Productivity Commission recommendation number 8 was that:

 

·          Remuneration reports should include

 

–        A plain English summary statement of companies’ remuneration policies;

–        Actual levels of remuneration received by, and the total company shareholdings of, the individuals named in the report

 

·          The Australian government should establish an expert panel under the auspices of ASIC to advise it on how best to revise the architecture of section 300A of the Corporations Act 2001 and the relevant regulations to support the changes

 

In its response, the government supported the recommendations but indicated that it will use the Corporations and Markets Advisory Committee (CAMAC) as its expert panel.  In addition, the government announced that it would also ask CAMAC to make recommendations on how the incentive components of executive pay arrangements could be simplified in order to improve transparency and strengthen the correlation between the interests of a company’s executives and the interests of shareholders.

 

The Minister for Financial Services, Superannuation and Corporate Law, the Hon Chris Bowen, has now requested CAMAC to:

 

1.     Examine the existing reporting requirements contained in section 300A of the Corporations Act and related regulations and identify areas where the legislation could be revised in order to reduce its complexity and more effectively meet the needs of shareholders and companies;

 

2.     Examine where the existing remuneration setting framework could be revised in order to provide advice on simplifying the incentive components of executive remuneration arrangements; and

 

3.     Make recommendations on how best to revise the legislative architecture to reduce the complexity of remuneration reports and simplify the incentive components of executive remuneration arrangements

 

The wording of the 2^nd and 3^rd points is interesting.  We are not quite sure what to make of CAMAC’s task to “simplify incentive components”.  Simplification of incentive arrangements while overcoming the principal-agent problem has eluded the world’s best minds since the modern corporation evolved from the limited partnership model over 300 years ago. The modern corporation has, because of technology, become larger and more efficient.  With size comes complexity.  As running ever bigger corporations becomes more complex, despite the technology, so do the solutions to resolve the principal-agent problem.  This was not an issue within corporations and their boards – complexity came with the territory.  That is, dealing with executive remuneration has always been an issue for the board.  Its increasing complexity was correlated with the increase in corporation complexity.  And, as with these other complexities, directors have taken these matters on board. 

 

But the non-binding vote on remuneration reports, with binding votes on equity grants to directors, has resulted in investor confusion and frustration.  While they do not have to deal with the complexities of other operational matters faced by boards, institutional investors have a fiduciary duty to deal with all matters requiring a vote.

 

Remuneration matters were an operational issue shareholders had delegated to their boards, as they did with all operational issues, because they were complex and required knowledge, wisdom, time and attention.  Now, remuneration has reverted to the owners, whether they like it or not (and many do not!).  But institutional memory for dealing with these matters does not exist in superannuation funds and fund managers, because they were delegated to the board before institutional investors existed.  All that investors at both retail and institutional level see is complexity. 

 

And they are right.  It is complex.  And investors do not have the competence to deal with it.  Does this matter?  After all, less than 15% of retail investors, on average, bother to vote.

 

Our view is that it does matter.  Institutional investors have a fiduciary duty to vote.  So it follows that they must have the competence to exercise this vote

 

Part of the reason is that complexity has compounded, to an extent unnecessarily, by a significant expansion in the principal-agent problem.  It is not just remuneration report complexity.  It is about who exercises votes and why. 

 

Now we have something like the principal-agent-agent-agent-agent problem.  That is, the superannuant (the modern day principal) relies on the super fund agent to employ a fund of funds manager (another agent), to invest money in fund managers (yet another agent), which in turn invests it in companies (the original agent first formed 300 years ago).  While boards can and do cope with the modern corporation’s complexity, today’s bleating about remuneration reports comes from the fiduciaries on whom the task of voting has been foisted.  Their mandates are confused, their interests at times conflicted, their voting guidelines inconsistent (or non-existent in some cases), and their application and use of technology inefficient and fragmented by law and lack of economic scale.  This is not unique to Australia (for example see the European Commission’s review of governance and the role of institutional investors HERE), but in many ways Australia’s framework lends itself to better coordination and simplification.

 

To their credit, the Productivity Commission did venture to an extent into this territory.  But their terms of reference were not enough.  Now, as it was with the PC, it seems the government’s framing of CAMAC’s terms of reference are also not only inadequate, but miss the point.

 

While much of the complexity of the remuneration report cannot be substantively simplified, we had a shot in one of our submissions to the Productivity Commission (with Allens Arthur Robinson, and CGI Glass Lewis, see HERE).   But remuneration reports could be regarded as a piece of cake if investors were able to exercise economies of scale and employ expertise and technology to assess and vote on them.

 

While we truly wish CAMAC luck, we are not hopeful.  Instead, we are trusting that some elements of the forthcoming Cooper Report on superannuation (see HERE) will address some of the principal-agent-agent-agent-agent problem.  But even then, we expect that there will be major holes to fill.  That is, instead of populist executive pay “fixing”, it may be more appropriate to consider more fundamental and economically more efficient amendments to resolve the principal-agent problem closer to its source.

 

 The Minister has asked CAMAC to report by 30 November 2010, and to consult with stakeholders who provided submissions to the Productivity Commission on this issue, including the AICD, the major accounting firms and remuneration advisers, as well as with the Treasury, which is responsible for the legislation.  We have canvassed non executive directors on this issue in the past few days.  All expressed interest in the review, as well as expressing firm opinions on how remuneration should be communicated to shareholders.  Given this, we urge directors to consider making submissions to CAMAC.  Do not leave it up to accounting firms, lawyers, and (dare we say it?) remuneration consultants to take the running on this.

 

A copy of the Minister’s reference to CAMAC is available HERE 

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