Effective July 1, 2011 the Corporations Act was amended to include what’s known as the “two-strikes” law.
The aim was to hold directors of publicly traded Australian companies accountable for board and executive remuneration. Fast forward a decade, whilst the number of companies receiving a ‘strike’ each year seems relatively minor (e.g., last year 28 companies in the ASX 300), the impact of the ‘two-strikes’ law on the remuneration landscape has seen increased levels of transparency, strengthening alignment of pay with performance and greater shareholder engagement. There are however lingering questions of its effectiveness such as the ‘strike’ not always reflecting the views of majority shareholders and the significant influence of proxy advisors on voting outcomes. A further question is to what extent does a ‘strike’ influence shareholder views and the subsequent effect on share price?
What is a ‘strike’?
It works like this:
If a company’s remuneration report outlining salary and incentives of key management personnel (KMP) receives a ‘no’ vote of 25% or greater from shareholders at the annual general meeting, the company receives a first ‘strike’.
If the following year’s remuneration report also receives a ‘no’ vote of 25% or more, the company receives a second ‘strike’. When a second ‘strike’ occurs, shareholders vote then and there to decide whether company directors must stand for re-election. This is known as a ‘spill’ vote. If the spill vote passes (i.e., 50% or more of eligible votes cast), a spill meeting is held within 90 days and the directors stand for re-election.
What impact does a ‘strike’ have on a company?
When a company receives a ‘strike’, beyond the legal responses that follow, the personal impact on boards and executives can be profound. It is effectively shareholders saying “you’re on notice,” and may cause considerable reputational damage to the company and its board – but that may not be the only impact. Historical academic research of ASX companies and a more recent US study shows that shareholder ‘no’ votes on remuneration may also trigger significant drops in share price – as much as 15 per cent in the following year.
Some market pundits suggest that ‘say-on-pay’ votes are reflective of not only shareholder satisfaction around remuneration, but also broader governance and strategic direction. If shareholders are voting against remuneration reports, it may be an indication of dissatisfaction in general and can be viewed within the market as a ‘signal to sell’.
Can a ‘strike’ affect company share price?
To put this theory to the test, we looked at companies in the ASX 300 that received a strike over the four years preceding the start of the pandemic in 2020. (It was expected that pandemic related figures might skew data so we went a little further back in time.)
For those companies who received a ‘strike’ in the four-year period 2016 – 2019, we posed two questions relating to the share price in the year that followed:
1) What is the likelihood of a share price reduction?
2) If there was a share price reduction, what was the average drop?
*Note calculations based on closing share price day prior to AGM and closing share price last trading day of financial year.
|The results of this analysis reinforce the findings from the UBS research and academic studies, suggesting a shareholder ‘no’ vote on the remuneration report can materially hurt the value of the company.|
How can companies avoid a ‘strike’ ?
To minimise the risk of organisational complications that may arise as a result of a ‘no’ vote on remuneration reports, we offer the following 3 suggestions:
Design the right structure
Developing a strong remuneration structure and strategy that is tailor-made to suit a company’s size, growth stage, industry and goals is the first step towards mitigating a risk of a strike. When a company’s remuneration structure is appropriately aligned with these aspects, it can appear as indicative of good governance across the board. With ‘at risk’ pay comprising up to 70% of executives total remuneration in ASX300 companies, getting incentive structures right should be a key focus. See our blog Designing Employee Incentives For ROI for more information.
Determine appropriate quantum
An effective remuneration benchmarking methodology is a useful means of developing appropriate quantum when it comes to executive pay in particular. Equally important is ensuring that incentive payouts are in alignment with overall company performance. This can help a company steer clear of negative voting outcomes. See our most recent Remuneration Pulse for more information on market trends regarding remuneration quantum.
Provide effective disclosures
Clear and comprehensive communication around what is being paid, combined with detailed rationale around why and how it’s being paid go a long way with company stakeholders. It’s easy (and common) for companies to omit key details in remuneration disclosures and that can have an effect on shareholder votes. See our blog 3 Strategies To Improve Your Remuneration Report for more information on how to create an effective rem report.
The Reward Practice specialises in designing fit-for-purpose reward solutions for Australian companies of all types, sizes and stages. For a no obligation discussion on how you could elevate your company’s remuneration practices, contact us today.