The Politics of SHRD II
The new amendment directive on shareholder rights (Directive (EU) 2017/828) was finally published in May 2017 with contents much in line with expectations. The initial proposals made in the aftermath of the financial crisis were sufficiently modified to allow for established practices to continue in most EU jurisdictions. Moreover, control rights of shareholders were not materially affected; SHRD II has largely resulted in status quo with some allowances for governance concerns of the day.
The directive has a few relevant themes: (i) facilitating shareholders engagement; (ii) introducing a stewardship concept for institutional shareholders, (iii) say on pay and (iv) scrutiny of related party transactions.
Shareholder engagement; the directive emphasizes the need for effective shareholder engagement as a cornerstone of corporate governance of listed companies. In this regard, the directive includes provisions requiring intermediaries to facilitate shareholder participation in shareholder meetings. The requirements of the directive are not very onerous but not necessarily very far-going either. Different registration procedures and holding models can still create barriers for practical purposes especially for smaller shareholders to actually participate in shareholder voting.
Stewardship; the directive also sets certain requirements on shareholders. Institutional shareholders are required (on a comply or explain –basis) to publish an engagement policy setting out “how they integrate shareholder engagement in their investment strategy”, including “how they monitor investee companies on … strategy, financial and non-financial performance and risk, capital structure, social and environmental impact and corporate governance”, and how they interact with the target company and use their shareholder rights. The engagement policy shall also address how they manage conflicts of interests. Similar stewardship codes have been in use in the UK. The requirements are based on the understanding that institutional investors and asset managers may have different, and more short-term, incentives regarding their holdings than other shareholders. This may well be true, but there is little evidence that is necessarily problematic. Nevertheless, to the extent that the compliance costs are not overly costly, the disclosure requirements may provide some additional information to other shareholders on the level of monitoring by institutional shareholders and asset managers.
Say on pay; The directive was softened regarding say on pay. From having direct powers to decide director remuneration, shareholders shall now have the right to vote on the remuneration policy of the company – and member states may provide for that vote to be advisory only. The directive provides some requirements on the contents of the remuneration policy, including a reference to director remuneration levels compared to employees. Considering the pressure in the aftermath of the financial crisis to allow for regulatory intervention in remuneration issues, the final directive is still far less onerous than what was originally considered. Remuneration issues have traditionally been, and generally should be, matters left to board discretion (and the board is accountable to the shareholders). However, it must be admitted that remuneration and incentive models have been less than perfect in aligning management interests with those of shareholders. Better quality can certainly be called for in compensation models (requirements for longer holding periods for share based schemes, claw-backs, compensation related to peer indexes etc.). Yet it is not clear that the requirements of the directive are the best ones to develop better quality compensation models.
Related parties; The directive provides increased scrutiny of related party transactions. Material transactions must be announced so that it is possible to assess whether the transaction is fair and reasonable for the company and its shareholders (other than the related party in question). Moreover, such transactions shall be approved “according to procedures which prevent the related party from taking advantage of its position and provide adequate protection for the interests of the company and of the shareholders…”. Member states may, but do not have to, provide that the transactions be approved by shareholders (again, not including the related party in question). Member states can also require that a report be produced and published on whether the transaction is fair and reasonable. The directive correctly requires increased transparency on related party transactions. The requirements in this regard have not necessarily been sufficient - annual disclosures based on IFRS requirements, for example, may be too general and come too late. At the same time, the directive, again correctly, did not provide for mandatory mechanisms which would allow an opportunistic minority, for example, to veto legitimate transactions between a company and a large shareholder. In this regard, it seems that jurisdictions with largely concentrated ownership were able to hold their positions in the EU legislative processes.
The Corporate Constituencies
From a political perspective the directive can be assessed based on how it affects the relative positions of different corporate constituencies, including shareholders (large and small), management and employees, as well as current political concerns related to corporate matters generally (an important aspect of corporate governance in the era post the financial crisis). Indeed, the directive was originally driven by political agendas resulting from the financial crisis. It was argued that corporate governance had provided inadequate mechanisms for the appropriate monitoring of management and of corporate risks. In fact, the directive states that “shareholders in many cases supported managers’ excessive short-term risk taking” and that shareholder monitoring may still be inadequate. Regulatory action pursued in the aftermath of a crisis could generally be expected to favour constituencies other than shareholders, to support protectionist tendencies and to cater to political agendas. The final outcome can be viewed favourably, as at the end of the day the directive did not significantly impede shareholder interests or promote other stakeholders at the cost of shareholders especially as regards the use of control rights. In this regard, the directive clearly reaffirms the primacy of shareholder interests in corporate governance in the EU.
EU Legal Strategies
SHRD II and the legislative process behind the directive may not reflect the best way to develop EU level corporate governance regulation. EU level regulation, as such, has promise for corporate governance in that nationally entrenched and inefficient structures can be side-lined and efforts made towards a more level playing field. However, the legal strategy and the legislative processes of the EU seem flawed. Detailed regulatory initiatives introduced by the Commission are subjected to intense negotiations and lobbying and often end up as watered down instruments – and in many cases rightly so where the effects of the original proposal have not been well investigated. A more general policy approach at the initial level would be appropriate – and then alternative mechanisms can be worked out to implement those policies in different institutional environments. Also, more detailed comparative analysis is still needed with respect to European company law and corporate governance to allow for more nuanced regulatory intervention at the EU level.