SUPERSTAR CEOS AND CORPORATE LAW.

• Author: Hamdani, Assaf

ABSTRACT

Larger-than-life corporate leaders, who can move fast and disrupt entrenched players, are often perceived as having the vision, superior leadership, or other exceptional qualities that make them uniquely valuable to their corporation. While the business press, management experts, and financial economists have long studied these "superstar" CEOs, the legal literature has largely overlooked this phenomenon. In this Article we develop a framework to explore the challenges that superstar CEOs pose for corporate law doctrine and scholarship.

We show that, even in the present era of increasingly powerful shareholders, superstar CEOs have significant power over boards of directors. The power of superstar CEOs arises not from their formal influence over director nomination, shareholders' rational apathy, or other sources of directors' agency costs. Rather, it is based on the widespread belief that a CEO, and only this individual CEO, has what it takes to produce superior returns for shareholders. Consequently, superstar CEOs' power is limited in both duration and scope: it is likely to vanish when markets lose faith in their star qualities, and it cannot be abused if its harm to the company exceeds the value of the CEO's unique contribution. This framework, we show, explains Elon Musk's continuous entanglement with Delaware courts, board failure at Uber and WeWork, the puzzling jurisprudence regarding management buyouts, and the failure of governance reforms to contain CEO misconduct. It also cautions against reliance on existing governance arrangements to induce companies to advance stakeholder interests.

TABLE OF CONTENTS I. From Powerful CEOs to Powerful Shareholders A. The Traditional View: Powerful Managers B. The Rise of Powerful Shareholders C. Is Corporate Law Dead? II. SUPERSTAR CEOS A. Unique Contribution to Company Value 1. The Qualities of Superstar CEOs 2. Examples 3. Academic Literature and Evidence B. Equity Stake and Founder Status 1. Significant Equity Stake 2. Founders III. CORPORATE GOVERNANCE A. CEO Power 1. Boards 2. Shareholders 3. The Limits of Superstar Power B. Implications 1. Synopsis: Governance with Superstar CEOs 2. Private Companies 3. Dual-Class Shares 4. Stakeholder Protection IV. CORPORATE LAW A. Definition of "Control" B. Management Buyouts C. Board Oversight and Managerial Misconduct CONCLUSION INTRODUCTION

Elon Musk is often described as a visionary, leading Tesla in its disruption of the car industry to become the world's most valuable car manufacturer. (1) He has also repeatedly pushed the boundaries of corporate law. Musk is currently the direct target of two derivative lawsuits and the subject of a third. One lawsuit attacks Tesla's 2016 acquisition of SolarCity--a public company in which Musk and his brother were the largest shareholders. (2) Another challenges Musk's unprecedented pay arrangement which, according to some estimates, could provide him with up to $56 billion. (3) The third lawsuit accuses Tesla's directors of abdicating their responsibility to monitor Musk's use of his Twitter account, which prompted the SEC to intervene. (4)

Musk's entanglement with Delaware courts presents corporate law scholars with two puzzles. First, his status as a visionary whose leadership is critical for Tesla's success (5) has been used by courts against Musk. Whereas Delaware courts normally dismiss lawsuits challenging executive pay and other business decisions, (6) the Chancery Court declined to dismiss the two lawsuits against Musk. Tesla's dependence on Musk's vision led the court to hold that Musk controls Tesla, thereby subjecting his transactions with the company to close judicial scrutiny under the entire fairness standard. (7)

The second puzzle concerns the failure of Tesla's board to supervise Musk's Twitter use. In the past, public company directors were commonly perceived as structurally weak and lacking incentives to resist powerful CEOs. Today, in contrast, shareholders empowered by legal reforms and market developments often discipline directors who are perceived as too deferential to management. (8) In fact, this rise of shareholder power and its effect on directors' accountability has led some scholars to argue that corporate law is dead. (9)

These puzzles, we argue, are typical of a phenomenon long recognized by management experts and financial economists, but largely overlooked by corporate law scholars (10)--the "superstar CEO." Some CEOs have--or investors believe they have--the vision, charisma, superior leadership, or other exceptional qualities that make them uniquely valuable to their corporations. Elon Musk is perhaps the most famous example today. Other well-known names include Jeff Bezos (Amazon), Jamie Dimon (J.P. Morgan), and Reed Hastings (Netflix). (11) In this Article, we develop the first account of the superstar CEO phenomenon and its implications for corporate law and governance.

We argue that, even in the era of increasingly powerful shareholders, superstar CEOs' unique contribution to company value accords them significant power over boards of directors. Even directors who are faithful agents of shareholders might struggle to fulfill their oversight duties when the CEO is believed to have star qualities. How effective can directors be in questioning the CEO's proposed strategy when all believe that the CEO's singular vision is what makes the company succeed? And how likely are directors to take harsh measures in response to the misconduct of a CEO who is commonly viewed as critical to the company's success?

Moreover, regardless of their sophistication or power, shareholders themselves might defer to superstar CEOs. As long as the CEO is viewed as critical to the company's success, shareholders may tolerate self-dealing, problematic governance, and other practices that would normally be met with their resistance. (12) This could explain, for example, how Netflix has managed to disregard for a long while its shareholders' call for governance changes, (13) and why WeWork's savvy investors permitted the company to enter into related-party transactions with its CEO. (14)

In the present era of active and engaged shareholders, superstar CEOs' power is unlikely to arise from their influence over director nomination, shareholders' rational apathy, or directors' agency costs. Rather, a superstar CEO derives her power from shareholders' widespread belief that this CEO, and only this CEO, has what it takes to produce superior returns. Superstar CEOs' power is therefore limited in duration and magnitude. First, it is likely to vanish when markets lose faith in the CEO's ability to outperform. Second, boards and investors are likely to prevent superstar CEOs from abusing their power if the expected harm exceeds the value of the CEO's singular contribution to company value.

Our account offers several insights into the corporate governance of firms with superstar CEOs. First, board failure to control managers is not necessarily the result of directors' incentives not being aligned with those of shareholders. Even truly independent directors--those who have no business or other ties to the CEO and who are genuinely committed to shareholders--might be limited in their ability to stand up to superstar CEOs. Indeed, our account explains why even sophisticated investors at venture capital (VC)-backed startups such as Uber and WeWork failed to contain related-party transactions and other forms of managerial conduct. (15) Thus, conventional governance remedies, such as enhancing director independence, might not improve board oversight of superstar CEOs.

Second, we shed new light on the link between superstar founders and the controversial use of dual-class structures. (16) Under our framework, superstar founders manage to go public with super-voting shares not because investors find this structure desirable to protect from capital market pressure to focus on short-term results. Rather, founders perceived by investors as critical to the company's success use their power to bargain for super-voting shares at the IPO stage. This could explain why the number of dual-class IPOs has increased with the rise of winner-take-all markets. (17)

Our account also cautions against the reliance on existing governance arrangements to protect stakeholder interests. There is growing optimism that increasingly powerful shareholders will push companies toward incorporating environmental and other social considerations into their policies. Our analysis, however, shows that even powerful shareholders might be disinclined to confront a superstar CEO who is not promoting stakeholder interests.

Superstar CEOs pose at least two questions for corporate law. First, should corporate law contain superstar CEOs' power? Specifically, should courts ensure that superstar CEOs do not abuse the power arising from the common belief in their singular contribution to company value? Second, assuming that a CEO does make a unique contribution to company value, should corporate law allocate the extra value created by that CEO to shareholders or to the CEO? These questions inform several pieces of corporate law doctrine: courts' expansion of the definition of controlling shareholders, their treatment of management buyouts, and directors' duty of oversight.

In the Tesla decision, the court treated Elon Musk as Tesla's controlling shareholder given his "singularly important role in sustaining Tesla in hard times and providing the vision for the Company's success." (18) Our analysis explains, but does not necessarily justify, this legal development. At first sight, superstar CEOs' power calls for legal intervention to protect investors. The power of superstar CEOs, however, is constrained by the expected magnitude of their unique contribution. The benefits from legal intervention, therefore, are likely to be limited as well. We further identify institutional concerns that complicate the case...