The controversial two-strikes law for shareholder voting on executive remuneration is now in its third Australian AGM season. The rule requires companies to put a motion to shareholders to “spill” the board if the remuneration report receives a “no” vote of 25% or more at two consecutive AGMs.
Previously, Australian corporations had been subject to an advisory shareholder vote on the remuneration report, a reform introduced in 2004 as part of the CLERP 9 package of enhancements to corporate law.
The two-strikes law was introduced on the back of recommendations made in the Productivity Commission’s 2009 Report on Executive Remuneration. Its purpose is to address public and investor concerns about excessive remuneration by providing greater accountability to shareholders around what executives are paid.
How everyone else does it
The particular form of the “spill and re-election” process following a second strike that has been adopted in Australia is just one version of the shareholder “say-on-pay” reforms introduced elsewhere in the world as a response to public concerns about executive pay levels.
In the United States, for example, the Emergency Economic Stabilization Act (2008) requires that financial firms receiving public GFC bailout funds give their shareholders an advisory vote on executive pay. More recently, the Dodd-Frank Act (2010) extended this advisory shareholder vote on pay to all US public companies. Corporations must report the results of the say-on-pay vote and, in the next year’s Compensation Discussion and Analysis, must disclose whether and how the board considered the results of the say-on-pay voting when making subsequent decisions.
Say-on-pay litigation has already been generated from the first series of US shareholder voting, with shareholder lawsuits alleging breach of fiduciary duty by directors of negative say-on-pay firms. When that course of action failed, suits based on the inadequacy of the remuneration disclosure made to shareholders followed.
Corporations in the United Kingdom have been subject to an annual advisory vote on remuneration since 2003. New legislation, which came into effect October 1, 2013, requires remuneration policy in UK public companies to also be subject to a binding shareholder vote at least every three years. Supporting legislation was also passed to improve remuneration disclosures.
A similar trend is evident in Europe. The European Commission recommended a shareholder vote on executive pay in 2004 and there is now say-on-pay voting in the Netherlands (since 2004), Sweden (since 2006), Norway and Denmark (since 2007), and Belgium (since 2012). Earlier this year, the Swiss government passed a binding shareholder vote requirement in addition to the introduction of other controls around executive remuneration.
Does our two-strikes law stack up?
This global trend suggests that remuneration will once again be a dominant issue during Australian AGMs this year. Pay will not go away. But has the two-strikes law changed executive pay trends in Australia? And how have Australian company directors responded to the demand for greater accountability surrounding remuneration?
Last year a small number of corporations received their second strike, triggering the board spill and re-election process. However, the process did not result in a subsequent change of the board of directors for any company.
The two-strikes vote works on a 25% threshold, with such voting excluding the key management personnel named in the remuneration report. Voting on the spill motion and, if necessary, the subsequent re-election of directors does not exclude key management personnel (who often have significant shareholdings) and is based on the usual principle of majority, not the 25% threshold. As a consequence, the two-strikes voting outcome at AGM can, and has, been reversed at the time of the spill motion.
Although the spill and re-election process required by the two-strikes law is a rare event so far in Australia, there are many more instances of corporations improving their communications and accountability to shareholders about remuneration after receiving a first strike. The resulting effect has seen subsequent remuneration reports being passed without dissent - for example, Bluescope and Crown.
The structure of remuneration may also have changed as a consequence of two-strikes. Research from 2011 indicated that pay-performance linkages strengthened after the introduction of the advisory vote in 2004. Preliminary evidence from the two-strikes voting suggests that companies similarly improve pay-performance linkages after a first strike. This is despite the generally negative market reaction to the introduction of the legislation, as noted by Eldo Felice in an as-yet unpublished research project.
Critics of the two-strikes law argue that it is costly and ineffective, since it has not so far resulted in the spill and replacement of a board. Also, it’s possible that for some companies, the vote may simply serve as an avenue for shareholders to express dissatisfaction with board performance generally, rather than voice specific concerns about remuneration policy.
Last reporting season saw some CEOs returning their bonuses as a response to shareholder concerns about pay - an approach of limited long term effectiveness.
This year Australian investors can expect that executive pay discussions will continue to dominate corporate AGMs. But with the vote now in its third year, company boards should be better placed to pre-empt and respond to shareholder concerns.
This is the third piece in our series on the 2013 AGM season. Click the links below to read the others.