Shareholders to get some teeth on executive remuneration

Giving effect to its April 2010 response to the Productivity Commission's report Executive Remuneration in Australia, the Federal Government introduced the Corporations Amendment (Improving Accountability on Director and Executive Remuneration) Bill 2011 (Bill) into the House of Representatives on 23 February 2011.

If passed, the legislation will give shareholders increased power over executive remuneration and significantly change the way listed companies will need to prepare and conduct their general meetings.  The key reforms, which are intended to come into effect on 1 July 2011, are highlighted below.

Two strikes rule

The Bill introduces the so-called ‘two strikes’ rule.  A listed company is currently required to subject its remuneration report to a non-binding shareholder vote at its annual general meeting.  The proposed rule gives shareholders the ability to vote in favour of holding a general meeting to re-elect the board of directors if the remuneration report receives 25% of votes against it in successive annual general meetings.

Under the rule, if a ‘no’ vote of 25% or more is cast on the company's remuneration report, the subsequent remuneration report must outline the board’s proposed action in response or state the reasons for any inaction.  If a ‘no’ vote of 25% or more is then cast on the company's remuneration report at the next annual general meeting, the shareholders must vote on a resolution (the ‘spill resolution’) at this meeting that another meeting (a 'spill meeting') will be held within 90 days to consider the election of directors.  The spill resolution will only pass if it receives a 50% vote in favour.

Key management personnel (KMP) and their closely related parties, whether in person or by proxy, will not be allowed to vote on the remuneration report if it includes details of the remuneration of a KMP or on spill resolutions.

At the spill meeting, all directors in place when the remuneration report was passed at the most recent annual general meeting, other than the managing director, cease to hold office immediately prior to the spill meeting.  Shareholders will then vote on their re-election.  The Bill contains provisions to ensure that a minimum of three directors remain after the spill meeting (being the managing director and two others).

No vacancy rule

A potential impediment to the election of new directors is the so-called ‘no vacancy’ rule.  This is based on a common clause in company constitutions that provides for boards to specify the maximum number of directors at any given time, within the limit set by the constitution.  There is a view that this rule can be used to inhibit shareholders from successfully electing non-board endorsed directors and is contrary to good governance and shareholder interests.

The Bill provides that a board of a public company will no longer be able to declare the maximum number of directors without first obtaining shareholder approval at a general meeting.  The notice of meeting must include explanatory statements stating the board's reasons for proposing to set a limit on the maximum number of directors.  If that resolution is rejected, vacancies would be declared to the maximum in the company’s constitution for that annual general meeting.

The board will still retain the right to appoint a director at any time throughout the year (subject to the usual confirmation at the next annual general meeting) and to fill, or leave vacant, casual vacancies as required.

Directed proxies

The Productivity Commission expressed concern over the ability of non-chair proxies to choose which of their directed proxies they vote, while ignoring other directed proxies.  Such ‘cherry picking’ lacks transparency and is said to reduce the effectiveness of shareholder voting.  The Bill requires that any directed proxies that are not voted by the proxyholder will automatically default to the chair of the meeting, who must vote all directed proxies.

Using remuneration consultants

The Productivity Commission saw the potential for conflicts of interest where senior executives appoint remuneration consultants to provide advice to boards on their pay.

Under the Bill, the board or the remuneration committee of the company must give their prior approval to the terms of engagement of a consultant before the consultant can be engaged to give recommendations about the remuneration of KMP.  The consultant must provide the recommendation to the board or the remuneration committee (or both) and cannot give the advice to an executive director, unless all the directors of the company are executive directors, and must include a declaration stating whether their recommendation is made free from undue influence by any KMP to whom the recommendation relates.

If the consultant provided any recommendations for the remuneration of KMP, the company's annual report must include details of their use of remuneration consultants, including a statement about whether the board is satisfied that the recommendations by the consultant was made free from undue influence by the KMP to whom the recommendation relates.

No hedging of incentive remuneration

Equity-based payments and performance hurdles are designed to align an executive’s interests with shareholders by linking pay to performance.  Hedging of incentive payments using financial products can reduce risk and enable executives to transform ‘at risk’ pay to fixed pay (at a cost).  The Productivity Commission was concerned that such practices undermine the intention of such schemes and break the link to performance.  The Productivity Commission considered the hedging of unvested equity and vested equity subject to holding locks should be prohibited.

While the Corporations Act currently requires companies to disclose their policy for directors and executives hedging their incentive remuneration, the Bill will prohibit KMP and their closely related parties from entering into hedging arrangements for KMP’s incentive remuneration.

For more information please contact Graham Nagle, Corporate Counsel on (08) 9288 6855 / graham.nagle@lavanlegal.com.au or Tony Chong, Partner on (08) 9288 6843 / tony.chong@lavanlegal.com.au.