Australian Institute of Company Directors releases guidelines on executive pay

The Australian Institute of Company Directors (AICD) released its executive remuneration guidelines on February 12 (see HERE).  They outline the AICD’s views on good practice for establishing appropriate executive remuneration frameworks and processes, setting remuneration policies and terms and reviewing arrangements.

While most of the guidelines are consistent with current market practice, there are several particularly worthy suggestions that, in our experience, are not considered often enough by directors. These include:

  • “Stress testing” of proposed incentive arrangements prior to accepting them or agreeing to variations to understand the impact of changes in economic or market circumstances.
  • Ensuring the issue of reasonable termination payments, particularly for non-performance, is addressed when drafting executive contracts so they are later properly managed in time-pressured circumstances.
  • Engaging with shareholders and other relevant stakeholders on their company’s approach to remuneration and where a material change in remuneration arrangements is to be made.
  • Whether there should be an upper bound on short- and long-term incentive rewards.
  • Using multiple measures to assess and pay for performance
  • Having in place remuneration processes that incorporate independent opinion, expertise and transparency, and seeking the advice of independent experts
  • Avoiding incentive arrangements that encourage short-termism and excessive risk taking
  • Establishing arrangements whereby a percentage of a CEO’s long term equity is held for a period that extends beyond the term of the employment contract

This last element is known in the US as “hold through retirement”, and is a significant change in emphasis in regimes where the credit crisis has struck hardest. It has been an area of interest to Guerdon Associates for some years now, and fits neatly with our arguments that boards need to incorporate risk as well as returns in their company’s management of remuneration.

The AICD, in suggesting that boards consider the holding of equity rewards beyond the termination of the executive’s employment contract, raises the issue of an executive’s “horizon problem”. That is, the decisions executives make as they approach retirement are more likely to suffer from short-term considerations. This is a particular issue for companies with significant capital expenditures and assets where the executive makes decisions that have a considerable impact on results years after he/she has left.

But there is a problem. Division 13A of the Income Tax Assessment Act 1936 requires that all vested and unvested equity be taxed at termination of employment. This discourages holding through retirement, and puts pressure on sympathetic boards to agree that, on termination, equity vests (fully or pro rata with service) so the executive can finance the tax liability, or lapses to remove the liability. While understandable, neither alternative serves shareholders particularly well. We address “hold through retirement” methods in another article below (see HERE).

That shareholders are not given additional insurance against “short termism” is an unintended consequence of government regulation. This is something to bear in mind as the government moves toward revealing more of its regulatory intent on 16 March (see HERE). It is also something we have noted before (for example, see HERE). Guerdon Associates is submitting a proposal to the Henry review on taxation to resolve this issue (to be featured in an article next month).

We are glad that the AICD views are similar to ours in this respect.

The Guidelines are available for directors to purchase from AICD’s website HERE

© Guerdon Associates 2024
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