The Business Judgment Rule

A few years ago Time-Warner’s Fortune Magazine headlined a cover story on the staggering pay spiral of top corporate bosses and why nothing will be done to stop these over-the-top compensation packages. “Whew” I reacted — this coming from one of the nation’s premier business publications — is a pretty good confirmation of a century-long silent coup d’etat against the rights of the owners of capital.

The owners are the shareholders, of course. In capitalistic theory, owners are supposed to control what they own. For decades, the managers and the rubber-stamp, pampered boards of directors have seized that control for themselves. Thus, my use of the phrase “corporate capitalism.”

The legal innovation that helped strip owners from controlling their large corporation is called the “business judgment” rule accepted by the courts. This rule shields members of the boards of directors from being held personally liable for approving decisions that seriously harmed their company or got their company into trouble, so long as these Boards can show they acted in good faith and with due care. Such a showing has often come in the garb of “not knowing” that the books were being cooked or that profits were being secretly inflated by company executives and accounting firms.

It is time to shed the charade and call the “business judgment” rule a cover-up for the irresponsibility or complicity of boards of directors (remember Enron, Health South, Worldcom, etc.). Boards are paid to look the other way in many large companies, as are outside corporate law firms and accounting firms.

Earlier this year, corporate critics and shareholder representatives thought things might be changing. A Delaware Chancery Judge William Chandler III refused to dismiss a case brought by stockholders against the Disney Corporation’s board of directors for approving a lavish termination payoff to Disney’s president, Michael Ovitz, after less than two undistinguished years on the job.

Plaintiffs charged that the Board did not exercise their fiduciary duty to shareholders (the owners) and did not dutifully review and reject Mr. Ovitz’s employment contract. A three month trial produced widely publicized testimony showing how utterly cavalier the Board was in letting Michael Eisner give Mr. Ovitz this “golden parachute” to leave the company after a falling out between the two super-rich men. Judge Chandler is expected to render his decision in a few weeks. In the meantime, shudders and shivers have been flitting through America’s giant boardrooms to start getting tougher with wastrels in top management and stop being wined, dined and paid into such stupendous stupors.

In 2002, the average pay of the CEOs of the top 300 largest companies in the U.S. came down to $7400 an hour!! Imagine Wal-Mart executives making this off of workers earning $7 an hour. Eisner himself in one whopper year made about $1 million a day, assuming a five-day week.

Now comes the venerable New York Stock Exchange firm of Morgan Stanley to show how prophetic were Fortune Magazine’s editors. When Dean Witter and Morgan Stanley merged, CEO Phil Purcell packed the merged company board with his buddies from Dean Witter. Trouble started and the company faltered. A revolt by ex-Morgan Stanley top executives led to toppling Mr. Purcell this year. He took away a package worth about $106 million, including a new $44 million cash bonus. Lots of people would like to be fired that way for not doing a good job.

But it was his protégé’s pay package that stunned the usually jaded business press. Look at the terms. One Steve Crawford, hardly in his Forties, was appointed by Mr. Purcell and served on the job for three and a half months as co-president. Crony capitalism. He was working in administrative jobs at Morgan Stanley before his windfall elevation.

Well, the Board gave Mr. Crawford a guarantee in June 2005 of $32 million in cash compensation over two years or $16 million a year. Then, catch this. The Board said that he could walk away with the entire cash hoard if he quit by August 3. Get the idea.

The Morgan Stanley wordsmiths explained these two huge payouts as insuring management stability and not distant from Wall Street’s world of the ordinary.

Rewarding Mr. Crawford, payment for his 100 day stint, said the Board, was meant to “mitigate the uncertainties that you may be experiencing regarding your future with the company.” This was too much even for the Wall Street Journal’s commentator who acidly said “That’s one word for it.” Whether they know it or not, millions of investors and thousands of pension and individual trusts will be waiting for Judge Chandler’s decision and subsequent court appeals. Delaware law is very influential in matters of corporate governance.

Lo the 47 million full time workers making between $5.15 and under $10 an hour, many without any health insurance or sick leave. Lo the poor children living in hovels. Lo the loyal workers whose jobs these executives so readily ship to communist or other dictatorships.

There is pay for real work, pay for real speculation and pay for real cronyism in this country. If the shareholder-investor owners of these companies organized and demanded by law that they must approve or disapprove compensation packages for the top executives managing the companies they purportedly own, obscene crony pay would become a thing of the disgraceful past.

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