Allens

Corporate Governance

Focus: Executive remuneration – new caps on termination payments announced

19 March 2009

In brief: In our recent Focus: Executive remuneration – to regulate or not to regulate?, we reported on developments in the regulation of executive remuneration in Australia and around the world. The Federal Government yesterday made two key announcements which seek to clarify some of the questions that have been raised about their approach to this area. Executive Partner Paul Quinn (view CV) and Lawyer Ben Ferguson report.

How does it affect you?

  • Under the Government's proposed 'golden handshake' reforms, shareholder approval will be required for any executive termination payments or rewards that are greater than one year's average base salary. The concept of 'executive' will also be expanded to include all those executives named in the company's remuneration report.
  • As we previously reported, the Government has requested the Australian Prudential Regulation Authority (APRA) to produce a framework for the remuneration of executives in financial institutions. Somewhat unexpectedly, the Government has also just announced that the Productivity Commission will concurrently review the Australian regulatory framework around executive remuneration. This is a clear signal that reform of this area will extend to cover all companies, not just those financial institutions regulated by APRA.

Action on 'golden handshakes'

The Federal Government proposes to introduce legislation aimed at curbing what it terms 'excessive golden handshakes' or termination payments paid to departing company executives. The proposed legislation will amend the Corporations Act 2001 (Cth):

  • to lower significantly the threshold at which termination payments must be approved by shareholders. Currently, shareholder approval is only needed for termination payments that are more than seven times a director's total annual remuneration. The Government proposes to require shareholder approval for termination payments that are greater than one year's average base salary;
  • to extend the range of executives whose termination payments can be subject to shareholder approval to cover all those executives named in the company's remuneration report; and
  • to broaden the definition of 'termination benefit' to catch all types of payments and rewards given at termination.

The proposed amendments will apply prospectively and will not affect existing contracts on termination payments from proceeding.

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Productivity Commission's review

The Government has directed the Productivity Commission to undertake an inquiry into the current Australian regulatory framework around executive remuneration.

The Productivity Commission's terms of reference are broad and cover a review of:

  • the existing regulatory arrangements that apply to director and executive remuneration for companies that are disclosing entities under the Corporations Act 2001 (Cth), including shareholder voting, disclosure and reporting practices;
  • trends in director and executive remuneration in Australia;
  • international trends and responses to the problems of excessive risk taking;
  • the effectiveness of the existing framework for oversight, accountability and transparency of director and executive remuneration practices including the:
    • role, structure and content of remuneration disclosure and reporting;
    • scope of who should be the subject of remuneration disclosure, reporting and approval;
    • role of boards and committees in developing and approving remuneration packages; and
    • role of other stakeholders, including shareholders, in the remuneration process;
  • the role of large institutional investors in the development, setting, reporting and consideration of remuneration practices; and
  • any mechanisms that would better align the interests of boards and executives with those of shareholders and the wider community, including the:
    • role of equity-based payments and incentive schemes;
    • source and approval processes for equity-based payments;
    • role played by the tax treatment of equity-based remuneration;
    • role of accelerated equity vesting arrangements; and
    • use of hedging over incentive remuneration.

The Productivity Commission is required to provide a final report, including recommendations on how the existing framework in Australia could be improved, within nine months. The Productivity Commission Chairman, Gary Banks, will oversee the review, and Professor Allan Fels AO, the former head of the Australian Competition and Consumer Commission, will be a key member.

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What next?

If the Government's proposed 'golden handshake' amendments proceed, boards will need to be careful when negotiating and determining termination payments. Shareholder approval will be required for any termination payments or rewards that are greater than one year's average base salary. This will give rise to the practical issue of how successfully a board can negotiate a contract with an incoming executive, where the termination provision is subject to shareholder approval (in circumstances where it exceeds one year's average salary).

We recently reported that APRA is currently developing a framework that will link regulated financial institutions' capital adequacy requirements to executive remuneration. The Government has made clear that the Productivity Commission's review is intended to complement the work currently being undertaken by APRA. However, the broad terms of the Productivity Commission's review are a clear signal that any reform of the regulation of executive remuneration will extend to cover all companies, not just those financial institutions regulated by APRA.

Regulation of executive remuneration is an increasingly busy space at the moment. Although it is certain that executive remuneration will come under great regulatory scrutiny, it is still not clear how the regulatory landscape will appear once all of the dust settles.

In a global market, will the new limits make it more difficult for Australian companies to recruit the best people? For example, will an executive located overseas agree to come to Australia in circumstances where he or she can be terminated with a payment of no more than one year's base pay? Will base pay increase as a proportion of the remuneration package as a result of this new rule, at a time when there is a desire to move towards increasing the proportion of long term incentive which takes account of risk? Time will tell.

We will keep you updated on the progress of the proposed 'golden handshake' reforms, APRA's proposed framework and the Productivity Commission's review. If you have any queries about this or any other corporate governance issue, please feel free to contact us.

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