Top director tactics for remuneration control

Investor perceptions of whether executive pay is justified can lead to uncomfortable flashpoints at annual general meetings.

In 2011, the Australian government amended the Corporations Act, adding the two-strikes rule, which was designed to rein in excessive executive remuneration and make boards more accountable to shareholders. The rule awards a first strike to a company where 25 per cent or more of shareholders vote against its remuneration report at the annual general meeting (AGM). If there is a similarly high “no” vote the following year, a second strike triggers a spill resolution. Shareholders vote on whether to remove the board and if 50 per cent or more votes are cast in favour of a spill, all directors except the managing director must stand for re-election.

“Our research confirmed that the two-strikes rule empowers minority shareholders and provides consistent evidence that receiving minority strikes has the effect of curbing excessive CEO pay,” says Raymond Da Silva Rosa, a professor of finance at the UWA Business School and co-author of the research paper Shareholder voting at Australian annual general meetings.

Tying pay to performance

One way to assess CEO pay is by comparing it with median employee salary. The UK, US and some parts of the European Union have mandated disclosure of the CEO-to-median-employee pay ratio, although this is not the case in Australia. Another method, of more interest to investors, is to consider the link between pay and performance.

“Given that, typically, the CEO’s pay is nowhere near the largest expense in the profit and loss statement, and that the CEO is usually the person with the greatest influence on the quality of management, investor angst usually surfaces when high pay is associated with unexpectedly low performance,” says Yaowen Shan, a professor in the Discipline of Accounting at the University of Technology Sydney and co-author of Show me your hand: An examination of voting methods at annual general meetings.

While technically about pay, a “no” vote can also signal wider shareholder dissatisfaction.

“Since the introduction of the two-strikes rule, the remuneration report vote has been increasingly used as a lightning rod for shareholder and proxy adviser scrutiny of companies for a broad range of governance, strategic and/or performance concerns,” says Aldi Djajaputra, Sodali & Co managing director of corporate governance. “For example, Mineral Resources received a strike in 2024 off the back of the high-profile corporate scandal with CEO and founder Chris Ellison. There was also a huge strike at Qantas at the 2023 AGM, following its reputational scandal in that year.”

Avoiding a strike

Da Silva Rosa’s research confirmed boards keen to avoid a strike should ensure CEO pay meets investor expectations. “We also found investors don’t have naïve expectations of the link between pay and performance,” he says. “They’re able to distinguish between “justifiable” and “unjustifiable” pay, and take factors such as industry conditions and economic circumstances into account.”

Where there is a misalignment between remuneration frameworks and/or outcomes and investor and proxy adviser expectations, boards should be proactive in engaging with shareholders and explaining the basis for those decisions.

“In practice, this means providing detailed disclosure about the performance metrics used, the strategic rationale for the pay design and why the package is in the long-term interests of shareholders,” says Da Silva Rosa.

Peter Warne FAICD, chair of Virgin Australia Airlines and IPH,  believes communicating clearly in every way it can is a board’s best chance of pre-empting negative pushback. “Directors need to be aware of and sensitive to shareholder views, especially where a matter could be perceived as controversial,” he says. “But remember, boards aren’t compelled to act on negative feedback. As a director, your job is to do whatever is best for the company, even if some shareholders disagree. It’s important to listen and understand their position, then let them know what you’re going to do and why. But it isn’t always possible to avoid the negative vote. Good communication will help you avoid unpleasant surprises when you get to the AGM.”

Exclusive reliance by institutional investors on proxy adviser recommendations can undermine the effectiveness of company engagement efforts. “A certain proportion of shareholders who outsource their votes to the proxy advisers don’t make an internal decision at all. This is often the case with smaller investors, particularly those based offshore, who have hundreds, if not thousands, of companies in their portfolio. They can’t possibly assess each one individually, so they outsource not only the voting decision, but also the mechanics of the vote. This makes it very difficult, if not impossible, for companies to communicate with their shareholders.”

Warne is also concerned that in shaping their advice, proxy advisers may inappropriately attempt to benchmark companies against peers, sectors and/or governance norms, which may not be relevant and could lead to distorted outcomes.

“In a country the size of Australia, there might not actually be a real peer group. We also have listed companies with almost all their operations overseas. These companies compete for people in those markets and have to remunerate according to local remuneration levels and practices, which might be very different from those commonly accepted in Australia. If proxy advisers compare a company with what they deem a fair comparison — but is based on financial metrics such as market capitalisation or revenues — without recognising geographic differences, they distort the picture.”