The Agenda – July

Preparing for the midyear remuneration review

Recent labour force and consumer price index (CPI) figures released by the Australian Bureau of Statistics (ABS) continue to dampen prospects of a remuneration increase for Key Management Personnel above 2%, which is below the Fair Work Commission’s (FWC) adjustment to the minimum wage.

The FWC lifted the minimum wage by 2.4% from $659 ($17.29) a week to $672 a week ($17.70 an hour), to take effect from the first full pay period on or after 1 July 2016.

Key figures for June show that the trend unemployment rate remained steady at 5.7%, and the participation rate also remained steady at 64.8%. Employment grew by 0.07%, which is consistent with the average growth rate over the last six months.

The Consumer Price Index (CPI) rose 0.4% in the June quarter (a rise of 1% from June 2015 to June 2016). This follows a fall of 0.3% in the March quarter.

ASIC due diligence guidelines for IPOs

The Australian Securities and Exchange Commission (ASIC) has released a new report on due diligence practices for companies undergoing an IPO, which found a close correlation between defective disclosure in a prospectus and poor due diligence.

In producing its report, ASIC conducted systematic reviews of the due diligence practices of 12 IPO issuers, ranging from small, mid-sized and larger offers and a sample of offers from emerging market issuers.

ASIC states this research is important given that the IPO market has been particularly active recently, with 42 IPOs this year which raised an average of $75 million. In 2015 there were 100 IPOs, raising a total of $13.5 billion. The sectors that are expected to be active participants this year are the technology and financial sectors.

Observations from the report include:

  • The adoption of poor due diligence practices often produced prospectuses with defective disclosure.
  • The issuers and their directors should conduct an effective due diligence process to mitigate the risk of any future liability from a quality-poor prospectus
  • It is important for directors of issuers and their advisers to be actively engaged in the due diligence process
  • Additional procedures may be required to overcome the additional challenges of foreign laws, language barriers and supervision for emerging market issuers.
  • A low cost due diligence process may often lead to delays, further work and ultimately be more costly to an issuer.

ASIC’s key recommendations for companies undergoing an IPO are as follows:

  • Issuers should adopt a due diligence process that contains the following elements:
    • Oversight of the process
    • Investigation of information
    • Record keeping of key and significant issues
    • Verification of all material statements in the prospectus
    • Continuation of the due diligence process throughout the offer period
  • Issuers and advisors are encouraged to conduct a thorough and investigative due diligence process to ensure “substance over form”
  • Engage directors throughout the process to ensure the contents of the prospectus are complete
  • Each professional and expert adviser – such as a manager, legal adviser, tax adviser, underwriters and lead managers – should be engaged on the basis that they are competent and bring their own unique set of skills, knowledge and experience to the preparation of the prospectus
  • Due to the heightened challenges associated with emerging market issuers, Australian advisers should provide effective oversight and apply sufficient scepticism of the due diligence work carried out by foreign legal and other advisers.

Exemptions to the lifetime cap on non-concessional contributions

The government may be considering adding a number of exemptions to the $500,000 lifetime cap on non-concessional contributions as part of its superannuation reforms.

Recent media reports state that the government will release draft legislation containing exemptions for “life-events”, which were one-off windfalls. These would include an inheritance, a divorce settlement, or eligibility for a trust payment.

There would be other exemptions, for example, for individuals with self-managed super funds (SMSF) who need to transfer additional funds into their SMSF to fulfil contractual obligations to purchase property. These arrangements would have had to be made prior to the federal budget.

While some sources have stated that the addition of exemptions could cost between $300 million to $450 million, others have said it will be much less than this.

Egan Associates summarised some of the expert opinions and questions raised by the proposed superannuation changes in last month’s newsletter. Click here to read the article on our website.

Significant shareholder Directors perform better than independent Directors

Recent research by UNSW Professor of Finance Peter Swan has shown that Directors with significant shareholdings perform better in an informed market than independent Directors.

Swan investigated the prevalence of swing trades and the presence of independent or substantial shareholders (over 5%) on the Board for 500 companies between 2001 and 2012.

Swing trading is defined by the length of time the trade is held – longer than a day, but not generally longer than a few weeks. The shares are held and traded based on intra-week or month changes between optimism and pessimism. According to Swan, these trades are a strong indicator of active and informed institutional trading.

If the market was informed, (prevalent swing trading) Boards with “experienced Directors” on their audit committee saw increased share prices and returns. Swan postulates that this is due to the Directors being held accountable through their shareholdings by informed stock price movements, while the actions of independent Directors are neither significantly rewarded nor punished.

The ASX corporate Governance Council (CGC) has required a majority of independent directors on the board of listed companies since 2003 in order to minimise excessive risk taking and fraudulent activity as well as provide effective independent oversight. Although the CGC guidelines are not mandatory, public pressure on large companies has generally led to compliance with the rules requiring independent directors.

However, Swan’s research found that the departure of substantial shareholders – with their necessary replacement by independent directors – was a determining factor explaining a decline in performance. Swan argues that shareholder directors are better on aspects of company performance such as negotiating and monitoring of CEO pay and advising on takeover acquisitions.

WorldatWork survey on prevalence of bonuses

The latest WorldAtWork survey of bonus programs and practices has revealed that the prevalence of bonus programs is increasing as companies search for alternative means of rewarding their employees.  Survey invitations were sent electronically to 5,200 WorldatWork members with 726 responses (mainly from North America).

The study compared four different types of bonus, which were defined as follows:

  • Referral bonus: a cash award paid to a current employee for referring a successfully hired job applicant.
  • Sign-on bonus: a cash bonus given at the beginning of a service period, usually for accepting an employment offer.
  • Spot bonus: a type of informal recognition that is delivered in cash, spontaneously or “on the spot.”
  • Retention bonus: a cash award typically tied to the length of service or some other milestone.

The survey found that all bonus programs have stopped their downward movement observed since the 2009 recession, and sign-on and retention bonuses were used at higher rates than in any other year. The average number of bonus programs offered by companies is three, which is an increase from an average of two programs in 2010 (when the last survey was run).

Other key findings from the survey are listed below:

  • 29% of participating organisations used all four types of bonus programs, an increase of 20% from 2010, while 9% do not have any bonus programs in place
  • Approximately one-third of companies budget for sign-on and retention bonuses, while 41% budget for referral bonuses and 53% for spot bonuses
  • Public companies use all bonus types more than any other sector, with sign-on bonuses being the most common
  • Referral bonuses have fallen from being the most prevalent program in the last survey (2010) to being the second most prevalent behind sign-on bonus programs.

UK disclosure rules fail to curb executive pay

A study by Cambridge University’s Judge Business School and King’s College London has found that new UK disclosure regulations have not been able to curb excessive pay or strengthen the link between pay and performance in FTSE 100 companies.

The rules, which were introduced in 2013, require large and medium-sized public companies to submit comparative information about the pay of chief executives and employees in an effort to “restore a stronger, clearer link between pay and performance, reduce rewards for failure, and promote better engagement between companies and shareholders”.

The study found that the average chief executive in the top 100 companies earned £5.57 million, including salary, bonus, benefits and equity, with cash of £1.64 million, compared with £4.68 million and £1.57 million respectively in the two years prior to when the regulations took effect.

There was also a significant, positive correlation between previous years’ AGM dissent and pay, which the authors believe supports the need for a binding vote regime.

On the point of CEO-employee pay comparisons, the effectiveness of the rules was reduced by the broad discretion afforded to companies in meeting their disclosure obligations. For instance, some firms chose only to report on particular geographical areas (London, UK, Australia) or certain types of workers (senior management, head office).

The ratio of total CEO pay to average employee pay had barely changed from 123.01 prior to the regulations to 122.37 afterwards. Although companies reported that employee salary (3.64%) and bonuses (22.66%) increased at a higher rate than CEO salary (0.2%) and bonuses (14.03%), the increase in CEO benefits (9.5%) was nearly six times that of employees’ benefits (1.6%).  Further, this comparison excluded equity linked pay.

Notably, larger, less profitable firms tended to have greater differences between CEO and employee pay, and there was some evidence that appointment of a new CEO and a shorter CEO tenure shrinks the pay differential.

Recently elected UK Prime Minister Theresa May has also vowed to crack down on executive pay by making shareholder votes binding on pay packages, and has  called or companies to be more transparent about performance targets and CEO-employee pay ratios.

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