Implementation test for exec pay reform

The government says new legislation will put the onus on listed companies to make sure they have provisions to clawback bonuses and other pay from executives.

IN February, Parliamentary Secretary to the Treasurer, David Bradbury, announced a new raft of changes to executive remuneration legislation.

Included among the changes are:

• formalisation of clawback provisions that were announced last year in the event of a material misstatement of financial statements;

• the Gillard government’s response to the Corporations and Markets Advisory Committee (CAMAC) 2011 report on executive remuneration reporting; 

• the removal of the requirement for some unlisted companies to prepare a remuneration report; and

• inclusion of related parties’ disclosure in the Corporations Act, as these requirements will be removed from the accounting standards from July 1 2013.

These changes are the fourth major change to executive remuneration legislation we have seen since 2009, which began with changes to the taxation of equity received as remuneration, a reduction in the cap placed upon termination payments, and the raft of changes in response to the Productivity Commission’s 2010 report that took effect from July 1 2011.  

The clawback provisions follow what Mr Bradbury described as an extensive consultation process that will “put the onus on listed companies to make sure they have provisions to clawback bonuses and other pay from executives”.   

He also stated that: “clawback provisions in executive contracts are already being adopted by many listed companies and these reforms will ensure shareholders have a say in the efficacy of these provisions.”  

It is true that there is an emerging trend of companies deferring a portion of short-term incentive payments, however Mr Bradbury seems to be a bit confused about the definition of ‘clawback’. The definition put forward in 2010 provides not only for the cancellation of unvested performance pay (a uniquely Australian viewpoint) but also for the repayment of remuneration already vested (as it is widely understood to be internationally).  

It remains to be seen which definition sees its way to draft legislation and whether the emerging trend is on the right track.    

In May 2010, CAMAC was charged with providing advice on the “possibility of reducing the complexity of executive remuneration reports”.

In 2011, it concluded that remuneration reporting was a dynamic process. 

“Companies should be allowed to develop their response to a changing environment without simultaneously having to come to grips with wide-ranging new reporting requirements”, it said, and that a non-prescriptive legislative approach to remuneration reporting should be taken.  

The government supported all but the recommendations that called for the removal of the prescriptive, accounting standard measures for reporting the link between company performance and remuneration and commercially, price-sensitive information. 

Providing shareholders with an upfront description of the company’s remuneration philosophy, and reason for it, is something I have advocated to clients for a long time.  

It sets a scene and allows for meaningful discussion around why pay is what it is. It also allows for an easier annual review in that all that is needed is a quick test of overall market movements in fixed remuneration and a recasting of the annual targets for the short-term incentive scheme.  

Shareholders are able to make their voting decision based on a framework and measure changes against general market movements rather than blindly on the quantum alone.

Providing information on crystallised past pay, present pay and future pay allows for a more meaningful discussion around pay and company performance. 

The inclusion of the value of equity grants that vest upon attainment of future, long-term performance potentially artificially inflates an individual’s remuneration in the current year.  

By providing information on past, present and future pay along with an explanation of the performance criteria that led to vesting will greatly improve shareholders’ ability to assess whether the executive has been rewarded appropriately. As with the trend towards the deferral of short-term incentives, companies are already beginning to provide this type of information in their reports.  

The removal of the requirement to express equity as a percentage of remuneration is at best a minor improvement in reducing the length of the remuneration report. Such information is usually expressed within the remuneration table itself and only represents a few lines.

The recommendation to disclose only the number of options that lapsed is a curious one. The value of the lapsed options is also of importance as shareholders typically focus on the total dollars in a remuneration package and the value of equity varies greatly between companies.  

It is also curious that only options are specified, surely the same should apply to all unvested equity such as performance rights?  For example it is quite feasible that an issue of 1,000,000 options in a junior explorer equates to a value less than $50,000 whereas the same value in a large producer is the equivalent of 2,000 options. After all, the tax office is interested in the value, why shouldn’t it be provided to the shareholders in an audited report?

With respect to recommendations 4-6, I tend to side with the government’s response. Given the remuneration report is providing information on the immediate past year, I see no reason for excluding information that deals with past company performance.  Indeed, many companies are voluntarily providing future dated information in relation to incentive payments including board set return on equity targets, project milestones and financial targets.  

By clearly stating what the targets are, you remove the grey area of incentive pay and again meaningful discussion can take place, rather than an abstract statement of ‘it’s too much’.  

The absence of a consistently applied valuation alternative makes the recommendation to remove the necessity for accounting standard valuation of pay unwieldy and results in further explanation (and therefore length) in the remuneration report. 

While accountants are on the record as saying the use of the accounting standards to value pay leads to misleading figures being reported by the media that appear out of step with company performance, at least the common method allows for a degree of comparability between companies.

For the most part the changes do have the capacity to improve the understanding of how companies remunerate their key management personnel. The true test will be in the implementation and whether the result is more transparent and concise reporting rather than further increasing the length and complexity of the remuneration report.

Mr Bradbury takes credit for the Gillard government’s reforms providing “a balanced and sensible template for other jurisdictions who want to improve governance in their executive remuneration frameworks and give shareholders more power to have a say”. 

While it is true that other jurisdictions are looking to emulate Australian governance, it should be remembered that both the Productivity Commission and CAMAC found Australia’s corporate governance and remuneration frameworks rated highly internationally in 2009 and recommended non-legislative and non-prescriptive change.  

Credit should be given to those boards that have voluntarily listened to their shareholders and remained ahead of the cumulative heavy handed and prescriptive legislative game.   

Draft legislation is due to be released for public consideration in the latter half of 2012.

• Pamela-Jayne Kinder is principal of PJ Kinder Consulting, which provides advice on board and executive remuneration governance.