Chapter 3
Consideration of the bill
3.1
A number of issues were raised in connection with the bill. These
included the timing of the measure prior to the report of the Productivity
Commission (PC) inquiry into executive remuneration, and questions relating to
the extent that shareholders should be able to deal with remuneration matters.
3.2
In relation to the bill itself, major areas of discussion included
whether the 12 month threshold was appropriate, whether termination payments
should be based on 'base salary' or 'total remuneration', and any possible
adverse impact the bill might have on the ability of Australian companies to
recruit.
3.3
A number of possible unintended consequences were raised, including the
possibility of other aspects of remuneration being increased, and the possible
burden imposed on subsidiaries and unlisted companies.
3.4
This chapter summarises some of these issues.
Timing of the bill
3.5
Several submissions proposed that it would not be appropriate to proceed
with the bill before the outcomes of the PC inquiry and the APRA inquiry.
Organisations which have called for delay until after completion of the PC
report include ACCI, Guerdon, BHP Billiton, Hay Group, the AICD, the BCA, KPMG
and Abacus.[1]
3.6
The AICD highlighted the risk that the PC might advise against the
adoption of measures such as the bill:
I put to the Productivity Commission at one stage whether, if
they actually thought our idea—namely, not to have termination payment legislation
of this sort—was a good one, they would say so. And they said that their job was
independent and, if they came to that view, they might. So the issue was: if
legislation went through and the Productivity Commission said it was a really
bad idea, it would seem to be not the best result for anybody.[2]
3.7
Regnan, a governance consultancy, argued that issues surrounding
executive remuneration should be looked at as a whole:
Analysis of the proposed reform of termination payments that
you are looking at today, we think, would be best viewed as part of an overall
package. It is a bit like dealing with the muffler of a car and not considering
at the same time, if you are talking about vehicle emissions, how other issues
such as the efficiency of the engine, the quality of the fuel et cetera ought
to be considered as a package.[3]
3.8
Treasury advised that it was a policy decision of government to proceed
with the bill prior to the outcome of the Productivity Commission report. Without
commenting on the decision either way, Mr Miller did make use of the 'muffler
analogy' to observe:
...if the car is very noisy at the time it might be best to put
the muffler on first and work the rest out later.[4]
Giving shareholders a greater say
3.9
Mr Gary Banks recently summarised some of the varied views received by
the PC during its inquiry into executive remuneration on the desirable level of
shareholder involvement in setting pay:
It seems generally accepted that the shareholder body en
mass and over time 'owns' the company, in the sense that they have claim over
the profit residual. By the same token, shareholders, whether individual or
institutional, face 'limited liability' and can sell their interest in the
company at any time.
Shareholders are a heterogeneous group. They can hold different
and often quite divergent views about company strategy and policy, reflecting
their different risk preferences and time horizons. Indeed, it’s been put to us
that investors often are more focused on the short term than executives and
boards, who need to make investment decisions with long-term pay offs.
The modern corporation emerged largely to circumvent problems
created by divergent interests of asset owners and their competing claims for
profits. Hence, the legal responsibility of executives and boards quite
deliberately is to the company (which has a legal life of its own), not
shareholders explicitly. So how much should company remuneration policy be
driven by shareholders?[5]
3.10
The Australian Council of Super Investors supported giving shareholders
a greater say. [6] Similarly, Professor Peetz
stated:
The interests of shareholders presently feature well behind
the urgings of remuneration consultants in shaping excessive executive pay.
Generous termination packages transfer risk from CEOs to shareholders, and
shareholders should have a say in containing those risks.[7]
3.11
A contrary view was put forward by the Australian Compliance Institute:
Whilst shareholders have always, to extent, had some say over
benefits for directors, they traditionally do not intrude into operational
matters associated with the actual running of the company. Shareholders
delegate these aspects to the board of directors. Giving a binding vote on
termination payments to non-director executives seems to go beyond this
oversight function into operational management matters. It is also questionable
whether shareholders would have access or exposure to the necessary information
or history of performance to be able to assess the appropriateness of payment
of termination payments due.[8]
3.12
Other submissions arguing that boards are responsible for such decisions
included Origin Energy, the ABA and IFSA.[9]
Guerdon Associates argued in their submission:
Interference by shareholders in operational matters
traditionally delegated to the board of directors blurs the extent that directors
can be held accountable on these matters.[10]
3.13
At the hearing, Mr Peter McAuley, Director, Guerdon Associates, further
explained this point:
...we think there is a line beyond which shareholders elect the
directors to serve them and represent them on the board. Shareholders should
clearly have a say in many issues but there are, what we would term, more
operational issues that we think belong with the directors in conducting the
duties that they are elected for.[11]
3.14
BHP Billiton argued the bill shifts the balance too far towards
shareholder decision making:
We are also supportive of the general policy behind
provisions of this nature – that at a particular level, shareholders should
have a say in order to provide reassurance that arrangements struck by a Board
are reasonable from the shareholders' perspective.
However, the threshold set out in the bill – 12 months' base
salary – represents an extreme adjustment in the other direction. It entails a
very substantial shift from Boards' exercise of business judgement to other
shareholder decision making.[12]
3.15
The AMWU proposed that decision making should be expanded to include
groups other than shareholders:
There is a general need to question, however, whether this
method is sufficient to address the mischief of executive excess. First, when
there are wider social concerns about executive corporate remuneration, it is
inappropriate to leave control of this excess to shareholders alone. It is
unlikely, whilst a company is rewarding its shareholders with higher profits,
that shareholders will be overly concerned about corporate social
responsibility...Secondly, it is often impractical to give more than advisory
power to the body of shareholders in a corporation. If shareholders are given a
veto over executive salaries, it is difficult to conceive an effective
mechanism to negotiate salaries which are capable of approval by a group of
shareholders with diffuse interests.[13]
3.16
The committee heard discussion about whether a shift to shareholders' approval
will be successful, given the role of institutional shareholders. The argument
here appears to be that decision makers at institutional shareholders, who are
themselves likely to be senior executives or board members, are likely to be
sympathetic to remuneration claims made by their fellow executives at other
companies. This has been likened to a 'club'.
3.17
ACSI noted that there is a high degree of overlap between boards in
Australia:
...there is in fact a smallish number of people who move
between boards. ACSI does research each year about the movements of boards and,
if I remember correctly...the people who moved onto ASX boards not last year but
the year before, 75 per cent were already on another ASX 100 board.[14]
3.18
In spite of this, ACSI argued a strength of the bill was to provide
greater transparency on the way in which these decisions are made:
There is a wonderful quote that we have come across in
governance: ‘Boards are like subatomic particles. They behave differently when
they know that they are being observed.’[15]
3.19
Regnan Governance Research and Engagement Pty Ltd agreed that greater
transparency offered by the bill will be advantageous, but noted that
shareholders will need to play their part:
We think that the bill is helpful because it forces companies
to engage with their share owners and to give these issues a greater level of
transparency than in the past. Remember that the bill takes the threshold from
being seven times total remuneration to one times base salary, which is
probably more than a sevenfold decrease in terms of the proportionality before
companies are forced to engage with their share owners. So we think that that
will be an opportunity, because, in the past, there has not been the ability to
engage with the share owners. What does the share owner do? In the absence of
information they go out and terminate a director because they suspect that
something is there. At least now they will have the information. As we said
earlier, it is important that share owners play their part in ensuring that
those directors who struggle with termination payments perhaps get invited to
be terminated themselves.[16]
3.20
Chartered Secretaries Australia argued that a more practical approach to
giving shareholders a say on termination benefits would be for shareholders to
approve a 'termination policy' containing a 'formula,' rather than approving
each individual payment. Shareholders would then only need to approve
subsequent payments which fall outside the approved policy or formula.[17]
The 12 month threshold
3.21
Several organisations argued the new 12 month limit was too low.
3.22
The BCA questioned the basis of 12 months, suggesting that the
government has provided 'no explanation as to why such a
"significant" reduction is required or discussion of the market
failure which warrants the threshold being set at that level'.[18]
BHP Billiton also opposes the 12 month period as too low.[19]
3.23
Alternative time frames were suggested. The AICD called for the
threshold to be set at 2 years, or failing that, for the two year threshold to
be adopted during the first year of a contract.[20]
The Australian Compliance Institute also proposed two years.[21]
Guerdon Associates support three times base salary and short term incentives,[22]
whilst Origin Energy calls for the period to be equivalent to that used in the
US or Europe.[23]
Other submissions supported the proposed timeframe of 12 months.[24]
3.24
Professor Peetz argued one year is too generous:
The legal minimum for termination payments set out in the
Fair Work Act 2009 is a useful benchmark. It is unclear why CEOs should receive
extraordinarily generous payouts on terms vastly superior to those available to
ordinary employees dismissed for similar reasons.[25]
3.25
The National Employment Standard (NES) provisions in the Fair Work
Act 2009 provide that in general, employees will be entitled to 1-4 weeks
notice of termination (or payment in lieu) depending on their length of
service. This consists of 1 week for those who have served less than one year,
rising to 4 weeks for more than 5 years, with an additional week in the case of
employees who are more than 45 years old and who have completed 2 years'
continuous service. This is based on an employee's full rate of pay, which may
be inclusive of loadings, penalties, overtime and allowances.[26]
Some awards and industrial agreements provide for greater amounts, including
more than one year's base salary.
Pro-rata limit for service less than 12 months
3.26
For executives who have served less than 12 months with a company, the
threshold reduces according to a formula established by items 31 and 37 of
Schedule 1 of the bill. This was raised in some submissions as being too low in
the initial stages of a contract.
3.27
The Law Council of Australia argued against a pro-rata limit for
executives who have served less than 12 months.[27]
The AICD suggested that higher payments are justified:
This risk, and the potential cost, to an incoming CEO is
greatest at the start of a contract. It is therefore common practice, in order
to entice a CEO to join a company, for there to be a relatively high potential
termination payment in the early part of a contract (typically expressed as a
notice period), should a company terminate the contract.[28]
3.28
Guerdon Associates also spoke about the potential need for higher
payments during the first year of a contract:
That would be a particular concern, I believe, to an
individual. That is the high risk time for them—the short period of time after
leaving one employer to arrive in Australia and take on a role which is terminated
shortly thereafter. They would be entitled after three months only to a payment
of three months...We just feel it is unduly harsh to have a pro-rating in the
first year. That is very limiting in terms of what can be achieved, unless of
course there is an opportunity to go to shareholders to achieve something
higher than that, but that brings obvious uncertainties to the individual at
the critical time of recruitment.[29]
3.29
Similarly, in the case of persons who have held a position for three
years or more, the bill states that the average salary will be based on 'the
average annual base salary that the person received from the company and
related bodies corporate during the last 3 years of the relevant period'.[30]
Chartered Secretaries Australia argued 'this does not take into account a
change in position that may occur for a particular executive, for example, an
executive could be promoted to CEO'.[31]
Origin Energy and Hay Group shared these concerns about the methodology used
for setting 'average annual base salary'.[32]
3.30
Treasury advised that they were aware of these arguments:
We believe that the pro rata is the fairest, most equitable
outcome. We do note that, if executives are seeking a payment above that [either
as a sign-on payment or agreement on a termination payment] before they start, there
is capacity under the existing rules for them to negotiate that before they
start...That would be allowed under the current framework, so you could get a
vote on that grounds already. You would have to question, though, whether or
not an executive saying that they needed a couple of years payment before they
started would be an overly good way to start a new job.[33]
Global competition for talent
3.31
A number of submissions argued that the bill could put Australia at a
competitive disadvantage in recruiting talented executives from overseas, or in
restraining talented Australian executives from seeking more highly paid
positions overseas. These views were noted by Hay Group, Origin Energy, the
Australian Compliance Institute, Ernst & Young and IFSA.[34]
3.32
The AICD expressed this view as follows.
A one year base pay approval threshold for termination
payments is materially lower than approval thresholds in comparable
jurisdictions overseas. Australian companies will be at a distinct disadvantage
in the market for executive services compared to companies domiciled overseas
or local subsidiaries of foreign companies...In other words, Australian companies
will be put at a competitive disadvantage both overseas and in the domestic
market.[35]
3.33
The ABA conceded that the majority of Australian banks currently provide
for notice periods of between 6 and 12 months to their executives.[36]
Even so, they argued the bill could impose a constraint in recruiting from
abroad:
What the boards are showing is that they have responded to
pressure that has come from shareholders groups over—talking to some of their
professionals in this area—probably four years and from the community in
general. They do not like contracts that have got provisions for large
termination payments. The banks have responded to that...But our point is that
we do not want a legislative constraint because the banks may want to engage an
executive who will not agree to a contract without two years or whatever it is.
So we do not want that constraint on the banks.[37]
3.34
The ABA proposed that ideally, an international agreement (such as the
recent G20 agreement on executive remuneration) should address termination
payments. Failing this, they proposed an appropriate international benchmark
(i.e. the US threshold of three times base pay plus bonus) should be adopted.[38]
3.35
Guerdon Associates provided data on the source of Australia's
executives:
Given that 17% of ASX 200 executives are recruited from
overseas (according to the ACSI Productivity Commission submission), where
termination provisions are more generous, the new maximum of “one times” is too
low. The combination of geographic isolation, onerous taxation structures and
the dislocation of moving families extensive distances to Australia militate
against Australian companies’ success in attracting executives. This problem
will be exacerbated if those potential recruits, required to relinquish existing
financial and employment security to accept a role in Australia, cannot have
reasonable certainty of adequate compensation in the event of early termination
equivalent to what they would otherwise receive in their source country.[39]
3.36
A variation of these arguments is that it may not be possible to fill
positions on subsidiaries of Australian companies abroad. The BCA raised this issue,[40]
as did Insurance Australia Group Limited (IAGL):
For overseas subsidiaries of IAGL there are also issues of
the potential conflict between the regulatory requirements of their home
jurisdiction and those under the Australian law. We understand that the EU is
considering caps on termination payments at two years salary. This difference
in the levels of termination payments is likely to have an adverse impact on
the recruitment of appropriately qualified individuals in these jurisdictions.[41]
3.37
Mr Alex Christie, Deputy Head of Group, Human Resources, IAGL, expanded
on this issue further before the committee:
...if we have a company in United Kingdom, which we do, and we
need a managerial person to sit as a director on that company, the standard in
the UK may be two years— the cap for termination payments that has been talked
about in the EU—then clearly we would have a different arrangement, which is
one year. So we can see the potential for those managers, when we recruit them,
raising that as an issue in the context of their remuneration. That could lead
us to a higher fixed pay component or potentially to a sign-on payment or
something else, restructuring them for that perceived disadvantage that they
might suffer.[42]
3.38
This appears to suggest that the European Union is contemplating a hard
'cap', rather than allowing higher payments subject to shareholder approval.
This would be much tougher than the proposal contained in this bill.
3.39
Ernst & Young argued that there may be a potential conflict between
Australian and local laws allowing payments of over 12 months' base salary for
overseas based executives. This 'may give rise to a claim against the employer
under local employment law'.[43]
QBE Insurance has also expressed concern about the application of the proposed
law to its employees overseas.[44]
3.40
Other submissions questioned arguments about international
competitiveness. Professor Peetz argued that the evidence did not support the
view that there was significant leakage of Australian executives to other
jurisdictions:
...an examination of executive appointments and departures at
the 50 largest ASX companies over the 2003-2007 period showed that only 4 per
cent of confirmed departures 'were as a result of an executive being recruited
by an offshore employer'. Indeed, only 17 per cent of departures were due to
executives being recruited by another employer in Australia or overseas – most
were terminations or retirements. Amongst CEOs, departures were even less
common – only 7 per cent of CEO departures were to join another employer,
including less than 4 per cent (one CEO) going overseas.[45]
3.41
Professor Peetz also disputed the argument that executive remuneration
is influenced by international rates of pay more than that of ordinary workers:
If the recent growth over the last two decades of executive
remuneration was due to the move to this international labour market for
executives while labour markets for ordinary workers were still national then
you would find quite different rates of pay between countries in local labour
markets because that would reflect those local labour market circumstances. It
would reflect differences in productivity and technology between Australia, New
Zealand, Sweden, the US and so on. So you would have big differences in wages
for ordinary workers between countries that have similar wages for CEOs because
they are all part of an international labour market... But the data does not
actually support that. The data indicates that there are differences in CEO pay
between countries. I mentioned Sweden and the US. A Swedish hamburger flipper
gets about eight per cent more than an American one. But an American CEO gets
4¾ times more pay than a Swedish CEO. So there is not an international labour
market.[46]
3.42
ACSI stated that claims relating to international competition are
overstated.[47]
RiskMetrics data provided by ACSI indicates that the most common causes of
retirement by CEOs were retirement (57.1 per cent) and termination (28.6 per
cent).[48]
3.43
Treasury stated it does 'not believe the draft Bill will have the stated
impact',[49]
referring to the lack of consistent global requirements and ACSI data on
reasons for executives leaving a corporation cited above. They also argue:
The concerns raised by stakeholders would be more valid if a
cap or upper limit on termination payments was being introduced. However, the
proposed reforms do not introduce a cap, but rather allow payments of higher
amounts provided that shareholder approval is obtained.[50]
Increased base salaries or 'golden hellos'
3.44
A number of submissions warned that a likely consequence of reducing
termination payments to one year's base salary would be to increase base
salaries, or to see increases in other aspects of executive remuneration.
3.45
AICD described this possibility in the following terms:
...attempts to restrict termination payments are likely to
result in a "squeezing the balloon" effect, by which we mean
artificial restrictions on one component of executive remuneration will cause
upward movement in another components.[51]
3.46
The Law Council of Australia expressed similar views:
For many executives in large corporations, base salary
represents less than half the value of their remuneration package...this proposal
will actually limit termination payments to less than 6 months total
remuneration, which is likely to be viewed as inadequate compensation for the
risks to tenure of executives in these organisations...the likely consequence of
the proposal will therefore be to increase base pay levels, both in absolute
terms and as a proportion of an executive's total remuneration.[52]
3.47
The Law Council warned that could lead to increased use of 'golden
hellos' when executives commence a new position. The Law Council warned that
this reduction in the proportion of an executive's remuneration linked to
performance was a 'systematic distortion of remuneration structures in a manner
which is disproportionate to the issue being addressed'.[53]
3.48
Two reasons were provided to the committee on why the increase in the
size of base pay as a proportion of the total was undesirable. The first reason
was that it would reduce the percentage of pay that is linked to good
performance – in other words, it reduces the incentive to perform. Chartered
Secretaries Australia noted this possibility:
One thing that springs to mind is that the sort of behaviour
it could lead to is that the fixed component of remuneration packages relative
to the at-risk component could go up so that we might actually perversely end
up encouraging less pay for performance and a bigger base...If I were an incoming
executive wanting to look after myself the best, I would be trying to negotiate
a higher fixed salary component rather than a variable component. It would be human
nature that you would expect that.[54]
3.49
The other reason was the likely increased cost to business, given that
base salary components are guaranteed whilst performance based aspects of
salary only arise if the conditions are met:
I think the issue we would see, for instance, is if the
additional remuneration is in base salary, it is a certain additional cost to
the company. A contingent remuneration based on the way of termination, whether
it is redundancy or a merger or acquisition—whatever reason leads to that
termination— is a cost that may or may not arise. From a company’s point of
view you would much prefer to have the possibility of not having to pay
anything than clearly having a frontloaded or higher base. I guess it is a cost
issue for the company from that point of view.[55]
3.50
Other submitters to warn about possible increases in base pay included
Guerdon Associates, BCA, Ernst & Young, Origin Energy,
ACCI, the ABA, the Insurance Australia Group and IFSA.[56]
3.51
The AMWU warned that treating termination payments in isolation could
lead to manipulation of other aspects of remuneration:
...there is a natural tendency of the self-interested to
manipulate the form of remuneration for their own benefit. This realisation
must be reflected in wider regulation of those same corporate players across
the entire scope of their remuneration, or any attempted control of retirement
remuneration will be ultimately meaningless.[57]
3.52
Professor Peetz stressed the importance of culture in setting overall
remuneration, and argued that it did not necessarily follow that narrowing
termination payments would lead to increases in other areas of pay:
It is not as though there is a fixed amount of money that
goes to executive pay and it is just a matter of divvying it up; the amount of
money that goes to executive pay is shaped by the relative power of the
occupation and the culture that is involved in determining executive pay. If you
create a culture that says excess is fine then all of the elements of executive
pay will go up. Termination payments, base pay and bonuses will all go up. It
is not as though you squeeze one and the other goes up. It is not a fixed
balloon, the size of the balloon varies.[58]
3.53
The ACSI were less concerned about the likelihood of base salaries
increasing due to existing rules allowing shareholder votes on the overall
remuneration package.[59]
3.54
Treasury argued that current rules on setting executive base salaries
would act as sufficient restraint on increasing salaries as a result of this
bill:
...there is greater transparency and accountability with
respect to the payment of base salary during the tenure of the director or
executive. Such payments are required to be disclosed in the company's
remuneration report, and the company is required to clearly explain the policy
for determining the nature and amount of remuneration, and a discussion of the
relationship between such policy and the company's performance. These
requirements operate to provide a measure of accountability and transparency,
particularly if a company seeks an unjustified increase in base salary.
Shareholders also have the opportunity to cast a non-binding vote on the
company's remuneration policies and anecdotal evidence suggests that companies
are increasingly responsive to the non-binding vote.[60]
3.55
Or to use the analogy of 'squeezing the balloon':
I would expect that, generally, the balloon will shrink somewhat
and that it is unlikely you will see exactly the same amount bulge out the
other side if it changes. But even if it does...it is a bulge that will show up,
for example, in the remuneration report, so it will be part of your normal
salary and will be shown in the remuneration report and there is a non-binding
vote sitting over the top of that remuneration report....at least it pops out
somewhere where there are other rules.[61]
3.56
The Explanatory Memorandum indicates a post-implementation review of the
amendments will be undertaken within 'one to two years of the commencement of
the new requirements'.[62]
The committee sees this review as an opportunity to examine any impacts that
might occur on base pay.
A new 'floor'
3.57
A concern was raised in some submissions that lowering the threshold
could lead to an increase in payments up to the new level, in effect
transforming it into a 'floor.' Guerdon Associates raised this risk in their
submission:
By extending shareholder approval to cover employees other
than executive directors, it is possible that an unintended consequence of the
proposed Australian Corporations Act changes could be a rapid increase in
termination benefits for employees below the CEO, from the current median of
about 4 months' pay.[63]
3.58
Professor Peetz referred to this risk as an argument in favour of a
lower threshold for seeking shareholder approval:
A danger, perhaps not large, is that the new ceiling on
termination payments, of one year's salary before shareholders' approval must
be sought, may also become a floor. Consideration should be given to a lower
limit.[64]
3.59
In response to these concerns, it is worth noting that no evidence has
been provided to suggest that payments are routinely being made up to the
existing (admittedly very generous) 'floor'.
What is included in 'termination benefit'?
3.60
The definition of 'benefit' is to be determined by regulations (Item 7,
Schedule 1 of the bill). Several organisations have put forward views about
what should, and should not, be included in the list of benefits subject to
shareholder approval.
3.61
Ernst & Young called for a distinction between payments for past
service (e.g. equity awards that have already vested, mandated holding of
bonuses, incentives, accrued leave) and ex-gratia payments made in respect of
termination. Payments for past service should not be subject to shareholder
approval.[65]
3.62
Chartered Secretaries Australia suggested currently the bill is not
sufficiently clear that accrued statutory benefits are not subject to
shareholder approval:
In fact, we are saying that the people we are most concerned
about under this draft legislation are the mail boys made good, who have worked
their way up through the organisation, been there 30 years, got up to a very
senior position and have been made redundant. We want to make sure that this
does not work a mischief to actually put them in a worse position. Ironically,
it can put someone in a position where they can decline a promotion because
their accrued entitlements, unless this is made right, may actually be in jeopardy.
That is the biggest mischief. We are putting our hands up to say, ‘We don’t
want to take issue with this bill in general, but please make sure you get that
right.’[66]
3.63
The ABA, BCA, Hay Group, Regnan,
and Rio Tinto also sought the exclusion of statutory entitlements.[67]
3.64
BHP Billiton noted that its current remuneration includes long term
incentives in plans which are already approved by shareholders. It argued that
these benefits should not require additional approval by shareholders.[68]
3.65
Several submissions referred to superannuation, including voluntary
contributions to superannuation. For example, Regnan, RiskMetrics and ACSI and
IFSA argued that voluntary super contributions should not be subject to
shareholder approval.[69]
Bluescope Steel, Guerdon Associates and KPMG also sought
clarification of the treatment of superannuation.[70]
3.66
Regnan argued that the inclusion of superannuation benefits could lead
to clashes in obligations for superannuation trustees:
In particular we note that under the Bill, superannuation
trustees will be subject to criminal penalties if a benefit is paid to a member
where that benefit (taken together with other benefits covered by the proposed
provisions) exceeds the new limits...Where the trustee is aware of the
restrictions in relation to the particular member, and withholds payment, this
will result in a breach of other superannuation law.[71]
3.67
KPMG, the ABA and IFSA sought clarification in relation to the inclusion
of 'deferred bonus'.[72]
3.68
RiskMetrics urged that regulations on the definition of 'benefit' should
clarify whether deferred benefits are to be excluded from consideration, but in
so doing, care should be taken to ensure companies do not seek to avoid
shareholder approval requirements by 'categorising amounts paid on cessation of
employment as bonuses for services prior to departure'.[73]
3.69
ACSI also saw 'merit in "carving out" unvested performance pay
and deferred bonus incentives from termination pay calculations', but urged
caution to ensure that this did not become a 'loophole'.[74]
3.70
Treasury provided evidence that statutory benefits will be excluded by
the legislation:
The legislation itself does exclude the statutory
entitlements. However, there is still clearly confusion as to whether they do
or do not, and so we have made recommendations that those specific statutory
entitlements go into the regulations just for clarity, I suppose.[75]
3.71
The committee welcomes this reassurance by Treasury.
Contract Disputes
3.72
Some submissions pointed to the risk that the bill could lead to increased
numbers of contract disputes on key terms, and heightened risk of litigation as
a result.
3.73
The Law Council of Australia noted that the proposed definition of
'benefit' (in regulations) includes 'voluntary out of court settlements' as a
matter requiring shareholder approval. They argued:
This provision will have the effect of forcing employees with
legitimate claims against employers, for breach of contract, unfair dismissal,
harassment, discrimination and other breaches of the law, to litigate at
material expense in order to win damages award from a court, rather than accept
a "voluntary settlement" from the employer. This is clearly an
inappropriate consequence of these reforms.[76]
3.74
Treasury indicates that the explanatory statement to the Regulations
will provide guidance on what is meant by voluntary out of court settlements.[77]
3.75
It should be noted that the Law Council do not question the scope of the
regulation-making power relating to the definition of benefits, only the detail
of what that regulation says.
3.76
The Business Council provided the following evidence in relation to the
current role played by termination benefits in avoiding contract disputes or
litigation:
Employment agreements for CEOs and other senior executives
typically provide for termination payments with very little notice. And, when a
board decides a CEO is not delivering acceptable results, it is in everyone's
interests to encourage the CEO, through mutual agreement, to leave sooner
rather than later. Protracted contractual disputes can be damaging to the
business, including through the potential to affect important commercial
factors such as public reputation, client relationships and staff morale. This
means compensation for the risk of early termination is a priority issue in
contract negotiations.[78]
3.77
A recent media report by Ian McIlwraith in The Age
described this phenomenon more bluntly:
Another element of the system, one companies do not want to
talk about, is that some termination payouts are the equivalent of "hush
money" for failed executives. So a parting pay-off is negotiated on the
understanding there will be no unfair dismissal claims.[79]
3.78
The AICD has described some of the issues surrounding dismissing an
executive for non-performance:
It is not uncommon for a board to believe a CEO is performing
poorly while the CEO believes he or she is performing well...The CEO's position
in a company is atypical of other executive positions. The company's board
needs to have full confidence in the CEO. If the board loses confidence in the
CEO it may need to terminate the CEO's contract even if the company is
otherwise performing well. If so, the board needs to consider terminating the
contract in a manner that takes into account the best interests of all
shareholders.
It can be difficult to proceed under a non-performance clause
in a contract because of the many views that exist on what constitutes poor
performance and how it is measured. This is often a subjective issue. For this
reason, boards may prefer to have a clause in the contract entitling the
company to terminate the contract on notice without the need to provide
specific reasons.[80]
3.79
ACSI argued that these matters could be addressed in the company's
remuneration policy:
Currently companies are required to have their remuneration policy
approved by their shareholders...it is non-binding approval. But it is still
persuasive. Those who get close to a no vote or get greater than 50 per cent in
our experience do then look at that. So if they have an appropriate
remuneration policy then some of those issues should be covered off in that. I
cannot see what circumstances necessarily would say that they have to give
someone a golden handshake to get them to go quickly. Most people are on contracts
of three or five years. If they wanted to come to shareholders and say, ‘Well,
we sign up for five-year contracts. We would think it reasonable that if
someone is in year 3 and we want to get rid of them then we pay them out the
rest of their contract,’ the shareholders will consider that to see in effect
if that is reasonable. Most of these people are on contracts so the golden
handshake cannot go on forever; it has to be confined to what that particular
contract is.[81]
'Total remuneration' versus 'base salary'
3.80
A number of submissions discussed whether it was better for the
threshold for shareholder approval to be based on 'base salary' or 'total
remuneration'.
3.81
Treasury argued that the change is justified due to the growing
percentage of total remuneration represented by components such as performance
pay. Treasury referred to anecdotal evidence that base salary often represents
'one third to one half of total remuneration'.[82]
Treasury argued:
The inclusion of performance pay has the potential to
significantly increase the threshold for shareholder approval, potentially by
millions of dollars, which would undermine the purpose of the proposed reforms.[83]
3.82
This is in itself not a conclusive argument. If the concern is that
'total remuneration' might be too high, it could be possible to set the
threshold as, for example, six months' total remuneration.
3.83
Treasury also argued that the use of base salary rather than total
remuneration is 'consistent with best practice guidelines developed by
industry, referring to ACSI 2005 guidelines.[84]
In its submission, ACSI supports the change to 'base salary'.[85]
3.84
A number of submissions expressed a preference for 'total remuneration'.
For example, the Law Council argued that 'total remuneration' was appropriate,
due to the risk that the bill could lead to a possible decline in the proportion
of remuneration based on long-term incentives.[86]
3.85
Other organisations preferring the retention of 'total remuneration'
include the AICD, the ABA, Guerdon Associates and IFSA.[87]
3.86
Ernst & Young argued that the threshold:
...should be based on a multiple of fixed remuneration
(which includes base salary, fringe benefits, salary sacrifice benefits and
superannuation) as most Australian companies remunerate executives using such
an approach.[88]
Key management personnel
3.87
The bill expands the number of positions which require shareholder
approval for termination benefits. This attracted comment in submissions.
3.88
Chartered Secretaries Australia argued that that any expanded
requirement should apply only to key management personnel and the five most
highly remunerated executives in the previous accounting year.[89]
Ernst & Young, whilst supportive of the expansion, recommended against
reference to the 'five highest paid executives' as this group may vary from
year to year.[90]
3.89
The Law Council of Australia expressed concern about the coverage of all
persons mentioned in the remuneration report for listed companies on equity
grounds:
For executives of listed companies, the entitlement to
termination benefits depends on whether they are listed in the remuneration
report. This is an arbitrary measure, for several reasons. Inclusion may change
from year to year depending on total remuneration relative to other executives
in the company. Executives will not know from one year to the next whether
their termination benefits are limited under the proposed new laws. Perversely,
the inclusion of termination benefits in total remuneration will often cause a
person to be named in the remuneration report for the first and only time in
the year the person retires. Further, a person earning $100,000 in a small
listed company may have their termination benefits restricted, but a person
earning $2 million in a large listed company may not. This is an odd result,
and does not appear to have any sound policy basis.[91]
3.90
The Law Council of Australia argued that it would be 'logical and less
anomalous' for the rules to apply only to executives whose annual remuneration
exceeds a nominated amount, and to treat listed companies, including
subsidiaries, as a single entity.[92]
3.91
ACSI supported the scope of the regulations expanding to include 'key
management personnel'.[93]
Subsidiaries and unlisted companies
3.92
A number of organisations argued that the change would have a
significant impact on companies with multiple boards of subsidiary
corporations. Chartered Secretaries Australia explained the problem of
subsidiary boards in the following terms:
Large listed companies can have hundreds of non-listed
subsidiaries in Australia. For example, BHP Billiton has over 200 (most of
which are in Australia; ANZ has almost 100...The directors of the wholly-owned
subsidiaries are often employees of the parent company, for example general
managers. These persons are often not senior at the scale of the parent company
and their potential termination payments are not at a level that would concern
shareholders in the parent company or the community...if the definition of
'termination benefit' in the Regulations is extended to catch all types of
payments, including accrued annual and long service leave and salary into
superannuation, as was proposed in the exposure draft of the Bill, the
calculation of termination payments to executives in subsidiaries could result
in a payment larger that one year's fixed salary, as it would capture general
managers retiring or resigning, or subject to retrenchment. CSA cannot point to
any public benefit or benefit to shareholders in imposing a new and onerous
requirement on companies that would require shareholder approval of termination
payments of general management in the parent and subsidiary companies.[94]
3.93
Origin Energy, the BCA, Hay Group, KPMG the Law Council, the ABA, Rio
Tinto and the Insurance Australia Group also raised concern about the impact on
members of boards of subsidiaries.[95]
3.94
Rio Tinto gave an example of how their operations might be affected:
In Rio Tinto’s case, approximately 300 subsidiaries form the
Rio Tinto Ltd group of companies and about 150 Rio Tinto employees would be classified
as either a director or an officer. Importantly, a number of these employees
hold positions within Rio Tinto below what would be viewed as senior management
level. Given the new one-times base salary limit, this will mean that Rio Tinto
will need to go to the trouble and expense of general meetings and accompanying
notice papers to seek shareholder approval for payments to a large number of
middle managers as they retire or leave.[96]
3.95
The Australian Bankers' Association also provided evidence on this
issue:
That has certainly been a concern of those HR professionals
and compliance experts in the bank, but when they have looked at the
legislation one bank with, I think, 200 subsidiaries and all are scratching
their heads wondering whether this is going to apply. The reading of the
legislation is that it is going to apply to all of those boards. That is just a
compliance nightmare. I know a lot of the people serving on those subsidiary
boards who are involved in issues with them and they are not the very senior
people in the organisations. They are middle management.[97]
3.96
The AICD opposed the application of the measure to unlisted companies:
...we would argue that the proposed reduction in the
shareholder approval threshold for termination payments applying to companies regulated
by the Corporations Act, which includes not-for-profits, charities, school
boards, community boards et cetera, is too stringent. There is no evidence of
any problem or community concern with the unlisted companies that would
necessitate such changes.[98]
3.97
In response to concerns about the implications for subsidiaries,
RiskMetrics proposed that any uncertainty 'could be resolved by specifying that
in a listed entity, those holding managerial and executive office are only
those persons whose remuneration details must be disclosed in the remuneration
report'.[99]
3.98
Treasury clarified that the bill only will apply to middle managers if
they are also the directors of companies. Treasury also clarified that the Act
already applies to such persons. Treasury explained the prominence of this
issue in submissions as follows:
I am assuming that their termination payments before fell
within the seven times and now their termination payments may be in excess of
what this legislation is requiring. But we are not dragging in a whole group of
people who were not there before.[100]
Compliance cost
3.99
The Explanatory Memorandum states that the compliance cost for companies
associated with the bill will be 'nil.'[101]
This has been disputed by some of the submissions.[102]
3.100
Guerdon Associates noted that the expanded number of persons who might
be subject to the requirement for approval could impose added administrative
costs:
It could require companies to include quite a significant
number of individuals, potentially, with all that that involves including the
requirement to have lengthy details in shareholder notices and meeting notices.
The more that is involved, obviously, the greater the administrative costs
incurred. It seems to us to serve little purpose when you consider the level of
payment that might be involved in absolute dollar terms.[103]
3.101
No Regulation Impact Statement (RIS) is provided. The Explanatory
Memorandum states that the Office of Best Practice Regulation advised a RIS is
not required 'due to the Government's prior announcement to progress reforms in
this area'.[104]
The BCA and Rio Tinto expressed dissatisfaction about the decision not to
complete a Regulation Impact Statement.[105]
Cause of Termination
3.102
The bill does not specify different treatment for retirements which
occur for different reasons. Some submissions saw this as a flaw in the bill.
3.103
The Australian Compliance Institute argued that the circumstances of
termination should be taken into account:
...in circumstances where an employee's employment is
terminated as a result of undertaking an activity that is deemed to be either a
significant breach of the organisation's compliance or governance plan and/or
also in breach of the law, then that employee should forfeit any claim to a
termination payment.[106]
3.104
A number of submission argued that termination payments in cases of bona
fide redundancy are appropriate, particularly if the redundancy early in an
executive's tenure. Rio Tinto also referred to the need to protect cases of bona
fide redundancy.[107]
3.105
Chartered Secretaries Australia argued that the focus of the bill should
be on 'ex gratia payments that might be made to very senior people after a
period of poor performance'.[108]
They argue that bone fide redundancies should be excluded.[109]
3.106
In 2005, Geof Stapledon noted one of the arguments often provided in
favour of termination payments is compensation in cases of bona fide
redundancy:
...if there is a possibility of a company merging or being
taken over, termination payments ensure a measure of objectivity on the part of
executives during negotiations. Executives may otherwise not act in the best
interests of shareholders because they are more concerned about losing their
jobs following the change in management that will occur if their company is
taken over by another.[110]
3.107
However, Stapledon also acknowledges the counter argument:
...termination payments can, in fact have the opposite effect.
They may cause a passive attitude by executives who know that regardless of the
actions they take, they will be compensated.[111]
3.108
The ACSI were supportive of exclusion of redundancy payments, provides
such payments were genuine redundancies:
...we can understand why in relation to the termination
benefits you exclude the statutory benefits, why you determine that the
superannuation is not a benefit if it is a bona fide contribution and why you
exclude redundancy payments—as long as it is a genuine bona fide redundancy.
Consistent with industrial law...we are talking about where a position is genuinely
surplus to requirements...We need to make sure that we do not have a loophole...[112]
3.109
Treasury argues that the amount provided for by the bill represents a
'reasonable amount' for redundancies.[113]
They have also indicated that legitimate redundancy payments are still a matter
being considered by the government.[114]
Technical Matters
Delegation of critical terms to the
regulations
3.110
Several organisations expressed concern that definitions of critical
terms (such as 'base salary' and 'termination benefit') in regulations were not
available at the time of preparing their submissions. These include the BCA, Chartered Secretaries Australia, Bluescope Steel; Origin
Energy and Rio Tinto.[115]
3.111
These submissions argued the bill and regulations need to be considered
by the committee as a package. It is not clear if these organisations object to
the scope of the regulation-making provisions in the bill, or simply to the
unavailability of the draft regulations.
3.112
Treasury released an exposure draft of the regulations in May 2009, and
developed redrafts of the regulations for targeted consultation with
stakeholders. It is understood that this targeted consultation includes all
organisations who made submissions on the exposure draft and others who request
participation.
3.113
Treasury argue that it is necessary to specify the definition of 'base
salary' in the regulations to provide 'flexibility for the law to respond to,
and to quickly address, any attempts to manipulate the definition'.[116]
The AMWU support this as 'an attempt to remain flexible and fleet of foot in
response to rapidly rearranged executive pay packages which will circumvent the
strictures of this Bill'.[117]
3.114
Treasury argues that the power to make regulations prescribing things to
be, or not to be, a benefit is required in order to address 'some legal
ambiguity as to whether certain types of payments are considered to be a
termination payment requiring shareholder approval'.[118]
3.115
The committee notes that these suggestions for improvement of the draft
regulations do not argue that it is inappropriate for such matters to be
delegated to regulation. The committee urges Treasury to continue working with
stakeholders to resolve any remaining concerns, where possible.
Lack of clarity of transitional
clauses
3.116
The government has stated that bill 'will not affect existing contracts,
and will apply all new contracts which are entered into, extended or
substantially varied after the commencement date'.[119]
In its submission, Treasury states that 'where an essential term of the service
contract has been varied (including terms relating to remuneration), the
contract will be subject to the proposed new laws.[120]
3.117
Several organisations expressed a view that the transitional clauses
were not clear in regard to what constitutes a 'substantial variation.' These
include the ABA, BCA, Chartered
Secretaries Australia, Bluescope Steel, Guerdon Associates, Ernst & Young, Rio
Tinto and IFSA.[121]
Clayton Utz and Mallesons Stephen Jacques have both referred to this issue in
online advisories.[122]
Penalties
3.118
The bill increases penalties under subsections 200B(1), 200C(1) and
200D(1) from 25 to 180 penalty units (currently $2,750 to $1,980) for a natural
person and from 150 to 900 penalty units (currently $16,500 to $99,000) for a
body corporate. These provisions remain strict liability offences.
3.119
The Explanatory Memorandum argues that the increase 'is intended to
reflect the seriousness of giving a termination benefit where it has not been
approved by shareholders in accordance with the Act, and to provide a
sufficient deterrent to unauthorised benefits'.[123]
3.120
The AICD opposes a breach of the termination provisions being a strict
liability offence (as currently provided under the Act). They also oppose the
proposed increase in penalties.[124]
3.121
The AMWU 'appreciate that penalties have significantly increased, but
are concerned that manipulation by the recipients of termination payments may
not be adequately controlled by these penalties'.[125]
The AMWU argue that the bill would be strengthened by inclusion of 'sanctions
against avoiding or conspiring to avoid the shareholder approval required by
this Bill'.[126]
Amount in excess of 12 months not
specified
3.122
RiskMetrics has suggested that the bill as currently drafted would allow
the board to seek approval for payments in excess of the 12 month base salary
limit without specifying the extent to which the payments would be in excess of
12 months base salary'. They argue that the bill should be amended 'to require
any advance approval of a termination payment to specify a maximum dollar cap
that may be paid under the authority sought from shareholders'.[127]
This concern was also raised by the ACSI.[128]
3.123
If accurate, this would represent a significant loophole in the bill.
Recommendation 1
3.124 The committee recommends that Treasury examine the bill to ensure that
shareholders have the opportunity to approve a specific amount, and not an
unnamed amount greater than 12 months' salary.
Removal of exemption for pre-1991
contracts
3.125
The drafting of amendments to 200F(1)(a) appears somewhat complex.
3.126
Item 25 (Schedule 1, Part 1) inserts words into the paragraph. Item 42
repeals the paragraph, and replaces it with new words. It is not clear from the
Explanatory Memorandum why it is necessary to amend the paragraph twice in this
way.
3.127
Item 43(3) provides that the amendments made by item 42 do not apply for
contracts entered into before 1991. As item 42 removes the exception which
currently applies to contracts made before 1991, item 43(3) appears to negate
the effect of item 42. The EM does not explain why this approach has been
adopted.
3.128
These provisions were not raised in submissions. Accordingly, the
committee makes no further comment
Recommendation 2
3.129 The committee recommends that the Senate pass the bill.
Senator
Annette Hurley
Chair
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