'Two strikes' falls foul

Shareholders are increasingly comfortable exercising their voice on executive pay. But the 'two strikes' rule is easily manipulated to leave them powerless.

As AGM season winds up, shareholders will be revelling in the fact that they now have a real, effective say on executive pay. But the recent success masks a glaring problem with the legislation – it doesn’t actually give shareholders much power at all. This will become a major issue once directors get tired of pandering to shareholder demands – which they likely will, if given the chance.

Between 2000 and 2010, chief executive salaries in Australia’s top listed companies rose, on average, by 131 per cent. Meanwhile, median bonuses grew by a staggering 190 per cent. These are sobering figures, especially given that the average worker's pay rose by just 52.3 per cent in the same period. Shareholder returns fared even worse, with just a 31 per cent increase in returns recorded for the decade.

After years of watching from the sidelines as executive salaries grew by monstrous proportions, shareholders were last year rewarded with an amendment to the Corporations Act that gave them more power over executive pay – the 'two strikes' rule.

The new law stipulates that if 25 per cent or more of shareholders vote against a remuneration report for two consecutive years, a spill resolution must be put to shareholders. If the spill resolution passes, an EGM must be held within 90 days to put the board up for re-election.

Shareholders suddenly had the power to voice their opinion on executive pay and have it mean something. Last year, over 100 companies received a first strike. Included on the list were heavy hitters like Crown, BlueScope Steel and Pacific Brands.

But the big question was whether directors would pay any attention to shareholder discontent. So far, shareholders have recorded mostly wins in the battle, giving them renewed confidence in their ability to bring about change.

In almost all cases where companies received a first strike last year, executives took the feedback from shareholders seriously, either giving better explanations as to the reasons for such generous remuneration packages or reducing the remuneration for top executives, or both.

Executive bonuses are now down to the lowest level since 2004 as boards finally take heed of disgruntled shareholders.

Crown chief executive James Packer, while initially defiant following last year’s first strike, went as far as releasing previously private information on which the company's long-term incentives, including shares and options, are based.

BlueScope Steel also took notice, reducing overall bonuses by 67 per cent this year. Executive salaries increased by 3 per cent overall, but shareholders took this without much argument at the AGM, most likely due to the substantial drop in bonuses.

Meanwhile, Pacific Brands managed to avoid a second strike this year by cutting directors’ fees and imposing a salary freeze on top management.

But there are those who continue to ignore shareholder concerns.

Linc Energy is one such culprit. Despite 40 per cent of shareholders voting against the executive remuneration report last year, Linc Energy increased cash salaries by more than 50 per cent.

Chief executive Peter Bond received a 41 per cent increase in his base salary, while non-cash benefits for executives rose by 40 per cent. This is despite the company’s share price declining by more than 75 per cent.

Linc Energy’s AGM is scheduled for later this week, giving shareholders the chance to voice their opinions on the excessive executive remuneration. The fact that the company has already scheduled an EGM for the same day indicates the direction Bond believes shareholders will take.

So why risk a second strike? Well, that’s where the problem lies.

While a second strike triggers a board spill, in many cases the board can simply be re-elected.

Firstly, in a number of listed companies, including Linc Energy, boards have significant voting power. While they can’t vote on their own remuneration due to the obvious conflict of interest, they can use their power to re-elect the current directors once a spill has occurred.

Globe International, which received a second strike earlier this month, is a perfect example of how the flawed legislation can be manipulated.

Chief executive Matthew Hill and his two brothers hold a combined 67.8 stake in the company. But come spill time, the board can simply use its voting power to re-elect the existing directors. Matt Hill and chairman Paul Isherwood have already indicated that this is their plan. So in effect, where the board has significant voting power, the two strikes rule has little weight.

There is another issue that was also overlooked when the legislation was brought in.

The majority of company constitutions require a nomination for an alternative board member at least 45 to 60 days in advance. But following a spill, boards can elect to hold an EGM much sooner, as in the case of Linc Energy. The result is that there can then be no chance for a dissident shareholder to put up an alternative board nomination.

This has to be changed. There must be a sufficient period of time between the spill and the EGM to enable a challenger to put up an alternative board or the legislation is useless.

Without further amendments to clarify shareholder power, there is only so much pushing shareholders can do before boards eventually push back. The effect of the current flawed legislation is that both boards and shareholders are running around in circles trying to out-do each other. Without intervention this will only get worse, inevitably leading to a further deterioration of the relationship between the two groups.

Executive salaries cannot and should not continue at their dizzying heights, especially when the returns to shareholders are as dismal as they have been. Chief executives are just the highest paid employees in a company, and should be treated as such. Directors should be working to enhance the rewards to shareholders rather than defending the excessive rewards given to executives.

What has become clear is that shareholders are increasingly comfortable exerting whatever power they have over executive pay. But the current legislation doesn’t actually solve anything. For shareholders to have any real power, they need to have a more definitive option on pay. It's the only way to force boards to fundamentally re-evaluate the consensus among executives that they somehow deserve such excessive remuneration packages.

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