Remuneration as a Governance Tool: Lessons from Solvency II

Introduction

Remuneration has traditionally been viewed as a compensation matter: namely how much, in cash and bonuses, should directors be compensated for their services. Increasingly, however, remuneration is being recognised as a governance tool. The focus has shifted from the amount of remuneration awarded to the behaviours that remuneration structures incentivise. Well-designed remuneration structures may encourage prudent risk-taking, long-term value creation and customer protection. Conversely, poorly designed remuneration structures may encourage excessive risk-taking and short-termism.

As a result, remuneration has become a central governance tool for boards, regulators, shareholders and other stakeholders alike. This trend is particularly evident under Commission Delegated Regulation (EU) 2015/35¹ (“CDR”) within the Solvency II framework, Directive (EU) 2016/97² on Insurance Distribution (“IDD”), and, more broadly, in current governance disputes, such as the litigation concerning Elon Musk’s compensation package at Tesla.

This report examines how remuneration can be leveraged as a governance tool to promote prudent risk management, customer protection, long-term value creation and alignment. It draws on lessons from Solvency II, the IDD and the Tesla remuneration litigation, and considers whether the Maltese tax framework supports such remuneration structures.

The Evolution of Remuneration as a Governance Issue

Historically, executive remuneration often focused on short-term targets. Emphasis was placed on short-term returns, such as total shareholder return, as a primary metric in the evaluation of pay plans. However, tying executive pay to enterprise value over short periods of time encouraged executives to prioritise short-term performance over the long-term interests of the company. Therefore, companies actually put their long-term interests at risk through such remuneration structures.³ Modern remuneration structures have hence shifted away from this approach, and towards arrangements that align with the company’s objectives. The simplest arrangement is direct stock ownership by executives, with long-term holding periods. Therefore, equity participation has become a common mechanism through which alignment with the company’s broader objective is achieved.⁴

The underlying rationale is that a director whose remuneration depends on annual financial targets may focus on short-term results. By contrast, a director whose interests are aligned with those of shareholders through long-term ownership is more likely to focus on the sustainable success of the company. Accordingly, the central question is no longer “how much are directors paid?”, but “what behaviours are being rewarded?”. Effective remuneration frameworks seek to reinforce prudent decision-making, sound governance and long-term success.

Solvency II

Within the insurance sector, these governance principles have been given effect through the Solvency II framework, under Article 275 of the CDR. The CDR requires insurance and reinsurance undertakings to establish remuneration policies that are consistent with their business and risk management strategy, risk profile, objectives, long-term interests and overall performance. Remuneration policies must also address conflicts of interest and promote sound and effective risk management. Moreover, remuneration arrangements must not encourage excessive risk-taking.

The CDR also provides that the remuneration policy must contain specific arrangements, that comply with the following principles:

• fixed and variable components in remuneration schemes shall be balanced, to avoid overdependence on variable components;
• in the case of performance-related remuneration, basing variable remuneration on both the individual performance and the overall results of the undertaking;
• the payment of a substantial portion of the variable remuneration shall contain a flexible deferred component, that considers the nature and time horizon of the undertaking’s business. The deferral period shall be not less than three years;
• assessing performance using both financial and non-financial criteria; and
• performance measurement as a basis for variable remuneration shall include a downward adjustment for exposure to current and future risks.

The above requirements highlight that under Solvency II, remuneration is viewed as a component of the undertaking’s overall governance framework, rather than merely a compensation matter.

The Insurance Distribution Directive and Customer Protection

Whilst Solvency II approaches remuneration from a prudential perspective, the IDD approaches it from a consumer protection perspective.

Article 17(3) of the IDD provides that insurance distributors must not be remunerated in a manner that conflicts with their duty to act in the customer’s best interests. In particular, distributors must not create remuneration arrangements, sales targets or incentive structures that encourage the recommendation of one insurance product, where another product would better meet the customer’s needs.

The reasoning behind these provisions is that where remuneration is linked primarily to sales volumes or product-specific commissions, there is a risk that distributors may prioritise financial gain over the needs of the customer. Such arrangements can create conflicts of interest and undermine confidence in the distribution process.

Article 17(3) of the IDD therefore demonstrates that remuneration is not merely an internal matter. It also serves as a mechanism for achieving regulatory objectives, such as consumer protection. In light of Article 17(3) of the IDD, boards therefore need to ensure that distributor remuneration arrangements incorporate qualitative factors, such as customer satisfaction, complaints data, customer retention and quality assurance outcomes, rather than focusing exclusively on sales performance.

The Maltese Tax Framework and Equity Participation

An increasingly important question is whether the Maltese Tax Framework supports remuneration structures that promote long-term alignment between directors, employees and shareholders. As discussed above, one of the most effective methods of aligning interests is through equity participation. Directors who hold shares in an undertaking are often more likely to focus on sustainable value creation and long-term success of the company. This is consistent with the broader governance trend away from short-term bonus structures and towards long-term ownership.

However, the current Maltese tax framework may create practical obstacles to such arrangements. Under the Income Tax Act⁵ and the Fringe Benefits Rules⁶, gains arising from employment-related share awards or share options may become taxable before the individual receives any corresponding cash proceeds from a disposal of the shares. This can create a liquidity mismatch whereby tax must be paid, even though no cash return has yet been realised. This has led to calls for targeted reforms, including de minimis exemptions for modest equity awards, deferral of tax until disposal, and application of appropriate caps. However, the Fringe Benefits Rules tax such income separately at 15%, a relatively low rate, improving the overall position for equity-based remuneration.

The Tesla Litigation: A Lesson in Process

Perhaps the most significant remuneration dispute of recent years is the litigation surrounding Elon Musk’s compensation package at Tesla. In 2018, Tesla granted Musk what was reported to be the largest compensation package awarded in public market history⁷, amounting to a maximum value of $55.8 billion⁸.

However, following a shareholder derivative lawsuit, in January 2024⁹, the Delaware Court of Chancery rescinded the package. The Court found that¹⁰:

1. the process in determining compensation had been controlled by Musk¹¹: “the Compensation Committee operated under a “controlled mindset”¹²;
2. the compensation was unfair¹³: the “Defendants failed to prove that the Grant was the product of fair dealing or at a fair price”^14;
3. the disclosure to shareholders had been inadequate¹⁵: “the stockholder vote was not fully informed”;¹⁶
4. the Compensation Committee lacked independence from Musk: “The Compensation Committee and Musk were not on different sides.”¹⁷

Therefore, although the size of the package was unprecedented, the Court’s concerns centred primarily on the governance framework through which it had been approved.

Tesla then supplemented disclosure to shareholders. Although shareholders later voted again to approve the remuneration package, the Delaware Court of Chancery held that the ratification was ineffective, as it followed the issuance of a decision that had invalidated the package. Tesla appealed the decision to the Delaware Supreme Court and reincorporated in Texas.¹⁸

The board and shareholders unaffiliated with Musk then approved a $35 billion compensation package, that would be paid to Musk if the Delaware Supreme Court affirmed the decision. In addition, a new equity-based incentive compensation package for Musk was also approved.¹⁹

Ultimately, the Delaware Supreme Court reversed the lower court’s order of rescission, reinstated the compensation package and awarded nominal damages of just $1. The litigation nonetheless shows how remuneration process concerns, once raised, can lead to years of uncertainty for a company.

The litigation illustrates the importance of independent decision-making and transparent disclosure in remuneration processes. It also demonstrates that shareholder approval alone does not eliminate concerns regarding the independence and transparency of the underlying remuneration process. More broadly, the Tesla litigation reinforces the view that remuneration is a governance tool, rather than merely a compensation mechanism, as the effectiveness of remuneration governance depends not only on the amount awarded, but also on the independence and transparency of the process through which remuneration is determined.

Conclusion

Remuneration has become an important tool through which governance objectives are pursued. Whilst Solvency II approaches remuneration from a prudential perspective, the IDD approaches it from a consumer protection perspective. Together, these frameworks demonstrate how remuneration can promote prudent risk management and protect customers. The Maltese tax framework may also affect the viability of equity-based remuneration. The Tesla litigation highlights the importance of independence and transparency in the remuneration process.

Overall, remuneration is not merely a compensation matter, but a governance tool that shapes behaviour and decision-making.

¹ Commission Delegated Regulation (EU) 2015/35 of 10 October 2014 supplementing Directive 2009/138/EC of the European Parliament and of the Council on the taking-up and pursuit of the business of Insurance and Reinsurance (Solvency II)
² Directive (EU) 2016/97 of the European Parliament and of the Council of 20 January 2016 on insurance distribution (recast)
³ Joel Paula, ‘The CEO Shareholder: Straightforward Rewards for Long-term Performance’ (Harvard Law School Forum on Corporate Governance, 23rd October 2023) < https://corpgov.law.harvard.edu/2023/10/23/the-ceo-shareholder-straightforward-rewards-for-long-term-performance/>
⁴ Ibid
⁵ Chapter 123 of the Laws of Malta
⁶ Subsidiary Legislation 123.55
⁷ Gail Weinstein et al, ‘What the Tesla Decision Means for Executive Compensation and Other Corporate Issues’ (Harvard Law School Forum on Corporate Governance, 2nd February 2026) <https://corpgov.law.harvard.edu/2026/02/02/what-the-tesla-decision-means-for-executive-compensation-and-other-corporate-issues/>
⁸ Tornetta v. Musk, 30th January 2024, Court of Chancery of the State of Delaware
⁹ Ibid 1
¹⁰ Weinstein (n 7)
¹¹ Weinstein (n 7)
¹² Tornetta (n 8) 168
¹³ Weinstein (n 7)
¹⁴ Tornetta (n 8) 159
¹⁵ Weinstein (n 7)
¹⁶ Tornetta (n 8) 191
¹⁷ Ibid 146
¹⁸ Weinstein (n 7)
¹⁹ ibid

Disclaimer: This article is for informational purposes only and does not contain or convey legal advice. The information contained in this article should not be used or relied upon in regard to any particular facts or circumstances without first obtaining legal advice. This article was first published in the ‘Independent’ on 14/10/2026.