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Research Report on Australian Market


Research Report on Australian Market document sample

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									                                                                                Michael O'Sullivan
                                                                                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
                                  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
   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
       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

“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

“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.

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
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

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
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
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

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