Corporate Governance

Executive Compensation and CEO Involvement in the Process

By J. Robert Brown

As we have noted (and as has been discussed in the paper, Returning Fairness to Executive Compensation), both the Delaware courts and the NYSE rely on approval of independent directors to validate executive compensation decisions.  Delaware courts extend the protections of the business judgment rule to decisions approved by independent directors.  The NYSE requires that a majority of the board consist of independent directors and that only independent directors sit on the compensation committee (see NYSE Manual, 303A.05). 

We have already noted many many problems with this approach, including the failure to enforce a meaningful definition of independent (the definitions, among other things, do not adequately account for friendship, for structural bias from longstanding service together, or the impact of fees, see Disloyalty Without Limits: 'Independent' Directors and the Elimination of the Duty of Loyalty) and the failure to ensure that compensation advisors who bless compensation decisions are truly independent. 

But the most significant problem concerns the refusal of both state law and the stock exchanges to limit the role of the CEO in the compensation process.  The NYSE may require the compensation committee to consist of independent directors but it does not prohibit or limit the CEO from making recommendations and participating in the deliberations.  Similarly, Delaware courts merely require approval by a board with a majority of independent directors.  They do not make the business judgment rule contingent upon an exclusion of the CEO from either the debate or the vote.

With all of this in mind, it was quite interesting to read about the dispute between the soon to be extinct (at least as an independent entity) Merrill Lynch and its CEO, John Thain.  Thain has apparently recommended to the compensation committee that he receive a bonus of $10 million.  The article notes that the committee is "resisting" the request.  There was an earlier proposal suggesting that he receive $30 million but the Journal notes that it is unknown whether Thain was aware of the proposal.  On the other hand, Thain will have his "first formal discussion with the firm's compensation committee" on Monday. 

We are not debating the merits of his compensation.  He was paid handsomely to leave the NYSE and go to Merrill (somewhere around $80 million) and has only been working at Merrill for around a year.  By most assessments, he has done a yeoman's job at Merrill during the turmoil, particularly the successful negotiation of the merger with BoA. 

On the other hand, one wonders about the fairness of a compensation process that involves such heavy handed participation of the CEO.  The situation at Merrill, which is likely typical, puts the board in the position not of determining bonuses but of deciding whether to reject or accept a CEO's recommendation.  As we have noted over and over, directors have an incentive to avoid conflict with the CEO as a means of retaining their sinecure on the board.  With neither regulator caring much about this dynamic, it is no wonder that the executive compensation process is out of control. 

Full post as published by The Race to the Bottom on December 10, 2008 (boomark / email).