THE INHERENT CONFLICT IN SETTING DIRECTOR PAY: Boards must keep director compensation within a fair range and ensure strong procedures are used to set the number.

• Author: Cunningham, Lawrence A.

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 they 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...