Transparency of corporations needs to be enhanced

Thursday, 10 June 2010

“Valor Econômico”

Brazil has already benefitted from corporate governance improvements.

After a public consultation process that lasted 11 months, Instruction 480 came into force on January 1st, 2010, implementing comprehensive modifications regarding issuer registration with the CVM and public companies disclosures. The main purpose is to improve the quality and amount of information available to investors about the companies and adopt a standard for ongoing disclosure similar to that currently presented to potential investors during an offering. The benefits of keeping the market well informed are clear and result in better price formation of traded assets, in addition to gains for the companies themselves, as their cost of capital is reduced.

A considerable part of the information to be provided by the companies is in the so-called “Reference Form”, a document that, together with financial statements, can offer an excellent overview of the issuer. One of its sections requires information about executive compensation (amounts and policies).

Some professionals of public companies have decided to file lawsuits questioning the legality of the provision that requires the disclosure of the lowest and highest individual amounts paid to members of the supervisory board and of the executive management, as well as the average remuneration of each corporate body.

One of the claims is that Instruction 480 is unconstitutional, as it affects the privacy of executive management members. It is my understanding that this criticism is based on the false premise that the right to privacy is absolute and above any other legal interest or value. Today, we know that fundamental rights are not absolute and thus they should yield to other equally important interests according to the Constitution. This statement is not new and Brazil’s Supreme Court has highlighted the relativity of individual rights.

In particular, the relativity of the right to privacy of public companies’ executives is evident, due to the special characteristics of these companies. After all, their executives should know that such of legal entities, as they resort to public savings to fund their activities, are subject to a regulatory system based on the principle of transparency. That is exactly why they are called public companies in countries where this principle is firmly established.

So much so that countries such as France, the United States, Portugal, Germany, Canada and United Kingdom require quantitative information about the remuneration of main executives to be individually provided, which, in fact, exposes the administrator much more than the rule issued by the CVM, which requires the disclosure of information sorted by body and with no individual identification.

In addition, it is easy to recognize that requiring the disclosure of the highest, the lowest and average compensation sorted by corporate body does not change the situation of, for instance, a public company’s chairman, who usually already has a high public exposure due to his/her position.

The information about compensation required by Instruction 480 will be useful for the investors and the CVM to evaluate at least two issues that still are little known to the public. First, the incentive policy or regime to which executives are subject. It is mainly through remuneration that a corporation motivates them to address objectives in the short, medium or long term and to achieve targets established by the organization.

Depending on how the remuneration policy is structured, management will have incentives to accomplish the results that are nominated as priorities. On the other hand, as seen during the international financial crisis, inadequately designed remuneration systems may encourage managers of companies to take excessive risks, hurting shareholders in the process.

The second issue refers to compensation distribution among the company’s senior management members. A situation may exist in which the total administration cost of a certain issuer is compatible with the market average, but the company may have individuals whose remuneration is much above the average and others whose remuneration is considerably lower than their peers.

Awareness of this reality will enable investors to identify the company’s governance characteristics that would not otherwise be noticed, such as the possible power concentration indicated in the information about the lowest and highest amounts paid in the same management area. Besides, such information complements the other data that describe the compensation policy, also enabling the checking of implementation consistency. Therefore, we can say that compensation is an essential element to any governance system.

We, at the CVM, think that, in an attempt to meet our responsibility of considering the various interests at stake, we have adopted an intermediate solution that represents to investors a significant progress in terms of transparency and, to executives, a public exposure level compatible with that that a public company’s manager, who resorts to public resources, should reasonably expect.

Fortunately, the arguments contrary to the rule can already start to be confronted with facts. Since the beginning of this year, numerous Brazilian public companies have disclosed their compensation systems as required by the CVM and they are distinguishing themselves for exactly this reason. The first benefits of disclosing such information can already be seen, as investment analysts and the media are discussing the specific characteristics of the programs implemented by some companies, their contexts, qualities and potential ris ks. This process should progress, also with the companies’ efforts to improve the information provided and finally elucidate one of those non-transparent aspects related to the governance of Brazilian public companies.

Maria Helena Santana, Chairperson, CVM (Securities Commission of Brazil).