Guido Ferrarini

Executive Remuneration in Crisis: A Critical Assessment of Reforms in Europe

This article considers the regulation “on the books” of executive pay across the EU and the evidence “in action” on corporate practice concerning executive pay (based on disclosures by FTSE Eurofirst 300 companies) in relation to the best practice recommendations set out in two key Commission Recommendations from 2004 and 2005. It finds that Member State implementation of the two Recommendations has been patchy and, in particular, that reliance on Corporate Governance Codes has not resulted in the embedding of good practices, particularly with respect to disclosure concerning executive pay, across Europes largest companies. It argues that if the EU is to succeed in promoting stronger alignment between shareholder and manager interests by means of the executive pay contract, closer attention is needed to remuneration governance and that a mandatory, harmonised disclosure obligation should be introduced. Although the Commission has recently adopted a 2009 Recommendation on executive pay in the corporate sector generally as part of its response to the financial crisis, the article suggests that this attempt to influence the design of executive pay is misconceived and that attention would have been better focused on the enforcement of basic disclosure obligations.

Executive Remuneration and Corporate Governance in the EU: Convergence, Divergence, and Reform Perspectives

Abstract This article examines the current controversy as to the effectiveness of executive remuneration as a tool of corporate governance but places the analysis in the particular context of the dispersed ownership/blockholding ownership faultline which runs across European corporate governance. It reveals that there is a close relationship between governance systems and the sophistication and rigour of the regulatory response to executive remuneration. To place the European responses to the executive remuneration question in context, Part I sets out the main theoretical arguments which frame the executive remuneration debate and examines the link between remuneration and corporate governance. Part II examines, in the light of the preceding discussion, the regulatory strategies adopted by EU Member States with regard to executive remuneration and reveals the extent to which their responses track corporate governance systems in terms of sophistication and degree of intervention in remuneration practices, particularly with respect to disclosure. Overall, regulatory strategies focus on company disclosure and corporate governance structures, and are grounded both in public regulation and in corporate governance best practices. Part III discusses reform perspectives with particular reference to the 2002 Winter Report and the 2003 Company Law Action Plan.

Directors' Remuneration Before and after the Crisis: Measuring the Impact of Reforms in Europe

In this paper we measure the impact of recent reforms on directors’ remuneration by comparing the remuneration practices at large European listed companies before and after the financial crisis. We analyse the data concerning directors’ remuneration at FTSE Eurofirst 300 Index companies and assess to what extent the changes occurred between 2007 and 2010 reflect the economic crisis determined by the 2008 financial turmoil and the remuneration reforms generated by the same. Our analysis reveals that country-specific characteristics such as corporate governance, firm ownership, and the nature and quality of the legal system still have a relevant impact on the level and structure of directors’ pay.Section I briefly connects our work with previous studies in this area, while section II introduces some core aspects of recent EU and national reforms. In section III, we analyse the data concerning remuneration governance and disclosure, and show that all firms have experienced improvements. However, variations persist reflecting national regulations and practices. Moreover, companies with more dispersed ownership tend to comply better with remuneration governance and disclosure requirements. Our data confirm and extend to Europe theoretical predictions and previous country-specific empirical evidence about the impact of ownership concentration on remuneration governance and disclosure. In section IV, we analyse pay structure and levels. We measure the level of total compensation, the variable component including the estimated value of annual stock grants and stock options. The evolution of total compensation between 2007 and 2010 reveals that pay practices are permeable to the effect of the financial crisis. Board total compensation decreases in most European countries. However, significant differences emerge between financial and non-financial companies, with board compensation at financial firms decreasing rather significantly, while non-financial firms experience less relevant changes. Also the CEO compensation level and structure significantly changed in 2010 relative to 2007, mainly as a result of the reduction in variable cash compensation. This is partly due to the negative performance of firms in 2010. However, our results show that these changes may be also related to other factors, in particular the regulatory pressure on financial firms in the relevant period. Indeed, several items in the pay structure of financial firms go in the direction indicated by regulators, i.e. better focus on the risk implications of pay, appropriate balance between variable and fixed compensation, and a substantial portion of variable compensation awarded in shares or share-linked instruments. Section V concludes by advancing some policy suggestions.

Reshaping Order Execution in the EU and the Role of Interest Groups: From MiFID I to MiFID II

The controversial and long-awaited Commission Proposals to revise the cornerstone Markets in Financial Instruments Directive 2004 (MiFID I) were presented in October 2011. The Proposals are currently going through the Council and Parliament negotiation process, and final agreement is expected sometime in 2013. This article places these important reforms (together, MiFID II) in context by examining the impact of MiFID I since its application to EU financial markets in November 2007, and by considering what MiFID I’s impact suggests for the design of MiFID II. It considers how MiFID I reshaped the EU share trading marketplace and how the dominant interests which shaped MiFID I’s regulatory design fared. It also examines how those interest groups are seeking to shape MiFID II, and the implications. It suggests that the influence of interest groups may have led to overly ambitious MiFID II Proposals which are excessively concerned with investment firm and trading platform interests, and not sufficiently focused on the overall efficiency and effectiveness of EU share trading markets. It calls for a more modest approach to reform, based on fine-tuning MiFID I.

Reforming Securities and Derivatives Trading in the EU: From EMIR to MIFIR

The financial crisis has generated a deep revision of the regulation of securities and derivatives markets. In this paper, we critically examine the extent to which current reforms, such as the European Market Infrastructure Regulation and the proposed new Markets in Financial Instruments Directive and Regulation, will expand “public” securities and derivatives markets, while correspondingly reducing the scope of “private” markets (which broadly coincide with the “unregulated” over-the-counter markets). We also ask whether these reforms will on the whole reduce systemic risks and transaction costs of securities and derivatives trading in Europe. For these purposes, we formulate conjectures that are partly based on the experience of past reforms in the area of equity trading.

Independent Directors and Controlling Shareholders Around the World

In this paper, we examine independent directors as a legal transplant from dispersed ownership systems to concentrated ownership ones. We focus on Continental Europe, Japan, Brazil, Russia, India and China. Our main thesis is that independent directors have a different and relatively narrower role to perform in controlled corporations. We also argue that in the law and practice of controlled corporations independent directors often play an even weaker role than economic theory would predict. In order to prove our thesis, we compare the legal regimes applicable to independent directors across countries. We find that the notion and functions of independent directors vary remarkably across our sample jurisdictions. Firstly, the role of independent directors is not always specified. Secondly, independent directors often play a role in audit committees and, less frequently, in nomination and remuneration committees. However, they are rarely tasked with the vetting of related-party transactions and other conflicts of interest situations. Moreover, controlling shareholders often perform some of the functions that are typical of independent directors in diffuse ownership, such as the hiring and firing of managers and the setting of their remuneration. We conclude that the weak role of independent directors in several countries shows that they are often appointed mainly to accommodate investors’ preference for western-style corporate governance.

Executive pay: convergence in law and practice across the EU corporate governance faultline

This article considers the regulation of executive pay practices in listed companies in the European Union and the empirical evidence of pay practices, based on the FTSE Eurotop 300 memberships annual report for 2001. The analysis is placed in the context of the dispersed ownership/blockholding ownership faultline which runs across EU corporate governance, and in light of recent EU initiatives, particularly the Commissions May 2003 Company Law Action Plan and the 2004 Consultation on Executive Remuneration. The outstanding feature of executive pay in the EU is the extent to which it reflects the interconnection between pay and corporate governance or ownership structures. Executive pay, regarded as a management incentive contract, is a key agency-cost control mechanism in dispersed ownership systems. Legal controls on pay are accordingly at their most sophisticated, in terms of promoting the adoption of an optimal contract for shareholders, in those EU Member States where dispersed ownership dominates. These systems also see the heaviest reliance in practice on high-powered, equity-based, incentive-driven pay contracts. In blockholding systems, controlling shareholders can, in theory, monitor management directly without the need for an incentive contract. Pay controls are accordingly less sophisticated and, as revealed by the FTSE Eurotop 300 evidence, the prevalence of high-powered equity-based incentive contracts is reduced. Different concerns arise, however, as to the protection of minority shareholders from controlling blockholders.

Stock Exchange Governance in the European Union

Stock exchanges are generally viewed as a type of firm that produces ‘transaction services’. They facilitate transactions between buyers and sellers of securities by providing either a centralized location for trades to take place or an electronic system to perform the same function.1 Thus, the primary benefit of exchanges is that they save traders the cost of independently searching for someone on the other side of the transaction.2 Another benefit is that exchanges produce information, as reflected in the prices of the instruments traded on them.3

CRD IV and the Mandatory Structure of Bankers’ Pay

In this paper, I analyse the rise of mandatory structure of bankers’ pay in Europe as outcome of criticism of pre-crisis remuneration practices at financial institutions. Whether flawed bankers’ pay contributed to the financial crisis is still debated amongst scholars. It appears more likely that insufficient prudential regulation and flawed risk management contributed to banks’ undertaking risks that were later proven to be excessive from a societal perspective. All this would have suggested improving risk management systems and reforming areas of prudential regulation such as capital adequacy and organizational requirements, rather than intervening directly on bankers’ incentives. Nonetheless, governments and legislators, under the pressure of the media and public opinion, proceeded to extensive reforms of bankers’ remuneration, with reference to both the top executives and other risk-taking/high-earning employees at various levels of the institutions concerned. Indeed, the FSB principles and standards cover not only remuneration governance and disclosure, but also remuneration structures. Both the fixed and the variable remuneration components and the relationship between the same are subject to detailed regulation. As a result, the international standards have nature of “rules” and have been implemented as such. The EU in particular has followed a strict approach to the implementation of the FSB standards and has also departed from the latter by introducing an unprecedented cap on variable remuneration in CRD IV. I analyse this cap from a legal and economic perspective, showing that its rationale is flawed and that unintended consequences may derive from it as a result. Moreover, the cap is inconsistent with other aspects of CRD IV which incorporate the international standards on variable pay.

Corporate Boards, Incentive Pay and Shareholder Activism in Europe: Main Issues and Policy Perspectives

In this chapter, we offer an overview of the present volume, placing the same in the context of recent European Union (EU) reforms and of corporate governance theory and summarising the main outcomes of the following chapters. In addition, we offer some policy perspectives – as to boards, incentive pay and shareholder activism – based on the theoretical and empirical outcomes of the research project of which this volume is the product. In drawing this broad picture, we underline particularly that variances in ownership structures of listed companies and in the adoption of either a shareholder value or a stakeholder approach have pervasive implications for corporate governance issues. For example, board composition criteria may reflect a stakeholder orientation, such as that found in the German codetermination system (Schmidt 2004). Also the board’s function, the role of independent directors and incentive pay arrangements may vary depending on whether diffuse shareholders or blockholders own the company. Similarly, diffuse ownership companies represent the natural setting for shareholder activism, which may not be a cost-effective solution in controlled corporations.