Thank you Martin (Morrow) and Ben (Travers, of KPMG) for that introduction and for the invitation to come and address this year's KPMG Executive Remuneration Forum for Non-executive Directors.
I recall that last year's forum was my first keynote address as Parliamentary Secretary so it's great to be back here today to talk specifically with non‑executive directors on this very important topic and at this important juncture.
I'd like to thank KPMG for hosting today's roundtable, and giving me the opportunity to engage further with you. This afternoon I'd like to talk to you about the Gillard Government's latest executive remuneration reforms and how we're responding to recent developments in this area.
But first, some context.
Background to the current reforms
In the aftermath of the global financial crisis, there was a perception that the nexus between pay and company performance was breaking down, and that remuneration was encouraging excessive risk-taking and rewarding short-term gain.
There was widespread concern that the executive pay of some directors was increasing while the value of their companies was heading south.
It was around this time in 2009 that the Federal Labor Government responded promptly to community concerns about executive pay practices by passing legislation to curb excessive 'golden handshakes'.
Given the issue of CEO exit packages has been in the media spotlight again recently, it's worth recalling that as a result of these reforms, termination benefits for executives that exceed one year's average base salary now require shareholder approval. Prior to this, shareholder approval was only required if termination payments exceeded seven years' total compensation.
In that same year, the Government asked the Productivity Commission to examine the framework governing executive pay in Australia.
This was a thorough and comprehensive look at whether our regulatory environment stacked up, and indeed, whether there was room for improvement – undertaken by one of Australia's premier economic bodies, and informed by extensive consultation.
The PC concluded that we had a framework that compared very well internationally. But it put forward a number of options for how it could be enhanced by, for example, improving the capacity of boards, reducing conflicts of interest and encouraging more shareholder involvement in remuneration matters.
The Commission's recommendations formed the basis of the Government's executive remuneration reforms that were passed by the Parliament in June of 2011.
You will no doubt be familiar with the 'two strikes' test, which the Gillard Government introduced that year as the centrepiece of reforms to strengthen the accountability and transparency of Australia's executive remuneration framework.
The two strikes rule is designed to empower shareholders to have a say in the remuneration paid to executives in the companies that they own.
The test gives shareholders unprecedented power over the pay of company executives.
If the company's remuneration report receives a 'no' vote of 25 per cent or more from shareholders at two consecutive annual general meetings, a resolution supported by a majority of shareholders can force a spill of the board.
We have recently come through the second AGM season in which the two strikes rule has been in force, and it's worth looking at some of the results.
In 2012, only nine of the 108 'first strike' companies received second strikes. Of these, only three (Globe International, Rey Resources and Penrice Soda) faced a spill of their board after the majority of shareholders passed a spill resolution. However, the boards of both Globe international and Penrice were ultimately returned, while the entire board of Rey Resources resigned after the meeting so there was no need for a spill meeting to be held.
What I'm suggesting is that the success of the reforms shouldn't be judged by the number of strikes recorded. Rather, we should look at the overwhelming majority of companies for which strikes were not recorded.
I want to emphasise that these reforms are intended to drive a culture of change within companies and ensure that boards are held accountable to shareholders for the decisions they make on the level and composition of executive pay.
As owners of a company, shareholders expect executives to be rewarded based on the performance of a company.
So let's be clear, these reforms aim to ensure that remuneration remains closely linked to company performance and the value that executives bring to a company.
Fortunately, the fact that so many companies did not experience first or second strikes suggests that company culture has already begun to change for the better.
This is resulting in better engagement between boards and shareholders, and more transparency around the decisions they make on executive pay.
And we're continuing to see the effect of these reforms in increasing the accountability of boards.
For example, executives from Fairfax Media, Rio Tinto, Qantas, BHP Billiton, BlueScope Steel, ANZ, Pacific Brands, Commonwealth Bank of Australia, AMP and Perpetual all recently waived their share-based and cash bonuses, at least partly in response to shareholder concerns.
In fact, many boards have made it clear they're demonstrating restraint against a backdrop of uncertain global economic conditions.
Indeed, boards should be more conscious of the need to justify executive pay to shareholders, particularly when profits and profit outlooks may not be meeting expectations.
In this way, the Gillard Government's reforms provide a balanced and sensible template for other jurisdictions to improve governance in their executive remuneration frameworks and give shareholders more power to have a say.
Going forward, remuneration reporting practices are likely to evolve over the next few years in response to the introduction of the two strikes test. The Government has no plans to change the rule, but will monitor the changes that companies choose to make to improve their communications with shareholders as a result.
So while I believe Australia's current remuneration policy settings are sound and working well, it's important we don't allow ourselves to become complacent.
Which brings me to the focus of my address today.
The next step to ensure that Australia's executive remuneration framework remains at the forefront of international best practice is to promote more transparent disclosure of the details surrounding remuneration.
This will ensure that shareholders have the information they need to convey their views through the non-binding shareholder vote, and to hold directors accountable for their remuneration decisions.
As you know, under the Corporations Act, all disclosing entities are required to prepare an annual remuneration report. This is a key source of information for shareholders on how executive remuneration is set and it has assumed even greater significance in the context of the two strikes rule.
Concerns have been raised in the past about the increasing length and complexity of remuneration reports. In particular, shareholders can sometimes find reports impenetrable and potentially even misleading.
In considering these issues, the Productivity Commission recommended that remuneration reports include a plain English summary of the company's remuneration policies, actual levels of remuneration received by individuals named in the report, and the total company shareholdings of the individuals named in the report.
In our response to the Commission's recommendations, the Government asked the Corporations and Capital Markets Advisory Committee (or 'CAMAC') to examine the disclosure framework around remuneration practices and consider how best to revise the requirements in the Act and supporting regulations.
The Government also broadened CAMAC's terms of reference to include options on how the incentive components of pay could be simplified.
This is because the size and complexity of remuneration reports is partly due to the increasing complexity of the underlying remuneration arrangements.
The CAMAC report was publicly released in May 2011. It contained a range of recommendations designed to simplify and improve the quality of remuneration reports, and provide more relevant information to shareholders – while noting that boards are best placed to determine the particular remuneration arrangements that promote the interests of the company and its shareholders.
The Government also released a discussion paper on proposals to 'claw back' remuneration in the event of a material misstatement.
Following on from the CAMAC review, the Government announced the next tranche of proposed reforms on the remuneration disclosure framework for public consultation in February last year.
In announcing the Government's response to CAMAC's recommendations, my predecessor David Bradbury indicated that the Government intended to consult widely before introducing an enacting Bill into the Parliament.
The reforms he announced are designed to strengthen the transparency of executive remuneration disclosures, and enable shareholders to better understand the company's remuneration arrangements.
Then on 14 December last year, I released an exposure draft Bill for public consultation setting out the Government's response to the CAMAC review and the claw-back consultation paper.
These proposals would implement several CAMAC recommendations designed to strengthen the transparency of executive remuneration disclosures in remuneration reports.
As part of this package, unnecessary disclosure requirements will be removed to simplify remuneration reports, and clearer categorisation of pay will be introduced to better enable shareholders to understand the company's remuneration arrangements.
These reforms will require companies to improve the disclosure requirements in their remuneration report, including:
- providing a general description of the company's remuneration governance framework;
- disclosing all termination payments or 'golden handshake' payments made to key management personnel; and
- clearer categorisation and breakdown of remuneration, differentiating between present pay, future pay, and so‑called 'crystallised' past pay, for each key management personnel.
The reforms also remove some existing requirements, such as the need to disclose the value of lapsed options, instead requiring disclosure of the year in which the option was granted.
Additionally, the reforms relieve certain unlisted entities from the obligation to prepare a remuneration report at all.
These draft laws will further enhance transparency around executive pay and simplify disclosure requirements in annual remuneration reports.
I will now briefly outline each of these reforms.
Remuneration governance framework
Firstly, as I mentioned earlier, 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.
To that end, 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.
I think we'd all agree that remuneration information is best disclosed in the context in which it's been set. Companies with a good understanding of their shareholders' need for the details of performance‑based pay also provide an explanation of the processes and systems that underlie how it's set.
The Government agreed with CAMAC that it's not necessary to legislate which specific details of the framework need to be disclosed. This recognises existing requirements such as those arising from listing rules, ASX corporate governance guidelines and elsewhere in the Corporations Act.
For simplicity, companies will be able to cross‑reference existing disclosure that describes the processes for setting remuneration. This amendment simply ensures that, as a minimum, all disclosing entities will be required to provide this information.
Reducing the regulatory burden for certain unlisted companies
Second, 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.
In a step further, we have simplified the reporting requirements so that companies will only need to report the fact that options held by key management personnel have lapsed, and identify the years in which they were granted.
However, there will be no obligation to report a value for those lapsed options, which is of little or no use to shareholders.
Thirdly, this next phase of reforms has been developed after extensive consultation on a proposal for 'claw-back'.
Currently there's no requirement for clawing back bonuses or other remuneration in the event of a material misstatement by the company.
I think it's legitimate to ask whether directors and executives should be entitled to keep remuneration that was based on materially erroneous financial information.
And similar questions have been asked around the world.
The new global standards on pay in the financial sector require that any unvested performance-based component of remuneration must be able to be reduced or eliminated if long-term performance objectives are not realised.
Under the proposal, the Government will progress amendments to the Corporations Act to require listed companies to disclose to shareholders through the remuneration report the steps they have taken to claw back bonuses and other remuneration where a material misstatement has occurred in relation to the company's financial statements.
If the company has not clawed back any remuneration, the board will be required to provide a detailed explanation to their shareholders.
If shareholders are unhappy with the company's actions, they would be able to use their powers under the two strikes rule to vote down the remuneration report and potentially spill the board and force fresh elections of directors.
This approach gives boards flexibility, while ensuring they remain accountable to shareholders.
This reporting obligation is triggered only where a company's financial statements are materially misstated, thus minimising the regulatory burden on companies.
As owners of a company, shareholders expect executives to be rewarded according to the performance of a company. These reforms put the onus on listed companies to make sure they have provisions to claw back bonuses and other pay from executives if there has been a material misstatement of a company's financial statements.
The Government considered views put to it that the claw-back of bonuses should be mandatory in cases of material misstatement. However, in keeping with the Government's general approach on executive remuneration, we announced a disclosure based approach that will provide the owners with the necessary information.
There was extensive consultation on the claw-back proposal in 2011, and stakeholders were generally supportive of the 'comply-or-explain' approach.
I commend the fact that claw-back provisions in executive contracts are already being adopted by many listed companies. These reforms will ensure that shareholders are able to have a say about the efficacy of those provisions.
Going forward, we intend to continue to monitor company practice in the area of bonus claw-back, to ensure the ongoing effectiveness of this approach.
Past pay, present pay and future pay
Lastly, following recommendations from both the PC and CAMAC , the Government will now require companies to disclose realised pay for key management personnel.
Specifically, CAMAC recommended that the remuneration report should specify, for each key management personnel, the actual pay received by that person, including their current pay and any crystallised past pay, in addition to any entitlements granted during the period but deferred as future pay.
CAMAC considered that mandatory disclosure of each of these elements would ensure that shareholders of all companies are given appropriate and comparable information on remuneration outcomes.
As you may appreciate, this disclosure model has been the focus of debate in consultations, with a range of varying perspectives.
Ultimately, our guiding principle will be that simplification of remuneration reports should not lead to a diminution or dilution of the richness of information that's provided to shareholders.
In terms of next steps, the Government is seeking formal feedback from the corporate and investor community, and their advisers, on the disclosure of remuneration outcomes for key management personnel.
I would encourage you all to consider the proposals, and to provide feedback to Government on these important reforms. I know Treasury has already been discussing the issues with many of you.
The deadline for submissions on the Exposure Draft Bill is next Friday, the 15th of March, and I would urge you to participate in the consultation process.
I'm pleased to hear the business community broadly supports the Government's reform objectives and is keen to be part of this process. For our part, we're keen to work together with you to help achieve transparency and simplicity in the disclosure of executive remuneration.
In closing, can I say again conferences such as this provide a great opportunity to come together to share experiences on executive remuneration and corporate governance more generally.
Taken together, the remuneration reform proposals I've spoken about today build on the Federal Labor Government's earlier reforms and our intention to continue to drive cultural change in boardrooms and AGMs around Australia.
These balanced and sensible changes are part of a consistent and coherent policy framework. They're part of a set of sound corporate governance principles, which are critical to the effective operation of Australia's corporate regulatory system.
These reforms seek to improve accountability and transparency while preserving our international competitiveness.
Better engagement between directors and shareholders, better understanding of the role of company management and company owners, and better alignment of the interests of principals and agents in the corporate structure, will drive improved company performance.
This is good for both shareholders and employees. But it also has broader positive implications for jobs, productivity and our international competitiveness.
Thank you again for the opportunity to come and speak with you today. I'm happy to take a few questions.