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23 Feb 11
Executive remuneration - window dressing or glass shattering

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In recent times, policy makers have been on an apparent bandwagon of executive remuneration reforms. On 20 December 2010 the Treasury released the Corporations Amendment (Improving Accountability on Director and Executive Remuneration) Bill 2011 (Bill) which is stated to improve the transparency, disclosure and accountability of the remuneration process.

The due date for the closure of submissions was 20 January 2011 with the Bill being introduced in Parliament on 23 February 2011. Businesses and professional organisations have made a number of significant submissions on the Exposure Draft, which based on initial parliamentary discussions appear to have been somewhat acknowledged by the Government.

Laws already in place

The first of these reforms came into effect on 24 November 2009 in the form of the Corporations Amendment (Improving Accountability on Termination Payments) Act 2009 (Act). This Act amends the Corporations Act 2001 (Cth) (Corporations Act) by significantly tightening the restrictions on excessive termination payments to executives.

The main amendments under the Act are as follows:

  • shareholder approval will be required where a termination payment is more than one year’s ‘base salary’. The previous threshold was calculated under a generous formula, for effectively three years and excluded a number of elements, such as equity incentives
  • previously, shareholder approval was only required for the payment of termination benefits to directors this has now been extended to include any person who holds a managerial or executive office
  • the definitions of ‘base salary’ and ‘termination benefit’ have been amended for the purpose of clarifying which payments will require shareholder approval
  • directors affected by these amendments are excluded from any vote to approve their termination benefit.

The next round

In summary, the main changes under the proposed Bill are as follows:

Two strikes test

There will be a ‘two-strikes’ test regarding the remuneration report. The ‘first strike’ will occur where the company’s remuneration report receives a ‘no’ vote of 25% or more shareholders. The subsequent report must then explain how the shareholder comments at the AGM were addressed and if not, why not.

The ‘second strike’ will occur if the remuneration report receives a ‘no’ vote of 25% or more shareholders at the following AGM. Where this occurs there will be a ‘spill resolution’ at the same AGM to decide if the directors in office should be re-elected at the ‘spill meeting’, to be held 90 days later.

Those directors in place at the AGM (except the managing director) where the ‘second strike’ occurred will cease to hold office immediately prior to the ‘spill meeting’. The resolutions to appoint persons to these positions will then be put to vote at the spill meeting.

Remuneration consultants

The engagement of remuneration consultants must now be performed by non-executive company directors.

The remuneration consultant must only give advice to the remuneration committee or the non-executive directors of the company. This advice however, must not be given to executive directors, unless all directors of the company are executive directors.

Voting on remuneration matters

‘Key management personnel’ and their closely related parties are not able to vote on the non-binding resolutions in the remuneration report where they are also shareholders of the company and would otherwise be able to vote.

There will also be a prohibition on key management personnel and their closely related parties voting on any undirected proxies in relation to remuneration related matters.

Hedging of incentive remuneration

The Bill prevents key management personnel or their closely related parties from hedging an incentive portion of their remuneration. Contravention of this section is a criminal offence.

‘No vacancy’ rule

Shareholder approval at the AGM will be required should the company fill less than the maximum number of board positions specified in the company Constitution. Persons can be appointed as a director by other directors between general meetings and any appointment will have to be confirmed at next AGM.

Proxy holders

The existing provision requiring the Chair to vote all directed proxies is to be repealed. The new provision will require all proxy holders to vote all directed proxies, prohibiting them from ‘cherry picking’ the appointments they vote on.

Limiting disclosures

Remuneration disclosures will only be required for the key management personnel of the consolidated entity, this removes the requirement to disclose the remuneration of the five highest paid executives.

Submissions

It has been argued that the Bill, in some instances, puts onerous obligations on the executive which are not reflective of the needs of the law. Below, we have briefly outlined some of the main points from the submission made by the Law Council of Australia:

  • the requirement to report on shareholder comments under the ‘two strikes’ test creates practical difficulties and may involve excessive detail
  • the ban on hedging should only apply to those arrangements which have the effect of limiting the exposure of the member to risk on the non-satisfaction of the performance condition that should be prohibited. This ban should also be limited to companies that are disclosing entities and their subsidiaries
  • external remuneration consultants need to work with management to formulate their advice. If they cannot do this freely, it will have a material adverse effect on the advice given. This new provision imposes management obligations on non-executive directors when their time could be valuably used elsewhere
  • the definition of ‘remuneration consultant’ should be amended as the current drafting captures advice ‘relating to’ remuneration and could include legal and accounting advice on the structuring of the remuneration
  • it was agreed that the Board should not set a maximum amount of company directors. It is inconsistent that shareholders by ordinary resolution should be able to approve a limit below the maximum number of directors in the Constitution, when this should be done by a special resolution to amend the Constitution
  • the requirement that all directed proxies must vote will not work in practice as the effect of the drafting is that if a directed proxy is unaware they have been appointed or is unable to vote they will be in contravention of the law. We also note that shareholder voting is not compulsory and this new provision goes against this principle.

As demonstrated above, there are many instances where these rules are seen to give shareholders unnecessary powers. It appears that several of these amendments as drafted, do not take into account practical considerations and would act to clog up procedures that are effective in their current form. There is also a strong risk the ‘two-strikes’ rule may be used strategically by significant shareholders to spill a Board, rather than being a genuine vote of disapproval on remuneration issues. There is also a concern a Board on a ‘first-strike’ may be unduly distracted from normal business or hamstrung in implementing the rollout of new incentives that may actually promote performance.

In addition to the Bill, a further discussion paper has also been released on the clawback of executive remuneration where financial statements are materially misstated. The paper aims to capture directors who misstate financial statements for the purpose of influencing the decision making of investors and stakeholders. Submissions on this paper are open until 30 March 2011.

The Bill is due to come into effect on 1 July 2011. It will be interesting to see how many points raised in the submissions will be taken up by Parliament. In our opinion, if the Bill is enacted substantially in its current form this would on many counts increase the complexity of the executive remuneration situation with limited tangible benefits.

Focus covers legal and technical issues in a general way. It is not designed to express opinions on specific cases. Focus is intended for information purposes only and should not be regarded as legal advice. Further advice should be obtained before taking action on any issue dealt with in this publication.

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