An edited version of this article appeared as an op-ed in The Australian on Monday, 6 February 2017
In securing her leadership of the Conservative Party, Theresa May pledged to dramatically reform corporate governance in the UK, proposing measures more restrictive on remuneration practices than anything suggested by either side of Australian politics. The UK Business, Innovation, and Skills Committee has since launched an inquiry with terms of reference that challenge positions we’ve considered immutable in Australia - proposing employee representatives on boards and remuneration committees, binding shareholder votes on pay, duties to promote long-term success and even government control over executive pay.
This is a new peak in a building mood across Western economies to question corporate governance and executive remuneration. Communities are wanting evidence that companies exist for more than simply generating short term profits for current shareholders. This mood found voice in the Occupy movements, reactions to Thomas Piketty and in recent shock electoral results (notwithstanding some fairly tepid swamp-draining from President Trump to-date).
It’s unlikely Prime Minister May’s proposals will be picked up in Australia any time soon though. Board discretion to deal with executives (including setting remuneration) and to pursue other corporate objectives, more-or-less unfettered by shareholders, is the Australian way. Simply put – shareholders’ real power is to vote out a Board that makes bad decisions, not to make the decisions themselves. But even though our boards have resisted the serious excesses of their US and UK counterparts in executive remuneration, they would be unwise to ignore the global trend.
It’s always been said that Australia should be a fertile ground for shareholder activism. Australian shareholders have some big sticks in their kitbag - the ability to convene meetings, nominate and remove directors and to propose other resolutions. Historically, however, Australia’s shareholder base has been relatively passive. But even this is changing.
2016 saw a burst of shareholder activism on the ASX. Over 100 listed companies received a first strike against executive pay, including AGL Energy, Woodside Petroleum and the Commonwealth Bank. Australian investors seem increasingly unconvinced that our executives are 10 times better at their jobs than their forebears were 40 years ago. 29 ASX listed companies also received shareholder requisitions to convene extraordinary general meetings, 11 of which were pulled after the threat motivated the relevant directors to resign ahead of a vote they were bound to lose.
If historically inert Australian shareholders are afloat on the tide, then looked at with international trends, some change is needed for Boards to stay ahead of the breakers. And there is still an opportunity here, because, unlike other Western governments, Australia’s has not pursued regulatory action to address the rising temper, yet.
By contrast, as of 2017, US companies are now required to disclose the ratio of a CEO's annual total remuneration against the median of all employees. More dramatically, the City of Portland approved the introduction of a new 10 per cent tax on companies who pay the city’s business license tax if CEO pay is greater than 100 times median employee pay. If CEO pay is greater than 250 times the median pay (apparently conceivable), an additional 25% tax applies. This tax could affect hundreds of listed companies (including Walmart). California initiated, but failed to pass a similar effort.
Bundled in with discontent about executive pay are other societal issues where companies are dragging their feet – the gender pay gap and climate change being prominent in this regard. A draft UK regulation given to Parliament calls on companies with 250 or more employees to publish annual metrics on their gender pay gap, including gross mean and median hourly pay and mean and median bonuses paid to female and male employees.
Instead of waiting for the inevitable blunt instrument of government regulation, there’s been an industry led response to some community concerns. A number of high-profile companies voluntarily committed to a UN Climate Disclosure Standards Board framework for reporting on climate impact, including ANZ and Infigen in Australia. Michael Bloomberg’s Task Force on Climate-related Financial Disclosures is another industry initiative which emphasises the importance of climate transparency in reporting for investors and the broader community. The TCFD is now working with companies with a combined market value of $2.1 trillion.
Ideally these industry led responses would be the rule, and not the exception. However, moving to more long-term company decision making isn’t just a question of values, it’s also a question of law. The Corporations Act requires directors act in good faith in the best interests of the company. This is the foundation stone of directors’ duties in this country. While some academics argue that ‘interests of the company’ includes those of future shareholders and even the community, the approach of Australian courts has been to treat shareholder value as the be-all-and-end-all. This widely accepted reading of directors’ duties – where protecting and generating value is all that matters – could mean directors are breaching their duties (and exposing themselves to penalty) if they focus on anything other than returns for current shareholders. Essentially, devoting company resources to long-term or non-financial factors (or voluntarily airing laundry by disclosing non-compulsory metrics) could actually be a breach of duty. A UN environmental initiative has acknowledged this issue. In a recent report, it asked APRA to clarify whether fiduciary duties in Australia require attention to be paid to long-term factors in decision making, and for all relevant Australian regulators to clarify that responsible investment includes environmental, social and governance integration and policy engagement, regardless of the effect on shareholder value. The only reason those types of assurances would be needed is because that’s not the law as it currently stands.
Until any such proclamations are made (and no-one is holding their breath) - how do Australian directors respond to the tide of the times while complying with their fixed duties? The answer must be in successfully making the argument that change is in the interests of the companies they serve, that moving away from fishing with dynamite is better for shareholders despite the short-term pain. This is not hard to prove with genuinely long-term focused executive remuneration practices, a perfect example being bonus claw-back provisions now used in the event of historical financial misstatements. The TCFD’s argument that environmental disclosures allow shareholders to make better decisions on capital allocation and risk assessment is a good example of a case for a less cut-and-dried issue.
The drums are beating. Australian boards would be wise to ensure their remuneration and disclosure practices reflect the current views of shareholders and the broader community. In doing so, they will need to navigate the requirements of the duty to act in the best interests of the company, which isn’t necessarily as simple as it should be. If they don’t make some changes to meet expectations, going by what’s happening everywhere else, a surging wave of populist legislators will likely force change on them, and that could lead to greater miseries.