19 October 2011

'Redefining Executive Remuneration and Performance', Keynote Address to IQPC, Remuneration and Reward Conference, Melbourne

Thank you Sabiha (Vorajee, Compensation and Benefits Manager, Lend Lease) for that warm introduction.

I would like to thank IQPC for inviting me to deliver the keynote address this morning. 

The remuneration of executives is an important issue that is of great interest to shareholders and the public.  This interest is not likely to wane anytime soon; and nor should it.

Such interest is always highlighted during the AGM season, which is now underway for this year.

And it is also highlighted in an environment of increased global economic uncertainty and volatility, where in some other parts of the world people are 'occupying' their financial centres in protest.

Reforming the executive remuneration framework

In the aftermath of the global financial crisis, there were common perceptions that the link between pay and company performance was breaking down, and that remuneration favoured the kind of risky behaviour that rewards short-term gain. 

There was widespread concern that the executive pay of some was increasing while the value of their companies was plummeting. 

As a result, in 2009, the Government asked the Productivity Commission to examine the framework governing executive pay in Australia.

This was not a kneejerk reaction to overseas developments that some branded it to be.

The examination of remuneration in Australia was a timely and appropriate look at whether our regulatory environment stood up, and indeed, whether there was scope for improvement.

And it was a comprehensive examination – an examination undertaken by one of Australia's premier economic bodies, and informed by hundreds of written and oral submissions.

The Productivity Commission concluded that we had a framework that was highly-ranked internationally, but also one that could be made to better align with the interests of shareholders, improve the capacities of boards, and reduce conflicts of interest.

The Productivity Commission's recommendations formed the basis of the Government's executive remuneration reforms that were passed by the Parliament in June of this year.

Key aspects of the executive remuneration reforms

The central plank to the reforms, and the one that has attracted the most attention, is the new "two­strikes" test. 

The test strengthens the non-binding vote by giving shareholders recourse in the event that recalcitrant boards fail to respond to their concerns on remuneration matters.

Under the "two-strikes" and re-election process, the first strike will be triggered where a company's remuneration report receives a "no" vote of 25 per cent or more. 

A second strike will be triggered if the company receives another "no" vote of 25 per cent or more the following year. 

Ultimately, if a board fails to adequately address shareholder concerns over a two-year period, the shareholders can vote on whether the entire board of directors should be made to stand for re-election within 90 days. To be successful, this resolution would require a majority of the votes cast.

The Government implemented this measure to provide an additional level of accountability for directors, and increase transparency for shareholders. 

While it is not a binding vote, as some had advocated in this debate, it sends a clear signal that unresponsive directors will be held accountable for their decisions on remuneration. 

Moreover, it sends the message that boards have to engage with shareholders to provide sufficient justification for their executive remuneration decisions.

Shareholders shouldn't be expected to rubber stamp remuneration reports, or to have their concerns ignored year after year.

The two-strikes test gives boards an incentive to ensure that they communicate the rationale behind remuneration decisions.

In addition to the introduction of the two-strikes test, the Government's executive remuneration reforms include reforms relating to remuneration consultants.

Stakeholders commonly expressed concerns about the real and perceived conflicts of interest involved in the engagement of remuneration consultants, particularly where they are asked to advise on the remuneration of those officers who have either directly engaged their services or have some influence over that process.

We want to make sure that information surrounding the payment and identity of remuneration consultants is properly disclosed.

The Government's reforms require a board to declare, in its remuneration report, whether it believes the recommendations of a consultant were made free of undue influence.  This ensures that shareholders can make an informed assessment about the independence of the remuneration consultant.

The reforms also include several other important measures.

They prohibit the company's directors and key executives, as well as closely-related parties, from voting their shares in the non­binding vote on the remuneration report.  In this way, the reforms address the conflicts of interest that arise when executives vote on their own remuneration.

Hedging of incentive remuneration has also been prohibited to make sure that remuneration remains linked to performance.

In relation to board composition, our reforms ensure that shareholders can address concerns that a board is functioning in a 'closed shop' fashion.  The reforms prevent boards from declaring "no vacancy" without explicit shareholder consent.

The reforms also stop proxy holders from "cherry picking" proxies – or voting only those proxies they choose to – a reform that will enfranchise more shareholders who choose to vote by proxy. 

We now have a series of reforms that will maintain our international competitiveness and improve the transparency of, and ultimately confidence in, Australia's executive remuneration framework.

The reforms are designed to shift boardroom culture towards better engagement with shareholders.  And to ensure that remuneration outcomes are linked to the performance of a company and the value that executives bring.

Directors should be held accountable to shareholders for the level and composition of their remuneration decisions.  After all, as owners of a company, shareholders share in the company's profits and losses so it is reasonable that they have a greater say in the pay of those responsible for a company's profitability.

These reforms are part of a set of sound corporate governance principles which are critical to the effective operation of Australia's corporate regulatory framework. 

Adhering to new legislative requirements

It's clear that many of the measures implemented in the reform package will substantially affect the way companies conduct their AGMs — including those companies that are holding their AGMs in the current reporting season.

These reforms are not intended to place unnecessary regulatory burdens on companies. 

Rather, they are designed to strike the right balance between strengthening our framework, and maintaining the principle that the level and composition of executive remuneration should remain a matter for boards to determine.

In other words, we want to ensure that executives who bring value to a company continue to be appropriately remunerated for their work, while also ensuring that the board will be more accountable to shareholders.

It would be fair to say that the two-strikes test attracted a great deal of attention when it was first proposed. 

Some stakeholders believed that it would allow shareholders to usurp the role of the directors and interfere in the operational aspects of the company.

I disagree. 

The two-strikes test does not provide shareholders with the power to determine remuneration.  Rather, it places a responsibility on the board to clearly explain and justify the remuneration packages being offered to executives. 

In this way, boards that submit a compelling explanation to shareholders about executive remuneration would not expect strikes to be triggered over two consecutive years.

So far this AGM season, we have yet to see a strike. In fact, many boards have made it clear that they are demonstrating restraint against a backdrop of uncertain global economic conditions.

I think that this also demonstrates that boards are more conscious of the need to justify the pay of executives to shareholders, particularly when profits and profit outlooks may not be meeting expectations.

I acknowledge that some stakeholders remain sceptical about the two-strikes test. 

But I think it's also important to reflect on some of the historical context in this policy area. Many of the same people who vehemently opposed the two-strikes test opposed with equal vehemence the introduction of the non-binding vote, but now sing its praises as a tool of engagement with shareholders.

Shareholder engagement

Shareholder engagement on the issue of remuneration and more broadly, should be seen as an important part of a board's activities.

A company's approach to executive remuneration and shareholder communication helps define the perceptions of how they operate as a company and the culture that they foster. This also affects company value.

I have been astonished to read recent reports of some directors suggesting that if shareholders are unhappy with the remuneration of their executives they should simply sell their shares.

Apart from being a poor advertisement for any company seeking to attract capital in the equity markets, such views would appear to be completely out of step with the last decade of regulatory reforms on remuneration matters, which have sought to make boards more accountable to shareholders, who, after all, are the owners of a company.

It was also of concern to hear that some companies have reportedly sought to avoid a first strike under the new laws by reducing the level of transparency, particularly around the use of proxy votes. Holding back information from shareholders to avoid having them express their views on executive pay undermines confidence in boards and feeds shareholder suspicion that remuneration outcomes may not be justified.

It would be unwise for boards to fail to recognise the importance of communication with shareholders. Even worse, it clearly would not be in the spirit of the Government's reforms for boards to reduce the level of accountability by engaging in tactical games to avoid an adverse vote on their remuneration report.

Any such attempts run the very real risk of alienating a shareholder base that will only return at the next AGM alert to these tactics and with a greater resolve to make their sentiments known.

At the same time, boards who seek to engage with their shareholders, in good faith, should not be frustrated by proxy advisers standing between them and their shareholders. In this regard, I note that there has been some recent commentary suggesting that some proxy advisers have shown an unwillingness to respond to the shareholder engagement approaches of some companies. While proxy advisers have an important role to play in advising shareholders, under the new executive remuneration changes they are expected to avail themselves of the information they need to properly advise shareholders on remuneration matters.

I believe that most companies will approach the new executive remuneration reforms in good faith, because doing so has a demonstrably positive impact on the company's reputation and value.

But those companies who fail to act in this way serve only to increase the calls on Government to extend the heavy hand of regulation to areas where it is perceived that deficiencies may exist. 

Next steps on the Government's agenda

Beyond the recent reforms to the remuneration framework, the Government is also looking at reviews of two further areas related to remuneration.

In our response to the Productivity Commission's executive remuneration recommendations, the Government announced its intention to ask the Corporations and Markets Advisory Committee (CAMAC) to consider how best to revise the remuneration disclosure requirements contained in the Corporations Act.

The CAMAC report was publicly released in May.  It contains a range of recommendations designed to simplify remuneration reports and provide more relevant information to shareholders, while noting that boards are best placed to determine the particular remuneration arrangements that would promote the interests of the company and its shareholders.

The Government is examining these recommendations and will respond in due course.  Our guiding principle in our response will be that simplification of remuneration reports should not lead to a diminution of the richness of information that is provided to shareholders.

The Government will also be monitoring the changes that companies choose to make to improve their communication with shareholders as a result of the two-strikes test.  As the CAMAC report noted, remuneration reporting practices are likely to evolve over the next few years in response to the introduction of the two strikes test.

The Government is also considering the submissions made to its proposal for a process to allow the "clawback" of remuneration in the event of a material misstatement in the financial statements.

There is currently no requirement that provides for clawing back bonuses or other remuneration in the event of a material misstatement by the company.

It is legitimate to question whether directors and executives should be entitled to keep remuneration which was based on materially erroneous financial information.

And similar questions have been asked globally.

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.

The Government publicly consulted on the proposal of clawback earlier this year.  A number of submissions to this consultation process highlighted concerns with the workability of a legislative approach to clawing back remuneration.

The Government continues to consider the issues raised in these submissions to form a view on an appropriate policy response.


The issue of executive remuneration is about delivering value for money for shareholders – the owners of companies. Boards should be accountable for the pay they award executives and be ready to justify it against the value these executives add to a company.

The Government's role is not to dictate pay decisions to boards; nor is to tell shareholders that they cannot reward hard work and innovation through remuneration.

But the Government is keen to foster, through our reforms that commenced in July, a culture of greater transparency and accountability in the setting of remuneration and a culture of greater engagement with shareholders.

We want these reforms to play an important role in redefining executive remuneration and performance in Australia.

Once again, thank you for inviting me to speak with you today.