Recommendation on directors' remuneration - briefing

29 April 2009
by eub2 -- last modified 29 April 2009

The European Commission has adopted a Recommendation on the regime for the remuneration of directors of listed companies, complementing previous Recommendations 2004/913/EC and 2005/162/EC. The Commission says that an appropriate remuneration policy should ensure pay for performance and stimulate directors to ensure the medium and long term sustainability of the company. The existing Directors' remuneration Recommendation is based on the idea of pay for performance through disclosure of the remuneration policy. The new Recommendation will give further guidance on achieving this by setting out best practices for the design of an appropriate remuneration policy. To this end, it focuses on certain aspects of the structure of directors' remuneration and the process of determining directors' remuneration, including shareholder supervision. The Commission has also adopted a Recommendation on remuneration policy in the financial services sector.

Why has the European Commission decided to adopt a Recommendation, which is not legally binding, and not proposed a Directive?

This new Recommendation is based on a thorough assessment of the situation at national level and of some EU Member States' efforts to improve their corporate governance framework. The objective is to promote greater convergence within the European Union towards best practices on directors’ remuneration. Since remuneration policies will differ between companies and sectors of activity, the Commission considered a Recommendation to be more suitable than a Directive: legislation with binding principles in this area would be difficult to articulate. Furthermore, it will also allow Member States to take due account of national corporate governance traditions and practices.

How do we reconcile prohibition of article 137.5 of the EC Treaty on pay with measures such as limiting severance pay or golden parachutes?

Article 137.5 excludes any Community competence on certain key aspects of industrial relations, such as the right to strike, the right to impose lockouts, and pay. Level of pay falls within the contractual freedom of the social partners at a national level and within the competence of Member States. The Recommendation does not aim at harmonising level of pay and nor does it modify national labour law. The Recommendation also indicates that its provisions are without prejudice to the rights, where applicable, of social partners in collective bargaining.

Why is the Recommendation directed at listed companies only?

The Recommendations invites Member States to adopt measures which would be applicable to listed companies, defined as companies whose securities are admitted to trading on a regulated market in the EU. EU-level measures on corporate governance have always been focused on listed companies. However, since some features of corporate governance best practice for listed companies could prove to be beneficial also to other companies, it is left to Member States, if they so wish, to extend all or some of the provisions introduced at national level to all or some categories of non-listed companies.

What is the justification for new principles on directors' remuneration?

These new principles are based on best practices found in Member States legislation or various national corporate governance codes in Europe. Following several recent high-profile cases and mounting evidence that executive pay structures need to be improved, the Commission’s new Recommendation on the structure of directors' remuneration and on the process of design and operation of the remuneration policy for directors in listed companies sets out a series of new principles complementing the existing Recommendations. There is widespread consensus that remuneration policy should be linked to long-term results and should not reward failure. This is in line with the ECOFIN Council's conclusions of 2 December 2008, which invited the Commission "to update its Recommendation so as to promote a more effective control by shareholders, and encourage a stronger link between pay and performance, including on leaving pay (“golden parachutes”)".

Will these new principles have an impact on attracting or retaining skilled directors in the EU?

Most of these measures already exist in one form or another in many Member States. Furthermore the choice of a Recommendation as the legal instrument and the "comply or explain" principle offer full flexibility for Member States and companies. Claiming back variable pay ("clawback" provisions) may raise difficult legal or fiscal issues, but the Commission considered that companies should be able to claim back money when variable pay has been granted on the basis of manifestly misstated data. Appropriate provisions would need to be included in contracts for this and negotiated with directors. The G20 leaders recently agreed at the London Summit to endorse the Financial Stability Forum recommendations on compensation, which also provide for strict rules on variable pay. The EU will be leading the way in implementing these commitments but will also be working with other G20 members to ensure their global implementation. Lastly, there are other potentially more important factors such as tax, language, culture and social considerations which also influence executive mobility.

Is the Commission modifying the role of remuneration committees and the responsibility of (supervisory) boards?

Remuneration committees play a key role in responsible pay policy. To strengthen the operation and accountability of the remuneration committee, the new Recommendation contains new principles in this respect to improve their efficiency. However the new Recommendation does not modify their existing role and functions as set out in the 2005 Recommendation. As defined in the 2005 Recommendation, the role of remuneration committees created within the (supervisory) board should essentially be to make sure that, where the (supervisory) board plays a role in setting remuneration (whether it has the power merely to table proposals or to make decisions, as defined by national law), this role is performed in as objective and professional a way as possible. So the balance of power and relation with boards (or with a supervisory board structure, where applicable) remain unchanged in the new Recommendation.

Since this is a Recommendation, Member States are free to decide whether to implement it or not. What would the Commission do if a majority of Member States did not follow the main lines of the Recommendation?

The Commission nevertheless invites Member States to inform it by 31 December 2009 of what they are doing to promote the application of these Recommendations. That will allow the Commission to monitor closely the situation within the EU. To this end, the Commission intends to make extensive use of different monitoring mechanisms, such as annual scoreboards and mutual evaluation by Member States.

After one year, the Commission will examine both Recommendations in the light of the experience acquired and the outcome of the aforementioned monitoring and submit an evaluation report on the application by Member States of both Recommendations.

Source: European Commission