Corporate Governance

Compensation and National Culture (Part 1)

By J Robert Brown Jr.

The EU just approved compensation requirements for financial institutions (although they will need to be enforced at the national level).  The US has likewise adopted new regulations designed to reign in executive compensation.  The two approaches, however, are widely different.  They reflect large cultural differences on how to approach the problem of excessive compensation.

With respect to the EU, the European Parliament focused less on process and more on firm caps. The legislation adopted on Wednesday, July 7, favored caps on the proportion of a bonus paid in cash, required vesting schedules, and provided for recapture of bonus amounts in the event that performance suffered.  In addition, the legislation called for over all caps in proportion to salary. 

More specifically, as the New York Times reports, the cash component of bonuses must be limited to 30% in most cases, 20% where the bonuses are particularly large (a standard to be determined at the national level, although based on EU guidelines).  In addition, as the European Parliament describes, a significant portion of the non-cash component would need to be deferred for up to three years and would be sujbect to recapture in the event the performance of the financial institution suffers.  Specifically, between 40-60% of the bonus must be deferred for at least three years and can be recaptures "if investments do not perform as expected."  At least half of the bonus must be paid in "contingent capital" and shares.  Contingent capital is described as "funds to be called upon first in case of bank difficulties) and shares."

Finally, bonuses must be limited in size as a proportion of salary.  The limit, however, was left to each financial institution to set, although they must be consistent with EU guidelines.  The limits on bonuses will apply to The rules will apply to "senior management, risk takers, controller functions and any employee receiving total remuneration that takes them into the same remuneration bracket as senior management and risk takers."  The provisions apply to the subsidiaries of foreign banks (read US banks) operating in the EU.  The provisions will go into affect in January 2011.

Full post as published by The Race to the Bottom on July 13, 2010 (boomark / email).