Corporations Amendment (Improving Accountability on Termination Payments) Bill 2009: Second Reading
Thu, 17 Sep 2009
12:35 PM - Senator David Bushby
The Corporations Amendment (Improving Accountability on Termination Payments) Bill 2009 represents the government’s first legislative response to the general public outcry about the obscene amounts that are paid to some chief executives when they leave their employment. Every time such an executive moves on from their position and the terms of their final entitlement become public, sometimes including literally millions of dollars, the public rightly question how and why these individuals receive such a significant payout—a payout of a size and scale that most Australians would have no hope of even relating to, nevertheless ever receiving.
Clearly, the issue of termination payments for executives is closely related to their remuneration generally. Indeed, their entitlement to termination payments and their size and makeup are often a specific part of the terms of their engagement and of the size and terms of the overall remuneration package. It is no misrepresentation to say that, if the Australian public have concerns about termination payments, they also have concerns over the size of some remuneration packages as a whole paid to top executives.
This is why I am so disappointed that the government, on the very same day that it announced that it would commission the Productivity Commission to examine the issue of executive remuneration as a whole, pre-empted an area subject to that review—being the part of executive remuneration we are looking at today: termination payments. I must say that the tendency of this Labor government to act on matters that it says it is inquiring into is symptomatic of its approach to and the weight it gives to many, if not most, of the inquiries it commissions—that is, that such inquiries are far more about the perception it wishes to foster in the electorate that it is properly considering issues before making decisions on them than actually finding out the facts.
Of course what the government’s action in respect of the Productivity Commission executive remuneration inquiry and other inquiries shows is that the government has its own agenda and that the inquiries it holds are held, more often than not, at worst, to validate that agenda rather than determine it and, at best, to provide a smokescreen for that agenda. This tactic of holding inquiries to create the perception that the government is consultative seems to have been a clear trait of state Labor governments like the highly controversial state Labor Party governing in New South Wales and, again, state Labor in my home state of Tasmania, and it is a trait picked up with glee by the national Labor government. I guess it is just more evidence that Labor governments at all levels are cut from the same cloth.
But there is no escaping the fact that community sentiment about inequality or unfairness cannot be ignored by governments, and neither should it be. However the consequences of any intervention by government into business affairs must also be considered and balanced against the need for that action. This is because ill-considered government interventions to promote fairness can have perverse effects, sometimes even working against the interests of those very groups whose interests are sought to be protected through the intervention.
This bill has been considered by the Senate Economics Legislation Committee. Coalition senators, of which I was one, broadly supported the objective of the bill. However we were concerned about legislative overreach, that the parliament’s intervention in the corporate sphere in this manner will almost certainly introduce distortions in executive remuneration, and that this could occur to the extent that shareholder interests may not be best served.
Coalition senators also found that there were a number of specific issues regarding this bill including that this legislation appears to be a knee-jerk reaction to appease public opposition to ex gratia payments made to executives to remove them from office. That is, despite it commissioning a full review of executive remuneration it went for the low-hanging fruit of golden handshakes because it saw political advantage in pre-empting the review’s findings. The government is acting after the event insofar as companies are already reviewing their policies in this area. In response to community outrage, consultation with shareholder groups and governance consultants, effectively the market is doing what it should be doing and adapting to properly voiced and highlighted shareholder and community concerns without government intervention.
This is evidenced by the downward trend in executive payouts in the last five years and evidence provided that 12 of the top 20 listed companies already limit termination payments to about 12 months entitlements. There are reported instances of perceived excessive termination payments but we recognise that these decisions are matters for boards and are generally taken for sound reasons, and that the legislation pre-empts the report by the Productivity Commission into executive remuneration, as already mentioned, and is typical of the rushed approach of the Rudd government.
Coalition senators were also of the opinion that Australia’s corporate framework is sound and that the capacity of boards to respond to community concerns is reasonably fluid and flexible. As such, we believe it is right to be cautious about wholesale interference in the decisions of boards, such as that proposed in this bill. As mentioned, we noted with satisfaction the Australian Council of Superannuation Investors study finding that most companies already have policies in place which will deliver termination payments around the bill’ s proposed base pay threshold.
This and other evidence received back the fact that the vast majority of large listed companies—the very same group with the high-profile headline offenders—are self-regulating on this issue, whether that be in response to cyclical changes, cash constraints or, more likely, other drivers such as community or shareholder outrage. Coalition senators also recognised the particular broader importance of oversight of executive remuneration packages in the banking and insurance sectors because of the potential for executives to chase the rewards of short-term risks at the cost of financial stability.
Of course coalition senators also found that there would be a number of adverse effects and unintended consequences of the bill as written. Having expressed our broad support for the signal effect of the bill, coalition senators noted that they are concerned that its passing may have unhelpful consequences for our corporate sector and protested the fact that the legislation has been introduced before the Productivity Commission report into executive remuneration has been released. It is worth noting here that the Productivity Commission was due to release its draft report this month and the final report is due only a couple of months later, in December. That is right: the Productivity Commission, which was commissioned by the Labor government to look at all aspects of executive remuneration, particularly regarding the extent to which it can be considered excessive, is due to report this month. And here we are today debating an aspect of executive remuneration that certainly falls directly within the purview of the PC’s terms of reference. It seems incredible to me that the Labor government could not wait another few weeks to see how the PC viewed the issues around the executive remuneration in its draft report and the extent to which any recommendations it makes is likely to impact on the matters which are the subject of this bill. Now, because the government pig-headedly wants to proceed without waiting for the results of its own inquiry, the Productivity Commission has decided to delay its draft report pending the outcome of this debate. Generally, I would have preferred to receive the full, frank and complete findings of the Productivity Commission on this issue without their being informed by policy decisions of the government.
Coalition senators also shared the view of many that presented or submitted evidence to the inquiry that the bill has elements of regulatory overreach. In its rush to be seen to be legislating in the area of executive termination payments the government has forgone a regulatory impact statement on this bill and, hence, failed to highlight legislative overreach in the bill which, in the view of coalition senators includes a number of instances. The scope of existing provisions is broadened so as to include unlisted companies and the lowered threshold provisions may potentially capture middle managers serving as directors of subsidiary companies particularly those who have accumulated long service and other entitlements. The definition of termination payment is broadened and there is concern that it may catch genuine retirement of long-serving director employees, redundancies and deaths in office. There is an anticipated impact on international recruitment and impact on firms operating internationally. In addition there are expected to be compliance costs, that is, for the holding of general meetings of shareholders to consider retirement packages, which would constitute an additional financial and administrative burden particularly for unlisted companies, and there is the potential difficulty of securing senior managerial employees to sit on the boards of overseas subsidiary companies.
As part of our additional comments in the report, coalition senators also foresaw possible distortion arising in executive remuneration as new recruits negotiate packages around the revised shareholder approval required framework producing what a number of witnesses to the inquiry referred to as the ‘squeezing the balloon effect’. That is, executives will continue to seek to negotiate a package reflecting what they believe they are worth and, if part of the package is limited, negotiations will see other parts of the package inflated to compensate.
This likely outcome was put forward by every business representative organisation based on their own experiences and those of their members, but was also very compellingly put to the committee by Guerdon Associates, an executive remuneration firm. When put to Treasury, their comment was that this would not occur because such increases in other aspects of executive packages would show up on the remuneration reports which go to shareholders.
Prior to my remarks being interrupted, I was talking about what has been referred to as the ‘squeezing the balloon’ effect. This is where executives who consider themselves to be worth a certain amount will seek to adjust their remuneration package by increasing some aspects of it if other aspects are made smaller. I mentioned that every business representative organisation that appeared before the committee indicated that this was likely to occur based on their own experiences.
When this was put to Treasury, their comment was that this would not occur because such increases in other aspects of executive package would show up on the remuneration reports that go to shareholders and would be subject to a non-binding shareholder vote. This may well be the case, but a non-binding vote as to whether to accept a report on the remuneration of the top five executives in a company is likely to be seen as a far easier path by many than selling to shareholders a specific termination package, a package that follows the cessation of employment of an executive after the usefulness of the executive to the company and hence its shareholders has passed, which would involve more than a year’s salary and potentially attract negative media interest.
To argue otherwise also requires one to accept that Australian companies are currently paying more than they need to to secure the services of their top executives—in other words, that it is possible to go out there and secure their services for a lower overall remuneration package than that which they are currently offering. Personally, I would be surprised if Australian boards do not already work very hard to ensure that they pay no more than necessary to land the executives that they wish to employ. If this is the case, it follows that they will still need to offer a package of equivalent value to attract any given employee.
What we are likely to see is an increase in the incidence of golden hello payments, front-loading and sign-on bonuses, in addition to the expected increases in base salary. What is more, the transparency in remuneration reporting referred to by Treasury will apply only to listed companies.
The net effect of all of this is the real possibility that companies may in fact face higher remuneration costs as a result of this legislation, an outcome that is totally contrary to that posited as the reason for its enactment. As it currently stands, most executive remuneration packages contain performance clauses under which part of the executive’s package is payable only upon meeting successful performance criteria. When the executive and the company part ways, the termination payment may or may not include a component based on such performance criteria. It will if he or she has met them and it will not if they have not. But if a higher base salary or front loading is negotiated, such a package will be handed over with certainty and may end up costing more than where a performance component would not have been paid. In this regard, then, the legislation threatens to disturb the alignment of the interests of shareholders and their directors. This is contrary to the aims of the shareholder groups that argue against any disconnect between executive stakeholders and shareholders, as both groups should share sharing in both any pain and any upside. This misalignment occurs because the current form of the bill may encourage executives to move away from incentive based remuneration.
The other specific aspect of this bill which will seriously distort the way executive remuneration packages are constructed is the adoption of base salary in place of total remuneration as the basis for the calculation of the threshold above which shareholder approval is required. This amendment to the legislation will have two very likely impacts which will directly shift senior executives away from short- and long-term pay incentives in favour of maximising base salary. The first is, as already discussed, the ‘squeezing of the balloon’ effect, which will lead to the tendency for negotiated packages to compensate for the risk that termination payments will be curtailed by shareholders. The second is the more direct impact of the threshold being based on base pay, which will lead to a tendency for higher base pay to increase the actual dollar value of the threshold in practice.
On the basis of the evidence presented, coalition senators feel there are a number of issues requiring clarification or further scrutiny. These include the application of the bill to all companies, not just listed ones; the meaning of ‘key management personnel’; the definition of ‘base salary’, which will not be known until the regulations have been released; the definition of ‘termination benefit’, which again will not be known until the regulations have been released; the role of institutional investors in shareholder voting on termination payments; the treatment of superannuation in threshold calculation and its impact on termination payments; the treatment of statutory entitlements; the calculation of the average base salary over three years; the pro rata limit for service of less than 12 months and the fairness in relation to its proposed application; and the treatment of voluntary, out-of-court settlements for unfair dismissal actions and other issues arising out of a forced termination.
Coalition senators also agree with the recommendation of the majority of the committee that the draft bill be altered to permit shareholders to vote on a specific amount over the threshold in cases where it has been triggered. The bill as drafted arguably permits a vote for an unspecified termination payment. This oversight in the framing of the bill is again cause for reflection on the government’s undue haste to intervene in this area and highlights once again that the government is legislating on the run. Referring matters to committees before consultations on the all-important regulations are complete results in witnesses being forced to speculate on the content of legislation, as we certainly observed during the committee stage. The common practice of this Labor government is to introduce legislation that is a bare skeleton, with the key questions on its application yet to be revealed in as yet unspecified regulations.
Coalition senators in their report also welcomed APRA’s focus on the issue of executive remuneration and support APRA in the development of its guidelines for the setting of remuneration for executives of ADIs. In common with coalition senators on the committee, I remain of the opinion that there are sound reasons to await the final report of the Productivity Commission in December 2009 before enacting legislation on termination payments. Similarly, there are good reasons to await the release of the APRA standards due shortly.
I accept the prevailing sentiment that the present threshold is high by international standards and in the view of the community. At the inquiry, I heard a divergence of views of what an optimal threshold would be. Seven years is clearly too much. The evidence suggested that probably two or three years would be ideal. The bigger issue was that of consideration of the salary upon which the remuneration package threshold would be based. In their comments, coalition senators considered that, for the reasons already outlined, there is this clear and strong case for adopting total remuneration, rather than base or fixed pay, as the threshold. I reaffirm this. This is why Senator Coonan has foreshadowed an amendment to try to deliver this outcome and I commend her amendment to the chamber.
It seems to me that interference in private companies’ rights to manage their own affairs should only occur to address extreme cases, the cases that rightly cause outrage in the community, and not the 50 to 60 per cent of termination payments the Treasury has in its sights. Similarly, the provisions in this bill should only apply to those executives whose remuneration is already disclosed in the remuneration report. I commend the bill and I also commend the amendments. I hope that the Senate views them favourably.