Business leaders welcome Productivity Commission report on executive pay

Business groups have welcomed yesterday’s release of the Productivity Commission’s draft report on executive salaries, which recommends a “two strikes” policy where shareholders be given the power to elect new boards if two subsequent remuneration proposals are rejected.

Lee White, general manager for leadership and quality at the Institute of Chartered Accountants, said in a statement the report points to the need for strengthening corporate governance.

“A more balanced and long-term approach to remuneration structures, coupled with promoting accountability and engagement through enhanced disclosure, will deliver improved shareholder value and manage community expectations.”

“Fundamentally, users need to be able to distil from the remuneration report a clear explanation of the true economic value of benefits provided to executives of the company,” he said.

The Australian Bankers’ Association said in a statement the report was well researched and reached balanced conclusions, with chief executive David Ball commenting on the draft’s findings that company boards should be directly responsible for remuneration proposals.

“Our starting point has always been that a company board should primarily determine an executive’s remuneration, and be accountable for that responsibility.”

The Australian Institute of Company directors also welcomed the report. Chief executive John Colvin said in a statement that it commends the Commission for recognising the role of the board in setting executive pay and ignoring the possibility of salary caps.

“The Commission recognises that these would give rise to severe practical problems and have undesirable consequences for Australian companies and shareholders, as well as serving to weaken the important alignment between shareholders’ interests, company performance and executive pay,” he said.

The draft proposal puts forward 15 recommendations that would give more power to shareholders in determining executive salaries, some of which include:

• If a company’s pay policy receives a “no” vote of 25% or higher, the board must report back to investors on how these issues were fixed, and if not, why.
• Large investors must disclose how they voted on pay issues each year.
• All directors and key executives must be banned from voting their shares on remuneration reports and similar pay-related votes.
• ASIC must confirm electronic voting at meetings is permitted.
• All ASX300 companies must have a remuneration committee made up of no less than three people, with the majority being non-executive directors.
• Laws should be changed so investors can set a maximum number of board members, so directors can be limited on new appointments.
• Remuneration reports must disclose take-home pay amounts, along with the total shareholdings of the individuals named in each remuneration report.

But despite the welcome of the report, these executives still point out issues within the draft. Institute of Chartered Accounts tax counsel Yasser El-Ansary said the report has not properly addressed restrictions on salary sacrifice arrangements.

“The Commission’s recommendations to date are encouraging, but we will be raising the issues of taxation of rights and restrictions on salary sacrifice arrangements in our formal submission in response to this report.”

Additionally, while Ball welcomed the report he also said Australian companies have done well in keeping salaries in check and that many are performance-based.

“More generally, Australian bank boards have done a good job. While it is a case that executive salaries in some US and UK financial institutions may have contributed to excessive risk-taking and are inconsistent with performance, we see no evidence to suggest that this has been the case in Australia.”

“Australian banks are among the most secure in the world – Australia currently has four of only 10 AA-rated banks in the world.”

Colvin said the Australian Institute of Company Directors has concerns about the practical problems that may arise from the “two strikes” policy.

“Such a ‘Say on Pay’ policy, while perhaps superficially attractive from a shareholder engagement perspective, could open a Pandora’s box of unintended consequences for both boards and shareholders. The current non-binding vote on the remuneration report has worked well. Boards take them very seriously and have generally responded to the shareholder concerns expressed in those votes.”

“Requiring them to formally explain and respond to shareholders after a 25% ‘no’ vote – the ‘first strike’ – is merely codifying something many companies would already do.”

Finance professor Peter Swan from the Australian School of Business said in a statement the “no vacancy” rules for board members could be potentially damaging.

“The first questionable recommendation aims to increase board diversity by ending the ‘No Vacancy’ rule. The problem with this proposal is that it is likely to achieve an even worse outcome for the board with the number of board members escalating to the maximum allowed under the constitution.”

“If there is one quite well-established fact about the performance of boards, smaller boards tend to outperform larger boards. This resulting upward shift in board size will almost certainly be expensive in terms of board performance, as well as being more costly for shareholders.”

A number of executives said their organisations are preparing submissions before the final report is due later this year.

Meanwhile, the Government welcomed the release of the report but said it would still wait until the final report is released in December to make a final decision on whether legislation will be drafted based on the commission’s recommendations.

Assistant treasurer Nick Sherry said in a statement the report fits into the Government’s agenda for financial regulatory reform.

“The PC’s draft report complements both actions taken by the G20 and work that has been undertaken by the Australian Prudential Regulatory Authority (APRA) with respect to Australian financial institutions.”

“The Government is determined to ensure that executive pay practices are in line with both community standards as well as sustainable business practices, and today’s draft report is a key part of that commitment.”