Welcome to Guerdon Associates’ first newsletter of 2006. We look forward to another very interesting year in board and executive remuneration, and we trust this year’s 11 issues will continue to delight and intrigue you with the trends, innovations, influences, anomalies and regulatory issues that will continue to change the way board and executive remuneration is governed, structured, determined, disclosed, approved, practiced and administered. With that mouthful of a sentence we at Guerdon would have no trouble producing newsletters on a daily basis, if it were not for the demands of our clients. So we trust that what we choose to present every month meets at least some of your needs.

Over the summer vacation we did not rest much! So we are bursting with lots of information and ideas for you. In this month’s newsletter we assess how Australia stands internationally in terms of remuneration disclosures, let you know of the changes to accounting standards which will impact how companies disclose remuneration details, have a knock at relative TSR performance hurdle methods, and lastly come to some interesting conclusions from our analyses of CFO remuneration levels and trends for ASX 300 companies. We conclude with the latest on executive and director remuneration disclosure updates available on the GuerdonData™ on line database.

Global Remuneration Disclosure Standards – Australia Leads The World (For Now!)

The USA more often than not has led the world in standards of disclosure. Several countries have even copied elements of the oft-criticised 2002 Sarbanes Oxley Act. Recently the SEC has announced details of changes to executive compensation disclosures

Will this result in changes down the road for Australia? Are the proposed US changes to disclosure better than what Australia has now? In assessing this, an underlying assumption is that better disclosure attracts more and cheaper global capital. With over 42% of Australian listed company shares owned by foreign institutions, this has a great impact on the cost of doing business here.

It is understandably difficult to make a clear cut judgement when comparing public company governance standards internationally. While some countries are better in one area, they are lacking in others. But with our work often straddling several countries for our larger clients, combined with our consultants’ direct experience working in several different regimes, we have had a crack at comparing the standards of international disclosure. And while this may surprise some, Australia ranks very highly.

While policy disclosure requirements in Canada, the UK and Australia are broadly similar, Canadian disclosures probably are superior in governance aspects, followed by the UK and then Australia and the US. Canadian companies disclose the independence of directors and any possible influences or conflicts of interest. UK companies disclose who was present at remuneration committee meetings other than the committee members, who were external advisers, and if external advisers provide services to management. All countries except Australia require companies to have independent directors determining executive remuneration.

We think Australia is currently the world leader in disclosure of individual levels of remuneration. So far Australia is the only country that tabulates the accounting fair value of all remuneration received by directors and executives and requires this to be subject to audit.

Will this comparative disclosure advantage hold beyond 2007 when the SEC changes become effective in the USA?

The changes in the US are almost a carbon copy of Australia’s current disclosure, but with some important differences. The US will require disclosure of 3 years’ compensation data (for Australia it is 2 years). US companies will be required to disclose the actuarial present value of changes in pension benefits. This is a major change, given that a large proportion of US companies provide “special” pension arrangements that often escape scrutiny. This includes up to decades of “service credit” for determining defined benefit pension payouts that are worth many millions. In addition, they will include the present value of deferred compensation. This very tax ineffective and relatively expensive form of compensation hides many more millions of compensation that, in theory at least, cannot escape being quantified and reported in Australia (in any case, prevalence of this form of compensation in Australia is miniscule compared to the US). Long term incentives that are not share based will be reported as they are paid out, unlike Australia’s method of reporting cash LTI accrual for the period. Lastly, and importantly, they will have to more comprehensively disclose equity value received and accrued as compensation in the summary compensation table, and in various other tables.

So in summary, Australia will still be well positioned in global terms. It will still remain ahead of the UK in totalling all compensation items in one table, and in disclosure of individual equity rewards; and it will remain ahead of Canada for similar reasons until they copy US reforms (which they will find necessary because of capital market proximity and relatedness). From 2007 we believe Australian disclosure will remain the equal of the USA except in two major areas of difference. Australian cash LTI will be reported on an accrual basis relating to the service period, while the US will report cash LTI on pay out rather confusingly alongside current period accruals for other items. So in this regard Australia will probably remain ahead of the US. In the US it is proposed to disclose separately in tabular form equity compensation that is subject to performance and equity compensation not subject to performance. This is not done in Australia, and is the area of disclosure that is most seriously lacking, given that it is the fastest growing area of compensation. Will this change in Australia, and if so when?

The short answer is that we cannot see this happening in the near term. CLERP 9 and adaptation to new IFRS accounting standards has probably sated any appetite for further reform. And it could be argued that the Section 300A directors’ remuneration report describes all aspects of performance-related equity remuneration adequately. Lastly, it could be argued that private sector analysts currently assess, break down and publish equity compensation in performance and non performance related components from existing disclosures. That last claim is a little tenuous; given there is only one firm in Australia that does this (i.e. Guerdon Associates through the GuerdonData™ service). Nevertheless, our conclusion is that in regard to capital market disclosure standards on director and executive remuneration, Australia is currently world leader and should remain near best practice after new US disclosure standards are implemented in 2007.

For more information on the proposed US standards, click on "More Info" below.

But Will Behaviour Change From Better Disclosure? Don’t Bet On It.

For access to more and cheaper capital via effective governance there needs to be more than just better disclosure.

Again there are significant variances in areas other than disclosure affecting remuneration governance across countries. It is in these other aspects, however, that Australia, the UK and now Canada are leagues ahead of the US, at least in terms of director and executive pay. The primary difference is in the balance and concentration of power. Unlike US companies, Australian and the UK companies tend to have independent (and part time!) chairmen. Canada is fast catching up. But in the US the CEO is also the chairman of the board in over 95% of companies. (Cosmetic changes are taking place, where an existing CEO changes his/her title to executive chairman, and the COO’s to CEO, and more often than not somehow translates this into a reason for more pay). Change in the US, at least in this regard, is moribund. Power is not given up easily. Unlike other Anglo countries, the US shareholder has little power over the board. There is practically no provision under US securities laws for shareholders to nominate and vote for alternative directors. The best they can do is vote against the existing board’s CEO-friendly nominated directors. And they cannot explicitly vote on remuneration matters, except in so far as to approve extremely broadly worded “omnibus” equity plans allowing director and CEO participation.

Slowly more “lead” directors (i.e. independent directors to head sessions of other independent directors on the board required under NYSE rules) may become more assertive (to the extent that they can until the full board fails to nominate them for re-election next time), but that may ruin their weekly golf game with their friend and boss. So we are not betting on too much behaviour change in the US. That will have two primary impacts for us in Australia. On the one hand Australia will seem an attractive haven for global capital with well governed boards. On the other, there will continue to be a brain drain as our best and brightest executive talent is driven to join the 900,000 expatriates truly seeking their fortune in higher paying countries like the USA.

Don’t Get Comfortable Just Yet – International Accounting Standards Now Require Australian Companies To Disclose Differently

Just when you thought it was safe to relax….

The people at the AASB provided boards and senior management, as well as the people at ASIC, with a Christmas present. To tell the truth, it is probably only a gift to audit companies and firms like ours! AASB 1046 disclosure requirements ceased to be in effect at December 31, to be replaced by AASB 124. The new standard largely replicates IAS 24 issued by the IASB. The exceptions are mainly to ensure greater individual remuneration disclosure, hence maintaining Australia’s comparative governance advantage.

Beware! While the basis of calculation under AASB 1046 is consistent with AASB 124, AASB 124 has substantially reduced requirements and guidance on calculating remuneration. Complying with the new accounting standard could be inconsistent with the intent of Corporations Law, Regulation 2M.3.03 (select the “More Info” button below to view this Regulation on the internet).

It may take management, boards and investors some time to get used to the new remuneration disclosure categories. However, because there is less prescription in how data is presented, there may be more difficulty in comparing across companies than under the old standard. So, while it will result in more work for our own programmers and analysts, we expect comparison data from our GuerdonData™ technology will be in even more demand.

ASIC In A Rush On Remuneration Disclosures Too

With December 31 financial year end reports coming out from the first companies in just 3 weeks, ASIC rushed out a class order to ensure that companies did not have to report in multiple places and different formats on director and executive disclosures.

ASIC "Class Order [CO 06/50] Transfer of remuneration information into directors' report" will apply to listed companies preparing financial reports under Chapter 2M of the Corporations Act (the Act) (select the "More Info" button below to view the press release on this Class Order).

The class order will allow listed companies to transfer remuneration information required to be disclosed in the financial report under accounting standard AASB 124 Related Party Disclosures into the directors' report. This will enable listed companies to combine the remuneration disclosures required by accounting standards with those already required to be included in the directors' report under s.300A of the Act.

Companies will be able to reduce the duplication of remuneration information between the directors' report and the financial report, and present the information in a manner that is more convenient to users of their annual reports.

But, as mentioned above, ASIC provides the caveat that complying with the lesser requirements of the new accounting standard may not be enough to comply with the intent of Section 2M.3.03 of Corporations Law.

Relative Performance Comparisons

By far the most popular long term incentive (LTI) performance hurdle is relative total shareholder return (TSR).

Since this was first introduced to Australian boards by one of our directors in 1995 it has come to dominate LTI plans. ASX 300 use of relative TSR exceeds FTSE 500 use, where these measures were first applied from 1992 after the UK commissioned Cadbury report on governance. Unfortunately we have to say that now most applications of the measure have strayed far from what we would consider to be effective performance requirements.

Most relative TSR applications today are ineffective contributors to the establishment of credible and efficient LTI designs. As a key component of the remuneration mix they fail to attract, retain or motivate. The reason is peer group selection for comparison purposes. The size of Australia’s economy means that most sectors, at best, are dominated by oligopolies. Yet peer groups are often selected with 20, 50, 100, or even 200 companies for comparison purposes. Senior management have next to no influence over relative TSR outcomes against a group representing such diversity of industries, markets, and expertise, and subject to widely varying profit cycles. With no line of sight over outcomes the LTI is akin to a lottery ticket. Hence, about 20% of senior management pay expense is wasted.

We urge boards to review LTI performance measures. Much more can be done.

CFO Remuneration – Or How Life Is Too Short!

Recently we looked at how CFO remuneration may impact their time perspective on the job for CFO Magazine. The February edition contains our analysis of CFO pay from 2004 and 2005 for CFOs in ASX 300 companies.

Twenty-four percent of CFO remuneration was paid in the form of short-term incentives (STIs). This compares with 17% in long-term incentives (LTIs). Hence, the average CFO stands to earn significantly more in STIs than in LTIs.

The short term emphasis of the remuneration mix is further exacerbated by the fact that the average CFO’s tenure is 4.7 years (albeit that this was based on 2 years’ data). Over the average tenure, a CFO hitting target performance levels will receive an actual payout of 3 STIs and only 1 LTI (assuming 3 year vesting). So company career STI is worth over 4 times the LTI. And it does not take a CFO to work out that these numbers place a premium on getting short term results.

While shareholders may benefit in the short-term, their long-term interests may be less well served if the reward program does not encourage investment in future growth.

This conundrum for the board remuneration committee is resolvable. But space limitations mean that these methods need to wait until future issues.

Latest GuerdonData™ Updates

Over the summer, updates to GuerdonData™ include disclosures from the following 24 companies:

Australia and New Zealand Banking Group Limited, Australian Wealth Management Limited, AVJennings Homes Limited, AWB Limited, Bank of Queensland Limited, Centralian Minerals Limited, Colorado Group Limited, CSR Limited, Lion Nathan Limited, Lion Selection Group Limited, Macquarie Bank Limited, National Australia Bank Limited, Nufarm Limited, Patrick Corporation Limited, Peptech Limited, Rinker Group Limited, Sigma Company Limited, St George Bank Limited, Symbion Health Limited, Tattersall’s Limited, Ten Network Holdings Limited, Timbercorp Limited, Tower Limited, Westpac Banking Corporation.

Executive and director remuneration data from all ASX 300 companies on GuerdonData™ is available to any subscriber. More information on GuerdonData™, including a link to our 6 minute demo, can be found by clicking on the "More Information" button below.

Guerdon Associates in the News

Fry, E 2006, “Fast In, Fast Out”, CFO Magazine, February, p 23 – 29.

Disclaimer

The information, analysis and opinion in this e-mail and attachments are intended to be for informational purposes only. Analyses are based on information taken from public documents or private surveys, and we do not represent to its accuracy. Guerdon Associates assumes no liability for the use or interpretation of information contained herein. This publication is provided "as is" without warranty of any kind, either expressed or implied, including, but not limited to, the implied warranties of marketability, fitness for a particular purpose, or non-infringement of third party rights.