For some time there has been speculation that investors dissatisfied with a company’s remuneration report will pull their punches and not exercise a vote that may result in a second strike, in order to prevent a possible board spill. Directors hoping for this outcome will be disappointed; it is not going to happen.
This AGM season is the first during which some companies will be exposed to a second strike. Since 1 July 2011, ASX listed companies have been subject to a regime under which:
· A vote at one AGM against the remuneration report of 25% or more is a “first strike”.
· A vote of 25% or more against the remuneration report at the next AGM is a “second strike”. If a company suffers a second strike, shareholders must vote, at the same AGM, on whether a meeting should be held at which all non-executive directors would be required to seek re-election. A simple majority of eligible votes is required for such a “spill” resolution to be carried.
· Institutional investors (along with other eligible shareholders who cast their votes via proxies) will therefore be required to decide whether they would support a spill resolution before knowing whether a second strike will occur.
· Key management personnel (KMP) are the personnel whose remuneration is disclosed in the remuneration report. KMP and their “closely related” parties cannot vote on the remuneration report or the “spill” resolution (but all shareholders can vote on the re-election of directors).
In the lead up to this AGM season significant pressure has been building up for institutional investors to be “kinder” to companies in voting “no” if this could result in a second strike. The argument is that a “no” vote will create instability, as all non-executive directors may be open to re-election, and that given this outcome, some may not volunteer service for the board again. The instability would result in loss of share value. Investor returns will plummet. Fund managers will miss their index return performance targets and fees, and not receive their own incentive payments. The world will go to hell.
Unfortunately for the directors concerned, the institutional investors are paying no heed. They know that a majority of votes is required for a board spill. They also know that an investor voting against the remuneration report will be unlikely to also vote for a spill. Significant shareholders, those with 5% of shares or more, have had the opportunity before the 2 strikes law to call for a meeting to toss out directors on a remuneration matter, but they never have. In the usual course of director re-elections, ASX 300 shareholders have overwhelmingly endorsed company nominated directors, even if the company had received significant no votes for the remuneration report.
So, the huge majority of institutional investors are likely to vote on the remuneration report in a “business as usual” fashion, and not support the spill resolution. Several have already confirmed that this will be their intent (see, for example, ACSI’s perspective HERE).
This is not to say that no games will be played at the periphery, but these will tend to cancel out. On the one hand, some investors will insist on governance changes to ensure their support. This will require companies to indicate changes to remuneration policy. In cases where company performance has been very poor, an investor may be successful in obtaining concessions on board renewal as well. On the other hand, there may be some investors who support the remuneration report as an indication of confidence in the board, despite no major concessions being made on remuneration. We do not think this is likely. What is more likely is that a company’s engagement and disclosure has been more effective at explaining the remuneration policy, with no concessions on remuneration policy being made, and that this is enough to convince investors to support the remuneration report.
So, given that investors are not likely to pull any punches in voting on the remuneration report but will do so for the spill resolution, what does this mean for directors?
Some directors may gain confidence to continue with remuneration practices that raise the ire of a significant number of shareholders. But these will remain very much in the minority. Most accept that the standard required has been raised. That is, reputations now have to face a bar set at a 25% “no” vote. With the change in the height of the reputational risk bar is the added urgency for directors to respond to shareholder concerns. From what we see, investors are not about to go soft on you.
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