Here Come The Judges

From a director's point of view, what were the hot issues before the Delaware court last year?
Director liability concerns are at this point paramount, given the Disney case. I think the results of that case could give good directors comfort and bad directors some cause for heartburn. What it said was that if you're not independent as a director, and if you engage in poor processes to make a decision, there could be personal liability for you, because you've violated your duty of good faith. Directors who are independent of management and insist on effective process should take great comfort.

The Disney decision was strongly worded, though, and the judge sounded angry. What message did that convey?
It was clearly a warning. Because what it said was, "We're not imposing liability here, but in the future we may." I think this is part of the Delaware movement to effectively—gently, if you will—create stronger boards through this means.

What is this "Delaware movement" really about?
Traditionally, the board, rather than being monitors of management, tended to be more advisory. The idea [now] is that to protect shareholder value and protect the longterm health of the corporation, it's necessary that the board be an active, monitoring institution. The way that can be accomplished is through compositional changes and process changes. So you see a whole wave of decisions coming out of Delaware that recognize the importance of that kind of board and its composition— independent directors who all have significant equity in the company themselves.

So, is it fair to say the Delaware courts are joining with other forces to strengthen shareholder rights?
It's clear that the judiciary is moving in that direction along with everyone else. It's a fourlegged stool. It's the legislature, it's the institutional investors, it's the regulators and it's the judiciary. It's the Securities and Exchange Commission through its enforcement of Sarbanes-Oxley, it's the New York Stock Exchange listing standards, it's investor pressure through shareholder resolutions and it's Congress through Sarbanes-Oxley.

What new or different principle does this movement rest on, in terms of Delaware's laws?
You've seen a shift in Delaware— a very gradual shift, but a shift—from a model that was I think pro-managerial to a model that is more balanced, that recognizes the importance of managerial and board authority balanced with the rights of shareholders.

You mean corporate law as it now stands is pro-management?
No, the law itself is balanced. It's how you interpret the law. Traditionally, there was a view that shareholders were not particularly sophisticated and that management was the best force to protect shareholder interests. And that great deference should be given to managerial decisions, because that was the best way to protect shareholder value.

Two things have occurred. No. 1 is a recognition that shareholders are as economically sophisticated as management and may be privy to the same or better information about the company as management. No. 2 is a recognition that management was not always the greatest protector of shareholder value. And that change in philosophy or viewpoint I think has affected the way the court views corporate controversies. What you're seeing is greater deference to shareholder authority, and a little less deference to management.

Should CEOs or directors be worried?
If there's managerial concern that the regime is moving away from one where they've completely dominated the corporation without any input from the investors—well, so be it. That was a rather unrealistic regime anyway, if you believe in the continuation of a system where we raise capital from public investors. If you're going to raise capital from the public, you've got to be accountable to them.

How does a case like Disney affect the debate over CEO compensation?
You've seen a signal from the Delaware courts that they're much more willing than traditionally to hear compensation issues. The mere fact that a court would entertain a compensation suit, and review it carefully, is I think strong enough medicine to an ineffective board.

What are your feelings about the majority voting issue? It's clear that we need more vibrant director elections. You have to delicately balance the authority of the board versus shareholder authority. If you move too far to a model of shareholders having the ability to direct the board to take certain actions in various matters, you begin to lose some of the benefit of centralized authority that a board-based system creates.

The issue is frustration by shareholders with boards that repeatedly ignore shareholder resolutions. I think the solution there is not to force them to accept the resolution but to create more vibrant elections, where the directors fear replacement if they ignore the constituents long enough.

Do you think the poison pill will survive?
I think you'll see a real reining in of the pill. The pill, if you look at it, at its core was designed to protect shareholders from their own foolishness. The idea was the board and management know better than you whether or not you should sell. But that theory has disintegrated. It started back with Chesapeake v. Shore, where vice-chancellor [Leo] Strine said, "If investors are smart enough to know when to get in, they're smart enough to know when to get out." And that was a substantial, significant case, because it led to recognition of the intelligence and sophistication of institutional investors.

Is there a danger that the shift in Delaware will be so dramatic that boards and executives have difficulty managing?
Delaware law shifts very slowly and very temperately. I think what you're seeing is a shift to a balanced approach from one that was slightly tilted toward management. It would never be in Delaware's interest to go in the opposite direction. If you went to pure democracy in a shareholder context, you'd have no reason for a board of directors. And it would be impossible to operate a company under those circumstances.

If you look at it, it's like our political system. If we don't like what our elected representatives do, we can replace them. But while they're in office, we give deference to their judgment. That's the most effective way to run a representative democracy, and I think the most effective way to run a corporation.