The highly publicized war for good governance began two years ago with scandals at such companies as Enron, Vivendi and more recently, Parmalat. The outcome of the battle remains in doubt. Throughout the world, governments have been trying to regulate good business practices. In one of the most recent reforms, the European Union recommended last month that publicly traded companies in all member countries publish information about the remuneration of each member of their board of directors. Member states can choose either comply, or follow a formula for explaining why they intend not to comply.


Spain was one of the first countries to announce that it will make this an obligatory provision within the two years provided in the directive. The EU’s goal is for every country to follow the Spanish example. José María Garrido, executive director of Spain’s National Stock Exchange Commission (CNMV), approved this approach during recent meetings about good governance organized by Recoletos (the Spanish media company.) “The commission recommends that companies be required to reveal the remuneration of their individual managers,” Garrido said. The measure is scheduled to be enacted during the second half of 2006.


The news alarmed many people because compensation has been one of the thorniest aspects of European good governance. When the Aldama Report – the framework of the former Transparency Law of 2003 – was prepared, one of its most controversial provisions involved announcing the salaries of corporate directors. Nevertheless, the measure required companies to make public the worldwide remuneration of board members, and provide details about each category of director (part-time, executives, and independents). In addition, companies were required to specify the total remuneration of senior managers who do not belong to the board.


Two weeks ago, the CNMV and the Spanish government acknowledged that they will require companies to announce the salary of each individual director. That move was in line with the EU’s recommendation. The annual reports of 2007, dealing with the results of 2006, will be the first reports to include this information.


Toward An Obligatory Norm

Although making this information public is a common practice in the United States and Great Britain, it is a topic of great controversy in Europe. There is a lot of uncertainty about the benefits that can be derived, and how effectively this could control business scandals. There is also the issue of board members’ privacy rights.


Nevertheless, experts believe that every country in the European Union will wind up adopting the recommendation. Whether or not it becomes the law, Pablo de Andrés Alonso, professor at the University of Valladolid (Spain), thinks that it would be desirable for companies to adopt the EU recommendation. “Any initiative that aims to provide more information about the governing of a company is good news for everyone involved in managing that company,” he says. “Compensation is an especially interesting piece of information.”


Álvaro Cuervo García, professor of business economics at the Complutense University of Madrid, agrees. “The two fundamental pillars of any company – and its stock valuation – are information and transparency. That’s why owners and shareholders of the company must be informed about the compensation of senior managers and directors.” The question, he adds, is “whether to differentiate the compensation of executives as executives, and as members of the board of directors. You also have to know the criteria for providing compensation to various board members who participate in executive committees.” Generally speaking, “I see no problems involved in presenting individualized information about the compensation given to members of the highest administrative organs.”


A Violation of Privacy?

Nevertheless, some people oppose publicizing salaries of corporate directors. They argue that directors have privacy rights. In Spain, for example, some argue that revealing this sort of information might make some executives the target of a revolutionary tax campaign. Or, executives could become targets for kidnapping or extortion by ETA terrorists (especially in the case of Basque executives).  “This could become a threat to our security,” asserts an executive of a publicly traded Basque company who prefers to remain anonymous.


This much is certain: It will not be easy to draw a line between directors’ privacy rights and shareholders’ rights to be informed. According to De Andrés, “Given our institutional framework, it will probably not be easy to salvage the right to privacy. People in English-speaking nations have an institutional framework more oriented toward protecting investors. They have no problem when it comes to publishing the compensation of “representatives of the investors” – in other words, board members. He adds, “Legal experts are the ones who will have to study this.”


Cuervo justifies the rights of shareholders to share this sort of information. “There is a basic principle that ownership of the company belongs to its shareholders. It’s equally true that shareholders are the people who exercise their power of action through voting. I don’t believe in shielding people from information. Shareholders have the right to know every detail about the functioning of the enterprise.”


Both Cuervo and De Andrés stress companies benefit when they provide a greater flow of information. “It will limit discretionary behavior and abuses in specific situations,” says Cuervo. De Andrés says that the EU’s proposal “should reflect, to some degree, the incentives that board members have to comply with its functioning, and the possibility of becoming entrenched in their positions. It should also contribute by proving greater credibility to management and to corporate governance.”


A Wayto Prevent Business Scandals

For all that, this measure would not be the only means of restraining the recent series of business scandals. De Andrés says, “We knew about compensation at Enron, and that didn’t stop the abuses.” In his view, “publicity about compensation must not detract from other key elements of corporate governance such as incentives, legal protection of investors, mechanisms for internal control, supervision of capital markets, and the role of creditors. Finally, there is the ultimate guarantee of individual behavior – their ethics.”


When we talk about business scandals, stresses Cuervo, we are talking fundamentally about American business. European business scandals are not comparable either in number or significance. In Europe, he says, scandals are less common because of the weight and relevance of controlling corporate shareholders; there is a greater concentration of capital. Given the ownership structure, he says, “Management has less discretionary power, and that means a lower probability of scandals.”


Greater transparency about compensation could lead to another scenario: Companies could decide to limit the salaries of board members in an effort to quiet criticism about excessive compensation. De Andrés views this approach as demagoguery. “It implies that scandals would not exist if directors and managers were not compensated the way they are compensated.” Nevertheless, “the problem is not about whether people make too much; it is about devoting resources to better alternatives.”


In his view, these measures can be evaluated in terms of their ability to create value for shareholders, and in broader terms such as creating value for all participants in the company (including shareholders). De Andrés says it is reasonable to think that “you need to establish some proportionality between the resources you contribute; your success in using those resources; and the remuneration you provide. However, you don’t achieve this goal by setting limits [on compensation].” Should they also set limits on the talent or on the knowledge that individuals bring? De Andrés wonders. The important thing “is that directors contribute relevant resources (knowledge), and that directors be adequately compensated.”


Nevertheless, “It is likely that some companies will limit the salaries of their directors as a social gesture. However, this will come at a cost. (It will also provide a benefit if the board members do not actually do any work.)”


The Dubious Role of Independent Advisors

One measure that the European Commission has suggested involves strengthening the role of independent directors. De Andrés considers this a vague concept. “It’s not clear what it involves; we don’t know what it is yet.”


In his view, the entire body of American academic research about independent directors has not led to any conclusive result. “People presume that some benefits will be derived from incorporating independent directors, but this has not been demonstrated.” Quite possibly, he adds, it will be hard to determine what an independent director actually is. The research has not managed to define this concept clearly, and doubts about its functions remain. In any case, “In my view, the most relevant thing is to provide directors with powerful incentives to achieve their mission.”


De Andrés wonders if independence itself is a sufficient incentive. “There is no doubt that the board of directors is the leading mechanism for governance. Moreover, every improvement in governance will lead to better corporate performance. However, the question is about which proposals are appropriate, and, especially, when to implement them.”


According to Cuervo, independent directors raise different issues. Their role depends fundamentally on whether diluted shareholdings exist in the company and how relevant they are. If ownership in a company is concentrated, then “independent directors reflect the views of the shareholders who own and control” the company; they “are the ones who find out who has power. Independent members can be relevant insofar as they contribute information and knowledge about the functioning of the company. But the company’s effectiveness does not depend on how many independent directors you have.”