One quick comment on the Disney case. Both Elizabeth and Jeremy want to stick it to the Disney directors, but would the result have changed without the BJR? Justice Jacobs wrote: "The [Ovitz Employment Agreement] was specifically structured to compensate Ovitz for walking away from $150 million to $200 million of anticipated commissions from CAA over the five-year OEA contract term." If that's true, what basis do you have for suggesting that the actions of the board were substantively unreasonable?

1. An empirical question -- is it true that exec comp pay packages aren't linked to forward looking business plans? Extensive discovery about how and why the plans were designed as they were might unearth some useful information for competitors. I suspect that some plans out there are already linked to meeting hurdles -- I know this was true of some contracts I worked on a while ago, altho I'm less up to date on current practices.

2. Wouldn't Telman's rule lead to a re-design of pay packages so that they explicitly include (easy to meet) hurdles, thereby re-invoking the business judgement rule? In other words, I suspect comp committees could and would plan around the rule change to avoid scrutiny.

Having said that, I'm not sure it's a bad idea. Conditioning BJR protection on having the comp committees link incentive comp to business plan hurdles may not be a bad development.

Gordon, if you and your colleagues at Wisconsin wanted to hire me (good choice, by the way), and I said that I would only leave Richmond for $150 million, would I get it?

Similarly, I think Justice Jacobs was confusing what the directors looked at when pegging Ovitz's salary versus what they SHOULD have looked at. I don't care what it would take to get Ovitz - I care what he (or someone like him) is/was worth to Disney. It blows my mind that Justice Jacobs and his colleagues cared not a bit about that point.

To that end, I would like to link you to my recent, related post on concurringopinions.com, but I have no idea how to successfully do trackbacks. I will try. . . .
www.concurringopinions.com/movabletype/mt-tb.cgi/996

Perhaps some day some kind soul will tell me how to do trackback links.

Vic, I have been away for a year, but you do see what I think are being called "LTIPs": a very precise algorithmic long term incentive plan. I am cutting and pasting this from the Great Lakes Chemical 2004 Proxy Statement (which is still on EDGAR):

"The following table provides information related to long-term incentive awards granted to the Named Executives during 2003 under the Company's long-term incentive plan for senior executives. This plan was established to retain certain senior executives and to motivate them to maximize long-term shareholder value during the performance cycle from January 1, 2003 to December 31, 2005.

"For participants who are business unit leaders, components of any award will be as follows: 25 percent determined by the Company's performance on earnings per share, 25 percent by the Company's performance on return on investment and 50 percent by his or her business unit's performance on return on investment. For all other participants, components of any award will be as follows: 50 percent determined by the Company's performance on earnings per share and 50 percent by the Company's performance on return on investment. The maximum award amount when paid in restricted shares is 1.65 times the individual's base salary and target bonus for 2005. If the individual elects to receive a cash alternative, the maximum award amount will be 1.5 times the individual's base salary and target bonus for 2005.

"Awards will be paid under this long-term incentive plan only to the extent that the measures achieve at least a threshold. The thresholds, targets and maximums for earnings per share and return on investment are all significant "stretch" goals, requiring substantial performance by the Company, both on an absolute and relative year over year basis. Awards may be paid as to a component for which a threshold is achieved even if the thresholds of other components are not achieved. The threshold payouts are 25 percent of the maximum award amount for return on investment and 50 percent of the maximum award amount for earnings per share. If minimum performance for the measures is below the threshold level, then no payout will occur."

It was specifically designed to insure deductibility under IRS 162(can't remember the subsection).

I think GE's options are now designed to factor out "market appreciation" - i.e., the strike price increases to reflect gains that are attributable to exogenous market influence.

The last comment is interesting: what was Ovitz worth to Disney? The issue is who gets to make that decision. I can't imagine how business gets done if there is no presumption about the validity of the process, not the outcome. At the end of the day, why is the Delaware Chancery Court or a bunch of law professors more in touch with what an executive is worth? Using $150 million in incentives to recruit a law professor is off the point, just because the numbers are so off the point.

Bad cases make bad law - most incentive packages don't look like that one. Most people in the world don't understand how a twenty-five year old with no experience can be worth $130,000 a year in a big law firm. So while most comp packages don't look like Ovitz's, they still might look like a lot to an academic. (BTW, why do law professors tend to make so much more than, say, linguistics professors?) Are 750,000 options too many to grant an executive? Is it unreasonable to grant $1,000,000 in restricted stock as a "bring on" incentive? Is a three year severance payment based on last year's base and target bonus too much?

Is there really an empirical basis for saying directors have as little compensation expertise as the Delaware courts? Certainly with respect to their own compensation, the directors ought not to have a favorable presumption, but what is the basis for saying that directors have more or less compensation expertise than expertise in environmental, manufacturing, business valuation, litigation reserves, strategic planning, accounting, operational excellence, or the myriad of other things that fall within the management of the business and affairs of the corporation"? Do we really want any shareholder with $120 for a filing fee to second guess a board's decision on the question I raised above with no presumption in favor of the decision, and instead require Towers Perrin, Wyatt and Mercer (the big comp experts) to set up major offices in downtown Wilmington so as to staff the routine determination of executive compensation by the Delaware courts?

I do think Telman makes a convincing argument regarding why the rationales for the BJR appear inconsistent with the manner in which directors determine executive compensation, particularly on the issue of expertise. Yet I wonder like Gordon how far that gets us. If you believe that directors had a valid reason for hiring Ovitz, and that they legitimately believed that it would take $150 million to get him, then how does one respond to the question "how much is Ovitz worth to Disney?" I guess my question is, why isn't the answer $150 million regardless of how you frame the question?

Once again, let me start by thanking the folks at The Conglomerate for organizing this Workshop and Elizabeth Nowicki and Joan Hemingway for taking the time to read and comment on my BJR piece. That said, I fear that nobody else will ever read my Article, because Elizabeth Nowicki has managed to summarize my argument with great fidelity in a very short space.

As I said in my comments on Joan Hemingway’s post, I am very happy to read that she Elizabeth Nowicki found Part I of the Article useful. This is the first piece that I have written about which I can honestly say that it grew out of my classroom experience. I have been down in the trenches with my students trying to understand why the BJR exists and what role it plays in regulating the conduct of corporate boards. I kept Part I in the Article over the objections of those whose comments might be reduced to “no one could have wished it longer,” in part because I hope that, even if my argument about disclosure does not carry the day, students may still find in the piece a useful outline and critique of the main rationales for the BJR.

There is, I think, some overlap in Professor Hemingway’s critique of my functionalist approach to the BJR and Professor Nowicki’s suggestion that the Article explain in more detail how I reach the conclusion that the BJR is intended to protect corporations rather than directors. Both comments are astute and point to my failure to work through the logical steps necessary to my conclusion. It seems clear to me that in creating the BJR, courts were not interested in the directors in their individual capacities but as agents of the corporation who would not be able to act freely in the corporation’s interest if saddled with potential liability for ordinary negligence. It follows, in my view, that the BJR was always really intended to protect the interests of the corporation and that the focus on protecting individual directors is a case of misdirected intent. I need to better educate myself about the history of the BJR, but I would also argue that, even if I am wrong about what the BJR was designed to do, statutory developments now render it unnecessary with respect to directors. But it still seems a useful mechanism for protecting corporations from forced disclosure.

Elizabeth Nowicki provided a pithy response to Gordon’s Disney comment. I would add just a one additional thought. I do not think that I am advocating “sticking it” to the Disney directors. Rather, as the synopsis provided above indicates, my concern is that the BJR insulates decisions from substantive review and thus eliminates the incentive for good behavior that a standard of care ought to provide.

Vic Fleischer’s comments echo comments that I received from a reader who has served as general counsel to a public corporation and has also served on numerous boards. “If I were presented with the Telman rule,” he told me, “as GC, I would simply tell the court that the decision on executive compensation relates to prospective business plans.” Vic Fleischer’s answer to his own question is the same as mine. That representation would have to be true, and to the extent that it is true, this is already an improvement in the decision-making processes affecting executive compensation. Of course, this assumes that I am right on Vic Fleischer’s empirical question. Here I have relied on extensive secondary literature indicating that executive compensation is determined with reference to compensation schemes at comparable firms.

I’m not sure I quite understand what Jeff Lipshaw is getting at with the Great Lakes Chemical Proxy Statement. The fact that compensation is tied to performance does not mean that a court’s review of the formulas underlying that compensation would subject the corporation to forced disclosure of prospective business plans. In order for review of compensation plans to trigger the BJR’s protections, I would think, the corporation would have to argue that the executive in question was crucial to the corporation’s accomplishment of specific goals and that the compensation package was linked to the achievement of those goals.

But I think Jeff Lipshaw, Lisa Fairfax and Gordon Smith are all more fixated than I am on the amount of Ovitz’s compensation. The part of the Article on executive compensation takes Bebchuk and Fried as its point of departure. They profess agnosticism on the question of whether executive pay in the U.S. is inflated and merely criticize the decision-making processes through which it is set. I do not know if Ovitz was worth $150 million to Disney, and given that the Delaware courts determined that the BJR applied to the decisions to hire Ovitz and then fire him without cause, it strikes me as appropriate that those courts refrained from extensive comment on the substance of those decisions. But look, Graef Crystal acknowledged that there were oversights in review of Ovitz’s pay package. If those oversights resulted in a compensation package that all recognized as outrageous (say $150 million for a law professor – or worse, a history professor!), would we really want the BJR to protect such a decision because the decision-making process that led to it was faulty but not actionable?

Jeff Lipshaw: Section 162(m). Limits deductibility of executive comp unless, inter alia, the pay is peformance-based.

Jeremy: on the GLCC proxy, I was just answering Vic's question, with an example I know, about current forms of performance-based compensation. I don't think it's relevant to the BJR discussion.

As I said, bad facts tend to make bad law. (Let's see if I can throw several more cliches in here: I'm thinking the line "when you are a hammer everything looks like a nail" fits but not quite.) That is, if every case looked like Disney one might well be justified in saying "why not have a standard of review with no bias in favor of the board's judgment?" But that's not the context in which most cases arise, and my intuition (from being in the trenches with directors) is the negative impact in the vast majority of cases will overwhelm the few more egregious ones.

My sense is that the analogy in the article to ex post liability in litigation in other disciplines is wrong, and what follows is in the nature of thinking out loud. I'm not sure medical malpractice is the place to look for a system that has worked wonderfully - indeed, maybe the argument ought to be reversed, and there ought to be something like a medical judgment rule for doctors. But I can think of at least one difference off the bat - the doctor is not governing a dispersed organization with thousands of employees. So how we think about reviewing even the process of decision-making, not just the outcome, it seems to me is different. (Do I feel differently about being called to account for a judgment I make as a practicing lawyer versus my judgments, or lack thereof, sitting as a member of the board of trustees of my childrens' prep school? Do you have a different sense of accountability as between your own classroom teaching and your participation as a member of the faculty appointments committee?)

Jeff, with respect to Disney, I don't think one can say that bad facts make bad law because I don't think much law was made in Disney -- especially since the Supreme Court sidestepped most of the really tricky questions this last time around by finding them procedurally barred. I am not too concerned that Disney could become a precedent for the proposition that as long as directors are not willfully sticking their heads in the sand they will not be liable for breach of the duty of care, because the Chancery Court made clear that what was acceptable (though not optimal) corporate governance in the 1990s is not acceptable today.

As I wrote in response to Michael Guttentag on another thread, I am unpersuaded by the argument that perhaps we should retain heightened review in the BJR context and also heighten review in other professional contexts. This to me is the force behind Stephen Bainbridge's formulation of the BJR as an abstention doctrine. If we don't trust courts to distinguish between sound board decisions and negligent ones, why should we trust them to distinguish between negligent business decisions and grossly negligent decisions? Better to just abstain absent a showing of fraud, waste, self-dealing or illegality.

I don't think heightened review would change much about how malpractice claims are adjudicated. Plaintiffs attorneys would simply have to ramp up the rhetoric and courts would respond by routinely finding doctors not only negligent but grossly negligent. But I don't think abstention is a reasonable solution in professional contexts other than review of board decisiosn because abstention focuses on deliberative processes that are characteristic of boards and not of how doctors, engineers, architects, etc. are expected to make decisions.

Jeremy, to address both this and the other thread, perhaps my intuitions about this come from a base skepticism (acquired after many years as a law firm lawyer and a public company GC) about positive impacts on board behavior from doctrinal changes designed to make things better because of the threat of litigation (which of course is a subset of the entire "law & society" question). That is very much a classical lawyer's approach to resolving a problem; but does the threat of litigation (much less liability) in malpractice make doctors better, or does it create defensive medicine?

I remember an ass-chewing session from the managing partner when I was a young associate in a big law firm about work ethic. My work ethic, by and large, was fine (but not -aholic). It was those guys billing 1400 hours he was talking to. But they didn't care, so the people who left feeling defensive and beaten-up were those of us who already took it pretty seriously.

In the end, it's really an empirical question about the efficacy of doctrinal changes and litigation risk on the quality of the board deliberative process. My casual empiricism, having lived through the entire Enron-Sarbanes-shareholder democracy period with what I thought was a pretty conscientious public company board, is that the result of "legal engineering" (whether Sarbanes-like or case law doctrinal) is "defensive board practice": (a) board members spend more time worrying about their own exposure without significantly changing their own approach to deliberation and due care, (b) the company spends more time (and money) engineering better and more comprehensive forms of D&O insurance, and (c) good directors don't need the hassle, and decide to put their time to better use elsewhere (or at least contemplate doing so).