France’s New Regulation on Executive Directors’ Compensation in Listed Companies

The 2008 financial crisis highlighted the excessive salaries, bonuses and other means of compensation paid to executive directors, particularly when they do not take into account companies’ performance.

Even though existing European Union and French regulations already covered the need for criteria to determine and measure the part of variable compensation in listed companies, France’s socialist government decided to go a step further with the enactment of a new set of corporate governance rules, dealing in particular with supervision of executives’ compensation. Instead of a regulation, the solution chosen was to use the “soft law” path. Indeed, the “soft law” concept could allow the government to meet citizens’ expectations without being too restrictive on companies.

This led to the revision of the AFEP-MEDEF code¹ on the corporate governance of listed companies. This 2013 version of the code introduces into French law the principle of Anglo-Saxon origins of “say on pay”, but without giving it binding impact.

The change in corporate governance for French listed companies thus has an impact on all aspects of compensation schemes and employee-related corporate matters, as the implementation of the rules covers not only 1) “say on pay” but also 2) the strengthening of controls on the remuneration of executive directors and 3) the compulsory appointment of an employee representative on boards of directors, as discussed below.

Introduction of the ‘Say on Pay’ Rule

The “say on pay” rule already exists in more than 10 European countries. As it would have been difficult to implement a binding vote in France², the AFEP-MEDEF code introduced the rule in its Article 24.3 with an advisory vote. This new rule will be applicable during the next general meeting held in 2014 on 2013 accounts³.

The French “say on pay” rule consists of the submission of the executive directors’ compensation during the annual ordinary general shareholders meeting. This rule is applicable to all listed companies whose securities are traded on a regulated market. For those companies listed on a multilateral trading facility, i.e., Alternext in France, application is highly recommended by the code.

By comparison, the “say on pay” rule applies in the United States with consultative effect to all listed companies since January 21, 2011⁴, even those with market capitalization of less than $75 million since January 21, 2013, but listed “emerging growth” companies (as defined in the Jumpstart Our Business Startups (JOBS) Act⁵) benefit from an exemption for five years from their initial public offering if their total annual gross revenues⁶ are less than $1 billion during the most recently completed fiscal year.

The remuneration at stake covers all aspects of the compensation due or awarded to each executive director: the fixed part; the annual variable part and, where necessary, the multiannual variable part, with the contributing objectives that determine it; exceptional remuneration; stock options; performance shares and all other elements of long-term remuneration; golden haloes and golden parachutes; any additional pension plan; and similar benefits of all kinds.

All such compensation shall be submitted to the shareholders, being specified that it is recommended to present one resolution for the executive director or the chairman and a separate resolution for the managing directors or the other board members.

As the vote is not binding, a negative vote by the shareholders meeting would not have any impact on the compensation of such executive director, but the board of directors, after having taken the opinion of the compensation committee, shall deliberate on this issue during the following meeting and immediately publish a press release on the company’s website to explain if it will reduce compensation or not.

As a result, the French system is now closer to the U.S. system, except for the scope of executives concerned (chief executive officer, chief financial officer and the three executives who receive the highest salaries in the company in the United States, but not all the board members), and the frequency of the vote (either each year or every two or three years in the United States, when it is annually in France).

Strengthening Control of the Remuneration of Executive Directors

Since 2001⁷, France has enacted several regulations targeting greater transparency in the compensation allocated to executive directors and chief financial officers⁸. Each year, the board of directors shall issue a report indicating the total compensation and any kind of benefit awarded to each board member, including in the form of equity securities, bonds or securities giving access to capital (Article L.225-102-1 of the French Commercial Code), and the amount of shares the executive directors need to retain until the end of their mandates (Articles L. 225-185 and L. 225-197-1 of the French Commercial Code). The board shall describe the fixed, variable and exceptional compensation (including agreements for termination of service) and explain the criteria for their calculation. As for stock options and performance shares, the criteria shall be sufficiently restrictive in order to take into account the company’s performance.

The French financial markets authority, the Autorité des marches financiers (AMF), recommended in 2012⁹ improving the transparency of compensation policies, for example, by specifying the internal and, where possible and appropriate, external performance criteria for allocating stock options and performance shares (being noticed that the beneficiary’s continued presence within the company when options are exercised and performance shares are finally allotted cannot be considered as a serious and demanding performance criterion).

On this basis, the revised version of the AFEP-MEDEF code proceeded to a strengthening of the performance conditions applicable to stock options and performance shares:

• The allowance for taking office can be granted only to a new manager coming from a company outside the group. In such a case, the amount must be made public;

• Severance pay, and the payment which is subordinated to conditions of performance, must be estimated over at least two years;

• The non-compete indemnity is subject to strict recommendations (such as authorization by the board of directors, maximum amount of the indemnity equal to two years of fixed and variable wages, maximum severance pay and non-compete clause equal to two years of fixed and variable wages, disclosure of the conditions and amount of the indemnity); and

• Additional pensions (pensions-hat) are subject to binding measures (allocated after two years of mandate minimum within the company, increase of potential rights of the beneficiary’s compensation set at a maximum 5 percent per year, cap on additional pensions set at 45 percent of the reference income, including the fixed and variable compensation).

It also strengthens the obligations to retain shares resulting from the exercise of options or performance shares:

• The retaining commitment shall be sufficiently binding so as to allow better recognition of the company’s performance in the long term; and

• The executives shall commit not to use any hedging operation, according to the AMF recommendation mentioned above, until the end of the holding period determined by the board.

Representation of Employees on the Board of Directors

The recent law n° 2013-504 of June 14, 2013¹⁰, published on June 16, 2013, called “securing employment” introduces the principle of compulsory representation of employees on the board of directors or supervisory board of the biggest companies (Article 9). As this law is applicable to all commercial companies employing more than 5,000 employees (in the company) or 10,000 employees (in the corporate group, including foreign subsidiaries), it is likely to be applicable to most listed companies, with the effect of imposing on boards of directors the presence of a representative of employees.

As a result, affected companies shall welcome new board members representing employees with the same powers and votes as any other board members.

This new law also foresees the yearly delivery to the members of the works committee and union representatives of an economic and social database and information on the strategic directions of the company.

As a matter of implementation of this new law, the revised version of the AFEP-MEDEF code created a specific chapter on employee representative directors specifying that, as for all directors, they can be designated by the board of directors to participate on committees¹¹. Furthermore, they benefit from training adapted to the areas of their mandates. As for the compensation committee, the code recommends that an employee representative director be a member of this committee.

Conclusion

Although this trend towards transparency is commendable, it is not certain that the recent measures will achieve their goals and bring more rationality to the compensation of executives. Time will tell, but the situation in the United States shows that the introduction of “say on pay” has not led to a revolution. In 2011, a large majority of listed companies (now required to submit their compensation policy to an advisory vote) received shareholders’ support¹².

This will probably drive French companies towards seeking to secure maximum support from their major shareholders and stimulate communication between shareholders and management. For example, the U.S. companies concerned are said to have adopted more sophisticated communication strategies and to have launched an upstream dialogue with key shareholders and proxy advisors, in order to pass their resolutions.

Jeremy Blimbaum is a Partner in Duhamel Blimbaum, Paris. He may be contacted at jblimbaum@duhamel-blimbaum.com.