Challenges with the Statutory Reporting of Rights Grants to Executives

With ASX companies commencing or progressing preparation of their Remuneration Report for the current financial year, there are many issues for Boards to consider. Two critical issues which often emerge are who constitutes a member of the company’s Key Management Personnel (KMP) and how rights-based long term incentive grants are reported.

Remuneration Report

KMP

The Corporations Act requires disclosure of KMP remuneration. Who is a KMP is, accordingly, critical to what is disclosed.

KMP is defined in the Corporations Act by reference to the accounting standards. The definition in the relevant accounting standard (AASB 124) is “those persons having authority and responsibility for planning, directing and controlling the activities of the entity, directly or indirectly, including any director (whether executive or otherwise) of that entity.”

Until 28 June 2007, the Corporations Act prescribed remuneration disclosure relating to directors, secretaries and “senior managers”. Senior manager is defined as a person (other than a director or secretary) who participates in decision-making affecting the whole or a substantial part of the business of the corporation, or who has the capacity to affect significantly the corporation’s financial standing.

The current KMP definition is less clear than the previous senior manager definition. Specifically, senior executives with defined roles impacting a substantial part of the company’s business (for example, Head of Sales / Distribution) may not satisfy the current KMP definition on the basis that he/she does not have authority and responsibility for general planning, direction and control of the company’s activities (despite being highly remunerated). Similarly, whilst the Chief Financial Officer clearly has the capacity to affect significantly the company’s financial standing, he/she may not satisfy the current KMP definition.

Rights-based LTI grants

Equity-based long term incentive grants constitute remuneration for the purposes of the Corporations Act. Specifically, share-based payments to KMP constitute compensation as defined in AASB 124. The Corporations Act requires the Remuneration Report to include the value of options granted to KMP during the year as part of their remuneration. We note that options here include those with zero exercise price (‘in-substance’ share rights).

The value of the options to be disclosed is to be worked out as at the time they are granted and calculated in accordance with applicable accounting standards. Accordingly, the Corporations Act requires the disclosure of the fair value for share rights granted to KMP during the relevant financial year. As we have discussed in previous editions and elsewhere in this Newsletter, the fair value for the share rights should, however, not be the basis for calculating the number of rights to be granted to KMP.

In this context, Boards should clearly distinguish between the valuation of the rights for remuneration intent purposes and valuation of the rights for financial reporting purposes. As importantly, Boards should be cognisant of not blindly adopting a prior year accounting-based disclosure as the basis for formulating current year rights grants. This issue has sponsored comment from institutional investors and proxy advisors.

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