Attention Compensation Committees: Discretion-Based Director Compensation Faces Stricter Scrutiny

December 15, 2017

On December 13, the Delaware Supreme Court issued an opinion, In Re Investors Bancorp, Inc. Stockholder Litigation, with significant implications for director compensation under equity incentive plans. In Investors Bancorp, plaintiff stockholders alleged that the directors breached their fiduciary duties by awarding excessive equity awards to themselves under the company’s equity incentive plan. The Delaware Court of Chancery had dismissed the plaintiffs’ claims, holding that the stockholders’ ratification of the equity incentive plan meant that the directors were entitled to the protections of the highly deferential business judgement rule when they subsequently made awards to themselves under the plan. In reversing the Court of Chancery’s decision, the Delaware Supreme Court applied the more onerous “entire fairness” standard to the directors’ actions and remanded the case to the Court of Chancery, where the directors will be required to prove that their awards were fair to the company.

The key fact in Investors Bancorp was that the company’s stockholder-approved equity incentive plan gave directors discretion to grant themselves awards within general parameters, as opposed to a plan providing for awards based on fixed criteria with specific amounts and terms approved by the stockholders. While it’s too soon to know the full ramifications of the Delaware Supreme Court’s decision, it may signal the end of discretion-based director compensation. As a practical matter, directors will abhor the cost and uncertainty inherent in attempting to prove “not only that the transaction was in good faith, but also that its intrinsic fairness will withstand the most searching and objective analysis.”

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