Independent Directors and Fees

Independent directors have increasingly become the solution to all problems of governance. Delaware gives boards with a majority of independent directors special deference. The stock exchanges require boards of listed companies to have a majority of independent directors.

Nonetheless, problems exist with the definition of independence used both under state law and by the exchanges. The issue is discussed in greater detail here. One area of concern has been the categorical exclusion of directors fees in determining whether a director has a material financial relationship with the company that impairs independence.  See, for example, NYSE Manual 303A.02 (A director is not independent where "The director has received, or has an immediate family member who has received, during any twelve-month period within the last three years, more than $100,000 in direct compensation from the listed company, other than director and committee fees").   

Directors fees have been a high growth area. Until last summer, however, it was often hard to determine the total amount of compensation paid to outside directors. The Commission has, however, amended Item 402 of Regulation S-K to require a table showing total compensation paid to directors. In other words, like executive compensation, there must be a single table that shows all compensation and a single number reflecting the total amount paid.

We will, from time to time, examine some proxy statements and illustrate the level of compensation received by “independent” directors. Let us start with the proxy statement filed in early March by US Bancorp.  According to the proxy statement, US Bancorp has 14 directors. All of them, except Richard K. Davis, Jerry A. Grundhofer and Victoria Buyniski Gluckman, are independent and have “no material relationship with U.S. Bancorp”. The proxy statement also revealed that the board met six times during fiscal 2006.  Here is the amount paid to each "

Director Compensation (footnotes omitted)

Name	Fees Earned or Paid in Cash ($)			Stock Awards ($)	Option Awards ($)	Total )
Victoria Buyniski Gluckman			80,000	90,098	79,874	249,972
Arthur D. Collins, Jr.			90,000	90,098	141,281	321,379
Peter H. Coors			90,000	90,098	140,995	321,093
Joel W. Johnson			85,000	53,743	76,294	215,037
Olivia F. Kirtley			21,250	681	681	22,612
Jerry W. Levin			90,000	90,098	141,254	321,352
David B. O'Maley			90,000	90,098	140,241	320,339
O'dell M. Owens			85,000	90,098	79,874	254,972
Richard G. Reiten			85,000	62,443	51,360	198,803
Craig D. Schnuck			85,000	49,746	69,503	204,249
Warren R. Staley			100,000	53,909	82,855	236,764
Patrick T. Stokes			80,000	90,098	79,768	249,866

The directors, therefore, earned anywhere from $200,000 to over $300,000 (the low amount paid to Ms. Kirtley occurred because she was on the board for only a portion of the fiscal year) yet were still characterized as independent.  The Blog does not question the amount of compensation relative to the work performed (although the entire board did only meet six times during the year).  Instead, the broader question is whether directors making this type of sum can truly act in a neutral fashion, particularly when confronting a transaction involving the CEO (like his or her compensation). 

Comments

[Clark]

While your post states that the Blog does not take a stand on board member compensation specifically, it might desire to do so. The level of board member compensation has much more of a direct impact on CEO compensation than an indirect impact.

Direct Impact: When faced with the decision to increase CEO compensation (and to what degree), board members surely consider the time/effort/impact/etc their compensation yields in comparison to the time/effort/impact/etc that a CEO compensation should yield. If they believe they are well-paid, they will want to make sure the CEO is well-paid. If they meet six times in a year and get $200K in compensation, what should the person who works 2,000+ hours a year in the CEO role make? This calculation must enter their minds and it must have an impact on their decision. However, the impact that it has on the decision is, in theory, limited by their fiduciary duty to the company (with their equity as collateral).

Indirect Impact: If I understand you correctly, you suggest that directors may not be independent because they receive a large amount of compensation and, therefore, may conform so as to make sure they are not booted from the board in future years. While I see the dilemma, I find the amount of stock and stock option compensation somewhat compelling. While a director may be seen as non-independent because the director is counting on certain compensation, wouldn’t that logic lead to the belief that the director is (when stock options are involved) actually independent? If the premise is that these so-called “independent” directors will do all necessary to make sure their compensation is consistent and secure, wouldn’t these directors make decisions that protect the value of their stock and stock options as well?

While not required by SOX, SROs, or State law, if a director was paid in only stock options, could the director then be considered independent to the standards of theracetothebottom.org?

[J. Robert Brown]

Even if the director received compensation in the form of stock options, overpayment of a CEO would likely have only a modest direct impact on share prices. I think a well paid, under worked, "independent" director would have an incentive to maintain the income stream (by keeping the CEO happy) rather than protecting shareholders by driving down compensation. At the end of the day, my only objection is that the courts should not be giving deference to the decisions of directors who have reason to act in a bias fashion.

[Clark]

Since every director may have reason to act in a bias fashion (whether due to a certain relationship, a salary, or merely notoriety), I agree with your point that no deference should be given without some form of discovery (or at least a less specific pleading requirement). I concede that the the question presented above, regarding stock options, would not fully dissolve the independence problem associated with direct compensation, but rather lessen the possibility. Given that “independence” is a threshold and not an absolute, I wonder what makes someone “truly independent." On another note, creating a presumption that the board is not neutral and thus requiring the board to prove otherwise (as suggested in your article linked in the original post) is a much more daunting task than the present requirement on plaintiffs, as the board would be forced to prove a negative assertion.

[J. Robert Brown]

At least under Delaware law, boards that have a majority of independent directors get certain advantages (they have an easier time getting derivative suits dismissed and get the benefit of the duty of care standard for interested party transactions). In order to get these advantages, it seems to me it's not unreasonable to require that the directors truly be independent. I concede it would not always be easy but right now it's my opinion that Delaware defers to decisions of boards where there is substantial doubt about their independence.