It is becoming more important for boards to have a clear and transparent remuneration process due to heavy scrutiny from shareholders and the media. Transparency encourages market confidence and allows comparisons between organisations.
This Q&A will focus on directors’ fees in public companies. It does not cover executive remuneration.
What is the difference between directors’ fees and executive remuneration?
The wider community and the media often seem to be confused about directors’ fees and executive remuneration. There are significant differences between the two.
Directors may be paid fees in return for the services provided in governing an organisation but only if their shareholders approve a resolution to pay them. The board presents what they think is an appropriate pool of fees for the board as a whole to shareholders at a general meeting. The fees, if approved, represent the upper limit that can be paid to the board. The board then decides how the pool is split between individual directors. This is the amount paid to non-executive directors. Shareholders only have to be approached when the board wants to increase the pool – it is not an annual requirement.
Executive remuneration refers to salaries and bonuses paid to executives as senior company employees and forms part of the executive’s employment contract with the organisation. The board of directors determines executive remuneration and bonuses. Some senior executives will also be directors (ie executive directors) and they will usually receive no extra fee for serving on the board.
Listed Companies – Remuneration Report
Under sec 300A of the Corporations Act 2001, listed companies must present a remuneration report to shareholders at every annual general meeting showing the board's policies for determining the nature and amount of remuneration paid to key management personnel (which includes any director), the relationship between the policies and company performance, an explanation of performance hurdles and actual remuneration paid to key management personnel.
ASIC Deputy Chair, Belinda Gibson, has provided the following advice in relation to the preparation of remuneration reports (see Company Director, 'Fine-tuning your AGM reporting', September 2011):
'ASIC encourages directors to approach remuneration reporting with the objective of arming investors with comprehensive information. The remuneration report should explain the relationship between company performance and the remuneration of executives. This approach will inform shareholders and help limit surprises and controversy in the event of particular payments being made, especially termination payments.
Comprehensive disclosure involves discussing the board’s policy for determining the nature of remuneration, not simply the board’s policy for determining the amount. Companies should also explain how the policies and arrangements aim to influence executives to achieve the company’s objectives.
Companies often pay executives "at risk" remuneration subject to one or more performance conditions under an incentive plan. These performance conditions may be a mix of financial and non-financial performance conditions.
Boards should disclose a detailed summary of the performance conditions and what an executive needs to do to meet those conditions. The remuneration report should also explain why the performance conditions have been chosen and provide details about any discretions given to the board under the company’s incentive plan. This information helps shareholders assess whether the performance measures are appropriate to the company’s circumstances and whether an executive will have earned the remuneration offered.'
Remuneration Report – 'Two Strike' Rule
The Corporations Act 2001 was amended from 1 July 2011 to provide for the 'two strikes' rule in relation to the remuneration report. At the annual general meeting, the shareholders must vote approval or otherwise of the remuneration report. The first strike is when a company’s remuneration report receives a ‘no’ vote of 25 % or more. Where this occurs, the company’s subsequent remuneration report must explain whether shareholders’ concerns have been taken into account, and either how they have been taken into account or why they have not been taken into account.
The ‘second strike’ occurs where the company’s subsequent remuneration report receives a ‘no’ vote of 25 % or more. Where this occurs, shareholders will vote at the same annual general meeting to determine whether the directors will need to stand for re-election within 90 days. If this resolution passes with 50 % or more of eligible votes cast, then the ‘spill meeting’ will take place within 90 days. At the spill meeting, those individuals who were directors when the report was considered at the most recent annual general meeting will be required to stand for re-election (other than the managing director, who is permitted to continue to run the company).
Do directors have to be paid?
Directors are not entitled to payment for services unless this is provided for in the constitution of the organisation or approved in a resolution of shareholders. The Corporations Act 2001 provides that ‘the directors of a company are to be paid the remuneration that the company determines by resolution’ (s 202A (1), a replaceable rule). The company ‘may’ also pay the directors' travelling and other expenses that they properly incur:
- In attending directors' meetings or any meetings of committees of directors
- In attending any general meetings of the company
- In connection with the company's business.
A person who is the single director and shareholder of a proprietary company is to be paid any remuneration for being a director that the company determines by resolution (s 202C).
It is in shareholders’ interests to remunerate appropriately in order to attract the best calibre of person to serve on the board. Remuneration should reward directors for the value they add to the organisation as well as reflecting their duties and the legal liability assumed on behalf of shareholders.1
Who determines directors’ fees?
Shareholders of public companies generally approve an upper limit or pool of fees for the board as a whole. The board then determines how this is distributed to individual directors. The chairman will normally be paid more than other directors, as will directors sitting on board subcommittees, in recognition of their extra workloads.
Additional fees should not be construed as meaning that these directors carry responsibilities above those of other directors on the board.2 The chief reason for appointing a chairman and subcommittees is to obtain efficiencies in getting the board’s work done. The board as a whole retains collective responsibility for decisions on recommendations made by committees.
Larger companies may create a remuneration committee to assist in developing policies and procedures for determining remuneration.
What is the role of a remuneration committee?
Creating any board subcommittee is a means of managing the workloads of directors on the board. Rather than all directors discussing and debating every issue an organisation faces, committees allow a small group of directors to investigate issues in detail and report back to the board with recommendations for action. The full board is then responsible for making decisions. Common committees include audit, risk, nominations and remuneration.
The main purpose of a remuneration committee is to develop policies and practices for the remuneration of directors, the CEO and senior executives, to disclose this to the market (s 300A,Corporations Act 2001) and to review the remuneration and benefits paid. The responsibilities of the committee are captured in a charter approved by the full board. The charter should state that the committee does not have any authority for decision-making delegated to it by the board – the full board retains responsibility for decision-making.
In relation to directors’ fees, the committee makes recommendations to the board on an appropriate level and structure of fees. The entire board then collectively decides what is put to shareholders for approval.
Recommendation 8.1 of the ASXCGC Corporate Goverenance Principles and Recommendations states that boards should establish a remuneration committee. Under ASX listing rule 4.10.3 if a listed company does not follow an ASX Corporate Governance Council recommendation it must explain why not. The Principles further recommend that the committee be comprised of a majority of independent directors with an independent chairman and have at least 3 members. The Principles recognise that having a remuneration committee may not be practical for small listed companies, so instead suggests that these companies have processes in place which allow the full board to consider the same issues as the remuneration committee would.
ASX Listing Rule 12.8 states that a listed entity which was included in the S&P/ASX300 Index at the beginning of its financial year must have a remuneration committee comprised solely of non executive directors.
Many larger non-listed companies will also have a remuneration committee although they are not legally obliged to have one.
Committees may not be practical for other non-listed organisations which have small boards that are not independent. These organisations can find it challenging to source directors experienced in remuneration to sit on the remuneration committee, if they have one.
Are there special requirements for APRA – Regulated Financial Institutions?
There are a number of special requirements for financial institutions (eg banks, building societies, insurance companies) regulated by the Australian Prudential Regulation Authority (‘APRA’). For example, Prudential Standard CPS 510 ' Governance ' (effective 1 January 2013) requires a regulated institution to have a remuneration policy. That remuneration policy covers executive directors and must provide that the performance-based components of remuneration is to be designed to align remuneration with prudent risk-taking and must incorporate adjustments to reflect:
- The outcomes of business activities
- The risks related to the business activities taking account, where relevant, of the cost of the associated capital
- The time necessary for the outcomes of those business activities to be reliably measured.
What factors should be considered when determining directors’ fees?
The board must be able to justify its directors’ fees to members and shareholders. Suggested considerations include:
- Company-specific factors
- Size, nature and profitability of the company
- Complexity of operations – lines of business, geographic spread of operations
- Industry sector – some sectors are paid more than others
- Structure and responsibilities of board including the number of board committees
- Risks and challenges of the business
- Shareholders’ vote on remuneration at annual general meeting
- Director-Specific Factors
- Qualifications and experience
- Time commitment required
- General performance and involvement in value-added decision making
- Additional responsibilities, e.g. chair of a committee, other special duties such as at takeover time
- External market factors
- Business and economic conditions
- Supply and demand – the shrinking pool of non-executive directors and the fact that such directors are taking on fewer board positions, increased workloads.
How should directors’ fees be structured?
There is no one best way of structuring director fees. Each organisation’s system must be tailored to their specific circumstances. However, there are some general guidelines set out in the ASXCorporate Governance Principles. First, Recommendation 8.3 states that companies should clearly distinguish the structure of non-executive directors' remuneration from that of executive directors and senior executives.
As to non-executive director remuneration, the Corporate Governance Principles state that companies may find it useful to consider the following in relation to non-executive directors:
- non-executive directors should normally be remunerated by way of fees, in the form of cash, non-cash benefits, superannuation contributions or salary sacrifice into equity – they should not normally participate in schemes designed for the remuneration of executives
- non-executive directors should not receive options or bonus payments
- non-executive directors should not be provided with retirement benefits other than superannuation
As to executive remuneration, the Corporate Governance Principles suggest that executive remuneration will involve a balance between fixed and incentive pay. Those Principles go on to provide guidance in relation to the following aspects:
- fixed remuneration
- performance-based remuneration
- equity based remuneration
- termination payments
Remuneration consultants may be able to assist with the structuring and size of a remuneration package for directors but smaller organisations may find the cost to be prohibitive. Listed companies are required to disclose details relating to the use of remuneration consultants. In addition, remuneration consultants are required to be engaged by non-executive directors, and must report to non-executive directors or the remuneration committee, rather than company executives.
When are directors paid?
Every organisation will operate differently. In general, directors can expect to be given an annual amount of fees. We would not expect fees to be calculated using an hourly rate.
The organisation will decide how frequently this will be paid, eg monthly, quarterly. Directors’ fees are paid for services rendered, hence they would normally be paid in arrears. We generally does not recommend payments in advance. It can cause problems in cases where a director resigns, dies or is disqualified from acting as a director.
Does longer tenure entitle a director to more pay?
Many factors contribute to how much a director is paid. As discussed above, these factors include the size and complexity of the organisation, time commitment, additional responsibilities such as sitting on a board sub-committee, etc. Length of time served on a board should not be used to determine a director’s fees as it is not a true indicator of the value that an individual adds to the board.
Are directors entitled to higher fees when their workload increases significantly?
Instances of when a director’s workload may increase significantly include during times of a merger, takeover or acquisition.
Directors’ fees are subject to shareholder approval. When the board recommends a pool of fees to shareholders for approval, it might request an amount higher than their needs. In times of higher workloads, this may give some leeway for additional payments above normal fees but within the approved upper limit.
Can a director’s personal company be paid instead of paying the director directly? How is the income taxed?
The rules regarding the taxation of directors’ fees are very complex. We sought general advice from the Australian Taxation Office (ATO) in 2007 on these questions. The response received from the ATO confirms this complexity – the answers depend on numerous factors, which makes it almost impossible to give a simple answer to either question.
This reinforces our position that we cannot give advice on a director’s or company’s specific circumstances. Directors are encouraged to seek their own advice from a tax lawyer or tax accountant tailored to their particular situation.
'Clawback' Reform Proposal
On 21 February 2012, the Federal Government announced a proposal to amend theCorporations Act 2001 to require a listed company to disclose in its remuneration report the steps the company has taken to clawback bonuses and other remuneration where a material misstatement has occurred in relation to the company’s financial statements. The proposal would then be that the shareholders would have the sanction of voting against the adoption of the remuneration report, which would be a 'strike' under the 'two strike' rule.
1. G Kiel, G Nicholson, JA Tunny and J Beck , 'Directors at work: a practical guide for boards', Thomson Reuters Australia, Sydney, 2012
2. This is a matter for legal debate. See 'The Greaves Case and Responsibilities and Liabilities of a Chairman' for more information.
John H C Colvin, J Turnbull and M Blair, Executive appointments and disappointments,Australian Institute of Company Directors, 2013
Remuneration Reports, Sydney Australian Institute of Company Directors,Sydney, 2010
Remuneration of Non-Executive Directors, Australian Institute of Company Directors, Sydney, 2008
Remuneration committees - Issues for Smaller Companies, Australian Institute of Company Directors, Sydney, 2004
Shareholder Consideration of the Annual Remuneration Report of a Listed Company; A Guide for Consideration of the Issues, Australian Institute of Company Directors, Sydney, 2004
Corporate Governance Principles and Recommendations (2nd ed), ASX Corporate Governance Council, Sydney, 2010
Executive Remuneration: Guidelines for Listed Company Boards, Australian Institute of Company Directors, Sydney, 2009
Remuneration Committees – Good Practice Guide, Australian Institute of Company Directors, Sydney, 2004
G Kiel, G Nicholson, JA Tunny and J Beck, Directors at work: a practical guide for boards, Thomson Reuters, Sydney, 2012
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Updated January 2013
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