Ever since the Detroit automakers’ CEOs took the ill-advised step of flying to DC on private jets to ask Congress for financial assistance, the private jet industry appears to have taken a hit.   To be sure, like other industries, the private jet industry already was experiencing difficulties as a result of the financial and economic crisis.  Moreover, business travel in general was suffering as a result of the crisis.  But that travel, along with the corporate jets sometimes used to facilitate that travel, also appears to have suffered from the negative image of corporate excess associated with such travel and private jets.  The president of the National Aviation Transportation Association is quoted as saying that “Most of us in the industry feel like we were the victims of a drive-by shooting.”  This gets reflected in the seeming decline of private jet use.  Hence, while companies have felt pressure to get rid of their corporate jets in the wake of public criticism, the public criticism has made it difficult for companies to sell their jets.  Illustrative of this point, a recent New York Post article lists several companies (including Coca Cola, Starbucks, and Xerox) seeking to unload their private jets without success—Citigroup’s jet had been on the market for 321 days.   News reports suggest that the waning use of corporate jets has had an impact on those who depend upon the industry, bankrupting some companies and prompting others to cut their workforce.  One industry expert notes that while 90% of the economic woes associated with the private jet industry stem from the general economic environment, the remainder results from the negative image associated with corporate jet use and companies resulting reluctance to be caught owning or using one.  To what extent is the image accurate?

Industry insiders say that the image has little connection with reality.  In February of 2009, the industry launched a campaign counteract the criticism of the private jet industry complete with numerous interviews and the unveiling of a website called “No Plane No Gain”.  The campaign is aimed at highlighting the importance of the industry to our economy, and thus notes, among other things, that private jets are used mainly by middle management.  According to the site, in contrast to the image of CEO’s excessive use of such jets, more that 70% of jets are used by “sales, technical and middle management employees.”  Moreover, the site insists that private jets are not just an unnecessary luxury, but instead are used to travel to cities not served by commercial airlines, or to provide service to cities for which commercial airlines only provide limited service, or to provide relatively short service to cities for which the commercial airline schedule generally involves hours or even day long connections.  In this regard, the jet industry saves corporations money by ensuring that corporate employees get to their destination in a timely and efficient manner.   Then too, the site notes that the industry employs more than 1.2 million people and generates some $150 billion a year for the economy.  The site even emphasizes the manner in which such jets help volunteer organizations bring critical supplies and services to communities in need.  Hence, the site paints a picture of a vital industry that has been unfairly criticized, while highlighting the concern that the criticism not only could hasten the industry’s downfall, but also could hamper its recovery.

By contrast, there are some who believe the industry should be curtailed, particularly in difficult economic times.  Certainly the auto executive’s trip to DC sparked a lot of outrage from the public and Congress.  Moreover, at least one researcher has argued that private jets really are not beneficial, and his (albeit criticized) study of the industry concludes that such jets harm the environment, cost shareholders unnecessary money, and that the industry does not pay its fair share of the costs associated with the traffic control system, and thus harms the public. 

And there is a new wrinkle in the debate about the industry.  A recent report reveals that CEO use of private jets actually rose in 2008.  In fact, the report suggest that, even if there is some genuine concern about excessive use of private jets, that concern has had little impact on corporate behavior.  As a New York Times article notes, if the report is accurate, it is certainly puzzling in light of the tales of plummeting use and sales and the general industry outrage about how public criticism is driving that decreased use and sales.   

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Between live-blogging the mid-year meeting last week and catching up back home, I'm just now getting into all of the TARP stuff the administration announced last week.  I have two initial reactions from my quick skim, and I'll put them in two separate posts.

First, Treasury is prohibiting gross ups for TARP recipients, and I think that's a very good thing.  Gross-ups basically reimburse executives for the taxes they pay on compensation.  The problem is that these reimbursements create new taxable compensation, and the company then has to cover taxes on that new amount, which is then also taxable.  This creates a tax death spiral.  According to a Mark Maremont WSJ article from December 22, 2005, "Grossing up an executive for taxes on $1 million can easily cost an additional $700,000 to $900,000."  Gross-ups always struck me as a weaselly and wasteful way to increase executive pay under the table.  The CEO gets the benefit of not paying taxes, but the company has to pay a lot more in taxes than it otherwise would.  Why not just pay the guy more up front?  Oh, because it looks bad.  Highly compensated employees of TARP recipients shouldn't get gross-ups.  Maybe no one should.

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 Yesterday, Exxon shareholders voted against all eleven of the shareholders proposals on the company’s proxy statement.  So it appears that the extra effort to reach out to mutual fund shareholders did not have the desired impact on the vote.  In fact, the proposal to split the CEO and chair functions garnered only 29.5% of the vote, a ten percent decrease from last year.  Moreover, despite the extra outreach by shareholders, Exxon’s annual meeting was notable because of the lack of protesters outside of the meeting place.  So perhaps the meeting and its outcome reveal that the financial crisis has had an impact on shareholder activism, making shareholders more hesitant to rock the boat and less willing to support initiatives that may impinge on managers’ discretion or otherwise pressure them to divert resources on green initiatives, despite assertions that such initiatives could improve the financial bottom-line in the long term.

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As you would expect, Lucian Bebchuk is in favor of the SEC's new proxy access proposal. In an editorial in today's W$J, he focuses on the issue of whether "one size fits all" in proxy access:

Opponents of the SEC's proposal argue that the SEC shouldn't impose a blanket rule about proxy access, but rather should leave the provision of proxy access arrangement to company-by-company choices. One size does not fit all, the argument goes, and the SEC's proposal would prevent variation and experimentation.

It is ironic that opponents of proxy access now raise the banner of company-by-company choices. In 2007, the SEC examined whether to let shareholders propose bylaw amendments that would establish proxy access for shareholders seeking to nominate directors. At that time, opponents of proxy access persuaded the SEC to prohibit the inclusion of such proposals on the ballot. This prohibition made it rather difficult for shareholders to adopt proxy access arrangements on a company-by-company basis. For many opponents of proxy access, then, uniformity seems to be quite acceptable when it doesn't involve shareholder access but becomes unacceptable when it does.

In fact, the proposed SEC rule would allow some meaningful variation. The proposal would establish some mandatory requirements as to shareholders nominations that would have to be included, but would allow companies to adopt arrangements providing shareholders with more expansive access to the company's proxy.

On the issue of federalism:

Opponents also argue that establishing any minimum requirements for inclusion of director candidates on the company's proxy card departs from the SEC's traditional role into an area best left for state corporate law. However, the SEC's proxy rules already mandate the inclusion of some information, including certain shareholder proposals, on the corporate ballot and accompanying proxy materials. The SEC's proposal would merely expand the current mandatory requirements, and wouldn't enter any new territory.

I am reserving judgment on the details of the new proposal until I have more time to study it, but I side with Lucian on the need for election reform. And this new proposal is sparking a healthy debate.

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First, the basics.  Shareholders will be able to include a nominee in the company's proxy materials under the following guidelines: For companies with a market value of $700 million or more, only shareholders with at least 1% of the voting securities will be eligible to nominate.  That percentage threshold requirement increases to 3% for companies with between $75 million and $750 million in market value, and 5% for companies with a market value lower than $75 million.  This rule also applies to mutual fund trustees as well as public company directors.

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The SEC is proposing amendments to the proxy rules to allow for shareholder nominations of directors. Mary Shapiro's announcement speech is here. (text) NYT story here.

A broad description from Shapiro:

I haven't seen the proposal, yet, but a Bloomberg story offers some intriguing details:

I was not a fan of the previous proxy access proposal, but this one sounds more promising. I will follow up with some detailed analysis in later posts.

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The worst vice, as they say, is advice. But Senator Schumer's "Shareholder Bill of Rights" is set to be released today at 11:30, and based on what I have been learning about the proxy access and say-on-pay provisions of the Schumer Bill, I thought that I would share some free investment advice with the Glom community on how I think these developments in Congress and the SEC will translate into investment opportunities. As I mentioned in my last post, I think that the Schumer Bill will legislatively buttress the proxy access initiatives already underway at the SEC. 

If a bill directly authorizing proxy access is passed it means there is no hope that the DC Circuit will be able to overturn an SEC access rule.  I think that this only firms up my long held opinion that Riskmetrics, and to a lesser extent its competitors, is a rational bet at this point. It trades, by the way, under the symbol RMG.  I should note that one reason I very much think that any proxy access rule that comes out of the SEC will benefit Riskmetrics is that SEC Chairman Schapiro hired a top level Riskmetrics Executive as her advisor on proxy access issues, see here.  

The say-on-pay element of the Schumer bill is also interesting.  Say-on-pay was introduced by Obama in the last Congress and it is also a part of the Schumer Bill.  I think it is worth considering how it will impact the publicy traded executive compensation consulting firms.  As best I can tell, the top 6 are listed in letters from House Oversight here.  Two of them are directly publicly traded: Watson Wyatt and Hewitt.  A third, Mercer, is a wholly owned sub of Marsh Mac, which is publicly traded but has a portfolio of six or so other consultancies, so perhaps any effects on the parent's share price will be diluted.  

It seems to me that, knowing what I know about Board Compensation Committee process, in an era of say-on-pay requirements the consultants become MUCH more important.  And, the consultants are already something of an oligopoly, which limits price competition. Plus there is the fact that the executive authorizes the company to pay the fee, but the executive gets the benefit of their work, in a transaction in which there is a conflict between executive and corporation, so we have
demand for a product that is somewhat inelastic (not responsive to price).  If I remember nothing from Econ class, I remember that the best position for a seller to enjoy is to have market power and sell an inelastic good....it's like having a monopoly on an addictive drug.

Now, the oligopoly and inelasticity effects are likely capitalized into the current value of shares, but my point is that both effects significantly magnify the value added from increases in industry demand resulting from the Schumer Bill. Riskmetrics, by the way, has a near monopoly on shareholder advisory services.  If I had money to spare, in this day and age, I would put every dime on Riskmetrics, Watson Wyatt, and Hewitt.

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At a Roundtable at Maryland on Friday, we were given the opportunity to speak with a corporate secretary and assistant general counsel of a Fortune 200 Company.  One person asked her why she believes corporations fight so hard to exclude shareholder proposals from the proxy statement.  Indeed, there are at least two reasons why such fights seem costly, unnecessary and even potentially counter-productive. 

First, many shareholder proposals fail to receive significant shareholder support.  This failure suggests that other shareholders are not interested in most of these proposals, and hence it should not bother corporations to allow proposals to appear on the proxy statement.  In fact, given the low level of shareholder support many proposals ultimately receive, it seems more cost-effective to simply allow such proposals to appear on the proxy statement than to spend resources fighting to exclude them.   To this point, the corporate secretary did note that her corporation chose not to exclude many shareholder proposals, even when those proposals appeared to focus on subjects about which few shareholders were concerned or were interested in supporting. 

Of course, some shareholder proposals do receive significant shareholder support.  But for those proposals, there is a second reason why corporations may not seek to exclude them.  That is, such proposals may serve an important signaling function, alerting the corporation about the kinds of issues that shareholders find important and hence would like the corporation to consider.  So one wonders, what is the corporate interest in excluding such proposals?  To be sure, one could adopt the cynical proposition that corporations oppose such shareholder proposals not only because they simply do not care about the issues that concern their shareholders, but also because corporate officers and directors fear that if certain issues are highlighted, their positions within the corporation may be jeopardized.  But if this cynicism is not warranted, what is the reason why corporations fight some shareholder proposals so strenuously?  The corporate secretary with whom we interacted suggested that at least some of that opposition stemmed from the fact that the shareholder proposal process is not an effective vehicle for shareholder communication with management.  Hence, she noted that when the corporation had legitimate concerns about a particular proposal and its implementation, the process did not really enable corporations to express or discuss those concerns with shareholders.   Instead, too often, the corporation’s attempt to address those concerns would be painted as defensive or illegitimate.   In this regard, the proposal process appears to create a one-sided debate that may undermine the corporation’s effort to address legitimate concerns with a given proposal, thereby decreasing, rather than enhancing, the potential for communication between the corporation and its shareholders.

Whether you agree with this account of the proposal process, it does suggest a need for more effective mechanisms of communication both between shareholders and the corporation and among shareholders.  This is not to say that the proposal process is not useful, but rather that we may be expecting too much from it when we use it as a primary means of prompting communication with the corporation.  To be sure, corporations like Pfizer  are seeking to engage their largest shareholders.  And the relatively new rules on electronic shareholder forums may encourage greater communications among shareholders.  The corporate secretary’s comments suggest that those interested in enhancing shareholder voice should focus on these and other tools for developing and enhancing communication channels that do not involve over-burdening the shareholder proposal process. 

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Notre Dame Law School is hosting a conference today on "The Future of Fiduciary Duties in Corporate Law." Julian Velasco has assembled a wonderful lineup of longtime friends, including fellow Glommer Lisa Fairfax, my co-author Bob Thompson, and Ideoblogger Larry Ribstein, as well as Chief Justice Myron Steele of the Delaware Supreme Court.

I will be presenting a new paper entitled "Unlimited Shareholder Power," which I hope to post on SSRN soon. Here is a glimpse:

By the way, this is my fourth trip to South Bend, twice on business and twice for football games. Every time I come here, I am more impressed with the University of Notre Dame.

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The Delaware Supreme Court finally issued its long-awaited opinion in Lyondell Chemical Company v. Ryan today. Remember, this is the case in which the directors of Lyondell Chemical Company were accused to breaching their fiduciary duties in connection with a sale of the company. The directors were admittedly independent and disinterested, but the plaintiff shareholders accused the directors of breaching their fiduciary duty of good faith by knowingly shirking their duties under Revlon. Vice-Chancellor Noble refused to grant the directors summary judgment because he wanted to know more facts about whether "the directors may have consciously disregarded their known fiduciary obligations in a sale scenario." (Ryan v. Lyondell Chemical Co., 2008 WL 2923427 (Del. Ch. 2008)).

In reference to that earlier decision, I expressed my frustration with the current state of Delaware law:

The problem with the decision is that [the defendants] can't get a lawsuit like this dismissed. But I don't see how you can pin that on Vice-Chancellor Noble. He is just taking direction from the Delaware Supreme Court.

Others, like Jeff Lipshaw, thought VC Noble was simply bootstrapping a duty of care claim into a non-exculpable duty of good faith claim. (Glom guest blogger Andrew Lund has written a paper about this possibility and how Delaware could more easily avoid it.) In its opinion today, the Delaware Supreme Court agreed with Jeff's assessment of the facts of this case: "At most, this record creates a triable issue of fact on the question of whether the directors exercised due care." (For Jeff's reaction to the opinion, see here.)

Importantly, this conclusion depends on a strikingly narrow understanding of "bad faith" in Delaware fiduciary law. In my first post on this case last August, I observed, "Disney and Stone now have defined 'bad faith' in a manner that does not require illegality or fraud (the traditional meanings of 'bad faith'), or disloyalty -- at least in the traditional sense of self-dealing. 'Bad faith' now has a more expansive meaning, that might include actions by directors who are admittedly independent and disinterested." While all of this remains true, it appears that the Delaware courts still have an extremely narrow view of bad faith. Steve Bainbridge described it this way earlier today: "Ryan ... goes a long way towards constricting the scope of bad faith claims to egregious and highly unusual sets of facts."

To understand how narrow "bad faith" has become, consider VC Noble's initial decision to deny summary judgment. That decision was motivated by a desire to gather more facts before determining that the directors here had not acted in bad faith. VC Noble was under the impression that directors could do something to fulfill their Revlon duties, but still knowingly fall short of doing enough. This is not an unreasonable view, though it would require a fair amount of precision to determine the difference between a care claim and a good faith claim. Chancellor Chandler made a similar point in a recent opinion in In re Citigroup Inc. Shareholder Derivative Litigation, 964 A.2d 106 (Del.Ch. 2009):

The Delaware Supreme Court wants to draw a brighter line in its opinion issued today:

And again:

The influence of Caremark is apparent here, and we know from experience that Caremark liability is almost unheard of in Delaware. Of course, Vice-Chancellor Strine recently found support for Caremark claims with respect to the former senior vice chairman of general insurance and former vice chairman of investments and financial services of AIG. See In re American Intern. Group, Inc., 2009 WL 366613 (Del.Ch.2009). In denying a motion to dismiss on this issue, VC Strine observed:

This sort of behavior, if proved at trial, would easily support a finding of "bad faith" under the traditional standards. In other words, the Caremark version of bad faith would be unnecessary. And if the Delaware courts are serious about the standards articulated in Lyondell, I suspect plaintiffs will need facts like these to prevail on a claim of bad faith. So while boosters of the fiduciary duty of good faith had reason to rejoice after VC Noble's initial opinion, they will not be pleased with this latest directive from the Delaware Supreme Court.

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I've recently posted the paper I'll be presenting at Vic's NIE conference.  The rather bulky title is Leverage in the Board Room:  The Unsung Influence of Private Lenders in Corporate Governance.  The link is here, and the abstract is below.  Comments welcome!

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Back in January, the Delaware Supreme Court heard oral arguments on the interlocutory appeal in Ryan v. Lyondell.  It was somewhat surprising that the court agreed to hear the interlocutory appeal.  It’s perhaps more surprising that, after taking the case and hearing oral argument, it has taken the court almost two months to issue a ruling.

In Ryan, Vice Chancellor Noble denied summary judgment for the Lyondell board of directors with regard to a claim by former shareholders that the board violated its Revlon duties in agreeing to sell to Basell/Access.  More interestingly (maybe), the court denied summary judgment on the claim that the Revlon violation was “conscious”, and therefore counted as a non-exculpable violation of good faith.

When the Chancery Court denied summary judgment in Ryan, it generated a lot of commentary.  The opinion didn't distinguish pretrial analyses of care and good faith, thus making it easy for plaintiffs to bootstrap a due care claim into a non-exculpable good faith claim.  I’ve just posted an article to SSRN offering a way forward on that issue.  I’ll be posting some stuff related to my argument in that piece later this week.

But after listening to the oral argument in the case, I’m not sure the forthcoming opinion will say anything about the issue.  At oral argument, the discussion focused almost entirely on whether Revlon applied during the period between Basell/Access’ filing of the 13D and its offer two months later.  If the court finds that Revlon had no relevance for board inaction during that period, there’s presumably no due care violation under Revlon based on the board’s behavior post-offer.  The court might choose to talk about good faith in dicta (as it did in Disney), but it won’t have to reach the care/good faith distinction.

To be sure, a bidder’s credible statement of interest (whether via a 13D or not), by itself, doesn’t trigger Revlon duties.  The Chancery Court’s opinion doesn’t say differently exactly – the opinion would allow a board to go on its merry, Revlon-less, way after the statement of interest, under penalty of considering its post-statement behavior in a Revlon analysis should the board ultimately choose to sell.  During oral argument, one of the Justices referred to this argument as creating a “zone of Revlon”. 

I’m not sure that the “Revlon zone” would be such a bad idea.  The target board that (1) has reason to think a credible offer will be coming in that it might accept, (2) does no background work on a potential sale and then (3) accepts the deal under a tight deadline has done something qualitatively different than another board that gets blindsided by a blowout premium with a tight deadline.  It seems disingenuous for the first board to throw up its hands and say that it didn’t have time to go through a full sales process because of time pressure.  Of course, creating this contingent Revlon application would pose a number of problems, e.g., determining whether the board had received a credible indication that a bid would be coming down the pike (although a 13D would seem to be an easy case). 

A bigger issue for the Ryan plaintiffs, though, is that the Revlon zone would seem to be new law, making it difficult to show that directors knowingly failed to satisfy their enhanced duty of care after receiving the 13D.

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Thanks so much to Gordon and Christine for the invitation to join in the fun!  As a longtime devotee of sports radio, “Long-time reader, first-time blogger” doesn’t quite sound right, but it’s close enough.  Over the next two weeks I’ll subject everyone to a number of thoughts on the Delaware Supreme Court’s upcoming decision in Ryan v. Lyondell, good faith more generally and some other stuff, but I wanted to start off with an exec comp post.

Pursuant to a last minute insertion by Sen. Dodd, last month’s stimulus bill limits annual incentive compensation for certain executives at bailed-out firms to one-third of their total annual compensation.  Suffice it to say that this provision has not fared well among commentators.  The basic complaints center on fear that firms will shift to higher salaries, they'll avoid participating in the program, and/or the limitations will lead to a brain drain.

Without commenting on the merits of the provision itself, I’m wondering about its implications for executive compensation across all firms.  Specifically, has the federal government officially fallen out of love with performance-based compensation?  As many know, Section 162(m) of the Internal Revenue Code denies deductions for public companies’ compensation expenses for any of its top five officers to the extent they exceed $1 million.  As almost all of the people who have heard of 162(m) also know, there is a gigantic loophole for this limitation.  Firms keep the deduction if the compensation above $1 million is “performance-based”.  That is, the federal government prefers performance-based compensation.

Or, it did until last month.  Now that Congress has rejected performance-based pay as an effective tool for aligning executives’ interests with the federal-government-as-creditor, can the 162(m) performance-based pay exception be far behind?  Maybe the federal government’s concerns as a creditor differ from the shareholder-intensive focus of 162(m).  If performance-based pay, as usually practiced, favors shareholders vis-à-vis creditors (and if we can justify preferring shareholders to creditors outside of the bailout context), the two positions are not necessarily irreconcilable.  But I’m more than a little skeptical that Sen. Dodd was thinking about this shareholder/creditor distinction when he forced the provision through in the face of opposition from the Obama administration.  Rather, it seems like Congress (and Barney Frank, in particular) doesn’t trust performance-based compensation anymore as a corporate governance tool.  Accordingly, I suspect there’s a better than 50/50 chance that the 162(m) loophole will be gone in the near future for all public companies.  In fact, Treasury had already started taking steps towards imposing limitations.

What would it mean to take away the deduction?  It isn’t clear how much 162(m) has really driven decisions about total compensation and, to the extent it has, whether it’s been a net positive. (See Gregg Polsky’s nice paper on the subject)  It certainly has shifted the kind of pay towards performance bonuses and stock options.  And although the feds may not be into performance-based pay anymore, institutional shareholders still are.  So the end of the 162(m) exception would likely not signal a shift away from options to salary or lower total comp.  Instead, it would only further level the playing field between plain vanilla options and both restricted stock and indexed options, neither of which currently count as “performance-based” for 162(m) purposes unless vesting is conditioned on a performance hurdle.

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