The European Commission has recently issued a recommendation on the remuneration of directors of listed companies. This recommendation strengthens two earlier recommendations published in 2004 and 2005, which called for greater transparency in the area of directors’ pay and benefits. This was to be achieved through the disclosure of remuneration policy, greater shareholder control in approving that policy, and the creation of a remuneration committee who are to at least advise on, if not actually set, remuneration for directors.

The new recommendation sets out the best practices for the design of an appropriate remuneration policy. It aims to place greater emphasis on long-term results and to avoid rewarding failure when it occurs. The recommendation focuses on certain aspects of the structure of directors’ remuneration and the process of determining it.

On the structure of directors’ remuneration, the recommendation encourages Member States to:

• set a limit of 2 years maximum of the fixed component of directors’ pay on severance pay and to ban severance pay in cases of failure;
• strike a balance between fixed and variable pay and link variable pay to predetermined and measurable performance criteria; 
• promote the long term sustainability of companies through a balance between long and short term performance criteria of directors’ remuneration, deferment of variable pay, a minimum vesting period of at least three years for stock options and shares and retention of some shares until the end of employment; and 
• allow companies to clawback variable pay which was paid on the basis of data that proved to be manifestly incorrect.

On the process of determining directors’ remuneration, the recommendation seeks to:

• extend certain disclosure requirements contained in the existing recommendations to improve shareholder oversight of remuneration policies;
• ensure that shareholders, in particular institutional investors, attend general meetings and make considered use of their votes regarding directors´ remuneration;
• provide that non-executive directors should not receive share options as part of their remuneration to avoid conflict of interests; 
• strengthen the role and operation of the remuneration committee through new principles on:
  • the composition of remuneration committees; 
  • the obligation for members of the remuneration committee to be present at the general meeting where the remuneration policy is discussed in order to provide explanations to shareholders; and
  • avoiding conflicts of remuneration consultants.

The earlier recommendations had little impact. However, as corporate governance and directors’ actions have come under intense scrutiny, these new recommendations may have greater impact this time around.