Institute of Law
Compensation and Remuneration
Gesellschaftsrecht (Master) – Lecture 11 25 November, 2013
Prof. Dr. iur. Kern Alexander Institute of Law
L1 Introduction L2 Common Principles of Corporate Law across Jurisdictions L3 The Role of Shareholders and Agency Problems L4 The Role of the Board of Directors L5 Reading Week – No Lecture L6 Investor Protection and Minority Shareholders Rights L7 Corporate Personality and Cross Border Transactions L8 EU Company Law L9 Law of Insider Dealing and Market Abuse L10 Takeovers and Mergers L11 Compensation and Bonuses L12 Corporate Governance, employees and corporate social responsibility L13 Role of Accountants – a “True and Fair View” plus Exam Review
12/6/2013 Lecture 7 Gesellschaftsrecht - Prof. Kern Alexander Page 2 Institute of Law Main Points
• Main principles and background • UK code of corporate governance and company law • UK financial services regulation of remuneration • EU financial services regulation • Swiss corporate law regulation of remuneration
Page 3 Institute of Law
Objectives of remuneration regulation 1. Reduce principal-agent problem – asymmetric information. Enhanced shareholder monitoring and complete contracts to control bankers‘ excessive risk-taking and enhance firm peraformance
2. Public policy concerns of taxpayer subsidies to financial firms (ie., bailouts) that encourage failed business and risk management. Subsidies create moral hazard to encourage greater risk-taking than what is socially optimal.
3. Social and political backlash at huge salary differentials and big bonuses – ‚Occupy the City‘, ‚Occupy Wall Street‘
06.12.2013 Seite 4 Institute of Law Compensation Excesses
Severance payments (golden parachutes) in 2008: - Marcel Ospel (President B.o.D.): CHF 2.3 Mil. - Peter Wuffli (CEO): CHF 20 Mil. - Huw Jenkings (Chief Investment Bank): CHF 20 Mil.
Institute of Law Swiss corporate law governing remuneration • Swiss Corporate Governance rules - 1991 • Board of directors sole right to determine remuneration policy - Art. 716 CO • Duty of loyalty and duty of care • Before 2007, Board only had to provide information about remuneration upon request by shareholder(s) (if necessary for the execution of shareholders rights & not against general interests of company) • To date: the Board has been largely free to determine and approve compensation
Page 6 Institute of Law Swiss Code of Obligations amendment - 2007
- Requires detailed disclosure of total compensation (to board of directors & management board) Art. 663bbis CO - Until 2013, Swiss corporate remuneration regulation was essentially ‘soft law’
Institute of Law Soft law - Legally non-binding guidelines & recommendations
• Corporate Governance Directive (SIX) • Swiss Code of Best Practices (economiesuisse) • Remuneration Schemes (FINMA)
More transparency & protection of shareholders «comply or explain-principle»
Page 8 Institute of Law UK Companies Act 2006 & Combined Code on Corporate Governance Greenbury Committee 1995 – Code of Best Practice for Director’s Remuneration. Remuneration committee consists mainly of non- executive directors to determine executive compensation Listed companies required to publish report on directors’ remuneration as part of annual report and report specific details of director’s package and company’s remuneration policy and remuneration committee role/membership. CA 2006 s. 420. Remuneration report must be submitted for shareholder approval (advisory vote)(as a whole, not individual packages) by way of an ordinary resolution at general meeting where company accounts are laid. CA 2006 ss. 420-422. role of institutional investors Performance-related incentives important. 1 year or less for directors, but CA 2006 s 188 allows for contracts > 2 years
Page 9 Institute of Law
UK financial sector remuneration regulation
European Commission Recommendations (2009)
FSA Remuneration Code 2009 – implemented into FSA regulations.
Financial Services Act 2010 – FSA statutory powers to require disclosure Regulate the way banks pay employees Recover deferred and undeferred compensation (malus &clawback)
Seite 10 Institute of Law EU Remuneration Regulation
• Complex web of overlapping legal & policy acts
• Since 2001, corporate governance principles (recommendations & guidelines)
• Main basis for remuneration reforms in financial sector: CRD III & CRD IV package – (consisting of Regulation & Directive)
• 2012 Action Plan – «engaging shareholders» Institute of Law EU Capital Requirements Directive III
• Align remuneration with effective risk management
• Prescriptive rules-based regime for bonus controls – 50%, 40%/60% rule
• Performance-based measures over time as risk materialises and bonus adjustment rules
• Enhanced corporate governance (ie.,independent remuneration committees) and proportionality
• Covers most EU-based financial firms and overseas branches and EU subsidiaries of non-EU groups
Seite 12 Institute of Law
EU/UK remuneration regulation under CRD III – all regulated financial services firms • FSA Revised Remuneration Code 2010 – Principle 12 ‚remuneration structures‘ • Reluctant adoption of 50%, 40%/60% rule • Critical of CEBS interpretations • EU Proportionality Principle • De minimis rule • 4 classifications of firms – application intensity depends on firm size, nature of risks, and market inter-connections • Performance adjustment – malus and clawback
Seite 13 Institute of Law Capital Requirements Directive: A Directive and Regulation Based on 2012 Action Plan and Basel III Capital Requirements Directive • Effective January 2014 • EU based credit institutions, investment firms & non-EU subsidiaries of such entities + EU subsidiaries of financial institutions headquartered outside EU. • Any staff with material risk (interpreted & applied by EBA) • Required disclosures of variable pay for staff with material risk
Institute of Law The Capital Requirements Regulation
• Limitation on firm discretion to pay guaranteed variable remuneration • 1:1 capped variable/fixed ratio • Between 1-2:1 variable/fixed ratio only with shareholder approval. • Deferral of payment – 60% over 3-5 years & 50% in equity-linked interests (CRD III rules) • Malus/clawback arrangements (up to 100%) • Remuneration Committee required disclosures Institute of Law Challenges of implementation
CRD III/CRD IV remuneration requirements – especially rules- based bonus structures - increase complexity Difficult for shareholders and stakeholders to comprehend complicated rules.
Limits effective disclosure to the market, thereby reducing shareholder protection and weakens risk management. Lack of disclosure of pay bands
Unintended effect of increasing excessive risk-taking and undermining firm performance?
Seite 16 Institute of Law Minder Initiative
March 2013, approved by 67,9% of Swiss voters Institute of Law Minder Initiative
• Art. 95 para. 3 FC • «Ordinance against Excessive Compensation (OaEC)»
Major Amendments: • Shareholders Say-on-Pay (binding) • List of prohibited types of compensation • Criminal Sanctions for infringement
Some legal uncertainty and political controversies
Page 18 Institute of Law Minder Initiative Say-on-Pay (Art. 95 para. 3 (a) FC): “The general meeting votes on an annual basis on the total amount of all remuneration (money and the value of benefits in kind) given to the board of directors, the executive board and the board of advisors.” Prohibited list (Art. 95 para 3 (b) FC): “The governing officers may not be given severance or similar payments, advance payments, bonuses for company purchases and sales, additional contracts as consultants to or employees of other companies in the group.”
Page 19 EU-Swiss comparison
Institute of Law EU Switzerland Goal CRDIII: Make financial institution become more resilient against FINMA soft law approach adverse market conditions and thus contributing to the stability of the financial sector.
Scope CRDIII(10)-(13)/CRDIV. All regulated EU financial services firms All listed Swiss public companies. Board of & staff whose professional activities have a material impact on directors, management, advisory board the risk profile of the financial undertaking
Rem Co CRDIII: independent from the business units they oversee, have Shareholders say on pay for all 3 groups – appropriate authority, and be compensated in accordance with Board, management and advisory board the achievement of the objectives linked to their functions, independent of the performance of the business areas they Ban on certain types of compensation: golden control. hellos, golden parachutes etc EBA: At least one member of the Rem Co should have sufficient expertise and professional experience concerning risk management and control activities. Risk CRDIII 50% - 40%/60% variable structure over 3-5 years. Alignment between shareholders and alignment CRD IV Fixed/Variable component: 1:1 variable cap to fixed, up to management but not with social risk 2:1 variable-fixed annual cycle of performance measure EBA: offer kinds of financial instruments for deferred pay. Malus and clawback arrangements
CRDIII 7-9/CRD IV Disclosure for listed companies to shareholders Disclosure Pillar 3 remuneration disclosures
Liability CRDIII/CRD IV – administrative sanctions against financial firm Criminal sanctions Institute of Law Swiss ‘1:12’ Initiative - 12:1 ratio of earnings of highest /lowest paid employee – 24/11/2013
• Swiss company Victorinex (red penknives) – now has 6:1 ratio highest earners to lowest earners • Different industries require differing levels of expertise and companies can relocate high-paid earners • Swiss multi-nationals have much higher than 12:1 ratio • Highest multiple – Roche Severin Schwan 261:1 • Nestle & Novartis also pay highest earner > 200 times • UBS/CS/Sprungli/Lindt – 200-100:1 ratios • Apply to 1300 Swiss companies
Page 21
Institute of Law Moral hazard of large investors & shareholder stewardship
• Role of large bank shareholders encouraging excessive risk- taking
• Limited liability structure creates moral hazard for shareholders to pressure the board/executives to approve greater risk-taking and reward it with lavish bouses. Prior to crisis, greater leverage increased risk-adjusted returns on equity (ROE) (25% for some large banks). New metrics on performance needed.
• Limitations on limited liability?
• New culture of shareholder stewardship?
Seite 22 Institute of Law Conclusion
• Executive compensation excesses late 1990s/2000s • The risks posed by up-front cash bonuses in banking sector • EU goal of remuneration regulation not to limit pay, but for compensation packages to incentivise and align the interests of employees with shareholders. • But in some case – banking/financial services – aligning interests with shareholders can lead to excessive risk-taking that puts firm and society at higher risk. Therefore, remuneration regulation must be sensitive to both agency problems and social risks. • Difficulties and challenges in determining the regulatory rules cvan lead to market unforeseen distortions
Page 23 A comparison with China
Institute of Law EU China Goal CRDIII: Make financial institution become more resilient against CBRC: improve the risk management in banks, adverse market conditions and thus contributing to the stability of enhance the stability of financial system. the financial sector. CIRC:build a set of standard compensation system for insurance company. Scope CRDIII(10) (13) /staff whose professional activities have a all banks-all staff, special requirement for senior material impact on the risk profile of the financial undertaking managers and risk-takers/ all insurance companies registered in China -senior managers mainly. Rem Co CRDIII: independent from the business units they oversee, have CBRC: Rem Co is necessary, and over 1/3 appropriate authority, and be compensated in accordance with should be experts in finance, be familiar with the the achievement of the objectives linked to their functions, risk of every product line. independent of the performance of the business areas they control. CIRC: independent director is responsible for the CEBS: At least one member of the Rem Co should have sufficient remuneration committee. expertise and professional experience concerning risk management and control activities. Risk CRDIII 4.1-5.4 Fixed and variable component/ cycle of CBRC: over 40% of total compensation should alignment performance measure be deferred after 3 years(at least ). CEBS: offer kinds of financial instruments for deferred pay. CIRC: for CEO and board member, over 50% of compensation should be deferred. CRDIII 7-9 CRBC:Structure of remueration committee, Disclosure Pillar 3 remuneration disclosures remueration pool, detailed information of the board and CEO, reason for exceptions.
Liability Not mention in CRDIII Not mention