8 March 2012

Keynote Address, KPMG Executive Remuneration Forum for Non-Executive Directors

Thank you for the introduction.

Earlier this week I delivered my first keynote address as Parliamentary Secretary, at the KPMG Executive Remuneration Forum. And it gives me great pleasure to be here today, to talk specifically with non‑executive directors on this very important topic. I would like to take this opportunity to thank KPMG for hosting today's forum, and providing me with opportunities to engage further with you.

The Gillard Government's executive remuneration reforms have been crucial in restoring investor confidence following the Global Financial Crisis, and it is this hard work which has made Australia's executive remuneration framework as internationally competitive as it is today.

Background to the reforms

Even before the Global Financial Crisis had hit, executive remuneration had been on the agenda for Government review. The concerns that the link between executive remuneration and company performance had broken, was an issue not only in Australia, but also abroad.

It was a global trend – a global trend towards escalating executive pay, as companies compete both within and between jurisdictions for the top talent, in an effort to gain as much as they could from the positive economic environment and strong investor confidence.

During this period, companies enjoyed high levels of growth, benefited from strong investor confidence, and executives were rewarded for this with large payments of bonuses and payouts.

The Crisis acted like a test to the corporate governance systems of every company.

It is widely recognised that Australia fared better than many other advanced economies – and part of the reason is the strong corporate governance framework we have in place.

However, we were careful not to be complacent.

The Gillard Government was quick to respond to concerns with excessive executive remuneration. One of the key actions we took was to task the Productivity Commission to examine Australia's executive remuneration framework, and the principles which govern executive remuneration.

The Productivity Commission undertook a comprehensive analysis – which sought input from all groups of stakeholders, with almost 200 submissions and nine rounds of public hearings as part of its consultation process. The final report was provided to the Government in December 2009.

The Productivity Commission concluded that, consistent with international consensus, that Australia's executive remuneration framework is robust internationally and ranks well on an international scale. It also made several recommendations to further enhance our framework. These recommendations subsequently formed the basis for the reforms that were enacted last year.

'Two-strikes' test

Most notably, the 2011 reforms gave shareholders a stronger say over executive pay through the "two-strikes" rule. During the AGM season last year, 108 "first‑strikes" were reportedly recorded against companies.

But the success of the reforms should not be judged by the number of strikes recorded. Rather, we should look at the overwhelming majority of companies for which strikes were not recorded.

Our reforms are intended to address company and shareholder culture — to return it to how things should be. And the fact that so many companies did not have strikes recorded suggests that company culture has already begun to change for the better.

Companies are making the effort to ensure that executive pay is reasonable, and making the effort to justify to shareholders the amount of executive pay determined. At the same time, shareholders are being reasonable in approving the level of pay when it is justified.

In a sense, the "two‑strikes" reform achieves two purposes.

Not only does it remind companies of the need to better engage shareholders and better evaluate the link between executive pay and performance, but it also serves to remind shareholders of their responsibilities and that they should be engaged.

As this year's AGM season is nearing, I am aware of the anxiety developing in boardrooms, especially in those companies which received a "first‑strike" last year.

I would reiterate that if remuneration is set reasonably, and the Board makes a reasonable effort to justify the remuneration report to shareholders, they should not be concerned that a "spill‑vote" would be triggered.

The "two‑strikes" test should remind directors that their shareholders ultimately own the company, so it is only logical that they have an avenue to express their disapproval to the company.

In order for companies to view shareholders as their owners, those owners should be able to access key information about the company to form a judgement on how their company has been performing. When shareholders are unhappy about management decisions, they should be able to express their disapproval and companies should account for such views.

And for shareholders to view themselves as owners of the company, they need to be active and engaged, rather than sitting back judging the value of their company purely on share prices, and the amount of dividends they receive.

I am aware that some have queried whether the threshold of 25 per cent is appropriate. The Productivity Commission consulted extensively on this proposal, particularly on the threshold level of 25 per cent. The Productivity Commission concluded that a threshold of 25 per cent for each of the strikes was appropriate, as this is in line with the level of support required for special resolutions, where a 75 per cent majority is required for the resolution to pass.

As well, a threshold of 25 per cent better aligns with levels commonly accepted as demonstrating serious shareholder concerns about remuneration, particularly in light of current voting patterns. Clearly, it would also have a greater reach than a threshold of 50 per cent.

The Government, has been mindful about concerns that a threshold of 25 per cent could have a de-stabilising effect on the company. That is why a 50 per cent threshold, or a majority of shareholders, is required to spill the board.

I am also aware that some have questioned the basis for calculating the strikes, indicating that it should be based on the total shareholding, rather than the number of votes cast. The Productivity Commission considered this issue, and came to the view that, consistent with normal voting protocols, it should be calculated on the number of votes cast. To base it on the total shares on issue would have the effect of significantly diluting the 25 per cent threshold, and lead to reduced accountability on remuneration issues.

Other measures in the 2011 reforms

The 2011 reforms also included reforms which aimed to address the real and perceived conflicts of interests involved in the engagement of remuneration consultants. Boards are now required to declare in their remuneration reports, an opinion on whether they believe the recommendations of a remuneration consultant were made free of undue influence.

Shareholders can then make an informed assessment about the independence of the consultant. These reforms are designed to ensure that information surrounding payment and identity of remuneration consultants is properly disclosed.

Measures were also introduced which prohibit the company directors and key executives, and related parties, from voting their shares in the non-binding vote in the remuneration report. This directly addresses the conflict of interest that would arise if executives were allowed to vote on their own remuneration.

Other measures introduced last year relate to prohibiting the hedging of incentive remuneration, prohibiting board from declaring 'no vacancy' without explicit shareholder consent', and disallowing proxy holders from voting only the proxies they choose.

Cessation of employment trigger for taxation

I would also now like to briefly touch on the recommendation made by the Productivity Commission which was not accepted by the Government. This recommendation related to the cessation of employment trigger for taxation.

Cessation of employment as a deferred employee share scheme taxing point has been a feature of the law since 1995. Removing the cessation of employment taxing point would increase the concessionality of schemes, providing a disproportionately large benefit to higher‑income employees.

It would reduce the integrity of the tax system and make it more difficult for the Tax Office to ensure the correct amount of tax was paid. The recommendation would have a significant cost to Government revenue.

The Government believes that the current taxation of employee share schemes strikes the right balance between providing concessions in support of employee share schemes, and tightly targeting expenditures to reflect key Government priorities.

These reforms enacted last year were all designed to encourage a change in boardroom culture, to a culture which is more transparency and accountable, a culture where shareholders are better engaged and have more say. The reforms also aimed to address the concern that the link between executive remuneration and company performance had been broken, by restoring and strengthening the link.

But ensuring that our framework remains robust is an ongoing job.

Further reforms to the executive remuneration framework

Last month, the former Parliamentary Secretary David Bradbury announced that the Government is proposing further reforms to the executive remuneration framework. There are four prongs to the proposed set of reforms… improving disclosure in remuneration reports… greater accountability and transparency on clawback… relieving certain unlisted entities of the obligation to prepare remuneration reports for certain entities… and lastly, moving some disclosure requirements from the AASB accounting standards to the Corporations Regulations.

The proposed reforms build on the previous set of reforms.

We are not looking to introduce more and more reforms. Rather, we are refining the framework while minimising the corporate burden wherever possible.

Improving disclosures in the remuneration report

Let me turn first to disclosures in the remuneration report.

The "two‑strikes" test introduced last year significantly enhanced the role of the remuneration report. Remuneration reports are now a very valuable means of communication between the company and its shareholders. For this reason, our reforms are designed to improve the information content in the remuneration report to facilitate the "two‑strikes" mechanism.

In April last year, the Corporations and Markets Advisory Committee released a report making several recommendations for improving the quality of remuneration reports. Our proposed reforms adopt some of those recommendations.

We propose to remove disclosures which are less relevant, to simplify remuneration reports; and improve relevant disclosures for other areas, such as termination payments, and dividends paid to directors and executives on unvested shares. We also propose to require a clearer breakdown of remuneration. These reforms will enable shareholders to better understand the company's remuneration arrangements — and will in turn facilitate the "two‑strikes" mechanism.

Clawback

Moving onto clawback…

As you may be aware, Treasury released a consultation paper last year discussing the possibility of a clawback requirement, in the case of materially misstated financial statements. Many stakeholders expressed the view that, while a clawback requirement was beneficial, it would be impractical to mandate clawback as companies needed flexibility to deal with the particular circumstances of the misstatement.

Taking stakeholder views into account, we propose to introduce a legislative requirement to oblige listed companies whose financial statements have been materially misstated to disclose in the remuneration report whether any overpaid remuneration had been subsequently "clawed‑back" as a result of the misstatement.

The idea is that if shareholders are not satisfied with the clawback arrangement, they can take action through the "two‑strikes" mechanism. This approach gives Boards flexibility, while ensuring that they remain accountable to shareholders. This reporting obligation is triggered only where a company's financial statements are materially misstated, minimising the regulatory burden on companies.

Relief for certain unlisted companies

Thirdly, the Government is committed to ensuring that companies are required to invest resources in producing information only when the cost is justified by the benefit it will bring to shareholders. As unlisted companies are not subject to the "two‑strikes" mechanism, the remuneration report is less significant to their shareholders. For that reason, we propose to relieve these entities from the obligation of preparing a remuneration report. This should significantly reduce the regulatory burden for these companies.

Related party transactions

The last of the proposed reforms relates to the disclosure requirements currently contained in the accounting standards relating to related party transactions. In July last year, the AASB announced that they will withdraw disclosure requirements contained in clause "Aus 29" of AASB 124 Related Party Transactions, because they felt that the requirements were better dealt with in legislation. We propose to adopt these requirements into the Corporations Regulations, so that shareholders still have access to the information.

As you can see, the proposed reforms are designed to work together and build on what we already have, to form a robust framework for Australia.

These reforms will further strengthen Australia's executive remuneration framework, keeping us at the forefront of the global movement towards better corporate governance.

Spiralling executive remuneration is not unique to Australia. Britain is considering introducing reforms similar to ours to improve accountability and transparency in their executive remuneration framework.

As the British Prime Minister David Cameron said recently:

"We need to change the way the free market works, not stop the free market from working."

I agree.

Our reforms are designed to shape — not prescribe — a company's internal processes, by influencing culture through imposing higher levels of transparency and accountability.

It is reassuring to see other jurisdictions also taking steps to address the issue of executive remuneration. As participants in the global economy, we want to see all economies, not just Australia, move towards a culture of transparency and accountability.

Ultimately, this will help to promote global financial stability, and facilitate transactions across the globe.

Conclusion

Before concluding, I'd like to say that conferences such as this provide a prime opportunity for companies to share their experiences on executive remuneration, and the broader corporate governance framework.

While there's no such thing as a one-size-fits-all approach to corporate governance, the underlying aim of the Government is to foster a culture of greater transparency and accountability, and allow owners to be more engaged with their company.

I look forward to working with you to build an internationally-recognised corporate governance framework amongst Australian businesses.

When adjusting your businesses operations to meet our corporate governance reforms, I would like you to stop and think of the reason behind the reforms, and implement them in a way that promotes transparency and accountability. And help Australia to build our image as a nation with a strong corporate governance framework, where investors can confidently invest their funds.

We must not forget that shareholders are the owners of the company, and their say is very important. By empowering shareholders, and increasing transparency and accountability, we can foster a stronger level of trust and cooperation between companies and shareholders.

Once again, thank you for inviting me to speak with you today and I trust you enjoy the rest of the conference.