Director and Executive Remuneration

By Andrew Hay.

Key Points:
CLERP 9 will require greater exposure and scrutiny of director and executive remuneration and termination benefits for listed companies.

Not unexpectedly, director and executive remuneration features heavily in CLERP 9. One of the Act's primary emphases is on greater levels of disclosure to shareholders. The new requirements in relation to executive remuneration and termination benefits apply to financial years commencing on or after 1 July 2004.

What are the changes?

Disclosure on group basis

Listed companies are required to disclose in the annual Directors' Report the nature and amount of the emoluments of the directors and the top five highest paid officers of the company. This has been amended slightly to include the top five paid company executives which includes secretaries and senior managers.

CLERP 9 extends the disclosure requirements for companies with consolidated financial statements, where they differ from the listed company. In addition to existing disclosure requirements, these consolidated entities will also be required to disclose the remuneration of the top five group executives of the consolidated entity (excluding directors). The term "group executives" is widely defined and includes secretaries, senior managers, partners and senior managers of any partnership within the consolidated entities, trustees and senior managers within the consolidated entities and senior managers of any joint venture within the consolidated entities.

Annual report

Listed company annual reports will need to spell out the details of remuneration in a separate and clearly identified "Remuneration Report" within the Directors Report. In addition to the disclosure outlined above, the Remuneration Report will need to specifically disclose and explain prescribed details in relation to a director's, company executive's or group executive's remuneration. Some of those prescribed details include, amongst others:

• discussion of the board policy for determining the nature and amount of remuneration;
• discussion of the relationship between such policy and the company's performance having regard to the company's earnings, dividends paid during the year, changes in the share price of the company during the year and any return of capital involving cancellation of shares;
• detailed summaries of any performance conditions relating to remuneration, why a particular condition was chosen and a summary of the methods used in assessing whether the performance condition is satisfied and why such methods were chosen;
• where an element of remuneration consists of securities and is not dependent on satisfaction of a performance condition, an explanation of why this is the case;
• an explanation of the proportions of such remuneration that are performance-based and those that are not; and
• the value of options granted during the year as part of remuneration of such persons and the value of those options exercised or that have lapsed during the year.

In short, the directors and top five company and group executives are to be individually named and each component of their remuneration disclosed.

The Corporations Regulations provide that in accordance with AASB 1046, the following will need to be disclosed for each of the specified directors and executives: salaries, bonuses, fees, commissions, expense allowances, options, shares, superannuation, personal benefits, company loans to executives that exceed $100,000 and post-employment benefits.

The purpose behind such increased disclosure is contained in the Government's explanatory memorandum on the Act . It states that companies should provide comprehensive disclosure to enable shareholders to understand the nature of the remuneration. This will require a listed company to disclose a detailed summary of performance hurdles or contingencies on which payment is based and of any securities issued (if such issue is not dependent on any performance hurdles) as part of the person's remuneration.

The Directors' Report will also need to disclose the duration of a person's contract with the company (if any), the periods of notice required to terminate the contract and the termination payments provided for under the contract. Shareholders will have access to a discussion of the board's policy for determining, in relation to the nature and amount (or value, as appropriate), the remuneration of directors, secretaries and other senior managers of the company (or group executives for a consolidated entity). The objective is to ensure shareholders are informed about the framework and main components of remuneration and understand the relationship between performance and remuneration.

AGM

Shareholders of listed companies must be allowed a reasonable opportunity to ask questions about, or make comments, on the Remuneration Report at the AGM. Shareholders will also be required to vote on whether to adopt the Remuneration Report. In this respect, the AGM notice of meeting will require a separate resolution in relation to seeking adoption of the Remuneration Report.

This vote will not legally bind directors and is described as advisory only. However, the discussion and vote is intended to provide shareholders collectively with an opportunity to express their views on the remuneration paid to directors and senior managers and the board's policies in relation to remuneration.

Termination payments

The Corporations Act requires shareholder approval for any payment made to a retiring director or executive unless a prescribed exception applies. These exceptions previously included termination benefits made:

• as a genuine payment by way of damages for breach of contract; or
• under an agreement made before the person's appointment, as the whole or part consideration for that person agreeing to hold such office.

CLERP 9 provides for a monetary limit on these exceptions. Shareholder approval will be required where a termination payment made for one of these reasons would exceed an amount calculated in accordance with s200F(3) or (4) of the Act. That formula restricts payment by reference to the director's or executive's remuneration, as follows:

• a director or executive who has served for one year or less would require shareholder approval for the payment of benefits greater than that year's or year's equivalent remuneration;
• a director or executive who has served for two years would require shareholder approval for the payment of benefits greater than the last year's or last year's equivalent remuneration;
• a director or executive who has served x years (being three years or greater) would require shareholder approval for the payment of benefits greater than x times his final average remuneration for the last three years, up to a maximum of seven times.

What is the Impact?

Shareholder participation

Shareholder approval of executive remuneration has been one of CLERP 9's more contentious issues.

From a legal perspective, the ability for shareholders to lodge a protest vote in relation to the adoption of executive remuneration schemes and policies of the board while not being legally binding on the board is a new concept under Australian law. It will be interesting to determine whether such non-binding votes do have legal consequences for boards when looking at their duties as directors. It will also be interesting to see what confusion this new concept may cause not only at the AGMs but also in the distinction between shareholder and director responsibilities. However, from a practical perspective, it will be difficult for directors to justify ignoring remuneration levels or board policies if rejected by a majority of shareholders, particularly where there is increasing pressure for institutional shareholders to participate more in AGMs and general meetings. One thing is for certain: listed companies will be increasing their communication to shareholders in relation to this area from now until the applicable 2005 AGM.

In the UK, where similar laws were introduced last year, a number of companies have had large scale shareholder protests over executive remuneration, manifested through large votes against the remuneration and high numbers of abstentions. Although not legally binding, these protest votes have had a negative impact through the degree of media attention that they have attracted.

Companies argue that they are competing for talent in the global market and therefore executive salaries need to be competitive. Shareholder groups complain that this does not justify the significant increase in executive remuneration over the last decade and shareholders should be able to monitor directors' decisions in this regard. This is a conflict that will need to be managed by companies.

While some argue that a greater level of disclosure in relation to the structure of executive remuneration and the top five executives of consolidated groups will promote greater transparency and allow shareholders to monitor the board, others insist that greater disclosure will disadvantage shareholders in the long term, because it will lead to an increase in salaries, as head hunters will know how much they need to offer to poach top executives.

Termination payments

Another contentious issue for shareholders has been the payment of excessive termination benefits to directors who have effectively failed.

CLERP 9 will require shareholder approval for termination payments made under the guise of damages for breach of contract or pursuant to provisions in an employment contract for excessive payouts on termination, where such payments are higher than the monetary limit set under the Corporations Act.

Again, this is an area that will have to be carefully managed by companies.

AGMs and notices of meeting

Listed companies will need to adjust their notices of meetings and their meeting procedures to take into account the new requirements regarding remuneration reports and where applicable, termination payments.