Director Bonuses for Performance, Prawf Debate and the Bigger Picture for Hess
posted by Lawrence Cunningham
A hot debate rages among corporate law professors amid one of the largest proxy battles in a decade: Hess Corp., the $20 billion oil giant, is the focus of a contest between its longstanding incumbent management and the activist shareholder Elliott Associates. Ahead of Hess’s annual meeting on May 16, where 1/3 of the seats on Hess’s staggered board are up, antagonists offer dueling business visions. They battle bitterly over such fundamentals as sectors to pursue, degrees of integration to have and cash dividend policy.
The professorial debate, more civil, is about a novel pay plan Elliott proposes for its director nominees, which Hess’s incumbents condemn and Elliott defends as suited to shareholders. On one side, all quoted in Elliott’s investor materials circulated April 16, are me, Larry Hammermesh (Widener), Todd Henderson (Chicago), Yair Listoken (Yale) and Randall Thomas (Vanderbilt); on the other Steve Bainbridge (UCLA), Jack Coffee (Columbia) and Usha Rodriques (Georgia), all of whom have blogged since the matter was first reported by Steven Davidoff (Ohio State) in the New York Times April 2 (for which he connected with me for comment).
As in all such cases, Elliott proposes to pay nominees a flat fee of $50,000 each for their troubles and to indemnify them for legal liability. The novelty is that Elliott will provide incentive compensation to the group: if any Elliott nominee is elected as a result of this year’s contest, all nominees receive a bonus at the end of three years if Hess’s stock performs better than a group of industry peers. Elliott, not Hess, pays all bonuses.
Hess incumbents portray the bonuses as objectionable (and Steve, Jack and Usha agree). Incumbents say they give nominees incentives to maximize short-term shareholder value rather than serve as long-term stewards. They say the pay somehow makes the directors beholden only to Elliott, preventing the exercise of business judgment for the benefit of the corporation and its shareholders as a whole.
I have taken a different view, set out in Elliott’s materials last month (p. 148): The bonuses seem surgically tailored to tie the payoff to Hess’s stock price performance compared to competitors. That is intended to align the interests of those directors with those of the company’s shareholders. Elliott makes the promise at the outset and then has no role to play afterwards, other than to pay up if milestones are met. No one is beholden to Elliott and the independence of those directors is not compromised. There is no incentive to liquidate the company or concentrate on the short term but every incentive to manage to outperform peer company stock price performance over three years.
In a blog post earlier this week, Prof. Coffee challenges the claim that the pay aligns director-shareholder interests, identifying three potential conflicts: (1) before three years are up, directors might jump at a blowout bid to cash in despite believing the company’s value will exceed the bid beyond three years; (2) directors might authorize excessive leverage to gain stock-price increases within the three years, leaving downside risk beyond that horizon; and (3) bonuses for some but not all directors can cause suspicion and tension on the board.
These examples do not persuade me to change my opinion. The first proves too much: differing judgments about time horizons plague every consequential board decision, including about responses to any takeover bid at any time. The second doesn’t work because tactics such as excessive leverage designed to obtain short-term advantages are transparent and stock prices digest related effects. The third example is an inherent feature of many boards, certainly any staggered board after a successful proxy contest, and deliberative bodies such as boards benefit from competing viewpoints.
Prof. Coffee acknowledges that Elliott’s proposal is legal and fully disclosed. Still he argues that law needs to catch up, by declaring that it impairs the independence of recipients for purposes of laws requiring that trait, such as screening for board committees. He believes that traditional notions of independence need updating to capture independence not merely from management but from shareholders or certain groups of shareholder. It’s an interesting notion and may be worth studying when a given director is in fact beholden to a given shareholder but that is not how this arrangement works.
In a blog post responding to Prof. Davidoff’s April 7 story, Prof. Bainbridge perceived a clear conflict of interest for directors in the arrangement, likewise based on the assertion of directors somehow being beholden to Elliott or because of the three-year time horizon. Again, the first assertion is not obviously true and the second identifies a variable over which reasonable people, including different shareholders, often disagree. Prof. Rodriques had also objected that the arrangement manifestly elevates the short-term, without wrestling out competing conceptions of time horizons.
Prof. Bainbridge further rejected giving weight to a shareholder vote electing directors under a fully-disclosed plan such as Elliott has proposed. He contended that a specific up-or-down vote on the plan would be necessary. That is also an interesting point and may be valid if there is a conflict of interest but, again, that is not established.
So the argument remains that paying directors bonuses for outperforming peer companies is something that aligns director interests with stockholder interests. Shareholders should be entitled to choose and a contested director election is a fine forum to do it. At Hess, shareholders will evaluate the historical performance of incumbents versus the prospect of change Elliott heralds. Many will rationally agree with me and Profs. Hammermesh, Henderson, Lisotken and Thomas while some may agree with Profs. Bainbridge, Coffee and Rodriques. They should have that choice.
POST SCRIPT: For further debate between Bainbridge and Cunningham, see this update.