Corporate Governance and the Problem of Executive Compensation: State Law Redux (Zucker v. Andreessen) (Part 1)
We have been looking at the problem of executive compensation. In that regard, we want to take a few minutes to discuss the most recent Delaware salvo on the subject, Zucker v. Andreessen, 2012 Del. Ch. LEXIS 135 (Del. Ch. June 2012). The case illustrates the lack of regulation of compensation at the state level.
This case arose out of the separation between Hewlett-Packard and Mark Hurd, the former CEO. Hurd left HP under a cloud. According to the Complaint, an internal investigation found "that Hurd filed inaccurate expense reports" and that this constituted "a breach of the Company's standards of business conduct." The board, however, approved a severance package for Hurd estimated to be worth $40 million. Plaintiff asserted that the severance arrangement violated the board's fiduciary obligations.
Hurd was dismissed by the board on August 6. His compensation package was determined the same day. Thus, he was either still a director at the time the compensation was determined or a non-director by a matter of minutes or hours. Ordinarily when directors determine compensation for someone inside the board room, the operating standard is the duty of loyalty.
In Delaware, however, the applicable standard has been changed to the duty of care. Because this is a process standard, the duty of care does not consider substance only process. Thus, in reviewing challenges to compensation, Delaware courts for the most part do not care about the amount or form of compensation only whether the process was adequate. As long as the board was independent and informed, any amount of severance will be deemed to be consistent with the board's fiduciary obligations.
Yet a purely process driven standard can lead to absurd results. Delaware deals with this possibility through the doctrine of waste. Even if the process is proper, compensation can still be so extreme that in amount that it constitutes waste. In Zucker, Plaintiff had little choice but to argue that the $40 million in severance constituted waste.
Waste in Delaware, however, is a theoretical limit. As a practical matter, it is almost never used to reign in the amount of compensation, no matter how extreme. This case illustrates that basic point as we shall show in the next few posts.