It may be nice to be your own boss, but setting your own compensation – and, at least arguably, giving yourself excessive pay – may get you in trouble. A number of boards of directors have found that out, as courts have given them judicial whacks upside the head for paying themselves too much. Not surprisingly, shareholders have gotten on the bandwagon as well.
Executive compensation – at least for public companies – has to be scrutinized and blessed by independent directors and, since the advent of Say on Pay, approved by shareholders (albeit on a non-binding basis). In contrast, directors have long set their own pay, with little or no scrutiny and no requirement for independent review, much less approval. (Director plans generally must get shareholder approval if they provide for equity grants, but neither the overall director compensation program nor specific awards have to be approved.)
Another intriguing thing about director compensation is that, at least until recently, investors seemingly couldn’t have cared less. For example, some years ago, a shareholder proposal seeking to have a “say on director pay” vote managed to get on a few companies’ ballots, but failed miserably. That seems to have changed.
Why the change? It’s been prompted by a few court decisions. First, in a 2012 decision, the Delaware Chancery Court decided a case in which the plan in question – even though approved by shareholders – had no meaningful limits on director compensation. Notably, the plan did provide for maximum awards, but they were so high as to be nonexistent. The Court also noted that the compensation received by the directors was far in excess of what peer company directors got. Because the board’s decisions on its own compensation were “self-interested”, the matter had to be considered under the “entire fairness” rule – in other words, the board did not get the benefit of the business judgment rule. The case ultimately settled.
Subsequent lawsuits have generated similar results, including in cases decided in 2015 and December 2017. While the facts of the various cases differ in some respects, the general result has been that, notwithstanding shareholder approval of equity plans with limits on equity grants, director compensation will be at risk if (1) those limits are not meaningful; (2) the directors exercise significant discretion in what they pay themselves; and (3) their decisions yield compensation that is excessive as compared to their peers.
And, as noted, investors have gotten on the bandwagon (aside from initiating litigation). Specifically, for 2018, Institutional Shareholder Services has adopted a policy to recommend negative votes against the members of the committee responsible for setting director compensation following two years of “excessive” pay without a “compelling rationale”. Whether or not pay is “excessive” will be based upon peer company pay.
What can directors do? Here are some suggestions:
- Be aware of what your peer companies pay their board members and act accordingly.
- Provide for grants based on dollar values rather than numbers of shares or units. (A fixed number of units can prove problematic if the stock price goes through the roof.)
- Consider more meaningful limits on grants under your plan.
- Determine whether any plan changes require shareholder approval.
- Provide better disclosure about director compensation, including how and on what basis it is determined, and how it compares to your peers.
And don’t be greedy. Remember the old saw: pigs get fat, but hogs get slaughtered!