Final Productivity Commission Report released

 

12 January 2010


As you would be aware, in March 2009 the Productivity Commission was asked by the Federal Government to report on the framework and structures around the remuneration of directors and executives of disclosing entities regulated under the Corporations Act 2001 (Cth) (Act). A draft report was released in September 2009. The Productivity Commission’s Final Report into Director and Executive Remuneration (Report)1 was released by the Federal Government on 4 January 2010.

The Report contains 17 recommendations covering areas such as remuneration principles and disclosures, shareholder engagement and conflicts of interest. In the main these recommendations reflect those contained in the draft report, including the draft recommendations to restrict remuneration report disclosures to key management personnel and to simplify the remuneration report, and the draft recommendation that cessation of employment be removed as a taxing point for deferred equity subject to forfeiture.

Key changes since the draft report

  1. Two-strikes plus a resolution to ‘spill’ the board (recommendation 15) – Significantly, in the Report the Productivity Commission has diluted the draft report’s two-strikes proposal under which two consecutive ‘no’ votes equal to or greater than 25% on a company’s remuneration report would trigger an automatic re-election of directors. The final ‘two strikes’ recommendation includes an extra hurdle which means that if two consecutive ‘no’ votes of 25% or more are received, a separate re-election resolution is activated to the effect that all elected directors who signed the directors’ report for that year must stand for re-election at an extraordinary general meeting, which must be held within 90 days. Set out below is a diagram, extracted from the Report, which illustrates the process.
  2. Declarations of ‘no vacancy’ must be approved by shareholders
    (recommendation 1) – The Productivity Commission has also retained its draft recommendation that shareholders must approve a declaration of ‘no vacancy’ on a company board at a general meeting. This recommendation is a response to criticism that boards use the ‘no vacancy’ rule to exclude outsiders, perpetuating a ‘boys’ club’ environment. However, the recommendation has been criticised by business groups who state that boards are best placed to decided how many members are needed to work efficiently and that resolutions such as these will distract boards from their most important role, which is protecting the company’s financial health and growth prospects. The Report also specifically supports the ASX Corporate Governance Council’s ‘if not, why not’ (finding 1).
  3. Recommendations 16 and 17 are new and relate to implementation of the Report. They respectively propose that:
    • Recommendations 2 and 3 on conflict of interest matters, and recommendations 10 and 11 relating to remuneration advisers be implemented by legislation if the ASX and the ASX Corporate Governance Council do not make the requisite changes, and
    • the reforms flowing from the Report be reviewed within 5 years.

The full list of final recommendations is set out below.

The Government has indicated that it is considering the Report and will respond ‘later in the new year’.

Two strikes plus a resolution to ‘spill’ the board2

Full list of recommendations3

  Recommendation Targeted benefits
Board capacities 1 Any declaration of ‘no vacancy’ at an AGM to be agreed to by shareholders.

Finding 1: Support an ‘if not, why not’ requirement for boards to report progress against gender objectives.
  • Increases shareholders’ input on board size and composition and addresses perceptions of a ‘directors’ club’.
  • Encourages boards to draw more widely from the available talent pool.
Conflicts of interest 2 On an ‘if not, why not’ basis:
  • remuneration committees to comprise at least 3 members, all non-executive directors, with a majority and the chair independent
  • companies to have a charter setting out procedures for non-committee members attending meetings.
  • Constrains executive influence on pay.
  • Promotes best practice for all listed companies.
3 For ASX300 companies, executives to be prohibited from sitting on remuneration committees (Listing Rule).
  • Constrains executive influence on pay.
  • Aligns with APRA initiative for finance sector and targets companies able to meet compliance cost.
4 Prohibit executives and directors voting their own shares on remuneration reports.
  • Increases shareholder signal on non-binding vote.
5 Prohibit executives hedging unvested equity remuneration or vested equity subject to holding locks.
  • Improves alignment between executives and shareholders.
    Engenders confidence in pay practices.
6 Prohibit executives and directors voting undirected proxies on remuneration reports.
  • Increases shareholder signal on non-binding vote.
7 Require proxy holders to cast all their directed proxies on remuneration reports.
  • Increases shareholder signal on non-binding vote.
Disclosure 8 Improve information content and accessibility of remuneration reports through:
  • a plain English summary of remuneration policies
  • reporting actual remuneration received and total company shareholdings of individuals in the report
  • expert panel to advise on revised Corporations Act architecture to support changes.
  • Better informed shareholders.
  • Reduced confusion (and misreporting) about pay structures.
  • Enhanced engagement between boards and shareholders.
9 Remuneration disclosures to be confined to key management personnel.
  • Aligns Act with accounting standards.
  • Reduces compliance costs.
  • Improves readability.
10 Companies to disclose executive remuneration advisers, who appointed them, who they reported to and the nature of any other work undertaken for the company (‘if not, why not’).
  • Constrains executive influence on pay through transparency.
  • Promotes best practice for all listed companies.
11 For ASX300 companies, advisers on executive pay to be commissioned by, and their advice provided directly to, the board, independent of management (Listing Rule).
  • Constrains executive influence on pay.
  • Aligns with APRA initiative for finance sector.
  • Targets companies able to meet costs.
12 Institutional investors to voluntarily disclose how they have voted on remuneration reports (and other remuneration-related issues).
  • Better informed (potential) investors.
  • Targets agency issues, particularly for compulsory superannuation contributors.
Remuneration principles 13 Remove cessation of employment as the taxation point for deferred equity subject to risk of forfeiture.
  • Removes barrier to deferred remuneration.
  • Consistent with longer term alignment.
  • Removes need for special tax rulings.
Finding 2: Remuneration ‘check list’ for boards to improve information content in remuneration reports.
  • Enhanced quality of disclosure.
  • Provides guidance to encourage and promote better remuneration practices.
Shareholder engagement 14 Confirm allowance of electronic voting without amendment of company constitutions.
  • Improves efficiency and integrity of shareholder voting.
  • Potential for cost savings.
15 Two strikes and re-election resolution’:
  • 25 per cent ‘no’ vote on remuneration report triggers reporting obligation on how concerns addressed
  • subsequent ‘no’ vote of 25 per cent activates a resolution for elected directors to submit for re-election within 90 days.
  • Increases shareholder signalling and power.
  • Increases pressure on companies to respond to shareholder concerns.
  • Targets unresponsive boards.
Implementation issues 16 The Australian Government to implement intent of recommendations 2, 3, 10 and 11 by legislation if the ASX and Corporate Governance Council do not make requisite changes.
  • Ensures potential benefits from recommended reforms can be achieved.
17 Review within 5 years to consider:
  • the effectiveness and efficiency of the reforms, including to termination payments and employee share schemes
  • the regulatory architecture.
  • Evaluation of efficacy and economic impact of reforms.
  • Identification of any unexpected outcomes that warrant corrective action.

 

Endnotes

  1. Productivity Commission 2009, Executive Remuneration in Australia, Report No. 49, Final Inquiry Report
  2. Reproduced from the Productivity Commission 2009, Executive Remuneration in Australia, Report No. 49, Final Inquiry Report, p XXXII
  3. Reproduced from the Productivity Commission 2009, Executive Remuneration in Australia, Report No. 49, Final Inquiry Report, pp XXXIV-XXXV

This article was written by John Cooper, Partner, Alexandra Moule, Senior Associate and Rebecca Mason, Solicitor, Melbourne.

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