Chris Pearce (Aston, Liberal Party, Shadow Minister for Financial Services, Superannuation and Corporate Law) Share this | Hansard source

I move an amendment to the Corporations Amendment (Improving Accountability on Termination Payments) Bill 2009, which I will return to in the consideration in detail stage of this debate:

That all words after ‘That’ be omitted with a view to substituting the following words:‘whilst not declining to give the bill a second reading, the House:

(1)

recognises the widespread concern in the community that termination benefits provided to some corporate executives and office holders have been excessive;

(2)

supports the introduction of more stringent requirements that payments in excess of reasonable levels should be subject to shareholder approval;

(3)

acknowledges that in its present form the government’s proposal is neither a practical nor an effective solution and that, if persisted with, it is likely to cause artificial and inappropriate alternative arrangements to be made, thus defeating the whole purpose of reform in this area; and

(4)

calls on the government to support the practical and effective amendments proposed by the opposition.’

This bill seeks to alter the Corporations Act in order to tighten regulation around termination payments. The bill is, in many ways, sound. The opposition welcomes reform which empowers shareholders, increases disclosure and, of course, enhances our corporate law.

The opposition supports the initiative to lower the quantum an executive can receive as a termination benefit from seven times their total salary before a shareholder vote is required. It is now appropriate that this threshold be reduced in a manner that will reduce excessive termination payments, whilst maintaining sound principles of corporate governance.

Unfortunately, the stated intention of this particular bill will be undermined through the bill’s practical application and its unintended consequences. The purpose of the bill should be to lower unjustifiable executive payments, to further align shareholder interests with directors and executives and to provide appropriate long-term incentives to directors to act in the best interests of companies and, of course, their shareholders. There is one significant problem in the bill which will likely have the perverse effect of raising executive and director payments on a permanent basis—that is, those payments which are not at risk or incentive based. This is because this bill will cause base pay to rise.

Make no mistake, this is sloppy policy making. Unintended consequences have again emerged—it is reminiscent of employee share schemes and the unlimited bank deposit guarantee, not to mention debacles such as Fuelwatch and GroceryWatch. It is very important that our parliament gets it right. We have to ask questions, such as, do we really want executives to have less pay at risk? Or, do we want to move away from performance based remuneration? ‘I think not,’ is the answer.

It is not hard to see how the government have managed to get this bill wrong. There was no regulatory impact statement prepared for the bill. I think this point goes some way in explaining the reason for the significant unintended consequences we find in this bill. Through the Senate Standing Committee on Economics’ process, a considerable weight of evidence has emerged which shows that this bill will undermine the alignment of executive and shareholder interests, and will actually cause base pay, and therefore total executive pay, to rise. I will return to this evidence in due course.

Let me now go to the substantial elements of the bill which, as I said earlier, seek to amend the Corporations Act. It does this by the following means: firstly, it lowers the threshold limit for termination benefits which can be received by directors and executives without requiring shareholder approval; secondly, it expands shareholder approval coverage to additional executives; and, thirdly, it broadens and clarifies the definition of a termination benefit.

The current corporate law provisions in the act relating to executive remuneration were devised during the Howard government’s Corporate Law Economic Reform Program, otherwise known as CLERP. A non-binding shareholder vote on the remuneration report was introduced in 2003 alongside a binding shareholder vote for termination payments to directors where greater than seven times total annual remuneration was to be provided. The current government announced in March this year that it would amend the Corporations Act to lower the threshold at which termination payments must be approved by shareholders from the current level down to one year’s average base salary. This termination payment initiative was announced alongside a holistic review into executive remuneration by the Productivity Commission, to be chaired by both Gary Banks and Professor Alan Fels. The commission is due to report to the government in November this year.

Despite the announcement of this holistic review, the government chose not to await its recommendations and decided to introduce this bill ahead of its completion. An exposure draft of this bill was released in May for public comment. On release of the exposure draft, many industry participants were of the opinion that the proposed provisions would be unworkable and indeed impractical. Subsequently, there have been a number of changes from the exposure draft to the final bill; these alterations are chiefly around the holding of AGMs for voting and the timing of shareholder votes when considering termination payments.

The bill carries four key objectives. Firstly, the bill seeks to expand shareholder approval coverage to additional executives and senior management. Currently, only certain executives are covered by termination pay provisions of the Corporations Act. The proposed requirements will extend coverage to senior executives and key management. Coverage of these additional persons will be determined through the accounting standards. This will occur through the Australian application of the International Financial Reporting Standards, otherwise known as IFRS.

Secondly, the bill broadens and clarifies the definition of a termination benefit. The definition of a termination benefit has been widened and regulation has been provided for the government to amend the definition at any given time.

Thirdly, a facility is provided for minor changes to the Corporations Act, including: repayment of unauthorised termination benefits and stronger penalty provisions for contraventions.

Fourth and finally, the bill lowers the threshold limit for termination benefits which can be received by directors and executives without shareholder approval. The current threshold provides for an unapproved termination pay limit of seven times a recipient’s total annual remuneration. Under the proposed changes, the new threshold before a shareholder vote is triggered would be any amount exceeding one year’s average—over three years—base salary. The definition of ‘base salary’ is provided by accompanying regulation, which was released last week.

It is this aspect of the bill—in relation to base salary—which will cause base salary to rise in order to compensate for the potential loss of incentive based remuneration. This defeats one of the key purposes of the bill, which is to limit excessive executive salaries. Low base pay reflects a company’s desire to remunerate executives and directors fairly and appropriately by linking their pay to performance. The coalition believes that this is desirable and must be maintained. In many cases, chief executives are provided with very low annual base salaries, with the remainder of their annual remuneration being short and long-term incentive based pay. It is often the case that the incentive component makes up some two-thirds of their total pay. The threshold of one year’s average base pay is a very low figure in terms of an executive or director’s total remuneration and inappropriate for the purposes of defining a platform level of remuneration.

This legislation threatens to undermine the objectives of short- and long-term incentives, which are designed—at the end of the day—to align the interests of those executives and directors with the shareholders and it will in fact increase fixed or guaranteed pay as a consequence. It is therefore the case that this bill, in its current form, will encourage companies to move away from incentive based remuneration.

Shareholders will ultimately bear the brunt of such low pay threshold provisions through growing base salaries, which will be fixed costs regardless of performance. In its current form, the bill is also likely to create ‘golden hellos’ or ‘golden welcomes’ or, if you like, ‘front loading’ in order to compensate for the potential loss of pay.

The Senate, through its Economics Legislation Committee, has clearly demonstrated these concerns around the base pay threshold. On Tuesday, 25 August in Sydney the committee conducted a public hearing. The majority of witnesses appearing before this committee highlighted the significant flaws in this bill. For the benefit of the House, I would like to quote some of the evidence provided to the committee.

The Business Council of Australia, with representation from Rio Tinto and Insurance Australia Group, discussed the definitional failure of base pay for the purposes of the bill. They said:

… we would like to bring to the committee’s attention the prospects for the bill to have a number of unintended consequences—consequences which are likely to extend beyond the stated policy objective and also have the potential to cut across other policy objectives of the government.

They went on to say:

… it is important to remain mindful of the objective of aligning executive remuneration with company performance. One consequence of the bill will be to encourage future remuneration packages to be more heavily weighted to base rather than performance linked remuneration.

They said:

Finally, the case does not appear to have been well made as to the basis for base salary being used as the critical threshold as opposed to the total remuneration package as the threshold.

They also said:

I think the issue we would see, for instance, is if the additional remuneration is in base salary, it is a certain additional cost to the company.

Moreover, the Australian Institute of Company Directors, AICD, stated in relation to the issue of the base pay threshold:

They are likely to cause an increase in the proportion of executive remuneration paid up other than as termination payments.

…            …            …

The bill is also likely to increase total executive remuneration, given the greater uncertainty for incoming executives and the likely necessary response by companies to have what would have only been a contingent payment.

They also said:

In practice it means you will be increasing your base pay. That is the inevitable consequence, because basically you are either guaranteeing STRs, which is not a good practice, or you are increasing the base pay. It introduces distortions to what should be a very open, transparent exercise.

In the context of a recent practical example of a company which has allegedly not produced optimum performances of late, the AICD also said in their evidence that there have been no fixed pay or base pay increases. They said:

Base pay has been held since April 2007. There is a direct relationship between the outcome for the shareholders and the outcome for the senior executives. If they deliver, they will be well paid. If they do not deliver then they do not receive their STI—

That is, short-term incentive—

and the benefit of any LTI—

in other words, long-term incentive—

under these circumstances is remote.

The Australian Bankers Association provided further evidence of problems with base pay as the platform. They said:

… the termination benefits legislation is likely to create pressure to increase the proportion of an executive’s salary which is base pay. This is inconsistent with moves to have executives put more salary at risk.

Guerdon Associates, who are remuneration consultants, said in relation to the base pay threshold:

The other issue is the possible consequences of the low maximum payment. It might put pressure on other areas of remuneration such as increase in base salary or increase in sign-on payments.

…            …            …

An elevation in the base payment in our view needs to be looked at carefully. The merit of a remuneration structure that has elements of variable reward and fixed payment is that it gives the company the opportunity to properly reflect payment and performance.

They went on to say:

More particularly, if you get an economic downturn, you have got a higher fixed cost base and so it probably translates in the extreme to the need for companies to separate employees, to reduce their workforce, rather than being able to reduce their overall costs by simply having the flexibility not to award variable remuneration payments. So, in essence, it is increasing fixed pay and it is taking control away from the company and its shareholders to be able to link the payments overall with the performance of the individual and the organisation.

They said:

Our preference would be to see a limit calculated by reference to both fixed pay and variable pay, because it has become part of the reward mix overall for executives, and a very important part, to have both short-term variable pay and long-term variable pay.

There is a considerable amount of evidence which emerged from the public hearings in the Senate Economics Legislation Committee inquiry into this bill. The evidence really does speak for itself. Clearly the bill, in its current form, would work at cross-purposes to what is good corporate governance practice. That practice is aligning the interests of shareholders and executives and increasing the amount of remuneration at risk, not decreasing the amount at risk.

I believe the failure to link pay with performance is contrary to the principles espoused by the Financial Stability Board of the G20, which has been championed by the Labor government. This bill, as drafted, is also inconsistent with recently stated government policy and regulatory approaches internationally. Furthermore, the threshold of one year’s base pay would leave Australia with one of the lowest base pay thresholds of comparable corporate law in any country. This prescriptive approach could threaten our ability to entice talented managers to our country and retain them.

Definitions of this essence should be vested in the legislation, not in the regulations. The market deserves certainty, not changing goalposts. It deserves not only certainty but consideration. As I mentioned earlier, a regulatory impact statement was not prepared for this bill. I think it is quite incredible that the government can have a bill here which will require many, many companies to restructure their remuneration policies and that a regulatory impact statement was not even bothered with. Regrettably, I think it demonstrates where the unintended consequences of this bill have emerged.

As this aspect of the bill will run at cross-purposes to the supposed objective of the bill, the coalition will move to amend this bill to alter the threshold to one year’s total annual remuneration. I will move this detailed amendment during the consideration in detail stage of the debate. Performance and pay should be linked, as should executive and shareholder interests. Causing base pay to rise will make these objectives far, far harder to achieve. Indeed, the adverse consequences of this bill will ultimately be borne by the shareholders themselves. This cost will be borne by all shareholders—by large institutional shareholders and by so-called mum and dad investors who are shareholders. It is for these very logical and, I believe, sensible reasons that this bill should be amended as proposed by the opposition so as to ensure that its objectives can actually be achieved.

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