03 Board Compensation

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BOARD COMPENSATION

[1500] Introduction

What role should the board play in setting remuneration?

No CEO should be allowed to set his/her own remuneration; that is a job for the board. In larger boards, and those which include

executive directors, the task of preparing a recommendation on the quantum and structure of the remuneration package will

probably be delegated to a remuneration committee made up of independent directors, which may obtain advice from specialist

consultants. It is probable that the final package will be approved by the board as a whole.

The board, or the remuneration committee, will probably wish to consider and ratify the principles which will govern the setting

of the remuneration of executives and other employees, and in some companies the board may review the CEOs proposals for

any variation in the terms and conditions of employment of the executives reporting directly to him/her. This will include

consideration of bonuses, options and other incentives.

The board, on the advice of the remuneration committee, will also need to decide on the recommendations to be made to the

shareholders on the total amount of remuneration to be available for the board to allocate to its members.

The disclosure of remuneration is an area that has attracted a great deal of scrutiny in recent times. Recommendation 1 arisingfrom the HIH Royal Commission states:

"I recommend that the disclosure and other requirements of the Corporations Act 2001, the relevant accounting

standards and the Australian Stock Exchange Listing Rules that relate to directors remuneration be reviewed as a

matter of priority, to ensure that together they achieve clear and comprehensive disclosure of all remuneration or otherbenefits paid to directors in whatever form."

Since the release of the report into the failure of HIH Insurance, the Australian Accounting Standards Board has issued AASB

124Related Party Disclosures (see 1550). The disclosure of remuneration has also been the subject of changes to the

Corporations Act 2001 introduced by the Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure)

Act 2004 (CLERP 9), which applied to financial years commencing on or after 1 July 2004. These requirements are discussed in

more detail at 1530.

Corporations Act requirements

[1510] Related party transactions

Public companies and entities over which they exercise control are prohibited from giving financial benefits to a related party

except in certain specified circumstances. The basic thrust of these provisions is that financial benefits (including loans, asset

transfers, executive remuneration and similar transactions) can only be given by a public company to a related party with

shareholder approval.

This prohibition does not apply to proprietary companies, although directors of those companies remain subject to the general

common law and statutory duties that bind all directors.

All of the following are considered to be related parties of a public company for the purposes of this provision:

a director of the public company

a director of an entity that controls the public company

each of the persons constituting an entity (other than a body corporate) that is a controlling entity of the public company

a spouse or de facto spouse of such a director or person

a parent, son or daughter of such a director, person, spouse or de facto spouse

an entity controlled by a related party of the kind listed above, unless the entity is also controlled by the public company.

The provision creates a general prohibition on public companies and their child entities from giving a financial benefit to a

related party subject to specified exceptions.

The exceptions fall into two categories: specific types of benefits and benefits approved by the shareholders.

Specific exceptions

The specific benefits that are permitted under these provisions are:

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benefits on terms that would be reasonable if the public company and related party were dealing at arms length, or terms

that are less favourable

reasonable remuneration to company officers or employees and the payment or reimbursement of their reasonable

expenses incurred in performing their duties

reasonable benefits that are indemnities, exemptions or the payment of insurance premiums or legal costs of officers

(note, however, that the Corporations Act 2001 prohibits the giving of an indemnity or exemption or the payment of

insurance premiums in some instances see 1520 for further details)

financial benefits to a related party aggregating no more than $5,000 in a financial year

financial benefits to closelyheld subsidiaries

financial benefits given to members of the company on a basis that does not discriminate unfairly in favour of one or

more of the companys related parties

financial benefits given as a result of a court order.

Benefits approved by shareholders

The related parties provisions set out a procedure for obtaining shareholder approval for a benefit that would otherwise be

prohibited. The need for this reflects the policy that, if the transaction is of a kind which might prejudice the interests of thecompany, it is appropriate that the shareholders of that company have the opportunity to consider whether to approve the benefit.

The procedure requires the approval to be given no more than 15 months before the giving of the benefit (or, if the benefit is

given under contract, no more than 15 months before the making of the contract). That procedure is:

the public company must prepare an explanatory statement for the members

that, and other explanatory material, must be lodged with ASIC before notice of the meeting is sent to the members

at the meeting, neither the related party who is to receive the benefit nor any of its associates may vote on the resolution.

Disclosure in the financial report

Both the Corporations Act 2001 and the accounting standards require detailed disclosure of information about related party

transactions in the directors report and the body of the financial statements. These requirements are discussed in detail at

1550.

[1515] Voting by interested directors

A director must disclose to fellow directors any material personal interest in a matter relating to the affairs of the company. This

can be provided by way of a standing notice. There is no distinction between directors of public and proprietary companies in

this area, except that the section does not apply to single director companies (for obvious reasons). For other types of proprietary

companies, a replaceable rule allows the director to vote on matters in which he or she has a material personal interest once the

declaration has been made.

The director of a public company cannot vote or even be present at board meetings during the discussion of matters in which

they have a material personal interest. There is an exception where the other directors decide that the interest should not

disqualify the director from voting or being present. The Australian Securities and Investments Commission (ASIC) may alsomake a declaration allowing an interested director to vote and/or be present at the meeting.

Contravention

A contravention of these provisions in relation to a particular benefit does not invalidate that transaction. Nor does the fact that a

related party voted on a resolution to give a benefit to that party, provided that enough "untainted" votes were cast to ensure that

the resolution would have been passed anyway. A court may order an injunction to prevent the benefit from being given to the

related party. The company itself is not subject to any penalties for a breach. However, individuals who are involved in a breach

of the prohibition are subject to the civil penalty provisions and an offence is committed if the involvement is dishonest.

Disclosure of in the financial report

Both the Corporations Act 2001 and the accounting standards require the disclosure of information about related party

transactions in the directors report and the body of the financial statements. These disclosures are discussed in detail at 1550.

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[1520] Indemnification, exemption and insurance

The Corporations Act 2001 restricts a companys ability to exempt or indemnify a director for liabilities incurred in their office

as a director.

Exemption

A company or related body corporate must not exempt any person from a liability incurred as an officer or auditor of thecompany.

Indemnification

The Corporations Act 2001 prohibits a company or related body corporate from indemnifying a person against any of the

following liabilities incurred as an officer or auditor of the company:

a liability owed to the company or a related body corporate

a liability for a pecuniary penalty order or a compensation order made under the Corporations Act 2001

a liability owed to someone other than the company or a related body corporate that did not arise out of conduct in good

faith (ie arose from conduct involving a lack of good faith).

The Corporations Act 2001 prohibits a company or related body corporate from indemnifying a person against legal costs

incurred in defending an action for a liability incurred as an officer or auditor of the company if the costs are incurred in

defending proceedings:

in which the person is found to have a liability for which the Corporations Act 2001 prohibits the company from

indemnifying them (see above)

in which a person is found guilty

brought by Australian Securities and Investments Commission (ASIC) or a liquidator for a court order (including orders

under the Corporations Act 2001 in relation to disqualification, oppression, civil penalties and injunctions), or

in connection with proceedings for relief under the Corporations Act 2001 in which the court has denied the relief.

Insurance premiums

The Corporations Act 2001 prohibits the payment of, or agreement to pay, an insurance premium insuring an officer or auditoragainst a liability that arises from:

conduct involving a wilful breach of duty, or

a contravention of the provisions of the Corporations Act 2001 regarding misuse of position or information.

This applies regardless of whether the premium is paid directly or through an interposed entity.

Disclosure in the directors report

The Corporations Act 2001 requires the disclosure of certain information in the directors report regarding indemnities given and

insurance premiums paid for officers and auditors (see 6030 for further details).

[1525] Entitlement to remunerationThe Corporations Act 2001 contains a replaceable rule which deals with the remuneration of directors and states that they are to

be paid the remuneration determined by the company by resolution. A separate provision deals with the payment of

remuneration to public company directors, exempting remuneration from the provisions prohibiting related party transactions

(see 1510).

The replaceable rule also provides for the payment of all travelling and other expenses properly incurred by directors in

attending and returning from meetings of the directors or any committee of the directors and general meetings of the company or

in connection with the business of the company.

Disclosure in the financial report

The Corporations Act 2001 and the accounting standards require detailed disclosure of the remuneration of directors in the

directors report and the body of the financial statements. These are discussed further at 1530, 1550 and 6030.

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[1530] Remuneration Report

Section 300A of the Corporations Act 2001 requires the directors report of a company to disclose certain details about the

remuneration of directors and other key personnel. These requirements initially applied only to directors, secretaries and senior

managers of listed companies, with respect to financial periods starting on or after 1 July 2004. For financial years that begin on

or after 28 June 2007, the requirements were significantly amended. The amendments had the effect of consolidating the

remuneration disclosure requirements in the accounting standards into the Corporations Act and Corporations Regulations. Thedisclosure requirements now apply to "key management personnel" of disclosing entities that are companies.

The term "key management personnel" is defined for this purpose, not in the Corporations Act, but in the accounting standards.

The term is currently defined in AASB 124:Related Party Disclosures as follows:

"Key management personnel are those persons having authority and responsibility for planning, directing and controlling

the activities of the entity, directly or indirectly, including any director (whether executive or otherwise) of that entity."

These requirements extend to the disclosure of performance conditions relating to remuneration packages. The remuneration

disclosures must be presented in a separate section of the report that is clearly identified using the heading "Remuneration

Report". The Remuneration Report must be put to the vote of members at the annual general meeting, although this is a

nonbinding resolution, which means that nonendorsement carries no direct legal consequences. The reaction of shareholders

and the market to a nonendorsement of the Remuneration Report, however, will be strong impetus for directors to gain the

support of shareholders for the Remuneration Report.The disclosures relating to performance conditions include a detailed summary of the conditions, an explanation of why the

performance condition was chosen, and a summary of the methods used in assessing whether the performance condition is

satisfied and explanation of why those methods were chosen. If an element of remuneration consists of securities and that

element is not dependent on the satisfaction of a performance condition, an explanation as to why there is no link between that

element of remuneration and the companys performance must be included. Again, if an element of remuneration consists of

securities, there must be disclosure of board policy in relation to directors and executives hedging their incentive remuneration

and the mechanism that the company uses to enforce this policy. There must also be an explanation of the relative proportions of

those elements of remuneration which are performancebased and those which are not.

Enhanced disclosures are also required to be included in the Remuneration Report in relation to the value of options granted as

part of remuneration packages. The duration of executive employment contracts must be disclosed, as must the periods of notice

required to terminate those contracts and the termination payments provided for under the contract.

The relationship between the remuneration policy and the companys performance (including the impact of the companys

performance on shareholder wealth in the current and previous four years) must also be disclosed.

The Remuneration Report is discussed further at 6030.

[1550] Disclosure in financial reports

The level and nature of the disclosure of directors and executive officers income and related party transactions is governed by

both the Corporations Act 2001 and AASB accounting standards.

With effect for financial years that begin on or after 28 June 2007, the requirements of the accounting standards in relation to

disclosure of remuneration of "key management personnel" have been consolidated into the Corporations Act and the

Corporations Regulations. The principal section of the Act governing these matters is s 300A, which is discussed in more detail

at 1530 and 6030.

Requirements of AASB 124

The accounting standard relevant to related party disclosures is AASB 124Related Party Disclosures. AASB 124 applies for:

identifying related party relationships and transactions

identifying outstanding balances between an entity and parties related to it

identifying the circumstances in which disclosure of related party relationships, transactions and balances is required, and

determining the disclosures that need to be made about those items.

AASB 124 applies to all reporting entities that are required to prepare financial reports in accordance with the Corporations Act

2001 and general purpose financial reports of other entities. Disclosing entities (including listed companies) are subject to

additional Australianspecific disclosure requirements (these apply in addition to the general disclosure requirements of AASB124).

The requirements of AASB 124 that relate specifically to directors are discussed in this paragraph. The other requirements of

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AASB 124 are discussed at 6130.

Compensation of key management personnel

AASB 124 requires disclosure of total key management personnel compensation and amounts separated into the following

categories:

shortterm employee benefits (all employee benefits other than termination benefits that fall due within 12 months of theend of the period, such as wages and salaries); these should be divided into at least the following components: cash salary,

fees and shortterm compensated absences; shortterm cash profitsharing and other bonuses; nonmonetary benefits; and

other shortterm employee benefits

postemployment benefits (any employee benefits other than termination benefits that are payable when employment is

completed); these should be divided into at least the following components: pension and superannuation benefits; and other

postemployment benefits

other longterm benefits (any employee benefits other than postemployment benefits and termination benefits that will

not become due within 12 months of the end of the period), separately identifying amounts attributable to longterm

incentive plans

termination benefits (employee benefits payable either as a result of the entitys decision to terminate the employees

employment prior to the normal date of retirement, or the employees decision to accept voluntary redundancy in return forthose benefits), and

sharebased payment (benefits in the form of equity compensation, rights to equity instruments or any other

compensation the amount of which depends on the future value of the entitys equity instruments); these should be divided

into at least the following components: equitysettled sharebased payment transactions (shares and units, options and

rights); cashsettled sharebased payment transactions; and all other forms of sharebased payment compensation

(including hybrids).

The term "key management personnel" is defined as those people who have authority and responsibility for planning, directing

and controlling the activities of an entity, either directly or indirectly. Both executive and nonexecutive directors fall within this

definition.

Related party transactions

In relation to transactions between the entity and its related parties (including directors), AASB 124 requires disclosure of the

nature of the relationship and sufficient information about the transactions and outstanding balances to assist users of the

financial statements to understand the potential effect of the relationship. These disclosures apply in addition to those relating to

key management personnel compensation discussed above. Disclosure must be made separately for the various categories of

related parties specified in AASB 124, one of which is the key management personnel of the entity or its parent.

As a minimum, the following disclosures must be made:

the amount

the amount of outstanding balances, terms and conditions (including any security given and the nature of consideration

for settlement) and any guarantees given or received

any provisions for doubtful debts relating to the outstanding balances, and

bad or doubtful debts expense recognised during the period in relation to amounts owed by the related parties.

Examples of transactions with related parties requiring disclosure include:

the purchase or sale of goods

the purchase or sale of property or other assets

the rendering or receiving of services

leases

transfers of research and development

transfers under licence agreements

transfers under finance arrangements such as loans and equity contributions

provision of guarantees or collateral, and

the settlement of liabilities on behalf of the entity or by the entity on behalf of another person.

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Key management personnel disclosures by disclosing entities

These requirements of AASB 124 apply only to disclosing entities that are required to prepare financial reports in accordance

with the Corporations Act 2001.

The following details must be disclosed about each key management person:

the name of the person

the position held, and

the dates of the period of responsibility, if this period is less than the reporting period.

If there is any change in the chief executive officer and directors, or retirement of any other key management personnel between

the reporting period and the date on which the financial report is authorised for issue, disclosure must be made of the name,

position and date for each person involved.

In addition to the details of compensation for each key management person discussed above, the following details must be

disclosed in relation to each key management person:

board policy for determining the nature and amount of the compensation

the relationship between that policy and the entitys performance

if an element of the compensation is dependent on the satisfaction of a performance condition:

a detailed summary of the performance condition

an explanation as to why it was chosen

a summary of the methods used to determine whether the condition has been satisfied, and an explanation of why

those methods were chosen

if the condition involves a comparison with external factors, a summary of the factors used to make the comparison,

and if any of those factors relate to the performance of another entity or an index in which the entitys securities are

included, the identity of that entity or index

the terms and conditions of each grant of cash bonuses, performancerelated bonuses or sharebased payment

compensation that affect compensation

additional explanations necessary to provide an understanding of the way in which compensation is determined for eachcontract of services between a key management person and the entity

if compensation includes securities and that element does not depend on the satisfaction of a performance condition, an

explanation as to why this is the case

the relative proportion of the elements of the persons compensation that are related to performance and those that are not,

and an explanation

if the person is employed under a contract, the terms of employment including duration, periods of notice for termination

and termination payments.

Certain disclosures are also required if the terms of sharebased payment transactions (including options and grants) granted to a

key management person as part of compensation have been modified by the entity during the period.

Compulsory disclosure Corporations Act

If the shareholders want more, the Corporations Act 2001 provides such an opportunity. Section 202B enables members holding

at least 5% of the votes that may be cast at a general meeting or at least 100 members who are entitled to vote at a general

meeting to require disclosure of the remuneration received by each of the directors. This power of compulsory disclosure applies

to all companies.

As soon as practicable, the company is required to prepare an audited statement showing the total of remuneration received by

each of the directors and each director of a subsidiary for the previous financial year. A copy of the statement must be sent to all

members. "Remuneration" does not include reimbursement for outofpocket expenses incurred for the companys benefit.

[1570] Fair and responsible remuneration

Principle 8 of the ASX Corporate Governance Principles and Recommendations requires companies to ensure that the level andcomposition of remuneration are sufficient and reasonable and that the relationship of remuneration to performance is clear.

Recommendation 8.1 says that the board should establish a remuneration committee. The remuneration committee should be

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structured so that it consists of a majority of independent directors, is chaired by an independent director, and has at least three

members.

The company should design its remuneration policy in such a way that it motivates senior executives to pursue the long term

growth and success of the company, and demonstrates a clear relationship between senior executives performance and

remuneration.

Recommendation 8.2 states:

"Companies should clearly distinguish the structure of nonexecutive directors remuneration from that of executive

directors and senior executives."

Recommendation 8.3 says that the corporate governance statement in the annual report should contain the following information

concerning remuneration (or a clear cross reference to the location of the information):

the names of the members of the remuneration committee and their attendance at meetings of the committee, or, where a

company does not have a remuneration committee, how the functions of a remuneration committee are carried out

the existence and terms of any schemes for retirement benefits, other than superannuation, for nonexecutive directors

an explanation of any departures from Recommendations 8.1, 8.2 or 8.3.

The following material should be made publicly available, ideally by posting it to the companys website in a clearly marked

corporate governance section:

the charter of the remuneration committee or a summary of the role, rights, responsibilities and membership requirements

for that committee

a summary of the companys policy on prohibiting from entering into transactions in associated products which limit the

economic risk of participating in unvested entitlements under any equitybased remuneration schemes.

The following guidelines are provided in relation to nonexecutive directors remuneration:

nonexecutive directors should be remunerated by way of fees (in the form of cash, noncash benefits, superannuation

contributions or salary sacrifice into equity). They should not normally participate in schemes designed for the

remuneration of executive directors

nonexecutive directors should not receive options or bonus payments, and

nonexecutive directors should not be provided with retirement benefits other than statutory remuneration.

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