On 13 September 1999, Philippe Jaffré, former chief of France’s oil conglomerate Elf-Aquitaine, left his post with a package of stock options estimated at 38 million dollars. Yet he also appeared to have failed as a manager, since he was the losing party in a mutual take-over attempt between Elf and its rival Total. The generous benefits package he received created the perception that he was being compensated not based on merit, but for selling out the company he ran. The event triggered immediate reactions from the political parties of the Left that were in power, who moved to impose a heavier tax burden on stock option earnings. To many in France, stock options now evoke the Anglo-Saxon shareholder model of corporate governance. They have also become the focus of public controversy and acrimonious debates in the French press. In what has become known as the “Jaffré effect,” French politicians have begun to question the logic of shareholder value.
One reason for the outcry is that France itself does not have a system of private pension funds like that of the United States. Judging from the emerging popular debate, the new economic model in France appears to oppose any effort at value creation in French companies. Why, asked president Jacques Chirac, should French workers suffer in order to protect the investments of “Scottish widows and California pensioners?”
Thus when on 10 January 2001 the Danone company, praised in the past for having successfully combined ethics and profitability, announced a plan to rationalize its business by closing ten of its European production sites (seven in France alone), it drew a broad public outcry.
Behind the public vituperation, however, the Anglo-Saxon shareholder model of corporate governance is rapidly diffusing among French firms. It has been driven in large part by the growing strength of British and American institutional investors in the French stock market.
Behind the public vituperation, however, the Anglo-Saxon shareholder model of corporate governance is rapidly diffusing among French firms. It has been driven in large part by the growing strength of British and American institutional investors in the French stock market. (See Table 1.)
But two other factors are also important. First, the increased globalization of the French economy has required that top managers pay close attention to their market valuations in order to ward off unwanted acquisitions. Take over battles such as Elf versus Total or BNP versus Société Générale and Paribas would have been unthinkable only a few years ago. Second, the globalization of the labor market for highly-qualified workers has pressured companies in high-technology sectors to offer incentive-based compensation. Linking compensation to performance, often through the use of stock options, is an important element of a value-creation business culture, and this culture is spreading rapidly in France. French employers now lead Europe in their use of stock option plans for compensation.
Value-based management makes an explicit link between a company’s strategic and operating decisions and their impact on shareholder returns. It does so in part by aligning executive incentives with shareholders’ interests. But while the ideas underlying value-based management are not new, their diffusion to firms has accelerated in the 1990s, first in United States and then in Europe. According to the May 2000 bulletin of the Commission des Opérations de Bourse, the French equivalent of the Securities and Exchange Commission, more than half of the 40 largest companies in the bourse now emphasize value creation in their reports to financial analysts and investors. This new emphasis has improved the quality of information they provide to share-holders. Quite a few French companies now use international accounting standards, and have introduced quarterly reports. They also now break down their financial reporting by business segment. And they rely more heavily on conference calls, and increasingly on web-based discussions, to communicate with major share holders.
A majority of the French companies that have adopted the language of value creation have neither made any real changes to internal management procedures nor adopted incentive-based compensation packages. They feel that value creation has always been the primary goal of business, and that they already understand the key priorities in pursuing shareholder value. But it is an open question how long these companies can continue to pursue a purely cosmetic approach to share-holder value.
A large and growing minority of companies in France have begun to change their internal procedures. Many are introducing new value metrics into their compensation systems.
The change has emerged from a growing recognition by top management that the financial performance of French firms in the early 1990s has been much lower than that of their American competitors. To bring this message home to their employees, many French companies are moving to systems of performance-based pay. Companies such as AGF, AXA, Danone, Lafarge, Rhone Poulenc, and Usinor have taken bold steps in this direction. Their management compensation packages include a high proportion of variable pay to fixed salary (from about 40% for top managers to about 15% for middle managers, which is still less than in the US). The amount of variable pay is determined through formal and open approaches. And the level of variable compensation is increasingly linked to external benchmarks, such as share price or return on capital, rather than internally-negotiated goals. The variable pay may take the form of short-term or long-term bonuses, and it is being extended to an ever larger circle of employees in these firms. A clear objective for these companies has been to introduce a business culture focused on the “cost of capital,” not just among their financial elite, but throughout the organization.
One of the most striking developments in performance-based pay has been the growing use of stock options. They were introduced in France in the early 1970s. But the sale of stock options remained largely confidential until 1984, when the government of François Mitterrand made the accounting loss for companies tax deductible. This change made stock options, often sold far below their current market price, an attractive device for evading taxes. The company could thereby evade compulsory contributions to social security and retirement, while the employee would pay less income tax. Successive tax reforms have since made such practices less attractive. Today, the regulation of stock options in France is comparable to that in other countries, although France still requires a 5 year delay between the attribution of an option and the sale of stocks. This is likely to be reduced to 4 years under a bill currently in discussion in the French Parliament, as part of the on-going law on New Economic Regulations.
Most stock option packages for top management in France today are designed explicitly as performance incentives. And many are based on the relative performance of the company. Stock options at Vivendi, for example, were at first conditional upon a 40 percent increase in stock price. Later, following a general increase in stock performance in France, tougher conditions were applied, based on achieving a performance at least 25% higher than Vivendi’s peer group. (See Table 2, below.) This contrasts with the usual practice in American companies, where such incentive-oriented stock options are still an exception.
Some controversial clauses still remain in French stock option packages. For example, while most companies require their employees not to exercise their options before the 5 year delay in order to avoid company taxes, some companies eliminate this constraint in the case of a take-over bid. This possibility for early exercise allowed top managers of Paribas, for example, to extract large capital gains in their battle with BNP. Episodes like this have reinforced popular concern over the “Jaffré effect.”
|Table 2: Examples of performance conditions placed on French stock options|
|Company||Conditions for Exercising Stock Options|
|Alsthom||38% increase in market price|
|Air Liquide||10% growth in earnings per share|
|BNP||Achievement of quantified operational targets|
|Schneider||12% growth in earnings per share|
|Vivendi||Old approach: 40% increase in market price
New approach: Exceed peer group performance by 25%
A second important trend in France has been the diffusion of stock option not just to top managers but also increasingly to a broad group of employees. A 1999 survey of French companies showed that this trend was still relatively limited; only 1 percent of employees in French firms received stock options at the time. But this picture may be misleading. The French telecommunications company Alcatel offers a striking example. The number of Alcatel employees benefiting from stock options grew from 1,000 in 1997, to 2,000 in 1998, to 4,000 in 1999, and is estimated to have jumped to 25,000 in 2000. The recent boom in stock options packages at Alcatel can be traced mainly to its acquisition of several American startups. While many companies were handing out stock options to their employees as simple rewards for achievement, Alcatel, along with many other international high-tech companies, has hired specialized consulting firms to restructure their entire compensation system. One of their first considerations has been the role of stock options in attracting highly qualified engineers. In an increasingly international labor market for technical skills, stock options have become a nearly mandatory component of compensation.
The recent diffusion of a value-creation culture in French companies has roughly followed the path mapped out by American companies ten years ago. France has progressed more rapidly in this direction than Germany, where a two-tier company board, legal co-determination rights and a high tax rate on corporate financial gains have slowed reforms. Germany is only beginning to catch up. But for France, as for Germany, the key challenge will be to construct a hybrid system of corporate governance — one that preserves some features of the continental model while promoting greater financial performance. A critical battleground in this process will be the proposed laws on new economic regulation, to be discussed in the spring of 2001. The current project combines corporate governance reforms that further shareholder value, including provisions for transparency in compensation and independence of board members, with other reforms favoring stake-holder interests, such as transparency towards employees in case of take-over bids. Whatever the outcome, the time of direct state intervention in France is clearly past, and the door is open for a new approach to corporate governance based on Anglo-Saxon common law.
Jean Pierre Ponssard is a professor at the Ecole Polytechnique, Paris and a Senior Research Fellow at the French National Center for Scientific Research (CNRS). He recently conducted a study for the French Ministry of Finance on the impact of foreign funds on corporate strategy in France.