True cost of the two strikes rule
New research suggests that Australia’s controversial law to curb excessive executive pay has met with some success – but at a price.
Our research shows that the link between pay and performance has tightened since the two strikes rule.
With Australia’s highest paid bosses now earning over $19m a year, it is perhaps little wonder that levels of executive pay have led to a public outcry.
Australia’s two strikes law, introduced in 2010, was designed to curb corporate excesses by giving shareholders a greater say on pay. However the rule, which allows shareholders to vote to ‘spill’ the board if the remuneration report receives a ‘no’ vote of 25% or more two years in a row, has itself come under fire.
Critics argue that it is costly and ineffective, since it has not resulted in any board replacements so far. As a third AGM season gets underway since its introduction, the business community is watching closely to see what the new round of voting will bring.
But what has been the impact of the two-strikes rule so far? New research by UQ Business School suggests that companies are now linking pay and performance more closely – but improvements in governance have come at a cost.
Associate Professor in Accounting, Julie Walker says: “Our research shows that the link between pay and performance has tightened since the two strikes rule. There have also been shifts in the remuneration structure.
“As firms are under increased scrutiny, they are shifting about the different elements of executive pay – salary, cash bonuses and equity options. So they might for example have more equity-based compensation instead of cash bonuses. They are also shifting the performance metrics because there is a lot of pressure to conform to industry standards.
“In the past there have been cases where cash bonuses have been at the discretion of the board, but on closer inspection are being paid every year, regardless of performance. Bonuses are now being tied more closely to specific performance measures, which may include details of what the executive has to do to achieve that part of the pay package.”
Professor Walker highlights the influential role played by proxy advisers – the professionals who act on behalf of the major institutional investors. Not only do their votes carry more weight, but smaller shareholders often follow their lead in the voting. They are also pro-active in contacting companies to express their concerns and request answers.
However separate research by the business school suggests that the two-strikes rule had a significant negative effect on the market value of ASX-listed companies. Researchers tracked share prices and used established methodology to exclude the impact of other factors on value. The effect was less pronounced for companies with strong corporate governance.
“There was an overall negative effect because the two-strikes rule potentially imposes costs on all firms,” says Professor Walker. “Looking at the impact on individual companies, the worse the governance and the more aberrant the pay package of the CEO, the more likely they are to have suffered a bigger negative price effect.”
Professor Walker says the law should be compared with other countries such as the UK where shareholders have a binding vote on pay but no right to sack the board. She adds: “The two strikes spill and re-election process is unique to Australia and perhaps a less dramatic mechanism would have done the job just as effectively. And it could be very costly if it results in a board spill. Executive pay has been a problem, but the cure should not be worse than the problem itself.”
How other countries do it:
- In the US, the Dodd-Frank Act of 2010 requires all public companies to have an advisory shareholder vote on pay. Companies must report the results and say how they have responded to these when making decisions on pay the following year.
- In the UK, shareholders have had the right to an advisory vote on pay since 2003 but new legislation effective from 1 October 2013 means companies will also be subject to a binding shareholder vote at least every three years. In addition, tougher rules on disclosure have been introduced.
- The European Commission recommended a shareholder vote on executive pay in 2004. Say-on-pay voting was introduced in the Netherlands in 2004, in Sweden in 2006, in Norway and Denmark in 2007, and in Belgium in 2012.
In March 2013, the Swiss public voted overwhelmingly to give shareholders a binding say on corporate pay. A further vote will take place on 24 November to agree on a more detailed proposal.