Paying CEOS in bankruptcy: Executive compensation when agency costs are low

Northwestern University Law Review

Volumn 101, Issue 4, 2007, Pages 1543-1618

  Henderson, M Todd ^a  

^a UNIVERSITY OF CHICAGO   (United States)

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EID: 37749038577     PISSN: 00293571     EISSN: None     Source Type: Journal    
DOI: None     Document Type: Review

References (427)

1. See ADOLPH A. BERLE & GARDINER C. MEANS, THE MODERN CORPORATION AND PRIVATE PROPERTY 123 (rev. ed. 1967); Michael C. Jensen & William H. Meckling, Theory of the Firm: Managerial Behavior, Agency Costs, and Ownership Structure, 3 J. FIN. ECON. 305, 308-10 (1976).
2. Symposium on Bebchuk & Fried's Pay Without Performance, 30 J. CORP. LAW 647 (2005);
3. see also LUCAN BEBCHUK & JESSE FRIED, PAY WITHOUT PERFORMANCE: THE UNFULFILLED PROMISE OF EXECUTIVE COMPENSATION (2004).
4. See generally Lucian Arye Bebchuk et al., Managerial Power and Rent Extraction in the Design of Executive Compensation, 69 U. CHI. L. REV. 751, 785-87 (2002) (arguing that compensation-setting practices are distorted by CEO influence over boards, and claiming that CEOs earn more than their marginal contribution to firm value).
5. See Andrei Shleifer & Robert W. Vishny, Large Shareholders and Corporate Control, 94 J. POL. ECON. 461, 465-71 (1986) (constructing a model showing that the presence of "large shareholders raise[s] expected profits and the more so the greater their percentage of ownership").
6. Security Holder Director Nominations, 68 Fed. Reg. 60,784 (proposed Oct. 23, 2003) (to be codified at 17 C.F.R. pts. 240, 249, 274).
7. Phyllis Plitch, SEC Is Stymied on a Final Rule for Shareholder Access to the Ballot, WALL ST. J., Oct. 11, 2004, at C3 (quoting SEC Commissioner Harvey Goldschmid).
8. See Douglas G. Baird & Robert K. Rasmussen, Private Debt and the Missing Lever of Corporate Governance, 154 U. PA. L. REV. 1209, 1226 (2006) (describing case of Warnaco).
9. Stuart C. Gilson & Michael R. Vetsuypens, CEO Compensation in Financially Distressed Firms: An Empirical Analysis, 48 J. FIN. 425, 426 (1993).
10. Lynn M. LoPucki & William C. Whitford, Corporate Governance in the Bankruptcy Reorganization of Large, Publicly Held Companies, 141 U. PA. L. REV. 669 (1993).
11. Id. at 711.
12. Id. at 723-38.
13. Id. at 740.
14. For a summary of Shleifer and Vishny's work, see John E. Core et al., Executive Equity Compensation and Incentives: A Survey, 9 FRBNY ECON. POL'Y REV. 27, 28 (2003).
15. Luigi Zingales, Corporate Governance, in 1 THE NEW PALGRAVE DICTIONARY OF ECONOMICS AND THE LAW 497 (Peter Newman ed., 1998).
16. Calculation based on Compustat's EXECUCOMP database, Wharton Research Data Services (WRDS), http://wrds.wharton.upenn.edu/. See also Erin White & Kris Maher, Companies Tighten the Pinch for White-Collar Compensation, WALL ST. J. ONLINE, Nov. 2, 2004, http://www.careerjournal.com/salaryhiring/negotiate/20041102-white.html (noting that executive compensation grew an average of 5-6% per year, with a 7% increase from 2002 to 2003, to a total of $2.12 million).
17. See, e.g., Bebchuk et al., supra note 3.
18. See, e.g., Gretchen Morgenson, Executive Pay, Hiding Behind Small Print, N.Y. TIMES, Feb. 8, 2004, §3. at 1.
19. For example, the AFL-CIO runs a website devoted entirely to cataloguing allegedly excessive executive pay packages. See AFL-CIO, Executive PayWatch, http://www.aflcio.org/corporatewatch/ paywatch/ (last visited Apr. 24, 2007).
20. See, e.g., Employee Abuse Prevention Act of 2002, S. 2798, 107th Cong. (2002); H.R. 5221, 107th Cong. (2002).
21. Gretchen Morgenson, Option Pie: Overeating is a Health Hazard, N.Y. TIMES, Apr. 4, 2004, § 3, at 1 (quoting Robert A.G. Monks, a founder of Lens Governance Advisors).
22. Lucian Bebchuk & Yaniv Grinstein, The Growth of Executive Pay, 21 OXFORD REV. ECON. POL'Y 283, 289 (2005), available at http://ssrn.com/abstract=648682.
23. Bengt R. Holmström & Steven N. Kaplan, The State of U.S. Corporate Governance: What's Right and What's Wrong? 10 (ECGI, Finance Working Paper No. 23/2003, 2003), available at http://ssrn.com/ abstract_id=441100.
24. See Michael C. Jensen & Kevin J. Murphy, CEO Incentives-It's Not How Much You Pay, But How, HARV. BUS. REV., May-June 1990, at 138, 139-40 (finding very weak pay-for-performance sensitivity in CEO pay during the period from 1975 to 1988; a $1000 change in corporate value corresponds to a change in CEO compensation of $2.59)
25. See BEBCHUK & FRIED, supra note 2, at 78 ("Whether the problem is conscious favoritism, honest stupidity, or a combination of both, the important fact is that directors have been at least to some extent willing to approve option arrangements that favor managers at the expense of shareholders.");
26. see also id. at 144-46.
27. Marco Becht et al., Corporate Governance and Control, in 1A HANDBOOK OF THE ECONOMICS OF FINANCE 83 (George M. Constantinides et al. eds., 2003).
28. As discussed below, a CEO is "worth" her marginal contribution to the firm, meaning she should be compensated up to the amount she would contribute to firm value in excess of the next best-qualified person for the job. No good method has been yet developed to test this measure of compensation efficiency.
29. See Jensen & Murphy, supra note 23, at 149 (describing the incentives for executives not paid like owners).
30. Obstacles to recontracting include the following: (1) the fact that CEO contracts are routinely three to five years in length and include severe early termination penalties; (2) the social and psychological barriers that arise because of the close working relationship between the board and the CEO; (3) the complexity of typical compensation contracts; (4) the opportunity cost of management and board time; and (5) the lack of compensation salience in any given year. See generally BEBCHUK & FRIED, supra note 2, at 23-44.
31. Core et al., supra note 13, at 28.
32. See Charles M. Yablon, Overcompensating: The Corporate Lawyer and Executive Pay, 92 COLUM. L. REV. 1867, 1872 (1992) (reviewing GRAEF CRYSTAL, IN SEARCH OF EXCESS (1991)).
33. See BEBCHUK & FRIED, supra note 2, at 23-44 (arguing that the pay-setting process is corrupted by CEOs who use the following to their advantage: carrots and sticks to control directors; social and psychological factors inherent in corporate board rooms composed of other current or former CEOs; the limited time board members have to focus on compensation issues; the information asymmetries between board members and CEOs on compensation issues; and the relatively small cost of favoring executives over shareholders).
34. Id. at 61-62.
35. Id. at 45-52.
36. See, e.g., DEL. CODE ANN. tit. 8, § 122(5), (15) (2006).
37. See, e.g., In re Walt Disney Co. Derivative Litigation, 906 A.2d 27, 53-54 (Del. 2006) ("[U]nder [Disney's] governing documents the board of directors was responsible for selecting the corporation's officers, but... the compensation committee... was responsible for establishing and approving the salaries[,]... benefits[,] and stock options... of the Company's CEO and President.").
38. BEBCHUK & FRIED, supra note 2, at 49.
39. See Detlev Vagts, Challenges to Executive Compensation: For the Markets or the Courts?, 8 J. CORP. L. 231, 262 (1983) (listing cases). A recent Delaware case has breathed life into the judges-assaviors view of executive compensation reform because the Chancery Court found a director personally liable for a compensation decision.
40. See Valeant Pharms. Int'1 v. Jemey, 921 A.2d 732, 736 (Del. Ch. 2007) (holding the director of a firm personally liable for approving bonuses paid to various officers and directors after a corporate spin-off). It is doubtful, however, that this case portends a greater judicial scrutiny of run-of-the-mill compensation contracts since the case involved an extraordinary business transaction and the director's decision invited a high level of scrutiny because he was also awarded bonuses under the approved plan.
41. See Susan J. Stabile. Is There a Role for Tax Law in Policing Executive Compensation?, 72 ST. JOHN'S L. REV. 81, 85 (1998). This may be changing.
42. See Joann S. Lublin, IRS Is Cracking Down on Abuse of Executive-Bonus Tax Breaks, WALL ST. J., June 18, 2004, at B5.
43. BEBCHUK & FRIED, supra note 2, at 25-27.
44. Id. at 31-34.
45. Id. at 33...34.
46. Id. at 36-37.
47. Yablon, supra note 30, at 1873 (citing GRAEF CRYSTAL, IN SEARCH OF EXCESS (1991)).
48. See Bebchuk et al., supra note 3, at 789.
49. See id. at 777-78.
50. BEBCHUK & FRIED, supra note 2, at 137-46.
51. Id. at 141-42.
52. Id. at 138 ("These [traditional option] plans include several important features that are difficult to justify from an arm's-length contracting perspective.").
53. Id. at 141-42. Numerous academic studies have, for many years, supported the use of indexed stock options.
54. See, e.g., Shane A. Johnson & Yisong S. Tian, Indexed Executive Stock Options, 57 J. FIN. ECON. 35 (2000) (proposing an option designed to filter out market risk, and thus increase the firmspecific incentive power of the option).
55. See John C. Coffee, Jr., Liquidity Versus Control: The Institutional Investor as Corporate Monitor, 91 COLUM.L.R EV. 1277, 1281 (1991).
56. See generally Shleifer & Vishny, supra note 4, at 464-65 (constructing model that shows how, through improving the market for corporate control, "large shareholders raise expected profits and the more so the greater their percentage ownership").
57. See. e.g., Charles Kahn & Andrew Winton, Ownership Structure, Speculation, and Shareholder Intervention, 53 J. FIN. 99, 100-02 (1998) (developing a model to examine the choice by institutional investors to intervene or follow the "Wall Street rule" by selling their shares);
58. see also Coffee, supra note 50, at 1342-45 (discussing insider trading restrictions that come with monitoring).
59. See Kahn & Winton, supra note 52, at 118-19;
60. see also MARK J. ROE, STRONG MANAGERS, WEAK OWNERS: THE POLITICAL ROOTS OF AMERICAN CORPORATE FINANCE 267-76 (1994) (describing how tax law, securities law, and structural aspects of the market limit the ability of institutional investors to provide a meaningful role in corporate governance).
61. See generally Bernard S. Black, Agents Watching Agents: The Promise of Institutional Investor Voice, 39 UCLA L. REV. 811, 836-49 (1992) (arguing for an increased role for institutional investors, especially as large blockholders, in choosing board members. approving compensation plans, and changing anti-takeover devices).
62. Randall S. Thomas, Should Directors Reduce Executive Pay?. 54 HASTINGS L.J. 437, 467 (2003).
63. See Shivram Rajgopal & Mohan Venkatachalam, The Role of Institutional Investors in Corporate Governance: An Empirical Investigation (Stanford Grad. Sch. of Bus., Research Paper No. 1436, 1997), available at https://gsbapps.stanford.edu/researchpapers/library/RP1436.pdf (correlating institutional investor ownership with better monitoring);
64. Sunil Wahal & John J. McConnell, Do Institutional Investors Exacerbate Managerial Myopia? (Oct. 30, 1997) (unpublished manuscript), available at http://ssrn.com/abstract_id=47271 (arguing that firms with greater institutional ownership invest more in research and development);
65. see also Willard T. Carleton et al., The Influence of Institutions on Corporate Governance Through Private Negotiations: Evidence from TIAA-CREF, 53 J. FIN. 1335, 1335 (1998) (empirically verifying TIAA-CREF's influence on firm governance).
66. See Robert Schroeder, 'Say on Pay ' Measure Clears First Hurdle in House: Bill Giving Shareholders Vote on CEO, Officers ' Pay Now Goes to Full House, Dow JONES MARKET WATCH, Mar. 28, 2007, http://www.marketwatch.com/news/story/say-pay-measure-clears-first/story.aspx? guid=%7BA3A 50F74-5093-40E8-BB19-451B43085DA1%7D&tool= 1&dist= bigcharts&.
67. George W. Dent, Jr., Toward Unifying Ownership and Control in the Public Corporation, 1989 WIS. L. REV. 881, 882.
68. Id. at 907.
69. See BEBCHUK & FRIED, supra note 2, at 201 ("Directors who safeguard shareholder interests are needed not only to address executive compensation problems but also to tackle the myriad corporate governance problems that would continue to arise even if compensation arrangements were optimized.");
70. MELVIN A. EISENBERG, THE STRUCTURE OF THE CORPORATION 117-20 (1966) (permitting shareholders holding more than 5% of a firm's stock to nominate directors in the proxy materials);
71. Louis LOWENSTEIN, WHAT'S WRONG WITH WALL STREET: SHORT-TERM GAIN AND THE ABSENTEE SHAREHOLDER 209-18 (1988) (proposing that 25% of directors should be elected by shareholders without any management role or interference).
72. See Charles M. Elson, The Duty of Care, Compensation, and Stock Ownership, 63 U. CIN. L. REV. 649, 652-53 (1995) (noting that empirical studies have shown that firms with substantial director holdings outperform those with lesser director holdings).
73. See, e.g., Laura Lin, The Effectiveness of Outside Directors as a Corporate Governance Mechanism: Theories and Evidence, 90 Nw. U. L. REV. 898, 912-13 (1996) (noting that boards are often powerless because they are controlled by management);
74. see also Arthur Levitt, Jr., Money, Money, Money, WALL ST. J., Nov. 22, 2004, at A14 ("[E]xcessive compensation... packages are a consequence of boards falling victim to a seduction by the CEO.").
75. The SEC has proposed but not adopted a rule that would allow shareholders to nominate candidates for director elections under certain circumstances. See Security Holder Director Nominations, 68 Fed. Reg. 60, 784 (proposed Oct. 23, 2003) (to be codified at 17 C.F.R. pts. 240, 249, 274). Concerns about special interest directors and the jeopardizing of board functioning by commentators has derailed the proposal.
76. See. e.g., Stephen M. Bainbridgc, A Comment on the SEC Shareholder Access Proposal 14 (UCLA Sch. of Law. Law & Econ. Research Paper No. 03-22, 2003), available at http://ssrn.com/abstract-470121 ("Large-scale investor involvement in corporate decisionmaking seems likely to disrupt the very mechanism that makes the public corporation practicable; namely, the centralization of essentially non-reviewable decisionmaking authority in the board of directors.").
77. Jay C. Hartzell & Laura T. Starks. Institutional Investors and Executive Compensation 10 (Sept. 2002) (unpublished manuscript), available at http://ssrn.com/abstract_id=236592;
78. see also Parthiban David et al., The Effect of Institutional Investors on the Level and Mix of CEO Compensation, 41 ACAD. MGMT. J. 200, 202-06 (1998) (finding that the presence of pressure-resistant institutional investors (i.e., investors with no other business dealings with a firm) leads to lower pay and greater pay for performance).
79. Marianne Bertrand & Sendhil Mullainathan, Are CEOs Rewarded for Luck? The Ones Without Principals Are, 116 Q.J. ECON. 901, 918-29 (2001).
80. Id. at 902.
81. Id. at 903.
82. Id. at 921.
83. See infra Part III.B.
84. Marilyn F. Johnson et al., Stakeholder Pressure and the Structure of Executive Compensation 1617, 38 (May 1997) (unpublished manuscript), available at http://ssrn.com/abstract_id=41780 (finding that pay packages are sensitive to negative media reports and specific lobbying by pension funds (i.e., CalPERS), but not shareholder proposals under Rule 14a-8).
85. Mary Ellen Carter & Luann J. Lynch, An Examination of Executive Stock Option Repricing, 61 J. FIN. ECON. 207, 222 (2001) ("[W]e detect no relation between institutional ownership and the repricing decision.");
86. see also Ronald C. Anderson & John M. Bizjak, An Empirical Examination of the Role of the CEO and the Compensation Committee in Structuring Executive Pay 14, 24-25 (Apr. 2000) (unpublished manuscript), available at http://ssrn.com/abstract_id=220851 ("[There is] no evidence that outside director representation on the [compensation] committee provides incentives that are substantially different from [strong] committees comprising insider or affiliated directors.");
87. Kam-Ming Wan, Independent Directors, Executive Pay, and Firm Performance 23 (EFMA 2003 Helsinki Meetings, June 27, 2003), available at http://ssrn.com/abstract_id=392595 (finding that "there is no support for the notion that non-independent directors entrench CEOs by allowing them to set their own pay" and that there is "no systematic evidence that board composition affects change in CEO compensation").
88. John E. Core et al., Corporate Governance, Chief Executive Officer Compensation, and Firm Performance, 51 J. FIN. ECON. 371, 385-88 (1999).
89. Michael B. Dorff, Does One Hand Wash the Other? Testing the Managerial Power and Optimal Contracting Hypotheses of Executive Compensation 5 (2004) (unpublished manuscript), available at http://ssrn.com/abstract=574861.
90. See Harry DeAngelo, Linda DeAngelo & Karen H. Wruck, Asset Liquidity, Debt Covenants, and Managerial Discretion in Financial Distress: The Collapse of L.A. Gear, 64 J. FIN. ECON. 3, 5 (2002) (describing the use of debt covenants in a case study of the financial distress of L.A. Gear, and concluding that "debt covenants sometimes constrain managerial discretion more effectively than does the pressure to meet cash interest obligations....");
91. see also HILARY ROSENBERG, THE VULTURE INVESTORS 19 (2000) (describing the ability of distressed investors to use the Bankruptcy Code's voting rules to achieve control positions-known as "negative control"-in debtors);
92. Baird & Rasmussen, supra note 7, at 1216-17.
93. See Baird & Rasmussen, supra note 7, at 1236-42.
94. Coffee, supra note 50, at 1281.
95. Id. at 1322.
96. Id. at 1329.
97. See Frank H. Easterbrook, Two Agency-Cost Explanations of Dividends, 74 AM. ECON. REV. 650, 653-54(1984).
98. For example, a $1 million investment in monitoring with a 50% probability of yielding $22 million in shareholder value has a positive expected value of $1.1 million.
99. See Frank H. Easterbrook & Daniel R. Fischel, Voting in Corporate Law, 26 J.L. & ECON. 395, 402 (1983).
100. Managerial power scholars note that even board members, who are required by law to be familiar with the financial and strategic state of the firm, are at an informational disadvantage vis-à-vis management. See BEBCHUK & FRIED, supra note 2, at 23.
101. Although the securities laws prescribe disclosures in extensive detail and require various filings to be made on a strict schedule, there is compelling evidence that managers manipulate disclosures in self-serving ways. See. e.g., David Aboody & Ron Kasznik, CEO Stock Option Awards and the Timing of Corporate Voluntary Disclosures, 29 J. ACCT. & ECON. 73 (2000) (finding that firms manipulate the timing of disclosures to maximize profits on options).
102. Securities Exchange Act of 1934 § 16(b), 15 U.S.C. § 78p(b) (2000).
103. Mark J. Roe, Political Preconditions to Separating Ownership from Corporate Control, 53 STAN. L. REV. 539, 545 (2000).
104. See 17 C.F.R. § 240.14a-2 (2006).
105. See Roberta Romano, Public Pension Fund Activism in Corporate Governance Reconsidered, 93 COLUM. L. REV. 795, 796 (1993) ("Public fund managers must navigate carefully around the shoals of considerable political pressure to temper investment policies with local considerations, such as fostering in-state employment, which are not aimed at maximizing the value of their portfolios' assets.").
106. Black, supra note 54, at 815-18.
107. Id. at 817.
108. Id. at 815.
109. See Eugene F. Fama, Agency Problems and the Theory of the Firm, 88 J. POL. ECON. 288, 291 (1980).
110. Although the investments in monitoring may be sunk costs that should be disregarded in a rational exit calculation, it is likely that firms that have invested in the success of a particular firm will be less likely on the margin to abandon the firm notwithstanding the investments. In addition, as discussed above, certain types of monitoring, say taking a board seat, bring with them restrictions on the ability to sell shares. See supra note 84 and accompanying text.
111. See Robert W. Hamilton, Corporate Governance in America 1950-2000: Major Changes But Uncertain Benefits, 25 J. CORP. L. 349, 367 (2000).
112. This demonstrates a potentially large cost of a robust mandatory disclosure regime.
113. See Romano, supra note 87, at 811-20 (noting that federal laws such as ERISA, which apply only to private funds, limit the ability of private funds to engage in certain forms of investor activism).
114. See Baird & Rasmussen, supra note 7, at 1226 (describing the case study of Warnaco in which financial distress resulted in a single credit facility with strong creditor control rights being established, and the banks being given control of the corporation).
115. A creditor holding more than 33% of the claims in a class has a blocking position and can effectively hold up approval of any plan. See 11 U.S.C. § 1126(c) (2006)
116. (approval by two-thirds in amount, and one-half in number, of claims is needed for approval of a plan). Because creditors rarely hold such large stakes in firms, without some way for creditors to buy claims from other creditors, no single creditor can achieve this leverage position vis-à-vis management. Prior to 1990, the market for distressed debt and claims was severely limited because courts scrutinized attempted transfers of ownership stakes to the point that it impeded the development of a market for these claims. This changed in 1991 when the Advisory Committee on the Rules of Bankruptcy Procedure amended Rule 3001(e)(2) to allow claims to be traded without the court's approval. As one observer notes, "[b]efore [1990], there was no secondary market for distressed bank debt.... But, by the late 1990s, an investor could buy defaulted loans through practically any bank or brokerage firm." ROSENBERG, supra note 74, at 19. This market allows turnaround specialists to play an active role in the outcome of Chapter 11 reorganizations by permitting debt to flow to those most willing to use it to create a blocking position and exert influence over management. According to a partner at a leading distressed-debt investment/turnaround shop, "I can't think of a big-time deal in the past ten years that didn't involve substantial participation, if not total control, by major vultures and banks." Telephone Interview with New York-based distressed-debt investor (June 5, 2004).
117. Edith S. Hotchkiss & Robert M. Mooradian, Vulture Investors and the Market for Control of Distressed Firms, 43 J. FIN. ECON. 401, 409 (1997).
118. Id. at 402.
119. Baird & Rasmussen, supra note 7, at 1226.
120. Many firms are also governed by industry-specific regulations that restrict the overall management decision space.
121. Richard M. Cieri & Michael J. Riela, Protecting Directors and Officers of Corporations that are Insolvent or in the Zone or Vicinity of Insolvency: Important Considerations, Practical Solutions, 2 DEPAUL BUS. & COM. L.J. 295, 300-01 (2004);
122. see also Unsecured Creditors Comm. of STN Enters., Inc. v. Noyes (In re STN Enters., Inc.), 779 F.2d 901, 904 (2d Cir. 1985);
123. Credit Lyonnais Bank Nederland, N.V. v. Pathe Commc'ns Corp., No. 12150, 1991 WL 277613, at *32-33 n.55 (Del. Ch. Dec. 30, 1991) (noting the diverging interests of creditors and stockholders in the vicinity of insolvency).
124. Douglas G. Baird & Robert K. Rasmussen, Chapter 11 at Twilight, 56 STAN. L. REV. 673, 696 (2003).
125. David A. Skeel, Jr., Creditors' Ball: The "New" New Corporate Governance in Chapter 11, 152 U. PA. L. REV. 917, 925-26 (2003).
126. Baird & Rasmussen, supra note 7, at 1226-27 (describing the use of these techniques in the financial distress of Warnaco).
127. Id. This phenomenon is also increasingly prevalent in solvent firms, although with fewer control rights and with less power than in bankrupt firms. See generally Michael R. Roberts & Amir Sufi, Control Rights and Capital Structure: An Empirical Investigation (Jan. 31, 2007) (unpublished manuscript), available at http://ssrn.com/abstract=962131 (showing empirical evidence that lenders use control rights to shape corporate policies outside of bankruptcy).
128. Baird & Rasmussen, supra note 7, at 1229 ("A creditor can now acquire a valid security interest in all of a debtor's assets and ensure that all of the cash coming into the corporation and leaving it passes through its hands.... By virtue of controlling the business's cash flow, the creditor is less dependent upon the debtor to tell it what is going on.").
129. Id. at 1241.
130. Id. at 1226.
131. Id. at 1227;
132. see also ROSENBERG, supra note 74, at 24.
133. LoPucki & Whitford, supra note 9, at 680 ("To deal with [the collective action] problem, the Bankruptcy Code provides for the appointment of committees of creditors....").
134. 11 U.S.C. § 1102(b)(1) (2006).
135. See LoPucki & Whitford, supra note 9. at 680 (noting that the Bankruptcy Code allows shareholders to bypass a collective action problem by hiring professionals to represent them, passing the cost on to the debtor corporation).
136. Edward B. Rock, The Logic and (Uncertain) Significance of Institutional Shareholder Activism. 79 GEO. L.J. 445, 465 (1991 ) ("A group can surmount a collective action problem if pre-existing organizational structures can be converted to provide the collective good at a sufficiently low cost or the collective good can be provided as a by-product of an organization based on other, often private, incentives." (citing MANCUR OLSON, THE LOGIC OF COLLECTIVE ACTION: PUBLIC GOODS AND THE THEORY OF GROUPS 132-35 (2ded. 1971))).
137. 11 U.S.C. §§1102-03.
138. Id. §1109(b).
139. For example, the Code requires a meeting of creditors (the "section 341 meeting"), which is typically held twenty to forty days after the petition is filed. This meeting is run by the United States Trustee and must be attended by the debtor, who is questioned under oath about the case. Id. §341. Once the committee is formed, it routinely elects a chair, engages counsel and other advisors, and sets up a meeting schedule and information-sharing protocol.
140. See In re Allegheny Inf'l, Inc. (Allegheny II), 118 B.R. 282, 298 (Bankr. W.D. Pa. 1990);
141. see also Shawn Young, SEC Probes WorldCom Creditors-Committee Trades, WALL ST. J., Sept. 20, 2004, at A3.
142. There is a concern among distressed-debt investors that at some point "claim purchases start to equate to a sub rosa Chapter 11 plan, requiring the imposition of the Bankruptcy Code's disclosure, classification, and equal treatment rules." Robert D. Drain & Elizabeth J. Schwartz, Are Bankruptcy Claims Subject to the Federal Securities Laws?, 10 AM. BANKR. INST. L. REV. 569, 585 (2002).
143. ROSENBERG, supra note 74 at 31.
144. 11 U.S.C. § 1103(c).
145. Id. § 1103(a) (authorizing creditors' committee to hire advisors);
146. id. § 328(a), (c) (authorizing (and limiting) compensation of advisors retained under section 1103).
147. Disclosure Statement For Debtors' First Amended Joint Plan of Reorganization Under Chapter 11 of the Bankruptcy Code at 35, In re Silicon Graphics, Inc., No. 06-10977 (Bankr. S.D.N.Y. July 27, 2006), available at http://www.sgi.com/reorg/disclosure_statement.pdf.
148. Even when these firms are affiliated with bigger institutions, so-called Chinese Walls are put in place to keep the information and activities of the relevant divisions separate, This is done to limit potential insider trading liability, so these barriers are taken seriously by the firms.
149. Telephone Interview with managing director of New York-based distressed-debt fund with over $2 billion in assets under management (Mar. 5, 2004).
150. Interview with vice president of New-York based global commercial bank (Apr. 3, 2004). Interview conducted in person at bank's offices.
151. According to Professor Edward Altman at the New York University School of Business, in 2003, the defaulted- and distressed-debt market had a market value of about $370 billion. See Prof. Edward Altman, Presentation at the GFA Seminar at the N.Y. Univ. Stern Sch. of Bus.: Defaulted Bond & Bank Loan Markets and Outlook (Mar. 29, 2004) (PowerPoint presentation available at http://pages.stern.nyu.edu/~gfa/resources/distressed_investing.ppt). This is trivial compared with the size of U.S. debt and equity markets, which are tens of trillions of dollars each.
152. See Tony Tassell, Europe Tops US in Stock Market Value, FIN. TIMES, Apr. 2, 2007 available at http://www.ft.com/cms/s/ bf6a00e4-e14b-11db-bd73-000b5df10621,_i_rssPage= 6700d4e4-6714-11 da-a650-0000779e2340.html (estimating the value of U.S. equity markets as $16 trillion).
153. This is starting to change somewhat. Courts are increasingly willing to approve trading by committee members if strict procedural mechanisms are put in place to keep confidential information obtained through the committee process from being used in trading. See Terry Brennan, FiberMark Creditors to Keep Trading, THE DAILY DEAL, Oct. 21, 2004.
154. ROSENBERG, supra note 74, at 17.
155. Vulture investors also have the advantage of being newcomers to the firm. As Frank Easterbrook observes, "[n]ew investors are better than old ones at chiseling down agency costs" because they can readily observe managerial performance prior to investing. Easterbrook, supra note 79, at 654.
156. Skeel, supra note 104, at 922.
157. Michael Bradley & Michael Rosenzweig, The Untenable Case for Chapter 11, 101 YALE L.J. 1043, 1049-50, 1052 (1992) (emphasis omitted).
158. Gail Schoetter, CEO: Constant Excessive Outrages, DEN. POST, Apr. 27, 2003, at E05 (opinion of Gail Schoetter, former U.S. Ambassador, Colorado lieutenant governor and treasurer, and corporate board member).
159. See, e.g., Alan Schwartz, A Contract Theory Approach to Business Bankruptcy, 107 YALE L.J. 1807, 1836-37 (1998) ("[F]irms operate under their current management during the pendency of a Chapter 11 reorganization and can manipulate the process to shift wealth to themselves.");
160. see also Lucian A. Bebchuk & Howard F. Chang, Bargaining and the Division of Value in Corporate Reorganization, 8 J.L. ECON. & ORG. 253, 267-68 (1992) (arguing that the control of the bankruptcy agenda is valuable, and noting that managers, acting in the interests of either equity or debt, can use this to their advantage to extract rents).
161. For example, section 503(c)(1) prohibits debtors from paying retention bonuses to insiders absent a finding by the court that: (A) the insider has a bona fide job offer from another firm at the same or higher amount of compensation; (B) the services to be provided are essential to the debtor's survival; and (C) the amount paid is not greater than ten times the average amount paid to nonmanagement employees. 11 U.S.C. § 503(c)(1) (2006).
162. See Bradley & Rosenzweig, supra note 132 and accompanying text.
163. A recent survey by compensation consulting firm William M. Mercer, Inc., found that over 80% of CEOs had employment contracts in 1998, most with generous severance packages in the case of early termination. See Valerie Patterson, Employment Contracts Attract Top Executives, CAREERJOURNAL.COM, Sept. 15, 1998, http://www.careerjournal. com/myc/negotiate/19980915patterson.html;
164. see also Stewart J. Schwab & Randall S. Thomas, An Empirical Analysis of CEO Employment Contracts: What Do Top Executives Bargain For?, 63 WASH. & LEE L. REV. 231, 246-54 (2006) (cataloguing the use and nature of termination provisions of CEO contracts).
165. This assertion is based on an examination of such contracts for this study. Such contracts are similar both inside and outside of bankruptcy. See infra Part V.
166. See Core et al., supra note 13, at 28.
167. See 11 U.S.C. §365(a) (providing for rejection of "executory contracts" by debtor);
168. Gouveia v. Tazbir, 37 F.3d 295, 298 (7th Cir. 1994) (noting that the lower court held that "executory contracts typically include ... employment contracts" and that executory contracts involve future acts);
169. see also Sarah C. Lichtenstein, Termination of Employment Contracts in Bankruptcy, 213 N.Y. L.J., Apr. 17, 1995, at 1 (noting that the Bankruptcy Code caps damages resulting from termination of employment contracts).
170. See. e.g., In re FBI Distrib. Corp., 330 F.3d 36, 42 (1st Cir. 2003) (citing 11 U.S.C. §365).
171. See, e.g., Amanda Bennett, Protecting Unsecured Pensions and Pay Becomes a Priority for Firms Under Fire, WALL ST. J., May 21, 1987, at 31.
172. See Edison Bros. Stores, Inc., Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 (Form 10-K), Exhibit 2 at § 7.4 (May I, 1997), available at http://secinfo.com/ dUQx.8d.d.hlm#3h2v (assuming all compensation plans);
173. Joint Plan of Reorganization Under Chapter 11, Title 11, United States Code of Sterling Chemicals Holdings, Inc., et al., Debtors at § 7.5, In re Sterling Chemicals Holdings, Inc., No. 01-37805 (Bankr, S.D. Tex. Oct. 14, 2002), available at http://www.secinfo.com/dsvRu.35Pc.d.htm (rejecting some components, assuming others);
174. Joint Chapter 11 Plan of Reorganization of the Debtors in Possession and the Official Committee of Unsecured Creditors of SLI Inc. at art. V.E, In re SLI Inc., No. 02-12608 (Bankr. D. Del. Apr. 17, 2003), available at http://www.secinfo.com/dsVsj.21C9.d.htm#lump (rejecting all compensation contracts).
175. See infra Part IV.A.2.
176. This is based on anecdotal evidence from discussions with bankruptcy practitioners at several New York and Chicago law firms.
177. In 2000. CEO compensation amounted to about 8% of corporate profits and about 17% of dividends. See STEVEN BALSAM, AN INTRODUCTION TO EXECUTIVE COMPENSATION 262 (2002).
178. See Matt Miller, When Failure Pays, THE DAILY DEAL, Feb. 27, 2003 (quoting lawyers involved in the reorganization of Peregrine Systems).
179. Getting new faces into management roles can be a key to changing a company's direction." Meg Richards, CEOs on Forced Diet of Lower Pay: Some Perks Also Eliminated in Wake of Corporate Scandals, CBS NEWS, Feb. 12, 2003, http://www.cbsnews.com/stories/2003/02/12/national/ main540271.shtml (quoting Ken Hiltz, a partner at a crisis management firm).
180. Telephone Interview with attorney in bankruptcy practice at large New York firm (Feb. 15, 2004).
181. See. e.g., Spectrasite, Inc., Proposed Plan of Reorganization (Form 8-K), at 19-21 (Nov. 15, 2002), available at http://www.secinfo. com/dsVsf.3bR9.d.htm.
182. Telephone Interview with managing director of New York-based distressed-debt fund with over $2 billion in assets under management (Mar. 16, 2004).
183. See generally Allison K. Verderber Herriott, Comment, Toward an Understanding of the Dialectical Tensions Inherent in CEO and Key Employee Retention Plans During Bankruptcy, 98 NW. U. L. REV. 579 (2004).
184. According to research done by management consultancy Booz Allen Hamilton, the average for the world's largest 2500 firms in 2004 was about 11%, and this was up dramatically from the prior decade, See Booz Allen Hamilton, Global Turnover Set New Record in 2005, available at http://www. boozallen.com/publications/article/3744370.
185. There is some suggestion that the retailing sector may be especially susceptible to the poaching of key people. See, e.g., Dai-Ichi Kangyo Bank, Ltd. v. Montgomery Ward Holding Corp. (In re Montgomery Ward Holding Corp.), 242 B.R. 147, 152 (D. Del. 1999) (noting that the lower court found that these retention agreements are "particularly" important in "retail cases" (citation omitted)).
186. The debtor has a 120-day period during which it has an exclusive right to file a plan. 11 U.S.C. S§ 1121(b) (2000).
187. Stephen J. Lubben, The Direct Costs of Corporate Reorganization: An Empirical Examination of Professional Fees in Large Chapter 11 Cases, 74 AM. BANKR. L.J. 509, 539-41 (2000).
188. Cynthia Baker argues that professional fees are excessive in Chapter 11 because the debtor does not pay professional fees, which instead are borne by the "last class of creditors or shareholders still 'in the money.'" Cynthia Baker, Fixing What's Broken: A Proposal for Reform of the Compensation System in Bankruptcy, 5 J. BANKR. L. & PRAC. 435, 442 (1996).
189. This should not depend on a creditor's investment horizon, since even vulture investors looking to sell quickly for a profit, known as "Migratory Birds," have incentives to write contracts that maximize firm value. Of course, long-term investors, known as "Nest Builders," have the proper incentives. See ROSENBERG, supra note 74, at 29.
190. See infra Part V.
191. The reservation wage for outside replacement may also be higher because the pool of potential candidates capable of rescuing a reorganizing firm (e.g., turnaround specialists) is shallow.
192. This may not necessarily be the case; some employers may value the experience gained from working for a financially distressed firm. See Joann S. Lublin, Ailing Employers Offer Marketable Ex periences, But Beware Pitfalls, WALL ST. J., Nov. 9, 2004, at B1 ("[W]eathering the ultimate business crisis could make you more marketable.").
193. These conclusions are supported by the data from Gilson and Vetsuypens, who found that outside replacements were paid 36% more than the managers they replaced, and that insiders who replaced the CEO were paid 35% less. See Gilson & Vetsuypens, supra note 8, at 425.
194. In comparison, the percentage of outside replacements in all firms was about 25% from 1990 to 2000. See Kevin J. Murphy & Jan Zabojnik, Managerial Capital and the Market for CEOs 24 (Queen's Univ., Queen's Econ. Dep't, Working Paper No. 1110, 2006).
195. Although some recent research suggests that CEOs are unfairly scapegoated for poor firm performance, see Naveen Khanna & Annette Poulsen, Managers of Financially Distressed Firms: Villains or Scapegoats?. 50 J. FIN. 919, 929 (1995), this threat reduces the value of an existing CEO, and thus the CEO's bargaining power.
196. See Gilson & Vetsuypens, supra note 8, at 426.
197. See Randolph P. Beatty & Edward J. Zajac, Managerial Incentives, Monitoring, and Risk Bearing: A Study of Executive Compensation, Ownership, and Board Structure in Initial Public Offerings, 39 ADMIN. SCI. Q. 313, 332 (1994).
198. Lucian A. Bebchuk & Jesse M. Fried, Stealth Compensation via Retirement Benefits, 1 BERKELEY BUS. L.J. 291, 294 (2004).
199. For a colorful, if somewhat overstated, description of outrage costs, see Paul Krugman, Editorial, The Outrage Constraint, WALL ST. J., Aug. 23, 2002, at A17.
200. Eagle-Picher Executives Prosper at Troubled Firm, USA TODAY, May 14, 1991, at 2B.
201. Chapter 11: How to Get Rich; Bankruptcy Can Mean Bonus, BLOOMBERG BUS. NEWS, Mar. 1, 1996.
202. For instance, AT&T announced 40,000 layoffs while its CEO was paid nearly $17 million. See Irwin M. Stelzer, Are CEOs Overpaid?, 126 PUB. INTEREST 26, 27 (1997).
203. General Dynamics paid its CEO over $10 million per year while cutting almost 73,000 jobs over three years. MARGARET M. BLAIR, OWNERSHIP AND CONTROL 9 (1995).
204. Dan Reed, American's Exec Pay Enrages Labor, USA TODAY, Apr. 18, 2003, at IB;
205. see also Russell Grantham, More Cuts for Delta Execs, Pension Funding, Bonuses Stopped, ATLANTA J.-CONST., Aug. 12, 2003, at Al.
206. See Coffee, supra note 50, at 1333 (describing implicit contracts whereby owners defer "a considerable portion of the managers expected aggregate compensation until the end of their careers").
207. See Burlington Indus., Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 (Form 10-K), at 35 (Dec. 21, 2001), available at http://www.secinfo.com/dV5Ff.4fjW9.htm#6jq (describing how Burlington entered into a new one-year agreement with the CEO to operate the company in bankruptcy, which "replace[d his] prior employment agreement");
208. see also id. at 33 (characterizing retirement, benefits, change-of-control, and stock option plans as "unfunded arrangements," and noting that "[a]s a result of the filing of the Chapter 11 Cases, each participant [in these plans] has the status of a general unsecured creditor").
209. 11 U.S.C. §§1103(c)(4), 1104(a) (2000).
210. See LoPucki & Whitford, supra note 9, at 701.
211. 11 U.S.C. § 1104(c).
212. LoPucki & Whitford, supra note 9, at 706.
213. Id. at 703. A related factor is that debtors face cash constraints that may make them less able to pay rich compensation packages to management. If managers have limited exit options, firms can argue to management that the lack of cash limits the amount they can pay. In practice, however, the result may simply be a shift from cash forms of payment (like salary and bonuses) to noncash forms (like options and deferred compensation).
214. Skeel, supra note 104, at 929.
215. This assertion is based on an examination of the dates of filing the petition for reorganization and the reporting dates of new employment contracts for firms analyzed in infra Part V, as well as on interviews by the author with directors of New York-based distressed-debt investors conducted via telephone on June 5, 2004 and August 19, 2004.
216. For example, J.C. Penney hired Allen Questrom, a 40-year retail veteran and "turnaround king," to manage its restructuring process. When the turnaround was complete, J.C. Penney hired a new CEO to lead the newly reorganized firm. See Teri Agins & Ann Zimmerman, J.C. Penney Names Ullman New CEO, In Early Decision, WALL ST. J., Oct. 28, 2004, at B8.
217. 11 U.S.C. §§ 327(a), 328(a), 1103(b) (2000) (discussing employment by the debtor of "professional persons" necessary to the reorganization).
218. Mike Groenendaal & Ryan Harvey, How People Issues Can Shape Bankruptcy, FIN. EXECUTIVE, Dec. 2003, at 60.
219. Michael Hiltzik, Key3 Execs Irrepressible But Not Irreplaceable, L.A. TIMES, Feb. 27, 2003, at C1 (quoting Jordan Teramo of Mackay Shields).
220. See Wade Lambert & Ellen Joan Pollock, Drexel Slashes Executive-Pay Proposal, WALL ST. J., Apr. 23, 1991, at B16.
221. Miller, supra note 147.
222. Peg Brickley, FAO Faces Challenge Over Bonuses for Execs, AP DATASTREAM, Jan. 30, 2004 (quoting filing of creditors' committee).
223. Telephone Interview with managing director of New York-based distressed-debt investor (Sept. 12, 2004).
224. Charles Sheehan, Owens Corning Creditors Say Executive Pay Plan Lacks Incentive to End Chapter II, AP DATASTREAM, Sept. 8, 2004.
225. See, e.g., Caldor Receives Court Approval for Employee Retention Program, BUS. WIRE, Mar. 27, 1996 ("Caldor's performance retention program, as approved by the court, has the full support of the company's Creditors Committee, Bank Committee, and Equity Committee.").
226. See Miller, supra note 147.
227. Software Company Fails to Secure Some Retention Bonuses, BCD NEWS & COMMENT, Nov. 8, 2002.
228. See Debtors' Second Amended Joint Plan of Reorganization Under Chapter 11 of the Bankruptcy Code as Modified December 10, 1999 at 19, In Re PWS Holding Corp., Bruno's Inc., Nos. 98-212, 98-223 (Bankr. D. Del. Dec. 10, 1999), available at http://www.secinfo.com/dRx61.5c.d.htm ("The initial Board of Directors of New Bruno's shall consist of seven individuals, five of whom shall be selected by the [bank syndicate], one of whom shall be the Chief Executive Officer of New Bruno's and one of whom shall be (a) selected by the Chief Executive Officer of New Bruno's and (b) either an officer of New Bruno's or a current member of the Board of Directors of Bruno's, or, if not an officer of New Bruno's or a current member of the Board of Directors of Bruno's, a person acceptable to the [bank syndicate].").
229. Ken Stammen, Banana Grower Aims for Fresh Start, CINCINNATI POST, Nov. 29, 2001, available at http://www.cincypost.com/2001/nov/29/chiq1 12901.html
230. Edison Brothers Names New Board; Directors to Take Seats Following Emergence From Chapter 11, PR NEWSWIRE, Sept. 9, 1997 (noting that officers at Highline Capital Management. L.L.C. and Citibank N.A., two of Edison Brothers's creditors, took board seats under the reorganization plan).
231. Greg Andrews, Executive Might Get Large Loan Forgiven, INDIANAPOLIS BUS. J., Apr. 28, 2003, at 3.
232. Micheline Maynard, US Air's Chief Lender Threatens the Ultimate, N.Y. TIMES, Dec. 7, 2002, at C1.
233. Skeel, supra note 104, at 931.
234. See supra notes 74-75 and accompanying text.
235. For the power of jawboning in another, related context, see Shleifer & Vishny, supra note 4, at 472-74 (modeling the use of jawboning in the proxy-fight/takeover context, and finding that while jaw- boning can be useful in making small-value improvements, it may be of "negative value" to shareholders because it reduces the threat of takeover as well as the likely takeover premium).
236. See, e.g., DEL CODE ANN. tit. 8, § 102(b)(7) (2001);
237. MODEL BUS. CORP. ACT § 2.02(b)(4) (2005).
238. Bernard S. Black et al., Outside Director Liability, 58 STAN. L. REV. 1055, 1074-76 (2006). While this remains true in nearly all cases, the recent settlement of a securities action against WorldCom's former directors may be a watershed event.
239. See Gretchen Morgenson, 10 Ex-Directors from WorldCom to Pay Millions, N.Y. TIMES, Jan. 6, 2005, at Al (reporting that ten former directors of WorldCom agreed to pay $18 million of their own money as part of a class-action settlement agreement).
240. See Cede & Co. v. Technicolor Inc., 634 A.2d 345, 361 (Del. 1993) (holding that, when share-holders allege a breach of "good faith, loyalty[,] or due care [in a corporate transaction,]. . . the business judgment rule attaches to protect corporate officers and directors and the decisions they make, and our courts will not second-guess these business judgments"), If any of these are shown, the burden shifts to the directors to show the "entire fairness" of the compensation package, including both a fair price and a fair process. See Solomon v. Armstrong, 747 A.2d 1098, 1112 (Del. Ch. 1999) ("If the presumption [that the directors acted in the best interests of the company] is rebutted, the board's decision is reviewed through the lens of entire fairness, pursuant to which the directors lose the presumption of good business judgment,").
241. See Brehm v. Eisner, 746 A.2d 244, 264 n.66 (Del. 2000) ("[D]irectors' decisions will be respected by courts unless the directors are interested or lack independence relative to the decision, do not act in good faith, act in a manner that cannot be attributed to a rational business purpose or reach their decision by a grossly negligent process that includes the failure to consider all material facts reasonably available.").
242. See. e.g., Angelo, Gordon & Co., L.P. v. Allied Riser Commc'ns Corp., 805 A.2d 221, 229 (Del. Ch. 2002) ("[E]ven where the law recognizes that the duties of directors encompass the interests of creditors, there is room for application of the business judgment rule.").
243. See, e.g., Geren v. Quantum Chem. Corp., No. 95-7554, 1995 WL 737512, at *1 (2d Cir. Dec. 13, 1995) ("Under New York law, directors of a corporation may become trustees of the creditors when the corporation is insolvent.");
244. see also Jewel Recovery, L.P. v. Gordon, 196 B.R. 348, 354 (N.D. Tex. 1996).
245. See, e.g., NLRB v. Bildisco & Bildisco, 465 U.S. 513, 523 (1984) (using a somewhat stricter business judgment standard when reviewing director decisions to accept or reject executory contracts).
246. In re S.N.A. Nut Co., 186 B.R. 98, 104 (Bankr. N.D. III. 1995).
247. See Cieri & Riela, supra note 102, at 304.
248. 294 B.R. 449 (S.D.N.Y. 2003).
249. Id. at 474.
250. Id. at 477.
251. Id.
252. For a discussion of whether the business judgment rule is a doctrine of substance or abstention, STEPHEN BAINBRIDGE, CORPORATION LAW AND ECONOMICS 242-51 (2002).
253. See supra note 202 and accompanying text.
254. See, e.g., In re Ben Franklin Retail Stores, Inc., Nos. 97C7934, 97C6043, 2000 WL 28266, at *7-8 (N.D. III, Jan. 12, 2000) (holding that an exculpatory clause does not preclude a bankruptcy trustee from proceeding against directors);
255. Pereira, 294 B.R. at 534.
256. In re Ben Franklin Retail Stores, 2000 WL 28266, at *8 ("[C]reditors should not be bound by the exculpatory provision because they were not parties to the contract").
257. See id. ("[T]he provision explicitly states that '[a] director. . . shall not be personally liable to the Corporation or its stockholders for monetary damages . . . . No mention is made of the potential liability to creditors that directors may incur," (citation omitted)).
258. The argument that these provisions should run only to shareholder claims (either directly or derivatively) does not hold water because the firm's charter, and thus the terms of the bargain, will be known to subsequent creditors that loan the firm money.
259. See, e.g., DEL. CODE ANN. tit. 8, §145(g) (2001) ("A corporation shall have power to purchase and maintain insurance on behalf of any person who is or was a director, officer, employee or agent of the corporation . . . .").
260. See Cieri & Riela, supra note 102, at 330.
261. BEBCHUK & FRIED, supra note 2, at 37.
262. Id. (quoting Jeffrey Sonnenfeld, Assistant Dean, Yale School of Management).
263. As Ken Langone wrote regarding the flap over Richard Grasso's pay at the New York Stock Exchange, "It is absurd to suggest that the [directors, some of the] brightest minds and keenest thinkers on Wall Street[,] were befuddled by the complexity of Richard Grasso's compensation package-especially one composed just like their own." Kenneth Langone, Let's Bring on the Jury, Mr. Spitzer, WALL ST. J., June 10, 2004, at A12.
264. For example, four members of the buyout firm Kohlberg Kravis Roberts & Co. were elected to serve on the board of debtor Borden Chemical. See Borden Chem., Inc., Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 (Form 10-K), at 63-65 (Mar. 28, 2003).
265. See CASS R. SUNSTEIN, WHY SOCIETIES NEED DISSENT 37 (2003) (examining the benefits of including different or dissenting opinions in group decisionmaking in a variety of non-corporate contexts).
266. See, e.g., Am. Banknote Corp., Amendment No. 1 to Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 (Form 10-K/A), at 8 (Apr. 30, 2004), available at http://www.secinfo.com/dsvr4. 15bh.htm#1stPage ("The Parent did not have a Compensation Committee subsequent to the filing of a petition for reorganization relief under Chapter 11 of the United States Bankruptcy Code, on December 8, 1999. Subsequent to the confirmation of the Plan and prior to April 2001, compensation agreements and plans subject to Compensation Committee action were instead addressed by the full Board of Directors,");
267. see also SLI Inc., Proxy Statement Pursuant to Section 14(a) of the Securities Exchange Act of 1934 (Schedule 14A), at 4 (May 22, 2002) ("Due to the Company's financial conditions. . . the [entire] Board of Directors. . . reviewed the compensation arrangements of its executive officers including the Company's Chief Executive Officer.").
268. Telephone Interviews with executives at two of the largest global compensation consulting firms (December 9, 2003).
269. Telephone Interview with managing director at New York-based vulture fund investor (June 2, 2004).
270. 11 U.S.C. § 365(a) (2000).
271. This generalization is based on an examination of court records, interviews with parties to the cases described in infra Part V, and telephone interviews with distressed-debt investors. See supra note 181 and accompanying text. See also infra p. 1592.
272. See Brehm v. Eisner, 746 A.2d 244, 263 (Del. 2000) (upholding the Chancery court's deferral regarding executive compensation).
273. See, e.g., Kerbs v. Cal. E. Airways, 90 A.2d 652, 656 (Del. 1952) (finding a stock option plan deficient in the specific circumstances of the case).
274. Section 191 of the pre-1978 Code provided in pertinent part that "[a] trustee or debtor in possession may employ officers of the debtor at rates of compensation to be approved by the court." 11 U.S.C. § 591 (1976), repealed by Bankruptcy Reform Act of 1978, Pub. L. No. 95-598, tit. IV, § 401(a), 92 Stat. 2549. The Supreme Court affirmed this power in 1963, concluding that bankruptcy courts have the "authority to pass in advance upon the . . . salary of an officer of the Debtor before he assumes or continues in office." Wolf v. Weinstein, 372 U.S. 633, 648 (1963).
275. 6 COLLIER ON BANKRUPTCY ¶¶ 8, 14[1], at 1430 (14th ed. 1978).
276. In re Lyntex Corp., 403 F. Supp. 284, 286 (S.D.N.Y. 1975) (quoting In re J.P. Linahan, Inc., 111 F.2d 590, 592 (2d Cir. 1940)).
277. See In re Curlew Valley Assoc., 14 B.R. 506, 510-11 n.6 (Bankr. D. Utah 1981) (detailing the legislative history of portions of the new Bankruptcy Code).
278. See id.
279. 11 U.S.C. § 327 (2000). See, e.g., In re Athos Steel & Alum., Inc., 69 B.R. 515, 520-21 (Bankr. E.D. Pa. 1987) ("I see no reason to distinguish corporate officers from other professional persons employed in the operation of a debtor's business . . . . [Therefore] I have the authority to review the proposed compensation of the debtor's chief executive officer in this case . . . .");
280. In re Hooper, Goode Realty, 60 B.R. 328, 332 (Bankr. S.D. Cal. 1986) ("This court finds . . . that the employment of the debtor's officers is subject to court scrutiny and is governed by 11 U.S.C. § 327 . . . .");
281. In re Schatz Fed. Bearings Co., Inc., 17 B.R. 780, 782 (Bankr, S.D.N.Y. 1982) (holding that directors acting to administer an estate exercised additional duties placing them in the scope of section 327).
282. In re Zerodec Mega Corp., 39 B.R. 932, 933 (Bankr. Pa. 1984).
283. 11 U.S.C. § 105(a);
284. see In re New York City Shoes, Inc., 89 B.R. 479, 483 (Bankr. E.D. Pa. 1988) (holding that corporate officer's compensation by the debtor created an intolerable conflict allowing the court to review it sua sponte);
285. In re Lyon & Reboli, Inc., 24 B.R. 152, 153-54 (Bankr. E.D.N.Y. 1982) (holding that the court must be able to review executive compensation to meet the goals of the Bankruptcy Code).
286. See. e.g., In re All Seasons Indus., Inc., 121 B.R. 822, 825-26 (Bankr. N.D. Ind. 1990) (noting that even when a court cannot review a debtor's decision to employ pre-petition insider management, the compensation may be reviewed for "reasonableness");
287. In re New York City Shoes, 89 B.R. at 483-84 (holding that a corporate officer would not receive any payment for services to the debtor after the debtor's assets were sold to his other employer);
288. In re State Optical Co., Inc., 70 B.R. 82, 83-84 (Bankr. E.D. Pa. 1987) (reducing CEO's salary from $104,000 to approximately $88,000);
289. In re Zerodec., 39 B.R. at 935 (reducing officer's compensation by one-third).
290. See 11 U.S.C. § 105(a) ("The [bankruptcy] court may issue any order, process, or judgment that is necessary or appropriate to carry out the provisions of this title. No provision of this title providing for the raising of an issue by a party in interest shall be construed to preclude the court from, sua sponte, taking any action or making any determination necessary or appropriate to enforce or implement court orders or rules, or to prevent an abuse of process.").
291. In re New York City Shoes, 89 B.R. at 484.
292. See, e.g., In re All Seasons, 121 B.R. at 826 (noting that the objector "must introduce evidence of exigent circumstances or the prima facie appearance of abuse" indicating compensation is unreasonable).
293. See, e.g., In re State Optical Co., 70 B.R. at 84 (reduced compensation by about 15% because the size and profitability of the DIP decreased);
294. In re Zerodec, 39 B.R. at 935 (authorized employment of the CEO but reduced compensation by over 30% upon the objection of two creditors).
295. In re Montgomery Ward Holding Corp., 242 B.R. 147, 153 (Bankr. D. Del. 1999);
296. see also 11 U.S.C. § 363(b).
297. See, e.g., Rebecca Blumenstein & Lingling Wei, WorldCom's CEO's Pay is Criticized: Judge Says Compensation May Be Unreasonable with Firm in Chapter 11, WALL ST. J., Dec. 11, 2002, at B5 (reporting that the bankruptcy court would be reviewing Capellas's compensation for excessiveness);
298. Richards, supra note 148 (noting that Capellas's compensation was reduced by $5 million over three years).
299. See Miller, supra note 147 (quoting Judge Jed Rakoff).
300. Morton Mintz, Judge Limits A.H. Robins Executive Pay, WASH. POST, Sept. 30, 1986, at Cl;
301. Sonja Steptoe, A.H. Robins to Cut Top Officers' Pay, End Some Former Executives' Consulting, WALL ST. J., Sept. 15, 1986, at 17.
302. Modified Second Amended Plan of Reorganization, In re Paragon Trade Brands, Inc. at 31, No. 98-60390 (Bankr. N.D. Ga. Jan. 13, 2000), available at http://www.secinfo.com/dr4Yq.5d.d.htm
303. See Coram Healthcare Corp., Annual Report (Form 10-K), at 34 (Apr. 15. 2003). available at http://www.secinfo.com/dvjdn.27c.htm#1stPage ("On March 3, 2003, the Bankruptcy Court denied the Chapter 11 trustee's motion for authorization to enter into the Transition [Employment] Agreement [with the incumbent CEO].").
304. Chapter 11: How to Get Rich; Bankruptcy Can Mean Bonus, supra note 170 (quoting Judge James L. Garrity, Jr.).
305. Id.
306. See Nancy Raiden Titus, Anthonys Urges Approval of Plan for Compensation, THE J. REC., Dec. 12, 1991, at 1.
307. Software Company Fails to Secure Some Retention Bonuses, supra note 193.
308. See. e.g., Dan Reed, American's Exec Pay Enrages Labor, USA TODAY, Apr. 18, 2003 (noting that compensation decisions at Delta, Northwest, and Continental airlines "outraged workers and some in Congress," and describing the outrage of the flight attendants' union at retention bonuses for the top six executives at American: "the equivalent of an obscene gesture from management to employees");
309. see also Carissa Wyant, Rep. Ellison, Others Join Pilot Protest of NWA Exec Pay, MINN./ST. PAUL BUS, J., May 29, 2007 ("Northwest pilots are angry that their 40 percent pay cuts are being turned into compensation increases for Northwest's senior executives. This egregious act is not only bad for NWA employees, but will have a counterproductive long-term effect on Northwest Airlines and unfortunately its customers." (internal quotations omitted)).
310. See, e.g., Judge Clears Way for Northwest Airlines to Exit Bankruptcy, N.Y. TIMES, MAY 19, 2007, at C4 (noting that the bankruptcy court judge approved compensation for top executives, including $26.6 million for the CEO, over "union objectors who argued that the equity award plan unfairly enriched executives");
311. Contracts Frontline Workers Critical of Adelphia Reorganization, PR NEWSWIRE, Feb. 11, 2003 (reporting that the labor union representing Adelphia's workers asked the court to reject the proposed executive compensation plan).
312. Groenendaal & Harvey, supra note 184, at 60 (noting that "employee groups, and some creditors[,] are quick to criticize executive compensation and benefits, based on public information," and this leads to increased attention to compensation issues).
313. Eric Heisler, Guilford Mills Plans Unfold: Proposals for Guilford Mills Bonuses Are Modest in Comparison to Those of Burlington Industries, GREENSBORO NEWS & REC., Jul. 13, 2002, at B12.
314. Skeel, supra note 104, at 943, 946.
315. These facts are adapted from the case of In re Sharon Steel Corp., 871 F.2d 1217, 1220 n.9 (3d Cir. 1989), where the court found that transfers of this type were fraudulent conveyances that justified the appointment of a bankruptcy trustee.
316. Baird & Rasmussen, supra note 7, at 1231 ("[Managers] know that they are in the end game. Final-period problems tend to reduce the efficacy of controls designed to bind managers over the long term. Left unchecked, managers are even more likely to put their interests ahead of those of the company.").
317. See Skeel, supra note 104, at 944 n.88 (arguing that the Code be amended to capture suspicious stock sales);
318. see also UNIFORM FRAUDULENT TRANSFER ACT § 7, printed in 7A Uniform Laws Ann. Part II (West 2006) (in force in 34 states).
319. Skeel, supra note 104, at 918.
320. The process for identifying firms that privately restructured their debt followed that of Gilson & Vetsuypens, supra note 8, at 425. There are undoubtedly more firms that did private workouts over this period, but a conservative identification approach was used to minimize overinclusion problems.
321. Compustat EXECUCOMP Database, supra note 15.
322. The average CEO compensation for all firms in 2002 was about $6 million per year, compared to about $2 million for financially distressed firms.
323. See infra Part V.D.2.
324. See Michael S. Weisbach, Outside Directors and CEO Turnover, 20 J. FLN. ECON. 431, 454 (1988) (finding a mean tenure of about ten years for CEOs at firms with both insider- and outsider-dominated boards).
325. Gilson & Vetsuypens, supra note 8, at 441.
326. Telephone Interview with managing partner of distressed-debt trading arm of major investment bank (Apr. 3, 2004).
327. Gilson & Vetsuypens, supra note 8, at 442.
328. Michael C. Jensen & Kevin J. Murphy, Remuneration: Where We've Been, How We Got to Here, What are the Problems, and How to Fix Them 66 (ECGI Finance Working Paper No. 44/2004, 2004), available at http://ssrn.com/abstract=561305.
329. Beatty & Zajac, supra note 166, at 314;
330. see also George P. Baker, Michael C. Jensen & Kevin J. Murphy, Compensation and Incentives: Practice vs. Theory, 43 J. FIN. 593, 597-99 (1988) (noting that changing compensation systems in large firms is extremely costly, even when moving toward a more efficient system, because of the risk of disrupting vested political and economic interests of employees).
331. See Stephen M. Bainbridge, The Business Judgment Rule as Abstention Doctrine, 57 VAND. L. REV. 83, 123-24 (2004) ("Decision makers experience greater regret when undesirable consequences follow from action than from inaction. Hence, decision makers tend towards inertia. Because the effect of these cognitive biases is considerably greater than traditional rational choice theory predicts, even a small risk of liability can be expected to have a large deterrent effect on managers who are already risk averse by virtue of their non-diversifiable investment in firm-specific human capital.").
332. See generally Adam Butler & Scott Highhouse, Deciding to Sell: The Effect of Prior Inaction and Offer Source, 21 J. ECON, PSYCHOL. 223 (2000) (discussing inertia and business decisionmaking);
333. Charles R. Schwenk, Information, Cognitive Biases, and Commitment to a Course of Action, 11 ACAD. MGMT. REV. 298 (1986) (discussing heuristics and biases in business management).
334. See, e.g., Ian Ayres & Stewart Schwab, The Employment Contract, 8 KAN. J.L. & PUB. POL'Y 71, 85-87 (1998) (discussing default rules and the use of penalty defaults to overcome some persistently irrational or unfair results in boilerplate employment and consumer contracts);
335. Stephen J. Choi & G. Mitu Gulati, Innovation in Boilerplate Contracts: An Examination of Sovereign Bonds, 53 EMORY L.J. 929, 938-39 (2004) (finding that contract innovation in a somewhat similar, lawyer-driven context proceeds in bursts that are separated by long periods of sticky status quo).
336. Contracts or contractual terms were taken from SEC filings, reorganization plans filed with bankruptcy courts, other public sources, or parties to the case. In order to create a fair pre-distress control group, employment contracts from years well before financial distress (years -6 to -3) were used. The terms of both "before" and "after" contracts were coded in several key areas, including salary, bonuses, equity compensation, long-term retirement, and so on. In addition, post-distress contracts were compared with the set of standard contractual terms for healthy firms as described in a recent empirical work by Schwab and Thomas, supra note 137. This comparison with firms outside the data set provides a check to ensure that the pre-distress contracts are representative of compensation contracting at healthy firms generally.
337. See generally Schwab & Thomas, supra note 137, at 246-58.
338. See id. at 247 (finding that approximately 82% of CEO employment contracts have terms greater than 1 year); Bebchuk et al., supra note 3, at 765.
339. See Joann S. Lublin, Many High Executives are Working Without a Net, WALL. ST. J., Oct. 26, 2004, at C4 (reporting that some firms have ceased using employment contracts for top executives because they do not provide for sufficient accountability).
340. Only one firm out of forty changed its practice in the post-distress period. See Table 2.
341. Compare Carmike Cinemas, Inc., Annual Report (Form 10-K/A), at 8 (Apr. 29, 2002) (describing 5-year term with no automatic renewal), with Carmike Cinemas, Inc., Annual Report (Form 10K/A), at 7 (Apr. 30, 2001) (describing 5-year term with automatic renewal).
342. See Federal Mogul Corp., Annual Report (Form 10-K), at 111 (Mar. 15, 2004) (describing contract length for former CEO Frank Macher and new CEO Charles McClure Jr.).
343. About 95% of pre-distressed firms had a performance-based bonus plan for the CEO. This fell to almost 90% in post-distress contracts, as some firms paid guaranteed bonuses as part of KERPs (perhaps to offset CEO wealth losses from stock options that went underwater).
344. See, e.g., Carmike Cinemas, Proxy Statement (Schedule 14A), at 33 (Apr. 16, 2004) (noting that the discretionary portion of the CEO's compensation was tied to "debt pay-down, asset sales and other performance metrics" in addition to the standard metric of EBITDA performance).
345. See AFL-CIO PayWatch, 2005 Trends in CEO Pay, http://www.aflcio. org/corporatewatch/ paywatch/pay/ (last visited Apr. 24, 2007) ("A reasonable and fair compensation system for executives and workers is fundamental to the creation of long-term corporate value. However, the past two decades have seen an unprecedented growth in compensation only for top executives and a dramatic increase in the ratio between the compensation of executives and their employees.").
346. Bebchuk et al., supra note 3, at 812;
347. see also supra notes 46-49 and accompanying text.
348. See Casual Male, Annual Report (Form 10-K), at 40 (May 1, 1998).
349. Michel A. Habib & Alexander Ljungqvist, Firm Value and Managerial Incentives: A Stochastic Frontier Approach, 78 J. BUS. 2053, 2076 (2005) (finding that options used by firms do not induce optimal risk taking).
350. There were a handful of firms that used premium-priced options in both pre- and post-distress periods. Compare, e.g., Casual Male, Proxy Statement (Schedule 14A), at 13 (May 5, 1998) ("[A]11 stock options granted to executive officers in fiscal year 1997 have an exercise price 140% higher than the fair market value of shares of Common Stock on the day of grant."), with Casual Male, Proxy Statement (Schedule 14A), at 21 (July 6, 2004) (awarding some options with an exercise price of fair market value and some with an approximately 15% premium built in).
351. BEBCHUK & FRIED, supra note 2, at 142 ("The overwhelming majority of executives have therefore been rewarded for absolute share price increases, even those that are purely a function of broad market or sector rises that lift all boats.").
352. Id. at 141.
353. Id. at 144.
354. The explanation for the failure of sophisticated institutional investors to implement indexed options cannot be lack of awareness. In fact, the reformers claim that "sophisticated institutional investors and their advisors do not share managers' negative view of indexed options. . . [and] have called for the use of indexed options, even though this step would reduce reported earnings." Id. at 148-49.
355. Two examples demonstrate the general trend. See, e.g., Guilford Mills, Annual Report (Form 10-K/A), at 66 (Dec. 29, 2003) ("Pursuant to the [Reorganization] Plan, all options outstanding on the Effective Date to acquire shares of Old Common Stock (including the options granted to [the CEO] during fiscal 2001) were cancelled. The options granted to the [CEO] during the 2003 fiscal year represent options. . . to acquire shares of New Common Stock."); Lason Inc., Annual Report (Form 10-K/A), pt. III, at 3 (Apr. 27, 2004) ("All options previously granted under the Company's 1995 Stock Option Plan and under the 1998 Equity Participation Plan were cancelled pursuant to the [Reorganization] Plan . . . . Pursuant to the [Reorganization] Plan, the Company adopted the Executive Management Incentive Plan . . . [under which it] issued [new] shares of its common stock to the . . . participants.").
356. See Core et al., supra note 13, at 38 ("[T]here is considerable implicit [indexing] in these portfolios.").
357. See Susan J. Stabile, Viewing Corporate Executive Compensation Through a Partnership Lens: A Tool to Focus Reform, 35 WAKE FOREST L. REV. 153, 208-09 n.235 (2000) ("[Indexed] options create adverse accounting consequences.").
358. Saul Levmore, Puzzling Stock Options and Compensation Norms, 149 U. PA. L. REV. 1901, 1922-24 (2001) (describing indexed stock options as "asymmetric calls" - that is, options on the firm's performance that amount to a heads-I-win, tails-you-lose bet-that create a preference for "super" risk, and stating that "[i]f the firm does better than the market, the holder-employee gains; if the firm does worse than the market, the same employee does not pay the employer or otherwise emerge with negative income").
359. Lisa K. Meulbroek, Executive Compensation Using Relative-Performance- Based Options: Evaluating the Structure and Costs of Indexed Options (Harvard Business School Working Paper No 01-021, 2000), available at http://ssrn.com/abstract=281028.
360. Compare Borden Chemical, Annual Report (Form 10-K), at Item 11, Summary Compensation Table (Mar, 31, 1999) (pre-distress: no restricted stock issued), with Borden Chemical, Annual Report (Form 10-K), at Item 11, Summary Compensation Table (Mar. 28, 2003) (post-distress: CEO issued approximately one million shares of restricted stock);
361. compare Carmike Cinemas, Proxy Statement (Schedule 14A), at 13-14 (July 24, 2002) (pre-distress: no grants of restricted stock), with Carmike Cinemas, Proxy Statement (Schedule 14A), at 25 (Apr. 16, 2004) (post-distress: CEO issued approxi-mately $15.5 million in restricted stock).
362. See BEBCHUK & FRIED, supra note 2, at 174.
363. Schwab & Thomas, supra note 137, at 235.
364. BEBCHUK & FRIED, supra note 2, at 191.
365. See Jensen & Murphy, supra note 275, at 67.
366. Timothy L. O'Brien, Mayday? Payday! Hit the Silk!, N.Y. TIMES, Jan. 9, 2005, § 3, at 1.
367. Id. (quoting Elliot Schwartz, research director at the Council of Institutional Investors). The answer to this question is obvious: retirement benefits are merely compensation deferred into future periods. Employees may benefit for tax reasons while employers may benefit for a variety of tax, accounting, or monitoring reasons. For this latter point,
368. see M. Todd Henderson & James C. Spindler, Corporate Heroin: A Defense of Perks, Executive Loans, and Conspicuous Consumption, 93 GEO. L.J. 1835, 1851-52 (2006).
369. See Covanta Energy Corp., Quarterly Statement (Form 10-Q), at "Reorganization Disclosure" (Nov. 14, 2003).
370. Luisa Beltran, WorldCom Files Largest Bankruptcy Ever, CNN MONEY, July 22, 2002, http://money.cnn.com/2002/07/19/news/ worldcom_bankruptcy/.
371. See, e.g., Jake Ulick, WorldCom's Financial Bomb, CNN MONEY, June 26, 2002, http://money,cnn.com/2002/06/25/news/worldcom/.
372. Beltran, supra note 310;
373. Susan Pulliam et al., Former WorldCom CEO Built an Empire on Mountain of Debt, WALL SR. J., Dec. 31, 2002, at A1 ("Bank of America ponied up $253 million. Citi-group lent Mr. Ebbers $552 million. To help Mr. Ebbers pay back some of those loans, the WorldCom board lent him $415 million from the company's coffers. The bank loans went to fund a jumble of acquisitions, including timberland, a yacht-building company and a refrigerated trucking firm.").
374. See, e.g., Press Release, DOJ, U.S. Charges Ex-WorldCom CEO Bernard Ebbers; Former WorldCom CFO Scott Sullivan Pleads Guilty (Mar. 24, 2004), available at http://www.fbi.gov/dojpressrel/pressrel04/ world030204.htm.
375. Krysten Crawford, Ebbers to Forfeit Assets, CNN MONEY, June 30, 2005, http://money.cnn.com/2005/06/30/news/newsmakers/ebbers/index.htm;
376. Sullivan Gets Give Years for WorldCom Fraud, ASSOC. PRESS, Aug. 11, 2005, available at http://www.msnbc.msn.com/id/ 8907976/.
377. See Andrew Backover, Giuliani's Firm Helps WorldCom Creditor, USA TODAY, Nov. 18, 2002, at 38.
378. Id.;
379. Daniel Gross, WorldCom is Bankrupt; So How Did It Get a $2 Billion Loan?, SLATE, July 24, 2002, http://www.slate.com/id/ 2068443/. At this point in the history of the firm, there were out-standing bonds for both WorldCom and MCI, and each had a role in the restructuring, but the details are not relevant to this discussion.
380. See Backover, supra note 315, at 38.
381. Based on numerous in-person conversations with employees of the distressed-debt investors and their advisors during the years 2002-2003.
382. Id.
383. See Andrew Backover, Overseer Confident WorldCom Will Come Back, USA TODAY, Dec. 29, 2002, at 48.
384. RICHARD C. BREEDEN, RESTORING TRUST, REPORT TO THE HON. JED S. RAKOFF, THE UNITED STATES DISTRICT COURT FOR THE SOUTHERN DISTRICT OF NEW YORK, ON CORPORATE GOVERNANCE FOR THE FUTURE OF MCI, INC. (2003), available at http://www.corplawblog.com/archives/ 000181.html [hereinafter BREEDEN REPORT].
385. David Schepp, Judge Slams WorldCom CEO Pay Plan, BBC NEWS, Dec. 11, 2002, http://news.bbc.co.uk/1/hi/business/2567669.stm.
386. Seth Schiesel, Judges Approve WorldCom CEO Pay Plan, N.Y. TIMES, Dec. 17, 2002, at C10. Despite the reduction, Capellas was still scheduled to earn in excess of $20 million over three years to turn around WorldCom.
387. See Larry Neumeistcr, CEO to Earn $22 Million for WorldCom Rescue, ASSOC. PRESS, Dec. 17, 2002, available at http://the.honoluluadvertiser.com/article/2002/Dec/17/bz/bz10a.html/.
388. See Terms and Conditions of Employment, Michael D. Capellas and WorldCom, Inc. (Dec. 2, 2002), available at http://news.findlaw.com/ hdocs/docs/worldcom/120902cpllswcmk.pdf. The contract, in accordance with the Breeden Report, limited the maximum amount of compensation in any year to $15 million without shareholder approval and limited severance payments to $10 million.
389. See BREEDEN REPORT, supra note 321, at 92 (Recommendation 4.03 (capping severance, without shareholder approval, at $10 million));
390. id. at 95 (Recommendation 4.04 (capping total compensation, without share-holder approval, at $15 million per year)).
391. Dawn Kaawamoto, MCI Chief's Severance Deal Nears $40 Million, ZDNET NEWS, Sept. 2, 2005, http://news.zdnet.com/ 2100-1035_22-5846030.html.
392. See BEBCHUK & FREID, supra note 2, at 90-91 ("[T]hese payments indicate the existence of managerial power over directors.");
393. AFL-CIO Executive PayWatch, Top 25 Largest CEO Pensions, http://www.aflcio.org/corporatewatch/paywatch/goldengoodbyes.cfm (last visited Mar. 2, 2007) (lam-pooning large executive compensation packages awarded in the face of poor performance).
394. The four years prior to the triggering event are designated -4 to -1, while the period after filing is designated 0 to 4. The average time a firm spends in Chapter 11 is about 18 months, but the increased monitoring of outside investors starts before the firm files for reorganization and continues after the firm emerges from Chapter 11. In the typical case, creditors begin to exert influence six months to one year prior to the firm filing for Chapter 11, although the intensity of the monitoring role increases as bank-ruptcy approaches. After bankruptcy, firms that emerge as new public firms often have a board appointed by or with several members from the distressed-debt investors.
395. The mean increase was approximately the same.
396. This conclusion is consistent with the prior work of Gilson and Vetsuypens, who found that "firms systematically restructure their management compensation contracts when they experience severe financial difficulty." Gilson & Vetsuypens, supra note 8, at 439. The changes in compensation levels are not dramatic (modest decreases in salaries and, more often, bonuses) but are real, and suggest that firms are facing the issue of executive compensation as part of their dealing with the impact of financial distress.
397. Id. at 434-35.
398. Our data indicate that average salary for healthy firms was about $600,000 per year, and for distressed firms $650,000 per year; average annual bonus was $450,000 per year for healthy firms, and $250,000 for distressed firms. The net result is that cash compensation in distressed firms was about 20% lower than in healthy firms.
399. An alternative explanation for the decrease in cash compensation is that powerful managers tweak salaries and bonuses slightly to reduce outrage, knowing fully well that compensation levels will return to "normal" once the specter of bankruptcy is lifted. This explanation does not hold water, as discussed in supra Part IV.A.2.
400. Contracts often allow for increases but not decreases in salary levels. See, e.g., Hayes Lemmerz Int'l, Inc. Annual Report (Form 10-K), at 34 (May 1, 2002) ("The initial annual salar[y] for [the CEO is] $755,000 ..., to be reviewed annually, and may be increased, but not decreased, by the Compensation Committee of the Company's Board of Directors.").
401. These barriers are lowered somewhat when an employment contract ends, and firms take advantage of these reduced costs to renegotiate in some instances. See Company News, Coca-Cola Chief to Be Paid Less Than Predecessor, N.Y. TIMES, Sept. 18, 2004, at C4 (reporting that Coca-Cola's new CEO's salary and bonus package was reduced to $4,5 million from the $5.5 million his predecessor received). Chapter 11 not only terminates every contract regardless of its term, but also reduces other re-contracting costs.
402. See. e.g., Covanta Energy, Annual Report (Form 10-K), at 139 (Mar. 30, 2004) ("Prior to the Company's emergence from the Chapter 11 cases, it formally rejected all of the prepetition employment contracts covering the executive officers named in the compensation tables.").
403. The median salary in the pre-distress period was $650,000, compared with $665,000 in the post-distress period.
404. The average salary for all firms in 1993 was $554,000, compared with $678,000 in 2002, representing an approximately 2.5% constant growth rate. Calculation based on Compustat's EXECUCOMP database, supra note 15.
405. See also Erin White & Kris Maher, Please, Sir, a Bit More?, WALL ST. J., Oct. 26, 2004, at B1.
406. Patrick McGeehan, Is CEO Pay Up or Down? Both., N.Y. TIMES, Apr. 4, 2004, § 3, at 1.
407. Bonuses were guaranteed in about 10% of the firms in the sample.
408. For example, in the reorganization of Fruit of the Loom, the debtor disclosed the following about its emergence bonus: The Bankruptcy Court also approved a retention plan for key employees, including executive officers. Pursuant to such order, executive officers, other than [the CEO], receive retention and emergence payments equal to 65% to 80% of their base pay. [The CEO] is entitled to receive an emergence bonus equal to $800,000. Fruit of the Loom Inc., Annual Report (Form 10-K), at 117 (Apr. 16, 2001). This was approximately the CEO's annual salary and bonus level prior to distress. See id. at 113 (showing a salary of $700,000 and zero bonus).
409. Beatty & Zajac, supra note 166, at 327 (noting that options granted in periods of distress also may impose excessive risk upon managers because of the diminishing marginal benefit of risk-increasing compensation methods in already risky circumstances).
410. This data comes from EXECUCOMP category "BLK_VALU," which is the Black-Scholes value of options granted. Compustat EXECUCOMP Database, supra note 15.
411. The median increase from distress-free periods (years -6 to -3) to the eve of distress (years -2 to -l) was 188%.
412. The mean and median for the few firms reducing the number of stock options was about one-half prior levels.
413. See Cieri & Riela, supra note 102, at 301 ("Arguably, with an insolvent corporation, its share-holders would prefer that directors and officers take the corporate assets and 'go to Las Vegas': using the assets in extremely risky ventures that have a high probability of failure, but hold even the smallest possibility of astounding success.").
414. Milton Harris & Artur Raviv, The Theory of Capital Structure, 46 J. FLN. 297, 300 (1991).
415. Douglas G. Baird, Revisiting Auctions in Chapter 11, 36 J. L. & ECON. 633, 645 (1993).
416. Bebchuk & Chang, supra note 134, at 255
417. (citing Lawrence A. Weiss, Bankruptcy Resolution: Direct Costs and Violation of Priority Claims, 27 J. FLN. ECON. 285, 286 (1990));
418. see also Allan C. Eberhart et al., Security Pricing and Deviations from the Absolute Priority Rule in Bankruptcy Proceedings, 45 J. FIN. 1457, 1459 (1990) ("[M]anagement has considerable leverage in having a plan confirmed that results in deviations from the [absolute priority rule].");
419. Julian R. Franks & Walter N. Torous, An Empirical Investigation of U.S. Firms in Reorganization, 44 J. FLN. 747, 752-55, 759 (1989) (offering several reasons for deviations from absolute priority, and noting that "[t]he ability to remain in Ch[apter] 11 when the costs are borne by the firm, and therefore in most part by creditors, may encourage [creditors] to give something to the equity holder").
420. See LoPucki & Whitford, supra note 9, at 689 ("So even if it is desirable to retain management, from the creditors' perspective it is cheaper to reward them by providing advantageous employment contracts than by providing a distribution to the entire shareholder class.").
421. See Valerie Patterson, Employment Contracts Attract Top Executives, CAREER J., Sept. 15, 1998, http://www.careerjournal. com/jobhunting/ncgotiate/19980915-patterson.html (noting that "[u]pfront award[s] often [are] designed to motivate executives to leave the perks, expected stock option awards[,] and bonuses from their current firms and make a move . . . ." (quoting Yale Tauber, a senior executive compensation consultant with William M. Mercer, Inc.));
422. see also Joann S. Lublin, Should Financial Turmoil Force You Out of a Company?, CAREER J., Nov. 10, 2004, http://www. careerjournal.com/columnists/manageyourcareer/20041110-managingyourcareer.html ("[The] next employer [will probably] cover at least a portion of the retention bonus you would lose by jumping ship prematurely.").
423. See Allegheny Energy Inc., Proxy Statement (Schedule 14A), at 36 (Apr. 8, 2004).
424. For example, the problem of CEOs timing option grants in self-interested ways that destroy shareholder value was recently considered in Iman Anabtawi, Secret Compensation, 82 N.C. L. REV. 835 (2004).
425. Skeel. supra note 104, at 944 n.88.
426. Anecdotal evidence based on interviews with partners at two executive search and compensation consulting firms. See supra note 229.
427. This data is from EXECUCOMP category "TDC1," which is "total compensation for the individual year, comprised of the following: salary, bonus, other annual, total value of restricted stock granted, total value of stock options granted (using Black-Scholes), long-term incentive payments, and all other total." Compustat EXECUCOMP Database, supra note 15.