Executive remuneration – what we can learn from Australia

It seems appropriate that Paul Glass (see New Zealand Herald, 8 October  http://www.nzherald.co.nz/business/news/article.cfm?c_id=3&objectid=11930836 ) should make use of annual reporting season to raise some serious questions about the need for a fresh look at the thorny issue of executive remuneration.  Institutional investors have a key role to play in shaping market expectations about a range of performance issues affecting corporate New Zealand.  And raising serious questions about executive remuneration is in keeping with the work to date by the Corporate Governance Forum, to promote good corporate governance in NZ companies.

Nonetheless, using a metaphor that seems appropriate this week, some care needs to be taken to ensure that the key issues underpinning calls to address issues such as the need to improve the transparency of remuneration arrangements and performance targets do not descend into a form of dog-whistle politics (small “p”).

Importantly, Paul’s article concludes with a call to introduce a form of Australia’s ‘two strikes law’ into our market.  The Australian model is a very different approach to most other attempts at a “say on pay” regime.  Tellingly, the Australian model focuses on the board of directors and its approval of remuneration policies – not what the individual manager/s are paid.

In a nutshell, the two strikes law holds the board of a listed company accountable, so that if two years in a row, shareholders refuse to endorse the board’s remuneration policy, the shareholders can force the board to be “spilled” (an Australian phrase that seems to have been over-used in relation to events in Canberra in recent years).

Shareholders of listed companies now have to vote on whether to spill all board positions if 25% or more votes cast are not in favour of adopting the remuneration report at two successive AGMs.  A spill resolution must then be put to a vote at a second AGM and, if passed with 50% or more of eligible votes cast, requires a spill meeting within 90 days to elect directors.

There has been a mix of feedback in Australia for the two strikes law since it was implemented in 2011.  Some critics argue it duplicates existing avenues already available to shareholders to register their unhappiness with remuneration.  The rule is also criticised because the hurdle for shareholders to force a first strike is low, but effecting real change (a board spill) remains difficult.

Interestingly, initial studies across the Tasman indicate that shareholders are not as upset by executive pay as the media suggests.  Instead, an overwhelming majority of remuneration reports have been approved, and only a small handful of companies have been the focus of discontent – and of those an even smaller number were the subject of board spills.  And, where there was a spill, less than a dozen directors were not returned following the spill (although the spills have also triggered resignations).

Where the two strikes law seems to be effective is because:

• It is seen to operate as a shaming measure – creating a setting where the board is (publicly) accountable rather than at actual risk of removal. That risk of reputational damage, and consequently, fewer board roles is seen to be effective.
• After a first strike, companies are seen to make more effort communicating with shareholders.
• (It is claimed) the impacts of a first strike and a hit to the company’s share price have also been seen to impact on CEO pay (particularly).

Institutional investors, and industry groups such as the Corporate Governance Forum, are well-placed to generate the sort of empirical analysis needed for a serious debate about issues of fairness to shareholders and value for money – and whether the seemingly endless upward spiral of executive remuneration overseas translates into a New Zealand context.  This also seems to be an issue for unlisted companies – and may even translate into some public sector appointments.

Similarly, a well-founded series of conclusions (based on sound research) could greatly assist the commentary about the apparent anomaly of rewarding ostensibly poor-performers as they exit.  Again, this seems to be an issue for a wider range of situations than just the listed company sector.

Finally, it is important that the issue of shareholders having a greater say on executive remuneration is linked to issues of performance and productivity.  It would not be helpful if this issue became blurred in a broader political debate, as seems to be the case in many countries at present, over issues such as pay inequality or even the living wage conundrum.  In this regard, the Australian model seems to have achieved an outcome that has de-coupled what should be an objective benchmarking process from wider issues based on calls such as those for a need to improve equality.  At least in the short term, a kneejerk reaction may have the negative impact of limiting the ability to foster home-grown management talent.  Longer-term impacts await further data.