Corporate Governance in the Age of Superstar CEOs

In recent years, certain CEOs have gained remarkable prominence and influence not only within the business world, but also in mainstream media. These 'superstar' CEOs are portrayed as exceptional, charismatic, and innovative leaders capable of extraordinary financial results. In other words, their leadership is 'essential' to the company’s value, and they wield significant influence and power over investors and their board of directors. Yet, balancing the influence of superstar CEOs and successful corporate governance mechanisms is a difficult challenge for directors, who must ensure that a CEO’s actions align with corporate policy and corporate law.

In a new article, I analyze the danger superstar CEOs pose to the integrity of corporate governance and the pressing need to devise methods to limit their power.

Among the best known superstar CEOs is Elon Musk. While Tesla’s directors have acknowledged that Musk is indispensable to the company’s value, they have themselves been sued for allegedly breaching their fiduciary duties for failing to oversee and control Musk. After several of those suits were filed in 2018, the Tesla board decided not to renew its directors and officers (D&O) insurance due to 'disproportionately high premiums.' Instead, Tesla entered an agreement with Musk whereby he would personally provide insurance for Tesla’s board members.

D&O insurance acts as professional liability insurance, protecting the assets of an individual director or officer from claims the company cannot or will not indemnify. Significantly, most states prohibit a corporation from indemnifying directors and officers for any settlement portion of a derivative claim if they are found personally liable to the corporation for a breach of fiduciary duties, like failure to oversee their CEOs.

Thus, D&O insurance not only shields directors from personal financial risk, but it also supports the proper function of corporate governance. In determining premiums, underwriters investigate the culture of the corporation and character of the named insured; in other words, they examine the strength of the corporation’s corporate governance. Thus, higher D&O premiums often indicate corporate governance risk within the company, such as inadequate oversight of a CEO.

While the Tesla-Musk insurance agreement lasted only three months, it created an opportunity to consider the potential consequences of such an agreement on corporate governance. Interestingly, under the agreement, the very person Tesla directors were charged with overseeing—Musk as CEO—was the same person who determined whether they would be indemnified if they were sued for failure of oversight. The arrangement essentially eliminated the board’s ability to properly oversee Musk’s actions and their ability to carry out their oversight duties. Further, by relying on Musk to personally insure the directors, the board’s ability to receive indemnification became linked with Musk’s personal financial stability. This could have led to the board prioritizing Musk’s interests over those of the company. This dependency could have also compromised the board’s oversight of Musk, as directors would hesitate to take action that could jeopardize Musk’s wealth, upon which their own indemnification relied. Overall, agreements like that between Tesla and Musk present serious risks to the company’s corporate governance and the board’s ability to act in the best interests of the corporation.

As custodians of corporate governance, directors must limit a superstar CEO’s influence and power over the board, and allowing the CEO or any other corporate fiduciaries to personally insure directors and officers increases their influence. It creates conflicts of interest, undermines the benefits of D&O insurance, and hinders directors’ ability to effectively fulfill their fiduciary duties and risk allocation.

State statutes play a crucial role in corporate governance and managing allocation of risk. To protect the role of fiduciaries, states should expand their corporate laws to prohibit directors or officers from personally insuring a company’s other fiduciaries and instead require independent and disinterested insurers. By clarifying and limiting how companies can insure their corporate fiduciaries and what they are prohibited from doing, states would establish clear standards and guidelines to safeguard directors’ fiduciary duties. That would eliminate the conflict of interests between the insurer and the insured, strengthening oversight duties. It would also limit superstar CEOs’ influence and power over their boards of directors.

Angela Aneiros is an Assistant Professor of Law at Gonzaga University School of Law.

The author's post is based on her recent article, 'Limiting the Power of Superstar CEOs,' available here.

This post was first published on the CLS Blue Sky Blog.