The Labor government will be introducing more legislation regulating executive pay.
The Parliamentary Secretary to the Treasurer, David Bradbury, announced the government’s latest changes on February 21. Mr Bradbury will be the keynote speaker at the Remuneration Forum for directors, institutional investors and company management to be held in Sydney on the afternoon of 5 March.
This next round of legislation has been developed after consultation on a proposal for executive remuneration 'clawback' and will also implement several recommendations made by the Corporations and Markets Advisory Committee to improve disclosure in remuneration reports.
These changes come after a series of other executive pay legislative changes. Examples include:
- Amendments to the way equity plans are taxed;
- Executive and director termination payments requiring shareholder approval if they exceed 12 months pay;
- Prescribed methods by which directors can receive external remuneration advice;
- Disclosure requirements on executive pay consultants;
- The 2-strikes laws requiring a spill and re-election of the board if a 25 per cent minority of eligible shareholders vote against the remuneration report twice;
- Anti-hedging laws relating to executive incentive plans; and
- Laws against directors declaring that there is no vacancy on the board.
The Gillard government will progress amendments to the Corporations Act 2001 to require listed companies to disclose to shareholders through the remuneration report the steps they have taken to "clawback” bonuses and other remuneration where a material misstatement has occurred in relation to the company's financial statements.
If the company has not clawed back any remuneration following a misstatement, the board will be required to provide a detailed explanation to their shareholders. If shareholders are unhappy with the company's actions, they would be able to use their powers under the two-strikes rule to vote down the remuneration report and potentially spill the board.
Mr Bradbury said that: "Clawback provisions in executive contracts are already being adopted by many listed companies and these reforms will ensure that shareholders are able to have a say about the efficacy of those provisions."
In this regard, Mr Bradbury appears to actually be referring to forfeiture provisions companies have in place for deferred short-term incentives. "Clawback”, as it applies elsewhere in the world, refers to seeking repayment of incentives that have fully vested. This currently requires litigation, and is rarely undertaken and even more rarely successful. However, as defined in the government’s December 2010 discussion paper ‘The Clawback of Executive Remuneration Where Financial Statements are Materially Misstated’, clawback may be a recoupment of remuneration already paid to the executive, or a cancellation of an outstanding but unvested and unpaid future award. This covers both forfeiture of deferred incentives and true clawback of amounts that have already been paid.
The disclosure requirements will hasten the trend to adopt STI deferral.
In response to CAMAC's 2011 report on executive remuneration, the government will be requiring more transparent disclosure of termination payments. Remuneration reports will now have to disclose all payments (including entitlement payments, severance payments and post-severance payments) for key management personnel upon their retirement from the company, regardless of whether those payments were provided under a contract of employment. Many governance stakeholders should welcome this, given that there remains a level of opacity and non-disclosure regarding payments post termination.
The government’s release further indicated that: "Unnecessary disclosure requirements will be removed to simplify remuneration reports.”
However, before leaping for joy at the prospect of shorter remuneration reports, be aware that the "unnecessary disclosure” is limited to reporting the percentage of a person’s remuneration that consists of options, and the value of options that have lapsed assuming they had not lapsed. By our calculation, this should save about an average of 65 characters, which is about the length of this paragraph.
Other CAMAC recommendations to shorten and simplify remuneration reports were rejected by the government.
The Corporations Act reporting requirements will be expanded to add disclosure requirements relating to related party transactions into the Corporations Regulations, as these disclosure requirements will be removed from the accounting standards from 1 July 2013, as we predicted.
Probably the most interesting change to disclosure is the additional requirement that the remuneration report disclose, for each key management personnel, crystallised past pay, present pay and future pay. This would be expected to hold a high degree of promise for clarifying what an executive is paid. In fact, many companies have been providing this sort of disclosure recently. However, it remains to be seen how the government plans to legislate on this given its insistence that "information contained in the remuneration report should be disclosed in accordance with the accounting standards”. It has been the accounting standards, especially the method of valuing and expensing unvested equity, that have contributed to the opacity in remuneration reporting.
The government has also picked up on the current lack of disclosure of dividends paid on unvested shares. As part of this process, the government will consult on the need for disclosure of dividends on unvested shares paid to key management personnel.
Other changes to remuneration disclosures will include a general description of the company’s remuneration governance framework.
Draft legislation to enact these reforms is expected to be released for public consultation in the latter half of 2012. We trust that this will not be a repeat of the last legislation’s consultative process that consisted of the 5-week period encompassing Christmas and the New Year.
Guerdon Associates is an independent consulting firm operating from Sydney and Melbourne that provides advice on executive and director remuneration, performance management, governance, and employee equity data and solutions.