Delaware and a Close Look at Independence

Subodh Mishra is Global Head of Communications at ISS STOXX. This post is based on an ISS-Corporate memorandum by Alyce Lomax and is part of the Delaware law series; links to other posts in the series are available here.

Key Takeaways

  • A Delaware judge’s decision to void $55.8 billion in compensation for Elon Musk was a noteworthy event for shareholders and corporate issuers, not only regarding compensation, but also the complexities around evaluating director independence.
  • Traditional measurements used by major exchanges and proxy advisors seem to show that board independence in the U.S. is robust, but some less obvious non-independent traits may lurk beneath the surface.
  • Our research indicates that Delaware courts could more frequently consider non-traditional/nonfinancial factors in evaluating board independence, process, and fair dealings with shareholders than widely believed.

“Was the richest person in the world overpaid?” So began the post-trial opinion regarding the lawsuit brought by a shareholder against Tesla, its CEO Elon Musk and some of the company’s directors. The Tornetta v. Musk trial and the headline-grabbing Jan. 30 ruling by Chancellor Kathaleen McCormick of Delaware’s Chancery Court touched on multiple issues, with corporate governance at the heart of all. It can be difficult to look beyond the dollar signs in that decision, as the judge moved to void a massive pay package for a well-known CEO. Now Tesla is asking shareholders to vote once again on the 2018 pay package struck down by the ruling, attaching as an annex to its proxy statement the full text of the post-trial opinion so shareholders have all the information at hand that the court deemed pertinent to the decision.[1]

How Tesla shareholders ultimately respond to this unusual “do-over” opportunity at the company’s annual meeting on June 13 will be fascinating. However, it’s arguable that the true crux of the issue extends far beyond one high-profile company and its upcoming annual meeting, and instead relates to fair and informed dealings with shareholders in general. Major takeaways include why board independence (and proper disclosure thereof) matters, and how to navigate some nuances beyond the standard formats for whether a board is truly independent.

Meanwhile, Delaware is in the spotlight, not just because Tesla seeks shareholder approval to reincorporate from Delaware to Texas, but also due to indications of a willingness to look at nontraditional indicators of director independence even beyond the Tesla case. Given its leading role in corporate law and preferred status as a state of incorporation, increased scrutiny beyond standard definitions of independence could be a significant development for corporate issuers and a win for shareholder democracy. Delaware’s strong influence and role as trusted arbiter of corporate law is underlined by a recent ISS-Corporate analysis showing that Delaware is not only the most common state of incorporation for public companies, but also that proposals seeking to reincorporate elsewhere are rare.[2]

Internal processes including independent compensation committees and proper checks and balances should be top of mind for any publicly held corporation in the wake of this ruling. Shareholders may take a second look at board composition, whether existing rules and guidelines always tell the full story of director independence, and the benefits of robust processes.

Plus, there are serious ramifications around the fact that Delaware legal cases against companies could increasingly expose opaque board oversight processes and more interconnected boards than previously believed.

Searching Beyond Standards

One of the key issues in the Delaware case was how Tesla defined its directors in its proxy. The case called into question the information shareholders had available when they approved the 2018 compensation plan. According to the post-trial opinion, “the defendants were unable to prove that the stockholder vote was fully informed because the proxy statement inaccurately described key directors as independent and misleadingly omitted details about the process.”[3]

How does one define director independence? Most companies follow listing rules imposed by the major exchanges. Proxy advisors add stricter criteria, which sometimes clash with the companies’ own definitions.

In recent years, Delaware corporate law has occasionally been delving into the “softer” side of questioning board independence, examining aspects that may indicate that directors who look independent according to accepted standards, may exhibit other traits such as personal relationships that place their independence under serious question.

On one hand, trying to ascertain whether a company’s directors and top executives are too emotionally invested in one another may sound onerous, intrusive, and highly subjective. On the other hand, any layperson would probably consider shared activities like attending vacations or family functions the opposite of “independence.”

Corporations, exchanges, proxy advisors, and shareholders may want to mull ways to direct a more critical eye on the complexity inherent in fostering and identifying truly robust, independent boards.

There is quite a bit of overlap in standards used by the major exchanges and proxy advisors to assess independence, focusing on obvious traits such as former CEOs and other employees of the companies in question, controlling shareholders, or family members of top management, as well as financially material relationships. For many employees, there is a set number of years between employment and the point in which they might be considered for an independent director role at their former company. Individuals who once served as CEO would never be considered independent.

Exorbitant financial compensation for directors, or professional services relationships or material related party transactions, can also negatively impact an independence assessment. ISS flags any professional services relationships that exceed $10,000. Glass Lewis, on the other hand, takes exception to services paid to a director valued at $50,000, or $120,000 if the service involves the director’s firm.

The High-Level View of Board Independence

Bearing in mind the above standards, which focus on more quantifiable attributes, the data may suggest an optimistic outlook regarding board independence in the U.S. marketplace. For the following data, we examined areas related to independence within the S&P 500, according to ISS U.S. Benchmark Policy.[4]

Take two common connections that can lead to less independent thought on a board: family ties with top executives and/or intermeshed financial dealings between executives, directors, and their respective companies (material related party transactions). Data sourced from the ISS-Corporate platform relating to factors within the ISS Governance QualityScore indicates only about 6% are thus defined in the S&P500.

Examining the same pool of companies, only 0.4% had boards defined as less than 50% independent according to ISS policy. On the other hand, nearly 80% had at least one non-executive director defined as having lengthy tenure (defined as serving on the board more than nine years). Too many directors with long tenure on a company’s board can be a warning sign of an overly familiar, complacent board. A good mix of longer-tenured directors to retain valuable institutional knowledge and newer directors to ensure an infusion of fresh thinking would be ideal.

Gender, racial, and other forms of diversity have long been considered positive for robust business outcomes, so it’s no stretch to suppose that a diverse board can be another indicator of a dynamic, more independent-thinking board (McKinsey has done multiple papers on this topic, including Diversity Matters Even More).[5] As you will see below, in terms of aggregate disclosure (assessing overall board diversity in terms of ethnicity, gender, nationality, and other diversity categories), shareholders’ ability to assess board diversity looks extremely healthy in the S&P 500.

Again, though, these statistics are quantifiable according to ISS policy, which, like all the standards previously discussed, is strictly drawn for a reason. Proxy advisors and listing exchanges are not flies on the walls of corporate boardrooms or tracking relationships beyond those parameters, but rather focus on the facts as are reasonably quantified from financial disclosures or other trusted public information.

A Next-Level View of Board Independence

Taking into account the high compliance with such standards, companies with potentially troubling flaws in board independence may look like anomalies in corporate America. However, in certain instances — if shareholders take legal action, for example — a higher level of scrutiny may be applied in the state of Delaware.

Given human nature, it’s easy to imagine that even directors who tick all the standard boxes regarding independence may still fall short of that ideal. On the most basic level, boards consist of individuals who collaborate several times per year, sometimes for many years, and some degree of relationship with management is inevitable.

Meanwhile, Delaware courts sometimes drill deeper into the definition of “independence” than other standards prescribe, even if such incidents don’t always command headlines such as the Tesla case.

Over the last several years, some thought pieces from law firms have pointed out cases that may suggest Delaware courts are shifting towards more “situation-specific” rulings when it comes to judging director independence and fair and proper board processes, whereas such assessments had traditionally been more limited to the financial realm.

For example, a January 2022 Cleary Gottlieb piece, The Delaware Courts’ Evolving View of Director Independence, pointed out that in Marchand vs. Barnhill (2019), the court held that Delaware law “cannot ignore the social nature of humans or that they are motivated by things other than money, such as love, friendship, and collegiality.” In other words, non-traditional/non-financial factors can matter too when assessing independence and potential conflict of interest.[6]

The piece also pointed to a 2019 proceeding, In re BCG Partners, Inc., Derivative Litigation, in which the Court of Chancery denied the defendants’ motions to dismiss due to the possibility that a majority of the board of directors (the defendants in question) could have been considered nonindependent from a controlling stockholder. In that case, which went to trial in 2021, one director came under scrutiny due to a 20-year relationship with the shareholder, and questions were posed around social activities and “personal admiration.” Ultimately, the court did not find the evidence against the slate of directors to be overwhelming, but enough compelling information was uncovered during discovery to move forward with the case.[7]

Bolster the Boards

Accepted standards are the first line of defense in ensuring adequately independent boards of directors — people who are charged with putting shareholder interests ahead of corporate management or themselves. Clearly most companies already have moved to make sure their boards aren’t packed with family members or individuals for whom powerful financial incentives may cloud their judgment and motivations, which is a positive for shareholders.

Accurately assessing a board’s independence can be difficult for many entities (including shareholders) if full, accurate, and verifiable information isn’t available and weaknesses aren’t apparent until events like media controversies or litigation shed light on inner dealings and flawed processes or biased, compromised decision making.

For corporations, the takeaway probably shouldn’t be to reject Delaware, but rather to ensure their own boards are as unimpeachably independent as possible and fully capable of fulfilling their fundamental duties to shareholders, including devising fair compensation for top executives.


1Tesla 2024 proxy statement: back)

2ISS-Corporate on LinkedIn: Data in Focus: Reincorporation Proposals(go back)

3Delaware Chancery Court Post-Trial Opinion, pg. 3(go back)

4ISS U.S. Benchmark Policy, back)

5Diversity Matters Even More, McKinsey, back)

6The Delaware Court’s Evolving View of Director Independence, Cleary Gottlieb, back)

7The Delaware Court’s Evolving View of Director Independence, Cleary Gottlieb, back)

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