Executive remuneration

Inquiry report

Released 04 / 01 / 2010

Download the report

Key points
Media release
Contents
Appendices

Strong growth in executive remuneration from the 1990s to 2007, and instances of large payments despite poor company performance, have fuelled community concerns that executive remuneration is out of control.
Pay for CEOs of the top 100 companies appears to have grown most strongly, at 13 per cent real a year, from the mid-90s to 2000, and then increased by around 6 per cent annually in real terms to 2007. Since 2007 average remuneration has fallen by around 16 per cent a year, returning it to 2004-05 levels.
- The rise and decline in executive pay over the 2000s largely reflects increased use of pay structures linked to company performance.
Executive pay varies greatly across Australia's 2000 public companies
- For the top 20 CEOs, in 2008-09 it averaged $7.2 million (110 x AWE) compared to around $260 000 for CEOs of the smallest listed companies (4 x AWE).
- Generally speaking, Australian executives appear to be paid in line with smaller European countries, but below the UK and USA (the global outlier).
Liberalisation of the Australian economy and global competition, increased company size, and the shift to incentive pay structures, have been major drivers of executive remuneration - companies compete to hire the best person for the job, and try to structure pay to maximise the executive's contribution to company performance.
Nonetheless, some past trend and specific pay outcomes appear inconsistent with an efficient executive labour market, and possibly weakened company performance.
- Incentive pay 'imported' from the United States and introduced without appropriate hurdles spurred pay rises in the 1990s partly for 'good luck'. More recently, complex incentive pay may have delivered unanticipated 'upside'.
- Some termination payments look excessive and could indicate compliant boards.
Instances of 'excessive' payments and perceived inappropriate behaviour could also reduce investor and community trust in the corporate sector more broadly, with adverse ramifications for equity markets
But the way forward is not to by-pass the central role of boards. Capping pay or introducing a binding shareholder vote on it would be impractical and costly.
Instead, the corporate governance framework should be strengthened by:
- removing conflicts of interest, through independent remuneration committees and improved processes for use of remuneration consultants;
- promoting board accountability and shareholder engagement, through enhanced pay disclosure and strengthening the consequences for those boards that are unresponsive to shareholders' 'say on pay'.
These reforms would significantly reduce the likelihood in future of inappropriate remuneration outcomes, or those that shareholders would find objectionable.

Executive Remuneration Reforms

The Australian Government today released the Productivity Commission's final report on Executive Remuneration in Australia, noting that it will consider the Commission's recommendations before responding later in the new year.

The inquiry's chairman, Gary Banks, welcomed the release of the report, which was handed to Government in late December, observing, 'the public availability of the Commission's final report should further promote public understanding of the issues ahead of the Government's policy response.'

The final report has been informed by many submissions, public hearings and industry consultations since the release of the Commission's discussion draft in late September.

Gary Banks said, 'we received substantial and constructive feedback in response to our preliminary proposals. The Commission's final recommendations are likely to be more robust and implementable as a result. Most changes are largely fine-tuning, but some have been more significant. This includes our proposed 'two strikes' rule, requiring boards to submit for re-election where shareholders repeatedly vote against their remuneration decisions. We consider that we now have a formulation that will encourage behavioural change in those boards where that is needed, without posing significant downside risks for public companies generally.'

The Commission's final recommendations constitute an integrated package of reforms that would strengthen board decision-making on executive remuneration, by reducing board 'clubbiness', removing potential for conflicts of interest and enhancing accountability for pay outcomes. Shareholders would get better information and would have more 'say on pay'.

'The Productivity Commission's reform package would reduce the likelihood in future of executive remuneration outcomes that shareholders find objectionable,' said Gary Banks, 'The Commission's proposed reforms would also promote greater community trust in how public companies handle pay issues.'

Preliminaries
- Cover, Copyright, Commissioner's letter, Terms of reference, Contents, Abbreviations and explanations
Overview - including key points
Recommendations and findings

Part A: Background and analytical framework

Chapter 1 What is the inquiry about?
- 1.1 Background to the inquiry
- 1.2 The Commission's task
- 1.3 The Commission's approach
- 1.4 Conduct of the inquiry
- 1.5 Report structure
Chapter 2 The role and evolution of the public company
- 2.1 Evolution of the public company
- 2.2 Aligning interests — the pivotal role of boards
- 2.3 The contribution of Australia's public companies
- 2.4 The evolution of the regulatory framework

Part B: Remuneration trends and drivers

Chapter 3 Trends in remuneration
- 3.1 Introduction
- 3.2 Data difficulties and the Commission's approach
- 3.3 What has happened to executive remuneration?
- 3.4 What has happened to directors' remuneration?
- 3.5 Remuneration and corporate performance
- 3.6 Executive remuneration overseas
Chapter 4 Drivers of executive remuneration
- 4.1 The 'market' for executives
- 4.2 Explaining increases in executive remuneration
- 4.3 'Principal–agent' issues and executive pay
- 4.4 Broader market drivers of executive pay
- 4.5 Some conclusions

Part C: Assessing the remuneration environment

Chapter 5 Overview of the regulatory and corporate governance framework
- 5.1 Australia's current framework
- 5.2 Approach to assessing effectiveness
Chapter 6 Assessing the role of the board
- 6.1 The central role of the board
- 6.2 Attracting talented and experienced candidates
- 6.3 How boards determine pay
Chapter 7 Linking pay to performance
- 7.1 Enhancing performance-based pay
- 7.2 Non-recourse loans
- 7.3 Hedging of incentive payments
- 7.4 Issues with termination payments
Chapter 8 Remuneration disclosure
- 8.1 Current remuneration disclosure
- 8.2 Are remuneration reports clearly communicating what investors want to know?
- 8.3 Can disclosure requirements be rationalised?
- Chapter 9 Strengthening shareholder engagement
  - 9.1 The non-binding vote in context
  - 9.2 How effective is the non-binding vote?
  - 9.3 Elevating the consequences of a significant ‘no’ vote?
  - 9.4 Facilitating voting
  - 9.5 Reducing conflicts of interest
- Chapter 10 Taxation issues
  - 10.1 Introduction
  - 10.2 Taxation of equity-based payments
  - 10.3 Treatment of termination payments
  - 10.4 Taxation of bonuses
  - 10.5 Allowable tax deductions for employers
Part D: Implications for public policy and corporate conduct
- Chapter 11 The reform package
  - 11.1 What sort of policy action is called for?
  - 11.2 Improving board capacities
  - 11.3 Reducing conflicts of interest
  - 11.4 Improving relevant disclosure
  - 11.5 Well-conceived remuneration policies
  - 11.6 Facilitating shareholder engagement
  - 11.7 Adding it up
- Appendix A Public consultation
- Appendix B Remuneration data
- References