The EU asks for corporate governance, American Investor, May 2011

The aftermath of the global financial meltdown takes a heavy toll, may effect business regulations

Corporate governance is a hot topic now. The recent crisis made legislators around the world less liberal and more suspicious not only towards financial institutions, but corporations in general. They are more and more aware of the influence that management and control over corporations has on the market and hence on the society. On the other hand, firms themselves have a significant interest in maintaining their image as well-governed, transparent and fair. Not only the results, but also the governance process influences a firm’s perception in the eyes of its prospective shareholders, and even consumers. In short, internal corporate process is no longer just internal.

EU concerned

The lesson the European Commission learned from the crisis resulted in last year’s Green Paper Corporate Governance in Financial Institutions and Remuneration Policies. On April 5, 2011, the Commission issued the more general Green Paper entitled The EU Corporate Governance Framework. The Commission is even considering the desirability of expanding corporate governance standards to unlisted corporations. As different companies have different problems, the Commission wonders if different measures should be adopted for corporations of varying type and size.

Despite the Commission’s assurance that non-financial firms are not to be punished for the crisis, as they did not cause it, the latest Green Paper contains an extensive review of the crisis. Some problems are explicitly labeled as having contributed to the crisis, and some justifications are drawn from the consultations on the previous Green Paper devoted to financial institutions.

The point is not that the Commission, haunted by memories of the crisis, is going to impose stringent rules on corporate behavior. Rather, it is collecting data to understand and avoid any failures that might lead to a future disaster like the one that occurred in the financial markets.

Going deep

The scope of the new Green Paper is quite extensive and, indeed, impressive. It covers subjects ranging from corporate governance for unlisted corporations, and diversification of corporate boards, to addressing and redressing “short-termism,” from the shortcomings of the “comply or explain” model to risk management and external board evaluation, and from directors’ salaries to minority shareholder protection and participation, to employee shares. These are divided into three main headings: board of directors, shareholders, and the “comply or explain” framework.

The EU is not about to regulate the whole field of corporate life. What is more, the Commission is in no way obliged to take any further steps, and it may well feel satisfied with the situation as presented by the feedback it receives. It is solely for the Commission to decide how and whether EU law in this area should be improved. Nonetheless, we may expect proposals for both binding and nonbinding measures. Even if the Commission acts, it may restrict itself to soft law. However, given the fact that three subsequent recommendations (on compensation of directors and on the role of non-executive directors) were more or less ignored by the member states, one might expect attempts to adopt some binding acts, such as directives.

It seems that the Commission is more concerned with non-executive directors than with executive directors (under the dual model, e.g. in Poland, that means supervisory boards rather than management boards). It is assumed that inadequate supervision played a part in the recent crisis. The Green Paper presents greater diversity as a hedge against herd thinking and proposes various solutions for improving involvement of non-executive directors.

Room for improvement

Plainly, improving diversity means more women and more foreigners. The Commission regretfully noted the underrepresentation of women on boards. (For example, according to a Commission study, 47% of listed corporations in Poland have no women on the board at all.) While less acute in terms of discrimination, the lack of foreign points of view is even more severe in terms of statistics. Sticking to the Polish example, 68% of listed companies do not have any foreign director on the board.

Another question is whether to require any special qualifications of non-executive board members. Additionally, it might be beneficial to introduce board evaluation, which could be both internal and external. This would presumably raise quality. For greater engagement in the firm’s affairs, the Commission is considering the possibility of limiting the number of positions one director may hold on various boards.

Finally, the Commission is pondering whether to introduce transparency of directors’ compensation and shareholder voting on the directors’ payroll.

Long-term rules

Another big issue is short-termism. The Commission wants corporations to disclose risk and think of the long term instead of stressing short-term yields. To this end, it attempts to improve shareholders’ involvement. However, the problem is that some shareholders are satisfied with short-term profits and neglect the long-term perspective, which is vital for the society as the whole. As a result, to alter management’s short-term perspective (reinforced by compensation systems), it is not enough to engage the shareholders in supervision. The percentage of long-term investors is shrinking, as is the average holding period for shares.

Interestingly, part of the Commission’s answer is to identify all EU provisions contributing to short-termism (such as accounting rules). Introducing transparency of institutional shareholders’ voting policies is also under consideration. Indeed, “transparency” is the keyword in the Green Paper. Following the US example, the Green Paper also touches on the issue of proxy advisers (firms providing voting advice to shareholders, attending meetings as their proxies and so on).

Minority counts

Finally, the section dealing with shareholders takes another pass at the Gordian knot of minority shareholders’ rights. Basically, the question is whether to assign more rights to them, and in particular how to protect them against related party transactions (withdrawing assets from the firm).

The Green Paper is intended to launch consultation by raising several questions and asking interested parties to submit contributions. This may be an opportunity for AmCham member firms to express their beliefs and reservations, which they may do until July 7, 2011. Further details about submissions, as well as the Green Paper itself, may be found on the Commission website at


Published in: American Investor, May 2011