Here’s something that Steven Seelig and Russ Hall of Towers Watson recently blogged:
A recent Delaware Chancery Court case (Seinfeld v. Slager) may provide the impetus for companies to refine the process by which independent directors set their own compensation. At issue in the case was whether the directors were protected under the “business judgment rule” from a potential self-dealing transaction in approving their own pay in accordance with a shareholder-approved stock plan that set upper limits on their compensation. The court recently refused to dismiss the plaintiff’s claim, finding that the shareholder-approved plan set compensation limits at such a high level that they were tantamount to the board being free to use its own discretion. Because no evidence was presented that the directors considered the grants entirely fair under the circumstances, the court permitted the case to move forward to determine whether the pay decision was in violation of the board’s fiduciary duties and constituted corporate waste.
The problem for the court was that, although the stock plan was approved by shareholders in accordance with Section 162(m), the plan put few, if any, limits on the board’s ability to set its own stock awards. The plan provided that the committee has the sole discretion to set compensation for the directors. Like many equity compensation plans, this plan provided upper limits on the number of shares granted to an eligible individual, but made no distinction between employees, officers or directors in applying these limits. Under the plan’s individual limits, theoretically each director could have been awarded restricted stock or stock units worth approximately $21.7 million each year. Even though the actual stock grant for the year was around $750,000 for each director, the court refused to dismiss the plaintiff’s claim, ruling that the stock plan lacked sufficient definition to afford protection under the business judgment rule due to the absence of a “meaningful limit” imposed by the shareholders.
Issues to Ponder
The court’s ruling did not provide any details on how the compensation committee arrived at its decision regarding its grant levels. This raises questions about whether the committee was advised by a compensation consultant who presented relevant market data to support the decision-making process or whether the committee documented any rationale for its decision in the minutes. Although there was no mention of such issues in the ruling, it’s possible they were not proffered simply because the defendant directors believed the case would be dismissed out of hand, as are many Delaware compensation-related claims. We will be interested to see whether the court’s ultimate ruling provides more information on these issues because prior Delaware cases have tended to set the bar fairly low for protection under the business judgment rule, typically holding that compensation committees need merely to have a rational basis for their pay decisions. We would hope that having a qualified expert advise the compensation committee on appropriate director pay levels would help meet this standard.
But would such actions have been enough in this case, given a rather open-ended, shareholder-approved plan? That’s not clear. The court was unwilling at this stage to describe any bright-line standard, noting that the sufficiency of plan provisions to provide potential protection under the business judgment rule “exists on a continuum.”
Among the questions this case raises are the following:
– Should companies consider drafting equity plans that set a separate “meaningful” maximum for director compensation levels when having their stock plan approved by shareholders?
– Should companies be more restrictive and provide for director compensation to be based on specific guidelines or criteria?
– Would the addition of a plan provision stating that the form and amount of director compensation should be set with respect to relevant market norms and/or appropriate for the time and energy required of directors be helpful in defending similar suits?
– Are any of these plan restrictions necessary if the board obtains and follows the advice of compensation advisers?
Assuming the Seinfeld case is not settled before the court renders its decision on the merits, the ruling could provide additional guidance on such issues. We’ll keep you posted on the litigation’s progress.
In this podcast, Christina Young and Sandra Pace of Steven Hall & Partners discuss how setting executive pay in the non-profit world differs from doing so for public companies, including:
– How do non-profit boards set pay compared to public company boards?
– What are some of the challenges non-profit boards face in developing peer groups in order to gather comparable compensation data?
– What practice pointers do you have for non-profit directors making compensation decisions?
Here is an interesting article from Arthur Kohn, Kathleen Emberger and Leah LaPorte Malone of Cleary Gottlieb about non-economic terms in executive employment agreements. In the article, theydescribe how careful attention to non-economic terms can often make a critical difference in the way that an executive departure unfolds.
Here is an excerpt from this blog by recently deceased Prof. Larry Ribstein about this paper from Prof. Harwell Wells and Randy Thomas about how the courts may be the only way to rein in executive compensation:
The paper suggests a new approach to controlling executive compensation: the courts. The paper is partly historical, noting that courts have, in fact, been “surprisingly willing to second-guess decisions on executive compensation,” although after doing so they ultimately withdraw from the field to avoid becoming “entangled in setting pay.” The article says Delaware’s recent Gantler v. Stephens, which recognizes fiduciary duties of corporate officers, “opens the door for courts to monitor executive compensation by scrutinizing rigorously officers’ actions in negotiating their own compensation agreements.” Thomas & Wells also draw on Delaware holdings “that corporate officers are bound by their duty of loyalty to negotiate employment contracts in an arm’s-length, adversarial manner.”
Thomas & Wells suggest their “approach should be welcomed by the courts, which will not be required to determine whether compensation packages are fair or merited, but will instead be asked to engage in a familiar task, examining whether proper procedures were followed in setting compensation.” The abstract concludes:
This approach promises to break an impasse between the two major academic approaches to executive compensation. Advocates of “Board Capture” theory have long argued that senior executives so dominate their boards that they can effectively set their own pay. “Optimal contracting” theorists doubt this, contending that, given legal and economic constraints, executive compensation agreements are likely to be pretty good and benefit shareholders. The approach advocated here should, surprisingly, please both camps. To Board Capture theorists, it offers to cast light on pay negotiations they believe are largely a sham; to Optimal Contracting theorists, it offers a way to improve the already adequate negotiating environment.
Check out this interesting paper from Profs. Fortin, Zhang, Subramaniam and Wang entitled “Incentive Alignment Through Shareholder Proposals on Management Compensation and its Bond Market Reaction: A Creditor’s Perspective.” Here is an excerpt:
“We contribute to the literature as well as the ongoing regulatory debates in several ways. First, we present ground-breaking evidence of bondholder reaction to shareholder proposals. Unfortunately, the realignment of manager and shareholder interests is not without consequences to a firm’s other stakeholders, as it is associated with a decrease in bond returns. Because there is a trade-off between shareholder-manager interest alignment and shareholder-bondholder conflict (DeFusco et al. 1990; Klein and Zur 2010; Ortiz-Molina 2007), our results suggest that boards of directors and regulators should adopt a balanced approach in dealing with activist shareholder campaigns, particularly those concerning top management incentive compensation.
The SEC was established in the 1930s with a mandate to protect investors in securities (both stock and bonds). To fulfill its duty towards public bondholders, the second SEC chairman William Douglas lobbied to pass the Trust Indenture Act of 1939 and established the bond trustee system in America. Recently, in response to the Dodd-Frank Act of 2010, the SEC released the new “Say-on-Pay” regulation in January 2011. From a bondholder’s perspective, the new SEC regulation might bring in unintended consequences, potentially compromising its duty towards bondholders.”
As happens every year for our week of executive pay conferences, our Conference hotel – the Hyatt Regency New Orleans – is nearly sold out. Act now to make a reservation and use this information to obtain a discount. If the hotel indicates it’s sold out, please contact our office at 925.685.5111 for assistance as sometimes the hotel operator makes a mistake (for example, the hotel is closest to being sold out for Sunday, October 7th and operator may tell you the hotel is full when it’s just full for that Sunday – we can help fix this stuff).
Register Now:Register for the combined pair of “7th Annual Proxy Disclosure Conference” & “Say-on-Pay Workshop: 9th Annual Executive Compensation Conference” that will be held October 8-9th in New Orleans and via Live Nationwide Video Webcast.
Here is an interesting article from Inside Investor Relations that describes how some companies that failed say-on-pay last year made special shareholder engagement efforts to improve their fortunes this proxy season. Sung to Shalamar’s classic…
Yesterday, Bloomberg ran this article entitled “Best Buy Pay Expert Said to Quit Over Retention Bonuses” about how compensation consultant Don Delves quit his engagement at Best Buy after the company awarded more than 100 managers retention bonuses without tying them to performance. Don has been a regular speaker at our annual responsible pay practices conference. I have not spoken to Don about this situation, but I can imagine quitting a client of Best Buy’s magnitude is not an easy thing to do. One has to make a living.
But it appears Don felt this was the right thing to do. For years, I have been noting how some compensation consultants are standing up to boards – that they are not always the excessive pay facilitator that they sometimes are painted out to be. In fact, I have heard of CEOs who want less pay – but yet their boards give them more because that is what the faulty peer surveys indicate they should do. This is precisely how bad processes have gotten in the way of common sense.
At some point, boards really need to be held accountable. Too many directors think that more conversation in the boardroom means they have done a better job. But there continues to be just incremental change and not the widespread change in pay dynamics that is necessary to overcome decades of bad practices.
If more advisors show more backbone, it might wake up some of the remaining pay apologists out there who spend more time fighting change than being concerned about whether they are engaging in sound governance practices. [I’m still waiting to hear about a lawyer who quits an engagement rather than go along with a bad pay arrangement – all I ever hear about are comp consultants doing this.] And hopefully those advisors who show backbone will be rewarded by being retained by those boards that are truly interested in doing the right thing. Kudos to Don! Now we wait and see if Best Buy’s board gets the message…