Executive compensation and the misplaced emphasis on increasing shareholder access to the proxy.

• Author: Marino, Lori B.

INTRODUCTION

Shareholder proposals in corporate America today come in all shapes and sizes.(1) Because the shareholder resolution process is fairly simple and inexpensive, it is an easy way for many large and small investors to have a voice in corporate governance.(2) The Securities and Exchange Commission ("SEC" or the "Commission") regulates the shareholder proposal process through the federal proxy rules.(3) These rules have been the subject of numerous amendments and changes in interpretation over time.(4) This Comment will focus on one of the ways in which a corporation can exclude a shareholder proposal from its proxy materials(5)--the "ordinary business" exclusion(6)--and its impact on executive compensation regulation.

There has been a tremendous amount of scholarly writing concerning executive compensation(7) and the ordinary business exclusion.(8) There have also been a substantial number of analyses regarding how these two issues overlap.(9) The most dramatic changes in the federal proxy rules occurred in 1992,(10) however, leaving most of the in-depth analyses without adequate time to witness the much-heralded fruits of these changes. Now is a good time to reflect on these changes and examine shareholder activism relating to executive compensation since these changes. The purpose of this analysis is to evaluate whether a rise in shareholder proposals, one that is consistently predicted by those favoring increased shareholder access to the proxy,(11) has actually occurred. This Comment will argue that the changes adopted in 1992 did not significantly affect shareholder proposals relating to executive compensation.

The SEC recently ended another reexamination of the proxy rules. It is useful to look at these new amendments with a view toward predicting whether they will alter the analysis of executive compensation proposals under the ordinary business exclusion. It is also instructive to consider the role that the SEC has given itself, by proposing, but then not passing, a number of amendments. This Comment will argue that the enacted amendments will have virtually no effect on the analysis of executive compensation under today's Rule 14a-8(i)(7). Furthermore, the emphasis that compensation critics place on altering the proxy rules as a means of correcting compensation abuses is misplaced.

Underlying this entire analysis is the assumption that excessive levels of executive compensation are a problem, and that they do, in fact, hurt someone.(12) In some respects, this discussion is simply a restatement of the shareholder passivity arguments originating from the work of Berle and Means(13) and developed more fully earlier in this decade.(14) This Comment goes further, however, and argues that shareholders are not passive in general; rather, there must be something in the fundamental nature of executive compensation proposals that affects their treatment in ways that other proposals are not so affected.

Part I explores executive pay issues and trends throughout the 1980s and 1990s. Part II discusses the history of shareholder proposals dealing with executive compensation issues under Rule 14a-8(i)(7) since its adoption in 1954. This Part focuses mainly on the changes in the proxy rules and their interpretation since 1992 and the recently passed amendments to Rule 14a-8. Part Ill examines statistics compiled by the Investor Responsibility Research Center ("IRRC") concerning the type and number of compensation-related proposals submitted by shareholders. This Part also outlines some of the arguments that have been raised against increasing shareholder access to the proxy and discusses the role of institutional investors. Finally, Part IV examines Delaware judicial attempts at dealing with executive compensation transactions. This Part gives a brief history of the tests used by Delaware courts and discusses the standard recently articulated by the Delaware Chancery Court in Lewis v. Vogelstein.(15) This Part concludes by setting out a proposal for addressing the problem of executive compensation in state courts.

1. THE RISING TIDE: EXECUTIVE COMPENSATION TAKES OFF

   1. The '80s: A Decade of Greed

      Stock option grants gained trendiness during the 1980s,(16) which is often referred to as the "takeover era."(17) During this decade, "average CEO[] compensation increased by more than 200 percent ... while the pay of the average worker rose only about 50 percent."(18) CEOs of major U.S. corporations were averaging thirty-five times the compensation of an average U.S. manufacturing employee by the end of the decade.(19) Not only were problems evident when comparing executive pay to the pay of other U.S. workers, but pay disparities between U.S. executives and their foreign counterparts were also becoming clear.(20) One commentator noted that the "prevailing ethos at least condoned, if not extolled, the lifestyles of conspicuous consumption made possible by such compensation levels."(21)

      The decade also saw the emergence of "compensation consultants"(22) and "compensation committees,"(23) both well-intentioned efforts at sanitizing the executive pay-setting process. In most large corporations, the final determination concerning compensation comes from a confluence of these two bodies--the compensation consultants "guide" the independent committee in making its decision.(24)

   2. The Early '90s: What Recession?

      In the early 1990s, the media and the recession combined to focus public attention on executive salaries.(25) The continued rise in executive compensation would not have been so problematic if company profits also had increased, or workers' earnings had risen commensurately, but studies indicated that this was not so.(26) Compensation simply did not correlate with company performance: "CEOs enjoyed an average pay increase of 9.4% in 1991 even though their companies' profits declined 7% and the median price of their companies' stock fell 7.7%."(27) Thus, stock options, a means of tying pay to performance,(28) continued as a popular source of CEO income in the early part of the decade.(29)

      Despite the heightened attention given to the issue, 141 companies paid each of their CEOs a salary of over $1 million in 1991.(30) One survey indicated that the median annual compensation package given to CEOs of 200 of the largest U.S. companies during 1991 was $2.4 million.(31) A similar picture was presented during the next few years. According to a Forbes study, the average pay of CEOs at the fifty largest U.S. corporations was $3.5 million in 1992,(32) while The Wall Street Journal reported the median income of all CEOs to be an estimated $1.5 million for that year.(33) Finally, a 1993 survey conducted by Fortune indicated that the CEOs of 200 U.S. corporations averaged salaries of $4.1 million.(34) Although the country was in a recession, it is clear that this factor was not noticed in compensation committee discussions or in the boardroom.

      A number of things Should be made clear in looking at these figures ($2.4 million in 1991; $3.5 million in 1992; $4.1 million in 1993). First, these figures are highly dependent on the calculation techniques used by each surveyor. Some surveys include a weighted value for stock options, even if these options are not exercised, while others fail to consider them if they remain unexercised for the year.(35) Second, some of these figures are focusing on a particular class of CEOs (for example, "the Super 50"(36)), while others purport to be reporting the mean or median for all CEOs. Third, and most important for purposes of this discussion, these figures are astonishingly large in absolute terms, regardless of the survey technique used or the class sampled.(37)

      Compensation committees also started to come under attack in the early part of the decade.(38) Salient questions have been raised about the actual independence of these committees, which attempt to remove the self-interest inherent in the pay-setting process and are usually the final arbiter of an executive's pay.(39) So-called "negotiations" between a CEO and the outside directors who determine her pay are hardly negotiations at all. Compensation committees advised by pay consultants usually set the CEO's salary.(40) Companies, in turn, "usually tell the adviser that they want to set pay levels at a certain industry percentile--often 75% or more."(41) Forging mutually beneficial relationships with the directors that make up the compensation committee apparently does not hurt either--Congress has received testimony to the effect that there is a strong relationship between a CEO's compensation and the compensation of the board members on the compensation committee that determines the CEO's pay.(42) Given these factors, it is generally acknowledged that a CEO can name her price.(43)

      Why the connection between director pay and CEO pay? This is an area laden with conflicts of interest--these conflicts likely result in directors acting in their own, rather than the shareholders', best interests. A clear manifestation of this conflict is evident when analyzing the directors themselves. Most directors are top executives at other corporations, logically suggesting that they would have a reciprocal interest in promoting healthy executive pay levels.(44) Two executives sitting on each other's compensation committees presents an even more egregious example of a conflict of interest.(45)

   3. Compensation Trends Today

      Executive compensation actually continued to increase after the SEC passed the enhanced disclosure rules in 1992.(46) Yet the disclosure rules were aimed at facilitating shareholder awareness of compensation abuses.(47) And with increased awareness and the newly granted ability to put forward a shareholder proposal addressing executive compensation,(48) shareholders were thought to hold the key to curbing managerial excess.(49) The truth of the matter, however, is that "the compensation of most CEOs rises each year, as...