The Advisors' Blog

– Daniel Smith, ISS’s Australian Research

The “two strikes” amendment to the Australian Corporation Act, which went into effect in July 2011, continues to make waves in the market. Under that rule, a board is subject to a “spill” resolution (which would force all directors to stand for election) should a company receive more than 25 percent opposition to its remuneration report for two consecutive years. However, lawmakers are considering legislation to address a so-called “drafting error” in the rule that currently prevents the chairman of the board from voting undirected proxies on the remuneration report.

Some corporate advocates, such as Chartered Secretaries Australia and the Australian Institute of Company Directors, see this exclusion as disenfranchising shareholders who, by explicitly appointing the chairman as their proxy, have effectively given a vote of confidence to the board and management. Other stakeholders, such as the Australian Shareholders Association, argue that this provision is necessary to exclude biased proxy votes.

In late 2011, the Australian Federal Government introduced an amendment to address this issue as a rider to an unrelated bill making its way through Parliament. Despite bipartisan support to allow the chairman to vote undirected proxies on the remuneration report, delays in the legislative schedule, driven in part by an internal leadership struggle in the governing Labor Party, are closing the window on whether any changes will go into effect for companies with annual general meetings (AGMs) in the second half of the year.

The lack of legislative resolution has left in flux the fate of the 36 companies in the S&P/ASX All Ordinaries index that received a “first strike” vote during the 2011 AGM season. Of those 36 companies, five were in the S&P/ASX 100, nine were constituents of the S&P/ASX 200, and 11 were in the S&P/ASX 300. Common themes among strike recipients included inappropriate bonus outcomes in light of company performance, high overall pay relative to the size of the company, and poor disclosure of remuneration practices. Other issues included excessive termination payments and poorly structured long-term incentive plans.

The two strikes rule has received mixed reviews in Australia, with some stakeholders concerned that investors could use the rule as a way of ousting directors instead of focusing on remuneration. These stakeholders fear that the rule could dilute the existing feedback mechanism without actually curbing any pay excesses. Additionally, critics claim the rule disenfranchises executives and directors, particularly those who maintain large ownership positions, as evidenced by Crown Limited, the casino operator that received a first strike at its AGM, where only 18 percent of Crown shares were eligible to vote on the resolution. While legislation prohibits key management personnel and their affiliates from voting on the remuneration report, executives and directors are allowed to vote on the spill motion. Crown’s chairman James Packer, who owns 44 percent of the company, has vowed to vote down the spill motion should it come to a vote.

Regardless of the concerns with the mechanics of the “two strikes” law, the rule has increased the focus on executive pay in the Australian market, and has led to a substantial uptick in engagement between companies, investors, and other stakeholders. Many board members and senior executives appear to understand the need to control the message at a minimum, but also to listen to shareholders’ questions, concerns, and suggestions on executive remuneration. Importantly, adroit company officials have started this conversation sooner in the year instead of waiting until AGM season, when the ink has already dried on many remuneration reports and shareholders’ time is in more short supply.