elected to serve on the Board, in my hypothetical)? That *cannot* be the position of the Delaware Supreme Court (yet that is what they seem to be saying).
On page 48, the court appears all giddy with excitement that the Disney Compensation Committee met twice – on September 26 and October 16, 1995. I will have to go back and check my notes, but wasn’t that basically *after* Einser had “hired” Ovitz? Phrased differently, after the CEO basically hired his long-time friend/acquaintance, what sort of pay leverage/flexibility does a Board really have? Moreover, is the court just skipping over the fact that nobody on the Board appears to try to back the train up and figure out whether Ovitz *should* have been hired in the first place by Eisner? Hiring Ovitz with basically no input from the Board seems like something the court might have wanted to mention. The court, on page 57 of the slip op., talks about whether the directors failed “to exercise due care in approving the hiring of Ovitz as the President of Disney.” Uhm, wasn’t that supposed to happen *before* Eisner brought Ovitz on board? I have to imagine it would have been hard, not to mention politically inadvisable, for Disney to have to turn around and “un-hire” Ovitz after Eisner basically hired him. As a matter of agency principles, can Eisner delegate to Ovitz some of the board’s DGCL § 141(a) powers without the board’s express permission in advance? I do not think so.
The court continues on page 57 of the slip op. to say that “[t]he appellants’ final claim . . . is that the Court of Chancery erroneously held that the remaining members of the old Disney board had not breached their duty of care in electing Ovitz as President of Disney. This claim lacks merit, because the arguments appellants advance in this context relate to a different subject – the approval of the OEA, which was the responsibility delegated to the compensation committee, not the full board.” The court then goes on to say on page 58 that the “only properly reviewable action of the entire board was its decision to elect Ovitz as Disney’s President.” I am not exactly sure how these three sentences jive, but I will not stop to quibble in full, given that the court is at least condescending to examine whether the board’s decision to elect Ovitz as President was beyond assail.
Indeed, the substance of the court’s review gives me plenty to object to, confusing introduction aside. The biggest problem I have with the court’s review on pages 58-60 of the board’s “electing Ovitz” decision is that it is scattered and poorly-focused. The court looks at the fact that the board was aware well in advance of September 1995 that Disney needed to hire a “number two” successor, and the court notes that there “had been many discussions about that need and about potential candidates who could fill that role.” Now, I might be misremembering the testimony from the trial, but I have no recollection of “many” full board discussions about other potential candidates. Where is the court’s discussion about how *many* candidates were considered? Where are the court’s citations to the trial transcript about the six or eight candidates that had at least been vetted to an initial degree? Where are the citations to the board deliberations (as a group) about why Ovitz was the best (or at least a preferable) candidate for the President position?
As to general discussions about need and potential candidates, I see no citations to any portion of the record that would indicate that the board ever met as a group to have a conversation along the line of the following:
We have a problem. Wells died, and Eisner is a people-skills/delegation-skills/team-playing/ego-managing/interpersonal-communications nightmare, so few people can work well with him. These are bigger problems than might initially seem to be the case, because (a) we need to have a successor in line for when Eisner leaves, (b) Eisner is a bit of a loose cannon such that having a second-in-command makes good management sense for purposes of monitoring Eisner’s decisions, (c) the fact that Eisner is, at best, abrasive and difficult to work with is going to make it challenging for us to find and retain a top-level, eager executive given that most good execs. do not need to deal with a pain like Eisner, and (d) if we wake up and start to realize that, at some point, we are likely to need to fire Eisner, we want to have something at least in the works for our “back-up” plan.
The court’s almost total failure to discuss the absence of this sort of board deliberation is unforgivable. The court notes on page 58 of the slip op. that “Eisner had individually discussed with each director the possibility of hiring Ovitz, and Ovitz’s background and qualifications,” but is the court *really* trying to say (with a figurative straight face) that individual, informal conversations are sufficient when dealing with a sensitive, high-level hire?
Further, the court makes much of the fact that “to accept a position at Disney, Ovitz would have to walk away from a very successful business.” The court tries to use this fact to both justify (a) the board’s decision to elect Ovitz as President and (b) the bloated pay package Ovitz is offered. My response to that mismatch between fact and justification is that Ovitz’s employment status prior to joining Disney has little to do with (a) his qualifications for the *Disney* position, (b) the question of whether he MERITED $140 million from Disney (regardless of what he merited from his prior employer), and (c) the issue of whether he was one of the best hires Disney was in a position to make. While I am on the topic of my response to the court’s reasoning, allow me to note that the court’s observation that the comp. com. did the right thing by comparing Ovitz’s option package to those awarded to Wells and Eisner astounded me. If I am understanding the court correctly, the court is saying that considering other bloated option grants within the bloated firm at issue is a valuable thing to do, when assessing whether Ovitz’s bloated compensation package was impermissibly inflated. Am I understanding that correctly? Is not the better course (the rational course) to look at option grants OUTSIDE the firm, to other Presidents at other businesses with similar backgrounds? And when the court, on page 51 of the slip op., appears to intimate that the compensation committee did the right thing in offering Ovitz that which he needed to be offered in order to leave his position at CAA, the court says nothing about the comp. committee needing to have, at some point, calculated whether Ovitz was *worth* the amount it would *take* to get him to leave CAA. That baffles me. Why would the court just *overlook* that failing? It matters not a whit to me what Ovitz *needed* to be paid to entice him to join Disney as President. What matters to me is what Ovitz was *worth.* And I fail to see the Delaware Supreme Court’s considered and thoughtful review of how the directors addressed exactly that point.