Stockholder-Approved Equity-Incentive Plans: Clarifying the Proper Standard of Review

  1. Director Compensation and The Shift Towards Equity Plans

            For much of the mid-20th century, executive compensation of salaries and bonuses were largely paid out in cash.[1]  Equity-based compensation, namely stock options, became more prevalent beginning in the 1980s, and is now used as a tool to align executive and stockholder interests.[2]  However in 1990, a study found that CEO wealth changed only $3.25 for every $1,000 change in stockholder wealth.[3]  Equity-based pay increased greatly in the 1990s, growing from 37% of total director compensation in 1993 to 55% in 2003.[4]  Today, this type of compensation remains significant, with one report putting the average mix for total director pay at 42% cash and 58% equity.[5]  Some scholars have even suggested that director compensation should exclusively be in the form of restricted equity to more closely align with a company’s long-term profitability goals.[6]  Thus, it is important to understand what types of protections are afforded to boards of directors when determining compensation amounts and equity structures under judicial review.

  1. What is The Proper Standard of Review for Decisions on Director Compensation?

            A notable consideration that has emerged in litigation surrounding breaches of fiduciary duty, within the context of director compensation, is whether to apply the business judgment rule or the entire fairness doctrine. By approving their own compensation in equity incentive plans (“EIP”), directors engage in conflicted, self-dealing transactions that require the entire fairness approach. However, boards can assert a stockholder ratification defense, wherein “a fully informed, uncoerced, and disinterested majority of stockholders approve the board’s authorized corporation action.”[7]  This would likely protect them under the business judgment rule.[8]  This deferential standard presumes that the directors of a corporation acted on an informed basis, in good faith, and in honest belief that the business decision was made in the best interests of the company.[9]  Absent a successful showing of corporate waste,[10] a company will generally prevail under the business judgment protection. However, when there is no stockholder ratification, the board decision is subject to entire fairness review,[11] where the directors must show “to the court’s satisfaction that the transaction was the product of both fair dealing and fair price.”[12] Entire fairness review is a fact-intensive inquiry and plaintiffs are more likely to withstand a motion to dismiss.[13]

  1. In re Investors Bancorp and the Limits of Business Judgment Rule Protection

            In examining stockholder-approved director compensation plans, Delaware courts typically applied the business judgment rule when the plans were specific.[14]  A number of recent opinions from the Delaware Court of Chancery applied the entire fairness standard when there was no “meaningful limit” to the discretionary plan.[15]  Until December 2017, the Delaware Supreme Court had not examined stockholder ratifications of director self-compensation plans since 1960.[16]  Of course, equity compensation plans vary across corporations. Some schemes provide for specific awards, some exist as non-discretionary self-executing plans based on a formula, and still others grant directors wide discretion with an upper limit.[17]  The Delaware Supreme Court noted that the first two types of plans might be examined under the deferential business judgment rule.[18]  The third type of compensation structure was the focal issue in In re Investors Bancorp. Investors Bancorp’s board of directors, on recommendation from its Compensation and Benefits Committee, set its 2015 EIP to “provide additional incentives for [the Company’s]officers, employees and directors to promote [the Company’s]growth and performance.”[19]  Among other things, the EIP reserved shares of restricted stock and options and provided for a maximum numbers of shares that can be granted to non-employee directors at 30% of the plan’s available shares. [20]  The company’s stockholders later approved this plan.[21]  Plaintiffs alleged that the awards resulted in each non-employee director’s award averaging $2,159,400, which was well above the peer average of $175,817.[22] The court focused on the stockholder’s approval of the general parameters of the EIP, which gave directors “broad legal authority” to determine the awards, and consequently compelled the directors to provide compensation under “equitable principles of fiduciary duty.”[23]  The court noted that the stockholders did not ratify the specific awards the directors made under the EIP.[24]  Delaware Supreme Court reversed the lower court’s decision and affirmed the ‘meaningful limits’ standard, which developed in the Court of Chancery, and held that the directors need to show entire fairness of the compensation awards, even when ratified by a majority of stockholders.[25]

  1. Implications for the Future Director Compensation Plans

            The holding in In re Investors Bancorp is consistent with the holdings of other jurisdictions that have examined discretionary equity awards for directors, ratified by stockholders, and applied the entire fairness standard.[26]  This case is just another iteration of the back and forth that exists between boards and courts when determining how much flexibility boards have in structuring their EIPs and whether they should be granted business judgment rule protection.

Even before In re Investors Bancorp, companies often limited director compensation.[27]  Given the standard set in In re Investors Bancorp, it would make sense for this trend to continue in other jurisdictions. There could be a shift away from discretionary compensation structures in favor of fixed or self-executing ones, so boards can obtain business judgment rule protection. While discretionary plans ratified by stockholders can still be examined under the business judgment rule, there must be specific meaningful limits – an issue that may result in judicial inquiry. Upon examining such a plan, a court may decide to apply the entire fairness test, even if the board genuinely believed there were legitimate limits on directors’ discretion.


[1] See Carola Frydman & Raven E. Saks, Executive Compensation: A New View from a Long-Term Perspective, 1936–2005, 23 Rev. of Fin. Stud. 2099, 2106–07 (2010).

[2] See id. at 2108; Michael C. Jensen & Kevin J. Murphy, CEO Incentives – It’s Not How Much You Pay, But How, Harv. Bus. Rev., (May-June 1990) (noting that “[m]onetary compensation and stock ownership remain the most effective tools for aligning executive and shareholder interests”).

[3] See e.g., Michael C. Jensen & Kevin J. Murphy, Performance Pay and Top-Management Incentives, 98 J. Pol. Econ. 225 (1990).

[4] Lucian Bebchuk & Yaniv Grinstein, The Growth of Executive Pay, Discussion Paper No. 510, Harv. John M. Olin Ctr. for Law, Econ., and Bus., page 10 (Apr. 2005).

[5] FW Cook, 2017 Director Compensation Report, page 2 (Nov. 2017),

[6] See, e.g., Sanjai Bhagat, Board Directors Should Be Paid Only in Equity, Harv. Bus. Rev. (May 3, 2017),

[7] In re Inv’rs Bancorp, Inc. Stockholder Litig., 177 A.3d 1208, 1217 (Del. 2017).

[8] See id. at 1211.

[9] Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984) (overruled on other grounds).

[10] Delaware courts define corporate waste as a transaction that “no person of ordinarily sound business judgment would be expected to entertain the view that the consideration furnished by the individual directors is a fair exchange for the options conferred.” Gottlieb v. Heyden Chem. Corp., 91 A.2d 57, 58 (Del. 1952).

[11] Calma v. Templeton, C.A. No. 9579–CB, 2015 WL 1951930, at *2 (Del. Ch. Apr. 30, 2015)

[12] Id. at *8 (quoting Cede & Co. v. Technicolor, Inc., 634 A.2d 345, 361 (Del. 1993)).

[13] See Encite LLC v. Soni, No. 2476–VCG, 2011 WL 5920896, at *20 (Del. Ch. Nov 28, 2011) (noting that entire fairness is Delaware’s “most onerous standard”) (internal quotations omitted).

[14] See, e.g., Lewis v. Vogelstein, 699 A.2d 327 (Del. Ch. 1997).

[15] See Sample v. Morgan, 914 A.2d 647, 663–64 (Del. Ch. 2007) (stating that “the mere approval by stockholders of a request by directors for the authority to take action within broad parameters does not insulate all future action by the directors within those parameters from attack”); Seinfeld v. Salger, No. 6462–VCG, 2012 WL 2501105, at *12 (Del. Ch. June 29, 2012) (noting that “a stockholder-approved carte blanche to the directors is insufficient” and that “there must be some meaningful limit imposed by the stockholders on the Board”); Calma, 2015 WL 1951930, at *17 (applying the Salger standard).

[16] In re Investors Bancorp, 177 A.3d at 1218.

[17] Id. at 1222.

[18] Id.

[19] Id. at 1212–14 (internal quotations omitted).

[20] Id. at 1214.

[21] Id.

[22] In re Investors Bancorp, 177 A.3d at 1215.

[23] Id. at 1222–23 (internal quotations omitted).

[24] Id. at 1225.

[25] Id. at 1211.

[26] See, e.g., Bono v. O’Connor, No.: 15-6326 (FLW)(DEA), 2016 WL 2981475, at *17 (D.N.J. May 23, 2016) (applying Delaware law and noting the meaningful limit qualification for stockholder-approved equity incentive plans); Cement Masons Local 780 Pension Fund v. Schleifer, No. 654453/2015, 2017 WL 2855101, at *6–7 (N.Y. Sup. Ct. June 28, 2017) (finding no ‘meaningful limit’ where the compensation committee had “sole and absolute discretion” to grant its members and other non-employee directors nonqualified stock options).

[27] FW Cook, supra note 5, page 1.


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Fordham Journal of Corporate & Financial Law