Boards need to plan for the implications of the Australian Productivity Commission‘s executive pay inquiry recommendations, if they have not done so already.
This article considers the factors the board remuneration committee should consider when setting an “independence” standard for their adviser.
Almost all submissions to the Australian Productivity Commission have supported, to varying degrees, the draft recommendation that board remuneration committees utilise “independent” consultants, and disclose details about the advisers used.
Many submissions (including ours – see HERE) argue that the requirement for larger companies to use independent external advice should be in the ASX governance principles, and not be prescribed in the ASX listing rules. This would also remove the need for the additional Commission recommendation to have disclosure prescribed in the Corporations Act, already burdened with black letter law implications from other recommendations.
A minority of submissions (primarily from consultants) were at odds with the Commission’s recommendations. One even implied that the independence requirement should apply to everyone, except those that possessed a particular expertise (is it just us, or do lawyers think about these things differently?).
A year of hot rhetoric from various government ministers on executive pay and executive pay advisers, the Commission’s final recommendations to be delivered in December, and a forthcoming election will guarantee that these recommendations will be seized upon for action early in the new year.
In anticipation, Guerdon Associates has prepared a checklist for board remuneration committees to set an adviser independence standard. This requires consideration of the underlying principles, which were not widely canvassed in the responses to the Productivity Commission. To an extent, we have assumed that boards will retain some leeway to determine an independence standard through an ASX Governance Council principle, rather than comply with a black letter independence standard.
“Independence” is fundamentally about avoiding conflicts of interest. For remuneration consultants, the most obvious perceived (and actual) conflicts arise when the one firm is advising both management and the board on executive remuneration, when the CEO engages a consultant to advise the board on the CEO’s pay, or when the consultant firm has substantial business with the client company in outsourcing, legal services, audit or other advisory areas while also advising on the remuneration of the CEO and other senior executives who also influence the adviser’s business relationships.
A consultant is also sometimes said to be ‘conflicted’ in the sense that it is in their interests to provide the advice the client wants to hear because the consultant wishes to be paid for their advice and to have an on-going relationship with the board. Such ‘conflicts’ would be greatest when the client represents a significant portion of the consultant’s total client base. In practice, of course, an enduring consulting relationship requires the board to be confident their consultant is providing well-informed, independent advice with the interests of the company in mind at all times.
Our checklist represents cascading levels of board remuneration consulting independence. We suggest remuneration committees consider these, with a view to adopting the level of independence best suited to their needs and incorporation into their policy.
1. No independence requirement
Having a policy that does not require independence will not necessarily contravene Productivity Commission recommendations as currently written, given that they only require that boards independently commission external advice. The adviser could still be an adviser to management and hence be conflicted. Interestingly, there is no requirement in the recommendations that there be disclosure that the adviser is, or is not, also an adviser to management.
2. Independence of remuneration advice through ultimate authority of the remuneration committee
This policy would require that the remuneration committee be the ultimate authority on remuneration matters considered by the consultant and that the committee determines to whom the consultant reports on these matters. This would allow the consultant to work for management if authorised to do so by the remuneration committee. The committee may also require that the remuneration committee chair be copied in on all material matters (conclusions and recommendations) made by the consultant in their work for management.
The board needs to be aware of the full circumstances of the consultant’s total relationship with their company so that it can assess the nature and extent of any possible conflict. There is an argument that the additional knowledge and understanding of the circumstances of the company and its remuneration practices the consultant will obtain in such circumstances enhances the value of their advice for the board. Further, it can be argued that the remuneration arrangements for the CEO and direct reports and other executives need to be consistent, and this is more easily achieved if the same consultant is advising in relation to both areas.
3. Independence of remuneration advice through exclusivity of client
This policy would require that the remuneration adviser be employed exclusively by the board, and not be an adviser to management. This does not preclude the adviser liaising with management to seek information, comment, or opinion.
4. Independence of remuneration advice through exclusivity of client and consultant services
This level of independence is a refinement of level 3. It additionally requires that the firm selected does not also provide non-remuneration services that could, at some time in the future, be employed by management. This level of independence removes the potential for conflicts of interest.
This level of independence is the ultimate level that a board remuneration committee can apply.
5. Independence of remuneration advice through exclusivity of client and fearlessness of advice
This is a refinement of the independence requirements of levels 3 and 4, and requires that the firm employed not be too dependent on the fees from any one client relative to other clients. That is, a more diversified fee base may allow the consultant to more easily take issue with directors’ opinions if, in his/her judgement, they are not in the best long-term interests of shareholders. This last level of independence will, to an extent, depend on the personality of individual consultants, as even consultants with a diversified fee base could also be “yes” men or women.
6. Other considerations
Assessing the level of independence best suited for a board requires that consideration is given to the impact such a selection could have on the full range of advisers to the board on remuneration matters. That is, while there may be a primary adviser, the committee may also make use of specialist legal, tax, accounting or other advisers from time to time. Given this, the committee may want to consider two levels of independence requirement – one for the primary adviser, and another for all other specialist advisers.© Guerdon Associates 2022 Back to all articles