Trends and Considerations in Director Compensation

Director compensation has undergone notable shifts in recent years. In addition, public concerns about excessive director compensation have cast a spotlight on director compensation practices.

Director compensation packages can be substantial, especially in light of the fact that director positions are not full-time roles and many directors serve on the boards of multiple companies. Equity compensation awards, such as stock options and restricted stock units, have increasingly become the dominant component of director compensation packages. This can provide lucrative financial rewards for directors of high-growth companies with rapidly appreciating stock prices.

The corporate laws of Delaware and most U.S. states provides significant discretion in the setting of director compensation. Under Section 8.11 of the Model Business Corporation Act, the board of directors is authorized to determine their own compensation subject to any restrictions in the company’s certificate of incorporation.

Setting director compensation is usually primarily the responsibility of the nominating and governance committee of the board of directors. If the nominating and governance committee is tasked with this responsibility, they should carefully consider the composition and amount of the director compensation package. Stock-based compensation should expose directors to both upside rewards and downside risks in order to keep director and shareholder incentives aligned over the long-term.

The nominating and governance committee should also benchmark the company’s director compensation package against the packages of comparable companies. This can help ensure that the company is offering competitive director compensation in order to attract highly qualified directors while also preventing accusations of excessive director compensation.

Certain board roles may justify increased director compensation. It may be appropriate to provide additional pay for particularly demanding board roles, such as service as an audit committee chair or non-executive board chair.

Under Item 402 of Regulation S-K, the Securities and Exchange Commission (SEC) requires publicly listed companies to disclose director compensation during the prior fiscal year in a summary table. The director compensation table must provide information about the aggregate dollar amount of all fees earned for service as a director, awards of stock, awards of options, perquisites and other personal benefits, and consulting fees earned from the company or its subsidiaries. This table is supplemented by narrative disclosure of the board’s procedures for setting director compensation packages.

In the event of litigation, courts will review the board’s plan for setting director compensation using the more stringent “entire fairness” standard, rather than the “business judgment” standard. The business judgment standard tends to be more deferential to the good faith decisions of the directors.

In July 2023, the non-employee directors of Tesla were required to return $735 million in director compensation to the electric vehicle company as part of a legal settlement. The lawsuit had alleged that the directors had unjustly enriched themselves with outsized compensation. The court concluded that the directors breached their fiduciary duties by awarding themselves excessive pay packages.

Delaware courts have paid increased attention to director compensation in recent years. In order to avoid litigation, the company’s board should consider implementing limitations on director compensation. The company may also consider specifying in the equity incentive plans that are put up for a shareholder vote the amount, form, and overall limitations on director compensation. Excessive director compensation may also raise director independence concerns or create the appearance of director self-dealing.

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