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Golden handshakes and golden parachutes : serverance packages for corporate executives Nussbaum, Matthias 2005

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GOLDEN HANDSHAKES AND GOLDEN PARACHUTES - SEVERANCE PACKAGES FOR CORPORATE EXECUTIVES -by MATTHIAS NUSSBAUM Dipl.-Jur. Univ., Ludwig-Maximilians-Universitat, Miinchen, 2001 Ass. Jur., Ministry of Justice of the State of Bavaria, Miinchen, 2003 Member of the German Bar Association (Rechtsanwalt) in Miinchen A THESIS SUBMITTED IN PARTIAL FULFILMENT OF THE REQUIREMENTS FOR THE DEGREE OF MASTER OF LAWS (LL.M.) in THE FACULTY OF GRADUATE STUDIES (LAW) THE UNIVERSITY OF BRITISH COLUMBIA April 2005 © Matthias Nussbaum, 2005 ABSTRACT GOLDEN HANDSHAKES AND GOLDEN PARACHUTES SEVERANCE PACKAGES FOR CORPORATE EXECUTIVES -Severance packages for corporate executives have recently caused public outrage in all parts of the world. Terms like "golden handshake" or "golden parachute" have been used in this context, but have remained somewhat uncertain as to their precise legal meaning. This thesis examines the legitimacy of executive severance packages in the three major areas of contract law, employment law and corporate law including supplementary regulation. Its intention is to determine whether the law imposes restrictions on the level of severance and constraints on the contracting parties' bargaining behaviour. An introduction to the area of severance packages and "golden handshakes" in the corporate realm is delivered by a brief presentation of the recent "Mannesmann Affair" that occurred in Germany early in 2000. The case involved generous "golden handshakes" for members of the management who were terminated as a result of a takeover of the corporation and resulted in criminal proceedings against members of the board of directors and the management. In light of the confusing use of the different terms with regards to severance pay, the thesis develops its own definitions for further purposes of study. The thesis then proceeds in three main parts. First, the basic principles arising from contract law and employment will be discussed in relation to the agreements concluded between the executive and the board of directors acting on behalf of the corporation. The main focus lies on the principle of freedom of contract and the notion of reasonable notice, both of which govern the executive severance agreement. Secondly, after a brief presentation of the structure of the Canadian corporation and the inherent potential for managerial self-dealing, the following chapter analyzes the impact of corporate law and other regulation on executive severance packages and managerial bargaining behaviour in general. Based on a comparative study of the Canadian and the German legal system, the thesis concludes with an assessment of the effectiveness of the present regime to impose limits on executive severance packages and takes a look on potential considerations for reform. ii TABLE OF CONTENTS ABSTRACT. ....ii TABLE OF CONTENTS iiPREFACE. viii INTRODUCTION 1 I. The German „Mannesmann Affair" on Executive Severance Packages 3 II. Spectacular Severance Packages in North America 8 III. Approach of the Thesis 13 CHAPTER 1 Executive Severance Terminology.. 20 I. Severance.... 21. Categories of Termination at Common Law 21 a) Termination with advance noticeb) "Garden leave" 2 c) Contractual Termination Provision 23 d) Payment in Lieu of Notice as Damages for Wrongful Dismissal 24 2. Severance as Advanced Settlement Payment 25 3. Statutory Severance 26 4. The Executive Severance Package 27 II. Golden Handshake 9 III. Golden Parachute 32 IV. Executive 4 V. Chapter Summary 6 TABLE OF CONTENTS CHAPTER 2 The Legal Framework for Executive Severance. 37 I. Contract Law: Severance Agreement 38 1. The Executive Service Contracta) The Need for an Executive Service Contract 38 b) The Formation of the Executive Service Contract 41 c) The Contents of the Executive Service Contract 3 (1) Severance Provision 44 (2) Golden Parachute Provision 5 2. The "Golden Handshake" Agreement 8 a) Rescission of the Executive Service Contract 49 b) Variation of Contract 50 (1) Severance Package 1 (2) "Golden Parachute" -52 3. Judgment of the Court 57 4. Conclusion for Contract LawII. Employment Law: Compensation for Dismissal 58 1. Damages for Wrongful Dismissal at Common Law 9 a) The Law of Wrongful Dismissal 60 (1) Dismissal for cause(2) Dismissal without cause 2 b) The Length of Notice of Termination 65 (1) Indeterminate Duration of Employment Contract 6(i) Reasonable Notice(ii) Contractually Determined Notice 70 (2) Fixed term contract 71 c) The Heads of Damages 3 (1) Contractual Salary 5 (2) Bonus entitlements 7(3) Stock Options 7 (4) Perquisites ..78 (5) Contributions to a Pension Plan...; 80 (6) Aggravated Damages 81 2. Statutory Employment Standards Legislation 84 3. Conclusion for Employment Law 5 III. Chapter Summary 87 TABLE OF CONTENTS CHAPTER 3 Legal Constraints oh Executive Severance Packages 88 I. The Issue of "Managerial Self-Dealing" 89 1. The Separation of Ownership and Control and The Agency Problem 90 2. Two Approaches to Corporate Governance 95 a) Optimal Contract Approach 96 b) Managerial Power Approach 8 3. The Legal Regime Governing Contracts between Executives and the Corporation... 101 a) Presence of Inside Directors 103 b) Compensation Committee 4 c) Compensation Consultants 107 4. Impact on Executive Severance Packages and "golden parachute" provisions 110 II. Legal Constraints Ill 1. The Fiduciary Duty (Duty of Loyalty) 112 a) The Concept of the Fiduciary Duty in Corporate Law ...11b) Mandatory Disclosure of Conflict of Interests 118 c) The "Reasonableness and Fairness" Test 120 (1) Cannaday v. McPherson 122 (2) Rooneyv. Cree Lake Resources Corp 124 (3) UPM-Kymmene Corp. v. UPM-Kymmene Miramichi Inc 125 (4) Conclusion 126 d) The "Proper Purpose Test" for "Golden Parachutes" 127 (1) The "Proper Purpose Test" .128 (2) "Golden Parachute" Provisions..... 130 e) Conclusion 139 2. The Duty of Carea) The Standard of Care at Common Law 140 b) The Statutory Duty of Care 141 c) The Business Judgment Rule 3 d) Severance Agreements and "Golden Parachutes" 149 3. Disclosure Requirements Under Securities Legislation 150 a) Introduction of Disclosure Rules to Canadian Securities Legislation 152 b) The New National Instrument 51 -102 On Continuous Disclosure 155 c) Implications of Mandatory Disclosure 158 4. Corporate Governance Guidelines .163 a) TSX Guidelines for Effective Corporate Governance 16b) Proposed Changes to Corporate Governance Guidelines .164 (1) NI 58-101 Disclosure of Corporate Governance 166 (2) NP 58-201 Corporate Governance Guidelines 167 TABLE OF CONTENTS c) Estimated Implications for the Future 169 5. Tax Deductibility Restrictions 170 a) Limited Deductibility of Executive Severance Packages 17b) Tax Deductibility Caps under United States Tax Legislation 172 (1) § 162(m) Internal Revenue Code regarding executive compensation 173 (2) § 280G Internal Revenue Code regarding "golden parachutes" 174 6. Criminal Law 178 a) Misappropriation of Money held under Direction, S. 332 CCC 179 b) Criminal Breach of Trust, S. 336 CCC 180 c) Fraud, Section 380 CCC 183 7. Conclusion 186 III. Shareholder Rights and Remedies 188 1. Shareholder Approval 189 2. Non-Compliance with Disclosure Obligations 191 3. Derivative Action 194 a) The Common Law Rule in Foss v. Harbottle 19b) Scope of the Statutory Derivative Action 5 c) Derivative Action against Executive Severance Agreements 198 4. The Oppression Remedy.......... 199 a) Scope of the Oppression Remedy 19b) Oppression Remedy against Executive Severance Agreements 204 5. Application to Set Aside the Contract, Section 120(8) CBCA 206. Conclusion 205 IV. Chapter SummaryCHAPTER 4 Assessment of the Effectiveness of the Legal Regime 209 I. Managerial Behaviour and Corporate Law Theory 209 1. Berle and Means' Conception of the Corporation as a Management Power Structure210 2. The Corporation as a Nexus of Contracts 213 3. The Role of Corporate Law 217 II. Analysis of the Effectiveness of the Canadian Regime 219 1. Market Mechanisms 220 a) The Capital Market......... 22b) The Product Market ...224 c) The Managerial Market 226 d) The Market for Corporate Control 229 TABLE OF-CONTENTS e) Conclusion.... 232 2. Legal Constraints 3 a) Balance between Freedom of Contract and Fiduciary Duty 23b) Dependence of the Effectiveness on the Availability of Information 236 III. Comparative Study of the German and European Union Legal Regime 239 1. The Capital Structure of the German Aktiengesellschaft 232. Independence of the Supervisory Board: The German Two-Tier System 240 3. Fiduciary Duty of Corporate Insiders 244 a) The Duty to Act in the Interests of the Business 24b) Statutory Requirement of Reasonableness of Executive Compensation 246 c) Shareholder Remedies 247 4. Disclosure 249 5. Special Takeover Legislation with Respect to "Golden Parachutes" 252 a) The New German Takeover Law 25b) The European Takeover Directive 4 6. Tax Law 256 IV. Conclusion and Chapter Summary 257 CONCL USION . 260 BIBLIOGRAPHY... 264 TABLE OF CASES r. 279 TABLE OF ST A TUTES AND REGULA TION. 298 PREFACE In recent years, compensation for corporate executives has increasingly been in the spotlight of concern and discussion. Generous salaries for top managers of well-known corporations have caused public outrage and have given rise to a controversy about the principles and possible limits of remuneration for executives in all jurisdictions. Until today, the criticism has not come to. an end. This thesis, however, is not designed to serve as yet another contribution addressed to the general issue of executive compensation. Rather than that, its intention is to examine the aspects of severance payment for executives at the time of the termination of the employment relationship as a separate issue of the overall topic. Terms like "golden handshake" or "golden parachute" have been quite common in the United States and Canada since the 1980s, but are yet to be elaborately scrutinized from a legal perspective. Most recently, enormous severance packages for top managers finally reached worldwide public attention. In Europe, the takeover of former German telecommunication giant Mannesmann AG by the even bigger British Vodafone Air Touch PLC in early 2000 caused a change in control of Mannesmann AG. Former Mannesmann chief executive officer Dr. Klaus Esser received a severance package of approximately 60 Million German Marks for his early departure from office. As soon as the figures had been published, just another controversy about the moral limits of executive compensation evolved, this time in the alternative of executive severance payment. Subsequently, the matter was even brought before the courts in Germany and, ever since then, it is referred to as the so-called "Mannesmann Affair". Apparently for the first time German courts had to deal with severance payment for top executives. Even more astonishingly though, proceedings were held before a German criminal court, as the department of public prosecution of Diisseldorf had accused several participants of a breach of fiduciary duties owed to their company Mannesmann AG. Lucrative executive severance packages have recently also been experienced in Canada. In this thesis I examine the legal framework for executive severance agreements as provided by the present Canadian legal regime. I assess whether the three main areas of law, contract law, employment law and corporate law are sufficiently effective to impose limits on the structure and viii PREFACE the level of executive severance packages for executives of Canadian corporations as to protect shareholders or even to avoid public outrage. My evaluation includes a comparative study of the German and the Canadian legal systems as a basis for considerations for future reform. This thesis has been the major part of the LL.M. program at the Faculty of Law of the University of British Columbia in Vancouver, Canada, in the academic year 2004/2005. Thus, the legal analysis concentrates on the Canadian common law system. Most of the case law and statute law referred to represents Canadian law. However, since generous executive severance agreements and "golden parachutes" had their origin in the United States, U.S. case law has also been applied where appropriate. The comparative part states German law as well as supplementary legislation of the European Union. Despite all my own efforts, this thesis would not have been possible without the help of a number of people. Accordingly, I wish to gratefully acknowledge the substantial assistance of Prof Dr. Ronald B. Davis, LL.B., S J.D., University of British Columbia, who not only provided me with essential background information regarding Canadian corporations law, but also spared his time for valuable reflections of thoughts and subsequent discussions. Additionally, this undertaking could not have succeeded without the very assistance of my German colleague Dr. Bernhard Trappehl, Rechtsanwalt & Abogado, Baker & McKenzie LLP, Miinchen, who contributed to this project by providing important input to my research as well as truly appreciated other means of assistance. Very special thanks I owe to my loved parents Ingeborg and Michael who always inspired me and profoundly supported me in one way or another, and to my partner Julia Spilker, whose love, encouragement and contributions have been vital to the success of this project. I would also like to thank Ute Stein for her incredible and mostly appreciated work in proofreading this thesis, and Joanne Chung, Graduate Secretary of the Faculty of Law, University of Britsh Columbia, for her time and patience with yet another German graduate student. Last but not least, I would like to acknowledge the inestimable support I have received from all other friends and colleagues, especially from Nao Araya Kashiwagi, LL.M., and James Sultanum, during my stay in Vancouver. Matthias Nussbaum Vancouver, B.C., April20, 2005 ix To my parents and Julia INTRODUCTION "Golden Handshake of 60 Million for Esserl" 12 Statements like this or similar were the dominant headlines in the German media in February of 2000, shortly after it had become known to the public that former chief executing officer3 of Germany's telecommunication giant Mannesmann AG, Dr. Klaus Esser, had received a generous severance package of about 60 Million German Marks for his early departure from the Mannesmann group's management.4 In the immediate aftermath, the message of Esser's multi-million severance entitlements gave rise to a broad public discussion about executive compensation in German corporations.5 A criminal information6 finally led to a preliminary criminal investigation carried out by the department of public prosecution in Dtisseldorf7 against several executives and board members of Mannesmann AG involved in the severance deal.8 By the end of its investigation, on February 17, 2003, the prosecution preferred criminal charges against Esser himself as well as against five The original headlines in the German language read "Goldener Handschlag fur Esser", see, for example, the following German newspaper articles and online-media releases: Frankfurter Allgemeine Zeitung (February 12, 2000) ; Die Welt (February 12, 2000); manager-magazin.de (February 11, 2000) <http://www.manager-magazin.de> (last visited on Oktober 24, 2004). 2 See, for example, headlines such as "Sweet Departure: Esser gets severance pay of 60 Million Marks" („SiiJ3er Abschied: Esser bekommt 60 Millionen Mark Abfinduhg") Spiegel Online (February 11, 2000) <http://www.spiegel.de> (last visited on September 29, 2004); "Esser gets 60.5 Million Marks as severance" ("Esser bekommt 60,5 Millionen DM Abfindung") Financial Times Deutschland (February 11, 2000); "Klaus Esser gets 60 Million Marks" ("Klaus Esser bekommt 60 Millionen Mark") Handelsblatt (February 14, 2000). 3 The term chief executive officer will be referred to hereinafter as "C.E.O." 4 At that time, the German Mark was still the valid currency in Germany. Therefore, all media reports mentioning a severance package of "60 Million" referred to the respective amount in German Marks. This amount also includes the so-called "appreciation award" of approximately 31 Million German Marks Esser received upon the takeover. 5 For example, German popular news magazin Der Spiegel asked if the severance payments had been a rip-off, see "Abfindungen: Mannesmann-Chef Klaus Esser ein Abzocker?" Der Spiegel (No. 7/2000, February 14, 2000) at 96. In the following, publications that critically dealt with executive compensation were frequently being released, see, for example, "Die Vergiitungen der Vorstande bleiben geheim" Frankfurter Allgemeine Zeitung (May 8, 2001); "Transparenz bei Vorstandsgehaltern gefordert" Financial Times Deutschland (December 19, 2001) ; "Schamlose Vorstandsgehalter" Frankfurter Allgemeine Zeitung (June 7, 2002); "Raffke-Mentalitat in deutschen Vorstandsetagen" Welt am Sonntag (June 16, 2002); "Dollarzeichen in den Augen der Chefs", DIE ZEIT (No. 28/2002); "Selbstbedienung in den Vorstandsetagen" Die Welt (June 25, 2003). 6 "Strafanzeige". 7 "Staatsanwaltschaft Dtisseldorf'. See Staatsanwaltschaft Dusseldorf, Az.: 28 Js 159/00, hereinafter referred to as "the prosecution". 8 Criminal information had been laid by the German law firm Binz & Partner on February 23, 2000. 1 INTRODUCTION members of the board of directors9 due to reasonable suspicion of criminal offences in terms of serious breach of shareholders' trust or aiding and abetting to it, respectively.10 The Regional Criminal Court of Diisseldorf admitted the charges for trial11 on September 18, 200312 and the 13 opening of the trial was ordered. As a result, the severance agreement between the board of directors of Mannesmann AG on behalf of the corporation and Esser triggered off the „most spectacular criminal proceedings in German business history".14 Most recently, on July 22, 2004, the Criminal Court rendered its verdict and acquitted the accused of all charges.15 As of today, however, the case has not been concluded since the prosecution immediately appealed against the sentence.16 The matter will now be dealt with in final instance by the German Federal Supreme Court of Justice.17 But what exactly had happened for this severance matter to surprisingly end up in criminal trials before German courts?18 Is there reason to believe that severance agreements for top executives are not always justified? Among these were Prof. Dr. Joachim Alexander Funk, Klaus Zwickel, Jurgen Ladberg, Dr. Dietmar Droste, as well as recent C.E.O. of Deutsche Bank AG, Dr. Josef Ackermann. 10 See the press release by the Presiding Attorney General Henke of February 25, 2003 (Staatsanwaltschaft DUsseldorf, Az. 28 Js 159/00). 11 "Landgericht DUsseldorf, referred to hereinafter as "the Criminal Court". See Landgericht Diisseldorf, Az. XIV-5/03. 12 Regarding the three accused executives Funk, Esser and Droste, only modified charges had been admitted by the Criminal Court. With respect to Esser, the Diisseldorf Criminal Court only permitted an accusation of the offence of aiding and abetting ("Beihilfe zur TJntreue"), see the Official Committal for Trial by the Criminal Court of September 18, 2003 (Landgericht DUsseldorf, Az. XIV - 5/03, Erofmungsbeschlufi v. 18.09.2003). 13 See the press release No. 7/2003 issued by the Criminal Court on February 22, 2003 (Landgericht DUsseldorf, Az.: XIV-5/03). Regarding the criminal charges and proceedings. See also David Olive, "Bountiful kiss-offs abundant in North America" The Toronto Star (September 24, 2003) at E01 Business. 14 See the press articles published prior to the proceedings, such as "Der Mannesmann-Fall spaltet die Fachwelf Die Welt (January 20, 2004); "Mannesmann-Prozess: Tarnen, tduschen und taktiereri'' manager-magazin.de, supra note 1; "Manager und Millionen - der Prozess" Hamburger Abendblatt (January 22, 2004). 15 See Landgericht DUsseldorf, Az. XIV 5/03, Urt. v. 22.07.2004, LG Diisseldorf, NJW2004, 3275. 16 See press release by the prosecution of July 23, 2004 (Staatsanwaltschaft DUsseldorf, Az. 28 Js 159/00). See also "Staatsanwaltschaft legt Revision gegen Mannesmann-Urteil ein" Frankfurter Allgemeine Zeitung (February 23, 2004). 17 "Bundesgerichtshof in Strafsachen". 18 In fact, the result that the deal ended in criminal proceedings rather than in civil action proceedings appears quite astonishing at first sight. However, it can be better understood when having looked closer at the German legal system governing corporate governance and shareholder rights, see infra Chapter 4, III. 2 INTRODUCTION I. The German „Mannesmann Affair" on Executive Severance Packages On February 3, 2000, after a duration of three months, the „most spectacular takeover war in German business history"19 finally came to an end.20 Esser, in his position as C.E.O. of Mannesmann AG, and Sir Chris Gent, C.E.O. of British Vodafone AirTouch PLC,21 had agreed 22 upon the takeover of Mannesmann by Vodafone with a symbolic handshake. Ever since the receipt of the first unfriendly takeover bid by Vodafone of approximately 100 Billion Euro on November 4, 1999 Esser had refused all offers by the British group. His defence strategy had apparently, caused an increase of the value of a Mannesmann share from the initial 144 EURO to 209.90 EURO. Even after Vodafone had increased its offer to a total of 124 Billion EURO on November 19, 1999 - representing the highest takeover bid a German company had ever received in history - Esser still had refused to consent. Finally, however, Esser gave up resistance on February 3, 2000 and agreed to the takeover considering a package of Vodafone shares of a volume of about 190 Billion EURO. As was revealed later, Canning Fok, the representative of Mannesmann's largest institutional shareholder Hutchison Whampoa Ltd. of Hong Kong, had suggested to grant Esser an "appreciation award"24 of 10 Million £25 in order to officially recognize Esser's success in enormously increasing the market value of Mannesmann in the course of the takeover-war. That appreciation award was indeed given to Esser, although finally not borne by the acquirer "Die spektakuldrste Ubernahmeschlacht der deutschen Wirtschaftgeschichte", see, for example, "Chronik einer Ubernahmeschlacht' Frankfurter Allgemeine Zeitung (February 17, 2003); "Tatort Chefetage" Stern (No. 16/2003 of April 10, 2003) at 188; "Was von den Vorwurfen ubrig ist" Handelsblatt (April 13, 2004). In fact, since Mannesmann's management team opposed Vodafone's takeover offers for that large period of time before ultimately accepting Vodafone's takeover bid, this publicly qualified as the first successful openly contested hostile takeover in Germanyever, see Neal E. Boudette, "Vodafone Deal Shows Market Forces Have Undercut Nationalism in Europe" Wall Street Journal (February 7, 2000) at A29. Hereinafter, the two corporations are simply referred to as "Mannesmann" and "Vodafone". In the following, the takeover process is briefly summarized for introductory purposes. For a complete reproduction of all facts and the exact schedule of the takeover, please confer to the authorities cited supra, at note 19 as well as to "Chronik einer Ubernahme-Affdre" manager-magazin.de, supra note 1. All important agreements and resolutions by the board of directors in connection with the takeover are in German language only and can be found in a legal opinion rendered by Professor Dr. Uwe Huffer on behalf of Deutsche Bank AG, see Uwe Huffer, "Mannesmann/Vodafone: Prdsidiumsbeschliisse des Aufsichtsrats fur die Gewdhrung von 'Appreciation Awards' an Vorstandsmitglieder" (2003) 43 Betriebsberater Beilage 7 (BB 2003, Beil. 7). See "Chronik einer Ubernahme-Affdre" manager-magazin.de, supra note 1. As the takeover negotiations between Vodafone and Mannesmann were pursued in the English language, the actual term used was "appreciation award". As the term was unprecedented at German law, the English term has also been used by German commentators ever since its first appearance. This amount is equivalent to about 32 Millionen German Marks or approximately 16.5 Millionen EURO. 3 INTRODUCTION Vodafone, but paid out of Mannesmann's own assets'^. Both Gent as well as Mannesmann's board of directors had agreed to the award before the board officially consented to the takeover by resolution on February 4, 2000. Shortly after that, on February 11, 2000, rumour had it that already on December 10, 1999 Esser had signed an agreement that granted him salaries and bonuses in the amount of his contractual remuneration entitlements until the end of his contract in June of 2004 in the event he would depart earlier as a result of the potential takeover.27 After having changed position from C.E.O. of Mannesmann to member of the Vodafone board of directors on June 5, 2000, Vodafone announced Esser's departure from the company effective September 30, 2000.28 At least at this time, it was obvious that the handshake concluded between Esser and Gent on February 3, 2000 not only had meant the final success of Vodafone's takeover efforts. In fact, it had also been a symbolic "golden handshake" for Esser, who despite his defeat in the takeover battle and the early termination of his office as C.E.O. was now entitled to receive millions in terms of severance payment. In particular, Esser allegedly received pay in lieu of notice of about 15.2 Million German Marks contemplating the remaining time of his contract, an additional bonus of some 12.6 Million Marks as well as the mysterious appreciation award of approximately 31 Million Marks. The total of about 58.8 Million Marks29 is still regarded as the "highest amount, the C.E.O. of a German company has ever received in return for his premature resignation from office".30 First reactions regarding the spectacular severance package varied. Whereas a spokesman of Vodafone announced that the amount was likely to be insufficient considering the high According to the written accusations of February 17, 2003, the "appreciation award" was granted not only to former C.E.O. Esser, but also to former Chairman of the board of directors, Funk, as well as to four other former executives, see Landgericht Dusseldorf, supra note 12; Huffer, supra note 22 at 2. See "Esser bekommt 60,5 Millionen DM Abfindung" Financial Times Deutschland, supra note 2, and all other authorities cited supra notes 1 and 2. Although at that point of time no payment had been executed because Esser was still remaining within the Vodafone group, all those press releases cited were already being published. However, no distinction was made between the contractually agreed severance payments and the additional appreciation award due at the time of the acquisition of the majority of the outstanding Mannesmann shares by Vodafone. See the official press release by Vodafone of September 26, 2000, available online under Press Releases on the Vodafone website <http://www.vodafone.com> (last visited on October 24, 2004). This amount is equivalent to approximately 30 Million EURO. "[...] die hochste Summe, die ein Vorstand eines deutschen Unternehmens jemals fur seinen vorzeitigen Abgang erhalten hat"), see "Goldener Handschlag fur Esser" Die Welt, supra note 1. See also • "Managergehdlter in der Kritik" Handelsblatt (June 26, 2000); and the chart "Der Goldene Handschlag -Millionen-Abfindungen fur Top-Manager "frankfurter Allgemeine Sonntagszeitung (February 16, 2003) 4 INTRODUCTION increase of shareholder value in the course of the takeover negotiations,31 other commentaries criticized the amount as "inappropriate"32 or even called it a "rip-off'.33 Not surprisingly, the matter caused an intense discussion about the appropriateness of remuneration and severance payment for German top executives. When in September 2000 the information against Esser and the other responsible persons was laid, Germany was about to experience its "largest business scandal after World War II",34 also referred to in a more legally prescription as the "Mannesmann affair".35 Until the Mannesmann affair, large severance payments to executives had been unprecedented not only in Germany, but even in Europe as a whole. Generally speaking, most of the European national jurisdictions had not provided for any transparency and disclosure of executive compensation.36 Accordingly, shareholders and the public had not had broad knowledge of the amounts executives were being compensated with. Consequently, ever since the Mannesmann affair, executive severance packages have not been well received by the European public - and especially by the shareholders. For example, upon his resignation from office in 2002, Jean-Marie Messier, at that time C.E.O. of French entertainment conglomerate Vivendi Universal S.A., claimed a severance package of EURO 20.6 Million that was supposed to be due according to his employment contract, which was governed by employment law of the 37 United States. Since the company's shares had lost more than 80 per cent of their value as Messier ran the company into billions of dollars of debt and left it close to bankruptcy, Vivendi Universal withheld the severance payment arguing that Messier was not owed the money See "Goldener Handschlag fur Esser" Die Welt, supra note 1. This was the actual wording of the criminal information of February 23, 2000, see supra note 6. See also Hermann Josef Schmidt, former chairman of the works council of German ARCOR GmbH, in "Mannesmann und die Millionenabfindung" Report Mainz (August 5, 2002). The report is published online at <http://www.swr.de/report/archiv/sendungen/020805/02> (last accessed on November 10, 2004). Shortly after the opening of the criminal trial, German Corporate Law Professor Dr. Holger Altmeppen regarded the amount as "inappropriate", see Holger Altmeppen, "Abfindungen im Fall Mannesmann" Siiddeutsche Zeitung (January 27, 2004) at 3. "Abzocke". See "Abfindungen: Mannesmann-Chef Klaus Esser ein Abzocker?" Der Spiegel, supra note 5. See "Eine Frage von Ehre und Ehrlichkeit" Manager Magazin (Volume 4, April 24, 2003) at 56. See "Mannesmann-Affare: Staatsanwalte rechnen mit Verurteilung" Financial Times Deutschland (February 26, 2003). See also "Staatsanwalteprufen die Beschwerde" Die Welt (September 23, 2003); "Grofie Namen auf der Anklagebank" Siiddeutsche Zeitung (September 20, 2003). Accordingly, I will also use the term "Mannesmann affair" when referring to the payments for former Mannesmann executives in connection with the takeover of Mannesmann by Vodafone. See also Heather Timmons, "Other Shoe Drops in Deal For Aventis: Severance" The New York Times (April 28, 2004) W Column 6 Business/Financial Desk. 1. The United States will be referred to hereinafter as "U.S.". 5 INTRODUCTION because he had resigned voluntarily.38 Both the ousted C.E.O. and the company spent 18 months injudicial proceedings before U.S. courts, only for Messier'?, claim to be finally39 turned down at the end of 2003.40 In April 2004, when the US$ 65.5 billion takeover deal between French Sanofi-Synthelabo S.A. and French-German drug company Aventis S.A. had just been sealed, news spread that the deal would result in the payout of some of the highest severance packages awarded in Europe in recent years.41 According to a document Aventis had filed with the U.S. Securities and Exchange Commission shortly before the closing of the deal, among others, Aventis' chairman and C.E.O. Igor Landau was entitled to as much as EURO 24 million in terms of nearly five years' compensation together with 1.5 times his bonus as well as pension and life insurance, regardless whether he stayed as C.E.O., was asked to leave or chose to go.42 Unlike other European companies, Aventis had been more open and had disclosed each individual executive's compensation in an annual 20F-filing with the U.S. Securities Exchange Commission because it traded it securities on the New York Stock Exchange as American depository receipts.43 As one of the most important implications of the Mannesmann affair, European national legislations have recently implemented changes as to the policy regarding the disclosure of executive compensation. Germany, for instance, in 2002 introduced the German Corporate Governance Code according to which all executive compensation shall be disclosed in the annual report of any publicly-held corporation.44 As a result of increasing shareholder pressure against pay packages for British executives considered to be overgenerous, Great Britain in 2003 established a new investor-protection law requiring companies to report much more information than before about executive compensation and giving shareholders an opportunity to reject to the 38 See Sarah Moore, " Vivendi's ex-CEO awarded $32 million" The Toronto Star (July 1, 2003) Business C02. The . company is also reported to have expressed that Vivendi Universal's board of directors had not approved the contract. 39 Messier firstly had prevailed before a New York arbitration Court that granted him the "golden parachute", see Ibid, at C02. See also Olive, supra note 13 at E01. 40 See Timmons, supra note 36 at 1. 41 Ibid. 42 Ibid. 43 See Timmons, supra, note 36, at Pg. 1. 44 The German Corporate Governance Code will be discussed in detail infra at Chapter 4 III. 4. 6 INTRODUCTION board's salary recommendations.45 However, as European boards still seem to be quite generous in determining executive compensation and severance payments, aggrieved shareholders have begun to take up their own actions and challenge specific compensation agreements. In March 2003, as a first reaction to the new British investor-protection law, shareholders of GlaxoSmithKline PLC of London, the world's Number 2 drug maker, voted to reject the proposed pay package for the company's C.E.O. Dr. Jean-Pierre Gamier and other top executives.46 The component of the compensation plan that drew the most criticism was a severance; provision that would have entitled Gamier to US$ 23.7 million in bonus salary and stock if he had resigned or had been dismissed any time through 2007.47 Moreover, the constantly increasing public criticism of executive compensation has caused some C.E.O.s to even reimburse their former companies for benefits previously received. For example, Pierre Bilger, former C.E.O. of Alstom S.A., received a severance payment of CDN$ 4.6 million when he left the French engineering giant in March of 2002.48 When it turned out that a major acquisition by Alstom had resulted in a ruinous loss of about 90 per cent of Alstom's share value, in August 2003 Bilger chose to return the complete amount of severance package he had received upon his departure in 2002.49 Like Bilger, several other former C.E.O.s of European companies that suffered substantial business losses waived all or part of their retirement payouts. Among these were Robin Jeffrey of British Energy PLC who agreed to surrender as much as CDN$ 628,000, Graham Wallace of Cable & Wireless PLC who returned about CDN$ 1.6 million, Percy Barnevik of Swedish-Swiss conglomerate ABB Ltd. who paid back not less than CDN$ 63.5 million in retirement benefits as well as Lukas Muehlemann of Credit Suisse Group who waived all of his severance received.50 See Statutory Instrument 2003 No. 2822, "The Financial Services and Markets Act 2000 (Regulated Activities) (Amendment) (No.3) Order 2003" of November 6, 2003, effective December 1, 2003. For more detail, see Jonathan Fisher, Jane Bewsey, Malcolm Waters, Elizabeth Ovey, The Law of Investor Protection (London: Sweet & Maxwell, 2003). See Olive, supra note 13, at E01; Timmons, supra note 36, at 1. See Timmons, supra note 36 at 1. Ibid. See Olive, supra note 13 at E01: Bilger explained that he wanted „not to be an object of scandal for the hundred thousand employees I had the honour to direct". Ibid. Since those executives never publicly gave reason for their doing so, it can only be assumed that they intended to avoid shareholder litigation and negative publicity. 7 INTRODUCTION II. Spectacular Severance Packages in North America While the judicial controversy has just been launched by the Mannesmann affair in Germany and has already hit other jurisdictions in Europe, large severance packages for top executives seem to have been the norm quite frequently in other parts of the World such as North America over the past years without seriously being questioned.51 High lump-sum payments for leaving executives and new terms like "golden parachute" were first noticed in the U.S. in the early 1980s52 and soon reached neighbouring Canada.53 Although there has been criticism of some kind over the past 20 years,54 the wave of indignation was by far not as high as it is in Europe at present.55 Even more, no case has ever been reported 51 For the U.S. generally see ibid. 52 For example, William Agee received a US$ 4 million golden parachute payment when he resigned as C.E.O. of Bendix Corporation following the takeover battle between Bendix Corporation, Martin Marietta, Allied Corporation, and United Technologies, see Tamar Lewin, "Using Golden Parachutes" New York Times (November 30, 1982) at D2. See also the following news articles of that period by Wendy Cooper, "Mergers and Acquisitions: The Spread of Golden Parachutes" Institutional Investor (August 1982) at 65-68; W. John Moore, "Golden Parachute Agreements Shelter Displaced Executives" Legal Times of Washington (October 25, 1982) at 5; Ann Morrison, "Those Executive Bailout Deals" Fortune (December 13, 1982) at 82, 86; Andrew C. McLaughlin, "The Myth of the Golden Parachute: What Every Dealmaker Should Know" (1982) 17 Mergers & Acquisitions 47. One first scholarly contribution was delivered by Robert H. Winter and Mark Stumpf, eds., Shark Repellents and Golden Parachute" (Aspen Pub, 1983). 53 See, for example, James B. Noonan, "Golden Parachutes" in: Employment Contracts (Toronto: Insight Press, 1988) at 2. 54 See, for example, Martin Riger, "On Golden Parachutes - Ripcords or Ripoffs? Some Comments on Special Termination Agreements" (1982) 3 Pace L. Rev. 15; Stephen Greenhouse, "Golden Chutes Under Attack?', New York Times (December 10, 1985) at D2; John A. Byrne, R. Grover, and T. Vogel, "Cover Story: Is the Boss Getting Paid Too Much?" Business Week (May 1, 1989) at 46; Frederick C. Klein, "A Golden Parachute Protects Executives, But Does it Hinder or Foster Takeovers?" Wall Street Journal (December 8, 1982) at 56; David V. Maurer, "Golden Parachutes - Executive Compensation or Executive Overreaching?" (1984) 9 J. Corp. L. 954. Early U.S. cases that indirectly involved the topic of golden parachutes were Lewis v. Anderson, 453 A.2d 474 (Del. Ch., 1982) at 480; Smachlo v. Birkelo, 576 F.Supp. 1439 (D. Del., 1983) at 1441; Schreiber v. Burlington Northern, Inc., 731 F.2d 163 (3rd Cir. 1984) at 167; Wolgin v. Simon, 722 F.2d 389 (8th Cir. 1983) at 393; Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946 (Del. Sup. Ct, 1985) at 957. The first case a court had to directly deal with the merits of golden parachute contracts was Koenings v. Joseph Schlitz Brewing Co., 126 Wis.2d 349, 377 N.W.2d 593 (Wise. 1985). Subsequent cases are Worth v. Huntington Bancshares, Inc., 43 Ohio St.3d 192, 540 N.E.2d 249 (1989) and Gaillard v. Natomas Co., 208 Cal.App.3d 1250, 256 Cal. 702 (1989). Also, in 1984 the U.S. introduced its first "anti-golden parachute legislation" as part of the 1984 Tax Reform Act, see Henry F. Johnson, "Those 'Golden Parachute Agreements: The Taxman Cuts The Ripcord" (1985) 10 Del. J. Corp. L. 45 at 56. 55 The arising public concern in the U.S. over the high rates of executive compensation in general led to a pledge by the Democratic Presidential Candidate Bill Clinton in his 1992 presidential campaign to curb excessive compensation practices should he be elected President, see "Presidential Candidates Divide on Executive Compensation Caps" 24:42 Securities Regulation and Law Report 1634 (October 23, 1992), as cited in Mark Salky, "The Regulatory Regimes for Controlling Excessive Executive Compensation: Are Both, Either, or Neither Necessary?" (1995) 49 U. Miami L. Rev. 795 at 826! 8 INTRODUCTION in neither of these jurisdictions of severance payments being subject to criminal investigation. In fact, here it long seemed to be an uncontested rule to pay out top executives at the time they were fired or for companies to provide their management with gracious severance clauses in order for them to - figuratively speaking - take the golden parachute directly into retirement. However, several reports on severance payments for C.E.O.s over the iast years have obviously caused Americans as well as Canadians to at least think twice as the figures constantly grew higher. As a result, various firms have been accused of paying out inappropriately generous severance packages to executives who are supposed to not having delivered good value to their shareholders. For instance, in 1997 Walt Disney Corp. was confronted by shareholder criticsm and finally sued by its shareholders after former C.E.O. Michael Ovitz had left the U.S. company in 1996 taking home a severance package of about US$ 140 million in cash and stock options after little more than one year of tenure.55 Shareholders accused the directors of failing to watch out for shareholder interests, leading to the squandering of company assets when Ovitz received his rich severance deal.57 In 1998, former Bank of America C.E.O. David Coulter was ousted after his bank had been taken over by NationsBank Corp. of Charlotte, N.C. Coulter received a huge severance package valued between US $ 50 million and US $100 million that not long after drew a massive protest from shareholder advocates, causing Bank of America to give shareholders a veto power over large severance payments in 2002.58 Notwithstanding, at the beginning of the new millennium yet another wave of huge severance packages upset investors who had suffered heavy losses on their respective stocks. Mattel Co.'s C.E.O. Jill Barad received what is publicly regarded as "perhaps the most lucrative exit package for an underperforming C.E.O."59 a US$ 50 million "golden handshake" severance See Christopher Carey, "Hilbert raised Compensation Bar; Although $74 million package upset investors, severance clause has been part of his contract" The Indianapolis Star (May 3, 2000) Business 01C; Richard Verrier, "Ovitz Case Haunts Disney Board" Los Angeles Times (September 20, 2004) Business CI. Ovitz' severance package is still regarded as the largest "golden parachute" ever awarded to a corporate executive, see Timmons, supra note 36 at 1. See Verrier, supra note 56 at 1. See also Christopher Parkes, "Eisner's Princely Ways Cut No Ice With Shareholders" Financial Times (U.S. Edition) (March 3, 1997) at 17. Regarding the litigation, see Brehm v. Eisner, 746 A.2d 244 (Del. Sup. Ct., 2000), affirming in part sub nom Re Walt Disney Co. Derivative Litigation, 731 A.2d 342 (Del. Ch., 1998). For a summary of the facts, see Vladimir S. Korolev, "Brehm v. Eisner, or Some Reflections about the Disney Case" (2001) 26 Del. J. Corp. L. 1105 at 1106. See E. Scott Reckard, "BofA Ex-Chief Heading to L.A.; David Coulter will lead J. P. Morgan Chase's private equity businesses and drum up corporate clients" Los Angeles Times (September 22, 2004) Business C2. See Gary Strauss, "Forget brass rings - execs grab for gold, Golden' contracts give bigwigs beaucoup bucks to stay... or sometimes to go", USA TODAY (March 20, 2001) at Money IB. 9 INTRODUCTION package when being fired in January 2000. In February 2000, after just two years in office, M. Douglas, Ivester departed as.C.E.O. of The Coca-Cola Company with a severance package of US$ 120 million in cash and stock.61 In total, Coca-Cola has paid out severance of more than US$ 200 million between 2000 and 2004 to departing executives.62 Not surprisingly, the company has faced a number of shareholder resolutions aimed at compensation reform.63 Steven C. Hilbert, as C.E.O. of Conseco Inc., received a US$ 72.4 million payment when he resigned from office and left Conseco in April 2000 after the board had concluded that investors had lost faith in him64. Hilbert's employment contract had contained a clause guaranteeing him five times his annual salary and bonus for the loss of his job and, in addition to his termination payment, granting him new options to buy 2 million shares of the company stock at US$ 5.75 a share.65 Ironically, in the same week that Hilbert was ranked among the highest-paid executives in Forbes annual compensation survey, his name was also added to the list of corporate America's biggest severance packages.65 Regardless of that, as shows the case of former General Electric C.E.O. Jack Welch, severance benefits can be still far greater for executives who are believed to have served to the investors' benefits by substantially increasing shareholder value. Welch, who resigned voluntarily in 2000 rather than being ousted like other executives at that time, received US$ 16.7 million in pay and bonus as well as a reward for his 20 years of leadership for the company consisting of restricted stock worth US$ 48 million, stock options valued at up to US$ 274 million and a lifetime annual pension valued at US$ 9 million per year.67 General Electric also provided Welch a lifetime consulting contract for up to a month of consulting services a year at about US$ 300,000 annually. During Welch's tenure as C.E.O., General Electric's market value See E. Scott Reckard, "Big Perks Put Seven CEOs in a Whole ,Other' Club; Insurance, forgiven loans, corporate jet travel, and gross-ups' are key features of their million-dollar packages" Los Angeles Times (June 6, 2004) Business C4; Carey, supra note 56 at OIC. See Carey, supra note 56 at 01C. See "Another Coke Classic" The New York Times (June 16, 2004) Editorials/Op-Ed. In the meantime, however, it was reported in summer 2004 that the company's recent C.E.O. Stephen Heyer would receive a severance pay of at least US$ 24 million after a disappointing three-years tenure, see ibid. See Carey, supra note 56 at 01C. See also Thomas P. Wyman, "Indiana's Top Executives; Firms' poor performances put new focus on pay" The Indianapolis Star (May 7, 2000) Business 01E; Bill W. Hornaday, "Conseco chairman's pay is one of a kind; Nonexecutive's $20.6 million deal loaded with stock, has its critics" The Indianapolis Star (December 14, 2003) Business 01D. See Carey, supra note 56 at 01C. Ibid. See Strauss, supra note 59 at IB. 10 INTRODUCTION increased by US$ 460 billion. Compensation experts say Welch might be one of the few C.E.O.s who actually deserved his ,,golden goodbye".68 In what might have been the richest payout in history when measured in severance dollars per hours worked,69 the Boston University's trustees in 2003 offered former NASA administrator Daniel S. Goldin a US$ 1.8 million severance package before Goldin ever reported to work.70 In March 2003, Richard Brown received retirement benefits, stock options and cash worth 37.4 million when he left Electronic Data Systems Corp. as C.E.O.71 In September 2003, Dick Grasso resigned from his job as head of the New York Stock Exchange with an overall pay package of US$ 188 million.72 Since it was not clear whether he departed for good reason or as a victim of wrongful dismissal, the severance portion of his package was estimated between as little as US$ 9 million or as much as US$ 57 million.73 At the end of 2003, Jeffrey J. Steiner, chairman and chief executive of Fairchild Corp., received US$ 3.1 million without even bailing out after a subsidiary of Fairchild Corp. had been sold to Alcoa Corp.74 While Fairchild, at the same time, reported a loss of US$ 53.2 million for its fiscal year that ended June 30, 2003, Steiner also received a US$5.2 million bonus from Fairchild for his work on the deal. Fairchild officially reported that contracts of its executives entitled them to change of control payments if the company sold "substantially all of our assets". The latest news of large severance payments in the U.S. is that of golden parachute payments in connection with an acquisition of Walt Disney Corp. by Comcast Corp. When takeover negotiations became public in February 2004, it was reported that Walt Disney C.E.O. Michael Eisner was likely to collect up to US$ 24 million as a golden parachute payment in See Rob Weisman, "BU Presidency / Golden Parachute; University's Severance Package for Goldin called Unprecedented" The Boston Globe (November 1, 2003) Metro/Region B5. Timothy K. Cutler, as quoted in by Weisman, supra note 69 at B5, called the deal "a new wrinkle in the golden parachute, [... since] the plane never took off the ground." See Timmons, supra note 36 at. 1. 1 See Landon Thomas, Jr., "Officials in 2 States Urge Big Board Chief to Quit New York Times (September 17, 2003) AT. See Olive, supra note 13 at E01. See David S. Hilzenrath, "Lucrative Cash Package Came as Fairchild Reported $53.2 Million Loss" The Washington Post (August 16, 2004) Financial E01: Although, according to documents filed with the SEC, Steiner's employment contract linked any change of control payment to the termination of his contract, Steiner received this change of control payment without giving up his position at Fairchild. The company had concluded a new deal with its C.E.O., allowing him to receive half of his US$ 6.2 million change of control payment in 2003 and the remainder at the time of expiry of his his. In return, Steiner agreed to stay on the job after the business had been sold to Alcoa. 11 INTRODUCTION addition to his right to execute US$ 500 million in stock options if he left Walt Disney as a result of the takeover.75 As for Canada, George Kosich who had been appointed C.E.O. of T. Eaton Co. Ltd. in 1997 received a CDN$ 1 million severance package after 18 months of service on December 15, 1998, although having failed in improving the business of the economically struggling department store chain. Kosich, who requested even more, filed a lawsuit claiming CDN$ 8 million for wrongful dismissal that subsequently was dismissed by the Court.76 The Canadian public was finally alerted to the fact that reasonable business results did not seem to be essential for generous executive compensation when Bill Fields, formerly a well-performing C.E.O. of Wal-Mart Stores Inc., left The Hudson Bay Co. in 1999 with a CDN$ 5.95 million severance package for his 21 months of leadership, leaving behind disastrous results for the company.77 When Stephen Bachand retired as C.E.O. of Canadian Tire Corp. in August 2000 after almost seven years of service, he received a package of CDN$ 10.3 million plus CDN$ 15.5 million upon exercising his stock options.78 In 2001, after four years of service as C.E.O. for Sears Canada Inc., Paul Walters walked away from the company with a CDN$ 6.4 million-severance package.79 In addition to his two-year's base salary pay of about CDN$ 1.6 million, Walters was awarded CDN$ 4.8 million as part of his termination settlement. In 2002, public attention in Canada was drawn to Eleanor Clitheroe, former C.E.O. of Hydro One Inc., when it was revealed that she would receive a severance package of CDN$ 6 million when being fired from office.80 Ontario's Premier Ernie Eves called the deal inappropriate and unreasonable"81 whereas Ontario's Energy Minister Chris Stockwell regarded it as „far too generous"considering that she was alleged by the company to have abused her powers.82 When in early 2003 CGI Group Inc. acquired Canadian Cognicase Inc. for CDN$ 329 million in cash and stock, a deal that also included the assumption of CDN$ 48.1 million in debt, 75 See Carolyn Said, "Eisner on shaky ground; Roy Disney says Comcast affirms his stand" The San Francisco Chronicle (February 13, 2004) Business BI. See Steven Theobald, "Walters well paid to leave" The Toronto Star (March 15, 2001) Business C0.1. Ibid. Ibid. Ibid. See Ian Urquhart, "Hydro One not secretive about numbers" The Toronto Star (June 8, 2002) B02; Richard Brennan, "Hydro One fires CEO; claims spending abuses" The Toronto Star (July 20, 2002) A01. See Richard Brennan, "Hydro board quits" The Toronto Star (June 5, 2002) A01. See Urquhart, supra note 80 at B02. 76 77 78 79 81 82 12 INTRODUCTION Cognicase founder and C.E.O. Ronald Brisebois as well as several senior executives agreed to leave the company, collectively taking with them a payment of CDN$ 14.8 million in golden parachutes.83 And finally, in connection with the recent merger between Canada's largest brewery Molson Inc. and U.S. brewery Adolph Coors Co. in June 2004, company documents filed with the U.S, Securities and Exchange Commission revealed that Molson's C.E.O. Dan O'Neill was supposed to receive a US$ 2.3 million golden parachute payment even though O'Neill was to stay on with the new company as vice-chairman. Quebec's pension plan, the Caisse de depot et placement du Quebec, holding 3 % of Molson class A shares, appealed directly to Molson's chairman Eric Molson, strongly urging him to drop the provisions regarding the „excessive" payments to the company's executives. In reply to that, Molson agreed to perform revisions in accordance with its shareholders' concerns.86 III. Approach of the Thesis The latest developments of increasing figures of executive severance packages in all different jurisdictions and the reaction by the public and the shareholders give rise to a legal analysis of the present legal regime governing those payments. Several questions arise. For example, what are the legal grounds for executive severance payments? Does the law impose limits on those payments? And, if those payments can be excessive, how can they be challenged? In part, those questions give new light to the controversy about general executive compensation agreements. That issue has already been in the center of public attention in North See Tyler Hamilton, "Heads begin to roll as CGI absorbs rivaF' The Toronto Star (February 20, 2003) Business C05. See the press release by Molson Coors Brewing Company issued on June 22, 2004, available online at <http://www.molsoncoors.com> (last visited on November 11, 2004). See Dana Flavelle, "Caisse fighting Molson merger" The Toronto Star (September 23, 2004) Business COL Ibid. Despite all the early criticism, the compensation of chief executive officers of those U.S. corporations that were listed among the 500 largest American corporations (the "Fortune 500" as compiled by Fortune magazine) still rose 481% during the 1990s, see Mary Diebel, "Stock Options are Making a Lot of Fat Cats Fatter" Treasure Coast Business Journal (Vero Beach, Florida) (November 2, 1999) at A9. In 2000, C.E.O.s of 730 publicly-held U.S. corporations received an average of 550 per cent more than their 1990 counterparts, see Louis Lavelle, Frederick F. Jespersen, and Michael Amdt, "Executive Pay" Business Week (April 15, 2002) at Special Report. On average, these C.E.O.s gained US$ 13.1 million in 2000, see Louis Lavelle and Frederick F. Jespersen, "Executive Pay" Business Week (April 17, 2002) at Special Report. 13 INTRODUCTION America since the 1980s and, therefore, has also been subject to intense scholarly scrutiny. In common law jurisdictions such as the U.S. and Canada, scholars have used two principle theoretical tools to analyse the issues concerning executive compensation.90 Whereas mainly financial economists have first approached the topic of executive compensation by looking at it as a means that optimal aligns the interests of executives and shareholders,91 others have based their proposals for governance improvements on the theory that executives have the power to use executive compensation agreements to generate personal benefits.92 The discussion about the present system of executive compensation has now also reached European jurisdictions, mainly caused by the German Mannesmann affair. Here, the debate to a great extent is still driven by mere moral concerns raised primarily by the popular media, asserting that the amounts of compensation for executives have become "excessive" or "outrageous", especially when compared with the amounts of salary of individual employees of the same company.93 That criticism from the moral standpoint regrettably lacks profound consideration of the legal framework of executive compensation and, subsequently, a material discussion thereof. See, for example, Carol Loomis, "The Madness of Executive Compensation" Fortune (July 12, 1982) 42 at 42-46; John A. Byrne, "The Flap over Executive Pay" Business Week (May 6, 1991) 90 at 90-96; Judith H. Dobrzynski, "Directors' Pay Is Becoming an Issue, Too" Business Week (May 6, 1991) 94. For Canada, see, for example, Jade Hemeon, "Bosses get 18% raises" The Toronto Star (September 7, 1995) BI; John McNeil, "Why make executives disclose their salaries?" The Globe and Mail (October 29, 1993) A33; Jeffrey Simpson, "Corporate Bosses are continuing to reward themselves handsomely" The Globe and Mail (April 16, 1996) A18. See, for example, Edward M. Iacobucci with Michael J. Trebilcock, Value for Money: Executive Compensation in the 1990s (Toronto: C. D. Howe Institute, 1996), delivering a general overview of the different approaches and further references. See also John M. Abowd and David S. Kaplan, "Executive Compensation: Six Questions that Need Answering" (1999) 13 J. Econ. Perspectives 145; Kevin J. Murphy, "Top Executives are Worth Every Nickel They Get" (1986) Harv. Bus. Rev. 125; Kevin J. Murphy, "Executive Compensation" in: Orley Ashenfelter and David Card, eds., The Handbook of Labor Economics (Amsterdam: Elsevier 1999) at 2485; Tod Perry and Marc Zehner, "CEO Compensation in the 1990s: Shareholder Alignment or Shareholder Expropriation?" (2000) 35 Wake Forest L. Rev. 123 at 145. At this point, I will only briefly mention the leading two theoretical approaches on executive compensation, as they will be discussed in detail in the course of this thesis, see infra at Chapter 3,1. 2. and Chapter 4,1. This approach is referred to as the "optimal contract approach". Among important contributors were, for example, Frank H. Easterbrook, "Managers' Discretion and Investors' Welfare: Theories and Evidence" (1984) 9 Del J Corp L 540; Daniel R. Fischel, "The Corporate Governance Movement" (1982) 35 Vand. L. Rev. 1259; Nicholas Wolfson, "A Critique of Corporate Law" (1980) 34 U. Miami L. Rev. 959; Robert Thomas, "Is Corporate Executive Compensation Excessive?" in M. Bruce Johnson, ed., 77je Attack on Corporate America: The Corporate Issues Sourcebook (New York: McGraw Hill 1978) at 276. For more detail, see infra at Chapter 3,1. 2. a). This so-called "managerial power approach" was mainly developed by Lucien A. Bebchuk, Jesse M. Fried, and David Walker, "Managerial Power and Executive Compensation" (2002) 69 U. Chicago L. Rev. 751; Lucian A. Bebchuk and Jesse M. Fried, "Executive Compensation as an Agency Problem" (2003) 17 J. Econ. Persp.71; Kevin J. Murphy, "Explaining Executive Compensation: Managerial Power versus the Perceived Cost of Stock Options" (2002) 69 U. Chicago L. Rev. 847. This view is described infra at Chapter 3,1. 2 b). See especially the collection of news press publications cited supra notes 1, 2, 5, 30, and 34. 14 INTRODUCTION However, the recourse to moral standards as a potential limit to compensation can at least be regarded as having served well to alert the public and legislators that something indeed might be wrong with the system. With respect to general executive compensation, the latest concerns raised by aggrieved shareholders have caused scholars to suggest that executive compensation be linked closer to performance and be disclosed to the public in more detail.94 With respect to performance-based pay, in particular the tendency to provide executives with stock options has been substantially critized,95 although stock options have long been regarded as one of the strongest tools for compensation under the optimal contract approach.96 Stock options capture at least some element of executive performance as they give an incentive to run the company in a manner which ensures that the company's equity has a value higher than the price the options have been granted at.97 On the other hand, however, as the value of stock options that are granted at the current share price strongly responds to actual stock market trends and, generally, increases with the passage of time, they will most likely provide the executive with substantial earnings, even if the executive's corresponding performance turns out to have failed or not been a factor to the increase in share price. Thus, a popular statement has been that the average executive is "handsomely rewarded when a company's share price goes up but endures few negative consequences when equity values have declined".98 As a first result, some jurisdictions have incorporated into, their corporate laws or corresponding securities laws specific rules requiring shareholder approval of all stock option plans for executives.99 Additionally, in an attempt to provide more transparency, several countries have responded to the latest corporate governance discussions by introducing stricter A good summary of the debate about performance-linked compensation is provided by Lucian A. Bebchuk and Jesse Fried, Pay for Performance: The Unfulfilled Promise of Executive Compensation (Cambridge: Harvard University Press, 2004). See, for example, Bebchuk et al., supra note 92 at 775. See Benjamin Alarie, "Executive Compensation and Tax Policy: Lessons for Canada from the Experience of the United States in the 1990s" (2003) 61 U. T. Fac. L. Rev. 39 at 56. See Brian R. Cheffins, "The Metamorphosis of 'Germany Inc.': The Case of Executive Pay"(20Ql) 49 Am. J. Comp. L. 497 at 507. See Brian R. Cheffins, Company Law: Theory, Structure, and Operation (Oxford: Clarendon Press, 1997) at 657. For the U.S., see Randall S. Thomas and Kenneth J. Martin, "The Determinants of Shareholder Voting on Stock Option Plans" (2000) 35 Wake Forest L Rev. 46 at 46-51. For Canada, see infra note 1052 IS INTRODUCTION disclosure rules with special attention to executive compensation. Furthermore, forced by investor advocacy organizations for better corporate governance,101 the directors of essentially all large publicly-held U.S. corporations now tend to establish special compensation committees that mainly or completely consist of independent directors to which the responsibility to determine the executive compensation is delegated to.102 Since many corporations are struggling to establish themselves in competitive and volatile industries in the present economy, it has also been perceived that the boards of directors themselves return to be more independent and more willing to fire executives who are performing poorly. In the U.S., the average tenure of C.E.O.s has decreased from seven years to about five years during the last twenty years.104 In turn, as a measure to insure themselves against financial loss arising from unemployment, executives have responded to that new tendency by negotiating employment contracts that guarantee high severance packages even if their performance should turn out to have failed.105 Accordingly, given that the controversy about overall executive compensation, corporate governance and shareholder value has caused some precautions on the part of the executives, separate executive severance agreements now have become a crucial feature of the general issue of executive compensation. Also, the increasing amount of corporate takeovers has led to an The regulatory movements in this arena undertaken recently in Canada will be discussed in more detail infra at Chapter 3, II. 3. For Germany, see infra at Chapter 4, III. 4. The Teachers Insurance and Annuities Association/College Retirement Equities Fund ("TIAA/CREF"), for example claimed for a policy that "compensation committees should be independent, knowledgeable, and willing to use an outside compensation consultant in negotiating CEO compensation", see "Fund Toughens on Executive Pay" Investor Rel. Bus. (April 3, 2000) at 17, as cited in Bebchuk et al, supra note 92 at note 16. See Kenneth A. Bertsch, Rachel Leahey, and Hawie Haun, "Board Practices (1998): The Structure and Compensation of Boards of Directors at Sandp Super 1500 Companies" (Washington, D.C: Investor Responsibility Research Center, Inc., 1998) at 6, reporting that in 1998 the average percentage of independent directors on compensation committees ranged from 83.5 percent among S&P Small Cap 600 firms to 91.9 percent among S&P 500 firms. According to Bertsch et al., a director is considered as independent if not employed by the firm or "affiliated". A director is considered "affiliated" if he is a former employee, a relative, a representative of a charity that receives contributions from the firm, a service provider, a supplier, a customer, or an interlocking director. See Luke Timmerman, "Tallying the costs of soft landings for C.E.O.s." The Seattle Times (June 20, 2004) Business and Technology 1. See Tom Neff and Dyton Ogden, "Anatomy of a CEO' Chief Executive (February 1, 2003) at 3032. See also Denis B. K. Lyons, "CEO Casualties: A Battlefront Reporf Directors & Boards (Summer 1999) 43, reporting that the percentage of Fortune 100 companies whose C.E.O.s have tenure of five years or less has increased from 46 per cent in 1980 to 58 per cent in 1998. According to a survey pursued by the Corporate Library in 2003, more than half of 367 large U.S. companies declared they would pay their C.E.O.s total compensation for three years or more upon termination, whereas fewer than two per cent of all companies asked would pay less than a year's remuneration, see The Corporate Law Library, "The Corporate Library's CEO Pay Survey - CEO Pay 2003", available online at <http://www.thecorporatelibrary.com/Products-and-Services/store/publications/default.asp> (last accessed on November 23, 2004). 16 INTRODUCTION increase in the draft of separate "golden parachute" provisions, granting the executive additional benefits in the event of a takeover. The intention of this thesis is to focus on the current issue of severance payments for corporate executives apart from the broader discussion about executive compensation in general. An attempt is being made to address the different aspects and questions raised in connection with executive severance packages from a legal perspective rather than from a merely moral standpoint. My goal is to determine the legal grounds for the different kinds of severance packages as well as, if any, the restrictions imposed by the law with regards to the structure and, most importantly, to the amount. Once that legal framework has been established, I will examine and assess the effectiveness of the means by which corporate outsiders like the shareholdes can challenge executive severance packages in order, to possibly make proposals for future reform. For the most part, the legal system analysed will be the current Canadian corporate law regime. However, the law of other jurisdictions will also be considered where it is believed to contribute to a specific issue. Especially, given the tremendous impact of the Mannesmann affair on the issue of executive severance pay, the German law will be applied for a comparative study in an attempt to assess the effeciveness of the Canadian system. Accordingly, this thesis proceeds as follows. First, in the course of my research I have noticed a remarkable inconsistency regarding the use of specific terms in the field of executive severance. Apparently, some commentators do not conceive of the different available terms with the same meaning as do others. For instance, whereas some authors use the term "golden handshake" to describe a payment in the event of a takeover, others refer to it as a general severance payment.106 Also, even the term "severance" is being used both as a general term for the overall payments made to an executive upon the termination of his contract as well as a description of one single component of benefits received. Before a legal examination in this area can be conducted, it is essential to previously determine the different terms to an extent that prevents any ambiguity or uncertainty as to their legal meanings. Therefore, in the first Chapter of the thesis, I will define and clarify the various terms that have so far been observed in practise in connection with severance payments to corporate 106 Compare, for example, Alarie, supra note 96 at 49, explaining that "golden handshake" provisions guarantee that the executive be generously compensated in the case of a change in control of the company, and Cheffins, supra note 97 at 523, referring to "golden handshakes" generally as a severance payment for executives. In fact, as we will see, neither uses the term in its correct meaning distinct from severance agreement and "golden parachute" agreement. 17 INTRODUCTION executives. I will show that it is essential for the following legal analysis to distinguish between contractual agreements conclude