ASX Corporate Governance Principles and Recommendations

The ASX Corporate Governance Council has released the final version of its Corporate Governance Principles and Recommendations (Third Edition), which will take effect for financial years commencing on or after 1 July 2014.

Corporate Governance Principles and Recommendations

Most changes we mentioned at the release of the draft made it into the final document, with a few deviations.

Effect of Director Tenure on Independence

The most high profile of the changes was the decision not to specify a recommended maximum length of tenure for independent Directors.

Instead of noting that tenure of over nine years may compromise Director independence, the final ASX Corporate Governance Principles state that there may be doubts about the independence of a Director if he or she “has been a Director of the entity for such a period that his or her independence may have been compromised”.

This is followed by commentary stating that shareholders are likely to be well served by “having a mix of Directors, some with a longer tenure with a deep understanding of the entity and its business and some with a shorter tenure with fresh ideas and perspective”, also noting that the Chairman is likely to have a longer tenure.

A long tenure does not necessarily mean a Director has become too close to management to be independent, the principles note, but they do recommend an assessment of any Director who has been in a role for over 10 years. Likewise, a short tenure does not make a Director more likely to be independent.

The decision to exclude the tenure limit followed consultations and aligns with our views that independence should be judged on a case by case basis rather than with regards to an arbitrary limit.

Clawback policy

Another change that has received less publicity is that the final rules have removed the standalone recommendation regarding clawback of executive remuneration. Instead clawback is mentioned in a statement within recommendation 8.2, which outlines remuneration disclosure requirements. The mention of clawback has also been removed from the commentary of Recommendation 1.3 regarding the terms of appointment for Directors and senior executives.

The Draft ASX Corporate Governance Principles had read:

Recommendation 8.3:

A listed entity should:

  1. have a “clawback” policy which sets out the circumstances in which the entity may claw back performance-based remuneration from its senior executives;
  2. disclose that policy or a summary of it; and
  3. disclose as at the end of each reporting period:
    1. whether any performance-based remuneration has been clawed back in accordance with the policy during the reporting period; and
    2. where performance-based remuneration should have been clawed back in accordance with the policy during the reporting period but was not, the reasons for this.

Commentary

Where a senior executive has received performance-based remuneration as a result of the listed entity’s financial performance and it is subsequently revealed that its financial statements were materially misstated or some other event has occurred that would mean that the senior executive should not have received some or all of the performance-based remuneration, the listed entity should be able to recoup the excess remuneration paid to the senior executive.

To deal with this, a listed entity should have in place a clawback policy (either as a standalone policy or as part of its broader remuneration policy) which sets out the circumstances in which the entity may claw back a senior executive’s remuneration and how those amounts will be clawed back (for example, by requiring the senior executive to pay back remuneration, by reducing any earned but as yet unvested incentives, or by adjusting current year incentives or fixed remuneration to take account of the previous overpayment).

Generally speaking, a listed entity should include contractual provisions in the service agreements with its senior executives that conform to the clawback policy and facilitate the recoupment of remuneration from the senior executive in accordance with the policy.

The final version of the Principles reads:

The disclosures regarding the remuneration of executive directors and other senior executives should include a summary of the entity’s policies and practices regarding the deferral of performance-based remuneration and the reduction, cancellation or clawback of performance-based remuneration in the event of serious misconduct or a material misstatement in the entity’s financial statements.

The newer commentary does not explicitly require a clawback policy, but implies that one should exist. This and the exclusion of the clawback requirement as a separate and distinct recommendation potentially reduces its effect, as commentary does not form part of a principle or recommendation and does not give rise to a reporting obligation.

In our experience, however, more companies are formally including clawback provisions within relevant incentive plan rules. Coupled with Recommendation 4.2 (which requires the Board to receive declarations from the CEO and CFO that the financial statements are in their opinion a fair view of the financial position and performance of the entity) it is arguable that clawback remains a critical component of a company’s corporate governance framework.

Board Capability Matrix

The new principles clarify that although the Council recommends that companies disclose the skills and diversity targets for the Board as a whole, disclosures need not identify the skills held by individual Directors.

Equity pay for Non-Executive Directors

The final Principles and Recommendations have clarified the guidelines for Non-Executive Director Remuneration, noting that it is generally acceptable for NEDs to receive securities as part of their remuneration, but that they generally should not receive options or performance shares with performance hurdles attached. It previously had noted that they should not receive options or performance shares at all.

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