DO CHANGES TO THE EUROPEAN COMMISSION SHAREHOLDER RIGHTS DIRECTIVE ON CORPORATE PAY ALTER SHAREHOLDERS’ MORAL RESPONSIBILITIES? Magdalena Smith, December 2014 INTRODUCTION This paper looks at the specific proposed amendments to European directives 2007/36/EC and 2013/34/EU and evaluates how such amendments alter shareholders’ moral responsibilities. Here a responsibility is understood as an obligation or requirement compelling an agent to either act or refrain from acting in a given way. In order to determine whether changes to the proposed directives alter shareholders’ moral responsibilities, the following analysis argues, we need to look at three factors: whether such changes do in fact alter the subject matter of shareholders’ obligations, who the agent is (i.e. the shareholders to whom the obligation is to apply) and whether the obligations do actually apply to these persons. Section one of this paper introduces the reader to the proposed amendments by the European Commission and the UK Government’s proposals. It also introduces the two specific ratios that will be analysed in greater detail, namely the ratio between the lowest‐ and highest‐paid persons in the corporation and the ratio between the fixed and variable parts of senior management remuneration. What an obligation, and particularly a moral obligation, consists of is presented in section two. The focus is on G. E. M. Anscombe’s and S. Wolf’s discussions of command theories and the force needed to turn a moral requirement into a moral obligation. More specific differences between the European and UK proposals are discussed in section three. These differences are relevant to understanding what the two authorities hope to achieve from the proposed amendments, as well as their differing approaches to what the role of shareholders has been and should be. Here I also draw on statements by politicians to form a stronger picture of the two perspectives. Section four combines the discussion of moral command theories and a closer look at the two proposed ratios to analyse how the proposals may affect the perceived moral obligations of shareholders. But this analysis alone is not sufficient to determine that moral obligations have in fact changed. It is also necessary to consider what it means to be a shareholder (section five) and whether such moral obligations can truly be said to apply to such shareholders (section six). My conclusion, presented in section seven, is that the proposals do in fact entail changes to shareholders’ moral obligations and their moral responsibilities. However, what the changes are depends on what type of shareholder we are looking at. Institutional shareholders’ responsibilities are altered more than 1 those of small private shareholders by virtue of their greater control over corporate boards and their existing moral obligations to their clients and beneficiaries, as stated by the UK Stewardship Code and the European Fund and Management Association (EFAMA) Code for External Governance. Furthermore, I show that the definition of shareholders significantly depends on the formal agreements determining the relationship between shareholders and corporations, and that in the case of institutional shareholders and their investors, any considerable changes in their rights or obligations in fact changes the meaning of the term shareholder. 1. AMENDMENTS TO THE SHAREHOLDER RIGHTS DIRECTIVE On 9 April 2014, the European Commission announced amendments to directives 2007/36/EC and 2013/34/EU with regard to long‐term shareholder engagement (European Commission 2014a). Such amendments include the introduction of mandatory and binding shareholder voting on corporate pay (European Commission 2014b). The reason for introducing such changes was said to be grounded in the recent economic crisis, where shareholders were too often shown to support managers’ excessive short‐term risk taking and further did not sufficiently monitor the companies in which they invested (European Commission 2014b). In a statement on the issue two years earlier (O’Donnell 2012), Michel Barnier, the European Commissioner in charge of regulation, stated: There is mounting public anger at the widening gap between earnings of bankers and business executives and ordinary workers when many European economies are in recession and unemployment is high. To encourage shareholder engagement and participation to control excessive short‐term risk taking by managers and to adjust the widening gap in earnings, the European Commission is looking at two proposed ratios (O'Donnell 2012) on which shareholders may be given the right to make a decision: the ratio between the lowest‐ and highest‐paid persons in the corporation, and the ratio between the fixed and variable parts of senior management remuneration. The European Commission are not alone in considering such amendments to shareholder voting rights. In January 2012, the UK Secretary of State for Business, Innovation and Skills announced a package of measures to address failings in the corporate governance framework for executive remuneration (Department for Business Innovation and Skills 2012). Such measures include empowering shareholders and promoting shareholder engagement through enhanced voting rights. 1.1 THE MATTERS AT STAKE In reviewing the two proposed ratios, the European Commission are investigating whether to increase shareholder engagement in two very separate 2 matters: excessive short‐term risk taking by corporate managers and the seemingly widening earnings gap in corporations. 1.1.1 RESPONSIBILITY FOR EXCESSIVE SHORT‐TERM RISK The ratio between the fixed and variable parts of remuneration is directly connected to excessive short‐term risk taking by corporate managers, in that fixed and variable aspects of remuneration are used as a tool to motivate specific behaviour and actions amongst managers. By introducing a mandatory and binding shareholder vote on such a ratio, the European Commission are extending shareholders’ legal responsibilities and rights to include that of controlling excessive short‐term risk. Shareholders would come under extended responsibility simply by virtue of being legally mandated to vote on the establishment of this ratio. They will be seen as fulfilling their legal responsibilities through this vote. Whether the amendment leads to any extended moral responsibility is not readily clear. One could argue that a moral responsibility is thereby placed on shareholders, saying something like the following: ‘Shareholders ought to control excessive short‐term risk taking by corporate managers working for corporations in which they invest.’ The basic assumption in this instance is that excessive short‐term risk taking should be avoided. This argument does not contend that shareholders alone are to be held responsible in case of shortcomings, but they clearly would share this responsibility. What makes this possibility especially interesting is not simply the question of whether excessive short‐term risk taking should be viewed as morally wrong (something that I intend to address in a future paper), but what type of risk the European commission might be referring to. One type of risk could be increased operational risk. Few would object to the idea of shareholders having some form of control and engagement in this concern, as it directly relates to the firm’s survival. However, by associating the need for changes to the directive with ‘the wider financial crisis’ (European Commission 2014b) and ‘public anger’ (O'Donnell 2012) the Commission seems to be implying a further risk to society as a whole that must be taken into account. The concept that shareholders are morally responsible for this broader level of social risk would face widespread objections, for example from Milton Friedman (1970) and his view of the social role of business. The lack of clarity as to whether these proposed amendments would extend shareholders’ moral responsibilities is by no means limited to the question of the type of risk that is at stake, as will be discussed in detail beginning in section two. 1.1.2 RESPONSIBILITY FOR CONTROLLING THE WIDENING EARNINGS CAP IN CORPORATIONS The idea of a mandatory and binding vote for shareholders with regard to the ratio between the lowest‐ and highest‐paid employees in a corporation could 3 have a still greater impact on shareholders and their responsibilities. Even though the proposal would mandate only that shareholders must vote on a ratio as proposed by corporate management, this issue is not traditionally seen as coming under the remit of shareholders. This ratio would seem to be more a matter of social justice than of best practice in corporate governance, and thus one that would fall within the responsibilities of politicians and legislators rather than investors. Is it then possible for shareholders to be bound by such responsibilities, and would such a binding provision compel us to change our perception of what it is to be a shareholder? 2. OBLIGATIONS AND THEIR ROLE IN RESPONSIBILITY To hold an agent responsible is, for the sake of this paper, considered the equivalent of viewing an agent to be under an obligation, i.e. a course of action that one is required or bound to take, given the acceptance of a particular code or standard. In order to determine whether the European Commission’s proposed alterations to the shareholder rights directive alter shareholders’ moral responsibilities, this section will look at the concepts of obligation in general and of moral obligation in further detail. What it means for an agent to be under an obligation will be discussed further in section four. For now I will simply provide the following definition: Agent A is under an obligation B, where B represents acting or refraining from acting in a given way, given that agent A exists, that there exists an obligation B and furthermore that obligation B necessarily applies to agent A. The word obligation has its origin in the Latin obligare, deriving from the root lig‐, meaning to tie or bind. The term can first be found in Plautus' (254‐184 BC) play Truculentus (Zimmerman 1996, 1), which describes the prostitute Phronesium’s relentless manipulation of all men. The concept of obligation was first introduced into early Roman law as a means for the state to overcome the common practice whereby a wronged party would be entitled to privately execute punishment of a wrongdoer. Such entitlement to private revenge, more often than not, resulted in the wrongdoer’s death. Instead, obligation law enabled the state to force the wronged party to accept financial compensation for the wrong. Hence, the early concept of obligation included a party who had a duty to pay and a party who had a right to claim compensation. Should the wrongdoer be unable to pay, then he or she would personally become the property of the wronged party, usually as a slave (Zimmerman 1996, 6). As the slave would typically be bound in chains, this practice came to be described wih the term obligare. Obligations come in a multitude of forms – legal, moral, social, political etc. What predominantly sets them apart is the established code or standards on which they depend to enforce a requirement to act in one way or another. When looking at an obligation, I adapt a legal frame of mind in the sense that I view it as a voluntary or involuntary contract containing the following three components: (1) an obligatoriness, i.e. a subject matter; (2) an obligated person, 4 i.e. an agent who is said to have a duty to perform; and (3) a defined bond that connects the agent to the obligation. This is more in line with English common law, where, unlike under Roman law, the concept of obligation does not involve a party claiming a right (Zimmerman 1996, 10). In this paper we are looking at a situation where a political body, namely the European Commission, seeks to alter shareholders’ legal obligations by way of amending a directive on shareholders’ rights. The question at hand is whether this change affects shareholders’ moral obligations. To deal with this question, we must clearly understand what a moral obligation is. 2.1 MORAL OBLIGATION Moral philosophy tends to look at moral standards as reasons for action (Pink 2002), since the fact that an action is morally commendable constitutes in itself a justification for taking that action. However, moral standards go beyond simply being reasons or justifications for actions, in that they also communicate obligations to act or refrain from acting in a given way. Let us take the Ten Commandments as an example. We are told to take certain actions, such as remembering the Sabbath and respecting our parents, while refraining from idolatry, blasphemy, murder, theft, dishonesty and adultery. These instructions are intended to guide how a good person will live. Their guidance goes beyond mere logical requirements or positive law; if you are of a Jewish or Christian persuasion you will see such instructions as binding rules, not as trifling guidance. These rules are to be followed regardless of the circumstances or consequences. To be a good person you must not murder or commit adultery. Furthermore, the Ten Commandments do not state simply that you must not murder because a good person refrains from such actions. Rather, the rule is further enforced by the fact that God has instructed us not to murder and that we are under an obligation to follow God’s instructions. Such enforcement is then meant to motivate us to act in a given way. Anscombe (1958) highlights how strongly such a Judeo‐Christian conception of ethics is linked to law. Under such a conception, a person either conforms to the law or is declared to be a bad man. The force and motivation behind the moral obligation in this instance is that divine law requires conformity. Yet, for such divine law to exist, there must exist a divine lawmaker, both to set out what such law entails and to function as a motivating force. Only then can we explain how something can go from ‘is’ to ‘ought’ (Anscombe 1958, 5). Anscombe here draws on Hume’s idea that truth consists in either relations of ideas or matters of fact. Let us take the moral judgement that ‘to murder is bad’ as an example. It may perhaps be a fact that ‘to murder is bad’ (something Hume would profusely oppose, as he objects to the idea of moral judgements being facts in general). Let us then see this fact as something that ‘is’. However, such a fact by itself could not motivate us to do anything. We would, for example, need to have some desire not to murder or not to do bad things in order for this fact to move us and thereby have an effect on our actions. Hume would refer to such a 5 motivating force as a passion. Such a passion would fulfil one of the requirements of obligation, namely that it provides us with a motive to act. Passion of this form is not part of or directly related to the fact in question; it is a psychological state of mind. Furthermore, even if we do have such a passion to move us into action, this still does not oblige us to do something – the ‘is’ has not yet turned into an ‘ought’ that necessarily binds us independent of circumstances and consequences, which is the second requirement of an obligation. You also need a further force demanding conformity, such as a divine lawmaker and judge, to fulfil all the components of a moral requirement. But is it not the case that murder would be wrong regardless of whether God exists? Wolf (2009, 3) raises this question, contending that to refrain from murder is an obligation that we have to each other and to society. However, the same challenge would apply if we wish to support such a social‐demand theory of moral obligation (Adams 1987; Wolf 2009) instead of a divine‐demand theory. That is, just as we previously need to show that a divine lawmaker existed, now we would need to show that there exists such a thing as a ‘society’, that such a society has the power to impose moral obligations on us, and that we can know what these obligations are. As we have seen from the above considerations, Anscombe has presented a concept of moral obligation according to which it is incoherent to claim that something is morally obligatory unless one is obliged by someone. Wolf (Wolf 2009, 8‐9) provides a different approach to the concept of moral obligation, defending the claim that we are able to discern what is morally required from what is merely recommended without requiring the existence of an external authority. Wolf refers to the way in which we blame or hold individuals accountable for their actions as a basis for differentiating between what is required and what is recommended. She finds her source of this idea in the following quotations from Mill: We do not call anything wrong unless we mean to imply that a person ought to be punished in some way or other for doing it – if not by law, by the opinion of his fellow creatures; if not by opinion, by the reproaches of his own conscience. (Mill 1979, 47‐48) There are other things, which we wish that people should do, which we like or admire them for doing, perhaps dislike or despise them for not doing, but yet admit that they are not bound to do; it is not a case of moral obligation; we do not blame them, that is, we do not think that they are proper objects of punishment. (Mill 1979, 48) However, the sheer notion that something is morally required of us need not be equated with an obligation. Wolf provides us with the example of etiquette, which requires us to pass port to the left (Wolf 2009, 10). This would still not constitute an obligation. What would be needed to create some obligatory bond is that, when we say that morality requires X of us, we in fact mean that we require X of us. But this brings us back to the problem of who ‘we’ is. 6 Both Wolf (2009) and Adams (1987) claim that this we should be viewed as society, and that it is in virtue of society’s demands that a morally required reason becomes morally obligatory (Wolf 2009, 16). This is the stance that I will take in this paper. However, we are still left with other issues to deal with, such as the need to know what society accepts of us in order to be obliged to act in a given way. Furthermore, to be obligated in this way, one must accept that society has this force and understanding what society is. These challenges will be explored in more detail below as they apply to the specific case of the European Commission’s recommended changes to the shareholder rights directive. 3. HOW THE UK APPROACH TO SHAREHOLDER RESPONSIBILITIES DIFFERS FROM THE EUROPEAN APPROACH The European framework for corporate governance consists mainly of individual national corporate governance codes and the Organisation for Economic Co‐ operation and Development’s (OECD) principles for corporate governance, which were first published in 1999. In this paper I will refer to the 2004 OECD Principles for Corporate Governance, 2014 UK Corporate Governance Code and 2012 UK Stewardship Code. All three documents are principles or codes offering non‐binding standards and good practices as well as guidance on implementation. These are the result of consultations with ministers, the private sector, labour and civil society (OECD 2004, 6). Furthermore, they are all based on a ‘comply or explain’ system, in that the participants can choose to deviate from the codes and still fulfil their responsibilities, provided that they explain why they have chosen this deviation. While the two corporate governance guidance documents seek to promote principles underlying effective board functioning and offers recommendations on the board’s relationship to shareholders, the UK Stewardship Code aims to guide investors in how to better exercise their stewardship responsibilities. However, the European proposal for changes to the shareholder rights directive goes further than the UK recommendations. Whereas the UK propose mandatory and binding voting by shareholders, they do not require a shareholder vote on the ratio between the lowest‐ and highest‐paid employees in the corporation or the ratio between fixed and variable compensation. On the other hand, both proposals are stricter than the regulations in the US, where the Dodd‐Frank financial reform law of 2010 requires that shareholders have mandatory voting rights, but the votes are not binding, i.e. corporations can choose to ignore the results. The difference between the European and UK approaches can also be seen in the language used by officials from the two entities. Both make clear that there have been ‘failings in the corporate governance framework for executive remuneration’ (Department for Business Innovation and Skills 2012) and that the implementation of sound corporate behaviour can reduce the damaging short‐term behaviour witnessed amongst European corporations. However, they seem to differ as to what role shareholders have played in causing such behaviour and what responsibilities they should have going forward. 7 In interviews and press releases, Michel Barnier, the European Commissioner, has been quoted as saying: Shareholders were too quick to support managers’ excessive short‐term risk taking and further did not sufficiently monitor the companies they invested in. (European Commission 2014b). Today's proposals will encourage shareholders to engage more with the companies they invest in, and to take a longer‐term perspective of their investment. (‘EU Bankers Bonuses’ 2014) The above comments indicate that Barnier has disapproved of how shareholders have acted and believes that they should have increased responsibilities going forward. This is not the tone taken by the UK’s Business Secretary, Vince Cable. He instead talks about the importance of empowering shareholders to monitor companies, as can be seen in these statements: These proposals restore a clearer, stronger link between pay and performance, they reduce awards for failures, they promote better engagement between companies and shareholders and overall they empower shareholders to hold companies to account through binding votes. (‘Cable Gives Shareholders’ 2014) Good corporate governance is vital to creating the right environment for long‐term, sustainable growth. Shareholders are at the heart of the UK corporate governance framework, so it is appropriate that we put more information and power in their hands. (Tolley 2012) But neither is the UK Secretary for Business claiming that shareholders do not have the duty to monitor their companies or that they should not play a role in corporate remuneration policies. Rather, these responsibilities are made clear in principles one and three of the UK Stewardship Code (Financial Reporting Council 2012). Indeed, institutional investors are also expected to report publicly on their policies on these matters, in accordance with principle two of the code (Financial Reporting Council 2012). Instead, the most likely reason why Cable is unwilling to criticize investors as Barnier has done is that he acknowledges shareholders’ lack of power to enforce their views. This situation would change with the proposed establishment of mandatory, binding voting rights on corporate pay. Perhaps the difference between the two perspectives also plays a role in explaining why the UK is not yet requiring shareholder votes on the ratio between the lowest‐ and highest‐paid employees in the corporation and on the ratio between fixed and variable compensation. In the UK, the Corporate Governance Code is very much a voluntary code, whose spirit must be followed rather than its words. A combination of the preference for a voluntary approach and the fact that shareholders have not yet necessarily had the control mechanisms to fully observe the code’s principles seems to make the British reluctant to impose further requirements at this point. There seems still to be 8 hope that the UK’s proposed changes will be sufficient to motivate shareholder behaviour in the desired fashion. Independent of these differences, conclusion that existing voluntary have proven insufficient in driving regulations should be put in place pay. both Europe and the UK have drawn the corporate governance codes and principles desired behaviour and that some additional to require shareholder voting on corporate 4. MORAL OBLIGATIONS AS IMPLIED BY THE AMENDMENTS TO DIRECTIVES 2007/36/EC AND 2013/34/EU In this section I will look at whether the proposed amendments to directives 2007/36/EC and 2013/34/EU should be viewed as moral obligations. To do so, I will first look more closely at the proposed ratios. In section one I presented the two proposed ratios on which shareholders would be expected to vote, one relating to the proportion of fixed versus variable pay and the other between the lowest‐ and highest‐paid employees in a corporation. I claimed that if it became legally mandatory for shareholders to vote on these two ratios, the shareholders would become legally obliged to do so. However, these ratios are being proposed not only in order to increase shareholders’ monitoring of the companies in which they have invested, but also to also reduce what politicians view as damaging short‐term risk taking (European Commission 2014b), help to tackle public anger over pay deals (‘Cable Gives Shareholders’ 2014) and curb anger at the widening gap between earnings of bankers and business executives and those of ordinary workers (O'Donnell 2012). All these functions go significantly beyond simply asking shareholders to vote. Instead, shareholders will also be held accountable for how they vote, since their votes are expected to have an impact in shaping corporate behaviour. Institutional investors are already being judged by such votes, as they are already obliged to make both their voting and their policy on corporate governance issues public in accordance with principle six of the EFAMA Code for External Governance (European Fund and Management Association 2011) and principle six of the UK Stewardship Code (Financial Reporting Council 2012). A shareholder can now be judged to have done the right or the wrong thing depending on how that shareholder voted. For this type of judgement to be just, there must be a right or wrong outcome that shareholders are expected to achieve. And the shareholders must have a clear understanding of the criteria by which they will be held accountable. Importantly, both the EFAMA Code for External Governance and the UK Stewardship Code make it clear that institutional investors have a duty to vote and act in the interest of their clients and/or beneficiaries. Substantial research has looked at the damaging potential of short‐term risk taking by managers as well as how to better overcome agency issues by aligning managers’ interests with those of shareholders by means of a mix of monetary compensational tools (Smith [1776] 1977; Berle and Means 1932). It is understandable that holding a vote on the ratio of fixed to variable compensation for managers could serve the purpose of looking after the interests of institutional clients and beneficiaries. However, this arrangement does not explain what role shareholders have in 9 tackling public anger over pay deals if the deals are in fact in investors’ interest. If a deal is not in their interest, then shareholders would have a legal and a moral duty to vote against the corporation’s proposal, and the corporation would now be legally bound to act in accordance with the results of that vote. Yet it is unclear whether this would be a new moral obligation, as the guidance to focus on such matters already existed before the currently proposed amendments. I will return to this issue in section six. As for the other measure under consideration, why should a vote on the ratio between the lowest‐ and highest‐paid persons in a corporation be relevant to investor clients and beneficiaries? At first glance, it does not seem relevant. This is an issue of justice and fairness, not one of corporate performance. However, the idea is that corporations would have to justify managers’ salaries in comparison to the lowest paid and that this would should lead investors to ‘put a break on the annual upward pay ratchet’ (‘Cable Gives Shareholders’ 2014). Considering that the average FTSE100 CEO is now paid 130 times as much as the average UK worker (High Pay Centre 2013), one can feel sympathy with politicians’ efforts to make corporations justify such differences. Yet, unless regulated, executives’ pay should be based on the value they bring to the corporation and its shareholders. It is not clear that such value is best presented in the form of a ratio between the lowest‐ and highest‐paid employees. As our codes of conduct stand currently, investors’ responsibilities lie towards their clients and beneficiaries and towards not society as a whole. Hence, if a CEO is in fact creating sufficient value for a corporation to justify his or her compensation, then shareholders should not be concerned with the multiple. Economic fairness per se is not the responsibility of the shareholder. The above discussion has been considering what may or may not be a moral obligation for shareholders. It is also important to look at whether the European Commission is in itself in the position to claim that one position or another is right in this matter, as well as whether the Commission has the required force to bind us to act in the right way if there is one. Both these factors are necessary for the subject matter to become in fact a moral obligation. Such an approach to moral obligation is consistent with the views of Adams (1987), Anscombe (1958) and Wolf (2009) as discussed in section 2.1 above, where I adopted Adams and Wolf’s viewpoint that it is in virtue of society’s demands that a morally required reason becomes morally obligatory (Wolf 2009, 16). To summarize, corporate governance frameworks consist of required codes of conduct and laws. The codes discussed in this paper aim to guide investors’ behaviour, both in individual European countries and across Europe as a whole. In section three I described the differences in approach between the European Commission and UK proposals. If the European proposal is approved, it would also apply in the UK, since the UK is a member of the European Union. Furthermore, such codes and laws would also apply to non‐European owners of shares in European stocks. As of 2011, 22% of European Stocks were in fact owned by non‐European investors (Observatoire de l’Epargne Européen 2012, 38) and in 2012, 53.2% of UK stocks were owned by non‐UK investors (Office for National Statistics 2013, 1). The European Commission, as representatives of a democratically elected European Parliament, have the legal right to set 10 regulations that affect all corporations registered within their borders and their shareholders. As such, they further have the obligation to represent the views and needs of that government’s people. Given that the proposed amendments to the shareholder directive are the results of significant consultation with representatives from a wide range of society, I would claim that they embody a fair reflection of the views and needs of those people. Furthermore, its people have voluntarily accepted the European Union as an institution and society, as the individual states made a conscious choice to become part of this union. When doing so we, the European people, also accepted the fact that there would be some instances when the wider union would overrule our national interests and views. Again, we (as a majority in each country) accepted this when the regulations determining how this union should operate were set up. Based on this line of argument, the European Commission does have the power to impose moral obligations on us. But the question still remains whether these subject matters are in fact moral obligations or moral requests, given that none of the European corporate governance or stewardship codes are a rigid set of rules. [They consist] of principles and guidance. The principles are the core of the Code and the way in which they are applied should be the central question for the institutional investor as it determines how to operate according to the Code. The guidance recommends how the principle might be applied. (Financial Reporting Council 2012, 4) Perhaps the principles individually do not have to be followed rigidly, but the spirit of the code as a whole is to be followed. The underlying moral obligation is that institutional shareholders have a duty to do right by their clients and beneficiaries, regardless of the circumstances. And if pressure from the wider society and shareholders’ own conscience do not sufficiently bind them to act in the spirit of that code, then the political authorities across Europe have clearly shown that they are willing to bind shareholders to it by law. Yet, even if we agree that the European Commission has the required force to demand a given behaviour, i.e. to establish its ‘obligatoriness’, we also need to look at the agent who is said to have a duty to perform (the ‘obligor’) before drawing any conclusion about that agent’s responsibilities. The section below will therefore look at what a shareholder is. 5. SHAREHOLDERS AS OBLIGORS A shareholder is simply an individual, organization, or company that legally owns one or more shares in a joint‐stock company. The following graph shows how the mix of the three types of shareholders has changed over the last forty years, making legal persons rather than purely natural persons the most dominant group of shareholders. 11 Source: INSEAD OEE Data Services 2013 Given that the definition of a shareholder involves a person who has entered a legal relationship with a corporation, the explanation of what a shareholder is most often focuses on the rights and duties that come with being a shareholder. The most commonly mentioned of these rights include the right to receive dividends as determined by the board of directors, the right to vote for members of the board of directors and the right to receive a fair share of the residual value should the corporate relationship be terminated. The specific rights of shareholders are further stated in a corporation’s articles of incorporation and bylaws. If we are attempting to look at shareholders from an ontological perspective, then we have a person (legal or natural), a corporation and a contract between the two. Moreover, the most general features characterizing a shareholder are rights and duties and the relationship between the person and the corporation in which the shareholder has invested. Because a shareholder is in itself a legal concept, and as the law is simply a collection of rights and duties, then any major changes in the rights or duties of shareholders will in fact redefine what it is to be a shareholder. As we can see from the graph, there are various groups of shareholders: households, investment funds, insurance companies etc. However, this does not mean the 12 same thing as saying that there are males and females, both of which genders are human beings who simply have different physical characteristics. In the case of shareholders, the different types not only have different characteristics, such as being more or less able to affect a corporation’s actions because of their size, but also come under different sets of rights and duties. For example, the duties described in the UK Stewardship Code and the EFAMA Code for External Governance apply only to institutional shareholders. Similarly, institutional shareholders are the main target of the proposed amendments by both the European Commission and the UK authorities. For the remainder of this paper, therefore, I shall differentiate between private and institutional shareholders when looking at their responsibilities. For reasons of simplification I have chosen to treat all institutional shareholders as belonging to the same group, although there is clear diversity amongst pension funds, mutual funds, sovereign funds, hedge funds etc. One thing that they all have in common, and that is critical for my assessment, is that they are all legal persons. As such, we need to ask whether they can ever be seen as having moral obligations, as the traditional concept of a moral agent does not involve legal agents. Rather than going into a deeper discussion of that matter here, I refer the reader to my paper titled Corporations and the sins of their forefathers (Smith 2013) where I support List and Pettit’s argument that corporations can in fact be seen as moral agents. However, this is true only in their limited role as enactors of the corporation’s deeds. This is where members’ and corporations’ responsibilities overlap and where simultaneously exercised control occurs. The corporation is responsible “given the decisions it licenses and the procedures by which it channels those decisions, (List and Pettit 2013, 166), whereas the members are responsible for implementing such decisions. Without such simultaneous contributions, no actions could be performed in the name of the corporation. This same corporate situation that occurs within larger institutional investors, where not only may different individuals possibly be involved – some buying the shares, others voting on corporate proposals to establish the policies according to which the shares are purchased – but also, the various and often simultaneously occurring processes are partly beyond the control of the individuals themselves. Given the above view of what it means to be a shareholder, and given my acceptance in section four of the European Commission’s right to impose moral demands, the last piece of the puzzle relates to what is required for shareholders to be bound by this specific demand. In section two I stated an understanding of what it means to be under the obligation to act in a given way as follows: Agent A is under an obligation B, where B represents acting or refraining from acting in a given way, given that agent A exists, that there exists an obligation B and furthermore that obligation B necessarily applies to agent A. In the next section I will discuss whether the moral obligations indicated by the proposed amendments to the shareholder rights directive can truly be said to apply to shareholders. 13 6. THE DEFINING BOND BETWEEN SHAREHOLDER AND OBLIGATION We can say that, to some extent, a moral obligation goes beyond an agent’s will and desires, for a moral obligation can be forced upon an agent. If an agent accepts an authority’s right to demand us to perform in some fashion, then we may for example be obliged not to commit adultery simply because we have been so commanded, even if we would prefer to commit adultery. A stricter requirement than mine might claim that we are morally obliged to some authorities (e.g. God’s authority) regardless of whether we accept it, simply by virtue of being human. Either version of the claim is sufficient to support the possibility that a moral obligation applies to an agent irrespective of the agent’s will or desires. However, we are not inclined to accept that an agent is morally obliged to perform a given act if the agent is not capable of doing so. In other words, whether an agent can be said to be under obligation to act in a given manner is partly determined by his or her capacity to act in that way. I am not here referring to the strict sense of control that Strawson (1993, 1) speaks of when arguing against the basic case for free will, the central idea being as follows: 1. Nothing can be causa sui (i.e. the cause of itself). 2. In order to be truly morally responsible for one’s actions, one would have to be causa sui, at least in certain crucial mental respects. 3. Therefore nothing can be truly morally responsible. Instead, I am referring to a simpler form of control. For example, we cannot be expected to vote if we do not have the right to vote. We need such rights to make it possible for us to vote. It would be pure madness to claim that we are under a moral obligation to vote by virtue of being citizens, if we did not have the right to vote. This type of control becomes relevant when we are assessing whether shareholders can be said to be under any new moral obligations by virtue of the proposed amendments to European directives 2007/36/EC and 2013/34/EU. A proposal to give shareholders mandatory, binding voting rights regarding corporate pay implies that shareholders are now, at least if they are part of or can put together a majority, more likely to affect outcomes. I say ‘more likely’ because a corporation previously could have chosen to adapt to the wishes of its shareholders in relation to pay, but would now be bound to act in accordance with those wishes. In other circumstances, corporations would not even offer shareholders the chance to vote on the issue of pay, as such votes were not mandatory. On the other hand, if the proposed amendments are approved, European corporations will be legally obliged to hold such votes every three years, provided that no significant changes have occurred in between, in which case they would have to provide annual voting opportunities. The UK have already passed these provisions into law as of October 2013. But does this alter shareholders’ moral obligation to vote on pay? I say no, it does 14 not – not if the only thing we are actually wanting shareholders to do is to vote on pay. In that case, then these changes to control are not relevant to changes in moral obligation. Previous to such changes, private shareholders had the right but not the duty to vote if a corporation chose to provide them with such opportunities. In saying that they had no duty, I mean no generally acknowledged or written duty. I thereby also support the view that a moral obligation does not apply to agents who are unaware of the fact that such demands are made on them. This differs from institutional shareholders, which are morally bound to vote by the generally acknowledged principles of the UK Stewardship Code and the EFAMA Code for External Governance. Under these principles, institutional shareholders would be under a moral obligation to vote on pay issues any time a corporation gave them the opportunity, regardless of any changes. They would also have been under the moral obligation to make their votes public. These amendments, then, result in a change in the legal obligation to vote and do not alter the moral obligation to vote that faces either type of shareholder. One reason why politicians have provided the public with reasons for making such changes was to encourage further engagement between shareholders and corporations, as the shareholders were seen as not sufficiently monitoring the companies in which they invested (European Commission 2014b). Again, if increased engagement and monitoring are simply defined by voting on corporate pay, then again nothing has changed from a moral perspective for either type of shareholder, as noted above, even if there is an increase in engagement or monitoring (as there clearly will be, simply as a result of the threat of punishment that comes with legal obligation). However, there are other ways in which to measure engagement and sufficient monitoring beyond direct participation in voting. Corporate boards are generally inclined not to be seen as proposing anything that goes against shareholders’ interests – partly due to concern for their reputation and because the shareholders elect the board, but also because they themselves have a moral obligation to act in the interest of shareholders. This behaviour is supported by the UK Corporate Governance Code (Financial Reporting Council 2014, 11), which states: The board should set the company’s values and standards and ensure that its obligations to its shareholders and others are understood and met. The OECD Principles for Corporate Governance (OECD 2004, 26) further state as follows: Board members should act on a fully informed basis, in good faith, with due diligence and care, and in the best interest of the company and the shareholders. As such, the proposed amendments to the European shareholder rights directive do give control to shareholders beyond simply mandatory, binding voting rights. However, such additional control truly relates only to institutional and other major shareholders, for these are the ones with whom management will want to 15 increase its engagement in order to ensure that the proposals are accepted. This greater level of control translates to having more input into the process of deciding on what the actual proposal on pay will be. Yet the increase in such control comes with an increase in duties. This is least true for institutional shareholders, who are already morally obliged by the stewardship codes to act in the interest of their clients and beneficiaries. Institutional shareholders will now be seen as having a greater impact on the proposals themselves and, as such, have the obligation to ensure that these proposals are in the interest of their clients and beneficiaries. For major private shareholders, similarly, the moral demand may exist by virtue of the fact that the authorities have expressed their demand for increased engagement with corporations and that this change in legislation enables them to do it. 6.1 THE GOLDEN RATIOS Let us now turn to the two specific ratios proposed by the European Commission: the ratio between the fixed and variable parts of remuneration and the ratio between the lowest‐ and highest‐paid employees in the corporation. As no shareholder has previously been presumed to be in a position to vote on these matters, there cannot be any change to previous moral obligations – at least, not with reference to the voting itself. However, what other kind of act may the authorities wish to promote by legislating mandatory, binding shareholder votes on these two ratios? As discussed in section four, politicians are hoping to promote a decrease in short‐term risk taking (European Commission 2014b) and to tackle the widening gap between earnings of bankers and business executives and those of ordinary workers (O'Donnell 2012). First, I would claim that smaller private shareholders again will not be able to exert any control over these matters beyond casting their votes. As such, they have no further obligations of any form. However, it is true that the reduction of short‐term risk taking amongst managers can potentially be achieved by altering the fixed and variable parts of the remuneration ratio. It is also true that, if a shareholder vote on this ratio is legally required and binding, boards will be more inclined to engage with larger shareholders, providing them with greater influence. However, it is not clear whether institutional shareholders would always be looking after their clients’ and beneficiaries’ best interests, as demanded by the stewardship codes, if they exploit their influence in this way. This is because not all clients or beneficiaries wish to invest for the long term. To the extent that clients have a short‐term investment horizon, the demand on institutional shareholders to reduce short‐term risk taking, and thereby possibly reduce short‐term share performance, may directly conflict with their already existing obligations towards their clients and beneficiaries. Authorities could potentially counter this problem by demanding that any short‐term rewards should not come at the cost of long‐term interests. Institutional shareholders would then have to find other ways to satisfy the needs of short‐term investors without increasing short‐term risk taking within corporations. But this is not a position that the authorities have clearly expressed or on which they have sought input. Therefore, as things stand, one moral obligation may directly conflict with another. It is not clear whether the moral obligation to reduce 16 short‐term risk within corporations should take precedence over institutional shareholders’ current moral obligation to serve the investment interests of their clients and beneficiaries. Their current clients and beneficiaries have chosen to invest with them partly in light of these obligations and the duties that result from them. As such, institutional investors cannot simply choose to violate their current obligations without the approval of their clients and beneficiaries. If they violated this fiduciary obligation without approval, the investors would have a basis for filing a complaint against them. This is the type of argument that Gilbert (1999, 11) uses when comparing a moral obligation to a promise. If the authorities, however, demand that institutional shareholders put another obligation above their current one, then the institutional shareholders could not be blamed for their action, since such a decision would be out of their control. The proposed voting on the ratio between the lowest‐ and highest‐paid employees in the corporation could have an even more profound effect on institutional shareholders. For institutional shareholders to engage with management in order to reduce the earnings gap in a corporation, it would have to be shown that this is to the benefit of their investors. However, there is very little evidence that such an improvement in social justice generates either higher equity returns or greater efficiency within corporations (Conyon and Murphy 2000). Furthermore, Falee, Reis and Venkateswaran (2013) studied the relationship between relative pay and employee productivity and found no statistically significant connection between the two; in fact, they found that the firm’s value actually increased slightly along with increased relative pay for CEOs. An increase of one standard deviation in the ratio was associated with a 5.3% increase in the firm’s value, and operating performance also increased with relative CEO pay. Institutional investors’ obligation is to ensure that management are not paid more than they deserve. A large multiple between the CEO and the average worker may raise questions and force the corporation to further justify its wage package. However, if the institutional shareholders accept this justification, then it should not be their role to push through a change on the basis of other societal values of justice. If the European Commission wants to require institutional shareholders to drive such change, this would be a major transition in moral obligation and would force us to redefine what it means to be an institutional shareholder. Short of such a redefinition, such a moral obligation cannot apply to shareholders as currently understood. 7. CONCLUSION This paper has set out to consider whether changes to the European Commission Shareholder Rights Directive on pay would alter shareholders’ moral responsibilities. Moral responsibilities are seen as involving a moral obligation to act or refrain from acting in a given way. The proposed changes to the directive include giving shareholders mandatory, binding voting rights on corporate pay and also having them vote on two specific ratios, namely the ratio between the lowest‐ and highest‐paid employees in the corporation and the ratio between the fixed and variable parts of managers’ remuneration. To determine whether these proposals would change shareholders’ moral obligations, we have looked at the 17 concept of moral obligations, what it means to be a shareholder and whether the proposed moral obligations could indeed apply to shareholders. Given my acceptance of the philosophical position that it is in virtue of society’s demands that a morally required reason becomes morally obligatory, I explained that the European Commission can impose moral obligations on shareholders of all types that invest in European corporations. We discovered that there is a noticeable difference in responsibilities between smaller private shareholders and institutional shareholders. These differences occur both because of the differing degree of control that the two types of shareholders have over corporate boards and because of the duties incumbent on institutional shareholders as stated in the UK Stewardship Code and the EFAMA Code for External Governance. The changes to responsibilities, depending on the type of shareholder, have been found to range from a purely legal responsibility to vote (for smaller private shareholders) to having a profound impact on what it means to be an institutional shareholder. What significantly altered the responsibilities was our reading of how the European Commission ultimately want shareholders to act as a result of the proposed changes. The most radical change would involve a major transition in moral obligations, if the Commission do in fact want to make shareholders responsible for the reduction of pay gaps between workers and CEOs. Because the agreement between shareholders, corporations and other parties is so central to the definition of what it means to be a shareholder, any changes in shareholders’ rights or duties or in the roles of any involved partners could have a strong impact on this definition. 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