I spoke in parliament last week about Labor's reforms on executive remuneration.
Corporations Amendment (Improving Accountability on Director and Executive Remuneration) Bill 2011
Second Reading (24 Mar 2011)
Corporate reform encourages innovation and entrepreneurship, and Australian corporations such as Qantas and Billabong, Westfield and CSR have had a long history contributing to the nation’s prosperity and continue to underpin our economic growth. Great managers are critical to business success. At their best, successful managers create jobs and ensure that employees have rewarding careers. The job of politicians is to ensure that we continue to attract great managers, including some from overseas, yet to make sure that pay does not become detached from performance.
When I speak with my electors, their concerns are not primarily about pay packets but what that great social commentator Mark Knopfler called ‘money for nothing’. It is fine to be well paid if you are delivering, but golden handshakes, salaries that encourage excessive risk-taking and pay packets that go up merely because the entire stock market is rising are what worry Australians. As my electors say to me, ‘If the firm is underperforming, why should the boss get a pay rise?’
From the late 1980s onwards a number of high-profile collapses dominated the headlines. Overseas we had Enron, WorldCom, Lincoln Savings, EIEI and BCCI. In Australia we had the HIH Insurance Group. In too many of these cases lavish remuneration was a feature of the way the company was managed. Just before Enron’s collapse, Kenneth Lay, as chief executive, was one of the highest-paid executives in the US, earning $5 million a year. Although the Labor Party is a party that has fought for higher wages, it is a failure of corporate governance if such compensation is detached from performance.
In Australia we have seen a steady growth in CEO salaries which has outpaced salaries in the broader community. According to the Productivity Commission and its report, Executive remuneration in Australia, over the period 1993 to 2009 the average earnings of CEOs in the top 100 Australian firms rose by an average of 7½ per cent per year. Over the same period, average salaries across the economy rose by an average of 3.7 per cent a year. In 1993 the average earnings of a CEO in a top 100 Australian firm was about $1 million. By 2009 this had risen to around $3 million.
We can go further back still and look at how these top earnings have changed over the long run of history. While I was at the Australian National University I did work with Tony Atkinson where we looked at how the income share of top income groups in Australia had changed going back to the 1920s. One way of looking at this is to look at the income share of the richest one per cent of Australians. That is a group who in 2007 had earnings of $197,000 a year or more. That top one per cent of Australians in 1921 had 12 per cent of household income. Then we saw a compression: we saw the top earners income share steadily drop until 1980, when that group had about five per cent of all national income. Then we saw a rise again until by 2007 the top one per cent had 10 per cent of household income, double they share in 1980.
We see an even starker pattern if we look at the top 0.1 per cent—the richest 1/1,000th of Australian adults. In 2007, this was a group earning $693,000 a year or more, and their income share of the Australian pie followed a similar trajectory. In 1921, they had four per cent of all household income. That fell till 1980 when they had just one per cent of household income. And then that income share rose again so that, by 2007, the richest 1/1,000th of all Australians again had four per cent of household income.
Too much inequality can cleave us one from another, and leave us a more fragmented society. It is an issue about which many Australians are, I think, rightly concerned. As the Parliamentary Secretary to the Treasurer pointed out in his second reading speech, it is important that our Australian remuneration system be internationally competitive, but it is also important that it is tied to performance—that executives are rewarded for the work they do and the value that they bring to their firms.
We should remember that executives need to be accountable to shareholders. Shareholders, of course, are the owners of the company. They are the ones who have placed their capital on the line. And it is appropriate that they have freedom to choose the executives they want and freedom, within broad limits, to set the appropriate remuneration.
A critical part of this reform is giving shareholders more say over how the pay of company executives is set. The government has been aiming to encourage shareholder engagement through transparent disclosure of how remuneration is delivered. Shareholders need to have the information to convey their views through the non-binding shareholder vote, and to hold directors accountable for their remuneration decisions.
Crises can test us. Sometimes in a crisis institutions are found wanting. And so it was with executive remuneration through the global financial crisis. Australia’s exposure to the global financial crisis was much smaller than that of the United States, due partly to our industrial structure and partly also to the rapid response by the Reserve Bank and by this government through its fiscal stimulus package. But the global financial crisis did highlight to us some of the issues around remuneration structures that focused too much on short-term results, that rewarded excessive risk-taking and risked promoting corporate greed. As I said, most Australians do not mind well-paid CEOs. What they worry about is CEO pay that is detached from performance.
With the legislation put to the House today, we will be empowering individual shareholders so that they have the muscle to take the fight to the institutional and directors’ associates. We are putting forward the ‘two strikes’ rule, where shareholders will be empowered to vote out a company’s directors if the remuneration report receives a consecutive no vote from a quarter or more shareholders at two annual general meetings.
As the parliamentary secretary has pointed out, once this second strike is triggered, shareholders will then be given an opportunity to vote on a resolution to spill the board and subject the directors to re-election. The spill resolution of course requires 50 per cent of eligible votes cast, as would be the norm with most resolutions in a board meeting. If that spill resolution is passed, then a spill meeting will be held within 90 days at which the shareholders will be given the chance to vote on the re-election of the directors, one by one. There have been concerns raised over this measure. But I would point interested members of the community to the extensive consultations that the Productivity Commission and this government have done, and particularly to the consultations around the threshold level of a 25 per cent no vote. The Productivity Commission chose that level on the basis that it was appropriate because it was in line with the 75 per cent majority required for the passage of special resolutions.
This bill also focuses on an issue around the independence of remuneration consultants. People have reasonably argued that, in the past, remuneration consultants have sometimes looked a little like the fox guarding the henhouse. We need to guard against a risk that remuneration committees will simply ratchet up pay one after the other. We need to create opportunities for remuneration consultants to bring the best objective advice as to appropriate remuneration to the company. It should be the case that remuneration consultants are able to confidently go to a company and suggest that the remuneration is too high. This ought to happen in more than a trivial number of cases, and I doubt that it presently happens in many cases.
The bill also contains measures to require boards or remuneration committees to approve the engagement of a remuneration consultant. Those consultants will be required to declare that their recommendations are free from undue influence, and they will have to provide their advice to non-executive directors or the remuneration committee rather than directly to company executives, who are themselves, of course, affected by the report.
In addition, boards will be required to provide an independence declaration stating whether, in their view, the remuneration consultant’s recommendations are free from undue influence. The board will then have to mention their reasons for reaching this view. The company will need to disclose in its remuneration report key details regarding the consultants, such as who the consultants were, the amount they were paid, and the other services that the consultant provides to the company.
Another important set of measures in this bill prohibits closely related parties from voting on remuneration. The bill will address conflicts of interest by prohibiting the company’s directors and key executives, or key management personnel and their closely related parties, from voting their shares in the non-binding vote on the remuneration report. Currently the Corporations Act does not prohibit key management personnel who hold shares in the company from participating in the non-binding shareholder vote on remuneration. This is in order to prevent both real and perceived conflicts of interest which can arise when key management personnel vote on their own remuneration packages.
The bill also prohibits the hedging of incentive remuneration, and that is, naturally, because the hedging of incentive remuneration is at odds with the rationale for incentive remuneration and can undermine the whole purpose for which companies put in place incentive remuneration. The bill also prevents the cherry-picking of proxies. Directed proxies must be voted—a reform which I certainly believe is long overdue.
Naturally, the bill has received considerable support from experts. Les Goldmann, the policy manager of the Australian Shareholders’ Association, said:
I don’t think that shareholders are going to use the power irresponsibly, I think shareholders will use the power very responsibly and only in cases where there is clearly something that the board and the shareholders think the board ought to be accountable for.
We do think the Government, in particular Minister Bradbury, have been very brave in pushing forward with this legislation and we applaud their efforts in that regard and I think that small shareholders and corporate governance area in Australia will be grateful for their efforts for many generations to come.
Stuart Wilson, former CEO of the Australian Shareholders Association, said:
At the outset there doesn’t seem to be an appetite from institutional investors for turfing entire boards. I don’t think it will come to pass. … However, I think the simple threat or embarrassment, or potential for that to happen, will see to it that there will be significant improvements on remuneration in the next couple of years.
He also said:
This has been a topic that’s been discussed ad nauseam for the last few years. The Productivity Commission had a lengthy consultation period—everyone got their say.
Alan Fels, former head of the ACCC, said of the two-strikes test:
This change will make a chairman more careful in making their original decisions about executive remuneration.
Ann Byrne, CEO of the Australian Council of Superannuation Investors, said:
We are pleased that the government has maintained a key recommendation of the Productivity Commission—a ‘two strikes’ test on remuneration reports. We believe that this test will only apply to a small minority of companies who have displayed intransigence and a lack of response to shareholders. Only those companies that continue to put up egregious pay propositions and blatantly ignore the views of a substantial group of shareholders should be concerned with these provisions.
The member for North Sydney wants less regulation generally, but he is unable to point to specific examples of where he would reduce regulation. Like the coalition’s position in the election that they would like to cut spending when their spending package had an $11 billion black hole, the coalition are all talk and no walk.
This bill, on the other hand, is in a great Labor tradition of promoting economic growth with an eye to equity. This bill recognises that capitalism requires checks and balances if innovation is to flourish. We on this side of the House, the party of true small-’l’ liberalism in Australia, believe in markets. Labor is the party that floated the dollar, cut tariffs, brought about major competition reforms and is now using market based mechanisms to price carbon and deal with dangerous climate change. But we also believe in an appropriate role for government. That is why we brought about fiscal stimulus when the global financial crisis hit. And that is why, with this legislation, we are empowering shareholders by providing appropriate checks and balances as a reasonable and sensible means of dealing with executive remuneration.
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