30/06/2011 - 00:00

Companies face new rules on executive pay

30/06/2011 - 00:00

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Changes to the law give shareholders more say on executive pay and tighten the rules on how boards decide.

A NEW era in Australian executive remuneration kicks off on July 1.

Since I wrote about the amendment to the Corporations Act 2001 in January, a revised Bill has been passed by both houses of parliament. Royal assent was due this week.

It is the third major change to executive remuneration since the global financial crisis (the first two being changes to the taxation of equity received as remuneration and a reduction in the cap placed on termination payments).

In short, the new law:

• Gives shareholders the opportunity to spill the board should the remuneration report receive ‘no’ votes representing 25 per cent or more of all votes cast at annual general meetings two years running (‘two strikes’).

• Introduces strict rules for the engagement and disclosure of remuneration consultants by reporting entities.

• Prohibits key management personnel (and closely related parties) from voting on the remuneration report or any two strikes board spill motion.

• Prohibits key management personnel from hedging incentive remuneration received in any form of equity.

• Requires shareholders’ approval before any ‘no vacancy’ declarations are made by a board.

• Introduces measures designed to prevent proxy holders from ‘cherry picking’ the proxies they exercise.

• Limits remuneration disclosures in the remuneration report to key management personnel.

The laws, which come into effect on July 1, mean companies will face their first two-strikes vote at this year’s annual meeting for the 2010 financial year.

The exceptions are the changes relating to proxy voting, which come into effect on August 1 to allow those companies that needed to issue meeting notices before the Bill was passed to still comply with the new laws.

Where the new law differs most from the one that was first proposed is that it further clarifies new rules around the engagement of independent advisers when considering the remuneration of key management personnel.

To a certain extent, it is a more workable method of operation than that put forward originally by the Labor government.

Where a disclosing entity chooses to use an independent remuneration consultant (there is nothing in the new laws that state that an independent consultant is required), the following must be done to give shareholders confidence there is greater transparency in remuneration advice given and that it is free from undue influence.

• The engagement of a remuneration consultant must be approved by the board or remuneration committee before engaging the consultant. This differs from the original proposal that saw the remuneration consultant only being able to engage with a non-executive director.

• The remuneration consultant must report to non-executive directors or the remuneration committee, rather than company executives (with the exception being entities with a board comprising of executive directors only).

This means the recommendation typically cannot be presented to the managing director/chief executive officer and chief financial officer/company secretary. As per the initial draft, it remains a criminal offence for a remuneration consultant to present the recommendation to someone other than a non-executive director, however, once presented to non-executive directors, the board may forward the report to the company’s key management personnel.

• The remuneration consultant and the board must make separate declarations that the recommendations on remuneration are free from undue influence by the key management personnel to which the recommendation relates.

• Companies that are disclosing entities will be required to disclose details relating to the use of remuneration consultants.

The new laws also provide a clearer definition of what a remuneration consultant is. The original draft implied that consultants that advised on the legal or accounting side of remuneration were covered by the changes to the law, however, this has been refined to cover only those recommendations that relate to how much the remuneration should be and the elements the remuneration should have for key management personnel.

Understandably, the focus for boards will be to minimise the likelihood they will face a first strike under the ‘two-strikes’ rule.

The key is for boards to ensure the remuneration report can be clearly understood by shareholders and that particularly variable remuneration is visibly linked to company performance.

The good news is that both the Productivity Commission (January 2010), the Corporations and Markets Advisory Committee (April 2011) have plainly stated the board to determine the appropriate quantum and components for its executive remuneration and this has been effectively upheld by the changes to the Corporations Act.

How then should boards proceed when determining the remuneration of their executive team?

Don’t be afraid to be different. Spend time in working out the composition of remuneration and the proportions of fixed versus variable pay.

When it comes to identifying the performance measures used to determine the variable pay component, do not just rely on broad measures such as relative total shareholder return.

Consider where your company is in its life cycle, look for measures that are clearly within your executive’s control that contribute to shareholders’ returns rather than relying on your competitors and peers to not do as well as you do.

When choosing a remuneration consultant, look for someone who is clearly independent, specialises in executive remuneration and works with the board to create a remuneration package and structure that reflects the specific circumstances of your company rather than providing a one size fits all approach.

A “we are doing what everyone else is doing” argument will no longer satisfy shareholders who from this annual meeting, while not having a binding vote, will have a greater say on pay.

Be aware that the legislative changes are not the last we are likely to see in the post-GFC world.

The government is still to release it response to its discussion paper on the claw back of executive pay where financial statements are materially misstated. The crackdown on executive remuneration is not quite over yet.

 

• Pamela-Jayne Kinder is principal of PJ Kinder Consulting – board and executive remuneration governance and advice.

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