Op-ed in today’s Europolitics:
In a strong signal about the importance of fostering sustainable and transparent companies, the European Parliament’s Committee on Legal Affairs (JURI) approved, in May, a number of revisions to the shareholder rights directive that aim to enhance the role of long-term shareholders in corporate governance. The changes include the introduction of ‘say on pay’ (with employees having the right to express a view) incentives to hold shares for more than two years and country-by-country reporting.
Shareholders do not own corporations
The directive will explicitly acknowledge that shareholders do not own corporations – a first in EU law. Contrary to the popular understanding, public companies have legal personhood and are not owned by their investors. The position of shareholders is similar to that of bondholders, creditors and employees, all of whom have contractual relationships with companies, but do not own them.
Giving voice to long-term investors
In 1960, the average holding period of stock in the S&P 500 was eight years. Today, it is four months. In the 1950s, the average life expectancy of a Fortune 500 company was 50-60 years; now it is 15 years. Executives point to pressure from capital markets as making it impossible to steer companies towards sustainable, long-term growth.
The new directive seeks to tackle the problem by requiring member states to give additional voting rights, tax incentives, loyalty dividends or loyalty shares to investors who hold shares for more than two years. This will reward patient investors, who have a better understanding of the business than short-term investors.
Democratic decision making on executive pay
Executive pay at FTSE 350 companies has increased by 233% since 2000, while pre-tax profits have increased by 95% and market value has only increased by 65%. The directive will promote the accountability of senior executives by giving shareholders a right to vote on the company’s remuneration policy every three years, which must include the maximum of directors’ average pay and the ratio between the pay of directors and workers. Employees will also have a right to express an opinion, which is a positive development that may help to stimulate engagement.
The aim is to shift increase transparency and accountability to long-term shareholders, as well as better align management remuneration with company performance. Current practice varies across member states: shareholders in UK companies have a binding vote and Germany introduced advisory ‘say on pay’ votes in 2009, but the changes will be completely new for many other European countries. There is not yet any clear evidence about the effectiveness of these provisions. Indeed, critics question whether the proposed changes will fix the root causes of short-termism or rather given additional powers to stockholders at the expense of companies’ ability to steer business strategy.
Increasing tax transparency
The recent explosion of the LuxLeaks scandal, which revealed that more than 300 companies had received secret tax rulings from Luxembourg allowing them to drastically reduce their tax burden, has shown how critical it is for companies to engage in responsible tax practices and for this to be monitored through appropriate international mechanisms. EU policy makers propose to address this issue through the introduction of country-by-country reporting, which would require companies to disclose their profits, revenue generated, taxes paid and the number of employees in each country where they have an operating subsidiary.
Currently, information is disclosed in a consolidated global report that does not break down information according to country of operation, making it difficult to determine whether companies are avoiding taxes through the use of tax havens or other forms of aggressive tax planning.
Consequences of changes
Following the vote in the Legal Affairs Committee, the changes will now go to a a vote in plenary before proceeding to trilogues. If passed, it remains to be seen whether the changes to the shareholder rights directive will have any effect on the behaviour of markets. There is nearly universal consensus about the need for patient capital to invest in long-term innovation and R&D but widely diverging views about how best to foster it.
Perhaps the root challenge is that the current proposal relies almost exclusively on shareholders to drive the shift to a longer-term perspective. This myopic focus on shareholders neglects potentially valuable input from other stakeholder groups, such as employees, who have a stronger stake in the company’s competitiveness and viability. Moreover, shareholders differ considerably in their time frames and approaches. Some shareholders are committed to holding for the long term, whilst others only hold for the short term. It is important that the former group become more engaged; however, there is a danger that the proposed directive will further empower shareholders with a short-term orientation, such as hedge funds and activist investors.
Beyond the directive
Achieving sustainability in European enterprises will require modification of the legal and regulatory framework at the national and EU levels, in addition to improvements to business education, practice and culture. We need a shift away from the current shareholder-centric approach to corporate governance and company law towards a model that prioritises the long-term interests of the company, whilst respecting the interests of shareholders and other stakeholders.