By Randall S. Thomas & Harwell Wells. Full text here.
Americans seem convinced that corporate executives are paid too much. So far, however, attempts to rein in executive compensation have met with little success. In the Article we propose a new approach to monitoring executive compensation, one that turns to an unlikely institution to oversee pay: the courts.
Enemies of high executive compensation have generally dismissed courts’ ability to curb executive compensation, reasoning that courts have never wished to become involved in pay decisions. We show, however, that at several points over the last century, courts have proven surprisingly willing to second-guess decisions on executive compensation. These courts ultimately retreated from activist approaches to executive compensation not because of complacency, but because they believed themselves incapable of determining whether pay was “fair” or merited.
New developments in corporate law point to a way out of this impasse and carve out a new way for courts to oversee executive compensation. In recent years, courts have begun focusing on the distinctive fiduciary duties of corporate officers, culminating last year when the Delaware Supreme Court held in Gantler v. Stephens that a corporation’s officers owe the same fiduciary duty to the corporation and its shareholders as do its directors. Gantler and similar cases open the door for courts to monitor executive compensation by inquiring whether officers fulfilled their fiduciary duties when negotiating their own compensation agreements. The Delaware Chancery Court has already held that corporate officers are bound by their fiduciary duty of loyalty to negotiate their employment contracts in an arm’s-length, adversarial manner. If they instead try to manipulate the negotiation process, the officers open themselves up to shareholder lawsuits which invite judicial scrutiny of compensation negotiations and the result of those negotiations, the compensation agreements.