Governance Matters: Convergence in Law and Practice Across the EU Executive Pay Faultline

Abstract

This paper 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 membership's 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 Commission's May 2003 Company Law Action Plan. 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.

At present, notwithstanding a growing pan-EU concern with executive pay, it cannot be regarded in a monolithic fashion for pan-EU reform purposes. A shift to more pervasive equity ownership across the EU may, however, bring the problems currently associated with pay practices in dispersed ownership systems. The governance and disclosure matrix proposed by the Commission's Company Law Action Plan to address the conflicts of interests inherent in executive pay setting may, therefore, be important as a precautionary measure. The Action Plan's executive pay proposals also reflect the growing convergence among Member States, on both sides of the governance faultline, as to the importance of full, individualized disclosure of executive pay and of the remuneration committee in managing conflicts of interests in the executive pay process.

Keywords: Executive pay, Corporate governance, Ownership structure, Company disclosure, Remuneration Committee

JEL Classification: G3, G38, J33, K22