All power to the shareholder!?

Opinion article by Vlerick professor Xavier Baeten

In the space of just a couple of days, a European initiative was unveiled to limit variable remuneration (as far as terminology goes, ‘variable remuneration’ seems preferable to ‘bonus’) to 1 year’s salary (2 years with the consent of the shareholders), and that was followed immediately by a Swiss initiative to subject executive salaries to obligatory approval by the shareholders and to abolish all severance compensation.

A couple of thoughts and observations:

A first observation is that confidence in the board of directors appears to be (partially) gone. As a reminder: it’s the board of directors that has the authority to determine executive management remuneration. However, the ‘say on pay’ arrangements – whereby the shareholder is more or less given an advisory function – are rampant. Thus, in Belgium, by virtue of the law of 6 April 2010, it is required that the shareholders approve the remuneration report. Meanwhile, in a great many countries, the shareholders have been given an advisory function concerning executive management’s remuneration. But the question is whether the shareholder is well-placed to evaluate such a complex matter. In addition, there are also several types of shareholders, and it could be that dominant coalitions would start to develop. The Swiss initiative even gives the shareholder an obligatory vote.

Corporate governance

So, are directors not competent enough to steer the issue of executive salaries in the right direction? Recent research from Vlerick Business School contradicts this, at least partially. In the past 5 years in Belgium, for example, the salaries of CEOs in organisations quoted on the stock exchange have risen by 7%, while those of the average employee have gone up 17%. On the whole, the variable remuneration in this period has even gone down, especially in the somewhat smaller organisations listed on the stock exchange. And, notably, in 2011 the directors succeeded in forging a significant link between the CEO’s salary and the company’s performance. This was not yet the case in 2007. These findings are based on a large sample of firms listed in Belgium, France, Germany, and the Netherlands. So there was already a major evolution going on, and it doesn’t seem desirable to have the government become further involved with the ‘design’ of executive salaries. Where variable remuneration in some companies is an important tool for aligning shareholder and executive interests, that’s less the case in companies in which a large portion of the shares are held by a couple of shareholders, who are also more closely involved with the goings on of the enterprise.

Furthermore, the Swiss initiative stipulates that the directors must be re-elected each year. It’s highly questionable whether this will help focus the company on the long-term and sustainability – will it not rather lead to risk-avoidance behaviour, which doesn’t always boost entrepreneurship.

Finally, let us not forget that there are organisations in many countries that specialise in research and education in the area of ‘corporate governance’. Thus, each year in Belgium, GUBERNA trains dozens of directors, providing them with insights into their duties and responsibilities, their monitoring role, their strategic role, and so on. This undoubtedly has an impact on the directors’ professionalism.

What really counts

As a second observation, we would also like to point out the purpose of the various remuneration components, because this sometimes seems to be forgotten. The annual salary remunerates the responsibilities and the complexities of the job. The variable remuneration is dependent on so-called performance indicators – which can be financial (e.g. profit, turnover, share price) and non-financial (e.g. CO2 emissions, customer retention, social relations) in nature, and they can pertain to a period of 1 year, or several years as well. This is a complex and specialised matter that makes a remuneration committee at least justifiable if not even necessary. And what about the severance payment? Well, this takes the form of an insurance premium: when, for instance, a company wants to attract an executive who has worked for several years in another company, it’s only logical that he/she receives an insurance premium in the event that it would not work out (certainly in the first few years with a new employer). This is a better solution than awarding a higher salary.

We cannot rid ourselves of the impression that the ‘diarrhoea’ of regulation will lead to box ticking, with scarce attention to what really counts: the creation of sustainable stakeholder value by means of a strategically embedded remuneration policy.

Related news

  1. New

    Are AI and deep learning the key to unlock the value of big data?

    Date: 26/04/2017
    Category: Opinions
    With fintech on the rise, data are clearly becoming a key ingredient of tomorrow’s business models. Yet, with PSD2, open banking and cross-industry collaboration around the corner, it seems that your data will be shared. To stand out, organisations will need to generate unique insights and understandings from unstructured and open data elements. Are AI and deep learning the key to unlock that much forgotten ‘V’ of ‘Big Data: Value’?
  2. New

    Strict regulation alone is no guarantee of preventing a new banking crisis

    Date: 25/04/2017
    Category: Opinions
    During the banking crisis of 2008, it became painfully clear that excessive risks could remain under the radar far too often and for far too long. However, the tsunami of regulations that was triggered by said crisis in response to the instability in the financial sector is no guarantee that it could not happen again in the future. “After all, decisions are made by people. And while a bank or insurance company can comply with all the formal rules, you also need a healthy risk attitude. Which requires a change of mindset and an open dialogue”, according to Regine Slagmulder, Professor Accounting & Control at Vlerick Business School. She asks attention for the development of a risk culture that goes beyond ticking boxes.
All articles