Constructive executive pay feedback given to the Australian Productivity Commission

Investors and directors provided Productivity Commission Chairman Gary Banks with direct feedback at a recent forum, and today Guerdon Associates formally submitted its feedback on the Commission’s draft executive pay report.

Guerdon Associates sponsored a briefing session for directors, institutional investors, and management on the draft executive pay Productivity Commission report in association with the proxy firm CGI Glass Lewis.  The meeting, held on Monday 19 October 2009, was at the offices of Allens Arthur Robinson in Sydney, with a video link to Melbourne.  The Chairman of the Productivity Commission, Mr Gary Banks, commented on the Commission’s approach and its draft recommendations, which were then considered in a panel and audience discussion.

Feedback was provided under the Chatham House Rule (see HERE), facilitating frank and open debate.

Some of the comments that Mr. Banks (on behalf of the Commission) has undertaken to consider further before the final report is produced are noted below.

1.  It was generally acknowledged that the Commission had done an excellent job in their analysis of the trends and issues.  There was also satisfaction expressed with many of the recommendations.

2.  While there was broad acknowledgement that Australia’s board composition fails to reflect the general population demographic, particularly in relation to gender diversity, doubts were expressed that removal of the “no vacancy rule” would be sufficient to address the issue or even to impact it at all.  The suggestion was made that more attention needs to be given to the role of the nomination committee.  Specifically, a review of its charter and a clear statement of the factors considered in the selection process for directors would bring focus to this issue.  Action might even be extended to requiring the board to report on the committee’s adherence to this revised charter.

3. Several comments were made in relation to Draft Recommendation 2 (on reducing conflicts of interest) that a new ASX listing rule should specify that all ASX 300 companies should have a remuneration committee with at least 3 members, all non-executive directors and with the chair and a majority of members being independent.

The concept of independence may be problematic.  There was support for the idea that a long period of service on a company board does not undermine the independence of non-executive directors.  Rather, the detailed knowledge built up over a lengthy period on a board contributes to the independence of directors by helping them to ask the right questions of management.   It was also suggested that directors who own more than 5% of a company’s shares are very independent.

4.  The proposal in Draft Recommendation 4 that directors be prohibited from voting their shares on the remuneration report and any other remuneration-related resolutions was queried. Although it was accepted that this is appropriate for NEDs and Executive Directors with a direct conflict of interest on a resolution, it was pointed out that this is already covered by the Corporations Act.

5.  For a number of people, remuneration is seen as a window on the relationship between a company’s board and management – an indicator of what is going on within the company generally.  For others, however, remuneration is a relatively minor issue – much less important than the more fundamental and material business matters that come before the board.

6.  It was noted that, to promote better governance, a number of companies are now seeking shareholder approval for all equity grants to executive directors, although Listing Rule 10.14 strictly only requires approval for grants involving new issue shares.   A counter view was expressed that Listing Rule 10.14 should be focused solely on dilution. 

7. A clarification of insider trading rules may encourage more share based remuneration.

8. Draft Recommendation 6 proposes that executives and directors should be prohibited from voting undirected proxies on remuneration matters.  This was criticised as having the potential to disenfranchise shareholders, because shareholders who are happy with a company’s direction and performance and a director’s stewardship often wish to entrust their nominated director to vote their undirected proxies.

9. In relation to draft recommendations 8-12 on improving disclosure, it was suggested that reporting ‘fair value’ rather than accounting value would reduce confusion by giving a more understandable view on the value and practice of equity grants. The wording of the Commission’s recommendation suggested the reporting of “fair value be continued” for specified key management personnel, whereas, in fact, it is not currently reported.  It was noted that after much reflection, both Canada and the US have indicated that this will be required in their future compensation disclosures.

10. There was strong support for the Commission’s Draft Recommendation 13 to remove cessation of employment as an automatic taxing point under employee share plans, so that equity can be taxed when performance conditions are met after termination.  As one participant put it, this would encourage CEOs to hire successors who are better than they are!  In addition, the use of equity to manage risk would be assisted if tax deferral was allowed where equity is vested from grant but subject to a holding requirement (as often occurs where STI rewards are provided in the form of deferred shares) instead of the government’s proposal to require a ‘real risk of forfeiture’ as a pre-condition for tax deferral.

11. Draft Recommendation 15, that two successive substantial ‘no’ votes on the remuneration report would trigger a spill of the board, was criticised as excessive, certainly if anything less than an absolute negative vote(s) could result in a spill (it was noted that more fundamental business issues like selling significant company assets or changing the principal business activity only require majority votes).  Particular care is needed on this proposal if significantly different groups of shareholders would be voting on 1. the remuneration report and 2. the re-election of directors after the spill.  This could occur if all directors and KMP are prohibited from voting on remuneration matters.

Another perspective on this was provided by some session participants who pointed out that current law allows as few as 5% of shareholders to call a general meeting.  This fact somewhat weakens the argument that the draft recommendation presents an opportunity for a small group of disaffected shareholders to use the remuneration report to de-stabilise the board in their pursuit of an unrelated agenda.

In addition to the feedback provided at this briefing, Guerdon Associates forwarded its formal submission on the Productivity Commission’s draft report on executive pay today (see HERE).

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