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Suggested Additional Assignments
Research: Boards of Directors
Ask students to choose a publicly traded company that makes something they own. Then have them look
up the company’s annual report on the SEC Web site (http://www.sec.gov). They can also find out
information at http://www.thecorporatelibrary.com. Using these and other Internet sites, what can they
learn about this company’s directors? What percentage are insiders? Outsiders? How many have
industry experience? How many have close ties to the company CEO? How would students evaluate this
board of directors?
Research: Executive Compensation
Ask students to find out the following information for two publicly traded companies in different
industries: How much did the CEO and the top five officers earn? How large is the company? How did
the company perform in the prior year? The prior five years? Compensation includes salary, bonus, stock
options, and other miscellaneous pay. Performance measures for the company can include stock price,
earnings, profits, return on equity, or any other measure the students choose. Information about publicly
traded companies is available at the SEC Web site: http://www.sec.gov and at
http://www.thecorporatelibrary.com.
Chapter Overview
Chapter Theme
In theory, corporate shareholders are immensely powerful. They own $13 trillion in assets worldwide.
Nevertheless, shareholders are carefully constrained in their efforts to exercise this power. Is the balance
of power between shareholders and corporate managers reasonable and fair?
Quote of the Day
“All powers granted to a corporation . . . are necessarily and at all times exercisable only for the ratable
benefit of all the shareholders.” –Adolf A. Berle, Jr. (1895-1971), social scientist.
Introduction
In many ways, this chapter is as much about ethics as Chapter 2. Corporate managers have a great deal of
power and, as the Enron case and other corporate scandals have illustrated, some have abused this power.
Research: Board of Directors
If students performed this assignment on boards of directors, they could discuss what they found.
General Questions:
What percentage of directors were insiders versus outsiders?
How many directors have industry experience?
How many directors have close ties to the company CEO?
How many also service as directors on other corporate boards?
How would students evaluate this board of directors?
Rights of Shareholders
As a shareholder, you have neither the right nor the obligation to manage the day-to-day
business of the enterprise.
Right to Information
Under the Model Act, shareholders acting in good faith and with a proper purpose have the
right to inspect and copy the corporation’s minute book, accounting records, and
shareholder lists.
You Be The Judge: Chopra v. Helio Solutions1
Facts: Facts: Paul Chopra was a minority shareholder and former director of Helio Solutions, Inc. Both
he and Helio were in the business of reselling Sun Microsystems hardware and software. Chopra
suspected that: (1) some of Helio’s majority shareholders had purchased a building and leased it to Helio
at an excessive rent, (2) the company had broken a lease so that it could rent this building, (3) some
shareholders had used assets of the corporation to secure a personal loan, (4) Helio had permitted
ex-employees to take away substantial business, and (5) the company had not collected a $1 million debt
it was owed. In addition, he wanted to know if Helio was planning to issue stock and thereby dilute his
ownership. Finally, he felt that his dividend of $1,952.55 was unreasonably low, given that Helio had $88
million in revenue. Chopra hired a forensic accountant to help him investigate Helio’s finances. At the
accountant’s request, Chopra asked Helio for these documents:
1. Articles of incorporation;
2. Minutes for meetings of the board of directors and shareholders;
3. All financial statements;
4. All tax returns;
5. The general ledger with accompanying journals;
6. Income and balance sheets;
7. Schedule of accounts payable and received and inventory;
8. Depreciation schedule for fixed assets;
9. Supporting documents including bank loans, lines of credit, accrued payroll liabilities, sales tax
liabilities, other receivables, loans to officers and owners, significant prepayments or deposits, and
equipment lease agreements;
10. Monthly bank statements;
11. Company credit card statements;
12. Compensation records;
13. The following contracts: life insurance policies for officers and/or stockholders; pension plan and
profit sharing plans; stock purchase plans; equipment and building leases; employment and bonus
agreements for owners or key employees; covenants not to compete; loan agreements and credit
information, documents connected with the company’s real property; option grants and each owner’s
curriculum vitae;
14. A list of patents;
15. Budgets projections for the current year;
16. Company brochures and/or marketing information;
17. A list of key management personnel with job title;
18. An overview of company positions and objectives for each department manager;
19. Information regarding contingencies and lawsuits.
1 2007 Cal. App. Unpub. LEXIS 5909, Court of Appeal of California.
Helio gave Chopra items 1-6 but refused to turn over the other materials. Chopra filed suit. The trial
court found for Helio and Chopra appealed.
You Be The Judge: Which of these documents must a company provide to its shareholders?
Holding: For Helio, the trial court’s ruling was affirmed. According to Chopra, the documents he
requested were necessary for assessing the value of Chopra’s investment in the company and determining
whether his interests as a minority shareholder were being protected. The records previously provided by
Helio were insufficient to make this determination.
According to the court, a shareholder has an interest in the assets and business of the company and
inspection of the company’s books may be necessary for the protection of his interest or for information
as to the condition of the company and the value of his interests. However, the inspection rights of the
shareholder are limited. Shareholder status does not, by itself, entitle an individual to unfettered access to
corporate information. The right does not extend to records not reasonably related to the proper purpose
for which they are sought.
According to the Appellate court, the trial court was correct in ruling that Chopra’s stated reasons for
inspection were vague and lacking in support. In addition, Chopra was asking for information about
certain shareholders rather than information about the company. Chopra was engaged in a fishing
expedition in which he was asking for information to support his unsubstantiated claims of corporate
wrongdoing rather than seeking information to support his interest as a shareholder.
Question: What was Chopra’s role at Helio?
Question: As a shareholder, isn’t he entitled to information about the company?
However, they do not have an unlimited right to information.
Question: Why type of information do shareholders have a right to receive?
Question: Was Chopra’s request broader than this?
Answer: Chopra’s request was much broader. Chopra requested, among other information, documents
Question: Why was he not entitled to receive this information?
Answer: According to the court there were a number of reasons why Chopra was not entitled to this
information. First, the court did not believe he was making the request with a proper purpose. The court
believed Chopra was looking for more than just information that would help him assess the value of his
Question: Why is this wrong?
Answer: Although board members have a duty to shareholders to maximize shareholder value,
shareholders have no duty to the corporation. Thus, shareholders can use the information they seek for
whatever purposes they wish. If corporations had to divulge everything, it would make it difficult for
Right to Vote
A corporation must have at least one class of stock with voting rights. Typically, common
shareholders have the right to vote and preferred shareholders do not, but there are many
exceptions to this rule.
Shareholder Meetings
Annual shareholder meetings are the norm for publicly traded companies. A proxy is a
person whom a shareholder appoints to vote for her at a meeting for the corporation.
Proxy access. By a 3-2 vote of the Commissioners, the SEC approved proxy access rules that require
companies to include in proxy material the names of all board nominees, including those selected by large
shareholders (who have owned 3 percent of the company for three years).
Independent Directors
Congress began its reform effort by passing the Sarbanes-Oxley Act (SOX), which applies to all publicly
traded corporations in the United States as well as to all foreign companies listed on a U.S. stock
exchange. Among other provisions, SOX stipulates that all members of a board’s audit committee must be
independent and at least one of these members must be a financial expert.
Shareholder Activists. Proxy advisors, such as Institutional Shareholder Services, Inc. (ISS) are a new
development in corporate democracy. They advise institutional investors on how to vote their shares.
Majority voting systems. Because of pressure from shareholder activists, two thirds of the S&P 500
(large companies) now refuse to seat a director if fewer than half of the shares that vote tick off her name
on the ballot. However, among smaller companies – those in the Russell 3000 Index – three quarters still
permit plurality voting – where one vote is often sufficient to insure election.
Shareholder Proposals
Under SEC rules, any shareholder who has continuously owned for one year at least 1 percent of the
company or $2,000 of stock can require that one proposal be placed in the company’s proxy statement to
be voted on at the shareholder meeting.
The SEC traditionally recommended that shareholder proposals be in the form of non-binding
requests because state laws sometimes prohibit binding resolutions. However, shareholder activists have
become angry that companies continue to ignore non-binding shareholder proposals that receive hefty
votes. In one recent year, shareholders of 29 companies voted in favor of non-binding proposals. Only
four companies made the changes recommended by shareholders.
In response, shareholders have begun to offer binding proposals although the validity of these proposals is
not clear.
Question: Should shareholders be allowed to pass binding resolutions?
Answer:
Arguments in favor:
Shareholders own the company. Why shouldn’t they be allowed to have some say?
Shareholders might pass proposals that harm a minority of shareholders; only the board
of directors can look out for everyone.
Compensation for O+cers and Directors – The Problem
Between 2001 and 2003, public companies spent 9.8 percent of their net income on compensation for top
executives. Executives also get many non-cash perks such as stock options, termination benefits,
retirement benefits, luxury perks, and sometimes illegal use of insider information. Additionally, the
power to set compensation and make other important decisions lies very close to the ones who benefit
from those decisions (directors and executives) but not with the ones who bear the risk (shareholders).
Corporate executives are not the only people to earn fabulous salaries. Some athletes earn more even than
CEOs. What is the difference between athletes and executives (besides a hook shot)? Athletes’ salaries are
indeed negotiated at arm’s length with the team owner who will actually be paying the bill. This
negotiation process means that (1) athletes’ pay is not camouflaged; (2) they do not receive enormous
severance packages on their way out the door; and (3) their retirement pay ranges from modest to
nonexistent. Also, an athlete’s performance is transparent and easy to measure.
Compensation for O+cers and Directors – A Solution?
The federal government has begun to respond to these perceived abuses by amending proxy rules, and by
passing the Sarbanes-Oxley Act and the Dodd-Frank Wall Street Reform and Consumer Protect Act. Even
with these new protections in place, shareholder influence over executive compensation is far from
guaranteed.
Case: Raul v. Rynd2
Facts: Hercules Offshore, Inc. provided drilling services to the oil and natural gas industry. In the prior
year, its revenue was down 11 percent and it had a net operating loss of $1.17 per share. Its total assets
decreased by $300 million while its net cash from operating activities was down almost 13 percent ($100
million). Its stock price had fallen almost 25 percent. In the face of this poor performance, the board of
directors unanimously approved a compensation plan that raised executive pay by between 40 percent
and 190 percent.
In its proxy statement to shareholders, Hercules stated that:
Our compensation committee will continue to design compensation arrangements with the objectives
of emphasizing pay for performance and aligning the financial interests of our executives with the
interests of long-term stockholders.
As required by say-on-pay rules, the company presented this compensation plan to shareholders at the
annual meeting. The board recommended that they vote in favor but 59% of Hercules’ shares voted
against it. The board ignored the shareholder vote and continued with the plan anyway.
Pincus E. Raul, a Hercules shareholder, brought suit, alleging that the board had breached its fiduciary
duty by approving the compensation plan in the face of a negative shareholder vote. He also alleged that
2 929 F. Supp. 2d 333 United States District Court for the District of Delaware, 2013
the compensation plan violated the company’s pay-for-performance philosophy as outlined in the proxy
statement.
Hercules filed a motion to dismiss.
Issue: Did the Hercules board violate its fiduciary duty when it approved the compensation plan?
Holding: Plaintiff relies heavily on the fact that the Hercules shareholders voted against the executive
compensation plan yet the Board thereafter did nothing to rescind or modify that plan in response.
However, [the Dodd-Frank statute] explicitly states that say-on-pay votes “shall not be binding” on a
company or its board of directors. Dodd-Frank also explicitly states that the results of say-on-pay votes
may not be construed in any of the following ways: (1) as overruling a decision by a company or its board
of directors; [or] (2) to create or imply any change to the fiduciary duties of a company or its board of
directors. Plaintiff’s allegations and arguments in this litigation fail to recognize these realities of
Dodd-Frank.
Plaintiff also relies heavily on his view that Hercules has adopted a strict pay-for-performance policy.
It is true that Hercules’ Proxy Statement explains that pay for performance is part of the philosophy and
objectives of the Company’s compensation programs. However, the same statement also identifies other
goals. In fact, the Proxy Statement states that the Company’s executive compensation policy is designed:
• to attract, retain, motivate, and reward executive officers who are capable of leading the Company in a
complex, competitive, and changing industry;
• to align the interests of our executive officers with those of our stockholders; [and]
• to pay for performance.
One of these goals merits particular discussion in light of Plaintiff’s allegations. This is the
Company’s goal of retaining its executive officers, a goal that may have taken on increased importance
precisely because of the difficult financial circumstances in which the Company found itself. As the Proxy
Statement explains:
The Board of Directors and its Compensation Committee remain committed to retaining the existing
management team, and as a result, have offered cash retention incentives to recover some of the
shortfall in long-term incentive compensation levels. The committee believes that the implementation
of this plan has been critical in deflecting efforts by competitors that can offer attractive
compensation opportunities, and in keeping the management team focused on executing the current
business strategy for future shareholder value creation.
The goal of retaining an executive could, under certain circumstances, lead to increased executive
compensation even if the Company is experiencing poor financial performance.
In addition, Plaintiff’s allegations incorrectly presume that executive compensation is solely awarded
retrospectively. As is common practice in executive compensation, the Proxy Statement makes clear that
much of the Company’s executive compensation is prospective. Hence, Plaintiff’s characterization of the
Hercules executive compensation policy as essentially mandating a strong correlation between certain
financial aspects of the Company’s performance and the compensation of the Company’s executives is
incorrect.
The Hercules Motion to Dismiss is GRANTED.
Question: What were the three arguments put forth by Plaintiff ?
Answer: (1) Hercules shareholders voted against the executive compensation plan yet the Board
Question: What goal of Hercules’ proxy statement did the Court rely upon to grant Hercules Motion to
Dismiss?
Question: What was the Court’s point in noting that much of Hercules’ executive compensation is
prospective?
Answer: To demonstrate that Plaintiff’s characterization of the executive compensation policy as
Executive Compensation
Question: How much of corporate earnings should go to the top five earners in a company (given that
there are millions of shareholders)?
General Questions: In 2006, Exxon had a profit of $36 billion, which was the largest any American
company had ever earned. Every time the price of oil increased by $1, Exxon’s earnings increased by
1.5%. Why were oil prices up? Because of the war in Iraq and increased demand from China.
Bonuses for the top five executives at Exxon increased by $14.3 million. Had the executives earned
such large increases?
In 2012, America’s Highest Paid Chief Executives according to www.forbes.com
(http://www.forbes.com/lists/2012/12/ceo-compensation-12_rank.html):
1. John H. Hammergen – McKeeson - $131.19 (1-year-pay; millions);
2. Ralph Lauren – Ralph Lauren - $66.65 (1-year-pay; millions);
3. Michael D. Fascitelli – Vornado Realty - $64.40 (1-year-pay; millions);
4. Richard D. Kinder – Kinder Morgan - $60.94 (1-year-pay; millions); and
5. David M. Cote – Honeywell - $55.79 (1-year-pay; millions).
General Questions:
What do you think of the salaries of these chief executive officers?
What would you do with that kind of money?
Current Focus
Why has executive compensation increased so dramatically? In the 1950s, executives earned 40 times as
much as the average worker. Now they earn 458 times as much. Some commentators suggest that
corporate law is to blame. As we saw in Chapter 34, state corporate statutes have given managers more
power to fend off hostile takeovers. These takeovers, to some degree, kept managers honest. Executives
knew that if their company did badly, a shark would come along to buy the business and throw out top
management. Without the discipline of hostile takeovers, managers can pay themselves what they want.
Question: What can companies do about executive compensation?
Answer: Some commentators suggest the following:
Companies should make much fuller public disclosure about executive pay. Not just how much
General Questions:
What ethical obligations do directors have in setting officers’ pay?
Should there be some limit to the ratio between executive pay and the income of the average worker?
Should executive pay relate to the company’s performance? To what measure of performance?
Should companies base compensation on a comparison of their performance with that of their
competitors?
If students completed the Executive Compensation Research, have them report what they found. Chart
the raw data on the board–what is the range of salaries for CEOs? Then see if the students are able to
discern any correlation among income, performance, and size.
Right to Protection from Other Shareholders
Anyone who owns enough stock to control a corporation has a fiduciary duty to minority shareholders.
Case: eBay Domestic Holdings, Inc. v. Newmark3
Defendant, craigslist, Inc., owned the most popular website in the country for classified ads. It had just
two shareholders – Craig Newmark and Jim Buckmaster -- and only 34 employees. eBay, Inc. was a
publicly traded company that operated online auction sites worldwide. It employed over 16,000 people.
eBay bought a minority interest in craiglist with the goal of ultimately acquiring the company or, failing
that, learning the “secret sauce” of craigslist’s success. It turned out, though, that craigslist and eBay
were not a good match because they had entirely different cultures and approaches to business. craigslist
focused on enhancing its user community, rather than maximizing its profits or expanding its business
model. In contrast, eBay’s primary focus was to increase profitability and market share.
Without undergoing any pre-marital discussions in which these divergent goals might have been revealed,
eBay purchased 28.4% of craigslist’s shares. Under the explicit terms of the deal, it had the right to
compete with craigslist. Craig and Jim said that if eBay was able to offer customers a better experience,
then it should be allowed to do so.
As eBay gradually realized that Craig and Jim would never sell out to them, at least in this lifetime, it
launched a competing classifieds website at www.Kijiji.com. In this process, it used nonpublic
information about craigslist that it garnered, without Craig and Jim’s knowledge, from its relationship
with the company. That “betrayal” further inflamed the situation. As other people have discovered,
agreeing in theory to an open marriage is very different from experiencing it in practice. Jim and Craig
were furious about eBay’s foray into online classifieds. They asked for a divorce, but eBay refused to sell
its stock.
Craig and Jim, in their role as directors, responded by adopting a rights plan that restricted eBay’s ability
to buy more shares of craigslist or sell its existing shares to third parties. They also eliminated its right to
choose one board member. eBay filed suit, alleging that this rights plan violated craigslist’s fiduciary
rights to eBay as a minority shareholder.
Issue: Did Craig, Jim and craiglist violate their fiduciary duty to the minority shareholder?
Excerpts from Chancellor Chandler’s Decision: All directors of Delaware corporations are fiduciaries
of the corporations’ stockholders. Similarly, controlling stockholders are fiduciaries of their corporations’
minority stockholders.
[In a situation such as this] directors must (1) identify the proper corporate objectives served by their
actions; and (2) justify their actions as reasonable in relationship to those objectives. Thus, the two main
issues I confront are: First, did Jim and Craig properly and reasonably perceive a threat to craigslist’s
corporate policy and effectiveness? Second, if they did, is the Rights Plan a proportional response to that
threat?
Jim and Craig contend that they identified a threat to craigslist and its corporate policies that will
materialize after they both die and their craigslist shares are distributed to their heirs. To prevent this
unwanted potential future reality, Jim and Craig have adopted the Rights Plan now so that their vision of
craigslist’s culture can bind future fiduciaries and stockholders from beyond the grave. Having given new
meaning to the concept of a “dead-hand pill,” Jim and Craig ask this Court to validate their attempt to use
a pill to shape the future of the space-time continuum.
3 2010 Del. Ch. LEXIS 187 Court of Chancery of Delaware, 2010
Ultimately, defendants failed to prove that craigslist possesses a palpable, distinctive, and advantageous
culture that sufficiently promotes stockholder value to support the indefinite implementation of a poison
pill. Jim and Craig did not make any serious attempt to prove that the craigslist culture, which rejects any
attempt to further monetize its services, translates into increased profitability for stockholders.
I am sure that part of the reason craigslist is so popular is because it offers a free service that is also
extremely useful. It may be that offering free classifieds is an essential component of a successful online
classifieds venture. After all, by offering free classifieds, craigslist is able to attract such a large
community of users that real estate brokers in New York City gladly pay fees to list apartment rentals in
order to access the vast community of craigslist users. Giving away services to attract business is a sales
tactic, however, not a corporate culture. To the extent business measures like loss-leading products,
money-back coupons, or putting products on sale are cultural artifacts, they reflect the American capitalist
culture, not something unique to craigslist.
The defendants also failed to prove at trial that when adopting the Rights Plan, they concluded in good
faith that there was a sufficient connection between the craigslist “culture” (however amorphous and
intangible it might be) and the promotion of stockholder value. Jim and Craig simply disliked the
possibility that the Grim Reaper someday will catch up with them and that a company like eBay might, in
the future, purchase a controlling interest in craigslist. They considered this possible future state
unpalatable, not because of how it affects the value of the entity for its stockholders, but rather because of
their own personal preferences. Jim and Craig therefore failed to prove at trial that they acted in the good
faith pursuit of a proper corporate purpose when they deployed the Rights Plan.
I personally appreciate and admire Jim’s and Craig’s desire to be of service to communities. The
corporate form in which craigslist operates, however, is not an appropriate vehicle for purely
philanthropic ends, at least not when there are other stockholders interested in realizing a return on their
investment. If Jim and Craig were the only stockholders affected by their decisions, then there would be
no one to object. eBay, however, holds a significant stake in craigslist, and Jim and Craig’s actions affect
others besides themselves.
As long as Jim and Craig have control they can maintain the craigslist “culture” regardless of whether
eBay sells some or all of its shares. The Rights Plan therefore does not have a reasonable connection to
Jim and Craig’s professed goal. It therefore falls outside the range of reasonableness.
I rescind the Rights Plan in its entirety.
Question: What was the court’s ruling?
Answer: The court rescinded a poison pill adopted by craiglist’s board of directors. The court found
Question: What does the outcome of this case demonstrate?
Answer: The willingness of the Delaware courts to uphold the use of poison pills when directors can
