Corporate Law - Executive Remuneration - Case Study Example

Corporate Law: Executive Remuneration Name Course Tutor Unit Code Date Introduction Executive remuneration refers to the total pay a top manager in a company takes home. This usually includes the basic salary plus benefits such as bonuses, deferred and restricted stock, pension and gratuity, vesting periods, along with other terms of employment based on performance measures, claw-back provisions, as well as golden-handshake. In recent times, specifically after the 2008/09 global financial crisis, there has been much discussion on the issue of executive remuneration, which to some extent could have contributed to the crisis. Australia was not as much of affected by the crisis; nonetheless, it has become party to the discussion given that the world today is very much interconnected, as a measure to prevent such problems in cropping up in the country in future1. It is for this reason that the Productivity Commission (PC) (2010)2 and the Corporations and Markets Advisory Committee (CMAC) (2011)3 embarked on the agenda to review and improve the Australian regulatory framework as regards the remuneration of directors as well as executives of companies regulated under the Corporations Act, 2001. In their report, the PC noted that, “The remuneration of company directors and executives is an issue which has attracted considerable interest from shareholders, business groups and the wider community. The recent global financial crisis highlighted the importance of ensuring that remuneration packages are appropriately structured and do not reward excessive risk taking or promote corporate greed.” This paper seeks to inform James, the managing director of Bayview Constructions Ltd (BC), regarding the current Australian regulatory framework on executive remuneration. The paper also addresses the impact of the current regulatory framework following that his Remuneration Report that sought to increase his pay by $150,000 in the July 2013 Annual General Meeting (AGM) was rejected. Controversy in Executive Remuneration In actual fact, only a small number of top executives would openly admit, in any case, that they are overpaid. So far, the concern of executive remuneration is rumbling away subsequent to the recent global financial crisis and its effects world over. Executive remuneration has come to be a thin-skinned issue for the executives as well as the companies that utilise their knowledge, skills, expertise and wisdom. The recent executive remuneration controversy has been propagated by little transparency regarding dealings at publicly traded firms. In some cases, some companies have been reporting lower profits, but on the other hand, their top managers have been getting more affluent as pay for junior workers remained somewhat stagnant. For instance, in the United States, some top executives took home well over $500 million a year. In addition, the wage ratio between top managers and low level managers ballooned from around 42:1 in the 1980’s to over 400 times today4. For the most part, the dilemma in executive compensation is linked to the evolution of executive remuneration packages that have come to be closely knight to short-term stock prices. Executive remuneration is today more inclined on stock options, a move away from the conventional fixed salaries. This also includes deferred stock along with stock purchase options that are commonly vested over shorter periods. Furthermore, options are characteristically tied to short-run publicly traded stock prices. The figure below illustrates the development of executive remuneration, which is today mainly based on equity5. Figure 1: Executive Remuneration Development Certainly, executives need to be compensated for a good performance, however the developments in executive remuneration packages, as depicted above, has predisposed to several startling results. Managerial decisions are now tilted to prefer short term gains and conservatory markets for overvalued equity created. For this reason, executive remuneration ought to be analysed objectively6. Furthermore, there is need to develop a means of aligning executive conduct with shareholders along with other stakeholders, considering that proper executive remuneration is necessary but not sufficient for long-standing value creation. Companies ought to make sure that incentives offered to top managers are in line with shareholder interest in long-term value creation. Executives in big companies only own a tiny stake of the company’s equity, which gives rise to a principal-agent against shareholders or debtors, among other stakeholders. Rationale for Policy Formulation The recent global financial crisis underlined the significance of making sure that executive remuneration packages are structured in a proper way and do not permit extreme risk assumption or endorse self-indulgence. Another key emergent aspect is that of maintaining a strong regulatory framework that supports transparency and accountability on executive remuneration deeds. The regulatory framework should as well bring into line the interests of shareholders and other stakeholders with the performance and reward structures of Australia’s corporate directors and executives in a better way7. On a global scale, executive remuneration has been the mandate of two key bodies: (1) the Group of Twenty (G-20); and (2) the Financial Stability Board (FSB). These two bodies have recommended that remuneration practices in the financial sector be propped up as a rejoinder to the crisis. These measures have been put into practice in Australia. However, individual countries such as the United Kingdom, France and the United States have developed their own conditions on executive remuneration mainly targeting those companies that benefited from bailouts and other government support packages. Even though Australia was not as much of affected by the crisis, one key consideration is that globally competitive compensation structures for company directors as well as executives still spur directors and executives to take on leadership and managerial roles in big companies. It is for this reason that the Australian government, through the relevant bodies, opted to improve the Australian executive remuneration framework. This was also intended to strengthen the Australian Prudential Regulation Authority (APRA) work in developing a template linking capital adequacy requirements to executive remuneration practices so as to restrain extreme risk taking in financial institutions. Apart from improving transparency and accountability, the reforms would improve the country’s international competitiveness8. The Productivity Commission (PC) in 2009 assessed the regulation of directors and executive remuneration in Australia. In their final report, the commission found out that Australia’s corporate governance and remuneration frameworks ranked very high globally. Nonetheless, the PC recommended that Australia’s remuneration framework needed to be strengthened further. The recommendations were intended to get better board aptitude, shrink conflicts of interest, support stakeholder involvement, and improve pertinent disclosure and to guarantee well envisaged remuneration policies9. Impact on Executive Remuneration Framework One key point of the Corporations Amendment (Improving Accountability on Director and Executive Remuneration) Act 2011 was the introduction of the ‘two-strikes and re-election’ canon for the non-binding vote on the remuneration report. First, the act stipulates that in an AGM voting process, if 25 per cent of the votes cast do not approval the remuneration report, and shareholders comment on the report during the meeting, the board is obliged to state in its annual report in the next year its reaction to those comments, or enlighten its failure to respond. Secondly, if in two AGMs following each other, 25 per cent of the votes cast do not approval the remuneration report, it follows that at the second AGM the company should put a resolution to shareholders to ‘spill’ the board. If the ‘spill’ is endorsed by 50 per cent or more of votes cast, the entire board (except for the managing director) have got to stand for re-election at a further general meeting, which should be convened in a period of ninety days10. However, the ‘two-strikes and re-election’ policy does not give power to shareholders to decide the executive pay through a binding vote. It remains the duty of a company’s directors to deal with the top managers by attracting and motivating them through remuneration practice. The key point of the reforms was to factor in additional powers for shareholders to influence the level and composition of executive remuneration. This would cultivate a board culture where they ensure that they answer to shareholders the reasons for adjusting their payment level and composition. Moreover, the reforms would closely link executive remuneration to the performance of the company. The CMAC (2011) necessitated improved disclosure in remuneration reports particularly as regards termination benefits. Also remuneration reporting would be simpler seeing as superfluous disclosure requirements would be done away with and the classification of pay will be apparent such that shareholders identify with the company’s remuneration practices11. Analysis Shareholders are the qualified owners of a company. They therefore look up on to the company’s directors and executives to be compensated in line with the company’s performance. In the past, shareholders did not have power over executive remuneration even in cases where the company posted poor performance. The effect of this as observed in several regions of the world was a constant increase and ballooning of executive pay through opaque and dubious ways. This factor was linked to the recent global financial crisis. It is through corporate governance that the ensuing principal-agent interests and incentives can be aligned to guarantee transparency and accountability. The regulatory bodies have got to coordinate the terms of executive remuneration to the performance of the company. Therefore, I believe that shareholders must be able to require the directors and executives account for their resolutions on remuneration, plus other decisions touching on the performance of the company. Hence, the provisions of the Corporations Amendment (Improving Accountability on Director and Executive Remuneration) Act 2011 in principle guarantee that governance arrangements are in place to guarantee director accountability when settling on executive remuneration12. Conclusion The aim of the Corporations Amendment (Improving Accountability on Director and Executive Remuneration) Act 2011 is to prop up transparency and accountability as regards directors and executive pay. It also gives some power to shareholders to influence executive compensation, which is intended to align the compensation to the company’s performance13. Following the stipulations of the act, James has a duty of explaining in the next AGM his response to the shareholders failure to endorse the remuneration report, or explain his failure to respond to their concerns. The ‘two-strikes’ policy permits the introduction of the report in the next AGM after which the shareholders will again vote on the remuneration report. The outcome of the vote shall inform the next move as provided for in the act14. Read More