by Cydney Posner
Just when the U.S. is looking at how to roll back its regulations on corporations (among others) (see, e.g., this PubCo post, this PubCo post and this PubCo post), the rest of the world seems to be headed in the opposite direction. On Tuesday, the EU Parliament approved a Shareholder Rights Directive, which introduces, among other things, the concept of binding say-on-pay votes for companies listed in EU markets (over 8,000 of them). The Directive also includes some interesting measures intended to impede short-termism. According to the press release fact sheet issued by the European Commission, the Directive must still be adopted by the European Council (expected shortly) and, assuming adoption, will become effective two years thereafter.
The Directive was developed in response to the global financial crisis, which highlighted “many shortcomings in corporate governance of listed companies.” More specifically, the Commission identified the following as examples:
- “important deficiencies in the engagement and control by shareholders impede good decision-making by companies;
- excessive directors’ [executive] pay not justified by performance has led to mistrust among shareholders and the society at large;
- complicated access and costly procedures for exercise of shareholder rights.”
These shortcomings led the Parliament to focus on the relationship between corporate results and executive compensation, triggered by “several recent cases where extremely high remuneration of CEOs perceived as undue in the light of the weak performance of the director or the difficult situation of the company, provoked the dissatisfaction of shareholders.” In that light, the Commission recognized that executive “remuneration plays a key role in aligning the interests of directors and shareholders and ensuring that the directors act in the best interest of the company. The way directors are paid influences their decision. If the pay incentives focus exclusively on [the] short term, decisions may be taken by directors with too much focus on short term, with prejudice for the company in the long-term. There is need for proper oversight to ensure that the pay is in line with long-term interests and sustainability of the company.”
To address these issues, the Directive provides for two shareholder say-on-pay votes, structured differently than are say-on-pay votes in the U.S.: First, shareholders
“will vote ex ante on the remuneration policy which lays down the framework within which remuneration can be awarded to directors. Second they will vote ex post on the remuneration report describing the remuneration granted in the past financial year. The vote on the remuneration policy will in principle be binding, which means that companies are only able to pay remuneration on the basis of the policy approved by shareholders. Member States will however have the possibility to opt for an advisory vote. This means that companies are allowed to apply a remuneration policy which has been rejected by shareholders, but are required to submit a revised policy at the next general meeting. The vote on the remuneration report will be advisory. Member States will also have the possibility to allow companies to replace this vote by a discussion at the general meeting.”
These new votes are designed to “encourage more transparency and accountability about directors’ pay. Shareholders will have the right to know how much the company’s directors are paid and they will be able to influence this. This will guarantee a stronger link between pay and performance.”
SideBar: Similarly, the U.K. Government’s “Green Paper” on Corporate Governance Reform also suggests making say-on-pay votes binding, along with pay-ratio disclosure, giving employees more influence on company boards and other proposals. With regard to executive pay, the Paper observes that “there is a widespread perception that executive pay has become increasingly disconnected from both the pay of ordinary working people and the underlying long-term performance of companies. Executive pay is an area of significant public concern, with surveys consistently showing it to be a key factor in public dissatisfaction with large businesses.” To address that concern, the Paper proposes the introduction of annual binding votes on all or some elements of executive pay. (See this PubCo post.)
By contrast, the still-anticipated Financial CHOICE Act 2.0, if signed into law, is expected (based on the contents of the original Financial CHOICE Act) to amend the Exchange Act to require say-on-pay votes only in those years “in which there has been a material change to the compensation of executives of an issuer from the previous year,” and to eliminate the say-on-frequency vote. (See this PubCo post.)
The financial crises in the EU also drew attention to the problems inherent in the “short-term strategies that are driving corporate governance.” Because institutional investors own most of the shares of listed EU companies and asset managers manage the assets on behalf of most of these institutional investors, the new rules focus on theses institutions and asset managers as potential drivers of short-termism:
- “The performance of asset managers, employed by institutional investors to manage their assets, are often evaluated on a quarterly basis or even on shorter periods, which doesn’t allow them to take into account long-term performance and puts pressure on them to deliver short-term returns.
- The average share-holding period is 8 months.
- On average, fund managers turn their entire portfolio in every 1.7 years.”
Interestingly, the new rules are a European example of disclosure-based “regulation by humiliation”: they
“will require institutional investors to disclose how they take the long-term interests of their beneficiaries into account in their investment strategies and how they incentivise their asset managers to take these long-term interests into account. Asset managers will be required to report to the institutional investors for whom they manage funds how they have performed in relation to their mandate. The new rules will also require institutional investors and asset managers to disclose their engagement policies including their implementation. Through increased transparency requirements, the new rules will encourage these investors to adopt more-long-term focus in their investment strategies and to consider social and environmental issue.”
Other changes in the Directive include the following:
- Companies will have the right to identify their shareholders (although personal data will be protected), and the chain of intermediaries will be required to forward information and “to facilitate exercise of shareholder rights including voting,” particularly cross-border voting. The purpose is to facilitate communication and interaction between companies and investors. Companies will also be required to confirm the votes cast at the request of the shareholder.
- Proxy advisors will be required “to disclose certain key information about the preparation of their recommendation and advice and to report about the application of the code of conduct they apply.”
- Companies will be required to publicly disclose material related-party transactions and to submit them for approval by the shareholders or the board.
SideBar: And speaking of the European Parliament, today it also approved rules on conflict minerals, according to the press release, “by an overwhelming majority.” Note that the EU rules do not come into effect until 2021. (See this Pubco post.)
Ironically, while the EU is adopting conflict minerals rules, the U.S. is looking at eliminating them. In February, Acting SEC Chair Michael Piwowar issued two statements — available here and here — on the conflict minerals rules, which advise that he had directed “the staff to consider whether the 2014 guidance is still appropriate and whether any additional relief is appropriate in the interim.” In addition, one of his statements includes his observations that the impact of the rule might undermine U.S. national security interests in the region. In that regard, Reuters has reported that the President “is planning to issue an executive order targeting [the conflict minerals disclosure rule],” based on the national security waiver provision in Dodd-Frank. (At the end of February, Acting Corp Fin Director Shelley Parratt reminded companies that, notwithstanding the two statements issued by Piwowar, the conflict minerals disclosure rules are still in effect. See this PubCo post.) In addition, it is anticipated that the Financial CHOICE Act 2.0, if adopted, would repeal the conflict minerals section in Dodd-Frank. (See this PubCo post and this PubCo post.)
