A devil disguised as a corporate angel? Questioning corporate charitable contributions to 'independent' directors' organizations.

AuthorLadd, Benjamin E.

A director's greatest virtue is the independence which allows him or her to challenge management decisions and evaluate corporate performance from a completely free and objective perspective. A director should not be beholden to management in any way. (1)

INTRODUCTION

Enron. (2) WorldCom. (3) Tyco. (4) The accounting scandals surrounding these former market giants (5) have precipitated a revolution in corporate governance (6) the likes of which the nation has never seen. (7) Congress passed the Sarbanes-Oxley Act of 2002 (8) ("Sarbanes-Oxley") less than two months after the WorldCom debacle. (9) Sarbanes-Oxley required the Securities and Exchange Commission (SEC) to demand that self regulated organizations (SROs), like the New York Stock Exchange (NYSE) and National Association of Securities Dealers (NASD), promulgate new listing requirements focusing on corporate governance measures. (10)

At the heart of this new wave of reform is a call for more independence within boards of directors. (11) Sarbanes-Oxley requires there to be independent directors on all auditing committees. (12) The SROs have gone further and demand more of listed companies in terms of director independence. (13) Yet this is only the beginning. Institutional investors with significant market clout view Sarbanes-Oxley and the new SRO regulations as only a starting point. For example, one of the largest institutional investors in the country, CalPERS, (14) has an extensive manual specifically defining what kinds of directors they consider to be truly independent and outlining how such directors should function. (15)

Lurking beneath this global whirlwind (16) is an issue that has not gained much attention in recent scholarship: corporate charitable contributions. (17) As noted above, many governmental, regulatory, and institutional organizations have gone to great lengths to issue proposals to arrest the apparent decline of corporate governance standards. Few of them, however, have considered the likes of Ellen Futter. Ellen Futter is the president of the American Museum of Natural History in New York City and she "serves on four [corporate boards of directors]: insurer American International Group Inc., pharmaceutical maker Bristol-Myers Squibb Co., the energy company Consolidated Edison Inc. and J.P. Morgan Chase & Co., the nation's second-biggest bank." (18) During Futter's tenure as President, the Museum of Natural History has received several large donations from the corporations on whose boards Ms. Futter sits. (19) Corporations such as these seek independence and credibility in the boardroom by employing accomplished and well-respected individuals, such as Ms. Futter, as directors. (20) The individuals, of course, have many reasons for serving as a director, but one cannot overlook the opportunity for those individuals to fundraise for their respective organizations through their special relationship with the corporation and its leaders.

In the past, there were relatively few instances where the courts (21) squarely confronted this ostensible conflict of interests. (22) Recently, however, the Delaware Chancery Court has dealt with the issue in two cases that gained significant attention from the media. Though corporate charitable contributions were not the primary issue in In re Walt Disney Co. Derivative Litigation, the court did make a determination in that case that director Father Leo J. O'Donovan, the President of Georgetown University, was not influenced by Chief Executive Officer (CEO) Michael Eisner's charitable contributions to the university. (23) The court acknowledged that Eisner had made donations of over $1 million to the school since 1989, but it quickly dismissed the plaintiffs' allegation that the donations affected O'Donovan's independence as a director. (24) More recently, the court took a completely different stance in In re Oracle Corp. Derivative Litigation. (25) In this lengthy opinion, the court thoroughly analyzed the independence of two members of a special litigation committee CSLC") charged with considering allegations against Oracle. (26) The court noted a myriad of potential biases that could have influenced the two committee members--both of whom were distinguished professors at Stanford University--not the least of which were large donations to Stanford from Oracle and its CEO, Larry Ellison. (27) Ultimately, Vice Chancellor Strine concluded that "these and other facts cause me to harbor a reasonable doubt about the impartiality of the SLC." (28)

It is the purpose of this Note to draw attention to the inevitable conflicts that arise when a leader of a nonprofit organization sits on a for-profit board, and to suggest a way in which to deal with the problem. The primary focus of this Note is on how the courts handle this issue and the ways in which they can improve the test they use to question the independence of such directors. The Chancery Court in Disney seemed to lack any concern that a Jesuit priest whose primary task is raising funds for Georgetown University could be influenced by corporate donations. (29) This Note argues that the Chancery Court should have been more inquisitive with respect to O'Donovan's conflicts in Disney, and it contends that the Chancery Court made the correct determination in Oracle only through a long-winded opinion that over-emphasized the minutiae in the case. This Note suggests that the court should apply a more streamlined test to similar cases in the future.

Before detailing how a more streamlined test would operate, Part I of this Note discusses the concept of corporate governance, the evolution of the desire for "independent" directors, and presents an explanation of why the courts care about whether a director is independent. Part II discusses more thoroughly the Oracle and Disney cases and their respective deficiencies. Finally, Part III presents evidence as to how the problem of corporate quid pro quos between seemingly untainted directors and the corporate boards on which they sit is a growing one that will only become more important as the call for adding independent board members continues. This Note then concludes by suggesting a functional approach by which the courts can effectively and efficiently deal with these suspect corporate charitable contributions and their effect on a director's independence.

  1. BACKGROUND

    1. Corporate Governance

      Corporate governance (30) is a concept that does not have a straightforward definition. In a Wall Street Journal special report, one expert put it simply: "Corporate governance is a hefty-sounding phrase that really means oversight of a company's management--making sure the business is run well and investors are treated fairly." (31) Others use a more elaborate definition, like the following: "It [corporate governance] is the relationship among various participants in determining the direction and performance of corporations. The primary participants are (1) the shareholders, (2) the management (led by the chief executive officer), and (3) the board of directors." (32) There is no doubt as to the significant role management plays in this triangular relationship, but it is worthwhile to elaborate on the roles of the shareholders and the board of directors in corporate governance.

      1. Shareholders

        It is important to realize that a shareholder may not be the average American dabbling in the stock market. In the past, "individual shareholders ... did not control enough stock to be owners ... [and] had little direct leverage over the company's strategic plans. Their only recourse was to observe the classic 'Wall Street Walk' and sell their shares." (33) At the opposite end of the spectrum from the average shareholder is the institutional investor. (34) Surprisingly, until recently, "voting with their feet" was how institutional investors voiced their opinions as well. (35) However, "[t]hese institutional investors have become increasingly active in corporate governance because exit has become a less viable option and norms have changed concerning the appropriateness of their participation in corporate governance." (36) It is not surprising that having become so involved with corporate governance, these investors put a high value on the concept. (37) A recent survey found that investors are willing to pay up to a fourteen percent premium for companies that have "good" corporate governance. (38) The shareholder is becoming a bigger player every day in corporate governance, (39) as evidenced by the cry for more independent board members by many institutional investors. Before addressing this latter issue, however, an explanation of the functions and duties of the board of directors is necessary.

      2. The Board of Directors

        Most simply, "[b]oards ... are expected to oversee management, corporate strategy and the company's financial reports to shareholders." (40) They "are a crucial part of the corporate structure" (41) in that "[t]hey are the link between the people who provide capital (the shareholders) and the people who use that capital to create value (the managers)." (42) But just as the role of the investor has evolved over time with respect to corporate governance, so has that of the director. Though directors have always had the same basic, key functions, (43) the extent to which they actually perform the duties asked of them has changed over time. (44) To ensure that directors' interests are aligned with those of the corporation--to wit, the shareholders--the law eventually imposed duties on directors that give them more incentive to effectively monitor management. As a result, today, "a director owes shareholders the fiduciary duties of due care, loyalty, candor, and obedience." (45) When discussing director accountability, however, the courts and scholarship usually speak in terms of the duties of care and loyalty; (46) therefore, these are the duties upon which this Note focuses.

        With its origins in the...

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