Executive Remuneration reforms

22 March 2011

Executive remuneration, as we have previously reported, has become a significant area for reform in recent times. Following the global financial crisis, there were calls for increased regulation of “golden hand-shakes” and other excessive executive pay outs. The Federal Government, in March 2009, commissioned an inquiry to assess the need for reform. As a result, legislation has been passed which amends the Corporations Act 2001 (Cth) (Corporations Act) and more recently a new bill has been introduced which, if passed, will enact further reforms.

First round of the executive remuneration reforms

The first of the executive remuneration reforms came into effect on 24 November 2009 in the form of the Corporations Amendment (Improving Accountability on Termination Payments) Act 2009 (Act).

As previously reported, this Act amends the Corporations Act by significantly tightening the restrictions on excessive termination payments to executives.

The key amendments that were made to the Corporations Act are as follows:

Shareholder approval is required where a termination payment is more than one year’s “base salary”. Under the previous law, termination benefits could have reached up to seven times a recipient’s total annual remuneration before shareholder approval was required.
Previously, the law only required shareholder approval for the payment of termination benefits to directors. Shareholder approval is now also required for senior executives or other Key Management Personnel (KMP).
There is a new definition of “termination benefit”, under section 200AB of the Corporations Act, which is broader than the previous definition. Also section 200 of the Corporations Act requires that in determining whether a benefit is given the substance should prevail over its legal form.
Unauthorised termination benefits must be repaid immediately.
The penalty provisions have been strengthened to 180 penalty units for a natural person and 900 penalty units for a body corporate, whilst retaining the option of 6 months imprisonment.

Round two of the reforms

On 23 February 2011, the Federal Treasury released the Corporations Amendment (Improving Accountability on Director and Executive Remuneration) Bill 2011 (Bill). The Bill is due to come into effect on 1 July 2011. The main changes under the Bill are as follows:

Two strikes test

There will be a ‘two-strikes’ test regarding the company’s remuneration report. The ‘first strike’ will occur where the company’s remuneration report receives a ‘no’ vote of 25% or more at an AGM. In this case, the next remuneration report must explain how shareholder comments raised 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, in which case a resolution known as a “spill” resolution must be put to shareholders. If the spill resolution is passed by at least 50% of the shareholders who cast a vote, those directors who held office when the second remuneration report was approved by the directors would be forced to vacate their office and stand for re-election at another shareholders meeting to be convened within 90 days.

Remuneration consultants

Companies sometimes engage remuneration consultants to provide advice on director and executive remuneration. Some stakeholders have expressed concern that remuneration consultants may be placed in a position of conflict if they are asked to provide advice on the remuneration of officers who might have the capacity to affect whether or not that consultant’s services will be retained. Under the Bill, listed entities will be required to disclose details relating to the use of remuneration consultants. In addition, remuneration consultants will be required to be engaged by non-executive directors, and must report to non-executive directors or the remuneration committee, rather than company executives.

Voting on remuneration matters

Section 250R of the Corporations Act provides that a listed company must put its remuneration report to a non-binding shareholder vote at each AGM. Concerns have been raised where directors and executives, whose remuneration is disclosed in the remuneration report, can also participate in the non-binding vote if they hold shares in the company. Under the Bill, KMP and their closely related parties will be prohibited from participating in the non-binding vote.

Proxy holders

Shareholders can provide directed proxies (which specify how they wish to vote on a resolution) or undirected proxies (which enable the proxy holder to choose how to vote). The current law requires all directed proxies held by the Chair to be voted, however, non-Chair proxy holders can choose which proxies to vote. As such, non-Chairs are able to effectively choose which votes they exercise and which they do not; this arguably impairs the transparency of shareholder voting. The new provision will require all proxy holders to cast all of their directed proxies on all resolutions.

Hedging of incentive remuneration

Currently, it is possible for directors and executives to ‘hedge’ their exposure to incentive remuneration (for example through shares and options). This involves the director or executive entering into a third party contract (such as trading in derivatives) to reduce their current exposure and mitigate their personal financial interest in the company’s success, or lack thereof. This is clearly at odds with the principle that remuneration be linked to performance and it places a director in a real conflict of interest as they may stand to benefit if the company’s share price falls. The Bill proposes that KMP and their closely “related parties” be prohibited from hedging the KMP’s incentive remuneration.

Declarations of “no vacancy”

The “no vacancy” rule allows a board to declare that it has no vacant positions even though the maximum number of directors allowed by the constitution has not been reached. This, in effect, gives a board considerable power over the composition of the board. Under the Bill, public companies will be required to obtain shareholder approval for a declaration that there are no vacant board positions in circumstances where the number of board positions filled is less than the maximum permitted by the company’s constitution.

Limiting disclosures

Currently, the remuneration details of the KMP and the five most highly remunerated officers are required to be disclosed in the remuneration report. Under the Bill, remuneration disclosures will be required for the KMP of the consolidated entity. This proposal is designed to simplify the disclosures in the remuneration report to enable shareholders to better understand the company’s remuneration arrangements.

More reforms to come

In addition to the Bill, a further discussion paper has also been released by the Federal Treasury on the clawback of executive remuneration where financial statements are materially misstated. Under the current framework, shareholders are only able to recover overpaid remuneration amounts by commencing legal proceedings. The proposal, as outlined in the discussion paper, aims to prevent directors, who are responsible for ensuring that a company’s financial statements are true and fair, from being rewarded for breaching this duty. The closing date for submissions, in response to the discussion paper, is 30 March 2011.

The reforms that have been proposed will have a significant impact on executive remuneration. Arguably, the reforms will increase the complexity of executive remuneration and therefore it is important that directors and executives are clear on their own and the company’s statutory requirements regarding executive remuneration.

To access a copy of the current Bill click here

Contact Details

Melbourne

Dan Pearce, Partner
T: +61 (0)3 9321 9840
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Sydney

Darren Pereira, Partner
T: +61 (0)2 8083 0487
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Jon Cane, Partner
T: +61 (0)2 8083 0489
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Brisbane

Philip Vickery, Partner
T: +61 (0)7 3135 0632
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