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Monday, April 10, 2006

Disney and Executive Compensation

Over at Ideoblog Larry Ribstein is predicting that the Delaware Supreme Court will overturn Chancellor Chandler's opinion in the Disney-Ovitz litigation.  For those of you who have not followed this saga, Disney hired Michael Ovitz in 1995 to be Disney's President and heir apparent to Michael Eisner, the Disney CEO.  Ovitz resigned under pressure fourteen months later and, thanks to a stock options vesting provision, pocketed $140 million for his work.  For doing a bad job, Ovitz made $10 million a month, or over $320,000 a day.

The Disney litigation has a fascinating history, going back to Chancellor Chandler's original 1998 decision dismissing the suit with prejudice.  In 2000, the Delaware Supreme Court agreed with most of the chancellor's analysis but remanded to have portions of the complaint dismissed without prejudice.  The plaintiffs refiled, using evidence from the Disney board's minutes about the transaction.  In 2003 Chancellor Chandler handed down a scathing denial of the new motion to dismiss, finding that the plaintiffs' allegations supported a claim against the board for failing to act in good faith.  After a chancery trial in Georgetown, Delaware, the Chancellor found for defendants on all counts.

Larry Ribstein believes that the Court will overturn the Chancellor's decision on narrow grounds.  Part of the controversy surrounded the decision to let Ovitz go under the "wrongful discharge" clause in his contract.  This clause let Ovitz collect on all of his stock options at the time of his dismissal, and these options formed the bulk of his compensation.  However, plaintiffs argued that Ovitz should have simply been terminated for poor performance, which would not have triggered the options.  In his decision, Chancellor Chandler found that Eisner made this decision, he was empowered to make this decision, and thus the Disney board had no duty to consider the issue.

Ribstein believes this conclusion is the most likely grounds for overruling:

The supreme court might hold that this was wrong -- the ceo's technical power does not limit the board's duty. This holding would satisfy the need to tell the board to do more, yet on a sufficiently narrow ground that the court can distinguish it in the future. So by taking this tack, the court will have satisfied its need to preserve V[an] G[orkom] without too great an expansion of the board's duties.

The result of all this would be a remand to apply Van Gorkom in light of the court's holding.

Note that all of this concerns application of the b[usiness] j[udgment] r[ule], and might well be mooted eventually by application of good faith on the "back end" of [Delaware GCL Sec.] 102(b)(7).  Obviously this would be a lot of running around to get to the same result.  However, as I noted before, the court's interested in making a point, not getting to a result.

Gordon Smith agrees, noting that this issue was "unquestionably the weakest part of Chancellor Chandler's opinion."

Ribstein also notes that the Court might reverse on the board's initial decision to hire Ovitz under the troublesome terms.  As he notes:

This would fit in with all the public agitation on executive compensation and the performance of executives and the need for active board supervision of these matters. But such a holding would be problematic because it seems to deny the need for perspective and judgment – just what the feds have lost with the obsession with trivia in the SOX internal controls rule.

The good Professor Bainbridge agrees, stating: "I don't see how the Delaware Supreme Court could reverse without creating new law."

Even if they affirm Chancellor Chandler's opinion on Ovitz's initial hiring, the Supreme Court justices would do well to further elucidate more specific requirements for compensation committees when negotiating compensation for top officers and directors.  The Disney case serves as a nice example of the lower end of what might be considered "reasoned deliberation."  The compensation committee spent an hour on the issue of Ovitz's compensation, along with discussing five other agenda issues.  An actual draft of Ovitz's contract was not distributed.  Although some discussion ensued, the minutes do not reflect the discussion, and the committee members did not recall the discussion in any substantive detail.  Prior to this meeting, members had had only brief phone discussions about the contract -- discussions that at least one member did not remember at the time of his deposition.  (See note 64 of the 2005 opinion.)  It is true that much of the work in developing Ovitz's contract was done by two (out of four) of the members of the committee working on their own with an executive compensation consultant.  But no one detected the potential loophole that ended up paying Ovitz so well for poor performance.

Today's New York Times has an article by Gretchen Morgenson about executive compensation consultants.  Her upshot: these consultants, while called on to provide independent expert advice, have powerful reasons to provide generous recommendations to the boards that hire them.  It is a symbiotic relationship: executives needs independent and expert justifications for their lucrative salaries, and the consultants need work.  Neither party has an interest in keeping salaries manageable.  As a result, boards can point to an expert and disclaim responsibility for what are exteremly subjective and value-laden decisions.

I hope the Court reexamines the relationship between boards and experts in the compensation arena.  Even if it affirms Chancellor Chandler's opinion, it could set new standards for the processes that compensation committees use in setting executive salaries.  Perhaps such standards will largely be hortatory, much like Chancellor Chandler's rhetoric.  ("As I will explain in painful detail hereafter, there are many aspects of defendants' conduct that fell significantly short of the best practices of ideal corporate governance. ")  But the Court would do a real service in setting some standards in this increasingly contentious area.

Posted by Matt Bodie on April 10, 2006 at 09:18 AM in Corporate | Permalink


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Has this been settled now? I can't seem to find any news on the outcome.

Browsing around, though, I've found some interesting comments from various people. One particular person said that they had a friend at a large insurance agency, and their take on the situation is that the D&O is 'testing the waters.' A verdict for the plaintiff would cause the insurer to pay but the whole thing allows for insurance companies to increase their rates (if the plaintiff has a verdict against the insurance company) on this sort of coverage. Now that I found interesting.

I don't know if this has been settled, but it would be interesting to see what policies have changed since this all started and how it has affected executive laws and boards in big corporations across the world. I agree that the case is small enough for it to be a good way to 'test the waters' but big enough to cause effect throughout business.

Posted by: Mobile Phones | May 30, 2007 5:57:47 AM

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