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Weekly Updates1996 was a year of change and strange events. The O.J. Simpson trial began, Nintendo 64 was released, Dolly the Sheep was cloned in Britain, the FBI arrested the Unabomber, and Prince Charles and Princess Diana agreed to divorce.
And in Burbank, California, the Disney Corporation, an American icon and stalwart of family-friendly entertainment, was having a crisis of leadership. It was a crisis that would pit Disney's board against the corporation's shareholders in an epic legal battle that would span more than ten years, involve at least ten teams of lawyers, re-define the long-established standards of corporate governance, and set the stage for the evolution in governance that continues today.
The Relevance of Publicly Traded Scandal to Not-For-Profit Cooperatives
The rules of corporate governance do not have a size limitation. They do not just apply to "the big guys," those that are publicly traded, or those in the spotlight. The fundamental rules of governance are universal, applied equally to any organization with a board of directors at the helm. And though it may be relatively easy for the electric cooperative community to reject, or even scoff at, any suggestion that scandal and lawsuit at "The House of Mouse" could possibly be applicable to a rural electric cooperative, it would be unwise to do so.
Disney not only applies, but provides important lessons in the continuing evolution of corporate governance that we ignore at our peril.
How It All Started
The opening of the story begins in 1994 much like a Disney storybook might, if it were set in corporate America. As the first scene opens, Disney President and Chief Operating Officer Frank Wells dies in a tragic helicopter crash. Michael Eisner, Disney's Chief Executive Officer, had lost his friend and partner with whom he had engineered the revitalization of Disney through the 1980s. Mr. Eisner takes over as Disney's CEO, only to undergo a quadruple bypass three months later. (1)
As a result, Mr. Eisner himself began a search for his successor. His prime candidate for the position was Michael Ovitz, with whom Eisner had shared a professional relationship and personal friendship that had spanned nearly 25 years. (2) Ovitz was one of the founders of Creative Artists Agency (CAA), a premier talent agency representing more than 1,400 of Hollywood's top actors, directors, writers and musicians. CAA generated $150 million in annual revenues, and Mr. Ovitz, who was perceived by many to be one of the most powerful figures in Hollywood, had an annual income in excess of $20 million. (3) He was successful--even by Hollywood standards.
After deciding that Mr. Ovitz should be courted to replace him, Mr. Eisner shared his desire with each Disney director individually, but did not discuss his desires formally with the full board, or ask the board to undertake a search for his successor. Instead, Mr. Eisner and the chairman of Disney's compensation committee, Irwin Russell, approached Ovitz about joining Disney. (4)
Having learned from Ovitz's attorney that Ovitz owned 55% of CAA and earned between $20 and $25 million per year, Mr. Russell personally took the lead in negotiating with Ovitz. (5) From the beginning, Ovitz made it very clear that he was not willing to accept any position with Disney without "downside protection." (6) In other words, Ovitz wanted to remain whole, and was unwilling to accept even potential losses.
It was with this background that Irwin Russell and Eisner set out to craft a mutually acceptable employment agreement for Ovitz.
What Disney proposed was a five-year employment contract with two "tranches" (7)--or pieces--that would make Ovitz whole in the event that his contract was terminated.
The first tranche consisted of three million Disney stock options, vesting in equal parts in the third, fourth and fifth years of the contract, with an anticipated value of $50 million. If the value of the options at the end of the five years had not appreciated to $50 million, Disney would make up the difference. The second tranche consisted of two million options that would vest immediately if Disney and Ovitz opted to renew the contract. (8)
The fundamental five-year agreement specified that neither Disney nor Ovitz could terminate the agreement prematurely without just cause. In other words, Disney could not fire Ovitz just because they didn't like him or he turned out to be a poor fit, and Ovitz couldn't just walk away if it turned out he didn't like the company. If one party did, there were significant penalties for the breaching party. For example, if Disney elected to fire Ovitz for any reason other than gross negligence or malfeasance, Ovitz would be entitled to a "Non-Fault Termination" which consisted of (1) his remaining salary for the five year period, (2) $7.5 million a year for unaccrued bonuses, (3) the immediate vesting of the first tranche of options to the tune of $50 million, and (4) a $10 million cash out payment for the second tranche of options. (9)
Such terms may seem excessive, if not extraordinarily lavish, in the world of electric cooperatives. But this was Hollywood.
As the basic terms of this employment contract were being solidified, it appears that Mr. Russell may have been having second thoughts. Russell penned a "case study" for both Eisner and Ovitz expressing his concern that the proposed terms of the Ovitz employment agreement constituted "an extraordinary level of executive compensation", although Russell did himself acknowledge that Ovitz was "an exceptional corporate executive" who was a "highly successful and unique entrepreneur." (10) Nevertheless, Russell cautioned that the proposed Ovitz compensation package would be "significantly above that of the Disney CEO", and that the stock options granted would exceed the standards applied to salaries at Disney and would "raise very strong criticism." (11) In fact, Russell went so far as to recommend another, additional study on the issue before proposing contract terms to Ovitz.
As a result, Russell recruited an executive compensation consultant, another member of the Disney compensation committee, and the past Disney board chairman who had helped to craft Eisner's compensation package to assist in evaluating the potential terms of the Ovitz employment agreement. (12)
The compensation consultant immediately set to work, and the three men met shortly thereafter to discuss different scenarios, and ultimately what impact the proposed compensation package might have on Disney. Ultimately, the executive compensation consultant concluded that the proposed Ovitz employment agreement would approximate Ovitz's current compensation at CAA. (13)
Meanwhile, like any good Disney film, all was not going as planned and the drama began to unfold. While the Chair of Disney's compensation committee, the consultant and the past board chair were taking time to evaluate the proposed offer to Ovitz, Michael Eisner had forged ahead to reach a separate agreement with Ovitz. Under this "Letter Agreement", Ovitz would get two stock option grants one for five million for the first five years, and a second grant of two million more if the contract was renewed, and Ovitz would join Disney only as President, not as a co-CEO with Eisner. (14) However, the "Letter Agreement" would have to be approved by Disney's compensation committee, as well as the board of directors. (15)
Ovitz accepted the terms of the "Letter Agreement", and agreed to join Disney. (16) Unlike the storied Disney films of old, however, our hero did not ride off into the sunset, having saved the town from the bandits. Indeed, all was not well.
The day before Ovitz signed the "Letter Agreement", two Disney executives met with Eisner and Ovitz, voicing concerns that Ovitz would "disrupt the cohesion" that existed on the management team. Both executives were emphatic that they would not, under any circumstances, report to Ovitz, but would continue to report to Eisner. (17)
Apparently, Eisner was able to convince Ovitz that it would all work out, because the following day, Ovitz signed the "Letter Agreement", and Disney's corporate counsel began the work of embodying the terms of the "Letter Agreement" into a full-blown employment agreement. (18)
Almost immediately, Disney's counsel spotted trouble. The guarantee for $50 million in stock options, with Disney making up the difference if the stock value did not reach $50 million, created big tax problems for Disney. (19) The employment agreement would have to be re-crafted. The new agreement would provide for a $10 million severance payment, a reduction in the value of the stock options (i.e. the "strike price"), a grant of three million more stock options at the reduced strike price, and a $1.25 million annual salary. (20)
Six weeks after the "Letter Agreement" had been signed, the Disney compensation committee met for one hour to discuss a number of items, only one of which was the proposed employment agreement for Ovitz. The trial record indicated that the compensation committee discussed compensation comparables, including the compensation of the two previous Disney presidents, and looked at a spreadsheet developed by the compensation consultant. (21) He did not attend the meeting, though he was available by telephone, but no one from the compensation committee called. (22) Immediately after the compensation committee meeting, the full Disney board met, and voted unanimously to elect Ovitz as President of Disney. (23)
Going Downhill Fast
After only twelve months on the job, things had gone sour for Mr. Ovitz. Although he had made some significant positive contributions to Disney, such as the successful recommendation to construct the gate to Disney's California Adventure Park across from the main gate to Disneyland thus increasing patronage, overhauling ABC's Saturday morning lineup and bringing Tim Allen back to Home Improvement following a disagreement, all was not good. (24) At trial, Ovitz contended that Eisner was a controlling micromanager who prevented him from making the changes that needed to be made. Eisner contended that Ovitz was insubordinate and did not follow his directions. (25) After only a year, Eisner sent a Disney executive to inform Ovitz that he ought to start looking for another job. (26) Eisner then sent the executive back to Ovitz to make it clear that Eisner no longer wanted Ovitz at Disney. (27)
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