Corporate Governance Reform in the European Union

Does the European Commission know what it is doing about Corporate Governance? We look at corporate governance reform in the European Union following the global financial crisis

Developments in corporate governance in the Commission

European Union: the European Commission and corporate governance

In 2005 the Commission set about, in its own words, “modernising company law and enhancing corporate governance in the European Union” to improve the rights of shareholders of companies across the Member States. In June 2007 it adopted a Directive on Shareholders’ Rights which had to be implemented in member states by summer 2009, whose purpose was to “ensure in particular that shareholders have timely access to the complete information relevant to general meetings and facilitate(s) the exercise of voting rights by proxy”.  Additionally, it attempted to tackle the issue of share blocking and related practices. Amongst other objectives, it was aiming to help shareholders in publicly traded companies to hold those companies to account.

In 2008 the global financial roof fell in and there was a subsequent search for scapegoats to blame. This caused much popular challenging of the way very large financial corporations, in particular, had been managed and  much discussion and argument about how to prevent such perceived bad behaviour causing a similar future disaster. So, as part of its own contribution to the debate, in April 2014 the European Commission presented a proposal for the revision of the Directive on Shareholder Rights. It identified “certain corporate governance shortcomings in European listed companies. These shortcomings relate to different actors: companies and their boards, shareholders (institutional investors and asset managers) and proxy advisors. Identified shortcomings related mainly to two problems: insufficient engagement of shareholders and lack of adequate transparency.”

What is the Commission’s rationale for its proposal to improve Corporate Governance in the member states of the European Union, and what is it proposing?

It has concluded that its direction of travel is driven by the “two objectives of enhancing transparency and engaging shareholders”. Certainly no objective observer would quarrel with this. It goes on to say that “the overarching objective of the current proposal to revise the Shareholder Rights Directive is to contribute to the long-term sustainability of EU companies, to create an attractive environment for shareholders and to enhance cross-border voting by improving the efficiency of the equity investment chain in order to contribute to growth, jobs creation and EU competitiveness”. 

Additionally, “it contributes to a more long-term perspective of shareholders which ensures better operating conditions for listed companies”. 

So far, so good, but then it gets more specific. In an Impact Assessment, it identifies five main issues: ”1) Insufficient engagement of institutional investors and asset managers; 2) Insufficient link between pay and performance of directors; 3) Lack of shareholder oversight on related party transactions and 4) Inadequate transparency of proxy advisors 5) Difficult and costly exercise of rights flowing from securities for investors.”

It sensibly picks up the (UK driven) comply or explain approach on the basis that this gives member states the flexibility to interpret the Directive in ways compatible with their local culture. But it then goes on to say that certain elements of corporate governance should be dealt with in a “more binding form”, particularly shareholder identification, the transparency and engagement of institutional investors and board remuneration. It then spells out its preferred options:

“1) Mandatory transparency of institutional investors and asset managers on their voting and engagement and certain aspects of asset management arrangements;

2) Disclosure of the remuneration policy and individual remunerations, combined with a shareholder vote;

3) Additional transparency and an independent opinion on more important related party transactions and submission of the most substantial transactions to shareholder approval;

4) Binding disclosure requirements on the methodology and conflicts of interests of proxy advisors;

5) Creating a framework to allow listed companies to identify their shareholders and requiring intermediaries to rapidly transmit information related to shareholders and to facilitate the exercise of shareholder rights.”

Naiive or being pulled in different directions?

It seems that there are multiple motivations influencing the people charged by the Commission with improving corporate governance in the European Union. These include:

  • improving the working of the internal market by harmonizing rules and regulations
  • making the EU capital market work more effectively
  • sorting out perceived deficiencies in corporate behaviour
  • improving the competitiveness of EU corporations
  • improving the behaviour of investing institutions and their advisers

This can result in the drafters being pulled in several different directions. But the motivations also include:

  • doing social good and supporting Corporate Social Responsibility
  • promoting equality in the workplace and moderating pay differentials

The proponents look to underpin their objectives by:

  • extending regulations, expanding official reporting and increasing compliance staffing
  • enforcing compliance by  introducing harsher sanctions for those judged to have broken the rules.

Some might say that here is a bureaucracy looking after itself. It considers that the requirements listed above in its preferred options “would best fulfil the objectives without imposing disproportionate burdens”.

However, this proposal is not only internally inconsistent – preaching minimum impact on business while mandating a raft of new requirements, but it shows a lack of understanding (or a wilful neglect) of the way corporate governance works. It attempts to impose on shareholders duties which they have, for very good reasons, delegated to the board. Anyone who has given more than passing consideration to the issue of stewardship in corporate governance knows the difficulty of getting shareholders in public companies to engage more closely with their investee companies. Indeed, we wrote about these issues in our article on Stewardship and the likely effects following the 2010 introduction of the Stewardship Code in the UK. 

The European Confederation of Directors’ Associations, ecoDa, which represents national institutes of directors throughout Europe (around 50,000 individual directors) has written a paper setting out its reaction to the proposal for a Shareholder Directive, making the point that this attempts to place on shareholders important areas of decision making which more properly belong in the boardroom. Boards of directors are charged by shareholders with the fiduciary duty of supervising the corporate management on their behalf. ecoDa is too polite to say that the Commission simply doesn’t understand the way business works, but the message is there.

This is a worrying development in the approach of the Commission to what should be the encouragement of good corporate governance in the EU.

Recent developments

Compounding these worries is the most recent reshuffle of the duties of the Commission among the various Directorates. Following Jean-Claude Juncker’s appointment as President-elect of the EU earlier this year, he announced in September various changes to the allocation of duties in the various directorates of the Commission. In the context of this article, the most worrying was the planned transfer of the Directorate F (Capital and Companies) away from the DG for Internal Markets. Directorate F currently embraces four departments - F1 Free movement of Capital, F2 Corporate Governance and Social Responsibility, F3 Accounting and Financial reporting, F4 Audit and Credit Rating Agencies. All of the Directorate F will be transferred to the DG for Financial Stability, Financial Services and Capital Markets Union with the exception of  Directorate F2 which is being transferred to the DG for Justice.

Looking back at the Shareholder Rights amendment proposal, which is all about corporate governance, it described itself as “consistent with the existing regulatory framework. In particular, the new Capital Requirements Directive and Regulation”. This would surely suggest that, if it was going to leave the DG for Internal Markets, F2 might belong in the DG for Financial Stability, Financial Services and Capital Markets Union. Sending it to the DG for Justice sends a very different signal.

The message it sends is that the Commission plans (indeed, prefers) to take a legalistic approach to regulation covering corporate governance. Moreover the areas covered by the Justice Directorate - Justice, Consumers and Gender Equality - embrace such currently contentious areas as fundamental Human Rights, gender equality and consumer affairs, consumer health and food. All this suggests not only a more legalistic direction but one highly influenced by social affairs and staffed by people whose beliefs and personal agenda may be potentially inimical to the corporate world. This may be alarmist but….

ecoDa, referred to above, has written to the Commission and to the members of the European Parliament drawing their attention to the illogicality of placing corporate governance into the Justice Directorate. It makes the case for it to remain in the planned Internal Market, Industry, Entrepreneurship and SMEs directorate.

Ignoring recent experience?

The UK implemented its Cadbury rules on corporate governance over twenty years ago, based on principles rather than detailed rules and an approach to enforcement based on comply or explain. Subsequently, a version of this has been adopted round the world, except in the US, which has its own approach to corporate law and governance. The experience thus far is that most countries are happy to adopt a set of rules which are recognisably similar to those initiated in the UK Corporate Governance Code. This has unquestionably improved governance to a degree, and such organisations as the World Bank routinely insist on such a framework being in place before they commit to investing in such countries. However, the degree to which the rules are implemented in spirit as well as letter is much less certain. Even in the settled and well trained UK, as we have said before, the Stewardship Code, while well-intentioned, is unlikely in our view to lead to significant changes in the behaviour of investors, for instance in regards to much criticised “short-termism”. There is little chance of the right boxes not being ticked, however, and little practical possibility of enforcement of the spirit of the Code, in our experience.

So the proposed introduction by the Commission of detailed and legally binding rules on the behaviour of investors covering nearly thirty nations comprising the EU, with widely differing cultures and traditions is, in our view, simply going to lead to bureaucracy, wasted resource and box-ticking. 

To quote Christopher Booker’s famous comment: this is a sledgehammer to miss a nut. Moreover, this would become a classical example of good intentions leading (inevitably) to unintended and adverse consequences.

Much better to adopt a different approach.

Our conclusions

Quoting the Commission again: 

“Harmonisation of disclosure requirements at EU level would be a remedy to asymmetry of information which is detrimental to shareholders and, therefore, plays a key role for minimising agency costs. It would be beneficial for cross-border investment, since it would facilitate comparison of information and make engagement easier and thus less costly. Moreover, it would make companies more accountable to other stakeholders like employees.”

We would certainly agree with the importance of addressing the asymmetry of information available to the various stakeholders in a business and this was the basis on which we developed our survey-based approach to implementing and monitoring good corporate governance. This is set out in our Five Golden Rules of Good Corporate Governance and our Applied Corporate Governance Survey is devised to link the key stakeholder groups (customers, employees, owners, suppliers etc.) regarding their views on the company’s performance against our five golden rules of good corporate governance. Hence the major stakeholders would be asked to express their opinion on whether the company had a strong ethical approach, whether they shared its business goals, if it seemed to be managed and organised soundly and if it operated in an open, transparent way and recognised its responsibilities to be accountable.

The feedback would enable the owners to judge the quality of the stewardship exercised by management, and the auditors to assess how well their audit picked up failings by management as reflected by the survey. Being conducted by the company, using an independent director to oversee the project and an independent professional market research firm to conduct the survey, our Applied Corporate Governance approach would achieve the objectives of the Shareholder directive at a fraction of cost. And, avoiding box-ticking and “capture” by the corporate machine, this would be a far more effective way to promote good corporate governance.


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