The Productivity Commission has released its long-awaited draft version of its review into the regulation of executive remuneration. After receiving hundreds of submissions from governance experts, executives’ representatives and remuneration consultants, the commission has developed a raft of ideas to attempt to curb the ever-increasing levels of remuneration, noting that executive pay has grown remarkably in recent years, increasing at a rate of 10% annually since 1993, with bosses of Australia’s largest companies now earning 150 times the wage of the average worker.
The commission’s major recommendation was to create a mechanism by which directors are held accountable if shareholders vote against consecutive remuneration reports (currently, remuneration reports are “non-binding” upon companies). The mechanism devised by the commission is known as the “two strikes” rule — that is, if more than 25% of shareholders vote against a remuneration report in consecutive years, the company will be required to have an extraordinary general meeting with all directors up for re-election.
While that sounds onerous for directors, in reality, it would amount to a giant hassle and waste of money for little benefit. No doubt a spill of the board is suitably dramatic, but perhaps the commission should have looked at the director election results before finalising their draft report — specifically the that company-sanctioned board candidates are virtually never voted out of office by shareholders.
For example, in 2007 Barbara Ward was one of three directors of Allco who approved of the related party acquisition of Rubicon. That acquisition enriched Allco directors Gordon Fell and David Coe by tens of millions of dollars and precipitated Allco’s collapse. Ward was also a director of Multiplex when is allegedly misled shareholders over Wembley Stadium cost delays. Despite those horrendous acts occurring under her auspices, Ward was appointed to the Qantas board last year. Similarly, David Ryan was re-appointed chairman of Transurban in 2008 despite previously having been chairman of ABC Learning Centres when it collapsed and spending four years chairing its audit committee while the company’s accounts were almost certainly fraudulent.
Given Ward and Ryan were appointed as directors, it is highly likely that if Amy Winehouse were put forward by the board of a pharmaceutical company for the board, she would find herself appointed with a comfortable majority. The commission’s grand idea, while good in theory, in practice, will have no real effect.
The commission implicitly rejected the idea of making remuneration reports binding with chairman Gary Banks telling the media that “we think that would be unwarranted, unworkable and would end up hurting shareholders and the economy”. Banks is correct — making remuneration reports binding would create difficulties, but the commission’s attempt at a solution, while brave, is poorly thought out. (A better option would be to strip directors of fees should a remuneration report be rejected making them personally accountable).
Another badly constructed recommendation was that remuneration committees be allowed to consist of “majority” independent non-executive directors — what this means is that executives, including the CEO, are still permitted on remuneration committees (most of the business media reporting this morning completely failed to understand this point). There is a clear link between abhorrent levels of remuneration and executives being on the company’s remuneration committee — for example, Phil Green sat on Babcock & Brown’s remuneration committee, Wal King is on the Leighton remuneration committee, as is Graham Burke at Village Roadshow. Those three companies developed Australia’s most generous remuneration plans in recent years. Quite simply executives should not be permitted to set their own remuneration — that should be the role of independent directors.
The commission also bizarrely noted that companies should reduce reporting of top-level executive remuneration because it amounts to a “compliance burden”. (The commission recommended that only key management personally be reported, rather than the top five executives). The more sensible view is that if a company is able to pay an executive $3 million annually, it isn’t too much to ask that the company add a line in its remuneration report informing shareholders of that.
The commission also forgot to address the glaring issue of equity incentives purchased “on-market”. Under the current laws, a loophole exists in which companies are required to seek shareholder approval for equity grants to directors for newly issue shares, but not for shares purchased by the company. This allowed Telstra to grant shares to former CEO Sol Trujillo without seeking shareholder approval. For the commission to not close this loophole was a grave error.
It isn’t all bad though, the commission did make some good recommendations.
The report recommended that arrangements regarding remuneration consultants be disclosed (first suggested by this column in 2008. Currently, boards are required to disclose details about their auditor, but the identity and payments made to remuneration consultants are not disclosed. That means that currently shareholders do not know if the company utilises remuneration consultants, how much they are paid or whether these consultants perform any other work for the company. Disclosure of these shadowy remuneration consultants is imperative given the critical role they have in setting executive pay levels and potential for conflict that exists given those consultants may be hired by management for other roles.
The commission also made some other excellent suggestions, including:
- ending the “no vacancy rort” to allow outsiders to be able to appointed to boards if they receive more than 50% support;
- prohibiting executives from hedging incentives (by law);
- requiring institutions to disclose how they voted on remuneration matters; and
- changing the taxation time for equity grants to when ownership of the shares is received, rather than when employment ends.
Overall, the draft report is a reasonable effort from Banks, Robert Fitzgerald and Allan Fels — while not perfect (especially with regards to the poorly constructed “two strikes” rule and allowing executives to sit on remuneration committees) it seeks to correct some clear corporate governance inequities and on the whole, represents a forward step for shareholders. Sadly though, the commission’s report represents only a small step and not any great leap forward for corporate governance.