Michael O'Sullivan President Phillip Spathis Executive Officer Level 29, 2 Lonsdale Street, Melbourne, Vic, 3000 Tel: 03 9657 4386 ABN 39 031 495 845 Fax: 03 9657 4378 www.acsi.org.au In conjunction with PRESS RELEASE Australian Council of Superannuation Investors 17 March 2005 Time for an informed debate on termination payments for Executives The Australian Council of Superannuation Investors (“ACSI”), today called upon company directors and regulators to re-think the current approach to providing termination benefits for executives. The call follows the release of a research report identifying key shareholder concerns with the design and size of termination payments for senior executives of publicly listed companies. The report, prepared by institutional governance advisor Proxy Australia, compared current practice in Australia with recent developments in international markets and leading academic research. ACSI called upon company directors and regulators to: Stop payments for failure. The report found executive service contracts routinely stipulate lengthy notice periods or pre-determined large payouts even where dismissal occurs as a result of poor performance, Excise bonuses from just termination. The research identified some termination benefits also included ‘bonuses’ that executives departing for poor performance otherwise had no entitlement to collect, Reduce the incidence of lump sum payouts. Australian companies have been slow to embrace the international trend of monthly termination payments which cease or reduce if the departing executive finds another position, Make more termination arrangements subject to shareholder approval. The existing threshold for shareholder approval of termination benefits ( up to 7 times annual salary) was too high to be meaningful in Australia. Review the merits of one year „rolling‟ contracts for executives. The report found such contracts that, whilst on foot, always have a maximum of one year to run are becoming commonplace in the UK. Bring disclosure of executive service contracts into line with other jurisdictions. The US and the UK now compel detailed contemporaneous filings on termination benefits. The latitude in Australia’s continuous disclosure regime has meant that key details often emerge only when an annual report is published. “The Proxy Australia research comprehensively „lifts the lid‟ on domestic and international practices and promotes an informed debate on the disclosure, design as well as the quantum of termination payments” said Executive Officer of ACSI, Phillip Spathis. “As a starting point, ACSI believes that termination benefits for executives must be brought more into line with community expectations. The issue of termination payments is not a peripheral one. The average CEO‟s tenure in Australia lasts just over four years and a quarter of the top ASX/S&P 100 companies have turned over their CEO in the last two years. The research highlighted several termination payments that create an impression of a „reward for failure‟ and give out a strong signal that there are no downside risks for these executives. This makes a mockery of any contention that their remuneration arrangements are aligned to the interests of shareholders” said Mr Spathis. “We regard executive remuneration and termination payment policy as a key indicator of a Board‟s effective oversight of its company executives. It is time that regulators reconsidered the limited say that shareholders have in the approval of termination payments. We rely on boards, as shareholder agents to approve and disclose appropriately structured contracts and reasonable termination payments . The report highlighted many instances where this stewardship has been found wanting over the past 5 years. Disclosure alone will not reduce excessive payments. Boards may well need to exercise better care when approving contracts, in such areas as restricting notice periods, for example to one year or capping the level of liquidated damages. This would involve agreeing at the time the contract is drawn up, a reasonable amount that will be paid in the event of termination, for example six months.” Said Mr.Spathis. ACSI is an umbrella organisation of Australian superannuation funds, representing over 34 funds collectively investing more than $110 billion in the Australian capital market. ACSI commissioned the research in response to a request for the research from an ACSI member and a major investor in the listed sector, HESTA. SYNOPSIS OF THE RESEARCH PREPARED BY PROXY AUSTRALIA The six key issues for consideration identified in the research include: 1. Payment despite poor performance ? Under a typical liquidated damages clause in executive contracts, no termination payment is payable if the executive is dismissed for cause (e.g. misconduct, wilful neglect or serious breach of the service contract). However, the notion of „rewards for failure‟ has arisen partly because some liquidated damages clauses allow for termination payments even where the executive‟s performance has been below the required standard (but not so bad as to constitute „cause‟). Contractual entitlement to a termination payment even where an executive is dismissed for poor performance is clearly an issue worthy of debate. 2. Should performance-related components of pay be taken into account? Disclosures in annual reports indicate that it is not uncommon for a termination payment to be calculated by reference not only to fixed remuneration but also one or more performance-related components of the executive‟s remuneration package (e.g. short-term incentive / annual bonus, and long-term incentive / options). In the case of one company, in 2004 dollar terms, this „short-term incentive‟ component could have added as much as $2,070,000 to the CEO‟s pay-out. And this amount is in addition to any short-term incentive payments that have accrued prior to termination but have not been paid at the date of termination. The UK Parliament‟s Trade and Industry Committee could not see how significant performance-related elements of the remuneration package could legitimately be included in the severance package, where an executive is being removed for underperformance. This issue needs further consideration in the Australian context. 3. Are liquidated damages clauses optimal? There has been a backlash in the UK about liquidated damages payments, which are typically made as one lump sum. Various investor groups have taken the position that the provision of liquidated damages to an executive is generally not desirable, because it involves the payment of lump sums which in practice are not recoverable even where the executive quickly finds new employment. The research observes a submission to the UK Parliament‟s Trade and Industry Committee that suggested that because service contracts tend to be drawn up in a climate of optimism, there is a tendency for liquidated damages to be set higher than might have been the case with the benefit of hindsight. The research also identifies a push for „phased payments‟ in the UK, rather than lump sum liquidated damages. The idea here is not to try to specify in advance how much will be paid out on termination. Instead, at the time of termination, the company continues to pay the former executive monthly payments, for the outstanding term of the contract. Payments cease if and when the executive finds new employment. Provided that specific reference and attention is given to the executive‟s obligation to mitigate his or her damage, this approach can result in a significantly smaller pay-out than a traditional liquidated damages clause. Mitigation means taking reasonable steps to try to find another job. The UK‟s Department of Trade and Industry (DTI) has also floated the idea of „capping‟ liquidated damages at, say, 6 months of basic salary. 4. Should shareholder approval be required in more circumstances? Section 200F and 200G of the Corporations Act requires termination benefits to be put before shareholders in limited circumstances. These types of payments are now subject to shareholder approval if they exceed a size cap. The cap varies depending on how long the executive has been employed. For an executive who has been with the company for 7 or more years, the cap is 7 times the executive‟s average annual remuneration over the past 3 years! However, the generosity of the cap in sections 200F and 200G is worthy of further consideration. As mentioned above, a proposal floated in the UK would see any termination benefit worth more than 6 months’ basic salary needing to be approved in advance by shareholders. The current Australian threshold of up to 7 years‟ remuneration seems extremely generous in this light. In any debate about sections 200F and 200G, it needs to be borne in mind that they do not cover every type of termination payment. And, for a termination payment that does not fall within the scope of sections 200F or 200G, shareholder approval is automatically required regardless of the size of the payment. This is specified by sections 200B and 200E. Interestingly, at least one major law firm interprets sections 200F and 200G as being too narrow to cover the types of liquidated damages clauses that are being included in CEO service contracts these days. 5. Are service contracts too long? Institutional investor pressure, followed by interest from the Cadbury, Greenbury and Hampel Committees, has led to one-year rolling contracts now being the norm in the UK. Whatever the merits or otherwise of one-year rolling contracts, no such comparable debate has occurred in Australia. But as stated earlier, part of the problem in Australia is a lack of data. It is simply not clear how many executives are on lengthy contracts — whether fixed-term or rolling — in the Australian listed company space. Greater disclosure in company annual reports now makes it much easier to conduct research to scope out these issues. 6. Are Australia’s disclosure requirements adequate? In the light of this, an Australian debate on termination benefits should also consider: 1) The approach in the United States. Listed U.S. companies — and foreign companies with securities trading on U.S. stock exchanges — are required by SEC regulations to: a. Disclose „a brief description of the material terms of any employment agreement‟ between the company and a new senior executive within 4 business days of the appointment (on Form 8-K), and then b. File a file a copy of the full contract itself as an „exhibit‟ to the next periodic report (e.g. annual report or quarterly report). A recent example of this was when James Hardie‟s former CEO Peter Macdonald left the company, but a consulting arrangement was struck with him. The company was obliged to file a copy of the entire consulting agreement as part of its Form 20-F filing on 22 November 2004. 2) A regulatory requirement in the United Kingdom. The UK Companies Act requires public companies to make available for inspection by shareholders copies of contracts of service between directors and the company or any of its subsidiaries. These must be available for inspection at the company‟s registered office during normal business hours and at the AGM. About ACSI ACSI was formed in 2001 and represents 34 superannuation funds with over five million members and over $110 billion in assets. About Proxy Australia Proxy Australia is an institutional governance and proxy voting adviser. Lead by Professor. Geof Stapledon and Dean Paatsch it draws together the staff and resources associated with leading edge corporate governance research and voting advice in the Australian market. For further information please contact: For comments from ACSI please contact: ACSI-Phil Spathis 61 3 9657 4386 0417 501 065 For detailed comments on the research please contact: Proxy Australia Dr. Geof Stapledon 0414 643 215 Dean Paatsch + 0412 485 787 61 3 9642 2062
"Research Report on Australian Market"