The Duty of Corporate Directors to Tie Executive Compensation to the Long-Term Sustainability of the Firm

Executive compensation is said to be for performance and, in liberal market economies, the board of directors along with compensation committees have largely been in charge of safeguarding pay for performance. This executive compensation system is legally protected by the business judgment rule (a strong judicial deference) and has recently been supplemented with shareholders' ‘say on pay'. Further legal or government intervention has been deemed unnecessary. However, such system has resulted in extremely excessive executive compensation, outrageous pay disparities between executives and workers, poor or short-term performance, recurrent corporate failures and economic recession. This paper explores the need for a stronger legal intervention and argues that directors, in exercising their fiduciary duties, should be legally required to tie executive compensation to the long-term sustainability of the firm that in turn requires the use of executive pay to promote not only sustained growth and long-term shareholder value but also steady improvements in the interests of multiple stakeholders involved in the long-term success of the company, notably employees. It is further argued that, in liberal market economies, employees' ‘say on pay' should be considered as it is crucial to allow employees to communicate their interests in order both to incorporate them in the metric of long-term firm sustainability and to counter the likely opposition from short-term oriented shareholders and self-serving directors and officers. This proposal will contribute to avoiding excessive pay and short-termism and to promoting long-term firm performance, which will ultimately protect shareholders and employees' interest in job security, fair and sustainable wages and secured pension while creating more stable economies and avoiding citizens subsidizing periodic corporate failures, excessive executive pay and the wealth accumulation plans of an elite shareholder class. The paper briefly analyzes whether directors have a duty to tie executive pay to long-term performance in the US and Canada and develops the argument building on the lessons that can be drawn from the 2009 German VorstAG (the Act on the Appropriateness of Management Board Remuneration) and the 2015 German Corporate Governance Code