On Wednesday 18 March 2009 Treasurer, Wayne Swan, and Minister for Superannuation and Corporate Law, Senator Nick Sherry, announced limitations on termination payments paid to company executives.

Under the Corporations Act, current laws allow termination payments to reach up to seven times a director’s total annual remuneration averaged over the past three years before shareholder approval is required (see our prior article HERE).

The government has responded to criticism of excessive golden handshakes in companies where directors and executives have received large termination payments where the company has performed poorly. The Government’s reforms will allow shareholders to reject such payments where they believe they are not in the interests of the company, the shareholders or the community.

The Rudd Government will amend the Corporations Act to significantly lower the threshold at which termination payments must be approved by shareholders from the current level down to one year’s average base salary.

The Government will also legislate to extend the range of executives whose termination payments can be subject to shareholder approval. Currently only directors’ termination payments must be approved, however the Government will legislate to expand the coverage of shareholder approval to cover all those executives named in the company’s remuneration report.

Finally the Government will also broaden the definition of “termination benefit” to catch all types of payment and rewards given at termination. This will presumably include long term incentives and bonuses. And what of benefits such as long service leave and annual leave accrued over sometimes decades of service?

This regulation will be at odds with new regulation being formulated by APRA, which will almost certainly encourage banks to defer a significant portion of bonuses to be paid later for sustainable performance, and for long term incentive payouts to be aligned with the business cycle and when returns are generated. Hence, at termination, it is likely that executives may have several years of bonuses and LTIs due to vest that well exceed the annual salary. While these may not be payable immediately on termination, they may be classified termination payments under the proposed government regulation.

Guerdon Associates has advocated consideration of “hold through retirement” provisions in executive incentive plans to encourage actions and behaviours in the better long term interests of shareholders (see HERE). This regulation will not encourage such provisions.

In terms of international competitiveness, most OECD countries practice maximum termination payments of 12 months for executive directors (except for the US which tends to provide 2.99 times annual pay), so Australia’s international competitiveness may not suffer too much. However, this will depend on the extent that deferred incentive payments and accrued benefits are captured within the definition of annual “salary”.

Fortunately, the government recognises that changes to the law cannot apply retrospectively. Today’s announcement will not prevent existing contracts on termination payments from proceeding.

The Government has also today referred the broader issue of executive remuneration to the Productivity Commission, which will provide a final report within nine months. The government announcement can be found HERE. 

We will keep you informed.

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