Improvements to the remuneration model and internal governance are only fruitful in a conducive environment. This means that there are requirements for the governance practices outside of the firm as well. We refer to this as ‘external governance’.
We already remarked the need for uniform standards in measuring, accounting and reporting non-financial performance. We also note the need for continuous updating of such a harmonised framework in light of changing market failures and/or the extent to which governments take steps to address those as well. Such standard setting and updating requires a widely supported body that works collaboratively with governments, companies and other stakeholders to arrive at the right framework.
The fact that governments may take steps to achieve better societal outcomes bears broader implications. One question is the optimal interaction between private initiatives for good corporate behaviour and proper remuneration practices and public action through regulation and legislation. Governments can support the implementation of a new remuneration model, for instance through reporting requirements, ratification of a harmonised non-financial performance framework, and/or legislation facilitating for instance claw-back (beyond current regulations to empower enforcement). Thus, continuous engagement with policy makers around the world is much needed.
A final issue is the management of incentives in other parts of the investment and business value chain. It is difficult for companies to move away from targeting short-term financial performance if the incentives for e.g. investors or professional money managers are short term. An asset manager whose own incentives are (significantly) based on e.g. quarterly or annually and (mostly only on) financial performance will have a strong interest in driving high short-term, financial returns. Driving remuneration policy changes throughout the entire investment value chain could contribute significantly to better pay practices at individual companies.