Although Corporations Act S300A requires disclosure of performance requirements for incentive payments, it provides no guidance on the form of the disclosure, other than stipulating that the information disclosed must include, among other things:
i) A detailed summary of the performance condition
ii) An explanation of why the performance condition was chosen
iii) A summary of the methods used in assessing whether the performance condition is satisfied and an explanation of why those methods were chosen.
Many companies currently sidestep the requirement by pleading commercial privilege, arguing that the information is competitively sensitive. As a result, many remuneration report disclosures lack the detail to determine if the performance condition and resultant performance pay seems reasonable. Performance requirements for short term incentives, in particular, are lacking. Yet bonuses often comprise a third or more of pay. Given that remuneration reports generally look backward, rather than revealing plans or objectives for future bonus payments, some governance reviewers are questioning whether the argument of commercial privilege is applicable.
US companies had initially tended to adopt the same stance, but the Securities and Exchange Commission (SEC – the US corporate watchdog) responded by issuing “please explain” letters to over 350 of the largest companies, sending a clear message that it will hold companies to a high standard of disclosure of material targets.
After some pushback by boards on determining whether they have to report these performance requirements, the SEC outlined the criteria it considers relevant to the disclosure of performance targets. In the absence of any such guidelines from ASIC, we suggest that Australian boards may well use a modified version of these to help determine the performance details that need to be disclosed under Corporations Act 300A. The modified guidelines are as follows:
• If a target is immaterial to executive compensation policies, it is not subject to disclosure.
• Companies cannot rely on the “competitive harm” defence if the target was disclosed previously.
• If a disclosed target is a non-AASB measure, the company must also disclose how that number is calculated from the audited financial statements.
• A material target is exempt from disclosure if it would result in competitive harm, but the company must then explain the difficulty of achieving the target. (While ASIC’s enforcement of remuneration disclosure compliance has never been evidenced we suggest that Australian directors be prepared to explain why it would result in competitive harm.)
• Boilerplate language such as “targets are stretch goals” is insufficient.
• Current or prior year information (including performance targets) should be discussed if it adds to an understanding of compensation in the last financial year.
Although this conceptual framework provides some guidance, many companies will still find the requirements and expectations far from clear-cut. The following more detailed checklist and commentary might help Australian companies to determine how they should respond to the relevant requirements:
1. Is the performance data material to the remuneration decision-making process?
The disclosure rules do not offer much guidance on what is and what is not material. Understanding incentive plan payouts assumes an understanding of the performance hurdles required to earn those payouts. The more formal the performance plan, the more likely that its measures and targets will be considered material and therefore subject to disclosure. The simple test is whether the data is essential to an understanding by the investor of the basis for an award.
Awards that are purely discretionary may not have criteria that need to be disclosed (although the company will still have to disclose how remuneration decisions were made). On the other hand, a company that uses an array of measures might not need to disclose all of them if some elements do not have a major impact on the generation of an award.
2. Have the measures or targets been disclosed previously?
In the US, the SEC has indicated that if a company has previously disclosed a performance measure, it cannot cite the ‘competitive harm’ exception. A similar stance may well be adopted in Australia. If there has been a modification of the measure since the time of previous disclosure, it might be argued that it was not previously disclosed. However, in those circumstances, the company will need to be prepared to explain how the performance measure differs from the one previously disclosed.
3. Measures that are not based on Australian Accounting Standards Board (AASB) measures.
If non-AASB measures are used in determining remuneration, the company must disclose how the number was calculated from the company’s audited statements.Typical AASB measures are earnings per share and net income, while non-AASB measures include EBITDA, EBIT, and derivatives of cash flow, operating income, margin and net income (where the adjustments are not AASB compliant). The implication here is that measures that are uncommon or not generally understood or defined might need to be explained.
4. A legitimate confidentiality argument.
If a company successfully argues that its measures and targets are commercially sensitive, it may need to explain the degree of difficulty associated with achieving an award under the undisclosed measure. In the US, the SEC dismissed a number of half-hearted attempts by companies to address this aspect, including such statements, as “the targets were stretch goals”. The expectation is that explanations will provide some constructive guidance on the degree of difficulty and likelihood of payments, perhaps by reference to historical levels of achievement against historical targets.
5. Assessing whether the disclosure would cause competitive harm.
The US experience has shown that most companies have so far failed to adequately explain their reasons for claiming competitive harm and have also failed to provide useful guidance on the difficulty of achieving the targets as an alternative disclosure. The SEC has made it clear that this is unacceptable and we consider it likely that a similar view will be taken in Australia.
A board seeking to rely on this defence should be prepared to provide a written explanation supporting its decision, recognising that the argument might be more difficult to support in relation to a year for which performance is already known. Issues to consider in assessing the potential for competitive harm include whether the disclosure may change the behaviour of others, how competitors might change their business strategy, and how customers, suppliers or other third parties might change pricing or negotiating strategies.© Guerdon Associates 2022 Back to all articles