MACQUARIE GRADUATE SCHOOL OF MANAGEMENT

MGSM WORKING PAPERS IN MANAGEMENT

The Practice of Director and Executive Remuneration Disclosure by Australian Firms

Nigel Finch

Macquarie Graduate School of Management MGSM WP 2006-10 October 2006

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© Copyright: Nigel Finch

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MGSM WP 2006-10

Title: The Practice of Director and Executive Remuneration Disclosure by Australian Firms.

* Corresponding Author Mr Nigel Finch Macquarie Graduate School of Management Macquarie University NSW 2109, Australia

Phone: +61 2 9850 9030 Fax: +61 2 9850 9019 Email: [email protected]

2 The Practice of Director and Executive Remuneration Disclosure by Australian Firms

Abstract

Mandatory disclosure of director and executive remuneration is a relatively new phenomenon and has only been a requirement in Australia since 2004. This paper will examine the current practice of disclosure of director and executive remuneration across a sample of Australian listed firms, examine the extent of coverage that this disclosure receives within the total annual report, and the uniformity of disclosure practice across firms of differing market capitalisations.

3 The Practice of Director and Executive Remuneration Disclosure

by Australian Firms

Reporting Framework

The regulatory framework for disclosure of director and executive remuneration by listed corporations in Australia is relatively new phenomenon, and is driven by three, often overlapping, policies: ASX Listing Rules (effective from May 2003);

AASB 1024 (effective from June 2004); and Section 300A of the Corporations Act

(effective from July 2004). Each of these regulatory frameworks is briefly discussed below.

ASX Listing Rule 4.1 requires listed companies to provide a statement in their annual report disclosing the extent to which they have followed the best practice recommendations (Deloitte, 2003, p. 20) set out in the ASX Corporate

Governance Council’s Principles of Good Corporate Governance Practice and

Best Practice Recommendations (2003). Principle 9 of the Recommendations requires disclosure of remuneration policies in a transparent and readily understandable framework, compliance with annual disclosure requirements under the Corporations Act (2001), and continuous disclosure on employment agreements with key executives.

AASB 1046 ‘Director and Executive Disclosures by Disclosing Entities’ was introduced with the aim of “improving the quality of disclosures relevant to individuals responsible for governance of listed entities” (ICAA, 2006, p. 1275).

This Standard is applicable to annual reporting periods ending on or after 30 June

4 2004 and applies only to the consolidated financial report. The disclosure requirements for AASB 1046 are extensive. The Standard requires detailed disclosure of the rewards provided to corporate directors and executives. This information is fairly sensitive and one that many stakeholders take a great deal of interest in (Deegan, 2005, p. 831).

Section 300A of the Corporations Act (2001) came into operation from July 2004 and was aimed at addressing concerns about the failure to disclose payments made to directors (Deegan, 2005, p. 838). Section 300A requires listed companies to provide a ‘Remuneration Report’ to appear in the Director’s Report. Among other things, the Remuneration Report is to provide information about the remuneration of all directors and the five highest paid executives; information about the Board’s policy for determining remuneration; and a discussion on the relationships between the remuneration policy and the company’s performance. There is much duplication between s. 300A of the Corporations Act and AASB 1046, however, the disclosures required by s. 300A are to be made in the Directors’ Report, whereas the disclosures required by AASB 1046 are to be made in the notes to the financial report.

Together, the ASX Listing Rules, AASB 1024 and s. 300A of the Corporations

Act form an overlapping prescriptive regulatory framework for the disclosure of director and executive remuneration for listed firms in Australia. In the next section of this paper, the disclosure of a sample of listed firms will be examined to examine the uniformity, or otherwise, of current disclosure practice in this area.

5 Sample of Firms

A selection of ten (10) firms listed on the Australian Stock Exchange that have

released their 2006 annual reports was obtained randomly using Aspect Financial

Analysis. This sample, along with other descriptive information, is shown in

Table 1 below.

Table 1 – Ten Australian listed company’s with 2006 reporting

No. Company ASX Reporting Industry(GICS) Market Cap Head No. of Year Code period Office Directors listed

Consumer 1 Altera Capital Limited AEA 30 June 2006 $0.3 million Perth 3 2000 Discretionary

BlueScope Steel 2 BSL 30 June 2006 Materials $4,549 million 7 2002 Limited

Comet Resources 3 CRL 30 June 2006 Materials $9 million Perth 3 1994 Limited

Merchant House Consumer Hong 4 MHI 31 March 2006 $16 million 7 1994 International Limited Discretionary Kong

Milton Corporation 5 MLT 30 June 2006 Diversified Financials $1,461 million Sydney 6 1962 Limited

Information 6 Oakton Limited OKN 30 June 2006 $220 million Melbourne 4 2000 Technology

Rocklands Richfield 7 RCI 30 June 2006 Energy $14 million Sydney 4 2000 Limited

Information 8 Sofcom Limited SOF 30 June 2006 $0.1 million Perth 3 2000 Technology

9 Tooth & Co. Limited TTH 30 June 2006 Diversified Financials $7 million Sydney 4 1961

Consumer 10 Webjet Limited WEB 30 June 2006 $106 million Melbourne 8 1997 Discretionary

A visual inspection of the data in Table 1 shows nine of the ten firms have a 30

June reporting date, with one firm reporting at 31 March. The ten firms cover a

range of GICS sectors comprising: materials (2); diversified financials (2);

6 information technology (2); energy (1); and consumer discretionary (3). The market capitalisation (as at August 2006) of the firms covered a broad range comprising; 2 micro-caps (less than $5 million); 4 small-caps (less than $20 million); 2 mid-caps (less than $1,000 million); 2 large-caps (more than $1,000 million). The head office location of the ten firms was: Sydney (3); Melbourne

(3); Perth (3); and (1). The firms have a range of board sizes comprising: 3 directors (3); 4 directors (3); 6 directors (1); 7 directors (2); and 8 directors (1). One average, the firm have been listed for 15.2 years, with 9 firms listed for more than 5 years, and two of these firms listed for more than 40 years.

In all, this sample represents a very broad range of firms to study the diversity of disclosure practise in Australian listed firms in 2006.

Observations from Sample of Firms

The annual reports for 2006 of the sample companies were reviewed, in particular the disclosure regarding the Remuneration Report. The number of pages of the annual report that contained information on this issue was totalled, as was the number of pages for the total annual report.

The disclosure regarding, (a) the amounts of rewards paid and, (b) the remuneration policy was examined and compared against the regulations as well as contrasted with the other companies in the sample. Where this was found to be meaningful and compliant it was coded as “Yes”. Also evidence was sought in the commentary of the annual report (especially the Director’s report) that linked the remuneration policy and the company’s performance. Where this evidence existed

7 it was coded “Yes”, otherwise “No”. A summary of the results is presented in

Table 2 below.

Table 2 – Analysis of remuneration disclosures

Annual % of Director and Link to Remuneration Remuneration Company Report Annual executive company’s report (pages) policy (pages) report remuneration performance

Altera Capital Limited 2 46 4.3% Yes Yes No

BlueScope Steel 17 132 12.9% Yes Yes Yes Limited

Comet Resources 3 52 5.7% Yes Yes No Limited

Merchant House 3 74 4.1% Yes Yes No International Limited

Milton Corporation 3 43 7.0% Yes Yes Yes Limited

Oakton Limited 4 64 6.3% Yes Yes Yes

Rocklands Richfield 2 41 4.9% Yes Yes No Limited

Sofcom Limited 3 41 7.3% Yes Yes No

Tooth & Co. Limited 2 47 4.3% Yes Yes No

Webjet Limited 8 69 11.6% Yes Yes Yes

All ten firms in the sample complied with the regulatory requirements and

included disclosure on director and executive remuneration, suggesting high

levels of uniformity among preparers.

All ten firms provided a detailed analysis of the type and the amount of each

reward paid to each director, and where applicable, the top five executives. Even

where there was no remuneration paid to directors (as in the case of Altera Capital

8 and Sofcom in 2006), this disclosure was still prepared, again suggesting high levels of uniformity.

All of the ten firms clearly articulated their remuneration policy, however only four of the ten firms provided any disclosure on the link between the remuneration policy and the company’s performance. BlueScope Steel provided the most detailed positive disclosure in this area devoting some six pages to this issue alone. Of the six firms that did not make a positive disclosure in this area, these firms had each made a statement similar to Merchant House International; “the

[remuneration] policy does not relate individual compensation with entity performance”. While this disclosure is compliant with the regulations, it does not provide any value to the user.

Interestingly, across the sample, the six firms that did not have a positive statement linking remuneration with firm performance were also the smallest firms in the sample (all 2 micro-caps plus all 4 small-caps) suggesting this level of disclosure is only being provided by mid-cap sized firms and larger.

On average, 7.7% of the total pages in the sample of 2006 annual reports were devoted to disclosure on director and executive remuneration, with Webjet and

BlueScope Steel devoting 11.6% and 12.9% respectively of their annual reports to this issue.

Overall, there was a high degree of uniformity in disclosure among all firms, with much higher quality voluntary disclosure in firms with larger market capitalisation

9 (greater than $20 million). The next section of the paper will look at the factors driving disclosure, before offering a conclusion.

Factors Driving Disclosure

Full and understandable disclosure of director and executive remuneration has emerged over the past two years and is now a mandatory requirement for all listed

Australian firms. The aim of this regulation is to achieve a more effective overall standard of dialogue between the company and its investors.

To comply with the requirements of ASX Listing Rules, accounting standards and the Corporations Act, Australian listed companies are devoting on average 4.7 pages of their annual reports (7.7% of total pages) to director and executive remuneration disclosure. The cost of preparing and reporting this information is high, but the regulators obviously consider these costs to be outweighed by the associated benefits (Deegan, 2005, p. 843).

An immediate benefit to the firm making the disclosure would be to reduce the number of general meetings featuring director and executive remuneration issues and the subsequent media profiling (Deloitte, 2003, p. 19). However, the underlying motivation for companies to make improvements (voluntary disclosures) to their director and executive remuneration are: firstly, to get investors to trust management with their money – the Agency problem (Uren,

2003, p. 192); and secondly to improve the value of the company (Healy &

Palepu, 2001). But these initiatives come at a cost that small size firms may not yet prepared to pay.

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Conclusion

The disclosure of director and executive remuneration in Australian listed companies has been a mandatory requirement since 2004. In the two year period to 2006, Australian firms have developed detailed and comprehensive disclosures to inform users of their rewards and policies. On average, this disclosure accounts for 7.7% of the total pages in the annual report. The disclosure practices of

Australian firms have quickly evolved to achieve high levels of uniformity across a wide range of companies, with most of the sample companies meeting the minimum regulatory requirements being covered in 2-3 pages of the annual report. This is most likely due to the prescriptive nature of the regulations meaning that the disclosure framework is easy to adopt and implement.

Larger size firms (greater than $20 million market capitalisation) show higher levels of innovation in their voluntary disclosure, providing more detailed discussion on the relationships between the remuneration policy and the company’s performance. This is in contrast to the smaller size firms that have not yet developed remuneration policies that relate individual compensation with entity performance.

11 References

ASX Corporate Governance Council, (2003), Principles of Good Corporate

Governance Practice and Best Practice Recommendations, Australian

Stock Exchange, Sydney.

Deegan, C. M., (2005), Australian Financial Accounting, McGraw-Hill, Sydney.

Deloitte Touche Tohmatsu, (2003), Executive Remuneration Best Practice

Principles and Guidelines, Sydney.

Healy, P. M. & Palepu, K. G., (2001), 'Information Asymmetry, Corporate

Disclosure and the Capital Markets: A Review of the Empirical Disclosure

Literature', Journal of Accounting and Economics, vol. 31.

The Institute of Chartered Accountants in Australia, (2006), Financial Reporting

Handbook 2006 Volume 1, John Wiley, Milton.

Uren, D., (2003), The Transparent Corporation: Managing Demands for

Disclosure, Allen & Unwin, Sydney.

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