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Abstract
Chapter 12 of the Key Code and Advanced Handbook examines government and market reform report recommendations for compensation or remuneration beginning with the recommendations of the Walker Review 2009 including the Compensation/Remuneration Committee and remuneration policy, executives and ‘high end’ employees, an overview of the Walker Review 2009 recommendations and ‘say-on-pay’ shareholder votes. We then examine the OECD Key Findings of 2009, the absence of pay for performance and Moody’s challenges for executive compensation as a forerunner to reviewing the existing compensation variables from Stage 1. These include a summary of the studies and relational effect paths for the [DirCEO$] (+/−), [EqOptIncent] (+), [EqOptEntrch] (−) and [CompCom] (+/−) variables.
There follows an examination of the Compensation/Remuneration Committee and high end employees to identify the risk ‘alignment’ effect and risk ‘failure’ effect of equity and options as well as the Compensation/Remuneration Committee variables for risk alignment with shareholders and risk-taking in excess of risk appetite. Here, there is emphasis on the significant [EqOptRiskAlignHighEnd] (+) and [EqOptRiskFailHighEnd] (−) variables.
Section 12.6 adds new governance variables for Compensation/Remuneration Committee composition, functions and policies in the ASX Principles and Recommendations, APRA’s Revised Draft CPS 511, the Walker Review 2009, APRA Final Report and the NAB Self-Assessment 2018. There follows the NAB Self-Assessment 2018 responsibilities for the Compensation/Remuneration Committee and governance variables for Compensation/Remuneration Committee functions and policies in the OECD Key Findings 2009 and the OECD 2010 Conclusions and Practices.
We examine the IIF Risk-based incentive principles, long-term profitability adjusted for cost of capital, risk-taking and risk appetite, adjustments for the ‘risk time horizon’, adjustments for organization as a whole and firm-wide profit, severance pay and transparency and disclosure. Section 12.16 reviews the IIF examples of risk-adjusted compensation and incentives and Sect. 12.17 reviews the disclosure of bands and elements of compensation for executives and high end employees and anonymous disclosure of pay ‘bands’ for ‘high end’ employees.
The Chapter then moves to examine relevant restrictions, delay, lock-up, deferral and clawback of incentive payments with the associated relational effect paths. Relevant principles include that remuneration should not promote excessive risks and principles relating to ‘material risk takers’, deferral, ‘malus/forfeiture’ provisions and ‘clawback’ including the APRA Final Report findings for risk adjustments and variable remuneration. There follows variables for failure to adjust pay bonuses for risks incurred for low level employees, required minimum shareholdings of executive board members, executives and high end employees including vesting arrangements and ‘skin in the game’ shareholdings and ‘retention’ vesting arrangements.
We then examine formal codes of conduct for remuneration consultants including use of the code by the Compensation/Remuneration Committee to engage advisers. We conclude with significant variables for incentive payments and bonuses to be calculated by economic profit and not revenue, remuneration design adjustments for the firm’s risk appetite, cost of capital and liquidity risk, adjusting pay benchmarks for risk and remuneration consequences for breaches of company risk appetite limits, internal procedures and legal requirements.
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The Bank for International Settlements, The Basel Committee on Banking Supervision, Guidelines, Corporate Governance Principles for Banks, July 2015, accessed 21 March 2017 at http://www.bis.org/bcbs/publ/d328.htm, (‘BCBS Guidelines 2015’), Para 76, pp 17–18.
OECD Steering Group on Corporate Governance, Corporate Governance and the Financial Crisis: Key Findings and Main Messages, June 2009, approved for publication 29 May 2009, accessed 12 April 2017 at www.oecd.org/corporate/ca/corporategovernanceprinciples/43056196.pdf, (‘OECD Key Findings 2009’), p 22.
Ibid, p 24 citing S. Davis, 2007, “Does “say on pay” work? Lessons on Making CEO Compensation Accountable”, The Millstein Center for Corporate Governance and Performance Policy Briefing Paper, 1.
See discussion in section 10.2.3.1 in Francesco de Zwart, Enhancing Firm Sustainability Through Governance, The Relational Corporate Governance Approach, Cheltenham, UK and Northampton, MA, USA: Edward Elgar Publishing, Corporations, Globalisation and the Law Series, July 2015, (‘Stage 1’), chapter 10, pp 299–304.
For Stage 1, see also, Francesco de Zwart, “Enhancing firm sustainability through governance – Part 1: The challenge of corporate governance” (2018) 33(2) Aust Jnl of Corp Law 144 and Francesco de Zwart, “Enhancing firm sustainability through governance – Part 2: The framework of the relational corporate governance approach” (2019) 34(1) Aust Jnl of Corp Law 27.
OECD Directorate for Financial and Enterprise Affairs, OECD Steering Group on Corporate Governance, Corporate Governance and the Financial Crisis, Conclusions and emerging good practices to enhance implementation of the Principles, 24 February 2010, accessed 11 May 2017 at www.oecd.org/corporate/ca/corporategovernanceprinciples/44679170.pdf, (‘OECD 2010 Conclusions and Practices’), pp 8-9.
Lutgart A A Van Den Berghe, “To What Extent is the Financial Crisis a Governance Crisis? From Diagnosis to Possible Remedies”, (27 May 2009), accessed 4 April 2017 at SSRN: http://ssrn.com/abstract=1410455, 11.
Christian Plath, Corporate Governance in the Credit Crisis: Key Considerations for Investors, Moody’s Global Corporate Governance, November 2008, (20 November 2008), accessed 10 April 2017 at SSRN: https://ssrn.com/abstract=1309707, (‘Moody’s Challenges 2008’), 4.
Martijn Cremers, Lucian Arye Bebchuk, and Urs C Peyer, ‘CEO Centrality’, Harvard Law and Economics Discussion Paper No 601 (December 2007, Revised May 2008), accessed 5 March 2015 at SSRN: http://ssrn.com/abstract=1030107, 1.
The terms ‘incentive alignment’ effect and ‘entrenchment’ effect are taken from O Fuerst and S Kang, ‘Corporate Governance, Expected Operating Performance, and Pricing’, accessed 5 March 2015 at SSRN: http://ssrn.com/abstract=141357, 6–7. See discussion in section 10.2.1 of Stage 1, above n 22, pp 295–296.
Board Independent Director: Executive Director Proportion – Monitoring Effect. See discussion in sections 7.3.2.1.1–7.3.2.1.2 of Stage 1, above n 22, pp 208–212.
For earlier versions of CPS 511, see Australian Prudential Regulation Authority, Draft Prudential Standard CPS 511 Remuneration, July 2019, accessed 30 September 2019, available at:
Recent pronouncements from APRA in January 2020 state that this draft will be finalised in the first half of 2020 with an expected effective date of July 2021. See:
Australian Prudential Regulation Authority, Information Paper, APRA’s Policy Priorities, January 2020, accessed 17 February 2020, available at https://www.apra.gov.au/apras-policy-priorities, section 2.1.2 Remuneration and Attachment B: Timelines; and
Australian Prudential Regulation Authority, Information Paper, APRA’s Supervision Priorities, January 2020, accessed 17 February 2020, available at https://www.apra.gov.au/apras-supervision-priorities, section 2.3.3 Remuneration.
In addition to finalisation of APRA’s Draft Prudential Standard 511 Remuneration, APRA has announced that it intends to consult on revised versions of Prudential Standard CPS 510 Governance, Prudential Standard CPS 220 Risk Management and Prudential Standard 520 Fit and Proper in the second half of 2020 with expected effective dates of 2022. See the above Information Paper, APRA’s Policy Priorities, section 2.1.1 Governance and risk management, section 2.1.3 Accountability and Attachment B: Timelines.
Compensation Committee – Disclosure of Enhanced Benefits and Conditions of Operation – Enhancement in Risk Management and Internal and External Monitoring - relational effect path. See discussion in Sect. 17.3 of Chap. 17 below.
Compensation/Remuneration Committee - Incentives Tied to Short-Term Share Price for Executives and High End Employees - Risk-Taking in Excess of Risk Appetite – Likelihood of Bank Failure. See discussion in Sect. 16.1 of Chap. 16 below.
Banks – Compensation/Remuneration Committee – Long-Term Focus for All “High End” Employees – Long-Term Variable Remuneration for All “High End” Employees – Enhancement of Level of Risk-Taking in Alignment with Shareholders (Walker Review 2009 and APRA).
Banks - Compensation Committee – Capping the Ratio of Variable to Fixed Compensation for High End Employees - Enhancement of Level of Risk-Taking in Alignment with Shareholders. See discussion in Sect. 16.6 of Chap. 16 below.
Banks – Compensation/Remuneration Committee – Long-Term Focus for All “High End” Employees – Long-Term Variable Remuneration for All “High End” Employees – Enhancement of Level of Risk-Taking in Alignment with Shareholders (Walker Review 2009 and APRA).
Banks – Compensation/Remuneration Committee – Long-Term Variable Remuneration for Performance Actually Realised – Enhancement of Level of Risk-Taking in Alignment with Shareholders.
Banks – Compensation/Remuneration Committee – Long-Term Focus for All “High End” Employees – Long-Term Variable Remuneration for All “High End” Employees – Enhancement of Level of Risk-Taking in Alignment with Shareholders (Walker Review 2009 and APRA).
Banks – Compensation/Remuneration Committee – Long-Term Variable Remuneration for Performance Actually Realised – Enhancement of Level of Risk-Taking in Alignment with Shareholders.
Banks – Compensation/Remuneration Committee – Long-Term Focus for All “High End” Employees – Long-Term Variable Remuneration for All “High End” Employees – Enhancement of Level of Risk-Taking in Alignment with Shareholders (Walker Review 2009 and APRA).
Grant Kirkpatrick, The Corporate Governance Lessons from the Financial Crisis, Report of the OECD Steering Group on Corporate Governance, 11 February 2009, Financial Market Trends, Vol 2009/1, ISSN 1995–2864, accessed 27 March 2017 at http://search.oecd.org/finance/financial-markets/42229620.pdf, (‘OECD Kirkpatrick Report 2009’), 15.
Ibid. The OECD Kirkpatrick Report 2009, above n 171, 16 further explained this issue:
These issues were picked up in the UBS report, which noted that the compensation and incentive structure did not effectively differentiate between the creation of alpha (i.e. return in excess of defined expectation) versus return from a low cost of funding. In the case of UBS, the internal cost of funds did not take account of risk so that the traders involved in sub-prime could obtain finance at a low cost. This made sub-prime an attractive asset to carry long. Super senior tranches carried low margins so that the incentive was to expand positions to achieve a given level of bonus…Essentially, bonuses were measured against gross revenue after personal costs, with no formal account taken of the quality or sustainability of those earnings. Senior management, on the other hand, received a greater proportion of deferred equity.
Bernard S Sharfman, Steven J Toll and Alan Szydlowski, “Wall Street’s Corporate Governance Crisis” (2009) 17(1) Corporate Governance Advisor 5–8, Jan/Feb 2009, (2 March 2009) accessed 10 April 2017 at SSRN: https://ssrn.com/abstract=1299879, 6.