On 20 June 2011, the Corporations Amendment (Improving Accountability on Director and Executive Remuneration) Bill was passed by the Senate, giving effect to the Government's response to the Productivity Commission's post-GFC report on executive remuneration.

A number of the amendments to the Corporations Act will take effect from 1 July 2011 or 1 August 2011, so will (subject to the legislation receiving Royal Assent) apply to the imminent AGM season.

In summary, the Act:

  • introduces the "two strikes" rule – if there is more than a 25% vote against the remuneration report, in two consecutive years, shareholders must be given an opportunity to vote on whether to spill the board and elect a new board;
  • prevents boards from declaring "no vacancies" where the board has less than the maximum number of directors permitted under the company's constitution;
  • restricts key management personnel and their related parties from voting on any resolutions relating to remuneration, other than under a directed proxy;
  • requires the Chair to vote all proxies held on a poll and, if other proxy holders do not vote on a resolution, provides for proxies to default to the Chair, so that shareholders have greater comfort that their votes will be cast;
  • affects the manner in which remuneration consultants are appointed and report to the company, to ensure their recommendations are free from undue influence; and
  • makes some helpful changes to the content of the remuneration report. 

When do the changes take effect?

Please click here to view table.

What are the key changes?

Two strikes and what next?

The "two strikes" rule will not directly affect any company until the AGM season in the second half of 2012 but it will certainly be the focus of board attention before then. 

If, at a listed company's AGM, at least 25% of votes are cast against the remuneration report:

  • the next year's remuneration report must contain details of any proposed actions to address any concerns raised by shareholders at the previous year's AGM, or the board's reasons for inaction.  It will be a brave board that adopts inaction as the appropriate response; and
  • the next year's AGM notice must include a resolution (the spill resolution) that another meeting (the spill meeting) be held, at which all directors, other than the managing director, face re-election. 

If more than 25% vote against the remuneration report for a second year running, the spill resolution must also be put to that second AGM.  If the spill resolution is passed, the spill meeting must then be held within 90 days of the AGM.  The existing directors cease to hold office just before the end of the spill meeting, with directors elected at the spill meeting commencing their term at the end of the spill meeting.  

The Act includes a mechanism to ensure that the company will have at least three directors after the spill meeting. This could mean that a person who received less than 50% of votes in favour of their appointment will be elected until the next AGM, when the appointment needs to be confirmed.  

Given the consequences of a spill resolution being passed, there will be considerable pressure on boards to avoid two consecutive adverse votes on the remuneration report.

It's not easy to hang out the "No vacancy" sign

Many company constitutions allow a board to determine the number of directors, being a number less than the maximum specified by the company's constitution.  From 1 July 2011, the board of a public company will not be able to make such a determination, unless it has been approved by members.  If the resolution is approved, a notice of the limit on board vacancies must be lodged with ASIC. The resolution is effective until the next AGM. 

This applies to both listed and unlisted companies so will catch many charities which operate as companies limited by guarantee.

If the board does not comply with the requirement for member approval of a limit on board vacancies:

  • a person who had indicated a desire to be appointed, but who could not be appointed because of the unapproved limit, can seek compensation from the company (for lost director's fees most directly, but any other loss which can be established could also be recovered); and
  • any directors appointed at a meeting at which there were more candidates than vacancies permitted by the board, will not be validly appointed.  

This offers considerable incentives to the company to ensure that any restrictions on the number of directors are approved by shareholders, either as resolutions under these new provisions or by an amendment to the maximum number permitted under the constitution.

Voting by key management personnel has been curtailed

Key management personnel, their family members and controlled companies may now not vote:

  • undirected proxies on any resolution which is directly or indirectly connected to remuneration of key management personnel. This includes a resolution to approve the remuneration report, a spill resolution, approval of the amount of the directors' remuneration and related party transaction approvals under Part 2E of the Corporations Act; or
  • on a resolution to approve the remuneration report or a spill resolution (other than under a directed proxy given by a person who is permitted to vote). 

This could have a marked effect on some listed companies where directors and management have substantial shareholdings, as institutional shareholders will be able to exert much more influence over the outcome on remuneration resolutions.

Appointment and independence of remuneration consultants

It is common for listed companies to use remuneration consultants to advise the board and remuneration committee on executive remuneration. From 1 July 2011, executives may not engage the consultants on behalf of the company – the contract must be approved by the board or the remuneration committee.

Further, the consultant's recommendations:

  • may only be given to the board or the remuneration committee, and not to an executive (unless all of the directors are executive directors); and
  • must include a declaration of whether the recommendations have been made free of undue influence from the key management personnel who are the subject of the recommendations. 

Changes to the remuneration report

In good news for companies, for financial years starting after 1 July 2011, the remuneration report need only include reporting on the key management personnel for the company or the consolidated entity.  The requirement to provide details of the five most highly paid management personnel has also been removed.  This removes a source of confusion in determining who must be included in the remuneration report.

Where a recommendation has been received from a remuneration consultant, the remuneration report must include details of the consultant, the amount they've been paid, any other work they have undertaken for the company and details of how the work was performed. The board is also required to state whether it is satisfied the recommendations were made free of undue influence by key management personnel, and the reasons for being satisfied on that issue.   This reinforces the board's obligation to consider and oversee the engagement and work of remuneration consultants used by the company.

Proxy voting now offers more certainty for small shareholders

If a proxy form specifies the way in which the proxy holder is to vote:

  • proxy holders who hold contradictory instructions from multiple shareholders must not vote on a show of hands. This prevents the holder from voting on behalf of some, but not all, shareholders who have given proxies;
  • where the Chair is the proxy, the Chair must vote on a poll and must vote in the manner directed;
  • other proxy holders need not vote on a poll but, if they do so, must vote in the way directed; and
  • if a proxy holder does not attend a meeting or does not vote on a resolution, the proxies are re-directed to the Chair, who is obliged to vote. 

These amendments give smaller shareholders more certainty that their voting intentions will be respected and given effect to, whether or not they are voting in favour of, or against, a resolution endorsed by the board.

No more hedging of "at risk" remuneration

Key management personnel of a disclosing entity (most relevantly, listed companies) may not enter any arrangement which would have the effect of limiting the individual's exposure to risk relating to a part of the individual's remuneration that has not vested or that remains subject to a holding lock.

What do you need to do now?

Listed companies will need to consider:

  • early adoption of the spirit of the Act. If the company's last remuneration report has been criticised, consider how to respond to the criticism, as part of a strategy to avoid getting one strike at this year's AGM;
  • the form of proxy used for meetings. It must expressly allow the Chairman to exercise proxies on resolutions related to remuneration;
  • the maximum number of directors permitted under the company's constitution. Is a permanent change (via a change to the constitution) desirable, rather than keeping the board below the maximum number by an annual shareholder resolution? 
  • how attendance records are kept at meetings, to identify proxy holders who have not attended or voted on a resolution. Any proxies which default to the Chair must be exercised in accordance with their terms, where the proxy holder has not attended the meeting; and
  • how they appoint and manage their relationships with remuneration consultants, to ensure that any new engagements after 1 July 2011, and any recommendations received under engagements made after that date, are effected with the requisite level of independence. 

The Act is designed to give shareholders more power over the remuneration of directors and executives and to increase directors' accountability to shareholders.  The changes will certainly focus attention on a company's practices for remuneration, voting and board composition, so there will be interesting times ahead for company directors.