Remuneration of Directors and Senior Executives in Australia - Essay Example

Title: Executive Remuneration Student’s Name: Course Name and Code: Institution: Date Submitted: Executive Remuneration Introduction For a long time now, governments have been effectively persuaded that market mechanisms control executive compensation, and that such market mechanisms should be allowed to operate freely without any constraint from the legislature. Legislatures should allow the market to control the practice of executive compensation, and any form of formal control should be designed to make sure that the market is run efficiently. Nevertheless, the global financial crisis that was experienced in 2008 and 2009, has led to the imposition of restrictions by Australian, UK and US governments targeting executive remuneration in attempting to help financial institutions to recover from the crisis. During this period there was the view that the remuneration of executives did not indicate companies’ poor performance. In 2009, the government instructed the productivity commission to carry out a public inquiry on executive and director remuneration. This commission was asked to evaluate the effectiveness of the existing regulatory framework, so as to acquire knowledge on the transparency and accountability of executive and director remuneration. The commission also had the task of identifying the mechanisms that would integrate the interests of executives and board with those of the wider community and shareholders (Lipton & Herzberg 2009, p.316) This paper discusses the regulatory framework that has been established for executive remuneration of directors and senior executives in Australia. The regulatory framework is founded on regulated remuneration cycle that is made up of four key activities; disclosure of remuneration, remuneration practices, voting on remuneration, and engagement of remuneration. The paper illustrates that the practice of executive remuneration is to a large extent synchronized by good practice statements, whereas legislative intervention is common for voting and disclosure of remuneration. The main focus of the paper will be on the principles, rules, and laws governing disclosure and payment to senior executives and directors in Australia. In addition, the paper discusses the importance of these regulations in corporate governance. Finally, the paper discusses the provisions existing in other countries and how they can be compared to those in Australia. Executive remuneration can be viewed as a cycle that is made up of four key activities: -Remuneration practice: this refers to the practices of individual executives and firms with regards to remuneration. These practices include drafting of the remuneration contract, formulation of a policy for remuneration, contract termination, and the execution of contracts. -Remuneration disclosure: this involves the annual disclosure of remuneration through the ad hoc disclosures and remuneration reports that relate to remuneration matters, such as company loans, margin transactions, and share transactions. -Engagement on remuneration: this refers to the actual engagement between shareholders and the company on remuneration issues. Two forms of engagement exist; there is the proactive engagement and the reactive engagement. -Voting on remuneration; this is the annual vote done on the remuneration report together with the other resolutions that are remuneration-related. The executive remuneration cycle’s four activities provide the rules that are applied under each activity, they include; Regulations and legislations are the basic corporate rules that are found within regulation and legislation that aim at governing given aspects of executive compensation. Such rules will normally require the disclosure of executive compensation by companies that are listed in accordance to the process of annual financial reporting; they include the required format for disclosure and the penalties for non-disclosure. Under each jurisdiction, these laws govern related party transactions and termination payments for senior executives and directors. In addition, the legislature may specify the duties of directors in equity and common law (Sheehan 2009, p.276). Guidelines and codes of practice; the corporate governance principles and recommendations by the ASX council on corporate governance are considered as the code for best practice. This code describes a variety of corporate governance practices that govern listed companies. Listed companies have the responsibility to report deviations or compliance with this code. This code functions as an observational plan that is used by shareholders to evaluate the performance company. Market exchange rules refer to the rules that are set by the market exchange for corporation that are listed in a specific market. These rules can be delineated further into operating and listing rules relating to executive remuneration. Accounting standards describe the procedures that must be adhered to in the preparation of financial records. These standards may deal with the content and form of statements or how the amount of money contained in such records is to be calculated. The details on how to value and report remuneration items are defined by the Australian accounting standards board. The accounting standards identify the items that should be incorporated in a remuneration report, in compliance with measurement and disclosure standards. Accounting standards are enforced by principles and rely heavily on how they are interpreted; any accounting treatment which complies with the principles is considered compliant with these principles (Sheehan 2009, p.278). Shareholder practice guidance; Shareholders in Australia have either collectively or individually, been able to come up with guidelines on the framework that governs executive compensation. Such guidelines for good practice have been issued collectively by organizations like the Association of superannuation funds of Australia, investment and financial services association, and the Australian council of superannuation investors. In addition, numerous individual investors have proposed statements of good practices in remuneration, like AMP capital investors. The other source of good remuneration practice information is from the proxy advisory board that does research on corporations meetings resolutions. Examples of companies that issue good remuneration practice statements are Regnan and Riskmetrics. In addition, remuneration consultants are also concerned with the dissemination of good remuneration practices. Nevertheless, their role is different because they give advice to a remuneration committee of a given firm considering the specific executives in a company. Practice statements by business interest groups; In every jurisdiction, there are business interest groups that engage in formulating statements of guidance and practice for executive remuneration. Such groups may represent company secretaries, large firms, investor relations experts, CEOs, or directors. Whereas such groups participate actively in the consultation processes in government, they also take part in making rules by disseminating guidelines on best practice to their members. Good examples of such organizations include chartered secretaries of Australia and Australian institute of company directors. These organizations have formulated a number of statements relating to board practice and remuneration. Proxy advisors conduct research on a specific meeting of a company and the resolutions made on the meeting. The advisors may suggest recommendations on how to vote and at other times when not to vote. The proxy advisory intermediaries stress on shareholders proposals, and the mandatory preconditions that should be fulfilled by institutional investors at voting meetings (Sheehan 2009, p. 292). Over the past few years, Australia’s state of corporate governance has received a lot of policy and media attention. This has been as a result of the financial and social implications of the corporate collapses of major companies. The most famous being the investigations that have been carried to identify governance irregularities in OneTel and HIH. In addition, there have been other governance irregularities in other countries such as the United States in corporations like Global crossing, Enron and Tyco. In Australia the formulation of best practice recommendations and principles of good corporate governance by the Australian stock exchange, has assisted in governing of disclosure and payment of remuneration to senior executives and directors as part of corporate governance (Barr, Singh & Suchard 2001, p.15). The corporate governance council was formed by ASX in 2002 with an aim of delivering and developing an industry wide framework to be used for corporate governance. The aim of this council was to come up with a practical guide for investors, listed companies, and the Australian community at large. The council came up with best practice recommendations and a set of principles on corporate governance. (Fleming 2003, p. 198).The principles of the council include: Principle 1: the establishment of a solid foundation for oversight and management; this principle deals with the disclosure and formalization of the roles reserved to the directors and those entrusted to management. Principle 2: deals with the structuring of the board so as to add value. This principle requires the board’s majority of the board to consist of independent directors. The principle also requires that the chairman should be independent and should not take up the role of chief executive officer while still serving as a chairman. Principle 3: promote responsible and ethical decision-making. This principle entails the creation of a code of conduct to govern the key executives such as the chief financial officer, chief executive officer, and directors. This is to make sure that they maintain confidence in the integrity of the company, accountability and responsibility for investigating and reporting unethical practices, and to disclose the requirements for trading in the securities of a company by employees, officers, and directors. Principle 4: maintaining integrity in reporting. This principle requires the chief financial officer and chief executive officer to write to the board explaining that the financial reports of a company indicate the true and fair view. The financial reports should also indicate that the operational results and financial condition of a company conform to specific accounting standards. Principle 5: make balanced and timely disclosures. This principle requires the formulation of written procedures and policies that are intended to make sure that company comply with the listing rules of disclosure and to make sure that there is accountability at the top level of management. Principle 6: Deals with the respect of shareholders’ rights. This principle entails the establishment of a communication strategy to facilitate effective participation and communication with shareholders. This requires the presence of an external auditor in all annual general meetings to respond to questions by shareholders about the content and conduct of the audit. Principle 7: Management and recognition of risk. This requires the establishment of policies on risk management and oversight. The chief financial and executive officers should write to the board explaining that the financial statements’ integrity is based on a good system of internal control and compliance and risk management. In addition, they should indicate that the internal control and compliance and risk management system is operating effectively and efficiently in all aspects. Principle 8: encourage improved performance. This principle deals with disclosure of the procedure of evaluation of the performance of the board, key executives, individual directors, and its committee (Lipton & Herzberg 2009, p.311). Principle 9: responsible and fair remuneration. This entails the disclosure relating to the remuneration policies to help investors to comprehend the benefits and costs of such policies, and the connection between corporate performance and remuneration paid to key executives and directors. This principle requires the creation of a remuneration committee and the clear distinction between the executives’ structure of remuneration and that of the non-executives. Moreover, the principle requires that executive remuneration that is equity-based is made in compliance with the thresholds that have been set by shareholders (Fried & Bebchuk 2004). Principle 10: Recognition of the legal interests of stakeholders. This principle deals with the disclosure and establishment of a code of conduct to direct compliance with the obligations and legal interests of stakeholders. These principles are aimed at producing an integrity, quality, or efficiency outcome and are not prescriptions. All companies that are listed are required to apply these principles in examining their practices in compliance with corporate governance (Fleming 2003, p.205). Internationally there is a strong pattern that is being witnessed whereby nations are asking companies to make disclosures relating to the remuneration of executives and directors in non-state, state owned, and publicly traded companies. For example, the corporate governance guidelines for OECD countries require the disclosure of remuneration of key executives and board members, their retirement and termination provisions, and other forms of in-kind or facility remuneration given by the management. This section outlines a brief description of the disclosure regimes in a number of countries worldwide (Clarke 2007). The disclosure regime in the US is considered among the most detailed disclosure requirement worldwide; this has led to its incorporation in the disclosure regimes of other countries In the US, there are rules that have been established by the securities &exchange commission, publicly traded companies, and non-state corporations. There rules require the detailed disclosure of information relating to the compensation of chief financial officers, chief executive officers, directors, and other officers who are highly paid. These provisions encompass 3 forms of disclosure; the tabular disclosures relating to the remuneration of directors and executives, the compensation discussion and analysis, and the narrative explanation of other forms of remuneration and the information that is relevant to understanding executive remuneration. Such information should be included in the annual proxy statement of a company and published on the website of SEC (Kaplan & Holmstrom 2003). Canada’s disclosure regime is almost the same as that of the US; this is because most Canadian companies are bound by the disclosure provisions in America as a result of being listed in America’s stock exchange. Even though there are specific differences in the actual information that should be disclosed and how such information should be presented, the needed disclosure is essentially as robust as that of the US. Therefore, under the provisions issued by the administrators of Canadian securities, publicly traded and non-state owned companies that are listed under the Toronto stock exchange should contain filings of the remunerations of directors, chief financial officers, chief executive officers, and the next 3 highly paid officers (Hill 2006, p. 68). In Europe, the European Union commission came up with disclosure policies on executive compensation for publicly traded companies, in 2004. These recommendations also included the form and level of the pay of each executive. However, these recommendations are not binding legally; in Europe there are numerous disclosure regimes that are mandatory. On one hand, France, Ireland, and the UK have compulsory disclosure regimes that require individual level reporting, and are almost identical to those in the US. On the other hand, countries such as Denmark and Portugal only ask for aggregate reporting and there is no breakdown of the amounts received by individuals. (Volpin & Enriques 2007, p.123) In Europe, the disclosure requirements of in relation to management compensation are the most expensive. Under the UK listing provisions and the 2006 companies act, publicly traded companies are required to reveal the compensation of executives in their yearly report. The provisions require the disclosure of long-term incentives, pension, bonus benefits, fees, and salaries in a tabular design. Moreover, corporations are needed to submit a detailed description of numerous elements of compensation such as; pensions descriptions, peer groups that determine the amount of remuneration, the payouts given to executives who are leaving, a description of the incentive plans, overview of bonuses, and the executive compensation philosophy. The unique disclosure in the UK is on the vote cast by shareholders to endorse the remuneration statement (Dine 2006, p. 82 The corporate governance code in Germany was revised in 2008 and it requires the disclosure of remuneration of executives in the companies listed in Germany. The compulsory disclosure rules on executive compensation are enclosed in the German commercial code, they require companies to write notes on the profit and loss statement and balance sheet of large and medium sized companies and indicate the amount of remuneration given to the leadership of the company. These notes should reveal the insurance payments, expense allowances, share-based payments, options, profit participations, salaries, fringe benefits, and commissions. However, the disclosure requirements in Germany do not need any qualitative description of remuneration. For example, the explanation of bonuses and the philosophy of executive compensation are normally not indicated in the annual reports. Conclusion Due to the high profile collapse of many firms internationally, the issue of corporate governance has attracted a lot of interest from corporations all over the world. The financial crises witnessed worldwide have been contributed by the executive remuneration of senior executives and directors. This has led to the imposition of restrictions on executive remuneration by governments in an attempt to help the financial institutions in crisis. Similar to other developed nations, Australia has not been left behind and has established laws, rules and regulations to govern the executive compensation of senior executives and directors. This includes; regulations and legislations, guidelines and codes of practice, accounting standards; shareholder practice guidance, proxy advisors, and practice statements by business interest groups. In terms of corporate governance, the Australian stock exchange developed a council with the aim of delivering and developing an industry wide framework to be used for corporate governance. This council came up with best practice recommendations and a set of principles on corporate governance to guide investors, listed companies, and the Australian community at large. However, in as much as a lot has been achieved in Australia, more needs to done in terms of additional regulations and rules that will instill ethical behaviors in corporations. References Barr, R, Singh, M, & Suchard, A 2001, ‘The market effects of CEO turnover in Australian firms’. Pacific-basin finance journal. Vol. 9, Pg.1-27. Clarke, T 2007, International Corporate Governance. Routledge, London and New York: Dine, J 2006. ‘Executive pay and corporate governance in the UK; slimming the fat cats?’ European company law. Vol. 3, Pg. 82. 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