“I need to make money.”
That is the reason given for joining the board of directors of Signature Bank by former Congressman Barney Frank. That reason, perhaps all too commonplace today, would have been out of place just a few decades ago.
Historically, public company directors served without pay. Even after 1969, when Delaware law first authorized directors to set their own compensation, pay remained nominal. Directors generally kept a low profile, with a mandate often limited to advising or cheering on the chief executive.
\All that has changed. Today, serving as a public company director is not only lucrative, but for some, such as Rep. Frank, a reason to take the job. The role is prestigious, as it has long been, but now more demanding than ever. Directors are expected to adhere to stringent independence standards, preside over both strategic direction and oversight of every possible risk, and be on call to respond to crises.
They also set their own pay, which is a challenge. Corporate directors are fiduciaries obliged to act selflessly yet face an inherent conflict of interest when deciding their own compensation for service. This reality has come into focus only recently, with roots in a 2017 Delaware Supreme Court opinion saying the courts will henceforth scrutinize director pay.
Most board decisions are insulated from shareholder challenge and judicial second-guessing under the business judgment rule. But board decisions involving conflicts of interest entice judges to apply the entire fairness test, evaluating the decision-making process as well as the decisions' fairness to the corporation.
In these cases, courts put the burden on the board to show they overcame the conflicts and treated the corporation fairly. Failing to do so exposes directors to personal liability in money damages that may not be covered by insurance, indemnification or charter exculpation.
If directors meet the burden, their decisions then receive standard business judgment rule deference. Therefore, when making director compensation decisions, boards should take steps courts will recognize as helping to meet their burden to show that the entire fairness standard has been met.
Keep Pay Fair
First up is keeping director compensation well within a fair range. Each board must calibrate compensation in relation to both benchmarks of peers and the specifics of their company. Peer pay is relevant not only as a proxy for fairness, but also as the price of competing for talented directors. While compensation may not be a factor for all directors interested in board service, it can be for some. Companies may need to offer attractive pay to recruit and retain talented directors capable of bearing the workload and contributing good business judgment.
Director compensation has been increasing. In 2022, average total director compensation for S&P 500 directors was $316,000, according to Spencer Stuart, up from $245,000 a decade earlier. Companies customarily pay each director a cash retainer, now averaging $136,000; most award stock grants and a few issue stock options. Additional compensation is typically paid for committee members and chairs, board chairs and vice chairs.
The distribution of total annual director compensation among the S&P 500 is bell-shaped. At the high end, a dozen companies pay more than $400,000 — a couple of outliers at the very top ($1.1 million and $2.1 million) and two others above $500,000. At the low end, three pay less than $200,000 — with one harkening back to the old days to pay a mere four digits ($3,160).
The form and amount of director compensation tends to vary with certain factors, including industry (regulated industries tend to pay least), company size (larger companies pay above average) and board size (logically reflecting relative work burdens). Corporate culture plays a role: the lowest-paid directors are those at Warren Buffett's Berkshire Hathaway, while the highest-paid are those at Elon Musk's Tesla.
Use Bulletproof Procedures
Next, directors would benefit from using scrupulously fair procedures in setting their compensation. The usual way of doing so for other interested transactions is to lodge the decision in the hands of a committee of disinterested fully informed decision makers.
It's easy to imagine forming two director compensation committees, each to set the other's compensation at arm's length and independently. But apparent and inherent conflicts are hard to escape, and courts may not see the value in an arrangement that may be a mere formality.
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.
Increasing Board Responsibilities
A third critical point should be stressed: Board burdens have risen in recent years. Expanded director leadership roles translated into greater workloads and increased exposure to liability and reputational risks. Public company directors averaged a workload of fewer than 200 hours in 2005, nearly 250 in 2016 and around 300 today, according to diverse reports and surveys. Burdens are higher at some companies, particularly larger, more complex ones and those engaged in substantial acquisition activity.
Liability risks are manageable but real. Directors benefit from the business judgment rule for most decisions, along with exculpation from mere haplessness. They usually receive indemnification or insurance for other violations so long as they acted in good faith and what they reasonably believed to be in the best interests of the corporation.
Yet even when behaving faithfully and when fully exonerated, directors can be dragged into lawsuits and enforcement actions that entail considerable costs, not only in money but in time, attention and aggravation. Reputations are also on the line, as Rep. Frank, known for his banking regulation expertise, may feel in the wake of the failure of Signature Bank.
Finally, despite the increased obligations, the market for public company directors is highly competitive. While pay should be commensurate with the burden, market forces help keep director pay within a range of reasonableness.
We've come a long way since the days when directors were unpaid cheerleaders. The rising demands for independent directors charged with expansive duties and facing associated risks doesn't come cheap. But directors should take care to ensure that they earn their keep.