Leiden Law Blog

Shareholders, executives and banks: Does he who pays the piper, still call the tune?

Posted on by Tom Dijkhuizen in Private Law
Shareholders, executives and banks: Does he who pays the piper, still call the tune?

Executive compensation has been under severe public scrutiny since the outbreak of the financial crisis. In particular, the structure of the remuneration policies of banks is perceived to be one of the many factors that have contributed to the financial crisis, as these structures incentivized excessive risk-taking and short-termism that in turn threatened the global financial stability. In order to prevent such excessive risk-taking and short-termism, the European legislator has tightened the remuneration requirements for bankers. These new requirements will, however, have an effect on the powers and interests of shareholders, as they hinder the use of remuneration structures to align the interests of executives with their own interests. This ponders the question whether he who pays the piper, still calls the tune?   

Executive remuneration has been a key issue in corporate governance for over a decade now. Originally, it was thought that remuneration policies were the solution to the principal-agent problem between the shareholders of a (dispersed) publicly owned company and the company’s executive directors, as a well-designed remuneration policy would give the director (or manager) incentives to decide on and pursue those actions that would maximize shareholder wealth. In other words, an efficient incentive-based executive pay contract could provide powerful means for aligning the interests of the shareholders and directors and for addressing agency costs within companies with dispersed or blockholding ownership.

However, corporate scandals such as Enron and WorldCom in the United States and Parmalat, Vivendi and Mannesmann in Europe gave rise to popular unease at the high levels of executive remuneration. Moreover, it was the recent financial crisis, which began in 2007, that provoked high levels of public hostility to, in particular, executive remuneration policies in the financial sector and which gave rise to ‘a new global prominence of a perceived link’ between executive remuneration policies and the stability of the global financial system. In the end, both developments led to increased attention for executive compensation and to regulatory responses across many jurisdictions, often fuelled by the European legislator.      

From a corporate governance perspective, it is interesting to see whether and to what extent these European legislative measures intervene in the governance of listed companies in general and banks in particular. The new requirements may, for instance, run the risk that executive remuneration is ousted from the debate between shareholders and the board and ‘pulled into a compliance debate’ with the financial supervisory authorities. In that event, the incentives for shareholders to be involved in the corporate governance of (financial) companies will be (further) diminished. As effective, sustainable shareholder engagement is one of the cornerstones of listed companies’ corporate governance models, caution should be taken and the consequences of these requirements for the involvement of shareholders should be assessed.

The question ‘What is the effect of the tightened remuneration requirements on the powers and interests of the shareholders of banks?’ is one of the issues that will be addressed in the workshop ‘The financial crisis and the impact of Europe on national parliamentary and stakeholder interests’ at Leiden Law School’s ILS Conference ‘Room for reflection’ in January 2015.

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