Thomas & Wells on Executive Compensation

Executive Compensation in the Courts: Board Capture, Optimal Contracting and Officer Fiduciary Duties, by Randall S. Thomas, Vanderbilt University - School of Law, and Harwell Wells, Temple University Beasley School of Law, was recently posted on SSRN. Here is the abstract:

This Article proposes a new approach to monitoring executive compensation. While the public seems convinced that executives at public corporations are paid too much, scholars are sharply divided. Advocates of “Board Capture” theory believe officers so dominate their boards that they can negotiate their own employment agreements and set their own pay. “Optimal contracting” theorists doubt this, contending that, given legal and economic constraints, executive compensation agreements are likely to be pretty good and benefit shareholders. Disputes about which theory is correct have hampered efforts to reform executive compensation practices.

Recent developments in corporate law point to a way out of this theoretical impasse. Last year, in Gantler v. Stephens, Delaware’s Supreme Court resolved a major unanswered issue in corporation law when it held that a corporation’s officers owe the same fiduciary duty to the corporation and its shareholders as do its directors. Gantler opens the door for courts to scrutinize rigorously officers’ actions in negotiating their own compensation agreements. The Delaware Chancery Court has taken up this invitation by holding that corporate officers are bound by their duty of loyalty to negotiate employment contracts in an arm’s-length, adversarial manner. If the officers do not do so, but instead try to take advantage of the Board, they will open themselves up to shareholder lawsuits and give courts the opportunity to examine the compensation agreements and their negotiations. This will provide a new level of judicial scrutiny of executive compensation arrangements, and should go far to answer criticisms leveled by Board Capture theorists, who believe the present negotiating system is corrupt, while Optimal Contracting theorists will welcome judicial intervention that improves the present negotiating environment.