Many corporations struggle to deal with the principal-agent problem; a term used to describe the conflict of interests between the shareholders and the executive directors of a listed company. This conflict is due to the fact that shareholders want the management of ‘their’ company to take greater risks in hopes of larger profits, whereas the directors themselves are less willing to take these risks keeping the company’s long-term position, and their own interests, in mind. An important mechanism enhancing the alignment of the interests of shareholders and directors is remuneration. A remuneration policy is considered as compensation given to board members in the shape of shares or stock options, in exchange for their business performances. In 2014 a proposal of the European Commission appeared regarding a new Shareholders Rights’ Directive, giving shareholders the right to vote on the remuneration policy. However, this proposal lets the Member States decide whether this vote should be a binding or advisory vote. The so called ‘say-on-pay regime’ is the subject of discussions and several empirical studies all over Europe, but this paper will merely focus on how the Netherlands should incorporate the European Commission’s Shareholders Right’s Directive. Discussing this proposal, remuneration in general and current say-on-pay regimes, the question whether the Netherlands should adopt a binding or advisory say-on-pay regime will be answered.
First of all, it is necessary to clarify what remuneration is and why it is considered as a crucial mechanism in corporate governance. As mentioned before, a remuneration policy has been developed as a method to cope with the principal-agent problem, which contains two difficulties. On one hand, shareholders are unable to monitor the board at all times, creating information asymmetry regarding the board’s decisions and business activities. Furthermore, shareholders will not know exactly in whose interests the board is acting, making them skeptical. This is referred to as the monitoring problem. On the other hand, the board can refrain from doing things in the shareholders’ interests because the shareholders have a minimal chance of discovering this due to the monitoring problem. In addition to this, the board might act merely in their own interests. However large the company’s profits, directors will always receive their monthly salaries, contrary to shareholders, whose compensation depends on the net profits. Therefore directors are less willing to take risks, which might have led to shareholder wealth maximization. This is referred to as managerial opportunism.
Remuneration is designed to align the interests of shareholders and directors by giving directors share options, incentivizing them in order to maximize shareholder wealth. Since directors then own shares themselves, they will profit directly from shareholder wealth maximization. Thus their goal is to realize as high as possible share prices. However, this may lead to short-termism and excessive engagement in risky activities, maybe even too risky.
In reaction to the growth of risk-management, the European Commission developed a proposal for a new Shareholders Right’s Directive, being of the opinion that “remuneration systems should be subjected to appropriate governance controls, based on adequate information rights.” The basis of this revised Directive was laid out in the Action Plan on European Company Law and Corporate Governance, of which the two main objectives were enhancing transparency between companies and investors and engaging shareholders. In the ‘Explanatory Memorandum’ of the proposal these objectives are stated as following: “The rules in this proposal (…) aim at increasing transparency and ensuring that shareholders have a vote on the remuneration policy and report.” European Commission. The proposal can be split up in five subjects; regarding remuneration the main focus is “strengthening the link between pay and performance of directors”. This can be achieved by publishing the remuneration policy as well as the executive remuneration and by giving shareholders the right to vote on and approve said policy. Giving shareholders the right to vote is referred to as the ‘say-on-pay’ regime. These requirements are codified in the Articles 9a and 9b of the revised Directive. However, these Articles allow Member States to decide whether the vote should be advisory or binding of nature and Member States remain entitled to regulate which level of remuneration they will apply.
Besides remuneration, the proposal also focusses on improving engagement of institutional investors and asset managers, improving shareholder oversight on related party transactions, enhancing transparency of proxy advisors and facilitating the exercise of rights flowing from securities for investors.
Due to the aforementioned proposal, say-on-pay regimes are now adopted in multiple countries. Aside from increased shareholder engagement, another advantage of this regime is that it tackles what is known as the agency problem. This problem occurs when directors overpay themselves with shares whilst … it under remuneration, abusing their management power in pursuit of self-interest utility maximization. This abuse will be reduced substantially if the remuneration policy has to be approved by shareholders beforehand.
In Belgium, the legal rules regarding remuneration are determined in the articles of association of its corporations. After the financial crisis, the Belgian corporate governance codes have been altered. The general meeting of shareholders votes on the remuneration report on a yearly basis. Even though their vote is only advisory, the board will most probably nonetheless reconsider its remuneration policy if rejected by the shareholders.
Contrary to Belgium, in France the shareholders’ votes are binding. If shareholders disapprove the total annual fees for the board (directors’ fees in a one-tier board and supervisory board fees in a two-tier system), directors are simply prohibited to receive remuneration. Despite their binding vote, similar to Belgium, the shareholders only decide on the total amount of executive remuneration, whereas the board has the power to allocate a certain amount of remuneration to the directors. Shareholders only have a binding ‘say-on-pay’ concerning termination agreements and additional retirement agreements. Regarding the individual remuneration, France adopted the ‘comply or explain’ regime, meaning shareholders either provide their vote or explain why they are unwilling to.
Moreover, say-on-pay is also seen in non-European countries such as the United States of America. The US adopted an advisory non-binding say-on-pay regime through the Dodd-Frank Act.
Thus, most countries have adopted an advisory say-on-pay regime. I share their opinions, which is why the Netherlands too should adopt an advisory say-on-pay regime, in my view.
However, some people argue that shareholders should have a binding vote as they are the ‘owners’ of the corporation. I agree that shareholders should have certain rights since they are the main financiers of the company, though in my opinion they have enough rights as it is. In fact shareholders have the power to appoint and dismiss management, the power to adopt the annual accounts of the company, the power to decide on the issuance, redemption and redistribution of share capital and last but not least the power to decide on the character and even the existence of the legal person.
Therefore, I believe it is best for Dutch corporations if the Netherlands would not give shareholders a binding vote on the remuneration policy. The independence of directors is an essential element of good governance and would be taken away (aangetast?) by giving shareholders even more power regarding the board’s decisions. Moreover, shareholders are likely to solely take their own interests into account which may lead to short-termism and risk-management, endangering the corporation.
For these reasons it would be wise for the Netherlands to adopt an advisory say-on-pay regime.