As we reported in our recent Employee Relations Express1 covering current issues in executive remuneration, the Treasurer, Wayne Swan, and the Minister for Superannuation and Corporate Law, Senator Nick Sherry have asked the Productivity Commission (Commission) to examine Australia’s legislative framework in relation to the remuneration of directors and executives.
On Tuesday 7 April 2009, the Commission released its initial Issues Paper on the Regulation of Director and Executive Remuneration in Australia.2
In this article, we discuss:
- the background and scope of the Commission inquiry
- key topics coming out of the Commission’s issues paper, and
- important details about making submissions to the inquiry.
About the Productivity Commission inquiry
The Commission’s inquiry into director and executive remuneration in Australia was first announced by Treasurer Swan and Senator Sherry on 18 March 2009. Heading the inquiry are Commission Chairman Gary Banks AO, Commissioner Robert Fitzgerald AM, and Professor Allan Fels AO, who has been appointed an Associate Commissioner for the duration of the inquiry.
The inquiry will be a broad-ranging examination of Australia’s corporate law, considering the existing regulatory framework governing director and executive remuneration for companies that are disclosing entities under the Corporations Act, including shareholder voting, disclosure and reporting practices.
The Commission has indicated that it will also reflect on the outcomes of the recent G20 meeting in London in considering executive remuneration for the financial sector. It will also examine whether differing regulatory responses are appropriate for different industries.
Treasurer Swan and Senator Sherry have asked the Commission to make recommendations on how the existing framework governing Australian remuneration practices could be improved.
Terms of reference
As we discussed in our Employee Relations Express covering executive remuneration on 24 March 2009, the Productivity Commission was given five terms of reference for its inquiry. These five terms of reference are dealt with in the Commission’s issues paper as follows:
Trends in director and executive remuneration in Australia and internationally
The Commission intends to examine:
- growth in levels of remuneration and the relationship between remuneration packages and corporate performance
- the extent to which existing executive remuneration levels in Australia are required to encourage an adequate supply of executive candidates (including international candidates), and
- what drives executive performance, including factors outside remuneration.
The Commission has also indicated that it may make recommendations for reform in the following areas:
- Bonus payments: the issues paper refers to research showing that bonus payments have significantly increased from the period 2000-2001 to 2006-2007. The Commission is likely to address this trend, particularly in respect of short term incentives, and consider the potential for bonuses to promote risk-taking corporate behaviour.
- Options: the Commission refers to research which shows that options are playing a far lesser role in the remuneration of Australian executives than in the past. It is likely that the Commission will address the diminished role of options in remunerating executives, with particular reference to options’ inability to appropriately adapt to substantial market fluctuations.
- Non-recourse loans: the terms of reference request the Commission to consider the use of non-recourse loans as part of remuneration arrangements. However, the issues paper notes that the inquiry will consider the role of non-recourse loans in light of the fact that such loans are often used in relation to all employees, not just executives.
Effectiveness of regulatory arrangements
The Commission will consider the effectiveness of the existing framework for the oversight, accountability and transparency of director and executive remuneration practices in Australia. This will include:
- considering measures to help company boards fulfil their duties to engage managing directors and executives on terms which are consistent with shareholders’ interests, and
- addressing whether the current regulations applying to executive remuneration are too complex and whether they offer sufficient transparency and accountability.
Role of institutional and retail shareholders in the development, setting, reporting and consideration of remuneration practices
The Commission will examine:
- the degree of influence shareholders should have over their companies’ remuneration practices, and
- whether the non-binding vote on the remuneration report should be ‘strengthened’ (for example, by excluding key management personnel who are shareholders from voting).
Mechanisms to better align the interests of boards and executives with those of shareholders and the wider community
- The Commission contends that current contractual arrangements do not always promote alignment of the interests of boards and executives with those of shareholders and the wider community.
- The Commission will consider whether shareholders should be given enhanced powers in regard to remuneration practices, and/or enhanced guidelines for, or regulation of, remuneration levels and structures.
Effectiveness of the international responses to remuneration issues arising from the global financial crisis
The Commission will examine:
- regulatory frameworks governing director and executive remuneration in other countries, and
- whether any international approaches to executive remuneration are particularly applicable to Australia and from which Australia could learn (including both successes and failures).
Key issues raised by the Productivity Commission
In announcing the release of the issues paper3, Chairman Gary Banks identified that the inquiry will specifically consider:
- whether current remuneration arrangements are effective in driving corporate performance, or
- whether they have the potential to lead to undue risk taking or other actions that may not be in the best interests of shareholders or the wider community.
The Commission also suggests that it will assess executive remuneration in terms of its effects on the productivity and performance of Australia’s economy as well as community wellbeing.
Consideration of the extent to which director and executive remuneration can promote or restrain risk-taking behaviour is not novel, and builds upon work being completed by a number of bodies, including:
- G20 and the Financial Stability Forum
- the Australian Prudential Regulation Authority, and
- the Australian Securities and Investments Commission.
Traditionally, analysis of the regulatory framework governing director and executive remuneration has focused on reconciling executives’ interests with the company’s long-term interests and the creation of shareholder value. In large part, this is because the corporate law which underpins remuneration is centred on promoting the interests of the company and its shareholders.
The terms of reference of the Commission’s inquiry and the resultant issues paper suggest that the Commission will be considering director and executive remuneration in a broader context which may include the impact of such remuneration on wider community interests. How the Commission approaches this issue will be interesting in the context of the current corporate law. It may also give rise to a number of challenging issues for companies in the future should the expectation arise that they have regard to community interests in setting remuneration practices for their directors and executives.
Call for submissions
The Commission is calling for submissions by 29 May 2009. It will hold an initial round of public hearings starting 16 June 2009.
It proposes to release a draft report with preliminary findings in late September to elicit feedback through further submissions and a second round of public hearings.
Freehills is able to assist you in drafting submissions to the inquiry.
The final report will be provided to the Government by 19 December 2009.
Endnotes
1. Executive remuneration: Treasury changes, Fels review and more
2. Regulation of Director and Executive Remuneration in Australia, Productivity Commission Issues Paper
3. Executive Pay Inquiry Releases Issues Paper, Media Release
This article was written by John Cooper, Partner, Sara Summerbell, Solicitor, and Timothy Stutt, Articled Clerk, Melbourne.
More information
For information regarding possible implications for your business, contact a member of the Employee Relations team.