Executive Compensation: At The Crossroads?

Tuesday, June 1, 2004 - 01:00
Michael S. Melbinger

Editor: Mr. Melbinger, would you give our readers something about your background in the employee benefits and compensation area?

I am a partner at Winston & Strawn and global head of the firm's employee benefits and executive compensation department. I have practiced in this area exclusively for 21 years, representing individual executives, together with companies, boards of directors and fiduciaries. My practice includes not just executive compensation, but also employee retirement and welfare plan issues, the fiduciary issues relating to those plans, litigation matters in this area, and the benefits and compensation aspects of change in control transactions and IPOs. I am also an adjunct professor of law at Northwestern University School of Law, and my book, Executive Compensation, was published this year. I also authored a book on retirement plan fiduciary duties, and I have written some 45 articles.

Editor: How did you come to Winston & Strawn?

I was head of the employee benefits and executive compensation department at another large law firm in Chicago. I had had some success in building a department there, and, as a consequence, Winston & Strawn asked me to join them. That was in 1997.

Editor: How has your practice changed over the 21 years that you have been engaged in it?

Today executive compensation has become a much bigger focus of the department than it was in the past. In 1983 the focus was more on qualified retirement plans, and there were almost no legal issues for health and welfare benefit plans. Now, executive compensation takes up most of our time, and health and welfare benefits also receive considerable attention. Of course, when I began my career there was no COBRA, no HIPAA, no flexible spending accounts. The field has become much more complicated, and the need to coordinate a variety of benefits with cash and other forms of compensation is much greater than in the past.

Editor: You have also enjoyed a parallel career writing and teaching. Will you tell us how these two aspects of your career interact? Do they reinforce each other?

Very much so. I came to writing as something of a release after having worked on the Internal Revenue Code all day. Lecturing and teaching constitute a natural outgrowth of writing. In point of fact, the academic side of my career forces me to stay on top of current developments - statutes and regulations, rulings, case law, the literature - on an ongoing basis, and that is of enormous benefit to my clients. If nothing else, they receive the benefit of my being up to date and having state of the art forms without having to pay for research time. The students benefit, I think, from a classroom experience with someone who knows the subject-matter and who has an active practice concurrent with his teaching. I think it is important for them to have at least some exposure during their law school years to the practical realities of law in the real world.

Editor: Your recently published book Executive Compensation has been well received. For starters, why did you think it necessary to undertake such a project now? Have there been enough changes in this area of the law in recent years to justify a new work of this magnitude?

When I undertook this project, there was no comprehensive treatise on executive compensation. That is the gap we sought to fill with the publication of my book. The timing turned out to be perfect. I do not believe there has ever been a five-year period during which the law that governs this area has changed so dramatically. Think for a moment of the tech boom, followed by the tech bust, and then the corporate scandals and finally the reforms resulting from the scandals. One of the most difficult things for me in writing the book was the speed with which truly significant developments took place. Many times when I thought I had come to closure with respect to a significant area, something would break, and I would be faced with a major revision job.

Editor: Please tell us what impact the recent corporate scandals has had on executive compensation.

The corporate scandals and the resulting media attention have put the spotlight on boards of directors and board compensation committees, in addition to executives. Members of governing boards and board committees face significant liability, and they are turning to executive compensation lawyers to a much greater extent than in the past. And with good reason. I believe that the corporate scandals and the attendant public uproar have affected the courts. For example, in the original action brought by the Disney shareholders who argued that the Disney governing board had breached its fiduciary duty by awarding former CEO Michael Ovitz a severance of $140 million upon his departure after a year's service, the Delaware Court of Chancery dismissed the complaint on the grounds that Delaware law protected directors from lawsuits purporting to second-guess their decisions. That occurred before Enron, WorldCom and the like. In July of last year, the same court listed 25 possible derelictions by the Disney board and found that the suit, which found its way back to Delaware Chancery after a stop at the Delaware Supreme Court, can proceed on the breach of fiduciary duty claim. That means that the directors may be personally liable for - and be required to pay to the Disney Corporation out of their own pockets - the $140 million they authorized for the Ovitz severance if their conduct is found to be outside the business judgment rule. I think the Delaware courts - which constitute a forum to which all corporate lawyers in America look for guidance - have decided that enough is enough.

Editor: What are the major issues in the executive compensation field today?

I think the focus is still on equity compensation. That is where governing board compensation committees still spend most of their time. The issue now is how to structure equity compensation. No one has been able to come up with an alternative to equity compensation as the way to link the corporate officers' interests to those of the corporation's shareholders. For many years compensation committees and corporate executives believed that stock options was the right way to link the fortunes of the company and its shareholders to those of key executives. Now everyone is giving that approach a second look. Some of the more outrageous compensation amounts paid to executive like Michael Ovitz and others, which have been in the press recently, were option-driven, and that is forcing compensation committees to look very carefully at things like restricted stock and other forms of equity compensation. In addition, full disclosure is coming to the fore. This is, of course, a direct consequence of Sarbanes-Oxley and the public furor caused by Richard Grasso's compensation. Just after the Delaware Court of Chancery issued its decision in the Disney case we had a CEO client, solely on his own initiative, ask to appear before his governing board, with the company's executive compensation staff and me in tow, to carefully explain to them every aspect of his compensation. That is a good practice.

Editor: Have there been any changes in the laws governing non-compete agreements and other restrictive covenants that our readers ought to know about?

There has been a dramatic increase in a company's ability to enforce non-compete agreements and other restrictive covenants, and that is mainly through equity and deferred compensation awards. Most courts look unfavorably on non-compete provisions in employment contracts. For many years courts in just about every jurisdiction have said that it is contrary to public policy to prevent a person from getting another job. Today, however, the courts seem to accept a non-compete provision that permits a person to get another job and forfeit some of the additional compensation - such as the equity piece - he would receive if he obeyed the non-compete. This really allows the employer to put some teeth into their non-compete agreements.

Editor: You have negotiated executive compensation arrangements for both individual executives and for the company. Will you share with us some of the pitfalls here?

With respect to the individual, I attempt to focus on the worst case scenario. What happens if, through no fault of the CEO, some technological breakthrough renders the company's products obsolete? What happens if the Chairman takes a dislike to him or her? There are many ways in which we can protect the executive - hopefully they won't have to be invoked - and, in light of the many ways in which executive compensation can be packaged today, not all of them involve cash payouts.

Concerning the company, the emphasis is also on the worst case scenario. The SEC recently brought an action against Gemstar-TV Guide International, Inc. in connection with exit agreements the company had signed with its former CEO, COO and CFO. Those agreements resulted in the company paying nearly $100 million upon their departure. The alleged reason for their departure was an SEC investigation into whether those officers had manipulated earnings. This is a typical worst case scenario, and something that might have been avoided with appropriate executive compensation planning in advance. Companies want to avoid having to make huge payouts to departing executives who leave behind a big mess.

Editor: A recent New York Times article pointed out that in 1940 the compensation of the CEOs of America's major corporations was, on average, 25 times the compensation of rank and file. Today that multiple is several hundred times. What are the implications of that? Where do you think we are going on this point?

I think this could be a real problem for our society. We reward performance, but there are times when just about everyone agrees the process has resulted in excesses that cannot be justified. I am a member of two groups involved in an attempt to address the ways in which we measure appropriate compensation. The National Association of Stock Plan Professionals has set up a task force to get our own house in order before the government feels compelled to step in and do so, and the National Association of Corporate Directors is very concerned about the connection - or lack of connection, really - between fiduciary responsibility and excessive compensation awards. As a result of the backlash from the corporate scandals, I do not think that we will see as many extravagant packages for executives. I also don't think you will see as many inattentive governing boards in the future. The court's opinion in the recent Disney case lays out a good list of "what not-to-do." Nevertheless, I think that compensation packages for high-performing executives - like professional athletes - will continue to be generous. What differentiates today from the 1990s is that executives who do not perform cannot expect to be similarly compensated.

Please email the interviewee at mmelbinger@winston.com with questions about this interview.