Introduction

A recent study published by the European Commission investigates the causes of ‘short termism’ in corporate governance and its detrimental effects on long-term economic, environmental and social sustainability. The prevalence of short termism is evidenced by data that identifies a fourfold increase in shareholder pay-outs (between 1992 and 2018) and a declining ratio of investment to revenues. The study delineates the relationship between these short-term focused activities and the resulting negative long-term impacts. The study proposes three broad tiers of possible EU action options.

The study aligns with the Commission’s push for sustainability to become integrated into the corporate governance framework. The possible EU actions are proposed with a view of attaining United Nations Sustainable Development Goals (UN SDGs) and the goals of the Paris Agreement on climate change. The proposals also come as a result of entrenched shareholder primacy (which has been identified as one of the main barriers to sustainability) and the ongoing debate around the meaning and scope of directors’ duties. The study makes clear that the risk of inaction is a threat to the survival of business and a negative impact on a wide range of stakeholders.

The problem drivers 

The causes of short termism are rooted in the currently unsuitable regulatory frameworks and general market practices. The study identified seven specific key problem drivers including a narrow interpretation of director’s duties. Due to the lack of a clear definition of ‘company interest’ in current company law frameworks, these duties can be interpreted on the basis of the social norm of shareholder primacy. 

Further drivers of short termism include the growing pressures from investors with a short-term horizon, a lack a strategic perspective over sustainability and board remuneration structures which incentivise short-term shareholder value. The issue is also seen to be exacerbated by board composition that lacks support for a shift towards sustainability, current corporate governance frameworks and the limited enforcement of directors’ duty to act in the long-term interest of the company. In combination, these factors result in a trend for EU listed companies to focus on the short-term benefits of shareholders at the expense of long-term sustainability.

EU action

Without action, the study asserts that the shareholder primacy norm will persist in the current regulatory framework. Future EU actions would aim to strengthen the role of directors in pursuing their company’s long-term interests, improve director’s accountability toward integrating sustainability in corporate decision-making and promote corporate governance practices that contribute to company sustainability. The study offers two non-legislative and one ‘hard’ legislative option based on increasing levels of regulatory intervention.

Impact on directors’ duties

The legislative (or ‘hard’) option would see the Commission set minimum common rules to enhance the creation of long-term value. Options in this tranche of regulatory action include a Commission proposal for a new EU directive providing an EU-wide formulation of director’s duties which have a greater balance of company and other stakeholder interests. Further options include proposals to amend the Shareholder Rights Directive II to introduce binding rules requiring Member States to introduce mechanisms to incentivise longer shareholding periods and align executive remuneration policy with sustainability goals. These come alongside further proposals of new EU directives and rules to ensure sustainability. The non-legislative options would instead promote sustainable corporate governance practices and foster national regulatory action. 

Authors
Bea Araujo 
Partner 
Beatriz.Araujo@bakermckenzie.com

Jo Hewitt
Partner
Jo.Hewitt@bakermckenzie.com

Josephine Lynch
Trainee Solicitor
Josephine.Lynch@bakermckenzie.com