This article was written by Tim Bednall and Miriam Kleiner.
On 12 June, ASIC released an information sheet entitled “Board oversight of executive variable pay decisions during the COVID-19 pandemic”. This came as a surprise because, after initially indicating that ASIC would release their report on executive remuneration in late 2019 (which did not occur), the expectation was that ASIC would release their report early in 2020. ASIC’s reason for failing to release the report was that their attention had been diverted due to COVID-19. ASIC has now indicated that the final report will be released later this year but, in the interim, ASIC thought it would be helpful to release the information sheet as it “draws on the review’s factual findings and [is] framed to assist the boards and remuneration committees of … listed companies to navigate decisions on executive variable pay in the challenging context of COVID-19”.
It is unclear to us why the information sheet is limited to the COVID-19 situation and further, why the information sheet does not contain any substantive guidance. There is also a risk that this information sheet will create further obligations for boards due to the commentary included on remuneration reports.
Summary of information sheet
In summary, the information sheet contains the following commentary (much of which is not new):
- Robust remuneration governance arrangements are critical to support effective and informed board decision making that is appropriate to a company’s changing circumstances;
- Decision making on variable pay can send strong signals to executives about conduct and performance that are consistent with the long-term interests of the company; and
- Effectiveness of board oversight and the exercise of discretion on executive variable pay outcomes would be enhanced by a number of factors including:
- active, timely and consistent exercise of discretion;
- structured and contextual information from unbiased sources;
- arrangements to manage conflicts of interests; and
- transparent recording and communication of decisions.
Active, timely and consistent exercise of discretion
ASIC suggests that boards consider whether any variable pay outcome is consistent with the objectives of the company’s variable pay framework and ensure that it sends the right message regarding each executive’s accountability for their conduct and performance.
ASIC also suggests that to help ensure that the exercise of discretion is in the best interests of the company, boards may wish to:
- adopt practices or frameworks to prompt the use of discretion in the company’s variable pay scheme; and
- apply practices or frameworks that guide the exercise of discretion before variable pay decisions are made.
ASIC encourages companies to ensure they have a “look back” provision so that prior to the vesting of deferred pay the board can:
- consider making adjustments using the discretion principles developed to avoid unintended gain; and
- address significant risk or conduct issues that have occurred since the variable pay award was granted.
These have been features of the remuneration framework of many companies following the Royal Commission into Financial Services (“Royal Commission”) and the APRA report into CBA.
Structure and contextual information from unbiased sources
ASIC suggests that whilst management is likely to be a primary source of information on the factual basis for remuneration outcomes, boards should supplement the information provided, for example, with input of independent third-party advisers or other external information.
ASIC further suggests that any joint committee meetings which deal with remuneration should be:
- scheduled either regularly during the year or to coincide with the timing of variable pay decisions; or
- have agenda time set aside at remuneration committee meetings to hear contributions from cross-committee members.
Boards should also ensure that any written material is provided before the meeting so that there is an appropriate opportunity to review these materials – this is common practice, and has previously been recommended by APRA, not just in relation to remuneration decisions but broadly in relation to any board decision.
Managing conflicts of interest
Although executives are often involved in preparing information to be presented to the board about variable pay outcomes, ASIC recommends that executives not be present for, or be allowed to participate in, decisions that impact their own variable pay. This practice has been prevalent in most listed companies for a number of years.
Transparent recording and communication of decisions
ASIC has suggested that boards consider including the following in their remuneration reports:
- the rationale for the exercise of discretion, or reasons that discretion was not exercised, in final executive variable pay outcomes;
- the governance process and principles adopted in making executive variable pay decisions; and
- how the company’s specific circumstances it faced with the COVID-19 pandemic were taken into account in its decision-making process and that this was done in a manner consistent with the principles adopted.
It is worthwhile noting that the call for this sort of information to be included in a remuneration report goes further than the recommendations made by the Royal Commission. A variation of these disclosure narratives was considered by Commissioner Hayne following testimonies of various witnesses at the Royal Commission. In his Final Report, Commissioner Hayne referred to evidence from APRA about how explicit disclosure (particularly if identifiable and personal) would be a ‘double-edged sword’ and might deter boards from making risk-related adjustments to remuneration. In his Final Report, Commissioner Hayne concluded that the remuneration arrangements of an entity need to be communicated to stakeholders, however no public disclosure should be required of risk-related adjustments to remuneration.
Further, there is already a significant amount of work that goes into producing increasingly voluminous remuneration reports which are governed by the Corporations Act. Whilst it is one thing to publish the outcomes for KMPs, and also, as many companies already do, to indicate that adjustments have been made to the remuneration of other senior managers, it is quite another to explain the basis for making or not making discretionary adjustments, which would inhibit the free exercise of discretion by the board, and would also raise privacy and defamation issues. Ad hoc “suggestions” like these make it even more difficult for boards to determine what to include in these reports and run the risk of making “soft” law which a company may feel must be followed to meet “community expectations”.