Toward a critical corporate law pedagogy and scholarship.

Author:cummings, andre douglas pond
Position:IV. CEO Primacy and America's New Economic Royalty through VII. Conclusion, with footnotes, p. 423-453

    Noticeably missing from all major business law texts is a discussion connecting the reckless mismanagement of many corporate leaders with the mortgage crisis of 2008. After the financial crisis of 2007-2009, many experts and commentators concluded that CEOs and senior executives at major financial firms received excessive compensation for pursuing reckless lending and investment activities, which led to catastrophic losses for the firms and huge paydays for senior executives. (152) In fact, the head of the Office of the Comptroller of the Currency ("OCC"), which supervises all national banks and federally chartered thrifts, concluded that underlying the entire debacle was "the worst mortgage underwriting in our nation's history." (153) These reckless mortgages added huge risks to an already over-leveraged financial sector, meaning that small losses could wipe out equity and lead to mass insolvency. (154) All of this led to massive losses for shareholders and the economy at large. (155) CEOs essentially manipulated risk to pump up short-term profits, saddling the entire financial sector with a very high probability of systemic failure. (156) The FCIC confirmed that compensation rewarded high-risk short-term gains and resulted in long-term threats to firms' financial viability. (157) Little mention of this lethal mismanagement is included in major business law texts today, even though they may include extended discussions of compensation issues. (158) It is as if the crisis simply did not happen, or corporate governance played no role--and these texts foreclose any debate on this point. (159) The problem of excessive executive compensation and incentives to manipulate risk continues to plague public firms, yet the subject is ignored in business law texts and classrooms.

    To address the problem of excessive compensation, Congress included a provision within the Dodd-Frank Act that gave shareholders a "say on pay." (160) More precisely, the Act mandated that shareholders have an advisory vote on executive pay. (161) This precatory vote, however, has not been an effective mechanism for controlling CEO pay. (162) In the past two years since say on pay took effect, CEO pay has soared--in some cases exceeding $ (1) billion in a single year. (163) Executive compensation now stands at a level that exceeds pre-crisis highs. (164) The core problem is that say on pay lacks teeth--a no vote is next to meaningless. And when shareholders do approve high payouts it serves to encourage excessive pay. (165)

    Progressive corporate law scholars have argued that the "say on pay" rules should have been an occasion for state courts to reinvigorate state fiduciary duty standards as a mechanism for imposing more effective corporate governance. (166) The prospects for this kind of change in any meaningful sense are dim at best. (167) Instead, this modest reform seems to have backfired as managers use shareholder votes to justify larger pay packages. (168) In sum, the say on pay effort to control perverse compensation incentives is a bust. (169)

    Another Dodd-Frank Act failure is the effort by Congress to reform proxy access so that shareholders could access management's proxy solicitation to nominate directors and run candidates against management's own selections. (170) The SEC attempted to implement the power Congress expressly gave it to allow shareholders expanded proxy access. (171) In Business Roundtable v. SEC, (172) the D.C. Circuit Court held that the SEC's effort to implement this part of Dodd-Frank was not valid because the SEC failed to perform an adequate cost-benefit analysis, and its rule was therefore arbitrary and capricious. (173) Consequently, in the public firm today, management still selects management, meaning that shareholder supervision is not possible and compensation soars ever higher. (174)

    Despite broad consensus that perverse compensation incentives drove the financial crisis and the resulting Dodd-Frank legislation, corporate law textbooks largely ignore the links between compensation and the crisis. (175) For example, the Klein text declines a perfect platform to take up the issue of skewed corporate executive compensation when it examines Disney. (176) In that case, Disney shareholders sued the Disney board of directors for entering into an astonishing contract with former Disney President Michael Ovitz that turned out to pay Ovitz more money when he was terminated from the company without fault than it would have paid out had he performed the life of his contract. (177) Ovitz took home close to $130 million for his fourteen months of service to Disney--roundly considered a failed tenure. (178) Noted commentators concluded that, in the end, the Disney litigation resulted in yet another judicial power transfer to CEOs to enter into dubious compensation arrangements with other officers. (179)

    When presented with the opportunity to critically examine executive compensation and the perverse incentives that motivate executives to take excessive and reckless risks based on astonishing pay packages, the Klein text eschews the opportunity. (180) Rather, the text reads as if astonishing executive compensation is natural, even appropriate, and board members are rightly protected from shareholder inquiry if an excessive pay package is approved by a compensation committee and compensation expert. (181) The message is that corporate executives deserve the hundreds of millions of dollars of compensation, even if their tenure is deemed a failure.

    While Klein fails to critically examine enormous executive-compensation payouts and the attendant consequences, it does take note of the Dodd-Frank Act's "say on pay" provisions to alert students to the fact that shareholders now have the right to take a periodic "non-binding" advisory vote on executive pay. (182) In noting that Dodd-Frank tries to address not only "Wall Street Banks" but also corporate compensation generally in the United States, Klein matter-of-factly reports that "[t]he results of the [say on pay] vote are not binding on the board of directors. Indeed, the Act makes clear that the vote shall not be deemed either to effect or affect the fiduciary duties of directors." (183)

    As the Klein text is perhaps the most widely adopted Business Associations textbook in the United States, thousands of law students annually are given no critical analysis of executive compensation as currently practiced in corporate America, nor are they encouraged to think about the possibility that executive compensation paradigms may have helped to precipitate the financial crisis. (184) One of the most controversial issues in corporate law today, excessive executive compensation and its manifest costs, is nearly invisible in one of the most widely adopted business law texts on the market. (185) Not only is the subject left unaddressed, but if a business law professor that uses the Klein text intends to examine executive compensation and the perverse incentives that motivate so many business leaders today, that professor is forced to supplement the text and bring in a significant amount of outside reading. This can alienate students, already burdened with significant amounts of work, and cause discordance for a professor who assigns materials some students may deem inappropriate because it is "not in the book."

    No other mainstream business law textbook adequately considers the issue of excessive executive compensation insofar as the financial crisis and CEO power is concerned. There is a mention of excessive executive compensation in the Epstein text, but no serious critical consideration of it or link to the financial crisis. (186) No substantial discussion at all of links between excessive risk-taking incentives in executive compensation and the financial crisis appears in the Choper text, (187) the Eisenberg text (188) or the O'Kelley text. (189) Leading corporate law professors who draft the most adopted business law textbooks in the country provide no assessment of the verdict of the FCIC, Nobel laureates, or a wide array of other economists that corporate law allows CEOs to pillage their firms to attain massive compensation payments.

    Excessive CEO compensation has now figured prominently in a series of corporate fiascos this century. First, in 2001-2002, a battery of public firms collapsed amid accounting frauds rooted in efforts by senior managers to increase their options-based compensation. (190) Second, in 2006, options back-dating emerged as another way for CEOs to take for themselves millions of dollars from shareholders. (191) Third, during the subprime debacle, senior executives received huge incentive-based compensation payments for manipulating risk, even though these risks ultimately sank the entire financial sector and led to the Great Financial Crisis of 2007-2009. (192) The costs of this misconduct are measured in the trillions. (193)

    Yet, perhaps the greatest cost of CEO dominance is not the occasional massive macroeconomic disruption implicit in financial crises. Instead, CEO primacy inflicts a daily toll on the economy in the form of compromised financial performance. (194) CEOs simply hold too much power. (195) For example, the simple expedient of splitting the CEO position from the Chair of the Board results in dramatic performance gains at the worst performing companies. (196) And there are other fundamental corporate governance matters that should be addressed and assessed in Business Associations casebooks. An independent risk-management committee is associated with superior financial performance, particularly in financial firms. (197) Diverse boardrooms have also been linked to valuation gains. (198) Shareholders value the ability to exercise votes in a meaningful way in the context of shareholder access to management's proxy for director elections. (199)

    The political power of CEOs is the...

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