Expect Higher Scrutiny Of Director Compensation

Whether you believe directors are underpaid or not, any fierce arguments for higher compensation will likely give the appearance of self-dealing.

Goldman Sachs Group’s recent decision to settle a shareholder lawsuit disputing the fairness of its director compensation plan is a reminder that director pay is coming under much higher scrutiny now that more corporate boards have acknowledged that they work for all stakeholders and not just shareholders.

According to Bloomberg, Goldman agreed that the annual pay of non-employee directors will not exceed $475,000 in cash or restricted stock grants over the next three years, a move that will cut the pay of some outside directors by as much as $130,000. Shareholders argued that directors at similar Wall Street firms were paid $352,000 on average and Goldman paying nearly twice that amount was far too generous. The courts agreed, noting that Goldman had not adequately demonstrated the fairness of the compensation that directors proposed to award themselves.

In court filings, Goldman stated it settled to “eliminate the burden, inconvenience, expense, risk and distraction to defendants of further litigation.” However, had the company not settled, it would have risked having the board’s entire process for determining compensation put on trial. No board wants internal dealings such as that made public.

There will always be disagreements about whether corporate directors are paid enough for the work that they do. However, it’s clear that fighting shareholders over director compensation is not something directors should be paid to do. Whether you believe directors are underpaid or not, any fierce arguments for higher compensation will likely give the appearance of self-dealing. That may lead to more intense questioning as to why directors are so adamant about pushing for higher pay.

Additionally, at a time when gender pay equity is top of mind and wage increases for all workers have slowed, it’s not likely that corporate directors arguing for higher pay will go over well with employees or shareholders. Can the board present a credible argument that increasing director pay is not a self-interested transaction and is in the best interest of all stakeholders? If directors are underpaid, you could argue to raise director pay to the level of companies in your peer group, but if shareholders still object, does the board fight them? It’s hard to see this as a winning strategy for directors.

As a fiduciary, corporate directors are expected to act in the best interest of the shareholders and stakeholders of the company. Shareholders often approve measures proposed by the board without much thought because they trust the judgement of the directors. Proposing unfairly high compensation pushes the limits of that trust. While deciding what’s fair is subjective, Goldman discovered that shareholders are willing to challenge director compensation in court, so expect to see more such lawsuits as these differences of opinion crop up. And with recession fears on the horizon, boards should also expect to see compensation challenged if their company share price takes a significant hit.

More importantly, this shareholder action reminds boards to conduct a regular review of their compensation plan for directors. Standards for director compensation are always changing, so comparing your internal process of determining director compensation with current best practices is never a bad idea. Detailing the process of how awards are earned and seeking preapproval of shareholders well in advance should make the next proposed increase in director compensation an easier ask.

And if directors really feel unfairly compensated, they can always step down and seek out a board that values their attributes at whatever level they believe is appropriate.