Executive Salaries Under Microscope

7th July 2009

The Global Economic Crisis and the revelations of worldwide executive excesses which have come to light have caused executive remuneration to come under intense public scrutiny.

As a result of increased pressure from the public for governments to act, the Federal government introduced the Corporations Amendment (Improving Accountability on Termination Payments) Bill 2009 into Federal parliament.

Current Position

At present in Australia, company directors of public companies are under an obligation to act in the best interests of the company. The board of directors of a company appoints executive directors and ratifies the remuneration of executives by board resolution.

The current framework allows shareholders a reasonable amount of control in relation to termination payments to executives.

The requirement for shareholder approval of executive remuneration in the existing framework is supposed to give transparency and induce the application of performance measures.

However, despite existing legislative requirements, public discontent continues to grow as a result of successive reports of exorbitant payments given to executives on their departure.

Whilst the Corporations Act 2001 (Cth) ("Corporations Act") prohibits payments in connection with a person's retirement from a board or managerial position unless it is approved by the shareholders, the Minister for Financial Services, Superannuation and Corporate Law, Chris Bowen MP, has pointed out that under that Act, "termination payments could reach up to seven times a director's total annual remuneration package before shareholder approval was required."

Proposed Reforms

The new Bill aims to change the shareholder approval rules for the approval of executive termination payments to company directors and executives. For example, the new regulatory framework will ensure that termination benefits for company directors and executives which exceed one years average base salary are subject to shareholder approval.

Other key features of the new legislative package include:

• The application of the new rules for termination benefits is extended to include senior executives or key management personnel of a disclosing entity;
• The definition of what constitutes a "benefit" has been broadened with an emphasis on interpreting a "benefit" from the point of view of substance over legal form;
• New regulation-making powers will specify what types of payments are (or are not) a termination benefit, and will define "base-salary". Further targeted consultation will be undertaken on these regulations;
• The immediate repayment of unauthorised termination benefits, with an increase in the penalty provisions;
• The retention of the existing requirement for the giving of the benefit to be approved by a resolution passed at a general meeting.

The draft of the legislation that was first circulated for public comment provided that executive benefits above a certain threshold can only be approved by shareholders after the cessation of the executive's employment. That requirement has not found its way into the proposed legislation. If that requirement remained, it would have effectively put an end to 'golden handshakes' because it would be unlikely that shareholders would approve a gift to already-departed executives.

The new legislation will only apply to new executive employment agreements and existing executive employment agreements that have an essential term varied after the legislation comes into force. As such, it may have limited application to the bulk of current executive employment agreements. An exception is that under the proposed legislation, shareholder approval will be required for termination benefits exceeding one years 'base salary' (rather than the current threshold of seven years remuneration) - whether or not the employment agreement is varied after the legislation is passed.

The Bill will be debated in Parliament during the current winter sitting.

Further Investigation

The Federal government has directed the Productivity Commission to undertake an inquiry into the broader issues regarding executive remuneration, including:

• A comparison of trends in director and executive remuneration in Australia and internationally;
• The role of shareholders in the determination of executive remuneration packages; and
• Mechanisms to better align the interests of corporate boards and executives with those of company shareholders.

The Productivity Commission's report will be published on 19 December 2009.

For further information please contact David Heidtman, Michael Tzirtzilakis, Jenny Vu or Adam Mazzaferro.

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