Following stakeholder submissions and extensive public consultation, the Productivity Commission released its final report on “Executive Remuneration in Australia” in early January. The report details some interesting facts about executive pay over the past couple of decades and outlines the Commission’s recommendations for improving shareholder confidence in public companies, particularly in terms of the remuneration of their boards.

There has been a strong focus over the past 12-18 months on the seemingly ever-increasing remuneration of executives, even while shareholder value has fallen. On top of this, there have been hefty termination payments and a widening gap between executive pay and the pay of other employees.

The primary motivation for the Commission’s report was the widespread view that executives have been rewarded for failure. This obviously reduced investors’ confidence in board performance across companies and in the equity markets.

The Commission’s view is that there cannot be significant restrictions placed on the central role that boards play in setting remuneration. Given the important role that a board has in managing the company and the interests of shareholders, the most practical solution is for shareholders of public companies to ensure they have competent and motivated board members.

Below is an overview of the Commission’s recommendations for determining executive remuneration and improving shareholder confidence in boards. The Commission believes putting these measures in place will improve corporate governance, enhance credibility and make boards more accountable.

Avoid conflicts of interest

• Limit the ability of executives to influence their own remuneration package by requiring companies, particularly top 300 companies, to establish a remuneration committee of at least three members, comprising non-executive directors, with the majority and chairperson to be independent members. The Commission suggests that the ASX Corporate Governance Council should introduce an ‘if not, why not’ recommendation, as well as a requirement to limit interaction with company executives, and the use of a charter setting out procedures for non-committee members attending committee meetings.
• A new ASX listing rule should be introduced specifying that executives are prohibited from sitting on remuneration committee.
• Companies should engage independent remuneration consultants who report directly to the board or the remuneration committee. The Commission recommends an amendment to the ASX listing rules to provide that where ASX300 companies use expert advisers for director and key management remuneration, the advisers should be commissioned by, and report directly to, the remuneration committee or board, independent of management.
• Remuneration reports should disclose the use of remuneration consultants, and detail who appointed them, who they reported to and the nature of any other work undertaken by the consultants for the company.
• The Corporations Act 2001 (Cth) and the ASX listing rules should be amended to prohibit directors and executives from voting their own shares and undirected proxies on remuneration reports, and on any resolutions relating to those reports.
• The Corporations Act should be amended to require all proxy holders to cast all directed proxies on remuneration reports and any resolutions relating to those reports.

Board accountability and capacity

• Companies should publicly report on achieving set targets.
• There should be greater transparency when selecting board members.
• Shareholders should have the ability to vote on any proposal to limit board vacancies, avoiding the perception of a ‘directors club’. The Commission recommends that this change be implemented through an amendment to the Corporations Act, so that where the board seeks to declare no vacancies and the number of directors is less than the maximum number provided by the constitution, shareholders must approve such a proposal by ordinary resolution.
• The Commission has endorsed adopting and reporting on an ‘if not, why not’ basis for the appointment of women to boards, which is an initiative introduced by the ASX Corporate Governance Council. Companies will be required to set gender objectives and disclose their progress on improving the representation of women on their boards. Consideration will be given in due course as to whether this requirement should be incorporated as an ASX listing rule.

Improve communication and disclosure

• Companies should give a plain English summary of remuneration policies to investors to promote understanding of executive remuneration.
• A report on total actual pay should be provided to investors, including total equity holdings and disclosure of performance hurdles.
• The Commission has recommended that the Australian Securities and Investments Commission (ASIC) advise how the structure of section 300A of the Corporations Act (Annual directors’ report – specific information to be provided by listed companies) could be revised to allow for better communication of remuneration policies and reports to shareholders.

Promote efficient incentive alignment

• Companies should conduct risk assessments of incentive pay arrangements and encourage simpler and less costly pay structures.

Encourage shareholder engagement

• The Commission believes that the ‘two strikes and re-election resolution’ will improve dialogue between shareholders and the board on remuneration.
  
  - If 25 percent or more of shareholders vote ‘no’ to the remuneration report (‘first negative vote’) at an AGM, the company will be required to provide a detailed response in the remuneration report of the following year. This response should outline how shareholder concerns have been dealt with and, if they have not been dealt with, why.
  
  - If a ‘first negative vote’ occurs, and in the second consecutive year shareholders constituting 25 percent or more of the company vote against the remuneration report, a separate re-election resolution will automatically be triggered at that AGM. If passed by more than 50 percent of the eligible votes cast, all directors who signed the directors’ report for that year will face re-election at an extraordinary general meeting to be held within 90 days.
• The Commission has recommended that ASIC issue public confirmation to companies that electronic voting is allowed without the amendment of company constitutions.

The government is currently considering the Commission’s recommendations and is yet to respond to the report. Companies should keep in mind that although these recommendations are not currently binding, many of them are likely to be introduced, and there will be compliance costs and behavioural changes associated with any implementation of the Commission’s recommendations. The Commission has suggested that a review take place in five years to determine the impact of the reforms.

For more information about the report or advice on implementing these recommendations, please contact HopgoodGanim’s Corporate Advisory and Governance practice.

Nicole Radice, Partner
Claire Fidler, Associate