The Productivity Commission released its draft report on its review into the regulation of director and executive remuneration in Australia on 30 September 2009.

The Commission concluded that while there has been rapid growth in executive pay since the 1990s, the evidence does not indicate widespread failure in remuneration setting across Australia’s 2000 listed companies, nor significant adverse impacts on the performance of the corporate sector as a whole.  Nevertheless, there is some evidence of executive labour market inefficiency. The Commission’s suggested response is to strengthen corporate governance to improve how boards set remuneration and engage with shareholders, rather than impose prescriptive pay constraints (such as caps or mandated structures), as they would be impractical, weaken the role of boards and could have perverse economic consequences, without necessarily achieving any real pay restraint.

Recommendations were made in five areas:

• Board capability — as directors need a mix of skills and experience, there
  should not be impediments to board diversity and renewal.

• Conflicts of interest — conflicts are inimical to efficient outcomes and can be
  addressed by inducing more transparency or, in some cases, through prohibition.

• Remuneration principles — well-designed pay structures facilitate alignment of interests, whereas poorly designed schemes can deliver the opposite.

• Disclosure — shareholders need to be able to understand how remuneration
  practices align with their interests.

• Shareholder engagement — effective engagement requires sound signalling
  mechanisms, voting opportunities and processes and audit trails.

The report incorporates a summary of the 15 specific recommendations, which are grouped into the five areas above. 

There are no major surprises, and generally the report assists with evolution of Australian governance practices, which are recognised in the report to be world-leading.

Perhaps the headline recommendation is the “two strikes and a spill” approach to give more teeth to shareholders when they vote on the Remuneration Report.  If a Remuneration Report receives a (non-binding) negative vote of more than 25% (strike one) then the next report must directly address how the Board has responded to shareholder concerns.  If the next report also fails to get strong support, then an election for the whole board would be required.

The report proposes that a 25% negative vote should be the catalyst for this “second strike”, but seeks views in consultation.  One issue in this regard is whether the second requirement should be a negative vote of around 50%, because unless there is a majority for change it could be pointless and frustrating to proceed to a vote on board members.  The argument is that the initial 25% negative vote is a signal and a trigger for review action, but the second vote needs to meet a higher test, because it relates to real change. 

The Commission’s report includes a recommendation to allow equity to be taxable on vesting after employment termination (not at the date of termination); this is positive, and of course interesting because it attempts to reverse a government policy embedded in the current draft bill on share plan taxation.

The other recommendations cover a fair bit of ground, addressing details of disclosure and other board practices, the independence of consultants, and some recommendations on governance issues which are wider than remuneration: ending the “no vacancy” rule, allowing electronic voting, and requiring voting of directed proxy votes. 

A message for directors from the report might be that: 

• the role of directors as the group responsible for setting remuneration has been supported

• boards should develop unique solutions in executive remuneration, but ensure they communicate clearly to shareholders on the design rationale, such as why they have selected particular performance measures and comparator groups

• shareholder communication and engagement must continue to improve

• the role of shareholders in governance has been facilitated in subtle ways, which reinforces the ability of shareholders to act collectively in electing directors to the board. 

The Commission will be seeking feedback on these findings and recommendations during October and early November, before finalising their report and submitting it to the government in December.

The full draft report and sections including the summary of recommendations can be found HERE.

Guerdon Associates, with proxy firm CGI Glass Lewis, is sponsoring a special session with Commissioner Gary Banks on the morning of 19 October in the Sydney offices of Allens Arthur Robinson (with a direct video link to their Melbourne offices for attendees in that city).  The session will allow institutional investors, directors and management to listen first hand to the Commission’s rationale, ask questions and comment on the Commission’s findings and recommendations.

If you have not received your invitation, or wish to attend, please contact us.

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