Dean Paatsch & Martin Lawrence
Money for nothing
Nothing makes shareholders angrier than waving farewell to a departing CEO who's carrying a large suitcase full of their money. Outrage at 'golden parachutes' is in part borne from impotence: by the time the company's highest paid employee is shown the door it’s almost always too late for action. Board ‘discretion’ will have already been exercised and egregious payments made in fulfilment of contractual obligations. It’s no wonder the Americans have renamed these one-sided deals ‘golden condoms’, as they seem designed to protect executives whilst screwing over shareholders.
So what can be done to fix this seemingly intractable corporate governance problem?
As agents of the company, it is boards and not shareholders who do the hiring and firing. Within the broad limitation of their fiduciary duties, non-executives are empowered to agree to almost any terms as they are romancing a CEO. Shareholders’ role in balancing board fervour has always been limited to approving grants of equity offered to executive directors. However even this function is under attack, courtesy of a loophole that appeared in the ASX listing rules in 2005. Whereas once all equity offered to executive directors was put to a shareholder vote, approvals are now routinely bypassed where boards use company funds to buy shares ‘on market’ and hold them in trust for executives.
Shareholders play no role in selecting a CEO or approving the pre-nuptial agreement that governs the terms of their departure. Feedback is limited to a non-binding vote on the company’s remuneration report, up to a year after the detail of executive contracts has been agreed. After the divorce, it is only when the proposed payout is more than seven times an executive’s total salary in the preceding three years that the Corporations Act gives shareholders any say at all. Oxiana owners will exercise this rare privilege on Friday when they are called on to approve the $10.7 million payout accruing to resigning CEO Owen Hegarty.
Disclosure on the precise terms of executive tenure has markedly improved as a consequence of the non-binding vote on remuneration reports. The attendant scrutiny has led to some improvement over the bad old days when fixed-term contracts let the CEO’s fingers remain in the till for up to five years after they had left the building. Now the most common type of termination provision in the Australian market is based on 12 months’ fixed remuneration in lieu of notice.
The catch is that 12 months of fixed pay on cessation is usually just the beginning. Contracts often allow for an allocation of all or part of the annual bonus for the year in which termination occurs – usually at the discretion of the board. Later this year, annual disclosures will finally reveal the generosity of the AGL directors that sacked Paul Anthony in 2007. He was entitled to trouser an array of sign-on bonuses, retention shares and unvested incentives worth at least $6 million, possibly more.
It’s ironic that the public concern expressed by CEOs about our rigid unfair dismissal laws is matched by a private obsession to profit from provisions that dictate the terms of their own removal.
Many companies now allow departing executives to retain unvested incentives, subject to the performance hurdles being met. In too many other cases, boards don't learn from past mistakes – they simply exercise their discretion to pay unvested incentives in cash or allow them to vest immediately. Consider the case of the ASX in 2006: when the board relieved the now-ASIC chief Tony D’Aloisio of his CEO duties, he was paid $7.7 million (6.7 times his base pay) despite only having a year to run on his contract. Incredibly, the termination provisions that the board agreed with his successor, Robert Elstone, provided for up to three years' payout on discharge.
Clearly the problem seems not so much to be directors' discretion itself, but the lack of judgement that accompanies its exercise. When the AMP board sent Paul Batchelor packing in 2003 with a mere $2.1 million, it showed it had learnt the lessons from the $7.5 million bequest it paid to remove his predecessor, George Trumbull. But cases like these are all too rare – mostly departure packages are waved through by boards anxious to get on with the reform agenda ahead of them.
Section 200E of the Corporations Act – Australia’s attempt to enfranchise shareholders on excessive termination payments – is in reality a dead letter. Confusion over how remuneration is defined and the ability of lawyers to take advantage of generously worded exemptions have meant that only an unlucky few CEOs have ever been obliged to have their termination payments approved by shareholders.
There is, however, a relatively easy legislative change that might help boards hold a tougher line when deciding on how much shareholder money to shower upon a departing executive. Section 200E of the Corporations Act should be amended to require any termination payment (including shares) that is greater than 12 months’ fixed pay to be put to shareholders for approval at a general meeting.
The future benefits to shareholders of generous termination deals are seldom apparent. Too many times companies defend golden goodbyes as being based on contractual entitlements or justify them by talking about the past benefits the executives have delivered for shareholders.
Predictably some will argue that any shareholder involvement in termination arrangements will require still higher rates of fat-cat pay by way of compensation, or leave Australia at a competitive disadvantage in the alleged global ‘war for talent’.
One size doesn’t fit all, but that’s a judgement that shareholders are equipped to make, either at the time of appointment or after the event. As they wave farewell to the next departing CEO, at least this way they’ll have no cause for anger – shareowners themselves will have counted the cash in the small briefcase their ex-employee is carrying.
Dean Paatsch is a director and Martin Lawrence head of research at RiskMetrics Australia
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