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Stockholder Challenges to Executive Compensation

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Joseph M. McLaughlin and Shannon K. McGovern

Investors, proxy advisory services and corporate governance watchdogs closely monitor executive compensation, and express their views on executive pay in diverse fora, ranging from advisory Say on Pay votes required under the Dodd-Frank Act to a CEO Salary Watchdog Facebook page. In the absence of stockholder approval, if a stockholder adequately alleges that directors breached their fiduciary duties by awarding themselves equity pursuant to an incentive plan, the directors must prove that the awards are entirely fair to the corporation. In litigation challenging compensation awarded by the board under an equity incentive plan that has been approved by a majority of informed and disinterested stockholders, however, the affirmative defense of stockholder ratification becomes relevant. Otherwise self-interested director compensation awards made within the confines of a fixed plan approved by fully informed stockholders may be subject to the deferential business judgment rule, not the entire fairness standard. The Delaware Supreme Court recently clarified the limits of the stockholder ratification defense in litigation challenging director compensation awarded under the parameters of a stockholder-approved compensation plan. In In re Inv’rs Bancorp Stockholder Litig., 177 A.3d 1208 (Del. 2017), the court recognized a business-judgment safe harbor for directors where the equity awards approved by stockholders are sufficiently specific as to amounts and terms. But when stockholders have approved an equity incentive plan that gives directors discretion to grant themselves awards within general parameters, and a stockholder adequately alleges that the directors inequitably exercised that discretion, a ratification defense is unavailable and the directors must prove the fairness of the awards to the corporation.

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