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

• Author: James D. Cox/Thomas Lee Hazen
• Profession: Professor of Law at Duke University/Professor of Law at the University of North Carolina, Chapel Hill
• Pages: 208-245

PART B. CORPORATE OPPORTUNITIES

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

PART C. CONTROLLING STOCKHOLDERS’

FIDUCIARY OBLIGATIONS

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

PART A. EXECUTIVE COMPENSATION

§ 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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