On Monday 23 March 2009 Senator Nick Sherry, Minister for Superannuation and Corporate Law, in an article published in the Australian Financial Review (AFR), indicated that the new regulation capping termination payments that can be provided without shareholder approval, when drafted, would be in complete accord with the APRA regulation that may encourage banks to defer bonuses over time.

Specifically, Senator Sherry wrote that the definition of termination payments will exclude any long term incentive plans, with the exception of those that had accelerated vesting, which would be “banned” under the legislation. In regard to the last point, we expect that LTI plans with accelerated vesting on termination would be subject to shareholder approval.

Overall, however, we think the approach, as clarified by Senator Sherry, is a significant improvement on the initial press release, media interviews, and ministerial presentations.

Assuming the final regulation is as clarified by Senator Sherry:

• It is likely that the Corporations Act section 200F (see HERE for our article published last year on this matter, and HERE for the Act) will have a tighter definition of “remuneration”
• The revised definition meets various governance guidelines (e.g. see the AICD guidelines that cover both termination provisions being limited to 12 months and holding of LTIs beyond termination HERE and HERE)
• The termination provisions are more reasonable than the “7 times” regulation that is part of 200F, yet allows shareholders to approve variations above 100% of base salary if there is a good rationale

Are some aspects still of concern?

• The primary concern is the extent to which regulation deals with remuneration in a piecemeal fashion. A danger with “black letter” legal requirements such as this is that there may be unintended consequences e.g. base salaries may increase more than they otherwise would;
• Performance pay as a proportion of fixed pay may reduce. The Australian Shareholders Association is the latest in a long list of commentators from all sides to have made this point (see HERE).
• It is also difficult to reconcile the extension of the vote from just directors’ termination pay to all executives named in the remuneration report. While shareholders have always, to an extent, had some say over benefits for directors, they traditionally do not intrude into operational matters associated with the actual running of the company. Shareholders delegate these aspects to the board of directors. Giving a binding vote on termination payments to non-director executives seems to go beyond this oversight function into operational management matters. With the extensive disclosure in remuneration reports, shareholders now have much better insight into how the elected directors exercise their management control. Ultimately, if they do not like what they see, they have the power to vote off directors and vote in new ones. A provision, by the way, that is denied to their less well-governed cousins in the US.
• There still remain issues of international competitiveness. While the government’s requirements seem, on the face of it, fair enough, termination payments for North American executives are typically about 3 times base salary plus bonus, while the Europeans, in their new governance guidelines released just two weeks ago (see HERE) are quite happy to settle for two times. Only the UK has a 12 month contractual period requirement that in effect is similar to that proposed in the announced Australian regulation. However, the UK practice is voluntary (on a ‘comply or explain’ basis) under their Combined Code, and no shareholder approval is required for variation.
• Lastly, there has been no mention of allowing the tax on unvested equity based performance incentives that is currently payable on termination to be deferred to align it with regulation that otherwise encourages long term incentives to be held post termination. We have raised this many times before, and recently made a submission to the Henry tax review to have it fixed (see HERE)

Our view is that:

• Excess termination pay above the limit should remain subject to shareholder approval, but it be confined to directors only (i.e. as it is now)
• We agree with the government that the definition of termination pay be tightened up in the Act in accord with the government’s clarification and announcements to date, including the important provision that it exclude unvested performance pay
• Penalties for director non-compliance be restricted, if anything, to fines, given that reputational risk impacts are likely to be a far greater influence on listed company director behaviour
• “Excessive” be defined as less than the current provision (7 times) but more than the government requirement (12 months). Three times seems reasonable, given that this is not uncommon practice in off shore labour pools for CEOs
• But the 12 months termination standard should be a governance principle (as, in effect, the UK), and feature in “if not why not” standards of the ASX Governance Council principles
• There should be no tax on unvested equity pay at termination. Rather, where equity grants vest after termination, tax should be applied when/if the reward vests.

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