Directors ‘remuneration: new policy measures to foster long-termism

65 European Commission, “Communication from the Commission to the Council and the European Parliament:

Modernizing company law and enhancing corporate governance in the European Union – A plan to move forward”, COM (2003) 284 final 8.

66 Directive 2007/36/EC of the European Parliament and of the Council of 11 July 2007 on the exercise of certain rights of shareholders in listed companies.

67 European Commission, “Green paper on corporate governance in financial institutions and remuneration policies” COM (2010) 284 final 8.

68 Article 3 (g) of the SRD II.

69 Article 9 (a) (b) of the SRD II.

The area of directors' remuneration is central to the discourse of incentivizing companies towards long-term development, and in recent years this field has developed various mechanisms and incentives to steer directors towards sustainable management that takes into account the companies’ long-term. Indeed, various studies have observed how individuals prefer a short-term view, choosing rewards they can receive in the present rather than investing in the future⁷⁰. A fortiori, directors have more reasons (e.g., career concerns, pressure to meet quarterly targets and remuneration anchored to short-term goals) to prefer the present than the future. In a survey conducted in 2005, the percentage of directors interviewed who admitted to sacrificing long-term value for easier earnings was 78%⁷¹. The reasons why companies should change their orientation towards a more long-term investment is obvious. Stakeholders are essential for the survival of a company and to maintain their competitiveness in the market, as well as to stimulate its growth. Customers are increasingly attached to sustainable issues and finding in a company a reflection of their ideals encourages their loyalty. All these arguments show how, in the end, a company's financial performance is inevitably influenced by the governance choices and investment orientation of its directors. In the words of Novo Nordisk CEO Rebien Sørensen, "corporate social responsibility is nothing but maximizing the value of your company over a long period of time, because in the long term, social and environmental issues become financial issues".

One of the tools that has developed in recent years in the area of directors' remuneration is CSR contracting, i.e., linking remuneration to non-financial performance. A study published in 2019 shows how the use of this technique has increased over time, rising from 12% of S&P 500 companies linking their directors' remuneration to ESG issues to 37% in 2013. The study also analyzed how CSR has impacted company performance and found that the adoption of CSR has led to (i) an increase in long-term investment; (ii) an increase in company value; (iii) an increase in social and environmental initiatives; (iv) a reduction in greenhouse gas emissions; and (v) an increase in green patents⁷².

70 FREDERICK,S.,LOEWENSTEIN,G.,&O'DONOGHUE,T.,“Time discounting and time preference”, Journal of Economic Literature, 100(3), 468-505, (2002).

71 GRAHAM, J.R., HARVEY,C. R.,& RAJGOPAL, S., “The economic implications of corporate financial reporting.”, Journal of Accounting and Economics, 40(1–3), 3–73, (2005).

72 FLAMMER,C, HONG,B, MINOR,D., “Corporate governance and the rise of integrating corporate social responsibility criteria in executive compensation: Effectiveness and implications for firm outcomes”, Strategic Management Journal, 40: 1097– 1122, (2019).

For all the above reasons, SRD II extensively amended the legislation on directors' remuneration to encourage a long-term view. This is aligned with the G20/OECD International Principles of Corporate Governance, which explicitly recognize the stakeholders' interest in the long-term performance of companies, as well as in their success and in the interest of the link between the remuneration policy adopted and the long-term performance of the company. In addition, these international principles state that shareholders should have a say in the remuneration of board members and executives⁷³.

Recital 29 of the SRD II states: “…The remuneration policy should contribute to the business strategy, long-term interests and sustainability of the company and should not be linked entirely or 20.5.2017 Official Journal of the European Union L 132/5 EN mainly to short- term objectives. Directors’ performance should be assessed using both financial and non- financial performance criteria, including, where appropriate, environmental, social and governance factors…”. The SRD affects the field of directors ‘remuneration in different ways.

Firstly, it prescribes that the shareholder shall have the right to vote⁷⁴ at the general meeting the remuneration policy of directors adopted by the company, and such policy must give a contribution to the company’s business strategy and long term-interests and sustainability.

This remuneration policy shall be clear and understandable and shall explain how it intend to implement the long-term interests and sustainability. The policy shall specify the variable and fixed components of the remuneration and must also specify the criteria that are applied to calculate the remuneration related to variable components and in particular distinguishing between financial and non-financial performance. Companies are allowed, under the SRD II, to temporarily derogate from the remuneration report if there are exceptional circumstances that refer to the long-term interests of the company and its sustainability.

In conclusion, it can be said that SRD II provides a set of forecasts that have the potential to impact the investment vision of companies and make them focus on long-term development.

On the other hand, the market will determine how and whether ESG factors will be utilized and anchored in the variable component of directors' remuneration. This process could be accelerated by institutional investors who, through the new tools provided to them by the

73 G20/OECD Corporate Governance Principles. Available at: https://www.oecd- ilibrary.org/docserver/9789264236882-

en.pdf?expires=1660127584&id=id&accname=oid025361&checksum=DE5247F3C2EBF8521F17ABDC78 3BD6A4

74 Article 9a (1) of the SRD II.

SRD, will be able to exert more pressure on the company to take more account of the sustainability factor⁷⁵.

75 LINCIANO N.,SOCCORSO P.,GUAGLIANO C.,(17).