The European Commission yesterday adopted two Recommendations relating respectively to directors' pay and the role of independent directors. Neither will be binding on Member States, but both seek to converge practices within Europe.
The Recommendations form part of the Commission's Company Law Action Plan, adopted in May 2003, which aims to promote the creation of a dynamic and flexible corporate governance framework within the EU.
The Action Plan contains a set of initiatives aimed at strengthening shareholders' rights, reinforcing protection for employees and creditors, increasing the efficiency and competitiveness of European business and boosting confidence on capital markets.
Public consultation on the Action Plan as a whole, which ended in mid-September 2003, revealed consensus behind its main measures. The Commission then committed itself to further open consultation on each of the key measures, as a result of which the Commission has now issued the two Recommendations.
Director's Pay
According to the Commission, this Recommendation takes due account of efforts already made by several Member States, including the UK, and aims to foster these developments by identifying best practices to ensure greater convergence in the EU.
The Commission recommends that Member States ensure that listed companies disclose their policy on directors' remuneration and tell shareholders how much individual directors are earning and in what form. It invites Member States to adopt measures in four areas:
Remuneration Policy: all listed companies should release a statement of their policy on directors' remuneration for the following year. It should include information on the breakdown of fixed and variable remuneration, on performance criteria, and on the parameters for annual bonus schemes or non-cash benefits. It should also explain the company's contract policy. The company should not have to disclose commercially sensitive information.
Shareholders' meetings: remuneration policy for directors should be on the agenda of the shareholders' general meeting. To increase accountability, it should be submitted to a vote, which may be either binding or advisory. An advisory vote would require neither directors' contractual entitlement nor remuneration policy to be amended.
Disclosure of the remuneration of individual directors: this should include detailed information about: the remuneration and/or emoluments of individual directors; the shares or rights to share options granted to them; their contribution to supplementary pension schemes; and any loans, advances or guarantees to each director.
Approval of share and share option schemes: variable remuneration schemes under which directors are paid in shares, share options or any other right to acquire shares should be subject to prior approval of the Annual General Meeting of Shareholders. The approval relates to the system of remuneration and the rules applied to establish individual remuneration under the scheme. It would not relate to the individual remuneration of directors.
"This is about providing guidance to Member States in ensuring that shareholders know what is going on and can get things changed if they do not like them," said Internal Market Commissioner Frits Bolkestein, announcing the measure.
"There is a conflict of interest when executive directors take part in setting their own pay. Shareholders should be better informed - they are the company, not the management. They must make sure remuneration policy gives enough incentive to directors and is right for the company," he explained.
Independent Directors
"There are groups within listed companies which sometimes have different interests – management, major shareholders, minority shareholders. There need to be 'referees'," said Commissioner Bolkestein. "So boards should have a sufficient number of independent non-executive or supervisory directors who can nip potential conflicts of interest in the bud."
To this end, the Commission has published its Recommendation on the presence and role of independent non-executive directors on listed companies' boards, stressing that since differing approaches to corporate governance are deeply rooted in national traditions, particular care has been taken to provide for maximum flexibility in the ways Member States can apply the principles in this Recommendation.
Protecting shareholders, employees and the public against potential conflicts of interest, by an independent check on management decisions, is particularly important to restore confidence in financial markets after recent scandals, said the Commission.
Accordingly, the non-binding Recommendation concentrates on the role of non-executive or supervisory directors in key areas where executive or managing directors may have conflicts of interest. It includes minimum standards for the qualifications, commitment and independence of non-executive or supervisory directors.
The main principles in the Recommendation are:
The administrative, managerial and supervisory bodies should include overall an appropriate balance of executive/managing and non-executive/supervisory directors so that no individual or small group can dominate decision-making.
Boards should be organised so that a sufficient number of independent non-executive or supervisory directors play an effective role in defining and dealing with potential conflicts of interest. To this end, nomination, remuneration and audit committees should normally be created within the (supervisory) board. The Recommendation defines minimum standards for the creation, composition and role of those committees.
A director is considered independent when free from any business, family or other relationship – with the company, its controlling shareholder or the management – which might jeopardise his or her judgement.
The (supervisory) board should be composed of members who, taken together, have the diversity of knowledge, judgement and experience to properly complete their tasks.
All directors should devote to their duties the necessary time and attention. When the appointment of a director is proposed, his or her other significant professional commitments should be disclosed.