Corporate Governance

Executive Compensation, AIG and the Consequences of the Delaware Model

By J. Robert Brown

By now, the payment of some $165 million in bonuses by AIG (apparently 73 people received bonuses of at least $1 million) has become widely known and generated enormous outrage.  The payments were apparently made, in many cases, under contracts that guaranteed bonuses similar to those paid in 2007 irrespective of performance.  As a result of the controversy, a number of executives returned all or a portion of their bonuses.

The irony in all of this is that the bonuses may well have been necessary and appropriate. 

AIG has gone through a process of financial turmoil, with the company coming perilously close to bankruptcy and ultimately ending up effectively nationalized.  Any top level employee had to know back in 2007 that there was some possibility that their job would be eliminated (or they would be eliminated) in bankruptcy or as part of a reorganization to streamline matters.  A rational approach would be to look for other employment, with lemmings all leaping over the cliff together.  A dramatic outpouring of skilled employees at AIG would probably have made matters far worse, making a return to profitability more difficult and perhaps precipitating bankruptcy or complete nationalization. 

The bonuses essentially said to employees, stay another year (2008) and, irrespective of the worsening of the crisis, we will ensure that you get the same pay you got in 2007.  A hardworking, independent board could certainly view these payments as important to the company and in the best interests of shareholders.

The problem is that the Delaware model (AIG is incorporated in Delaware, by the way) doesn't guarantee that the board is in fact independent or hard working.  Take the Citigroup case.  Here was an example of a suit alleging that the board did not actually oversee risk taking by the bank despite having a board committee that ostensibly was meant to examine this very issue.  Shareholders were lectured in the case by the Chancellor about how unreasonable it was to expect directors to participate in risk assessment. 

The same is true with executive compensation.  As the Disney case illustrated (the contract for Michael Ovitz), the board can have very little information about compensation and the impact of compensation and still meet their fiduciary obligations under Delaware law.  For more on this, take a look at Returning Fairness to Executive Compensation.

In the end, there is simply no faith in the board to make these decision.  There is no reason to presume that the board acted in a deliberate, thoughtful way.  Why not?  Because Delaware law does not require it.  Had there been meaningful standards for directors in place, the market and the public would have had greater reason to believe that the bonuses were necessary.  But unfortunately for AIG, this was not the case. 

Full post as published by The Race to the Bottom on April 09, 2009 (boomark / email).