August 13, 2005
Ovitz and Innovation
Posted by Victor Fleischer

Michael Madison thinks that the Disney decision encourages innovation.  Because directors are free to screw up without being second-guessed, they will take more risks.

I'm not so sure.  Extreme managerial slack allows risk-taking, but it also allows silly decisions by unconstrained CEOs.  Whatever else can be said about the hiring of Ovitz, the hiring process was not executed smoothly or sensibly.  If Disney had been owned by a private equity firm with firmer controls on management, I doubt we would have seen the disaster that we saw.  They may have hired Ovitz, but I suspect his pay package would have more tightly tied pay to performance, and his integration into the firm would likely have been more carefully thought through.

The extreme managerial slack that Madison and Chancellor Chandler praise exists mostly at public companies; it is less common, as a practical matter, among companies owned by VC firms or private equity firms.  And I suspect that more innovation takes place within those privately-held firms than at public companies. 

One possible counterargument:  the substantial freedom enjoyed by public company CEOs is a prize that founders may aspire to when they create companies in the first place.  So to the extent that the Disney decision makes becoming a public company executive look alluring, it may encourage innovation.

Madison is surely right that some sort of business judgment rule is necessary to encourage risk-taking.  But without getting too deep into merits review of business decisions, some sort of process review may be necessary on occasion. 

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