COMMISSION STAFF WORKING DOCUMENT EXECUTIVE SUMMARY OF THE IMPACT ASSESSMENT Accompanying the document Proposal for a DIRECTIVE OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL on amending Directive 2007/36/EC as regards the encouragement of long-term shareholder engagement and Directive 2013/34/EU as regards certain elements of the corporate governance statement and COMMISSION RECOMMENDATION on the quality of corporate governance reporting (‘comply or explain’)
Date: 2014-04-09
Institutions: European Commission
Subjects: access to information, administrative transparency, board of directors, corporate governance, management audit, protection of shareholders, remuneration of work, shareholder, trade intermediary













EUR-Lex - 52014SC0126 - EN











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52014SC0126

COMMISSION STAFF WORKING DOCUMENT EXECUTIVE SUMMARY OF THE IMPACT ASSESSMENT Accompanying the document Proposal for a DIRECTIVE OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL on amending Directive 2007/36/EC as regards the encouragement of long-term shareholder engagement and Directive 2013/34/EU as regards certain elements of the corporate governance statement and COMMISSION RECOMMENDATION on the quality of corporate governance reporting (‘comply or explain’) /* SWD/2014/0126 final  */









1.           Introduction
The past years have highlighted certain corporate governance
shortcomings of European listed companies. These shortcomings relate to
different corporate governance actors: directors, shareholders (institutional
investors and asset managers) and proxy advisors.
Only a number of key aspects of corporate
governance have been harmonised at EU level, in particular through Directive
2007/36/EC on the exercise of certain rights of shareholders in listed
companies. This Directive contains rules on the participation in general
meetings. The need to enhance the current framework has been highlighted in the
Commission Action Plan on European company law and corporate governance.[1] This impact assessment considers possible ways to achieve the objectives
of the Action Plan.
2.           Problem definition
This impact assessment analyses a number of
problems in the area of corporate governance. One of the key issues in
corporate governance is the separation between ownership and control and the
resulting principal-agent relationship between shareholders and directors. The delegation of management of the company by shareholders
(“principals”) to directors (“agents”) leaves
room for directors to act more in their own self-interest than in the
interest of the shareholders.
This could lead to suboptimal corporate governance and performance of
companies. Today, institutional investors and asset managers are an important
force in equity markets and intermediation within the investment chain (delegation
of the day-to-day management of the investment to asset managers) has increased
substantially. Increased intermediation has led to the emergence of incentives
within the investment chain that often focus on short-term performance and do
not sufficiently exploit the benefits of shareholder engagement. Institutional
investors and asset managers are therefore often absent and do not take an
interest in the governance of companies. This exacerbates the agency problem
between shareholders and company directors and leads to suboptimal performance
of listed companies. Studies demonstrate that long-term shareholder engagement
not only leads to better performance of investors but contributes also to
enhancing the competitiveness and performance of companies.  
2.1.        Insufficient engagement of
institutional investors and asset managers
The financial crisis has revealed that
shareholder control did not function properly in the financial sector. Rather
than containing excessive short-term risk taking by managers, shareholders, in
many cases, supported it. Listed companies in general do not have markedly different shareholders than financial
institutions and there is clear evidence that the current level of “monitoring”
of investee companies and engagement by institutional investors and asset managers
is sub-optimal. Research demonstrates that institutional investors and their
asset managers do not sufficiently focus on the  long-term  performance of
companies, but on share-price movements and the structure of capital market
indexes, which may not lead to an optimal return for the end beneficiaries (for
example future pensioners) and puts short-term pressure on companies. 
This short-termism appears to be rooted in a
misalignment of interests between asset owners and asset managers. Large asset owners, such as pension funds and insurers have
long-term interests as their liabilities are long-term.
However, for the selection and evaluation of asset
managers they often rely on benchmarks, such as market
indexes, and the performance of the asset manager is often evaluated on a
quarterly basis. In case of underperformance, the asset manager may lose the
mandate. As a result many asset managers’ main concern has become their short term performance relative to a benchmark or to other asset
managers, although the end beneficiaries have an interest in the long-term
absolute performance of the investment. Short-term incentives turn focus and
resources away from making investments based on the fundamentals and longer
term perspectives, from increasing long-term value through shareholder
engagement and result in short-term pressure on companies creating
disincentives for competitiveness-enhancing investments.    . 
Albeit still relatively limited, there is a
growing number of investors which aim to combine financial outperformance with
long-term value creation and their investment strategies also involve
engagement with investee companies.   
2.2.        Insufficient link between
pay and performance of directors
Shareholder oversight on directors’
remuneration has also shown to be insufficient. Directors’ remuneration plays a key role in aligning the interests of directors and shareholders and ensuring that the directors act in the best interest of the
company. Where shareholders do not oversee directors’ pay,
there is a risk that directors
will apply a strategy which rewards them personally, but that may not contribute to the long-term performance of the company. Several shortcomings have been detected in
the current framework. First, the information disclosed by companies is not comprehensive,
clear nor comparable. Secondly, shareholders often do
not have sufficient tools to express their opinion on directors’ remuneration. 
2.3.        Lack of shareholder
oversight on related party transactions
Related party transactions (RPTs), i.e. transactions
between a company and its management, directors, controlling entities or
shareholders, create the opportunity to expropriate value belonging to the
company to the detriment of (minority) shareholders. In most cases shareholders do not have access to sufficient
information ahead of the planned transaction and do not have adequate tools to
oppose to abusive transactions. As institutional investors and asset managers are
in most cases minority shareholders, more control rights over RPTs would
improve their ability to protect their investments. 
2.4.        Inadequate transparency of
proxy advisors
Proxy advisors provide
recommendations to investors on how to vote in general meetings of listed
companies. The large number of (cross-border) holdings by many institutional
investors and asset managers and the complexity of the issues to be considered
make the use of proxy advisors in many cases inevitable and thus proxy advisors
have considerable influence on the voting behaviour of these investors. In
particular, shortcomings concerning the quality of advice as well as conflicts
of interest have been observed.  
2.5.        Difficult and costly
exercise of rights flowing from shares 
Investors face difficulties in exercising
the rights flowing from their shares, especially if these are held
cross-border. In intermediated holding chains, especially when they involve
many intermediaries administering securities accounts, information is not
passed to shareholders from companies or shareholders' votes get lost. There is
also a greater likelihood of misuse of the voting rights by intermediaries.
Three main causes affect the systems: the lack of possibility for the company
to identify investors, a lack of timely transmission of information and rights
in the investment chain and price discriminations of cross-border holdings.
2.6.        Insufficient quality of
corporate governance information
Shortcomings have been observed as regards
the quality of corporate governance reports prepared by listed companies in the
EU, in particular as regards the explanations for deviations from corporate
governance codes’ recommendations.  In over 60% of
cases where companies chose not to apply recommendations, they did not provide
sufficient explanations. Inappropriate reporting makes it more difficult for
shareholders to take informed investment decisions and engage with the company.
  
            2.7
      Subsidiarity
The competence for action is based on
Article 50(2)(g) of the TFEU. The growing importance of cross-border equity
investments (some 44% of the total market capitalisation of EU listed companies
is held by foreign investors) and the changes in the equity investment chain
justify certain targeted measures at EU level in order to ensure the protection
of the interests of shareholders and other stakeholders. Only a limited number
of Member States has undertaken action or is considering doing so to tackle the
problems, and these actions cannot bring effective solutions to these problems.
Action from Member States alone is likely to result in different sets of rules
creating an uneven level playing field, which may undermine or create new
obstacles to the good functioning of the internal market.
3.           Policy options, impact
analysis and choice of preferred option
3.1.        Increase the level of
engagement of institutional investors and asset managers
 Policy options 
 1 No policy change 
 2 Recommendation on transparency of institutional investors and asset managers on their voting and engagement and certain aspects of asset management mandates 
 3 Mandatory transparency of institutional investors and asset managers on their voting and engagement and certain aspects of asset management mandates 
 Assessment of policy options 
   || Effectiveness || Efficiency || Coherence 
 Option 1: no policy change || 0 || 0 || 0 
 Option 2: recommendation on transparency of institutional investors and asset managers || + || + || + 
 Option 3: binding rules on transparency of institutional investors and asset managers || ++   || + || + 
Option 3 is
the preferred option: 
This option would increase transparency on
how asset owners incentivise their asset managers to act in the best long-term
interest of their beneficiaries and to pursue investment strategies involving
shareholder engagement. Asset managers would be required to be transparent
about their engagement policies, the benefits of these and how they discharge
their policies mandated. Substantial and relevant information would enable asset
owners to make better informed decisions about their investment policies. It
would stimulate them to engage more with investee companies. Transparency on the costs of frequent portfolio turnover by asset
managers may reduce the magnitude of such transactions, contributing to a
better focus on the fundamental value of companies and increasing this value
through shareholder engagement. These measures may ultimately result in cost
savings and better return for asset owners and ultimate beneficiaries. A better focus on the fundamentals and the real value-creative
capacity of companies could in particular be beneficial for listed SMEs. More engagement and a longer-term perspective could also contribute
to higher investments by companies into research and competitiveness and thus
more employment.
Binding rules on transparency would provide
the highest likelihood to trigger a positive change with limited cost.
3.2.        Create a better link between pay and performance
 Policy options 
 1 No policy change 
 2 Binding rules on transparency of remuneration 
 3 Shareholder vote on remuneration 
 Assessment of policy options 
   || Effectiveness || Efficiency || Coherence 
 Option 1: no policy change || 0 || 0 || 0 
 Option 2: binding rules on transparency of remuneration || + || + || + 
 Option 3: shareholder vote on remuneration || + || ++ || + 
Options 2 and 3 are the preferred
options: Providing shareholders with clear,
comprehensive and comparable information on remuneration policies and
individual remuneration of directors would help them in exercising effective
oversight. Harmonisation of disclosure requirements at
EU level would be a remedy to asymmetry of information
and, therefore, minimise agency costs. It would be beneficial for cross-border investment, since it would facilitate
comparison of information and make engagement easier and thus less costly. Moreover,
it would make companies more accountable to other stakeholders. 
Granting shareholders
a vote on pay would give them an effective tool to
oversee directors’ remuneration
and engage with companies while also strengthening the link
between pay and performance.  
3.3.        Transparency and oversight on related party transactions
 Policy options 
 1 No policy change 
 2 Soft-law providing guidance 
 3 Improving transparency requirements for related party transactions 
 4 Shareholder vote on the most important transactions 
 Assessment of policy options 
   || Effectiveness || Efficiency || Coherence 
 Option 1: no policy change || 0 || 0 || 0 
 Option 2: soft-law providing guidance || ≈ || ≈ || + 
 Option 3: improving transparency requirements for related party transactions || + || + || + 
 Option 4: shareholders vote on the most important transactions || ++ || ++ || + 
Options 3 and 4 are the preferred
options: providing investors with ex ante
information on most important transactions would allow them (in particular
minority shareholders) to act against unjustified transactions and to engage
more with the company, while the vote would allow them to reject abusive
transactions. A shareholder vote would also stimulate reflection of companies
on RPTs. This combination could have a positive impact on competiveness and
sustainability of companies and cross-border investment.
Binding rules are likely to be more
effective than soft-law guidance.
3.4.        Transparency of proxy
advisors
 Policy options 
 1 No policy change 
 2 Recommendation on transparency on methodology and conflicts of interests 
 3 Binding disclosure requirements on methodology and conflicts of interests 
 4 Detailed regulatory framework 
 Assessment of policy options 
   || Effectiveness || Efficiency || Coherence 
 Option 1: no policy change || 0 || 0 || 0 
 Option 2: recommendation on transparency || ≈ || + || ++ 
 Option 3: binding rules on transparency || + || ++ || + 
 Option 4: detailed regulatory framework || ++ || - || - 
Option 3 is the preferred option: requiring disclosure on the two main areas of concern (methodology
and management of potential conflicts of interest) would put additional
pressure on proxy advisors to establish adequate procedures on these crucial
aspects. Binding transparency requirements would be more effective than soft
law, while avoiding inflexible and disproportionate charges linked to a detailed
regulatory framework. 
3.5.         Shareholder
identification and facilitation of the exercise of shareholder rights by
securities account providers
 Policy options 
 1 No policy change 
 2 Minimum EU rules 
 3 Detailed requirements regarding the possibility of shareholder identification and obligations for the facilitation of the exercise of shareholder rights by intermediaries 
 Assessment of policy options 
   || Effectiveness || Efficiency || Coherence 
 Option 1: no policy change || 0 || 0 || 0 
 Option 2: minimum EU rules || + || ++ || + 
 Option 3:  shareholder identification mechanism  obligations for intermediaries || ++ || ++ || + 
Option 3 is the preferred option: An obligation for intermediaries providing securities accounts to
offer the service of shareholder identification to the company will facilitate
a direct contact between the shareholder and the company. The obligation for
these intermediaries to transmit information related to the share, facilitate
the exercise of shareholder rights and justify price differences for these
services if the rights are exercised across the borders will ensure that
shareholder votes do not get lost and shareholders are able to engage more
efficiently across the borders. 
3.6.        Improving the quality of
corporate governance reporting
 Policy options 
 1 No policy change 
 2 Recommendation providing guidance 
 3 Detailed requirements regarding corporate governance reporting 
 Assessment of policy options 
   || Effectiveness || Efficiency || Coherence 
 Option 1: no policy change || 0 || 0 || 0 
 Option 2: recommendation providing guidelines || + || ++ || ++ 
 Option 3: detailed rules || ++ || + || + 
Option 2 is the preferred option: Providing
guidelines on the explanations for deviations from codes is likely to give
companies more certainty in preparing such reports and improve their quality. It
would incentivise them to reflect more thoroughly about their corporate
governance arrangements and improve them, if necessary, which could contribute
to better performance. It could also contribute to cross-border investment, due
to increased transparency and comparability of reports. 
4.           overall impacts of the
package
The proposed approach constitutes a package of complementary
actions. The package is part of the Commission’s work on the long-term
financing of the European economy: it contributes to a more long-term
perspective of shareholders which ensures better operating conditions for
listed companies.
The objective of the preferred options is to ensure that investors
have clear, comprehensive and comparable information at their disposal, which
removes, in particular for cross-border investors, barriers to engagement. Creating
more transparency on the impact of the investment policies will result in more
informed decisions of investors and final beneficiaries, but will also
incentivise investors to become more engaged with their investee companies. Any increase in shareholder engagement is likely to have a positive
effect on both shareholder value and the efficiency, competitiveness and
performance of the target company.[2] 
The proposed package could therefore positively impact the long-term
sustainability of listed companies, including SMEs, which are likely to benefit
from a better access to capital markets. Some positive social impacts could
also be expected, since long-term oriented companies could create more
employment. No specific environmental impact is foreseen.
The package would result in an increase in
administrative burden, including for listed SMEs. However, these costs would be
limited considering that mostly transparency and publication measures are
foreseen and that some degree of transparency is already imposed or applied on
voluntary basis. Additionally, costs will be distributed evenly between the
different stakeholder groups.
5.           evaluation
An evaluation of the impact of the package
shall be carried out five years after the transposition deadline, and the appropriateness of eventual amendments may be considered on
basis of the results of the evaluation.
[1]               COM/2012/0740 final
[2]               Shareholder engagement on
corporate governance, with remuneration being one of the key issues, may
generate an average of 7-8% abnormal cumulative and buy and hold stock return  over
a year, lower the cost of capital for companies and significantly improve their
governance and profitability.