The Advisors' Blog

The process for setting director pay has become more fraught in recent years as the result of Delaware case law – leading some companies to adopt annual limits on compensation. In a recent article, Mayer Brown’s Lawrence Cunningham walks through the “inherent conflict” in setting director compensation – and suggests that it’s also important to think carefully about who holds the power to set these arrangements. Here’s an excerpt:

Probing substantive independence may help. Compensation will matter more to some directors than to others, bearing on their independence. All other things being equal, directors will feel less dependent on their board position when they are wealthier, higher paid, own more shares in the company or have many other comparable opportunities.

Reposing decisions over board compensation in those members may improve the integrity of the decision-making process. Indeed, if some directors were willing to accept no pay, they might be the ideal decision makers on what to pay the others.

It is tempting to consider enlisting compensation consultants for recommendations. Such consultants can add value to the process by providing relevant and reliable market research on prevailing practices and fair levels. Again, however, the consultants’ own fees and potential for repeat assignments may incentivize bidding high.

Nor would it help to have the directors delegate their compensation determination to management. That poses a broader conflict of interest since boards’ duties include appointing and overseeing managers.

Directors might consider submitting their compensation plans to a shareholder vote. After all, shareholder approval is the standard step to insulate an interested transaction from scrutiny in favor of business judgment rule deference. A common solution is for boards to propose compensation plans for shareholder approval that establish upper limits on the annual amount per director.

Under recent cases in Delaware, however, the value of shareholder ratification has become more limited. Courts credit such approval only when the approved compensation plan is fixed, not one where directors retain any discretion over it.

At many companies, the compensation committee sets or recommends director pay, so taking a closer look at whether those directors are disinterested and delegating this decision making to a subcommittee would be an extra step – but it may be worth the effort if director pay is higher than at peer companies or the company has another reason to think the decision would be challenged.

Lawrence observes that board pay has increased significantly over the past 20 years – which aligns with the increase to directors’ workloads, the competitive market for qualified board members, and litigation & reputational risks. He also notes that it’s important to benchmark the amount and structure of director compensation arrangements, in addition to having “bulletproof” procedures.

See our “Director Compensation Practices” Practice Area for benchmarking surveys and more…

– Liz Dunshee