Wasting the corporate waste doctrine: how the doctrine can provide a viable solution in controlling excessive executive compensation.

• Author: Caywood, Steven C.

In the midst of the global recession of the late 2000s, there was an outcry against corporate executives and what the public deemed to be their excessive compensation. Although this anger is still featured in today's headlines, it is nothing new. In fact, excessive executive compensation complaints arose when the very concept of a corporation was still new. Most of the complaints that the public has leveled have had little effect on boards of directors' decisions. Occasionally, however, the outcry is so great that the public compels a company's leadership to take action. This happened early in 2009 when American International Group ("AIG") stated that it was paying its top executives $165 million in bonuses. Within days, AIG, a company most Americans had not heard of was at the center of the excessive compensation debate. Under enormous political and public pressure, fifteen of the top twenty AIG executives agreed to give back their bonuses. This compromise is not typical, however; for every AIG-type controversy, many other payment plans some consider excessive are never publicly discussed. Both private and public proposals are currently under consideration that will limit excessive executive compensation in one way or another. This Note contends that the already existing corporate waste doctrine can serve as a preferable alternative to legislative or executive actions. While the corporate waste doctrine is rarely used by plaintiffs, it could be effectively enforced by using a legislative tool, the say-on-pay provision, as a gatekeeper for the courts. This judicial solution using a legislative act would allow those who are actually affected by the excessive compensation--the shareholders-to pursue effective legal action against the corporation. The corporate waste doctrine would be enforced more narrowly than a statutory scheme, avoiding the possible unintended consequences of a broadly applicable legislative or regulatory action.

TABLE OF CONTENTS INTRODUCTION I. POTENTIAL EXCESSIVE EXECUTIVE COMPENSATION REFORMS A. The Corporate Waste Doctrine's Inability to Provide a Solution on Its Own 1. The Delaware Courts Don 't Apply the Corporate Waste Doctrine Because the Standard Is Difficult to Enforce in Isolation 2. An Insufficient Number of Corporate Waste Claims Survives a Motion to Dismiss B. The Corporate and Financial Institution Compensation Fairness Act of 2009: A Positive Change, but Ineffective on Its Own C. Clawback Provisions Can Be Effective but Are Also Too Narrow to Provide a Complete Solution D. Pay Caps Can Be Overly Intrusive on a Corporation E. More Transparency in Executives' Salaries Has Done Little to Prevent Excessive Executive Compensation II. A POTENTIAL LEGAL CHALLENGE TO DEVELOPING A WORKABLE CORPORATE WASTE DOCTRINE A. Using the Say-on-Pay Resolution to Survive Early Dismissal B. The Rationale of the Model Litigation Strategy C. The Model Litigation Strategy Will Not Lead to Excessive Litigation CONCLUSION INTRODUCTION

"In a number of instances, executives have received compensation so large as to cause dissatisfaction among factory and office workers, and to lead stockholders to feel that they have been unjustly deprived of funds distributable as dividends." (1) This statement could have easily been made in 2010, Instead, it was written in 1941, when executive compensation was a hot topic with the Great Depression nearing its end in the United States. As this statement suggests, executive compensation has been controversial since the early days of corporate law. (2)

Although executive compensation reform is not a modern issue, the calls for reform are greater now than ever before. There are many possible reasons for the renewed focus on executive compensation reform. Currently, a chief executive officer earns roughly 400 times that of an average worker in his or her respective industry--a disparity twenty times greater than in 1965. (3) This gap is problematic not merely from a social justice standpoint, but also from an economic standpoint. (4) Ben Bernanke, Chairman of the Federal Reserve, called the problem of excessive executive compensation a threat to the "dynamism" of capitalism.(5) Corporations exacerbate this problem when they pay executives large bonuses even when the company loses money. (6)Shareholders view it as fundamentally unfair when executives are highly compensated while the stock price plummets) The recession that began in 2008 has stoked frustration even more. (8)

Although previous concerns over this issue failed to generate effective reform, the current iteration of the debate is different. First, as previously pointed out, the level of economic disparity is growing rapidly. (9) Second, the political climate favors some form of compensation reform. With Democratic majorities in both the Senate and House as well as a Democratic president, there is a strong possibility that some reform will emerge from the federal government in the near future. (10) Finally, the current global economic crisis is the most severe since World War II. (11) It is unlikely a coincidence that the Supreme Court first recognized the corporate waste doctrine in the midst of a similar economic crisis--the Great Depression. (12)

Given these factors, the conditions are ripe for executive compensation reform, and reform appears imminent. The question has become, what form should reform take? This Note examines a variety of potential reforms, including some that have been implemented and others that are under consideration. For instance, a bill currently before the Senate, the Corporate and Financial Institution Compensation Fairness Act, has a say-on-pay provision, which would require shareholders to vote annually on executive compensation structures. (13) Representative Barney Frank, who introduced the bill, stated that "[u]nder this bill, the question of compensation amounts will now be in the hands of shareholders." (14) This quote is not entirely accurate, however, because the say-on-pay vote would only be advisory and nonbinding on the board of directors.

Many reform discussions overlook the fact that there is already an existing legal doctrine designed to deal with excessive executive compensation claims: the corporate waste doctrine. (15) A waste claim is a relatively simple one. It is brought by shareholders against a company's board of directors alleging that the board wasted company assets. (16) Waste can include any distribution of company assets, (17) but the doctrine, when invoked, is most commonly employed for executive compensation claims. (18) The corporate waste doctrine has been described as an "equitable safety valve," meaning that it can be used for cases where relief would be otherwise unavailable. (19) Unfortunately, this safety valve is rarely invoked, which allows many seemingly valid excessive compensation claims to go unchecked. (20)

There are several reasons why the doctrine is not used. For one, the standard adopted for the corporate waste doctrine is impossibly high, which often leads courts to dismiss waste claims at the initial stages of litigation. Because of the doctrine's infrequent use, there is a dearth of academic debate over its use and effectiveness concerning executive compensation. (21) The doctrine has potential for meaning again, however, if used with the proposed say-on-pay legislation.

This Note argues that, in conjunction with the proposed say-on-pay resolution, a revitalized corporate waste doctrine would empower shareholders to curb excessive compensation by making shareholders' say-on-pay votes effectively binding. Part I discusses the viability of a series of potential solutions, including the corporate waste doctrine, that shareholders could use to address excessive executive compensation. Part II proposes a litigation strategy that would invigorate the corporate waste doctrine by using it in conjunction with the say-on-pay resolution, thereby providing shareholders with a viable solution for enforcing excessive executive compensation claims.

1. POTENTIAL EXCESSIVE EXECUTIVE COMPENSATION REFORMS

   Executive compensation in large publicly traded firms is often excessive in part "because of the feeble incentives of boards of directors to police compensation." (22) Directors can theoretically be ousted by a vote of shareholders, but this is a rare occurrence. (23) Board members are often influential in company management. Many board chairmen are also CEOs or founders of the corporation.(24) It would be extremely difficult to oust these board members, even when they are excessively compensating executives. (25) Furthermore, shareholders may realize that ousting a director over one bad action is an unwise decision. It is unreasonable to suggest that shareholders must remove a board member every time there is a disagreement.

   As a result of the lack of incentives to the board of directors, many proposals for measures to combat excessive executive compensation have been proposed in recent years. Many of these proposals are at least partially effective, but none of them provides a complete solution* This Part catalogues the most promising resources, both currently available and under consideration, in combating excessive executive compensation* Section I.A discusses the corporate waste doctrine and explains why the doctrine, by itself, fails to provide shareholders with an effective tool for combating excessive executive compensation. Section I.B discusses a bill containing a nonbinding say-on-pay resolution that Congress is currently considering, and argues that this bill alone will also prove inadequate in attempting to prevent excessive executive compensation. Section I.C explains "clawback provisions" and similarly argues that they are ill-equipped to solve the executive compensation problem. Section I.D discusses a strict pay cap on either executive bonuses or total compensation, and likewise posits that such caps will not suffice*...