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The Directive amends the so-called Shareholders’ Rights Directive (EU Directive 2007/36 as regards the encouragement of long-term shareholder engagement). The stated objective is to overcome certain corporate governance shortcomings in European listed companies and to promote the long-term engagement of shareholders.
The Directive deals with a wide range of corporate law and governance issues, such as identifying shareholders, providing information about shareholders, facilitating voting, making institutional investors, asset managers and proxy advisors more transparent, and regulating related party transactions.
HR practitioners will, however, be primarily interested in the provisions that deal with pay policy and the remuneration report – and it is these that we focus on in this newsletter.
1. Current law and practice
Current national law and practice on executive pay within the EU Member States varies widely. National laws or corporate governance codes may cover the publication of details of executive pay in listed companies. The EU Commission acknowledges the diversity in governance systems within the EU, but believes it is important to harmonise both the shareholders’ ‘say on pay’ rules and the rules about publication.
2. Scope
The Directive will affect directors in EU listed companies. The term ‘director’ is broadly defined as the CEO, the deputy CEO, and any member of the administrative, management or supervisory bodies of a company. The term will therefore encompass both executive and non executive roles, irrespective of the corporate governance structure. Where a listed company has, for instance, a management committee and a Board of Directors, the members of both bodies will be within scope.
The companies covered are those with their registered office in one of the 28 EU Member States and whose shares are traded on a regulated market in the EU. In other words, listed companies.
3. Remuneration Policy to be voted by the Shareholders’ Meeting
The Directive provides that the general meeting of shareholders must have a right to vote on the company’s pay. The vote must be binding. Once approved, companies can only pay their directors in accordance with the approved policy.
When implementing the Directive, Member States can give companies some leeway: they can allow deviations for individual directors in exceptional circumstances. They can also provide that the vote will only be advisory. Where that is the case, the policy must still be submitted for a vote to the shareholders’ meeting, and if it is rejected, a revised draft policy must be submitted at the next meeting.
The pay policy must be submitted for a vote by the shareholders’ meeting every time there is a material change or at least every four years.
The text of the policy and the results of the vote must be published on the company’s website and remain available there for as long as the policy remains in force.
4. Content of the Pay Policy
The pay policy must explain how it contributes to the business strategy, long-term interests and sustainability of the company. It must be clear and comprehensible and describe the different components of fixed and variable pay, including all benefits in whatever form that can be awarded to directors, and it must indicate their relative proportion.
The policy must also explain how the pay and employment conditions of employees of the company have been considered when setting the policy on directors‘ pay. This rather vague requirement is a leftover from the more controversial proposal made by the European Commission that the policy should explain and justify the ratio between directors’ pay and average employee pay – which was removed from the agreed final text.
If the company awards variable pay, the policy must set clear, comprehensive and varied criteria by which to do so. The policy must indicate the financial and non-financial performance criteria, including where appropriate, corporate social responsibility, that will be used to calculate variable pay and explain how they contribute to the business strategy, long-term interests and sustainability of the company.
The policy must specify any applicable deferral periods. It must also specify whether the company can reclaim variable remuneration (‘clawback’). For share-based remuneration, the policy must specify the applicable vesting and retention periods.
The policy must also say how long the arrangements with directors will last and how long the notice periods are. It must explain the main features occupational pension rights, any early retirement schemes and severance pay arrangements.
Finally, the policy must explain what mechanisms are in place to review the policy, what measures will be taken to avoid or manage conflicts of interest and the role of the pay committee. Whenever the policy is revised, all significant changes must be explained and it must set out how the votes and views of shareholders on pay policy and remuneration reports will be considered.
The European Parliament had proposed that share value should not have a dominant role in financial performance criteria and that share-based remuneration should not represent the most significant element of variable pay. But these ideas were rejected in the final agreed text.
5. Content of the Remuneration Report
The pay policy is a prospective document determining what executive pay should look like in the future. But companies must also produce a remuneration report each year, giving a clear and comprehensive overview of pay, including all benefits in whatever form that have been paid in the last financial year to all individual directors, including newly-recruited and former directors.
The remuneration report must contain the following information regarding each individual director’s remuneration:
- the total remuneration split into its constituent parts, the proportion of fixed and variable pay, an explanation as to how the total complies with the company’s pay policy, including how it contributes to long term performance, and information on how the performance criteria have been applied;
- changes to directors’ pay over at least the last five financial years, how the performance of the company has evolved and the average pay of on a full time equivalent basis of employees other than directors during that period, presented ‘together in a manner which permits comparison’;
- any pay awarded or due to directors of the company from any subsidiary or other group company;
- the number of shares and share options offered or granted and the main conditions attached to these, including prices, dates and any changes to the terms of exercise;
- information about whether the company can reclaim variable remuneration (‘clawback’); and
- information on any deviation from the policy, including explanations of exceptional circumstances.
The language that was most debated in this section of the Directive is the last part of item (b) (‘presented together in a manner which permits comparison’). It suggests that companies should have tables or graphs in their report showing increases to director pay and average pay, as compared to company growth over five years. It does not specify how one should measure the evolution of the performance of the company for this purpose, but when implementing the Directive, Member States can adopt more precise criteria.
6. Vote on the Remuneration Report
The Directive provides that the annual shareholders’ meeting has the right to hold an advisory vote on the remuneration report for the past financial year. As the report reflects historical data, a rejection will not affect remuneration paid, but will send a signal to the directors. The company is required to explain in the next remuneration report how the vote by the shareholders’ meeting has been taken into account.
7. Publication of the Remuneration Report
After the annual shareholders’ meeting, the remuneration report must be published without delay on the company’s website. It must remain publicly available, free of charge, for ten years.
As part of its audit, the statutory auditor must check that the remuneration report contains the required information.
The Directive also states that Member States must make their existing rules on director’s liability applicable to any breach of the obligations relating to the remuneration report.
Finally, the Directive authorises the EU Commission to come up with non-binding guidelines on a standardised presentation of the remuneration report to ensure consistency.
8. To be continued…
Publication of remuneration policies and data is not new in the EU. In recent years, various initiatives have been taken in Member States to promote shareholder ‘say on pay’. In many countries there are more or less binding rules in corporate governance codes. Various advisors have also for some time focused their attention on exective pay.
Even so, the Directive brings the debate to a different level. Once it is implemented, its requirements can be cast into national law and non-compliance may result in sanctions.
The Directive creates new rights for shareholders but also new responsibilities, as it makes the shareholders’ meeting the ultimate arbiter of executive pay policy. At the very least, it promises to provoke lively debate on executive pay in shareholders’ meetings in years to come…