European boards have too little skin in the game
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.
By Liam Proud
LONDON, July 17 (Reuters Breakingviews) -No self-respecting board would pay a company’s CEO entirely in cash. Yet for directors themselves, at least in Europe, it’s the norm.
Non-executive board members in London, Amsterdam and Frankfurt typically pocket cash fees while owning a relatively small slither of stock. It means they often have minimal financial interest in common with the shareholders they ostensibly represent. Giving them more skin in the game, as is common in the United States, could help improve directors’ engagement – and even boost competitiveness for the lagging region.
A typical non-executive director of a company in the S&P 500 Index gets about $300,000 a year, of which roughly 60% comes in ordinary shares and 40% in cash, according to compensation consultants Pay Governance. In addition, 95% of firms in the blue-chip U.S. stock benchmark have an equity holding guideline, which usually states that directors must own shares worth at least five times their annual base cash fee.
Across the pond, director pay is lower: total fees per board member at large listed companies average around $100,000 across Britain, Spain, Italy and the Netherlands, according to 2022 data from headhunter Spencer Stuart. Moreover, equity is rarer. A report by WTW and ecoDa, a Europe-wide directors’ body, found that only half of the biggest UK companies either paid outside board members in stock or had guidelines for holding equity. The proportions in Germany and Italy were 20% and 10%, respectively. No major Spanish company pays directors in shares.
Regulations are partly to blame. The Dutch governance code explicitly discourages companies based in the Netherlands from offering supervisory board members share-based compensation. The equivalent French guidelines recommend that non-executive directors use their cash fees to build up a shareholding. Given low fee levels, however, this often results in token ownership.
The result is a lack of alignment between shareholders in European companies and the board members who are supposed to stick up for them. Take semiconductor giant ASML ASML.AS. Other than Chair Nils Andersen, no supervisory board members owned any equity in the $430 billion Dutch company at the end of 2023, according to its annual report. Compare that with U.S. chip group Qualcomm QCOM.O, where non-executives other than the chair owned stock worth 5.1 times their cash fees, according to Breakingviews calculations using the average financial-year share price.
Supervisory board members at German software group SAP SAPG.DE, excluding the chair, owned about 3.4 million euros ($3.7 million) of equity at the end of 2023, based on the average share price during the year. On the same basis, non-executives on the board of U.S. rival Oracle ORCL.N sat on about $80 million of stock. Another extreme case in Europe is mining giant Glencore GLEN.L, whose Chair Kalidas Madhavpeddi owned no equity as of the date of its last annual report, while collecting an annual cash fee of $1.2 million.
Granted, share-based compensation seems out of control on some U.S. boards. Tesla’s TSLA.O five independent directors had 5.4 million shares in Elon Musk’s electric vehicle company on March 31, worth $1.4 billion at current prices, plus a ton of share options. Still, the European state of affairs is troubling, given the number of academic studies that find a positive link between director stock ownership and company performance. Surprisingly, some European boards are relaxed about the discrepancy with rivals on the other side of the Atlantic.
Almost half of directors at European companies believe there is a possible conflict of interest inherent in receiving shares, according to a WTW and ecoDa survey. A longstanding idea in Britain and continental Europe is that outside board members somehow compromise their independence by holding equity. The argument made sense when companies on both sides of the Atlantic paid non-executives using stock options, which typically disappeared if a director left. Directors had an incentive to avoid rocking the boat, because they would lose their options if they got fired.
Those pay structures have become rarer at blue-chips, though, even in the United States. Spencer Stuart reckons that just 7% of S&P 500 boards have stock option packages for directors, down from 74% in 2003. Most of the equity awards are now common shares, which poses no obvious risk to independence, since directors keep the stock even if they leave. The UK governance code explicitly discourages options-based pay for non-executives, but says nothing about normal equity.
Another common justification for shunning director equity is that European boards are supposed to consider the interests of wider society, not just shareholder returns. German and French boards include employee representatives, while the UK Companies Act requires directors to consider staff, customers and the environment. Those concerns could get cast aside if non-executive directors hold stock.
Not necessarily, though. These duties are enshrined in law, which makes them hard to ignore. In fact, director stock ownership could help. The most acute societal risks are also often risks for the share price – especially in Europe, where investors pay closer attention to environmental and social factors.
Cash compensation can create conflicts of its own, too. When directors with minimal equity examine a buyout offer, for example, their financial interest is at odds with investors. Imagine a non-executive who owns $100,000 of stock and gets $100,000 a year in cash to sit on a company’s board. The value of the future income stream is much higher, in today’s money, than the amount they would make from selling their shares.
Making European boards look more like their American counterparts will be tricky, however. One problem is that share-based awards are typically taxable immediately. If European companies suddenly started paying non-executive directors 60% of their fee in stock, without changing the overall compensation level, directors would have to earmark a large chunk of their diminished cash fees to pay tax. That could make the job unappealing to anyone other than already wealthy executives.
Having more skin in the game probably requires raising board compensation. That could be hard: European investors are often hostile to CEO pay hikes and may feel the same way about non-executives. Sticking with the status quo would be a mistake, though. Misaligned boards, along with fragmented capital markets, risk making European equities less attractive to investors – both at home and abroad. After all, if a company’s own directors don’t back the firm, it’s not clear why anyone else should either.
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Graphic: Equity ownership among board members is rare in Europe https://reut.rs/3VYO9nP
Graphic: Average total board fees per board member in 2022 https://reut.rs/3S43XVm
Editing by Peter Thal Larsen and Oliver Taslic
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