When the EU first detailed its action plan on company law and corporate governance in May 2003, many noted how different the EU’s solution was from Sarbanes-Oxley. And as each subsequent detail emerges, the schism between the flexible principles-based European approach and the rigid rules-based US one is only increasing.
Dutch lawyer Jaap Winter chaired the high-level group of company law experts whose recommendations formed the basis for the EU’s action plan; its main objectives are to boost shareholder rights and foster corporate efficiency and competitiveness.
Winter, a partner at the Amsterdam law firm of De Brauw Blackstone Westbroek, is also a professor of international company law at the University of Amsterdam and a visiting professor at New York’s Columbia Law School. The International Corporate Governance Network granted him its ICGN award in 2004, calling him one of the most important voices in governance today.
Winter says his appointment to chair the EU committee was as much geopolitical as it was recognition of his personal accomplishments. ‘The commission thought the head of the group should not be from one of the major European jurisdictions, so being Dutch was an advantage,’ he says.
The group was originally set up in September 2001 to advise the EU on European company law and the first thing it did was make some recommendations on takeover law. But its focus changed dramatically after Enron, WorldCom and Tyco. ‘At the April 2002 Ecofin meeting the finance ministers called on us to review director pay and non-executive director pay,’ recalls Winter. ‘The focus became much more on corporate governance and how to solve the crisis.’
The group’s recommendations left the issue of governance mostly in the hands of member states. ‘Corporate governance is an area where member states should lead, but states can discuss enforcement, monitoring and compliance and learn from each other,’ says Winter. He and his colleagues did not want to duplicate Sarbanes-Oxley; Winter is critical of Sox and rejects the notion that the EU plan is toothless.
‘I would be pretty scared if I made legislation in 29 days and thought I could go home having solved the problem,’ he says. ‘Legislation triggered by scandal isn’t often well thought out. If they had had one year rather than just 29 days, the outcome would have been much better. The result was legislation of incredible detail without any flexibility.’
The EU group worked for three years on its recommendations, some of which have become EU law, many of which are still in the consultation stages.
European style
Many wonder if the EU’s flexible approach is a sign it’s not taking governance seriously but Winter disagrees, saying enforcing corporate governance reform on a Europe-wide basis would be logistically and legally impossible. ‘There are 25 different systems that vary widely between member states and companies,’ he points out. Furthermore, he says the same laws that govern large international companies aren’t necessarily appropriate for small firms operating in one jurisdiction. ‘We didn’t want to impose a universal standard,’ Winter notes.
Most of the committee’s recommendations attempt to define best practice, but not to dictate what constitutes good corporate governance. ‘Companies should either comply or explain why they haven’t,’ Winter says. ‘They have to be explicit about their decision. If you have a very bad reason, you will be criticized by investors.’
Some US and UK-based governance activists ridicule European governance because often a majority shareholder controls the board and has little incentive to listen to minority holders. But Winter defends that model, saying the majority shareholder often closely scrutinizes management, benefiting all shareholders. ‘Having a majority shareholder works as a sufficient incentive to monitor management,’ he points out. ‘There’s perhaps a different risk – that the majority shareholder is engaged in fraud, as at Parmalat. But laws such as Sox wouldn’t have prevented this.’
Excessive pay
Winter concedes reasonable executive pay may not be absolute proof a firm is well governed, but high pay can be an indication something isn’t right. He consistently brings the focus back to excessive executive pay, a near obsession he shares with US shareholder activists. ‘Why did managers overstate earnings?’ he asks. ‘They made promises they couldn’t deliver because their pay was tied to share performance.’
The group’s advice became part of the EU’s recommendation on fostering an appropriate regime for the compensation of directors, issued last year.
The EU did not limit director pay, but suggested states adopt stringent rules for reporting such pay to shareholders.
Winter fears European companies have adopted US-style compensation plans, which he says give executives huge incentives to pad revenues. ‘We know if you give people financial incentives, it’s the strongest motivation,’ he says. ‘Shareholders haven’t understood how strong this incentive is and what behavior can be expected.’
Winter cautions boards against using stock options to tie performance to pay. Although this suggests an alignment of interests, he says it’s too reliant on the overall market and often says nothing about the company’s long-term viability. ‘In the 1990s when all shares were going up, shareholders and directors made huge sums of money regardless of the performance of the company,’ he observes. ‘Performance criteria have to be based on real benchmarks.’
Non-executive directors in Europe should also be watching out for minority shareholder interests – but this hasn’t been the case, says Winter.
‘One major problem was that non-executive directors didn’t think all that much was expected of them,’ he explains. ‘It’s clear now, however, that being a non-executive director is a job. The fact that you have been an executive director in another company doesn’t necessarily mean you will be a good director in all cases. You need to be trained. You need to understand the company. You have to be more committed.’
Unlike Sox, the EU recommendations do little to force directors to take their jobs more seriously – but Winter says you cannot legislate good behavior. ‘We have to find a balance,’ he notes. ‘If you just increase the responsibility of non-executive directors, they will simply avoid serving. In the US there is a tendency for insecure board members to want a lawyer sitting beside them all the time. This is not the way we should be going. You want directors to take responsible decisions, not just avoid sanctions.’
