Remu Rasi

European Business Organization Law Review 13: 599-637 599 © 2012 T.M.C.ASSER PRESS doi:10.1017/S1566752912000377

Regulatory Regimes and Norms for Directors’ Remuneration: EU, UK and Belgian Law Compared

Joseph Lee.∗

1. Introduction: regulatory failure and initiatives to curb ‘excessive’ remuneration .......................................................................................... 601

2. Issues of directors’ remuneration ........................................................... 603 2.1 How to address the question of legitimacy of government intervention ............................................................................................ 603 2.2 Concerted action in establishing necessary conditions for sustainable

development and for maintaining a level playing field.......................... 605 2.3 Adjusting the structure of negotiations .................................................. 605 2.4 Transparency as a legitimate value to the community ........................... 607 2.5 Claw-back (look-back) mechanism ....................................................... 608

3. Socio-legal norms or agency costs......................................................... 609 3.1 More than just laissez-faire.................................................................... 609 3.2 Socio-legal norms .................................................................................. 609 3.3 Agency costs of market efficiency norms.............................................. 610 3.4 Example of socio-legal norms for directors’ remuneration.................... 611 3.5 The ECJ and negative integration .......................................................... 613

4. The EU’s agency costs-based approach and its limit ............................. 614 4.1 Agency costs are the primary basis for legislation................................. 614 4.2 The limits of EU legislation based on agency costs............................... 615 4.2.1 Board control ......................................................................................... 615 4.2.2 Committee control ................................................................................. 616 4.2.3 Shareholder control................................................................................ 616 4.2.4 Cost and benefit-determined structure ................................................... 617 4.2.5 Legal vacuum......................................................................................... 617

5. The model of UK law in controlling directors’ remuneration: common law, statutory law, regulation and soft law.............................. 618

5.1 Socio-legal norms in common law ........................................................ 618 5.2 Statutory provisions: a hybrid of the socio-legal norm and agency costs norm.............................................................................................. 619 5.3 Compliance with the prescriptive rule ................................................... 620 5.4 The nature of soft law as a regulatory instrument.................................. 621 5.5 Socio-legal norms in English case law .................................................. 622

∗ Joseph Lee, PhD (London), Lecturer in Business Law, Nottingham University Business School, UK; Collaborateur scientifique, Faculty of Law, University of Liège, Belgium; Attorney-at-law, New York, USA.

600 Joseph Lee EBOR 13 (2012)

5.5.1 Excessive remuneration and conduct unfairly prejudicial to shareholders ........................................................................................... 622 5.5.2 Directors’ conduct and remuneration..................................................... 624 5.5.3 Transposing the applicability of unfair prejudice to a listed public

company................................................................................................. 625

6. The Belgian governance regime: implementing EU agency costs norm-based legislation........................................................................... 626

6.1 General legal framework ....................................................................... 626 6.2 Disclosure under the Companies Code .................................................. 627 6.3 Legal requirement of the remuneration committee ................................ 627 6.4 Golden parachute ................................................................................... 627 6.5 Employee-stakeholder’s role ................................................................. 627

7. Different socio-legal norms leading to diverse enforcement ................. 628 7.1 Belgian private enforcement .................................................................. 628 7.2 Belgian public enforcement ................................................................... 629 7.3 Discrimination caused by capping ......................................................... 630 7.4 Divergence in enforcement and the role of the ECJ............................... 630

8. Building socio-legal norms for the remuneration regulatory regime into the European company law framework .......................................... 630

8.1 Current approach without substantive socio-legal norms ...................... 630 8.2 The limit of an agency costs-based legislative approach ....................... 631 8.3 The current European company law paradigm: legal personality, limited liability, directors’ duty, shareholders’ rights, third parties’

protection, and the CSR......................................................................... 632 8.4 Risk management................................................................................... 634

9. Conclusions............................................................................................ 635

Abstract This article examines the regulation of directors’ remuneration in EU, UK and Belgian law. The author argues that there are two categorises of norms for the regulatory framework of directors’ remuneration: one is market-based, market efficiency norms of agency costs; the other is socio-legal norms. The paper argues that agency costs – a responsive mode of governance – alone cannot adequately address the problems of directors’ remuneration. On the other hand, socio-legal norms – which are value and ethics-focused – can better construct a paradigm capable of addressing a broader issue of directors’ remuneration in the EU con-text. Agency costs-based regulation has been used by the EU whereas socio-legal matters have been left to Member States. The article shows how socio-legal norms could form the underlying basis of the regulatory regime by examining the laws in the UK and Belgium. It is concluded that the European Court of Justice will need to carry out the role of negative integration by harmonising these social values in developing EU company law.

Directors’ Remuneration – EU, UK and Belgian Law Compared 601

Keywords: directors’ remuneration, corporate governance, agency costs, socio-legal, stakeholders, claw-back, risk management, company law, European Union, negative integration.

1. INTRODUCTION: REGULATORY FAILURE AND INITIATIVES TO CURB ‘EXCESSIVE’ REMUNERATION

Despite many attempts of governmental institutions to safeguard market confidence by establishing, implementing and then reforming the directors’ remuneration regulatory regime, such an effort neither prevented the financial crisis of 2008 nor removed directors’ remuneration from scrutiny. The G20 summit,1 the UN.2 and the OECD.3 have all made attempts to review the regulatory regime for directors’ remuneration. The EU, accounting for twenty per cent of the total world economy in value, has also addressed this issue and taken initiatives to establish a regulatory regime. However, the recurrence of systemic failure in the financial markets should prompt one to reconsider whether the theoretical bases and the underlying norma-tive principles accounting for the approach adopted so far can foster the objectives of long-term and sustainable social and economic development.4 For instance, stock options, a very much debated arrangement, have been used, on the one hand, to align the directors’ interests with those of the company and, on the other, to prevent short-termism; however, this remuneration system does not prevent the taking of excessive and justifiable risks and the focus from being on short-term investment strategies, which played a key role in causing the financial crisis.

It may be useful to briefly sketch out the responsive measures that the EU has undertaken in regulating directors’ remuneration so far. In 2004, in the aftermath of the Enron collapse, the EU Commission issued a recommendation to set the Euro-pean standard for remuneration structures for listed companies within the internal market. According to this recommendation, the remuneration governance structure was to be built upon the following areas: (1) disclosure of directors’ remuneration, i.e., the amount, the composition and the remuneration policy, (2) shareholders’ control through general meetings, and (3) shareholders’ ability to vote on the directors’ share option schemes.5 The recommendation was required to be imple-

1 Group of 20, ‘Global Plan for Recovery and Reform: The Communiqué from the London Summit’; Group of 20, ‘Leaders’ Statement: The Pittsburgh Summit’.

2 The United Nations Environment Programme Finance Initiative (UNEPFI) 2009. 3 OECD, ‘The Corporate Governance Lessons from the Financial Crisis’ (2009); ‘Corporate

Governance and the Financial Crisis: Key Findings and Main Messages’ (2009). 4 In the US, legislation was passed in 2007 to make further requirements on the disclosure of

remuneration. 5 Commission Recommendation 2004/913/EC of 14 December 2004 fostering an appropriate

regime for the remuneration of directors of listed companies, OJ 2004 L 385/55.


mented by Member States either through legislation or through soft law by 2006.6 In 2005, the Commission issued a further recommendation aimed at enhancing the role of non-executive directors in the regulatory regime introduced in 2004.7 In 2007, the Commission issued a consultation paper on the matter of directors’ remuneration with a view to introducing a directive which would provide for a better enforcement mechanism. In 2009, the financial crisis once again prompted the Commission to issue guidelines for directors’ remuneration for listed companies as well as specifically for financial institutions.8

What are the theoretical bases and normative principles underlying the EU’s ap-proach to directors’ remuneration? This also begs the question of what is the central axis of the EU regulation, even raising the existential question of the EU integration project.9 Corporate governance is emerging as a basis for regulators to intervene in the market economy and liberal society in order to regulate corporate exposure and restore public and market confidence. Corporate governance has the objective of maintaining market efficiency, but its more essential element is to establish norma-tive principles as the condition for the market economy. In the EU context, the regulation of corporate exposure is justified by its impacts not only on the market players but also on the public confidence in the governments that set social goals and projects, i.e., the European integration project. It is in this sense that interven-tion such as through tax measures is deemed legitimate.

This article identifies the key issues in directors’ remuneration and examines the regulatory approaches under two broad categories: socio-legal norms and agency costs. It then identifies what they entail, their implications and how they are played out in the regulation. The law adopted at the EU level is examined against these two categories. The law and approach adopted by the UK, with some references to US law, is discussed to show how socio-legal norms can play a part in the regulatory regime. Belgian law is investigated to discern the differences and similarities in the approaches and legal norms between continental European systems and Anglo-Saxon paradigms. Finally, the article reviews the current European company law paradigm and attempts to make some recommendations as to how to develop an approach based on socio-legal norms at the European level for the directors’ remu-neration regime.

6 Ibid., Art. 8.1. 7 Commission Recommendation 2005/162/EC of 15 February 2005 on the role of non-

executive or supervisory directors of listed companies and on the committees of the (supervisory) board, OJ 2005 L 52, 25 February 2005.

8 In the UK, the New Practice Code was introduced by the FSA and the new Walker Review proposed new rules on this Code.

9 D. Chalmers, ‘Europe’s Existential Question’, 29 European Law Review (2004) pp. 435-436.


2. ISSUES OF DIRECTORS’ REMUNERATION

2.1 How to address the question of legitimacy of government intervention

Questions of legitimacy of government intervention relate to government’s norma-tive power and functional effectiveness. Normative power can be provided, a priori, by the express mandate laid down by law.10 or the implicit mandate based on the relations government has with the subject matter.11 and the nature of govern-ment’s regulatory role vis-à-vis the objectives which the community, in a broad sense, aims to achieve. Functional effectiveness is a posterior authority since the legitimacy is only conferred after such functional effectiveness has been proven. Such legitimacy may be given based on the past experience or may be conferred subject to further review of the effectiveness of exercising such a power.

How can the government legitimately regulate the practice of directors’ remu-neration? It is evident that both the amounts of money involved in directors’ remu-neration packages and the way in which remuneration has been paid to the directors of a number of failing banks, especially those which received public aid in different shapes or forms, have caused public outrage. Many investors, regulators, politi-cians, academics and the general public have also raised doubts about the effective-ness of the current arrangements for directors’ remuneration under the overarching objective of corporate governance. It is well conceded that one of the objectives of corporate governance is to hold the board to account in order to improve corporate performance for the benefit of the shareholders and stakeholders alike as well as to justify the existence of the corporate entity granted by law.12 Corporate accountabil-ity is both a civil and political value embedded in European political governance.

Different from other corporate governance issues, directors’ remuneration has proven to be one of the most challenging areas for regulation, for the following reasons. First, regulation of directors’ remuneration means direct intervention in the wages of directors, which can appear as state control over the market price, hence raising questions around legitimacy in a liberal society and efficiency in a market economy where individual rights and freedom of contract are important constitu-tional conditions. As far as legitimacy is concerned, it is difficult to justify how the state or public authorities can regulate the wages of private companies’ directors, as such government intervention would deprive directors or companies of the oppor-tunity and freedom to engage in private negotiations as well as of their liberty and

10 An input-oriented legitimacy. See the analysis of the EU’s legitimacy in E. Jones, ‘Output Legitimacy and the Global Financial Crisis’, 47 Journal of Common Market Studies (2009) pp. 1085-1105.

11 An output-oriented legitimacy. See ibid. 12 This view is conceded by the concession theory.


entitlement to property. From a market efficiency point of view, direct state control over market prices could result in inefficiency and economic waste. Although state intervention on the level of wages is not uncommon, an EU intervention on wages will raise the question of the legitimacy of its regulatory role.

It may be safe to say that any direct intervention without good cause, or failure to adhere to the liberal democratic principles endorsed by the EU, will be not only illegitimate but also illegal. However, exposés of directors’ remuneration in the midst of the financial crisis have threatened public confidence in many governments’ ability to govern, because countless ordinary workers have lost their jobs, investors have lost their savings and taxpayers’ money has poured into failing companies while directors continue to receive handsome remuneration and termination packages according to their contracts. Public outrage reached its highest point when failing banks, previ-ously bailed out by the governments, could neither be stopped from giving high remuneration to directors, a kind of benefit not enjoyed by ordinary employees, nor claw back the money already handed out to failing directors. Furthermore, the differ-ence in wages, or pay disparity, between managerial employees and ordinary em-ployees is understood to be a necessary and unavoidable phenomenon, although the gap between top executive directors and ordinary employees is widening and contin-ues to be widened by, if correctly referred to, unregulated market forces. This poses a risk to social stability, a necessary condition for financial stability where internation-alisation and mobility of capital are to be promoted.

In response to public outrage and the necessity of maintaining confidence, gov-ernments in the most industrialised world economies, including those in the Euro-pean Union, have pledged to respond to the many problems of the financial crisis, one of which is directors’ remuneration.13 A plan of direct state intervention in directors’ wages, such as setting appropriate levels for actual wages or bonuses, has not been opted for. The closest form of direct state intervention is to use fiscal measures and taxes on companies and banks’ profits and on directors’ bonuses in order to ‘reduce’ their net wages.14 In the US, under the Financial Crisis Responsi-bility Fee, there will be a levy on top US banks to reimburse financial bail-out expenses incurred by the federal government.15 The UK government currently imposes a 50 per cent levy on bankers’ bonuses – which is applicable only to

13 European Commission, Green Paper on Corporate Governance in Financial Institutions and Remuneration Policies, 6 February 2010; Department for Business Regulation and Skills, UK Government Response to the Green Paper, July 2011.

14 P. Payne, ‘Corporation Salaries and Bonuses and the Federal Income Tax’, 12 Tax Magazine (1934), at pp. 301-302; ‘Tax Office Gives Warning on Directors’ Fees and Bonuses’, Business Wall Street Journal, 3 June 2011, available at: <http://www.theaustralian.com.au/ business/tax-office-gives-warning-on-directors-fees-and-bonuses/story-e6frg8zx-1226068257986> (accessed on 10 December 2011).

15 ‘President Obama Proposes Financial Crisis Responsibility Fee to Recoup Every Last Penny for American Taxpayers’, White House Press Release, 14 January 2010.


discretionary bonuses and not to contractual ones – exceeding £25,000.16 The problem of such a fiscal measure is its ‘effectiveness’ and what it intends to achieve. Furthermore, such a levy is not applicable to other entities such as insur-ance companies, asset managers and stockbrokers in the financial services sector.

Furthermore, social pacification, pay disparity, public means to aid ailing banks, public consensus on directors’ remuneration, the maintenance of financial stability for the promotion of capital mobility, the EU integration project, and constructing a normative economic power based on civil values form the legitimate basis for the EU’s regulatory intervention in directors’ remuneration.

2.2 Concerted action in establishing necessary conditions for sustain-able development and for maintaining a level playing field

The second difficulty lies in the very fact of global and international competition for capital and human resources. The lack of international cooperation and concerted action will signify that there is no universal recognition, at least at EU level, of the objective and legitimate concern for regulating directors’ remuneration. At a practical level, a country without regulation of directors’ remuneration will gain itself, at least in the short term, a competitive advantage, which could defeat the goal of combating excessive remuneration as well as the negative causes and effects associated with it. A country with a more favourable tax system, i.e., without a tax on bonuses, will attract executives, employees and capital. Without consistent and concerted action, there is a risk that international banks and companies will shop around for jurisdictions with more lenient policies for remuneration practices, which will eventually lead to a ‘race to the bottom’ problem in financial regulation. This defeats not only the idea of rules harmonisation but also the protection of legitimate public interests, such as reducing pay disparity, and the aim of removing distortions of competition within the EU. To ensure there is a level playing field, there must be global and concerted action.

2.3 Adjusting the structure of negotiations

Further indirect controls can be implemented under the principle of freedom of negotiation in the market economy. What governments or states can do is to adjust the structure of negotiation to give more power, voice and say to parties who have a right to participate, or are reasonably expected to have a say, in the negotiations with directors.17 Therefore, directors will be made more accountable to these parties

16 ‘Treasury Raises Tax Bill for Big Banks’, Financial Times, 9 December 2010, available at: <http://cachef.ft.com/cms/s/0/be339fa8-0381-11e0-9636-00144feabdc0.html#axzz1gRjoJBQL> (accessed on 11 December 2011).

17 This is similar to having a collective bargaining structure rather than direct wage control imposed by the state.


in order to reflect the foundations of a market economy and the civil values in the civil society/community. This begs the question: who are the parties that have a right to participate or are reasonably expected to have a say in these negotiations?

The principle of corporate legal personality seems to suggest that directors’ re-muneration is a private matter to be decided within a company, in which case corporate governance imposed by the state would be deemed to be interference in private matters within an organisation. Such interference is justified to enhance productivity, the protection of parties’ rights and interests in private companies, and social pacification.18 Reforms following the financial crisis have all moved in this direction. In the US, the Corporate and Financial Institution Compensation Fairness Act 2010 requires an annual non-binding advisory vote by shareholders to approve directors’ remuneration practices and packages, including golden parachutes in public companies. It also requires disclosure of the pay disparity between the remuneration of directors and that of the average workers in the company. In the UK, the FSA Code increases disclosure requirements and strengthens the supervi-sory function of company committees on remuneration practices, in particular the independence of committee members and their risk management tasks.19 Having said that, corporate governance is a matter not only for current shareholders and shareholder-oriented committees in a company, but also for prospective investors and stakeholders such as employees, whose job security depends on the success of the company, and consumers, whose purchasing power is linked to the company.20 In this sense, the directors’ remuneration, at least for certain types of companies, can no longer be properly called a private matter for the company.

18 B. Caillaud, R. Guesnerie, P. Rey and J. Tirole, ‘Government Intervention in Production and Incentives Theory: A Review of Recent Contributions’, 19 RAND Journal of Economics (1988) pp. 1-26; C. Bernini and G. Pellegrini, ‘How Are Growth and Productivity in Private Firms Affected by Public Subsidy? Evidence from a Regional Policy’, 41 Regional Science and Urban Economics (2011) pp. 253-265; V. Thomas and Y. Wang, ‘Government Policy and Productivity Growth: Is East Asia an Exception?’, Policy Research Department, The World Bank, Washington DC, 1993; J. Baffes and A. Shah, ‘Productivity of Public Spending, Sectoral Allocation Choices, and Economic Growth’, 46 Economic Development and Cultural Change (1998) pp. 291-303; J. Lee, ‘Government Intervention and Productivity Growth’, 1 Journal of Economic Growth (1996) pp. 391-414.

19 The Financial Services Authority Remuneration Code 2009; FSA, ‘FSA Publishes Revised Remuneration Code’ (2010), available at: <http://www.fsa.gov.uk/pages/Library/Communication/ PR/2010/180.shtml> (accessed on 10 December 2011).

20 R. Freeman, A. Wicks and B. Parmar, ‘Stakeholder Theory and the Corporate Objective Revisited’, 15 Organization Science (2004) pp. 364-369; G. Charreaux and P. Desbrieres, ‘Corporate Governance: Stakeholder Value versus Shareholder Value’, 5 Journal of Management and Governance (2001) pp. 107-128; B. Ruf, K. Muralidhar, R. Brown, J. Janney and K. Paul, ‘An Empirical Investigation of the Relationship between Change in Corporate Social Performance and Financial Performance: A Stakeholder Theory Perspective’, 32 Journal of Business Ethics (2001) pp. 143-156; S. Letza, X. Sun and K. James, ‘Shareholding versus Stakeholding: A Critical Review of Corporate Governance’, 12 Corporate Governance: An International Review (2004) pp. 242-262.


Agency costs analysis dwells mainly on the relationship between managers and shareholders, assuming that shareholders are the principals.21 This denies that employees could also be the interested parties to the agent-principal relationship or representatives of the corporate principal. Should directors also align their interests with those of their employees for the purpose of productivity, protection of em-ployees’ rights and welfare, and social pacification? The German industrialist model of co-determination combines the interests of the board and those of em-ployees, and in this model the employees should also have a voice in and influence on directors’ remuneration. Such a structural adjustment will cause directors’ remuneration to reflect not only on the directors of other companies in the sector (cross-sector comparison) but also on the employees (pay disparity review). The growing gap between the top executives and the average employees poses a risk to companies’ long-term interests, a factor of risk management that the board and relevant committees should not fail to take into account. The objective of such risk management is to enhance social stability, a condition sufficiently necessary for maintaining financial stability so as to realise capital mobility.22 Competition within the corporate sector tends to drive up the amount of remuneration rather than exercise downward pressure on it.23 Such a structural adjustment will allow those who set, oversee and approve remuneration to take into consideration the salary figures of average employees in companies as well as throughout the sector.

2.4 Transparency as a legitimate value to the community

Transparency has been the basis for disclosure requirements.24 The rationale is that the principals can then acquire the information possessed by the agents who are

21 B. Oviatt, ‘Agency and Transaction Cost Perspectives on the Manager-Shareholder Relationship: Incentives for Congruent Interests’, 13 Academy of Management Review (1998) pp. 1-12; P. Tufano, ‘Agency Costs of Corporate Risk Management’, 27 Financial Management (1998) pp. 67-77.

22 M. Jensen and K. Murphy, ‘Performance Pay and Top-Management Incentives’, 98 Journal of Political Economy (1990) pp. 225-264; J. Miller, R. Wiseman and L. Gomez-Mejia, ‘The Fit between CEO Compensation Design and Firm Risk’, 45 Academy of Management Journal (2002) pp. 745-756; J. Harter, F. Schmidt and C. Keyes, ‘Well-Being in the Workplace and Its Relationship to Business Outcomes’, in C. Keyes and J. Haidt, eds., Flourishing: The Positive Person and the Good Life (American Psychological Association 2003) pp. 205-224.

23 F. Allen and D. Gale, ‘Corporate Governance and Competition’, in X. Vives, ed., Corporate Governance in Theoretical and Empirical Perspectives (Cambridge, CUP 2000) pp. 23-94; M. Firth, P. Fung and O. Rui, ‘Corporate Performance and CEO Compensation in China’, 12 Journal of Corporate Finance (2006) pp. 693-714.

24 A. Fung, M. Graham and D. Weil, Full Disclosure: The Perils and Promise of Transparency (Cambridge, CUP 2007); L. Lowenstein, ‘Financial Transparency and Corporate Governance’, 96 Columbia Law Review (1996) pp. 1335-1374; P. Linsley and P. Shrives, ‘Transparency and the Disclosure of Risk Information in the Banking Sector’, 13 Journal of Financial Regulation and Compliance (2005) pp. 205-214.


meant to act on behalf of the principals, so that agency costs can be regulated. Oddly enough, the opponents to the transparency of directors’ remuneration argue that the amount disclosed may cause employees to ask more from the company as there is a danger that employees will bargain at a level above the ‘optimal’ level, which may lead to inflation. However, if company shares are dispersed within the capital market, a high stock index when companies make handsome profits can also drive up inflation.

2.5 Claw-back (look-back) mechanism

How do the interests, rights and expectations of other stakeholders such as suppliers and consumers relate to the directors’ pay?25 Directors’ salaries can be linked to a company’s profits even when made in contravention of laws such as competition law, consumer protection law or criminal law. The law should contain claw-back provi-sions.26 and not allow companies to cover directors’ liability, for instance, in criminal matters. The legal basis for clawing back can be the law of restitution if the bonuses or remuneration received (the unjust enrichment) were paid at the expense of suppli-ers, consumers or the general public, in which case the state will be the receiving party of such restitutionary amount. The principle and structure of legal personality leaves remuneration a matter privy to the members of the company – members who not only are shareholders but should also include employees. Suppliers and consum-ers do not have a say on the issue of remuneration and the design of the bonus sys-tem, even though they are members of the community with which the company has dealings. The market economy requires dealing between the company and suppliers, while consumers remain at ‘arm’s length’ in the transaction process. The practical difficulty also lies in the fact that if consumers and suppliers are allowed to have a say, a company will also be able to interfere with the remuneration of its own suppli-ers and consumers. That is not to say that the suppliers and consumers have no link to remuneration; rather, such a link offers a different form of participation from that of shareholders and employees. A claw-back (look-back) mechanism may be contained in the contract between a company and its directors, while any damages paid out to consumers or suppliers will come from the claw-back fund. However, if this is not made compulsory or set as best practice, it is questionable whether companies will take it up voluntarily. The new UK Code of Corporate Governance issued by the

25 S. Marshall and I. Ramsay ‘Stakeholders and Directors’ Duties: Law, Theory and Evidence’, 33 Journal of Law and Society (2006) pp. 1-53; A. Bruce, T. Buck and B. Main, ‘Top Executive Remuneration: A View from Europe’, 42 Journal of Management Studies (2005) pp. 1493-1506.

26 ‘Lloyds Bank to Clawback Part of Chief.’s £1.45m Bonus’, The Guardian (2011), available at: <http://www.guardian.co.uk/business/nils-pratley-on-finance/2011/dec/02/lloyds-banking-group-bonus-clawback> (accessed on 10 December 2011); ‘Lloyds Bank May Claw Back Former Boss’s £1.4m Bonus’, BBC News (2011), available at: <http://www.bbc.co.uk/news/business-16016155> (accessed on 10 December 2011).


Financial Reporting Council suggests a claw-back regime to enhance the appropriate-ness of director’s remuneration practice.27

3. SOCIO-LEGAL NORMS OR AGENCY COSTS

3.1 More than just laissez-faire

Laissez-faire liberal market theorists have written extensively on the cost, ineffi-ciency and danger of government intervention in market movements and prices. That is not to say that government can play no role in regulating directors’ remu-neration. A governmental or institutional role in the regulation of directors’ remu-neration is consistent with free market principles in so far as it is limited to the enhancement of private control over directors’ remuneration such as by way of giving shareholders or stakeholders more influence, through disclosure require-ments or by instituting more internal controls through a number of committees independent of the board. However, these approaches tend to exclude the interest and the participation of other stakeholders, as well as the considerations of the civil values embedded in society.

3.2 Socio-legal norms

This paper argues that there are two broad normative bases for the directors’ remu-neration regulatory regime: first, socio-legal norms, i.e., essentially social values manifested in legal norms.28 The norms are moral,29 ethical and value-based.30 and emphasise personal obligations.31 within a civil society, including the personal duty

27 Schedule A, UK Corporate Governance Code. 28 Before 1850, legal justice was used to express the similar concept of social justice. ‘Legal

justice’ was invented by Aristotle in his book of Ethics, which basically states that ‘law-abiding people made better citizens than gangsters’. Thomas Aquinas developed this concept as a special virtue which has a common good.

29 H. Kelsen, Pure Theory of Law (Berkeley, University of California Press 1967), at p. 62; H. Kelsen, ‘The Nature Law Doctrine before the Tribunal of Science’, in H. Kelsen, What Is Justice (Berkeley, University of California Press 1957); D. Berleveld and R. Brownsword, Law as a Moral Judgement (London, Sweet & Maxwell 1986), at p. 8; J. Bentham, ‘A Fragment on Government’, in J. Burns and H. Hart, eds., A Comment on the Commentaries and a Fragment on Government (London, Athlone Press 1977); Bentham also emphasised the importance of subjecting law to moral scrutiny.

30 A. Lisska, Aquinas’s Theory of Natural Law: An Analytic Reconstruction (Oxford, Clarendon Press 1996).

31 O. Grierke, ‘Chapter II: The General Theory of the Group (Verbandstheorie) in the Natural Law’, in E. Barker (transl.), Natural Law and the Theory of Society 1500 to 1800 (Cambridge, CUP 1934) p. 95.


to achieve the common objective, societal project, and political and economic good,32 and the exercise of personal rights reflecting the underlying values of the common objective, social project, and political and economic good. The obligations imposed or the rights conferred are not to achieve the end of ‘efficiency’ regulated by the cost and benefit analysis of the market. The regulatory regime based on these socio-legal norms is a normative legal institution, as opposed to responsive govern-ance, for directing the individual acts towards the common objective, societal project, and political and economic good.33 Socio-legal norms form a system to maintain and promote a sense of order in the human sphere, capable of relating to the wider environment.

These norms require their addressees to direct their good intentions towards the common objective and orient the parties involved to act in a socially just manner, with and through other parties. Through these just manners, a ‘just wage’ can be determined. On the basis of these norms, juridical and social institutions are estab-lished, which develop and shape the forms of economic as well as political life. This is different from the statist approach of legislation, which is centred on the end result without emphasising individual obligations and entitlements. For instance, the state uses monetary policy, such as interest rate or exchange rate, to monitor the labour wages. Another example of the statist approach of legislation is ‘capping’, putting a ceiling, on remuneration. Socio-legal norms take into account the right of the directors vis-à-vis the relations with the connected parties, i.e. investors, em-ployees, consumers and suppliers, and offer protection based on the common values and social good.34

3.3 Agency costs of market efficiency norms

Second, the agency costs approach is interest-based,35 founded on the principle of arm’s length transactions where transaction costs can be calculated, focusing pri-marily on cost-return relationships and using the market for cost-effective regula-tory policy.36 The regulatory model is responsive to costs in correcting market

32 T. Aquinas, Summa Theologiae (Madrid, Bibliotéca de Autores Christianos 1951), ‘Bonum agendum et persequendum, et malum vitandum’, in English: ‘That good is to be done and pursued, and evil to be avoided’.

33 J. Bentham, ‘Chapter II: The Ascetic Principle’, in J. Bentham, The Theory of Legislation (London, Routledge & Kegan Paul 1931) p. 4.

34 J. Eieder, ‘The Social Organisation of Vengeance’, in D. Black, ed., Toward a General Theory of Social Control (London, Academic Press 1984) p. 131.

35 R. Posner, The Economics of Justice (London, Harvard University Press 1981), at p. 60; R. Posner, ‘The Economic Approach to Law’, in F. Parisi, ed., The Economic Structure of the Law (Northampton, Edward Elgar 2002) p. 41, at p. 57.

36 R. Posner, ‘The Costs of Monopoly and Regulation’, 83 Journal of Political Economy (1975) pp. 807-827; R. Coase, ‘The Problem of Social Cost’, in R. Posner and F. Parisi, ed., Economic Foundations of Private Law (Northampton, Edward Elgar 2002) p. 207, at p. 250; I.


deficiencies.37 Currently, the approach to the regulation of directors’ remuneration at European level is based on agency costs rather than on the socio-legal norms of European jurisprudence, legal systems and perceived social and civil norms.38 Even if the Commission has the competence to make company-related legislation based on socio-legal norms, this approach has often been sidelined to give way to the political expedience of agency costs analysis. The result of rules based on agency costs is that compliance with these rules and norms is, in fact, pseudo-conformity, as there is a deficient sense of justice. This is because the rules would fail to intuit those they intend to regulate. Furthermore, rules based on these norms are prone to being modified and reformed in response to given market circumstances. These rules become ‘flexible’ and are not part of the constant content that forms a condi-tion reflecting the common objective, societal project, and political and economic good.

3.4 Example of socio-legal norms for directors’ remuneration

A number of examples of socio-legal norms are as follows. Firstly, directors owe personal fiduciary duties, such as a duty of loyalty to the company, as well as a duty of no conflict of interests.39As such, directors must not set the remuneration them-selves, nor allow the remuneration to be set by someone who is not independent of the directors, nor receive an excessive and unreasonable amount. The latter two are more difficult questions. What is entailed in the meaning of ‘independence’ requires a moral and political analysis reflecting the civil and political value in the commu-nity rather than a cost analysis. A deficient remuneration structure can encourage excessive risk taking,40 causing damages to the company and those dependent on the company. The board is also obliged to take this risk into account in setting corporate strategies.41Setting the directors’ remuneration without identifying the risk, employing an independent risk assessment, and mitigating the risk would

Ehrlich and R. Posner, ‘An Economic Analysis of Legal Rulemaking’, in Posner and Parisi, eds., supra n. 36, pp. 112-141; M. Adler and E. Posner, ‘Rethinking Cost-Benefit Analysis’, 109 Yale Law Journal (2000) pp. 165-247.

37 See G. Hertig and J. McCahery, ‘Legal Options: Towards Better EC Company Law Regulation’, in S. Weatherill, ed., Better Regulation (Oxford, Hart Publishing 2007) pp. 219-245.

38 Commission Communication to the Council and the European Parliament ‘Modernising Company Law and Enhancing Corporate Governance in the European Union – A Plan to Move Forward’, COM (2003) 284 final.

39 Commission Recommendation 2004/913 fostering an appropriate regime for the remuneration of directors of listed companies, supra n. 5, para. 2 of the Preamble.

40 J. Miller, R. Wiseman and L. Gomez-Mejia, ‘The Fit between CEO Compensation Design and Firm Risk’, 45 Academy of Management Journal (2002) pp. 745-756; L. Bebchuk, A. Cohen and H. Spamann, ‘The Wages of Failure: Executive Compensation at Bear Sterns and Lehman 2000-2008’, 657 Harvard Law School Discussion Paper (2009), at pp. 1-27.

41 E. Pan, ‘A Board’s Duty to Monitor’, 54 New York Law Review (2009) pp. 717-740.


place the board in breach of the directors’ personal duty owed to those whom it ought to protect. Furthermore, what is excessive begs the question of reasonable-ness.

Secondly, shareholders have rights to protect their interests in the company, which can include their right to express their views on the directors’ remuneration or on the risks imposed by the company’s remuneration practices.42 Since the remuneration structure is heavily linked to risk management and corporate strategy, shareholders should have a right to voice their concerns and exercise appropriate oversight over a company’s risk management policy. Even though they would in all likelihood not have expertise in complex risk modelling, especially in assessing the risk, they should have the right to ask questions and make sure that the risk man-agement function is independent of the board.43

Thirdly, the protection of stakeholders.44 should mean that stakeholders’ interests should be taken into account when setting the directors’ remuneration.45 As dis-cussed before, the success of the company depends on the contribution of stake-holders such as employees, consumers and suppliers. Employees particularly should also have a say on the remuneration issue, be it its structure, its practical application or the actual amount in relation to their own pay. This will adjust the negotiation structure. Such an inclusion is manifested in the German constitutional principle of co-determination. As far as consumers’ and suppliers’ rights and interests are concerned, if company profits are made at their expense, for instance, by violating laws and regulations, a claw-back mechanism should be in place so that adequate compensation can be demanded for their losses.

Fourthly, the concept of unjust enrichment,46 which is to control the case where directors or executives are overpaid at shareholders’ or employees’ expense, can be understood as a socio-legal norm. Such a norm should give not only the sharehold-

42 Commission Recommendation 2004/913 fostering an appropriate regime for the remuneration of directors of listed companies, supra n. 5, para. 7 of the Preamble.

43 A. Admati, P. Pfeiderer and J. Zechner, ‘Large Shareholder Activism, Risk Sharing and Financial Market Equilibrium’, 102 Journal of Political Economy (1994) pp. 1097-1130; L. Gillan and L. Starks, ‘Corporate Governance Proposal and Shareholder Activism: The Role of Institutional Investors’, 57 Journal of Financial Economics (2000) pp. 275-305.

44 G. Ferrarini, N. Moloney and C. Vespro, ‘Executive Remuneration in the EU: Comparative Law and Practice’, ECGI Law Working Paper No. 09/2003 (June 2003).

45 See R. Mullerat, ed., Corporate Social Responsibility: The Corporate Governance of the 21st Century (The Hague, Kluwer 2005); C. Mallin, Corporate Governance, 3rd edn. (Oxford, OUP 2009), at p. 137.

46 See the derivative suit filed against JP Morgan directors claiming breach of fiduciary duty and unjust enrichment in connection with JP Morgan’s $88.3 million settlement with OFAC, available at: <http://www.mondaq.com/unitedstates/x/152968/Financial+Services/Derivative+ Suit+Filed+Against+JPMorgan+Directors+Claiming+Breach+Of+Fiduciary+Duty+And+Un just+Enrichment+In+Connection+With+JPMorgans+883+Million+Settlement+With+OFAC> (accessed on 11 December 2011); D. Friedmann, ‘Unjust Enrichment, Pursuance of Self-Interest, and the Limits of Free Riding’, 36 Loyola Law Review (2003) pp. 831-848.


ers but also the stakeholders the right to make a claim.47 In the cases of government bail-out, directors can be overpaid at taxpayers’ expense. Taxpayers, represented by the government or other public interest groups, should also be able to make an unjust enrichment claim. Furthermore, it is a socio-legal norm to maintain a fair ratio between one’s contribution to the business and what one is paid, i.e., under the pay-for-performance umbrella, the pay must be reasonably expected, proportionate to set objectives, conscionable in comparison to the sector as well as the average employees of the company, not wasteful, and given in a just and right manner with honest intent and in good faith. This embraces the notion of ‘no reward for fail-ure’,48 a concept expressed under the doctrine of waste in Delaware corporate law in the US, a regulatory notion endorsed by many regulators. This will include examinations of the services provided by the company, which should also have been counted as part of the remuneration, such as tax and financial services, as well as insurance policies taken out in the director’s interest but paid by the company.

3.5 The ECJ and negative integration

These socio-legal norms do not form the bases for the EU directors’ remuneration regulatory regime, and less so than under some national systems. For instance, the fiduciary duty owed by the director to the company under English law,49 the doc-trine of waste in Delaware law and the duty of good faith under Belgian law can all be seen as expressions of socio-legal norms.

At a practical level, EU legislation based on agency costs will only partially harmonise the laws of the Member States, because such a legislative approach will not promise harmonised enforcement across the Union. That said, the ultimate goal of harmonisation could be achieved by the European Court of Justice (ECJ) through a process of so-called negative integration. A comparison of the directors’ remu-neration regulatory regime under Belgian and UK law will identify the similarities and differences in their socio-legal approaches. A set of common socio-legal norms will assist the Court in developing the regulatory regime.50 It is therefore important to carry out a comparative study in this area.

47 J. Brummer, Corporate Responsibility and Legitimacy: An Interdisciplinary Analysis (London, Greenwood Press 1991), at p. 145.

48 House of Commons Treasury Committee, Banking Crisis: Reforming Corporate Governance Pay in the City. Ninth Report of Session 2008-09 (2009), available at: <http://www. publications.parliament.uk/pa/cm200809/cmselect/cmtreasy/519/519.pdf>; R. Levine, ‘The Cor-porate Governance of Banks: A Concise Discussion of Concepts and Evidence’ (2009), World Bank Policy Research Working Paper 3404, at pp. 1-19.

49 Irvine v. Irvine [2006] 4 All ER 102. 50 For the reasons for harmonisation, see P. Mäntysaari, ‘The Law of the European Union’, in

P. Mäntysaari, ed., Comparative Corporate Governance: Shareholders as a Rule-maker (Berlin, Springer 2005) p. 35; K. Hopt, ‘Common Principles of Corporate Governance in Europe’, in J.


4. THE EU’S AGENCY COSTS-BASED APPROACH AND ITS LIMIT

4.1 Agency costs are the primary basis for legislation

Agency costs have been the basis for controlling directors’ remuneration at the European level.51 It entails several models of analysis, revolving around agency costs analysis.52 The extended analyses of agency costs are incentive analysis and competitive analysis. Agency costs analysis treats directors as agents of the com-pany or shareholders; therefore, their remuneration is a cost to the company as a principal. As a result, such a cost needs to be monitored to achieve efficiency. However, such cost control should not be carried out if in doing so firm and market efficiency will not be achieved. For instance, cost control procedures must not be too expensive and burdensome to the company; the control must not jeopardise the directors’ incentives to pursue the company’s overall interests; and the control must not damage the company’s ability to attract skilled directors to take up a director-ship. Therefore, cost and benefit analysis is a major instrument that measures reasonableness, fairness and the appropriateness of the rules, in other words, the optimal level of the regulatory model.

In standard practices, a remuneration structure comprised of a fixed basic salary and variable bonuses also includes discretionary bonuses and guaranteed contrac-tual bonuses. Many argue that bonuses increase agency costs because they encour-age excessive risk taking. However, oddly enough, directors’ variable bonuses are intended as an instrument for reducing agency costs, and their design is a way of aligning the interests of directors with those of the shareholders of the company. To avoid directors adopting short-term strategies influenced by such a bonus system, it is argued that a deferral system, through stock options, can create long-term incen-tives for directors. However, if such a long-term incentive scheme is too costly for the company, especially when the company is not doing well financially, it is suggested that the level of fixed salary should be increased to an appropriate level in order to reduce the maximum level of the bonus available. As a result, what the regulators care about is, on the one hand, the competitiveness of the firm, and, on

McCahery, P. Moerland, T. Raaijmakers and L. Renneboog, eds., Corporate Governance Regimes: Convergence and Diversity (Oxford, OUP 2002) p. 175.

51 See the Commission consultation document on remuneration policies, available at: <http:// ec.europa.eu/internal_market/company/directors-remun/index_en.htm#OtherDocs>. Establishing and maintaining remuneration policies ensures sound risk management. See also the Statement of the European Corporate Governance Forum on Director Remuneration, available at: <http://ec. europa.eu/internal_market/company/docs/ecgforum/ecgf-remuneration_en.pdf>. No reference is made to the core values in controlling directors’ remuneration, but there is a relation to excessive risks taken by the management relating to variable pay schemes.

52 G. Ferrarini, N. Moloney and C. Vespro, ‘Executive Remuneration in the EU: Comparative Law and Practice’, ECGI-Law Working Paper No 09/2003.


the other, the excessive risk taking and long-term interest of the company. This approach does not address the risk which the growing gap between the ordinary pay of employees and the top management’s remuneration poses to sustainable com-pany growth.

Agency costs analysis overlooks the primary responsibility of the legitimacy of government, which is to respond to the financial crisis beyond the issue of main-taining capital liquidity and designing a regulatory system that allows companies to recruit and retain corporate directors. The legitimacy question is not only about the liquidity efficiency of capital markets. How do agency costs answer the question of why shareholders only have a consultative say rather than a binding vote regarding directors’ remuneration? Is it legitimate to exclude employees from the same form of consultation that is available to shareholders? Should transparency be limited to certain parts of the remuneration package and not extend to the relationship be-tween independent committees and the board, on the one hand, and the pay dispar-ity between the directors and the average employee, on the other? How can such a requirement of transparency be effectively enforced? How do agency costs address the norm for sustainable growth?

4.2 The limits of EU legislation based on agency costs

At the European level, the structures of control for directors’ remuneration are built on three areas: (1) board control,53 (2) remuneration committee control,54 and (3) shareholders control.55 These form the institutional governance framework; how-ever, how these institutions should exercise their control is not clear.

4.2.1 Board control

Regarding board control, emphasis is placed on the independent non-executive directors who will exercise their judgment on the directors’ remuneration. However, the law does not require non-executive directors to exercise their judgment accord-ing to a particular socio-legal norm, for instance, whether the remuneration is ‘fair’, ‘reasonable’, ‘proportional’, ‘not wasteful’ and ‘conscionable’. What the law does require the non-executive directors to do is to check if the remuneration has been set in compliance with the imposed procedure. There are two aspects of procedure: first, the procedure to have the remuneration approved; and second, what is to be taken into account when approving the remuneration. The latter is a matter for the

53 Commission Recommendation (EC) 2005/162 on the role of non-executive or supervisory directors of listed companies and on the committees of the (supervisory) board, supra n. 7.

54 Ibid. 55 Commission Recommendation 2004/913/EC fostering an appropriate regime for the

remuneration of directors of listed companies, supra n. 5.


national laws of Member States. However, compliance alone does not effectively instruct the non-executives as to how to direct the executives to award themselves a right, fair, just, not wasteful, reasonable and conscionable salary. Another debate that has been directed by the agency costs theory focuses on the remuneration of non-executive directors. It is said that they should not be subject to the same bonus system as enjoyed by the executive directors, as this would compromise their independence. Against this it is argued that without an optimal level of non-executive directors’ remuneration, these directors will not be able to carry out their functions properly, not as far as independence is concerned, but as regards their inputs required.

4.2.2 Committee control

In regards to the remuneration committee control, an additional external control such as by an independent consultant or auditor should be included to complement the function of the non-executive directors. Their focus would be similar to that of the independent non-executive directors. The committee may be made accountable to the shareholders as well as to the other controlling agents, for instance, the supervisory board or the chairman. However, EU law is not clear on the commit-tee’s accountability to the shareholders, the duties of the auditors and the duties of the external consultant. This is because the committee has not been given a clearly defined legal status: its relations with the board, the general meeting and the com-pany’s auditors have been left vague. Legal status could be given to the controlling committees to enhance their ability to supervise the remuneration and to account to the shareholders and stakeholders.56 Agency costs analysis cannot offer guidance in this matter, nor can it offer guidance regarding the question of independence of the committee members.

4.2.3 Shareholder control

As for shareholder control, shareholders cast their votes on certain measures perti-nent to the control of directors’ remuneration. This can include voting on the direc-tors’ remuneration package, on the remuneration policy itself and on the report submitted by the committee. The outcome of the vote can be either binding on the board or purely consultative. Giving a choice as to whether the vote should be binding or not on the Member States will create regulatory competition within the internal market. This defeats the aim of rules harmonisation and the legitimate

56 See the report The Remuneration of Elected Chairs of Boards and Traders (in French), adopted by the French Parliamentary Committee on Constitutional Laws, Legislation and General Administration, available at: <http://www.eurofound.europa.eu/eiro/2009/08/articles/fr0908029i. htm>.


interest in creating a level playing field. The intention is to leave it to the investors to decide the destination of their investment according to the legal environment. It must be noted that shareholders’ approval for share option schemes concerns not the control of directors’ remuneration, but rather the increase of share capital and the dilution of shareholdings in the company.

4.2.4 Cost and benefit-determined structure

In order to achieve efficiency under the agency costs analysis, the cost of control-ling directors’ remuneration must not outweigh the benefit that can be achieved. For instance, for a small private company with just a few shareholders and directors, such as a family-controlled closed company, it may be too costly to set up a remu-neration committee if control can be carried out effectively in a general meeting. On the other hand, if the general meeting cannot effectively and efficiently control the cost, a remuneration committee or an alternative control mechanism such as court proceedings may be required to carry out the task. Similarly, whether the shareholders’ vote on directors’ remuneration should be binding or purely consulta-tive must be determined by a cost and benefit analysis. However, what differenti-ates private and public companies must go beyond mere agency costs. A public company has more power and rights to use public resources and engage in societal development. Such rights and power should come with a higher responsibility and accountability, which rests not only with shareholders but also with wider parties who have an interest in or may be affected by the powers exercised by the public company. The reason that a private company would not be required to be subject to such greater control is not simply a ‘cost’ issue, but rather the relation it has with public resources, i.e., access to information and cheaper ways of obtaining capital.

4.2.5 Legal vacuum

One of the effects of such an agency costs-based approach is that the rules would not be integrated into the legal paradigm where the rules are normative weights reflecting the primordial and authentic stratum of collective self-identification. To integrate these rules into the legal system, socio-legal norms must be furnished. If the legislator has not done so, it is then the role of the ECJ to carry out this task. This also suggests that a comparative study on the law of obligation across the EU will be essential. Furthermore, the absence of the proposed Fifth Directive, regulat-ing the structures and duties of the management, poses a crucial obstacle to the development of the regulatory regime.

The practices of national governments should give some indications to EU regu-lators, as many governments have injected public funds into their ailing banks, which, in turn, will not be able to receive bonuses or increase their pay in some cases. In the US, the Emergency Economic Stabilisation Act of 2008 (EESA) banned ‘golden parachutes’ and disallowed tax reductions for executives whose


annual compensation exceeds $500,000 and whose companies received financial aid through the Troubled Asset Relief Programme (TARP). In the UK, banks receiving government capital injections awarded no cash bonuses in 2008 and no pay increases in 2009. The norms of ‘no reward for failure’ and no reward at the expense of capital contributors have been shown in these cases. The difference is that this does not take place by the operation of a legal norm but through agree-ments, essentially on a contractual basis or through government pressure. This shows that these concepts could be the legal norms incorporated into corporate governance. The problem is that the shareholders or other stakeholders are not able to demand that these norms be included in the company’s articles or the directors’ service contracts. The remuneration, audit and risk committees did not recognise, in the past, that there was such a legal norm, subjective rather than procedural, in the performance of their function.

5. THE MODEL OF UK LAW IN CONTROLLING DIRECTORS’ REMUNERATION: COMMON LAW, STATUTORY LAW, REGULATION AND SOFT LAW

5.1 Socio-legal norms in common law

It is said that common law is a functioning harmonisation of vision with tradition, of continuity with growth, of machinery with purpose, of measure with need, mediating between the commands of the authority and the demands of justice. Common law offers a number of socio-legal norms reflecting tradition, practical needs and civil values. In common law, both in the UK and US, one of the princi-ples for regulating directors’ remuneration is based on directors’ fiduciary duty,57 in particular the duty to avoid conflicts of interest.58 Many US courts also approach the question of directors’ remuneration based on directors’ fiduciary duties.59 Such fiduciary duty entails good faith, honesty, conscionability and reasonableness. A rule designed to assist the board, such as a clause in the articles, in whitewashing their ‘bad faith’ or ‘dishonesty’ should not give the board the green light to go ahead with setting their own levels of remuneration and prevent further judicial scrutiny. Furthermore, the US Supreme Court stated in Rogers v. Hill that remu-neration could be so large as to constitute waste, irrespective of whether the remu-neration was tainted by fraud or self-dealing.60 In addition, the conflicts of interest rule is rooted in the personal obligation of exercising good conscience and loyalty.

57 In the US Delaware Chancery Court, it was held that directors ‘spring-loading’ stock options were in breach of directors’ fiduciary duty.

58 P. Davies, Gower and Davies. Principles of Modern Company Law, 8th edn. (London, Sweet & Maxwell 2008), at p. 382; Halt Garage (1964) Ltd, Re [1982] 3 All E.R. 1016.

59 Delaware Court in Gantler v. Stephens 965 A.2d 695 (Del 2009). 60 Rogers v. Hill 289 U.S. 582 (1933).


This is why remuneration must be approved either by the board where there are non-executive directors, or by an independent remuneration committee and/or by the shareholders in a general meeting. The duty is imposed to assist the board not only to ‘avoid’ such a conflict of interest, but also to be guided in exercising good conscience. This requires the directors to make full disclosure of any potentially improper relationships or conflicts of interest that they might have in their negotia-tions with their companies.

Contract law also plays a role in controlling directors’ remuneration. This was demonstrated in the bail-outs of Lloyds and RBS, two leading banks in the UK, from public funds in which the government was able to negotiate with the banks not to pay bonuses to directors in 2008 and not to increase pay in 2009. A company’s articles of association can be treated as a contract that binds its directors.61 For instance, the claw-back provision contained in the new UK Corporate Governance Code suggests that companies should incorporate such a provision into their prac-tices. For example, provisions that purport to prevent ‘reward for failure’ can be inserted in the articles, which will give shareholders the right to control directors’ remuneration in court. This will require the court to interpret clauses contained in articles of association, for instance, what constitutes a ‘failure’ under the contract. The court may also develop legal rules to deal with the effects of any remuneration given to directors that may be contrary to the articles of association.

Furthermore, a fiduciary duty to carry out risk management should also be de-veloped. This is discussed in a later section.62

5.2 Statutory provisions: a hybrid of the socio-legal norm and agency costs norm

In addition to common law control based on the directors’ fiduciary duty and the company’s articles of association, another form of control can be imposed by statutory law, which places emphasis on external control by auditors,63 internal control by shareholders.64 and internal control through general meetings. UK law imposes reporting duties on the directors, such as disclosing the amount of remu-

61 Problems can arise when the company seeks to fix the terms of a director’s remuneration without complying with the articles, see Guinness v. Saunders [1990] 2 AC 662, HL; UK Safety Group Ltd v. Hearne [1998] 2 BCLC 208.

62 This is discussed in section 8. 63 S 498(4) of the Companies Act 2006 requires the auditors to give the particulars of the

information not obtained in the report. The second part of the directors’ remuneration report concerning the actual payments made to the directors is subject to audit. However, the company’s remuneration policy is not. See Parts 2 and 3 of the Schedule of Regulations 2008/410.

64 S 439 of the Companies Act 2006, on shareholders’ advisory vote, makes it cheaper, otherwise it is only possible to vote on it if they requisitioned a resolution to be added to the agenda of the accounts meeting or requisitioned an extraordinary meeting of the shareholders.


neration in the directors’ report.65 These types of statutory control are different from the provisions on the general duties of directors, as they are the specific reporting duties imposed on directors to enhance the enforcement of their general duties. These provisions are not normative in nature, but prescriptive. These prescriptive duties can be altered if there is a change in circumstances, notably if the reporting duty becomes cumbersome and unnecessary. However, the changes are likely to reflect on the cost rather than on the changing relation between the board and other parties.

This prescriptive nature of the duties is the reason why they are imposed only on certain companies. Furthermore, the scope and extent of the disclosure of the remuneration are linked to practical rather than normative concerns. For instance, certain information is not disclosed and the amount of the remuneration packages is not disclosed in individualised form. However, the legal basis for the distinction between what is to be disclosed and what disclosure should be individualised has not been given. Is this to protect a director’s privacy right? Moreover, the auditors must give their opinion as to whether the actual amount given to the directors is in compliance with the performance criteria set by the committee, although the audi-tors are not required to comment on these criteria. Instead, the auditors’ role is to give a fair and true view of the affairs of the company rather than of the perform-ance of the committees. However, the confidence the public places in the auditors’ opinion must go beyond the simple ‘true and fair’ approach. Should the auditors assess the ‘independence’ of non-executive directors and the method(s) used in justifying their remuneration?

Some of the rules on reporting and disclosure are prescriptive and made to com-plement broad socio-legal norms such as directors’ fiduciary duty. Furthermore, the point of good faith – honesty – should not be overlooked in the whole process. In addition, while auditors should ensure that their statements are ‘true and fair’, they must carry out this exercise by focusing on the substance rather than on formal compliance.

5.3 Compliance with the prescriptive rule

The specific regulatory models set up by way of prescriptive rules based on agency costs are not in line with the socio-legal norms. One of the reasons for this is that the committees entrusted with the enforcement of those models do not enjoy legal status, and their duties and rights are not legally regulated to the same extent as those of the board’s directors. Hence, mere compliance with these rules cannot exonerate the remuneration from further scrutiny. For instance, there may be ques-tions about the independence of the committee and the adequacy of the time and

65 S 420 of CA 2006, on directors of quoted companies; Large and Medium-Sized Companies and Groups (Accounts and Reports) Regulations 2008/410, Sch. 8.


effort put in by the committee in scrutinising the remuneration policy, market data, the actual amount of the payment, and the information available to the committee to carry out reasonable deliberations on the issue of remuneration.

5.4 The nature of soft law as a regulatory instrument

The Combined Code, based on the Cadbury and Hampel reports, the Listing Rules on directors’ remuneration, the FSA Code on Remuneration Practices.66 and the Corporate Governance Code issued by the Financial Reporting Council are repre-sentative examples of the use of the soft law-based regulatory model. Although soft law has been used to regulate directors’ agency costs, neither the Combined Code nor the Listing Rules require shareholders’ approval of directors’ remuneration. The best practice on remuneration recommended by the Combined Code is that a ‘sig-nificant proportion of executive directors’ remuneration should be structured so as to link rewards to corporate and individual performance’.67 Furthermore, payouts under the incentive schemes should be subject to challenging performance relative to a group of comparator companies in key variables such as total shareholder return.68 The Corporate Governance Code 2010 clarifies that performance criteria in relation to the payment of annual bonuses ought to be designed with the long-term interests of the company in mind. Payments or grants made under incentives schemes should be based on performance criteria, which include non-financial performance metrics, if appropriate, and such remuneration incentives ought to be consistent with the risk management policies and procedures of the company. In addition, the provisions recommend that companies should consider the use of provisions that enable them to reclaim variable remuneration in the case of mis-statement or misconduct. The Listing Rules require shareholders’ approval for the granting of options to the directors, as this can dilute the position of other share-holders. However, if the granting of an option is to facilitate the directors’ incentive scheme, shareholders’ approval can be dispensed with. Such share option schemes need to be disclosed in the next annual report.69 This shows that control under the Listing Rules is not based on the socio-legal justice norm against excessive, unrea-sonable, disproportional and unconscionable remuneration.

Both the Combined Code and the Listing Rules do not enjoy the statutory force of law. As a consequence, the interpretation and enforcement of their provisions are subject to a different kind of mechanism. They are, however, more flexible. Whether such an alternative to giving actual legal force enhances social value is

66 Available at: <http://www.fsa.gov.uk/pubs/policy/ps09_15.pdf>; see also Walker Review of Corporate Governance of UK Banking Industry, available at: <http://www.hm-treasury.gov.uk/ walker_review_information.htm>.

67 The Combined Code, B1. 68 The Combined Code, Sch. A, para. 4. 69 LR 9.4.2-3.


questionable. These codes do not have democratic legitimacy, nor do they reflect the social value of the general public consensus. The argument of treating directors’ remuneration as a private matter no longer justifies the use of soft law.

5.5 Socio-legal norms in English case law

5.5.1 Excessive remuneration and conduct unfairly prejudicial to shareholders

Excessive (or wasteful) remuneration touches on the socio-legal issue rather than on the matter of agency costs. Excessive (wasteful) remuneration of directors can amount to unfair prejudice to shareholders.70 This is demonstrated in the High Court case of Irvine v. Irvine,71 in which the minority shareholders brought a petition for relief based on a statutory provision entitling shareholders to bring a petition for relief if the company’s affairs are being, or have been, conducted in a manner which is unfairly prejudicial to the interests of the shareholders. The court held that the director awarding excessive remuneration to himself amounted to conduct unfairly prejudicial to the interests of the shareholders.72In deciding whether the remunera-tion is ‘excessive’, that is, to assess the fair value of the contribution to the busi-ness, the test is whether an intelligent and honest person in the position of director would reasonably believe the level of remuneration to be appropriate.73 The court also stated that directors’ remuneration must be justified by objective commercial criteria.74 In assessing whether the remuneration was excessive, the court consid-ered the evidence presented by expert witnesses in the field. It is safe to say that the ratio established in this case was that if, against objective commercial criteria, an intelligent and honest person would not reasonably believe the level of remunera-tion to be appropriate, the director receiving the remuneration would be likely to be said to have conducted the affairs of the company in a manner unfairly prejudicial to the interests of the shareholders.

However, this is not to say that a director awarding himself a high level of re-muneration amounts to unfairly prejudicial conduct per se. For instance, it would

70 S 994(1) of the Companies Act 2006; Irvine v. Irvine [2006] EWHC 1875; Sam Weller & Sons Ltd, Re [1990] BCLC 80; directors have fixed their remuneration in disregard of the provisions of the articles governing that matter, see Ravenhart Services (Holdings) Ltd, Re [2004] 2 BCLC 375.

71 Irvine v. Irvine [2006] EWHC 1875 (Ch); for a comparable case in the US Supreme Court, see Rogers v. Hill, 289 U.S. 582 (1933).

72 R. Goddard, ‘Excessive Remuneration and the Unfair Prejudice Remedy’, 13 Edinburgh Law Review (2009) pp. 517-519.

73 Charterbridge Corporation Ltd v. Lloyds Bank [1970] Ch. 62. 74 The US Delaware Court also said, in Rosenthal v. Burry Biscuit Corporation, that the

directors’ services’ value must bear some reasonable relation to the value of the stock options given. See Rosenthal v. Burry Biscuit Corp., 60 A.2d 106, 109 (Del.Ch. 1948).


not be a case of excessiveness if a large part of such remuneration given to the director represented the dividend of the director’s shareholding in the company for the purpose of obtaining a favourable fiscal position. In the Irvine case, the fact that the director never consulted the shareholders at general meetings before awarding himself his remuneration was a crucial factor as to why such conduct was found to be unfairly prejudicial.75 This may be an aspect that influenced the court’s view on the whole case. However, whether shareholders have been consulted at general meetings may relate to issues other than ‘excessiveness’.

In this case, the factors that determine the issue of excessiveness of any remu-neration include: (1) what is included in the remuneration package, such as salary, bonus, expenses and dividends to which the director is entitled, and (2) how the level and structure of the remuneration are justified, taking into account the direc-tor’s personal contribution to the company. It is interesting to note that the court considered that the director’s personal connections with other companies, poten-tially a main factor to the growth of the company, did not justify a high remunera-tion. That is to say that a high level of remuneration, even though awarded in accordance with a performance-based remuneration policy, can still be deemed excessive, even if the attempted justification is that the company would not have been able to make profits but for the director’s contribution. As the court stated, the director should have built a company that was able to grow not just because of his personal connections. The court used the business jargon ‘corporatised’ personal connections to illustrate the director’s duty to make his personal connections an asset to the company. The director’s personal connections that brought profits to the company could not be regarded as ‘extra’ to his general duty to justify an extra reward.

The fact that the shareholders did not receive the dividends to which they were ‘entitled’ – not necessarily a statutory legal right – also influenced the view of the court. The shareholders were said to have a legitimate expectation as to their enti-tlement to the dividends, depending, inter alia, on their relationships with the directors and their involvement in the company’s affairs. Therefore, even though the shareholders did not have a strict legal right to receive dividends, the directors, by refusing to declare dividends to the shareholders, may have been considered to be in breach of duty not to exercise unfettered discretion.

However, a breach of the director’s duty might not have been found to exist, even if the remuneration was viewed as excessive, if:

(1) the company had adopted the dividend and remuneration polices agreed by the shareholders;

(2) the shareholders had promptly been given proper notices to attend the general meetings where they were to be consulted on the matter of remuneration; and

75 Irvine v. Irvine [2006] EWHC 1875 (Ch).


(3) the remuneration could have been justified based on objective commercial criteria such as using a comparative data survey.

Therefore, whether an excessive remuneration amounts to unfairly prejudicial conduct, and whether the remuneration is excessive, should be distinguished. Whether the remuneration is excessive is measured by an objective test of an intelligent and honest person in the position of director against the reasonableness and proportionality of such remuneration. The court did not expand on reasonable-ness and proportionality by giving a formula or providing a test, as it would nor-mally do in administrative cases. Instead, it decided the issue of ‘reasonableness’ and ‘proportionality’ by considering the evidence given by the expert witnesses based on (1) their professional competence, and (2) the reliability of the methodol-ogy used by them. In conclusion, remuneration can still be excessive even if there is (1) no breach of articles of association, (2) no breach of fiduciary duty, and (3) no breach of shareholders’ legitimate expectation. The court neither affirmed nor rejected the argument that there were direct relationships between the breaches and the point of excessiveness. It may be safe to say, therefore, that the breaches or conducts that fell short of the breach influenced the court’s approach in deciding (1) what an intelligent and honest person is, (2) what the concept of reasonableness and proportionality is, and (3) what the professional competence of expert witnesses is, such as the reliability of their methodology.

5.5.2 Directors’ conduct and remuneration

The conduct of the director and the excessive level of remuneration are the causes leading to the conclusion that the director’s conduct is unfairly prejudicial to the shareholders. It can be said that the unfairly prejudicial conduct leads to excessive remuneration being awarded, but such conduct is not the legal cause that deter-mines whether such remuneration is excessive. A director may have fulfilled all his statutory duties by complying with the requirements laid down by the Companies Act, regulations and soft law, by observing his fiduciary duties owed to the com-pany and by complying with the enhanced duties laid down in the articles of asso-ciation, but this may not affect how an intelligent and honest person perceives the excessiveness of the remuneration. Rather, these factors contribute to the assess-ment of whether the conduct of the directors is unfair and prejudicial to the share-holders.

Under the approach in Irvine, remuneration is likely to be treated as ‘excessive’ if the conduct is unfairly prejudicial, such as if there is a close or near breach of directors’ duties, a breach of shareholders’ legal rights or if shareholders’ expecta-tions have not be fulfilled. On the other hand, an ‘excessive’ remuneration can also amount to unfair prejudice to the shareholders.

This case demonstrates how socio-legal norms can be developed to be the basis for a regulatory regime. In this case, one can see how ‘unfair prejudice’ can be a


reference for evaluating a director’s conduct concerning the issue of remuneration. The discussion is more than a matter of quantitative assessment, and once the neces-sary socio-legal norms can be established, the issue of the ‘amount’ becomes an issue of evidence to be taken into account. The crucial matters to be considered include the shareholders’ expectations,76 the treatment of the shareholders by the directors.77 and the corporate environment surrounding the directors’ conduct. Such a socio-legal norm could also assist the shareholders while they exercise their votes on approving the accounts and management strategies of the company in the general meeting.

This case also demonstrates that transaction-based compensation.78 and promo-tion may lead to corrupt practices contrary to company’s policies and interests. The audit committee, the board and the risk department should note such a risk associ-ated with the compensation structure.79

5.5.3 Transposing the applicability of unfair prejudice to a listed public company

Although an unfair prejudice petition is a legal model offering protection to the minority shareholders of companies on a smaller scale, it is not easily available to shareholders of larger companies, e.g., listed companies. Even though the law does not prohibit shareholders from bringing petitions based on this provision, the reliefs that the court may award discourage the shareholders from using it. If the court is satisfied that there has been unfairly prejudicial conduct, it is empowered to con-sider a number of reliefs and grant the reliefs it thinks appropriate. These reliefs include:80 a buy-out order,81 a sell-out order, allowing minority shareholders to bring a derivative action against the directors,82 and regulating the future affairs of the company.83 The first two types of relief can be viewed as redundant if there is a ready market, because the shareholders can sell their shares in a ready market, either at a premium or at a loss; it is only when the shares are sold at a loss that it can be said that there is prejudice. Assuming the court could compel the majority

76 M. Duffy, ‘Shareholders Agreements and Shareholders Remedies Contract Versus Statute’, 20 Bond Law Review (2008) pp. 1-27; A. Raynaud, ‘Decisions Based on Shareholder Expectations’, Nissan Annual Report (2004), at p. 53; L. Mitchell, ‘The Legitimate Rights of Public Shareholders’, 66 Washington and Lee Law Review (2009) pp. 1635-1682.

77 E. Helland and M. Sykuta, ‘Who’s Monitoring the Monitor? Do Outside Directors Protect Shareholder’s Interests?’, 40 Financial Review (2005) pp. 155-172.

78 Remuneration awarded based on the number and amount of transactions entered into by the directors as if they are a commission-based remuneration package.

79 J. Song and B. Windram, ‘Benchmarking Audit Committee Effectiveness in Financial Reporting’, 8 International Journal of Auditing (2004) pp. 195-205.

80 S 996(2), CA 2006. 81 S 996(2)(e), CA 2006. 82 S 996(2)(c), CA 2006. 83 S 996(2)(b), CA 2006.


shareholders to purchase minority shares – not at a loss, which would be the case if the shares were sold at the market price – the issue is not whether the court can interfere with the market price or the ability to evaluate the share price, but whether it can ascertain the purpose of the reliefs granted. Should the reliefs be granted to compensate the shareholders because of the excessive remuneration or to force the directors to make restitutions for the remuneration received?

In the Irvine case, counsel for the respondent director asked the court to con-sider the relief of regulating the future affairs of the company by imposing a cap on the level of remuneration. The court did not give reasons for not doing so. Surely it is not because the court did not have the power to do so, but because doing so would subject the court to certain criticism. For instance, the court might be blamed for imposing the cap if the business failed and would not have failed had the alter-native reliefs been given. However, this cannot be the sole reason for not imposing a cap. Should the court consider the cash-flow problem of the company when deciding the compensations and damages to be awarded to the victims of the com-pany? Should the court be subject to criticism if it orders a monopolistic company to split up into two companies, which results in less profit or even a loss-making business? The answer must be no. If so, why should the court be afraid of imposing a cap on remuneration when such remuneration has been found ‘excessive’? Fur-thermore, as the court could grant such other reliefs as it thinks appropriate, a restitution order that compels the director to give back the excessive part of the remuneration would not be seen to be disproportionate or unreasonable.

6. THE BELGIAN GOVERNANCE REGIME: IMPLEMENTING EU AGENCY COSTS NORM-BASED LEGISLATION

6.1 General legal framework

In Belgium, the main laws governing remuneration are the Companies Code (Code des Sociétés), the Corporate Governance Act 2010 (Loi belge du 6 avril 2010) and the Corporate Governance Code 2009 (Code belge de gouvernance d’entreprise, also known as Code Daems). The FSMA (Autorité des services et marchés financi-ers) has also issued a circular governing directors’ remuneration in financial institu-tions. The main obligations imposed by the law are on the board, the committee, the non-executives and, to a certain extent, the auditors. Under the Companies Code, the remuneration cannot be set without the authority of the general meeting or the articles of association.84 Hence, the shareholders at the general meeting have a right to approve the remuneration report in addition to the annual report which must contain the remuneration report.

84 Art. 517, Code des sociétés.


6.2 Disclosure under the Companies Code

The disclosure regime imposed by the Companies Code includes disclosure of the remuneration policy.85 and the directors’ remuneration. The CEO (the executive) should disclose individually the amount and composition of his remuneration.86 For the other directors, group disclosure is sufficient. However, the shareholders may have the right to demand the directors to publish their individual remuneration through their ‘right of questioning’ (droit d’interpellation).87 For non-executive directors, individual disclosure of all direct and indirect advantages is required.88

6.3 Legal requirement of the remuneration committee

Unlike the British soft-law approach to the composition and duties of the remunera-tion committee, the Corporate Governance Act 2010 requires that the remuneration report be established by a remuneration committee to be set up by the board. The majority of the members of the committee must be independent.

6.4 Golden parachute

The Corporate Governance Act 2010, inspired by the EU’s recommendation, further regulates directors’ severance pay. A severance pay exceeding 12 months or 18 months if recommended by the remuneration committee must be approved by the general meeting. If the severance pay is contrary to this law, the disposition of it will be nullified. This position is not currently adopted by the UK law. The UK Corporate Governance Code also imposes the same limitations but does not grant shareholders the power to approve severance pay exceeding the 12-months and 18-months limitations.89

6.5 Employee-stakeholder’s role

Belgian law also gives greater power to the employees to give their opinion on the directors’ severance pay. This reflects what has been discussed in the earlier section as the approach to adjusting the structural deficiency of negotiation. The Corporate Governance Act 2010 provides that the works council – or in case there is none, the committee for prevention and protection at work or the trade union – should be informed at least 30 days prior to the general meeting of the board’s intention to

85 Art 7.4, Code de gouvernance d’entreprise. 86 Arts. 7.15 and 7.17, ibid. 87 Art. 549, Code des sociétés. 88 Art. 7.5, Code de gouvernance d’entreprise. 89 Art. 9, Corporate Governance Act 2010.


grant severance pay. Therefore, unlike in the UK, these stakeholders have the opportunity to make known their comments and recommendations about the sever-ance arrangements.

Before the enactment of this law, a certain controversy was created, notably in the opinion issued by the Belgian Conseil d’Etat, the Belgian supreme administra-tive court. The concern was that the requirement of shareholders’ approval for severance pay exceeding the limitations may interfere with the Employment Con-tracts Act 1978, resulting in discrimination between executives with an employ-ment contract and employees who may earn more than the executives but are not considered as leading persons by the Corporate Governance Act 2010.90 The issue will have to be resolved by the Constitutional Court in the future. This is an exam-ple of how these two legal institutions – company law and labour law – interfere with the direction of the remuneration governance regime.

7. DIFFERENT SOCIO-LEGAL NORMS LEADING TO DIVERSE ENFORCEMENT

7.1 Belgian private enforcement

Enforcement action under the remuneration regulatory regime imposed by the Belgian Civil Code and the Companies Code may be taken either by the board or by the shareholders. However, any legal action should be linked to the ‘fault’ of the directors.91 An action against the directors may be based on general ‘tort’ or on breach of contract under the Civil Code,92 on breach of companies’ articles of association,93 on conflicts of interests,94 on management fault (.faute de gestion simple)95 and on serious management fault (.faute de gestion grave et charac-térisée)96 if the company is liquidated under the Companies Code. A legal action based on contractual liability concerns the individual liability of the director, and the action – action mandatée.97 – can only be brought by the company provided no discharge has been granted to the directors by the general shareholders’ meeting. If minority shareholders have not approved the discharge at the meeting,98 for in-

90 O. Debray and D. Lemberger, ‘La nouvelle loi “Corporate Governance” et les limites à la rémunération et aux indemnités des dirigents d’enterpise’, Forum Financier (2010/IV) p. 195.

91 Art. 527, Code de gouvernance d’entreprise. 92 Art. 1382, Code Civil. 93 Art. 528, Sec. 2, Code des sociétés. 94 Arts. 523 and 524, ibid. 95 Arts. 527 and 528, ibid. 96 Art. 530, ibid. There is no need to establish a causal relationship between the serious

mistake and the bankruptcy. It suffices that the mistake contributed to the involuntary liquidation. 97 Art. 561, ibid. 98 Art. 562, Sec. 4, ibid.


stance, non-approval for the severance pay under the Corporate Governance Act 2010, they can bring the action on behalf of the company provided they represent 1 per cent of the votes of the total shares or own shares which represent the capital for a value of at least EUR 1,250,000.99 UK minority shareholders do not enjoy the same legal right to bring an action against the board in these circumstances.

Shareholders can issue proceedings based on the causes of action mentioned above through an action on behalf of the company (action sociale)100 or a minority action (action minoritaire).101 Furthermore, the corporate governance statement published on the company’s website may be considered material information to be relied on by the investors. Hence, if the company fails to follow the Code of Corporate Governance 2009 but it claims to have done so in the corporate statement, this may give rise to an action in tort under Article 1382 of the Civil Code. As far as the stakeholders’ action is concerned, Belgium follows the monist board structure, as opposed to the German-style dualist structure, and the employee-stakeholders do not have the right to enforce the requirements imposed by the Corporate Governance Act and Code.

7.2 Belgian public enforcement

As far as public enforcement is concerned, companies listed on the Belgian stock exchange are subject to oversight by the FSMA, the Belgian financial services regula-tor.102 Firstly, the FSMA can enforce the Corporate Governance Act against listed companies and the circular on remuneration.103 against financial institutions. Even though the FSMA cannot enforce the Code of Corporate Governance 2009 directly, it may be able to take action against a company that does not comply with its published corporate governance statement, which has been relied on by the investors.104 Sec-ondly, since the company should disclose its remuneration in the annual accounts, which are relied on by the investors, the FSMA can take action against the company if the disclosure does not comply with the requirements imposed by the Code of Corporate Governance. Even though the Code is subject to the principle of ‘comply or explain’, the reason for non-compliance cannot be capricious.105 The Belgian FSMA does not have a code of practice on remuneration, as adopted by the UK’s Financial Services Authority. With such a code of practice, the UK FSA is therefore in a better position to enforce the code. The FSMA and FSA may not treat all the com-

99 Art. 562, Sec. 2, ibid. 100 Art. 561, ibid. 101 Art. 562, ibid. 102 Law of 2 August 2002. 103 Circular No. 30 of 26 November 2009. It lays down requirements for remuneration in the

financial institutions. 104 Art. 7.4, Code des sociétés. 105 In this regard, the UK’s financial services regulator FSA may enforce soft law if the

company publishes information stating its compliance with soft law.


pany’s corporate governance statements as material information to be relied on by the investors. It should also be noted that the sanctions for non-compliance may be imposed against the issuers (companies) rather than the directors.

7.3 Discrimination caused by capping

In response to the public demand to regulate directors’ remuneration, the Belgian government purported to regulate severance payment, the so-called golden para-chutes. In April 2010, the Corporate Governance Act was passed to regulate golden parachutes. Before the Act was passed, the Belgian Conseil d’Etat had given a negative opinion on the law on the grounds that the law was discriminatory in nature. This is because it intends to impose a cap on payment to the directors – employees of the company – but such a cap does not apply to other ‘employees’.106 This is another example of how these two legal institutions – company law and labour law – interfere with the direction of remuneration governance regime.

7.4 Divergence in enforcement and the role of the ECJ

One of the implications of such diverse enforcement for the European harmonisa-tion project is that the European Court of Justice would have to take an active role in harmonising socio-legal norms for the remuneration regulatory regime. The issues include the legal enforcement of soft law, the basis of shareholders’ right to participate in the general meeting, the scope of the principle of equal treatment, the legal basis of transparency, issues on the interests of the company, minority share-holders’ rights, the application of conflict of interest, and shareholders’ expectations regarding public enforcement.

8. BUILDING SOCIO-LEGAL NORMS FOR THE REMUNERATION REGULATORY REGIME INTO THE EUROPEAN COMPANY LAW FRAMEWORK

8.1 Current approach without substantive socio-legal norms

The current approach to directors’ remuneration regulation is to follow the agenda of European corporate governance.107 Despite the agenda of European corporate

106 J. Clesse, ‘Les avantages financiers liés à la sortie de certaines fonctions: contribution en mode mineur sur les parachutes dorés’, in N. Thirion, ed., L’entreprise et ses salariés: quel partenariat? (Brussels, Bruylant 2009) p. 393.

107 Commission Recommendation 2004/913/EC fostering an appropriate regime for the remuneration of directors of listed companies, supra n. 5; Commission Communication on Modernising Company Law and Enhancing Corporate Governance in the European Union – A Plan to Move Forward, supra n. 38.


governance including other socio-legal norms, the normative basis for the legisla-tion revolves around agency costs. Therefore, emphases are placed on the disclo-sure regime, the function of independent control through non-executive directors and the remuneration committee, and the shareholders’ control in general meetings. However, unlike domestic UK law, other normative legal bases of control of direc-tors’ remuneration, such as duty of loyalty and duty of no conflict of interest, do not exist in European company law. The shareholders’ right to express their views on remuneration has been mentioned; however, it has not been expanded to become a normative basis which will lead to a shareholders action in court when their views have not been followed or taken into account.

8.2 The limit of an agency costs-based legislative approach

Agency costs can steer the direction of the regulation. Such a regulatory approach based on agency costs has the effect of limiting the content of regulation to disclo-sure and the method of control to procedural compliance. The result is that such a scrutiny does not probe into what is to be disclosed and for whose benefits and interests. This involves the exercise of a cost and benefit analysis in which a num-ber of factors such as firm competitiveness, inflation and market competitiveness are taken into account. Competitiveness issues focus on how to set a regime that can best recruit, motivate and retain directors. The aim of European regulation is to bring disclosure and compliance standards to the European level; however, such an approach does not aim at harmonising the normative legal basis for the governance of directors’ remuneration. It may be the case that harmonisation of the normative legal basis will take more time and effort as it involves more comparative analysis of the substantive laws of the Member States. It is therefore less costly to focus only on the procedural requirements, leaving the substantive socio-legal norms to the Member States.

Furthermore, harmonising regulatory and procedural requirements, such as on the information to be disclosed, the internal bodies that are to control the procedure and the effect of such control, will not challenge the national normative legal basis, in other words, the socio-legal norms of the Member States. Such a legislative approach intends to create an expedient model of control rather than a normative paradigm of a remuneration governance regime, which can form part of the legal institution of European company law. It cannot, therefore, be a normative legal paradigm as one may see in domestic company law. One of the reasons for this is that European company law covers only limited areas: shares capital, corporate accounts and reports, cross-border takeovers, corporate auditors and corporate prospectuses of listed companies. The normative legal paradigm of European law has not yet been formed. However, that does not mean that the current European legislative framework and the European company law agenda cannot set in motion the development of a remuneration governance regime based on a socio-legal norm. What it does, nevertheless, is to leave the existing laws of the Member States to


develop in parallel with European legislation. As the analysis of UK and Belgian law has demonstrated, the domestic laws of the Member States can develop beyond the theory of agency costs on the basis of corporate social responsibility norms. However, if European legislation continues its development based on agency costs and leaves the Member States to develop their own normative legal institutions, this may result in further divergence, which will make future harmonisation more difficult. As evident from the discussion of the Belgian governance regime com-pared to the UK regime, this can also lead to differences in enforcement.

8.3 The current European company law paradigm: legal personality, limited liability, directors’ duty, shareholders’ rights, third parties’ protection, and the CSR

If there were to be an emerging European company law paradigm, it would have to be established based on the follow principles: (1) a company is a legal person rather than a nexus of contracts;108 (2) shareholders’ liability is limited to their share contributions rather than unlimited;109 (3) the directors owe duties to the company and/or the shareholders;110 (4) shareholders have certain rights to participate in the management and have their grievances addressed;111 and (5) third parties such as creditors should also have their interests protected.112 There is a view that the model should include the protection of non-capital contributors, such as employees, known as stakeholders. With principles of free movement of capital and freedom of estab-lishment in the background, important democratic values such as transparency.113

108 E. Werlauff, EU Company Law: Common Business Law of 28 States, 2nd edn. (Copenhagen, DJØF Publishing 2003), at p. 1. However, the legal system of the Member State can also influence the development of such a doctrine. See F. Hallis, Corporate Personality: A Study in Jurisprudence (London, OUP 1930).

109 Article 2(1) of the Twelfth Council Directive 89/667/EEC of 21 December 1989 on single-member private limited-liability companies, OJ 1989 L 395, 30 December 1989, pp. 40-42; Werlauff, supra n. 108, at pp. 39 and 140.

110 Proposal for a Fifth Council Directive; on duty of loyalty, Article 43(1)(7)(b) of the Fourth Council Directive 78/660/EEC of 25 July based on Article 44(3)(g) of the Treaty on the annual accounts of certain types of companies, OJ 1978 L 222, 14 August 1978, pp. 11-31; Werlauff, supra n. 108, at pp. 44 and 420.

111 Proposal for a Fifth Council Directive; Werlauff, supra n. 108, at pp. 372 and 437. 112 First Council Directive 68/151/EEC of 9 March 1968 on co-ordination of safeguards

which, for the protection of the interests of members and others, are required by Member states, OJ 1977 L 26, 31 January 1977, pp. 1-13; it is also evident in the rules governing capital maintenance, see Second Council Directive 77/91/EEC of 13 December 1976, OJ 1977 L 26, 31 January 1977, pp. 1-13; Werlauff, supra n. 108, at p. 411.

113 It is evident in the Directives requiring corporate disclosure and publication of accounts: Fourth Council Directive 78/660/EEC, supra n. 110; Seventh Council Directive 83/349/EEC of 13 June 1983 based on Article 44(3)(g) of the Treaty on Consolidated Accounts, OJ 1983 L 193, 18 June 1983, pp. 1-17.


and accountability.114 are only just emerging in this development while civil values are currently not yet fully integrated in the framework.

From the viewpoint of corporate legal personality, directors’ remuneration be-comes an internal issue to be decided according to the company’s articles of asso-ciation and through shareholders’ general meetings. The current view is that once the remuneration has been awarded according to the company’s articles of associa-tion, and has been sanctioned by the shareholders at the general meeting, no ques-tion of substance can be raised thereafter.115 That is to say that shareholders may not revoke what has been approved other than on the ground of procedural irregularity, even if the remuneration has turned out to be excessive and unreasonable. Govern-ments may be said to have no role in such an internal corporate affair other than to protect the interests of the shareholders. However, it may be argued that since the protection of legal personality is made possible by the state, the state can impose conditions on such a possibility; it may choose to impose further regulatory re-quirements on the remuneration. A similar legitimacy argument can be made for businesses that benefit from state aid. For instance, state aid to ailing banks legiti-mises the state’s intervention on such an internal affair as remuneration practice.116

The principle of shareholders’ limited liability allows entrepreneurs who lack capital, or have limited access to capital, to be able to trade and gain a share in the market economy. It is a further protection in addition to corporate legal personality. An argument against such a principle is that it would encourage imprudent and dishonest trading against the interests of the creditors. This is the case when the directors are also the main shareholders in the company. One of the implications that can be drawn with regard to directors’ remuneration is that directors could award themselves a large amount of money against the interests of the creditors. Such distrust has been, to some extent, moderated by provisions of wrongful trad-ing and fraudulent trading: one against imprudence and the other against dishon-esty. Nowadays, shareholders may not be involved in the company’s affairs as much as they once were when they were also the directors; if they fail to regulate directors’ remuneration and thus encourage a high risk-taking strategy caused by excessive rewards, their liability is only limited to their share contributions. The dividends awarded or profits gained through shareholder trading are not subject to creditors’ claims. Corporate legal personality prevents the shareholders from being sued by the creditors or other stakeholders, even if they are the majority sharehold-ers or shareholders having paramount influence. However, it should be reconsid-

114 Commission Recommendation 2002/590/EC of 16 May 2002 – Statutory Auditors’ Independence in the EU: A Set of Fundamental Principles (C(2002) 1873), OJ 2002 L 191, 19 July 2002, pp. 22-57.

115 Institutional Voting Information Service (2011), ABI Principles of Remuneration, available at: <http://www.ivis.co.uk/ExecutiveRemuneration.aspx> (accessed on 10 December 2011).

116 S. Munoz, D. Enrich and P. Kowsmann, ‘Just Don’t Call It a Bailout’, The Wall Street Journal (2011), available at: <http://online.wsj.com/article/SB1000142405297020405840457710 8723777515602.html> (accessed on 10 December 2011).


ered whether this should continue to be the rule and whether the shareholders should have legal or legitimate duties to regulate directors’ remuneration.

From the viewpoint of stakeholders, in the dual corporate management structure employees may be represented on the board, where they can decide or supervise the matter of remuneration. However, employees do not have the right to decide the remuneration of the directors, and the directors do not need to consult the employ-ees regarding their remuneration. Furthermore, with a profit-driven, cost-cutting strategy, directors may be rewarded by cutting labour costs, which is in conflict with the interests of employee-stakeholders.

The participation of other stakeholders in deciding directors’ remuneration is limited. The difficulty lies in identifying who the stakeholders are. If the customers of a bank are to be considered stakeholders of the company, this will include de-positors, insurance policy holders, borrowers and mortgagors. Mortgagors may argue that directors’ remuneration is at the expense of their high interest payment, and that therefore they are justified in having a say on the matter or redress of damages caused. Against such a view based on strict legal entitlement and en-forcement it may be argued that a company should set the remuneration policy; however, the stakeholders’ enforcement should be by ‘social’ rather than ‘legal’ means, i.e., if a mortgagor is not satisfied with the bank’s policy on remuneration or the level of the remuneration of the directors, he can choose other financial institu-tions from which to purchase the same or similar kinds of services. Although the concept of corporate social responsibility (CSR) may reinforce certain common values such as prudence, fairness, honesty and transparency, it is difficult to argue which aspect of CSR is the basis for regulating directors’ remuneration. On the contrary, directors may be rewarded with a higher level of remuneration if CSR has been implemented, as an incentive for the directors to carry out CSR strategies.

8.4 Risk management

Remuneration and incentive systems have played a key role in influencing financial institutions’ sensitivity to shocks and the development of unsustainable balance sheet positions. Failure to employ the appropriate type of stress testing, scenario analysis and adequate impact assessment and to introduce an adequate corporate governance system with a sound risk management policy, ensuring a dialogue between management and risk function, constitutes a management and board failure. This should have a part to play in the remuneration of the board. If there is a systemic failure or board failures on risk management, this should also reflect on the board’s remuneration. Furthermore, a high ratio of pay disparity between the directors and the average employees in the company as well as the companies of the sector also represents a management risk as well as a reputation risk. The board should introduce the risk management concept into the company’s corporate gov-ernance. Risk management requires the board to properly identify the risks of the company’s remuneration practice as well as the strategies relevant to the company’s


remuneration policy, to assess the risk at both financial and social level, and to mitigate these risks. Finally, the board should review its risk management on a periodic basis. Failure to do so would constitute a breach of their duty and would have repercussions on their remuneration.

9. CONCLUSIONS

In this article, it is argued that the European legislative approach to directors’ remuneration should focus on socio-legal norms, which are: (1) directors’ duties, including the duty to avoid conflicts of interest, the duty to take the long-term interests of the company into account, and the duty of risk management; (2) the shareholders’ right to participate in the management and to promote the company’s long-term interest; and (3) the stakeholders’ right to participate in corporate govern-ance. The more specific norms such as a balanced negotiation structure, no reward for failure, and transparency should be incorporated into the governance regime. A claw-back (look-back) regime should be made available to the stakeholders based on the law of restitution. The legal status of various committees should be made clear. Auditors’ accountability should be strengthened. The objectives of maintain-ing a reasonable ratio between the top managers and the ordinary employees, fostering a sustainable development, should be incorporated into the regulatory system. The current European approach to legislation on directors’ remuneration is based on agency costs, using the cost-benefit analysis and the market as the basis for the broader regulatory policy at EU level. All of the rules are made to reflect the costs that are incurred or that could have been incurred by the directors to the company and neglect the underlying normative social and legal questions. As a consequence, the benchmark for measuring the correct rule is that the cost of the rules should not outweigh the benefits that the directors could produce without these rules. As shown, this has the effect of losing sight of the cost to the employees of the company, which is a social issue. Furthermore, these rules are responsive and temporary, because the choice of the optimal regulatory model is circumstantial and the primary result of a cost and benefit analysis exercise. Under this approach, the factors to be taken into account are: (1) whether the management cost to the com-pany of adopting the procedure will be too expensive and burdensome; (2) whether the control procedure will make European companies less competitive against other counterparts; (3) whether disclosure rules will result in inflation; and (4) whether harmonisation of the rules will reduce competition within the internal market. The model is prone to be modified once market conditions change. The European company law programme includes certain normative legal bases such as maintain-ing directors’ fiduciary duties, enhancing shareholders’ rights and third parties’ protection, and promoting corporate social responsibility. These values, though mentioned, have not yet been developed as the backdrop to the legislative process for the directors’ remuneration governance regime.


By examining the Commission’s recommendations on directors’ remuneration for listed companies, as well as its consultation paper on directors’ remuneration for financial institutions, it can be observed that the regulatory approach focuses on procedural compliance, in particular the regime of disclosure and the structure of independent control. However, a substantive normative basis has not been devel-oped. It is argued that procedural compliance cannot per se legitimise directors’ remuneration.

By the same token, it is argued that in order to maintain a common European law founded on socio-legal norms, European legislation should focus not only on procedural compliance based on agency costs to impose a positivistic form of law, but also primarily on building a governance regime based on socio-legal norms which are socially tested norms that reflect reality and are capable of growing organically. The example given is the control model under the UK and Belgian legal system in which there are similar procedural controls under different legisla-tive regimes, both statutory and soft law-based, i.e., the Combined Code and the Listing Rules. However, there are also normative legal bases for such control. One of the examples is based on the statutory protection against ‘unfair prejudice’ under UK law, which describes how the affairs of the company relating to directors’ remuneration can give rise to unfairly prejudicial conduct. Such unfair conduct triggers shareholders’ action and the court’s review of the remuneration as well as the process of granting such remuneration.

If directors’ remuneration is about market confidence, the focus should be on ethics and public consensus rather than agency costs. The Commission’s approach to regulating directors’ remuneration is based on the agency costs norm rather than the socio-legal one. Due partly to domestic legal developments and partly to law at the European level, both the UK and Belgian reforms towards the governance of directors’ remuneration also follow the trend of focusing on regulatory compliance rather than on normative legal development. However, this does not mean that UK and Belgian law do not have normative legal institutions that can be developed for the remuneration regulatory regime. It is evident that the UK’s statutory concept of unfair prejudice – normative rather than responsive – has been applied in a dispute relating to directors’ remuneration. Equally, a number of normative legal bases embedded in Belgian law can potentially be developed to form the governing basis of directors’ remuneration.

The intervention by the Conseil d’Etat in Belgium shows how the legal structure can lead to an unexpected discussion. It may be the case that the agency costs-based legislations of the Commission are easier for the Member States to agree to, be-cause such an approach may appear to be value-neutral and the scope of application is more limited. Therefore, the impact of these legislations on the domestic legal structure will be limited. Nevertheless, the domestic legal structure can lead to a different outcome than that intended by this type of legislation. Since most of the directives do not state the modes of enforcement, the enforcement will depend on the domestic legal structures of the Member States. It will, for instance, depend on


the directors’ duties, shareholders’ rights, the nature and duties of non-executive directors, the concept of independence, other rights and the protection of the stake-holders, the relationship between public and private enforcement, and the legal nature of soft law. This may lead to divergence in enforcement within the European Union. It is then for the European Court of Justice to play a pivotal role in harmo-nising the enforcement, through so-called negative integration. One of the effects may be to harmonise the fundamental legal basis across Member States. In this way, the shortcoming of the Commission’s legislative initiative to form a directors’ remuneration governance regime based on agency costs can be remedied by a more active Court of Justice. As in many areas of economic law, company law is influ-enced by political ideology, economic policy, international pressure, the law within the legal system and public expectations. The ECJ will have the task of discerning these elements in the multi-faced EU while turning them into legal science.

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