LEGL 4750 - Private v. Public Corps, Delaware, IPOs, and Controlling S/Hs

Exam 1

Executive Compensation

• Executive compensation is a function of the duty of loyalty as well as waste

• If a board engage in waste, then it is breaching its duty of loyalty to shareholders by destroying corporate assets.

• A board should form an independent committee to establish compensation based upon reasonable metrics.

  • Further, independent (sub)committees help corps and boards fulfill otherwise conflicted duties

• If compensation is grossly above the market rate, then it’s considered a “gift” and thus advances no corporate purposes. It’s a breach of loyalty.

TESLA, Compensation, and DE

• Tesla granted its CEO and founder, Elon Musk, a $55.8 billion bonus

• Shareholders contested the payment as a gift with no legitimate business purpose.

• The DE Court of Chancery determined that a majority of Tesla’s board was beholden to Musk and thus conflicted.

• After the initial ruling, a supramajority of Tesla’s shareholders approved the pay package; still, the judge blocked the payment

• The ruling asserted the necessity of protecting minority S/Hs against conflicted transactions

Private vs. Public Corporations

• Corporations are initially formed as private or “closely held” entities

  • At a corporation’s outset, it’s typically that one or a few people hold shares in the corporations.

  • There’s usually a majority or “controlling” shareholder who owns 100% of shares or, at least, over 50%

  • Over time, owners will often sell portions of the corporation (e.g., 10%) for investments. Think the Shark Tank examples.

• A corporation can “go public,” meaning that it will sell shares of the corporation on a public market like the New York Stock Exchange.

  • This will typically dilute the owners’ shares but also raise money and make the owners rich; this is often how a corp’s founder loses control

  • Once public, a corporation must frequently report information to the Securities and Exchange Commission where a private corporation can largely refuse to disclose information.

  • The process of going public is called an ”initial public offering” or IPO in which an underwriter buys new shares and then sells them.

  • A corporation can also go private again

IPO Choices and Effects

• An IPO will typically dilute the equity of shareholders and especially Founders. If a founder owns 100% of a corp’s stock before an IPO, the distribution of new shares will diminish the founder’s equity. This is equally true if numerous shareholders exists before the IPO.

  • The IPO will infuse money into the corporation, though.

• To help preserve a dominant shareholder(s)’s or founder’s equity, corporations have created dual-class shares.

  • A dual-class share creates a different, greater set of voting rights for some stock relative to other stock — e.g., “Type A Stock” might receive 10 votes versus the singular vote of Type B Stock.

• A dual-structure is typically meant to benefit founders so they may maintain control of their corporations