In a decision issued last week in a case against Goldman Sachs, the Delaware Court of Chancery has reaffirmed that non-employee director equity awards which are not specifically approved by shareholders or are awarded pursuant to a shareholder-approved but self-executing equity plan formula are “self-interested decisions” and will not have the protection of the business judgment rule if challenged in court. Instead, these awards will receive the “entire fairness” standard which would require the company to prove the awards and actions are reasonable.
While the Goldman Sachs decision did not change jurisprudence on the issue of non-employee director awards, it did add some new details. Most notably, the court noted that in an entire fairness challenge of non-employee director awards the plaintiff must plead facts showing that compensation is “unfair” beyond stating that non-employee directors are conflicted due to the self-interest in setting their own compensation. Presumably, this means that companies can work to dismiss a case by showing that director compensation is in line with peers. One key aspect of other challenges to non-employee director wards has been that the awards were outsized compared to industry peers. In fact, in the Goldman Sachs case, the board received over $600K compensation when the rest of its peers paid about $350K per director.
As the Center has previously reported, experts recommend that companies create a reasonable cap on the amount of director compensation which can be awarded. More practically speaking, however, in lieu of rushing major design changes which remove the discretionary elements of director pay, the more important step is for companies to review the amount of director pay to ensure it is reasonable, especially compared to peer companies. This reinforces the importance of a reasoned approach to director pay. For example, ISS now recommends against the reelection of directors responsible for director pay in the 95th percentile of companies in the same industry or index.