AREA DE ACTIVIDAD MIXTA No

Reflecting on the above, two important recommendations on directors’ remuneration and the role of non-executive directors or the supervisory board resulted from this Action Plan. Measures to improve remuneration governance and disclosure were adopted by the EC in 2004 and 2005.31 The reform proposed by the two recommendations covers the same three areas: disclosure, shareholder voice, and the composition of the remuneration committee. The recommendations covered the four key disclosure requirements proposed by the Winter Report,32 which are seen as following Anglo-American best practice.33 The recommendations require companies to disclose in their annual report, or in a separate report, general information on remuneration policy as well as giving as an overview of the manner in which the remuneration policy was implemented in the previous financial year. This serves to allow evaluation of incentive effects and facilitate assessment of the remuneration policy by shareholders. The emphasis is on providing information on the following: the relative importance of the variable and non-variable components of director remuneration; performance criteria; the link between pay and performance; the parameters and rationale for cash or non-cash bonus schemes; any supplementary pension or early retirement schemes for directors; and details of the duration and terms of executive contracts as well as the notice period and any provision for termination payments and other payments linked to early termination. The report on remuneration policy should also provide information concerning the decision-making process of the remuneration policy, including the mandate and

30

G Ferrarini and N Moloney, “Executive Remuneration and Corporate Governance in the EU: Convergence, Divergence, and Reform Perspectives” (2004) 3 European Company and Financial Law Review 251, 288.

31 _{Commission Recommendation 2004/913 (n 3); Commission Recommendation 2005/162 (n 4).} 32 _{Winter Report (n 1) 65 & 66.}

33

145

composition of the decision-making body, the names of external consultants whose services have been used in determining the remuneration policy, and the role of the shareholders.34 Individualized disclosure of executive director remuneration was also recommended. This includes details of total remuneration, which covers fixed pay, including salary, bonus and profit sharing, togather with the reasons why this was granted. Any additional payment for special services, termination payments, and other non-cash benefits should also be disclosed. Additional information is required for any share-based remuneration and any supplementary pension schemes. For shares and share options, information regarding the number of shares or share options offered, exercised and unexercised, and any change to the terms and conditions of the plans occurring during the year should be disclosed. With regard to pension schemes, this depends on the scheme. If it is a defined-benefit, changes in the director’s accrued benefits during the relevant year are to be disclosed; if it is a defined-contribution, information on the contributions paid or payable by the listed company for each director during the relevant financial year is to be disclosed.35 This disclosure requirement was only a recommendation to achieve harmonization across the EU Member States via minimum standards, and was not as high as the disclosure requirements introduced in the UK by law in 2002.

Shareholder voice became an element in the European reform of remuneration regulation following the 2004 recommendation although this was not supported by the Winter Report. This has probably been influenced by the different ownership structures in different European states (as it is not likely to have any significant effect on blockholding structure ownership) and by the so-called “rational apathy”, which was seen as a disadvantage by the Winter Report whereby shareholders would prefer to sell out their holdings rather than monitor and influence corporate performance. However, a shareholder vote would not have the desired effect without tabling a detailed remuneration policy at the AGM with clear accurate clarification regarding the link between remuneration and performance on a multi-year and peer comparison basis. In this way shareholders would be able to assess the remuneration level and form. The EC recommended submitting the remuneration policy to the AGM for

34 _{Commission Recommendation 2004/913 (n 3) Section II.} 35

146

either an advisory or mandatory vote.36 However, the EU is in the process of including new voting requirements similar to those introduced in the UK, and such requirements will form part of the updated Shareholders’ Rights Directive.37

Another reform applies to a vote on share options, a reform which has been introduced in many European countries and is linked to a change in capital structure rather than a vote on remuneration policy. Moreover, share granting and any long-term incentive plans as well as any change to the schemes’ main terms would require shareholder approval.38 Information regarding dilution and how the firm plans to provide the shares should also be provided.39 The third element in the reform relates to the effective governance of the body that decides the remuneration policy. This body can be the supervisory board (in a two-tier board system) or the remuneration committee (in a one-tier board system). This recommendation on the role of non-executive or supervisory directors of listed companies and on the committees of the (supervisory) board was set out in the 2005 recommendation and stems from the Anglo- American convention, as noted by Ferrarini and Moloney. They add that at the heart of this recommendation is the Commission’s view that independent board oversight, provided this independent board has the essential resources and ability to challenge management decisions, will protect the interests of shareholders and reduce the agency cost across both structures of ownership.40 Therefore, the assumption is that non-executive directors will play a vital role in protecting the interests of shareholders against management in dispersed ownership, ensuring that the interests of minority shareholders are considered in blockholding ownership.

The Commission Recommendation states that a remuneration committee in both governance structures (dispersed and blockholding) is essential for solving the conflict of interest that is inherent in the remuneration-setting process.41 If a remuneration committee is set up, the EC wants it to be composed exclusively of non-executive or supervisory directors with the

36

ibid section II, 4.2.

37 _{Commission, “Proposal for a Directive of the European Parliament and of the council amending Directive}

2007/36/EC as regards the encouragement of long-term shareholder engagement and Directive 2013/34/EU as regards certain elements of the corporate governance statement COM (2014) 213 final.

38 _{ibid section IV.} 39 _{ibid section V.}

40 _{Ferrarini “Executive Remuneration in the EU” (n 29) 319.} 41

147

majority of its members being independent. However, the Commission refused to offer a precise definition of “independent” owing to the different situations and circumstances which affect the independence of a director from one Member State to another and the rapidly evolving best practice in defining this term.42 Instead, the Commission listed the threats affecting a director’s independence, providing the general view that “independence” refers to a director who is “free of any material conflict of interest”.43 To help national regulators define independence for their own purposes, the Commission listed some general criteria. The Commission’s Recommendation divided the role of the remuneration committee into four main areas. The first related to executive or managing directors’ remuneration. The remuneration committee’s role is to propose a remuneration policy for executive directors detailing all forms of remuneration − fixed, variable, pension, and termination payments− for the board’s approval, explaining the objectives and evaluation criteria for achieving alignment between executive pay and the long-term interests of shareholders. This represents support from the Commission for firms in adopting performance-related payment with clarification of the objectives of the plan and its evaluation criteria.44 In addition to proposing individual remuneration for executive directors, the remuneration committee should also provide suitable forms of contracts for executive directors.

The second aspect of its role is related to making general recommendations to the board with regard to the level and structure of senior management remuneration, as well as monitoring the level and structure of senior management remuneration based on the information provided by executive directors.

The third area which it covers is share options and share grant schemes. The committee should debate the general policy regarding the granting of such schemes, review the information provided on this topic in the annual report and to the shareholder meeting, where relevant, and make proposals to the board concerning the choice between granting options or subscribing shares, specifying the reasons for the choice as well as the consequences that this choice has.

42 _{ibid Annex II.} 43 _{ibid recital 8.} 44

148

The fourth area regards the operation of the remuneration committee. This should consult the chair and/or chief executive about their views relating to the remuneration of other executive or managing directors. Moreover, the remuneration committee should be able to seek help from external consultants in obtaining the necessary information on market standards for remuneration systems with sole responsibility for establishing the selection criteria, and selecting, appointing and setting the terms of reference for any remuneration consultants. However, the Recommendation did not ask for disclosure concerning any relationship between the firm and the external consultant. Such consultancy firms usually offer a variety of services to their clients which might trigger a conflict of interests, as the external consultant might choose to support what executives want in order to secure a contract for other services.

Thus, these reforms can be seen as less interventionist and more flexible than those which were introduced regarding disclosure and shareholder voice.45 This flexibility comes from the fact that there is no requirement for the remuneration committee to be wholly composed of independent directors. Moreover, the function of the remuneration committee can be performed by a small supervisory board in a two-tier board structure if this board meets the requirement of having an independent majority. The recommendation of shareholder voice did not take into account the relative weakness in relation to the dominant position of large shareholders in the blockholding system. The dominant position suggests a greater need for independent non-executive directors to help balance the power between the management and the large shareholders on the one hand and the minority shareholders on the other. However, independent directors need to have the knowledge, skills, resources and information, commitment and experience to engage effectively, which the Recommendation sets out, while delegating the responsibility of monitoring and assessing the independence, competence and commitment of a director on the board to shareholders and the markets via the disclosure requirement.46

In 2006, a review of the Action Plan resulted in prioritization of the strengthening of shareholder rights, but also acknowledged that there was a growing sense of regulatory fatigue and the need to pause and allow both businesses and investors more time to digest

45 _ibid. 46

149

recent legislation.47 In July 2007, the Commission published two reports which reviewed the extent to which Member States had implemented the 2004 and 2005 Recommendations.48 The two reports found that all the Member States had issued corporate governance codes and most codes were to be applied on a comply-or-explain basis. However, the reports identified certain areas in which the Recommendation’s principles had not been adequately followed and implemented.