Fiduciary Duties For Executive Compensation, Corporate Opportunities, And Controlling Stockholders

AuthorJames D. Cox/Thomas Lee Hazen
ProfessionProfessor of Law at Duke University/Professor of Law at the University of North Carolina, Chapel Hill
11.8 Misappropriation of Corporate Opportunities:
Disloyal Diversion of Business
11.9 Forbidden Profits: Gains by Abuse of Official Position
11.10 The Duty of Employees Not to Compete
11.11 Fiduciary Duties of Majority
Shareholders to the Minority
11.12 Unequal Treatment Among Different Classes of
Securities or Holders of the Same Class of Security
§ 11.1 Contracts for Compensation
of Directors and Officers
No matter is more delicate or important in a corporation, whether
it be closely held or publicly held, than the compensation arrange-
ment between the corporation and its executives. A well-designed and
thoughtful compensat ion arrangement provides incentives for managers
to reduce the agency costs th at are inherent in a public corporation, and
in a close corporation it serves as a sign ificant component of how the
stockholders will div ide the company’s cash flows among themselves.
Just as there are perplexing planning problems concerning how best to
provide rewards and incentives to manager s,1 there are equally cha lleng-
ing jurisprudentia l questions of the proper role of the courts when asked
to judge the propriety of a part icular compensation arrangement.2
Courts tr aditionally have been reluctant to imply contracts for di rec-
tor compensation. It has long been a presumption at common law that
directors serve w ithout pay. They cannot recover on an implied contract
for the reasonable value of their service s, because both custom and their
fiduciary relationship repel any implication that official services are to
be paid for.3 This presumption also applies to executive officers such as
president, vice president, secretary, and treasurer, who are not entitled
to recover compensation for performing the ordinary duties of their
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office as direc tors in the absence of an express agreement.4 Simila rly, no
claim will lie in an action for quantum meruit.5
In the absence of a statute6 or a delegation of authority, the fees for
compensation of the directors for their ordinary duties must be f ixed
by the shareholders or by a provision in the bylaws.7 However, the clear
statutory trend is to authorize the board of directors to set the compen-
sation for directors.8 Even where no statutory authority exi sts, the char-
ter or the shareholders frequently authorize direc tors to fix their own
fees or salaries9 and, as such, the presumptions of the business judg ment
rule apply to even sizable awards to the directors.10 Substantia l fees are
freq uently pr ovided f or attend ance at d irector s’ meeti ngs or at m eeting s
of committees of the board of large corporations.
Typically, the compensation of officers is established yearly by a
resolution of the board of directors, although it is not uncommon for
executive compensation to be set forth in the bylaws11 or approved by
the stockholders. When a person i s selected to be an officer or employee
under circumstances indicating an expect ation of payment but without
any express contract , the law will imply a promise on the part of t he cor-
poration to pay a reasonable compensation.12 It has l ong b een r ecog niz ed
that officers involved in the active management of the company are
entitled to reasonable compensation for services as managers even if no
compensation had been previously fi xed, because the company could not
expect such onerous managerial services to be performed for nothi ng.13
By the great weight of authority, the presumption against a n implied
contract of compensation for the directors a nd officers of a corporation
does not apply to unusual or extraordina ry services—t hat is, services
that are not properly incidental to their off ice and are rendered outside
of their regular dut ies. If directors or other officers perfor m such ser-
vices at the request of the board of direc tors with the understanding t hat
they are to be paid for, the law will, in t he absence of any special agree-
ment, imply a promise to pay what they are reasonably worth.14 Thus,
the president of a company who acted as the general contractor for the
construction of an office building was not entitled to be compensated
additionally for the serv ices he rendered as the general contractor, where
the costs of constructing the building exceeded the funds available and
he took on the addit ional responsibilities to cut cost s. Furthermore, the
president had not been asked by the stockholders to assume the role of
general contractor.15
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§ 11.2 Methods of Paying Executive Compensation
Traditionally, there have been three basic ways of compensating the cor-
porate executive: (1) salary, (2) bonuses, and (3) a pension or other deferred
compensation. As a result of increased sophist ication in planning, the
variations of the three basic forms of compensation defy exhaustive cat-
egorization. The growing use of compensat ion “packages” arises out of a
desire to attract and hold top-f light personnel, provide them with incen-
tives for greater effort and dedicat ion, and fully utilize tax advantages
offered by some forms of compensation. Tailoring the most advanta-
geous compensation plan requires ca reful consideration of the securities
law, tax consequences, and the Federal Employment Retirement Income
Security Act ( ERISA).16 There is a widespread use in publicly held cor-
porations, and in the large close corporations for that matter, of vari-
ous kinds of contingent or deferred compensation— cash bonuses, stock
bonuses, stock options, stock purchase plans, profit-sharing plans, pen-
sion programs, allowances to su rviving spouses and dependents, medical
and dental payment plans, and other kinds of employee benefits.
Stock options are a highly popula r form of executive compensation in
the United States. The granti ng of stock options does not require a pres-
ent expenditure of corporate fu nds, which may be badly needed for busi-
ness operatio ns or for e xpans ion. Exec utives find st ock opti ons att ractive
because of their speculative appeal in offering a chance for really large
financial g ain. Further, under some circumsta nces, stock options carry
substantial ta x advantages for executives. When the options are exer-
cised, the proportionate interests of existing shareholders in the company
wi ll be d ilute d, but pr esum ably by that t ime t he empl oyees e xerci sing t he
options will have proved t heir worth and have benefited the shareholders
by contributing to an increase i n the value of the corporation’s shares.
A deferred compensation unit plan (“phantom stock” plan) is some-
ti me s u se d a s a n a lt er nat i ve t o o r i n a dd it ion to tr ad it io na l p ens io n a rr an ge -
ments for executive employees. Under a phantom stock plan, the company,
instead of requiring t he employee to buy stock or giving the employee
stock in the company, pays the employee additional annual compensa-
tion or gives credit toward retirement benefits equal to dividends paid
on a share of the company’s stock multiplied by the number of units t he
employee holds in the plan, and on retirement t he employee gets deferred
compensation based on the increase, if any, in the market value of the
company’s stock during the t ime the employee has held units in the plan.
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