Court rules that executives can keep their excessive pay packages.

Microsoft recently revealed that its shareholders approved an $84 million compensation package for their CEO, Satya Nadella.  Not bad for his first year on the job. 

Satya is in good company, as many other executives have also been receiving generous pay packages.  Accordingly to Equilar’s 2014 report on CEO pay, the median income for chief executives of the S&P 1500 is $5 million.  For chiefs of S&P 500 companies, the median pay doubles to $10.1 million.

All of these millions made me wonder what, other than one’s imagination, are the limits on a board’s authority in creating a compensation package for an executive.  The good news for executives is that a recent case from the Third Circuit – which encompasses Delaware, America’s corporate capital – held that virtually nothing stands in the way of board members granting ostensibly ostentatious salaries and bonuses to high level employees.

Freeman v. Redstone, 753 F.3d 416 (3rd Cir. 2014)

Viacom’s board of directors paid its chairman, Sumner Redstone, along with two other executives of Viacom, more than $100 million in salary, bonuses and incentive compensation.  One of Viacom’s shareholders, Robert Freeman, sued Redstone and all 11 members of Viacom’s board of directors, claiming the board breached its fiduciary duty by approving these supposedly excessive compensation packages.

The Court held that in approving pay packages, a board of directors is “entitled to a presumption that they were faithful to their fiduciary duties.”  To overcome this presumption, a complainant must create a reasonable doubt either that: (1) a majority of the board members were not disinterested and independent; or (2) the challenged transaction was not the product of a valid exercise of business judgment.  A heavy burden to carry.

The lower court dismissed Freeman’s claim for failure to meet these standards, and the Third Circuit upheld that dismissal.  It did so because Freeman failed to allege facts that called into question the independence of at least half of Viacom’s board members.  In addition, the Court emphasized that the “business judgment rule” protects board members “from judicial interference with their informed, good faith business decisions.”  Accordingly, with the board being afforded this presumption of good faith, and Freeman’s inability to otherwise set forth facts which might demonstrate that the board’s decision was not “the product of a valid exercise of business judgment,” dismissal of this case was affirmed; thereby ensuring Redstone and company can continue enjoying the $100,000,000+ previously awarded to them by Viacom’s board.

 Executive Takeaway

As colossal pay packages for executives like Satya Nadella and Sumner Redstone continue to make headlines, the frequency with which others will question those awards is likely to multiply too.  However, executives need not fret.  With the presumption of good faith provided by the business judgment rule, any attempted challenge to executive pay will likely fail unless there is evidence that those approving the compensation were not acting independently.