Key points

  • The Federal Government has announced several measures recently to address ‘community concern’ about executive pay including further limits on termination payments to certain executives unless shareholder approval is obtained.
  • These measures are probably appropriate if government has been required to ‘bail out’ business to avoid insolvency, as in many other countries. However, in Australia they are not necessary and may lead to inappropriate outcomes in the area of executive pay. Further, they may mean that we cannot entice the best executives to work in Australia.
  • Executive remuneration is a matter for company boards to consider and determine having regard to the best interests of the company they serve. Further regulation in the area on the basis of ‘community concern’ is not necessary or appropriate.  

What’s happening in Australia and why?

As the global financial crisis continues to affect the corporate sector, there is greater and greater scrutiny of executive remuneration taking place in Australia and overseas.

Since March the Federal Government has announced or undertaken the following measures to address ‘community concern’ about executive pay:

  • proposed amendments to the tax treatment of equity incentive schemes for employees including executives (for more information, see the article entitled ‘Tax and mining update’)
  • proposed amendments to the corporations legislation to limit termination benefits to certain executives to the equivalent of one year’s base salary which are expected to come into operation in late 2009, and
  • referral of the issue of executive remuneration to the Productivity Commission, which is expected to report by the end of 2009.

We discuss the second and third of these measures in more detail below.

In addition, at the request of the Federal Government, the Australian Prudential Regulation Authority (APRA) has released draft principles to guide businesses engaged in the financial services industry in considering executive pay which require boards to:

  • have in place a remuneration policy that covers various matters including alignment of remuneration arrangements with the long-term financial soundness of the institution and its risk management framework, and
  • establish a board remuneration committee comprised entirely of independent directors with the requisite skills and knowledge to perform its functions.

While this scrutiny and additional regulation may be justified in places where government has been required to ‘bail out’ business to avoid insolvency, such as the United States, the United Kingdom, France, Germany, Switzerland and Norway, or in the financial services industry generally where it has clearly been shown that some common remuneration practices do not promote the long-term strategic growth of an organisation, it is suggested that in an Australian context the general focus is unwarranted and may lead to perverse outcomes in the area of executive pay. It may also mean that Australia is unable to attract and retain the best executives to run businesses here.

Executive remuneration is a matter for company boards to consider and determine having regard to the best interests of the company they serve. In Australia, if shareholders are not happy or satisfied with board decisions in respect of executive pay then there are several ways for them to express or show their views. Further regulation in the area on the basis of ‘community concern’ is not necessary or appropriate.

Termination payments

In March, the Federal Treasurer, Wayne Swan and Senator Nick Sherry, the Minister for Superannuation and Corporate Law, made a joint announcement proposing reform of the corporations legislation in respect of termination payments. The reform proposal includes:

  • amending the Corporations Act 2001 (Cth) (Corporations Act) to cap termination payments at one year’s average base pay unless shareholder approval is obtained
  • extending the Corporations Act shareholder approval requirements to cover termination payments made to any ‘key management personnel’, and
  • expanding the definition of ’termination benefit’ under the Corporations Act to catch all types of payments, benefits and interests given on termination (other than statutory superannuation).

The legislation implementing this proposal has been released and is expected to be commence later this year, subject to the limited consultation process currently underway. It will apply to executive employment arrangements entered into after the legislation is passed.

Once implemented these changes will further limit the ability of company’s to provide benefits to executives on termination of their employment without shareholder approval. Further, because the draft legislation requires that any shareholder approval is sought after a relevant executive has gone, it will be unlikely approval is ever sought.

This legislation is a vote of no confidence in Australian boards from the Federal Government. It adds unnecessary complexity and burden to companies in Australia and is based on a largely irrelevant consideration, ‘community concern’. It will lead to perverse practices and outcomes in the area, for example, the payment of ‘sign-on’ benefits and higher base salaries and the provision of incentives long after the employment relationship is terminated in order to avoid the connection with termination relied on for the operation of this legislation.

Productivity Commission inquiry

The Rudd Government has also referred the broader issue of executive remuneration to the Productivity Commission, which is expected to report by the end of 2009.

The Productivity Commission has been asked to make recommendations on how the existing framework governing remuneration practices in Australia could be improved. This is intended to be a broad-ranging examination that will consider the existing regulatory arrangements that apply to director and executive remuneration for companies that are disclosing entities under the Corporations Act, including shareholder voting, disclosure and reporting practices.

Apparently, in undertaking the inquiry, the Productivity Commission will also liaise with the Australia’s Future Tax System Review and APRA.

The Productivity Commission review will be an opportunity for business and others to make submissions regarding the issue of executive remuneration more generally in order that any further legislation in the area considers appropriately and addresses adequately the interests of all stakeholders.

However, the cart seems to have come before the horse—despite appointing the Productivity Commission to review the matter, the Federal Government has pre-empted the review by releasing legislation and asking APRA to release guidelines to apply in the financial sector while the Productivity Commission is undertaking its work. If the Productivity Commission recommends changes to the regulation that has been recently introduced, it may be considered unlikely that the Federal Government would reconsider only recently passed legislation.

The recently announced legislative reform proposals and the release of the APRA Guidelines fatally compromise the potential for the recommendations of the Productivity Commission.

What now?

Company directors are already under legal obligations to act in the best interests of the company they serve and these duties extend to remuneration practices. For this purpose, the Australian Institute of Company Directors (AICD) issued the ‘Executive Remuneration Guidelines for Listed Company Boards’ in February 2009 which are designed to assist large publicly-listed companies negotiate and set executive remuneration. The guidelines reflect the AICD’s view that executive remuneration should remain a matter for boards, and that further regulation in this area is unnecessary and may be counterproductive to the desired outcomes sought.

The recent proposals for reform in the area of employee remuneration (including the APRA Guidelines):

  • seek to limit the ability of business to appropriately retain and incentivise their executives
  • increase shareholder participation in decisions about how companies remunerate their executives, and
  • impose an unnecessary administrative burden in the financial services sector.

All of these measures signal a move away from the current corporate law which reflects that remuneration is a matter for company boards.

In the context of an international market for executive services, structuring executive remuneration involves a delicate balancing of:

  • attracting appropriately qualified and experienced executives
  • retaining executives, and
  • providing incentives that motivate and challenge executives to perform at their peak for the benefit of the business,

all in the context of acting reasonably and for the best interests of the company.

Introducing added rules and requirements, not in the context of government style industry ‘bail outs’, has the potential to be unnecessarily and inappropriately restrictive and reduce flexibility for business in the international market for talent. In the most severe circumstances, it could limit companies’ ability to be competitive in attracting and retaining executives and capital in Australia.