Financial sustainability

This document largely deals with the remuneration of directors of companies under the Corporations Act 2001 (Cth) ('Act'). This covers all companies listed on the Australian Securities Exchange (ASX), the vast majority of for-profit organisations and those not-for-profit organisations which have the legal structure of a company limited by guarantee. It does not directly cover payments to directors/committee members other not-for-profits such as incorporated associations, co-operatives and government boards. However, many of the principles discussed can be applied to other forms of organisation.

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 classified as non-executive directors or executive directors. Executive directors are full-time employees of the company with day-to-day responsibilities.

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 Act 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.

“ 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.”

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 should be noted that s 202A(1) is a replaceable rule. This means that it can be varied in the company’s constitution. Constitutions can set out that all directors may not be paid or alternatively, only non-executive directors can be paid for the role of director. Many constitutions state that directors may be paid and specify a process whereby either the total amount for the entire board or amounts for specific directors and governance roles may be approved.

In short, companies have considerable flexibility in establishing if and how directors are to be paid.

Non-executive directors are remunerated for their role as directors of the company. This remuneration is paid for the time they spend on directorial duties, their experience, reputation and other skills they bring to the board, and for the risk they accept for being a director.

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.

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. Where senior executives are also legal directors (that is executive directors) they usually receive no extra fee for serving on the board.

Who determines the total amount of directors’ fees?

There are three basic questions with respect to determining directors’ fees.

The first is who determines the total amount to be paid to the non-executive directors? The second is who approves the total amount to be paid to the nonexecutive directors? The third is, once the total amount is approved, how is this sum divided between various directors?

With respect to the first question, the determination of the total amount of directors’ fees is normally made by the board, but in some instances may be made by the members (shareholders) directly.

For many companies which have large numbers of shareholders or members such as publicly listed companies and not-for-profits with large numbers of members, it is not practical for shareholders to determine the total amount to be paid to the board, let alone the specific amounts to be paid to individual directors. Consequently, the board, often through a remuneration committee as discussed below, will make a recommendation concerning the total amount of remuneration.

“ A number of commercial organisations provide data on current levels of directors’ fees broken down by factors such as company size, industry and so on.”

The exception to this norm is where a company may have one or very few shareholders. For example, a company which is owned by very few individuals such as many family owned companies, a subsidiary of another company or a company which is owned by government. In this situation the owners may decide to set the level of remuneration directly. They may or may not consult with the board concerning the amount.

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

Director-specific factors

• Qualifications and experience
• Time commitment required
• General performance and involvement in value-added decision making
• Additional responsibilities, for example chair of a committee, other special
duties such as at takeover time

External market factors

• Business and economic conditions

A number of commercial organisations provide data on current levels of directors’ fees broken down by factors such as company size, industry and so on. Some boards also commission remuneration consultants to make recommendations as to directors’ fees based on industry benchmarks and accepted methodologies.

Who approves the total amount of directors’ fees?

The answer to who has the final right of approval of the total amount of directors’ fees depends on the type of company, and possibly the company’s constitution. As noted above, director remuneration generally is dealt with under section 202 of the Act. Section 202A (1), which determines whether directors can be paid, was discussed above.

Section 202B (1), which is not a replaceable rule and hence applies to all companies, allows for members (shareholders) to obtain information about payments to directors. Specifically:

‘A company must disclose the remuneration paid to each director of the company or a subsidiary (if any) by the company or by an entity controlled by the company if the company is directed to disclose the information by:

(a) members with at least 5 per cent of the votes that may be cast at a general meeting of the company; or

(b) at least 100 members who are entitled to vote at a general meeting of the company.’

As a general principle, 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.

Below is discussed the specific situation for listed companies, non-listed for-profit companies, companies which are regulated by the Australian Prudential Regulation Authority (APRA) and not-for-profit companies.

Listed companies

Shareholders of public companies generally approve an upper limit or pool of fees for the board as a whole in general meeting. The board then determines how this is distributed to individual directors. Many companies obtain by resolution an upper limit to the total amount to be paid on an ongoing basis and then infrequently seek to have this increased. Usually companies do not allocate this total amount. A listed company will need to have sound reasons for seeking an increase to this amount.

Listed companies must account annually for directors’ fees as well as the remuneration paid to senior management under s 300A of the Act. 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.

The Act 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 per cent 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 per cent 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 per cent 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).

Non-listed for-profit companies

For a non-listed for-profit company, be that company a public or a private company, the constitution should set out the mechanisms for the approval and reporting of directors’ remuneration. If the replaceable rule 202A (1) has been followed, the total amount to be paid to directors should be approved at a general meeting of the shareholders. Constitutions may contain more specificity concerning the approval and reporting mechanisms.

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. For example, Prudential Standard CPS 510 ‘Governance’ (effective 1 January 2015) requires a regulated institution to have a remuneration policy.

That remuneration policy covers, among others, 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.

Not-for-profit companies

Not-for-profit organisations may or may not pay directors.

This is sometimes covered by regulations. For example, non-government schools in NSW are not allowed to pay directors, no matter what the legal structure of the school.

Some not-for-profits take the view that directors should see their contribution as service to the community and hence receive no remuneration outside of reasonably occurred expenses. Other, usually larger, not-for-profits take the view that they expect a considerable workload from directors and are seeking directors with high levels of skills. Hence it is appropriate to pay in these circumstances and as a past study has revealed, there is a growing trend to remunerating directors in not-forprofit companies with reported remuneration rising from 8 per cent in 2001 to 19 per cent in 2013.1

As noted above, when a not-for-profit company is a company limited by guarantee, the provisions of section 202 also apply. However, the Australian Charities and Not-for-profits Commission (ACNC) Governance Standards must also be considered. While not specifically mentioning payment to directors, Governance Standard 2 is relevant:

"‘Charities that have members must take reasonable steps to be accountable to their members and provide them with adequate opportunity to raise concerns about how the charity is governed."²

Under this Governance Standard it can be expected that the charity will seek members approval of the total amount of the proposed directors’ remuneration and provide details, usually as part of the annual report, as to what payments were made to directors. In short, although not legally required, it is recommended that not-for-profits which pay directors adopt many of the practices concerning approval and reporting as apply to listed companies.

How to allocate the total amount of director’s fees among the directors

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 ASX Corporate Governance Council’s (ASXCGC) Corporate Governance Principles and Recommendations 3e (2014). Firstly, Recommendation 8.2 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 ASXCGC Corporate Governance Principles and Recommendations 3e 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 ASXCGC Corporate Governance Principles and Recommendations 3e 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

As noted previously, 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, for listed companies, 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.

There are many different mechanisms which determine how much individual directors are paid. Common practices are:

• The chair will normally be paid more than other directors

• Chairs of board committees may receive an additional loading

• Directors sitting on board committees may also receive a loading, 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 (this is a matter for legal debate).

The chief reason for appointing a chair 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.

What is the role of a remuneration committee?

Creating any board committee 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 ASX Principles 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. Recommendation 8.1 further states that the committee should be comprised of a majority of independent directors with an independent chair, and have at least 3 members. The commentary to Recommendation 8.1 recognises 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, including not-for-profits will also have a remuneration committee although they are not legally obliged to have one.

Practical matters around director remuneration

When are directors paid?

Every organisation will operate differently. In general, directors can expect to be given an annual amount of fees. It is not recommended that fees be calculated using an hourly rate as this may promote time-wasting behaviours. 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. It is not recommended that payments be made 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 subcommittee, 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.

When the board recommends a pool of fees to shareholders for approval, it might request an amount higher than their needs at that point of time. In times of higher workloads, this may give some leeway for additional payments above normal fees but within the approved upper limit. Experience has shown that it can be difficult for directors to ask for additional payments due to unexpected workloads after the event.

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. General advice was sought 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.

Directors are encouraged to seek their own advice from a tax lawyer or tax accountant tailored to their particular situation.

1 Australian Institute of Company Directors, Directors Social Impact Study, 2013
2 Australian Charities and Not-for-Profits commission (ACNC), Meet governance standards, [website], 2016.


Disclaimer

This document is part of a Director Tools series prepared by the Australian Institute of Company Directors. This series has been designed to provide general background information and as a starting point for undertaking a board-related activity. It is not designed to replace legal advice or a detailed review of the subject matter. The material in this document does not constitute legal, accounting or other professional advice. While reasonable care has been taken in its preparation, the Australian Institute of Company Directors does not make any express or implied representations or warranties as to the completeness, currency, reliability or accuracy of the material in this document. This document should not be used or relied upon as a substitute for professional advice or as a basis for formulating business decisions. To the extent permitted by law, the Australian Institute of Company Directors excludes all liability for any loss or damage arising out of the use of the material in this document. Any links to third-party websites are provided for convenience only and do not represent endorsement, sponsorship or approval of those third parties, or any products and/or services offered by third parties, or any comment on the accuracy or currency of the information included in third party websites. The opinions of those quoted do not necessarily represent the view of the Australian Institute of Company Directors.