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Focus on Regulation

The EU Commission’s study on options to regulate directors’ duties and corporate governance

The EU Commission recently published a study on options to regulate directors’ duties and corporate governance which argues that short-termism reduces long-term sustainability of European businesses. The purpose of such study is to contribute in reaching the United Nations Sustainable Development Goals (UNSDGs) adopted in 2015 and the objectives defined by the Paris Agreement on climate change.

In that regard, while communicating the European Green Deal, the EU Commission highlighted the fact that corporate governance should address the issue of sustainability in the decision‑making process.

Study on sustainability in EU corporate governance

In that context, the EU Commission recently published the study on options to regulate directors’ duties and corporate governance which argues that short-termism reduces long-term sustainability of European businesses.

According to the EU Commission’s study there is not any defined threshold above which one can state that the focus on short term is excessive. Short-termism is evaluated in relative terms by (i) assessing the evolution over the time span of the amount of net corporate funds being used for pay-outs to shareholders (in the form of dividends or shares buybacks) compared with the evolution of the amount used for the creation of value over the life cycle of the firm and (ii) comparing between different companies, sectors or countries

This study thus aims at (i) identifying the causes of short-termism in corporate governance and (ii) assessing their relationship with current market practices and/or regulatory frameworks as well as (iii) finding potential EU solutions, including through common EU rules.

As for the root causes of short-termism, the study points out seven “key problem drivers” which are grounded in EU regulatory frameworks and market practices. The first problem would be that directors’ duties and company interests are interpreted narrowly and tend to favour short-term maximisation of shareholder value. Moreover, the study identifies a growing pressure from investors to focus on short-term benefits rather than long-term investments. It also appears that companies lack strategic perspective over sustainability and their current practices do not address sustainability risks and impacts. The actual board remuneration structures and the current board composition would incentivise short-term financial returns and would not fully support a shift towards sustainability. In addition, corporate governance frameworks and practices would not take into account the long-term interests of stakeholders in the decision-making process, and there is an alleged lack of enforcement of directors’ duties regarding the long-term interests of the company.

EU intervention

The study thus identifies three specific objectives that should be pursued by any future EU intervention to tackle the issue of short-termism and its cross-border effects such as climate change and pollution: (1) strengthening the role of directors in pursuing their company’s long-term interest, (2) improving directors’ accountability for their business conduct and the sustainability of their corporate governance and (3) promoting corporate governance practices contributing in the sustainability of companies.

For these measures to be taken, the study favours a “hard legislative” option, that is to institute a minimum of common rules that would promote the creation of long-term value. These rules could be adopted on the basis of Article 50(1) and (2)(g) of the Treaty on the Functioning of the European Union (TFEU), which allows the EU to coordinate safeguards to protect the interests of companies’ members and other stakeholders to reach freedom of establishment. EU intervention could also be based on Article 114 of the TFEU, which gives the EU the competence to adopt measures to harmonise regulations to ensure the proper functioning of the internal market.

Likely positive impacts of EU intervention

The EU Commission foresees a number of positive impacts resulting from its new propositions. EU intervention would create more legal certainty and level playing fields as to the necessary measures that should be taken to achieve sustainability in corporate governance. It would also give more leverage to business partners to comply with human rights commitments at all stages of the supply chain. Moreover, the Commission maintains that reaching sustainable objectives in corporate governance would improve the productivity, the profitability and the attractiveness of EU companies. Framing long-term decisions could also make EU businesses less vulnerable to short-term economic and social changes and to sudden crises such as the COVID-19 pandemic. Finally, this would also benefit to the economy and to the society as a whole, as increasing investments for innovation, research and technological development would generate macro-economic growth and help the transition to sustainability.

A public consultation on sustainability and corporate governance should be held in the coming months to inform on the EU Commission’s legislative proposal in this regard. Businesses should keep an eye out for the potential enactment of new EU rules increasing directors’ duties which will likely impact the enforcement of businesses’ policies to prevent any adverse human rights impacts that may be associated with their activities.