The Agenda – September

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Egan Associates in the News

Egan Associates featured in the media in the last month. Our research from last month’s Newsletter on the gender gap in Director pay was reported by the Australian Financial Review.

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We also provided our view to The Canberra Times on the declining use of bonuses within the Australian Public service.

A summary of our comments on these topics and links to the articles can be found here.

Our opinion was canvassed by The Australian (subscription) on the quantum of Vice Chancellors’ remuneration, which led to a follow-up interview from 2UE’s Tim Webster on the topic.

We will be publishing a detailed version of our views on this topic soon.

Lastly, we were asked by SME-focussed publication SmartCompany to provide some comment on the effectiveness of profit share plans.

Culture continues to be a hot topic

Egan Associates recently attended a Hattonneale Directors’ luncheon to discuss how Boards can influence culture in the way they approach their duties, the way they act on advice from advisors and the way they remunerate key management personnel.

A case of culture failure has surfaced recently in the form of incentive fraud at Wells Fargo. The bank had an incentive scheme rewarding employees when customers opened accounts. Since 2011, the company’s employees had secretly been opening up sham online banking services and credit card accounts without the consent of the customers. A number of customers learned of the accounts when they were charged fees, or when they received credit cards in the mail. Others never found out because the employees closed the accounts soon after opening them.

A number of customers took legal action against the bank and the extensive nature of the problem has since come to light. During the five-year period, Wells Fargo employees reportedly opened approximately 1.5 million bank accounts and applied for 565,000 credit cards that might not have been authorised.

The company has been fined US$185 million for its practices. It will repay US$2.6 million in fees. It has fired 5,300 employees who were involved, some of whom were managers.

Commentary around the case has at times blamed the incentive plan, which undoubtedly could have been designed with better safeguards, such as a minimum time for accounts to be open before an incentive is paid; however, in truth it is the ethics and behavioural expectations – the culture — of the company that allowed the fraud to happen. It raises the question of how deep a Board Remuneration Committee should delve into auditing company reward practices.

Australia’s wage growth slow, but not the slowest

Australia’s wage growth is at record lows, but it’s not as weak as the wage growth in other countries, according to recent global data from Korn Ferry Hay Group. Adjusted for inflation, it found that Australia’s salaries have grown by 5.9% since the start of the “Great Recession” in September 2008. In comparison, salaries in France grew by 5.2%, Germany by 5.0% and Italy by 2.4%. Salaries in the UK have decreased by 0.1% and in the US they have fallen by 3.1%.

In emerging markets, salary changes were mixed, with Turkey, Argentina, Russia and Brazil experiencing double digit falls, while China and Indonesia experienced increases in the vicinity of 10%.

Remuneration of ASX 200 CEOs

The Australian Council of Superannuation Investors has released its annual research into the remuneration of ASX 200 CEOs completed by Ownership Matters.

The research examines both “reported” pay, based on the accounting value of equity provided in statutory accounts, and “realised pay”, based on cash pay plus the value of equity vesting in the year (except for options, where the value is added when they are exercised).

Median reported ASX 100 fixed pay declined 3.1% year on year, continuing a trend that has seen fixed pay decline almost 12% from the 2012-2013 financial year. Median fixed pay in the year also declined for the ASX 101-200, however, this is not a trend – fixed pay had risen year on year for the prior three years.

The reduction in fixed remuneration was due to new CEOs receiving lower fixed remuneration than their predecessors, as when only considering incumbent CEOs, CEO pay had risen year on year for both groups of CEOs.

The amount that CEOs were actually paid including long term incentives also reduced. Median realised pay reduced by 2% for ASX 100 companies and 18.7% for ASX101-200 companies.

The median ASX 100 CEO cash bonus, however, increased by almost 10%, although the average cash bonus fell by a little over 5%. 93% of ASX 100 CEOs received a bonus and half of the CEOs received a bonus worth 76% of the possible maximum bonus or more. This matches data from Egan Associates on target and maximum STI levels conducted in 2015.

The median and average cash bonus level decreased for ASX 101-200 CEOs, by 1.6% and 16.9% respectively. The report noted that fixed remuneration and bonus levels for this cohort of CEOs were much smaller than those for ASX 100 CEOs and that it was less likely for ASX 101-200 CEOs to receive bonuses. This comment echoes articles Egan Associates has published in the past regarding the varied size of CEO bonuses across ASX 500 companies and the likelihood of CEOs from smaller companies receiving a bonus versus those of larger companies.

The ACSI research also looked at the bonus level “accrued” which it describes as “including any component deferred relative to bonuses paid over the past five years”. Whether this includes the amount earned in the year (ie the bonus paid and deferred for performance during the financial year), or the amount on foot at the end of the year (cash paid plus any STI that has been deferred and not yet vested to the executive) is unclear from this description.

The median accrued bonus increased by almost 6% for ASX 100 CEOs and fell 1.4% for ASX 101-200 CEOs. Incumbent CEOs earned a much higher accrued bonus than the rest of the sample.

Superannuation Legislation

The proposed $500,000 lifetime non-concessional cap has this month been abandoned. Instead, the current $180,000 annual non-concessional contribution limit will be reduced to $100,000. Individuals under 65 will continue to be able to bring forward three years’ worth of non-concessional contributions.

Individuals with a superannuation balance of over $1.6 million (indexed) will no longer be eligible to make non-concessional contributions after 1 July 2017.

To offset the cost of removing the $500,000 lifetime non-concessional cap, the government will no longer proceed with the removal of the work test for individuals over 65. This means that individuals over 65 who want to contribute to superannuation will need to be working for at least 40 hours over 30 consecutive days during the financial year in order to do so. The introduction of the proposed ability to roll over unused concessional contributions, intended to help individuals such as women who might be out of the workforce and unable to contribute to super for a few years, will also be delayed by one year to 1 July 2018.

Treasury had earlier released an initial tranche of exposure drafts to write into law the superannuation changes the Coalition took to the election and detailed in the 2016 Budget.

The draft legislation:

  • Defines the primary objective of the superannuation system as being “to provide income in retirement to substitute or supplement the age pension”. The focus of this statement is that the money is to meet the expenditure requirements of seniors rather than tax minimisation or estate planning. The intent is that enshrining the objective in legislation will provide a framework against which future superannuation policy proposals can be assessed. Subsidiary objectives are to facilitate consumption smoothing over the course of an individual’s life; manage risks in retirement; be invested in the best interests of superannuation fund members; alleviate fiscal pressures on Government from the retirement income system; and be simple, efficient and provide safeguards.
  • Allows individuals to claim a tax deduction for personal contributions to superannuation regardless of their employment status. Previously individuals had to earn less than 10% of their income from their employment related activities to be able to make deductions. Exceptions include contributions to untaxed funds and defined benefit funds. The government estimates this will affect 800,000 people, including those who are partially self-employed and those whose employers do not offer salary sacrifice arrangements.
  • Increases the salary an individual can earn and still have their spouse pay superannuation contributions into their account and receive a tax offset. The high-earning spouse can claim a tax offset for superannuation contributions made into the low-earning spouse’s account, as long as the low-earning spouse’s annual assessable income, fringe benefits and reportable superannuation contributions are below $40,000. The prior cap was $13,800. The maximum offset of $540 is claimable when the low-earning spouse’s income is $37,000 or below, reducing to zero at $40,000. The offset is not available where the low-earning spouse has reached their non-concessional contribution limit.
  • Introduces the low income superannuation tax offset, which allows a tax offset of up to $500 to be claimed for tax paid on superannuation for low-income earners (adjusted taxable income of $37,000 or below). This ensures individuals who have an effective tax rate below 15 per cent do not pay more tax on their concessional contributions than if they had received the money as salary or wages. In order to claim the offset, the individual must not have held a temporary visa during the income year (with exceptions); must have made at least one concessional contribution in the corresponding financial year; must receive at least 10% of their income from business or employment; and 12 months after the end of the income year, the Tax Commission must believe there is sufficient information to determine the taxpayers adjusted taxable income is at or below $37,000 (in some cases, where individuals do not need to file a tax return, the ATO can make an automatic offset payment to the individuals’ super fund). The government estimates that this will affect 3.1 million low income earners, 1.9 million of them women. Exclusions include superannuation payments to constitutionally protected funds.

The legislation had also removed the work test for those aged over 65, however, the government announced this month that this measure would no longer be implemented.

There are still a number of measures that have yet to be drafted into legislation, including:

  • Introducing a $1.6 million pension ‘Transfer Balance Cap’;
  • Reducing the concessional contributions cap and non-concessional contributions cap;
  • Allowing the roll-over of unused concessional contributions (now with a delayed implementation date);
  • Reducing the Division 293 threshold where 30% taxation of superannuation begins for high income earners; and
  • Stopping anti-detriment payments.

Also on the topic of superannuation, there has been a certain amount of commentary regarding the superannuation entitlements of politicians, which raises the issue we discussed in our June Newsletter that if the average Australian is to accept changes to their superannuation entitlements, similar changes must be made that affect defined benefit schemes, including those of public servants.

New Zealand Corporate Governance Code

The New Zealand Stock Exchange has published a proposed update to its Corporate Governance Best Practice Code that was last updated in 2003. The Exchange began consultation on the matter in November of last year and has now released a 20-page draft code to replace the previous five-page document.

The proposed Best Practice Code follows the structure of New Zealand’s Financial Market Authority hand book and the ASX Corporate Governance principles, using the hierarchy of Principles, recommendations and commentary. Principles are overarching, recommendations made in the code are to be adhered to on a comply or explain basis, while any suggestions in the commentary can be voluntarily followed.

The areas of focus in the new code are Board diversity; ESG and health and safety reporting; and remuneration reporting.

The sections in the code are summarised below:

Principle 1: Code of Ethics

The code of ethics section goes into detail about what the New Zealand Stock exchange expects to be included in any code of ethics a company adopts, such as expectations for Director and executive behaviour in the face of conflicts of interest, whistle blowing or other similar situations. It also recommends that organisations adopt a share trading policy that extends to Directors.

Principle 2: Board Composition and Performance

This section recommends that Boards have a charter setting out the roles of the Board and management; provide information on Directors’ holdings, experience and tenure; create written agreements with each Director outlining terms of service; arrange training that enables Directors to do their duty; develop and disclose a diversity policy; as well as adopt formal processes to appoint Directors and review Board performance.

The biggest difference in terms of Board Composition between New Zealand’s proposed guidelines and the ASX Guidelines is that there is no recommendation that the Board have a majority of independent Directors in the New Zealand guidelines or that the chairman be independent, despite this being best practice in a number of countries around the world.

In its consultation paper, the NZX noted that New Zealand’s pool of Directors was small and to immediately put such a requirement into place could be problematic. It stated that the listing rules required Boards to be comprised of a third of independent Directors, so the issue would be best addressed as part of the broader review of the Listing Rules later in 2016.

Principle 3: Committees

The recommendations under this principle are only partially new, adding in additional suggestions in the commentary that the audit committee have at least three members, half of which should be independent. The ASX Principles and Recommendations makes this a recommendation and makes similar recommendations regarding the remuneration committee.

Like the Australian guidelines, the proposed New Zealand Code acknowledges that having separate remuneration, nomination or other (such as risk) committees may not be appropriate for all companies.

Principle 4: Reporting and disclosure

The principle notes that where possible, disclosure should be on a constant basis, not purely annually. It recommends that the Board create a continuous disclosure policy and disclose it, as well as disclosing its code of ethics, Board charters and governance documents. It also recommends that the company provides financial and non-financial disclosure, with information on how non-financial targets are measured. The commentary goes into detail about ESG disclosure, providing a number of options for how companies could report their ESG performance, including referencing the Sustainable Stock Exchange Initiative, The NZX’s guidance note on ESG reporting or the Global Reporting Initiative’s guidelines.

Principle 5: Remuneration

Remuneration disclosure requirements in New Zealand are currently minimal. Legislation currently requires NZ companies to disclose employee remuneration in remuneration bands. Director remuneration has also been disclosed as this must be approved by shareholders.

The proposed code includes a recommendation that companies publish a remuneration policy for Directors and senior executives, detailing the proportion of remuneration comprised of base salary, short term incentives and long term incentives, as well as a description of the performance hurdles that must be met in order for incentive payments to be made.

It also includes a recommendation that actual Director remuneration be disclosed, with the suggestion in the commentary that the amount of remuneration paid for committee roles and fees and benefits received for other services provided to the company should be disclosed. The intention is that companies will be able to use guidance from the NZ Institute of Directors on a standard form of disclosure that can be used.

There is also a recommendation that actual CEO remuneration be disclosed, including base salary, short term incentives, long term incentives as well as the performance criteria used to determine performance payments.

The commentary notes that it should be possible via the report for a person to understand the levels of remuneration that have been earned or accrued during the period. It states that details on long term incentive grants or payments should be disclosed “in the years in which such entitlements are earned or accrue”, with the company to disclose the “basis on which the incentives have been paid/granted/issued and the time period to which they relate”. How exactly this will work in practice is unclear, although it appears from the explanatory document that the above could be similar to Australian “actual” or “realised” remuneration disclosure.

Principle 6: Risk Management

The Code recommends that companies have appropriate policies and procedures in place to identify and manage key risks and that the Board should review regular reports on the operation of the risk framework. This recommendation is discussed in more detail in the commentary, including on the subject of whether or not to have a separate risk committee.

Principle 7: Auditors

This recommendation revolves around establishing a framework for the organisation’s relationship with auditors.

Principle 8: Shareholder rights and relations

The Code recommends that the company have a website where investors can access information, including corporate governance information. It provides suggestions in the commentary of what kind of information should be on the website. The code also recommends that investors have the ability to communicate with the company.

The NZX is currently seeking feedback on the proposed code and a proposed timeframe for its implementation. It aims for the code come into effect in the first quarter of 2017 (for issuers with reporting periods ending in 2017 and onwards), noting that the majority of companies have June and December reporting dates.

Governance and Performance in the Not for Profit Sector

The Australian Institute of Company Directors has released its 2016 Not for Profit Sector Governance and Performance survey.

The survey raised concerns that a large number of not-for-profit organisations have significant assets which could be leveraged more effectively so that depletion of these assets was not solely being replaced by donations. Perceptions that the goal of an NFP was to “survive” led to a low risk appetite which meant that Directors’ views that organisations’ should be achieving financial strength was not occurring.

The report found that although Boards believed they should be spending more time on strategy, of the 90% of NFP Directors who underwent training during the year, only 40% received training on strategy.

Stakeholder expectations were also driving developments in performance measurement, although most Directors still considered their efforts to be a work in progress.

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