Board diversity and executive remuneration — student companion

Accounting Ahead | Original study resource | accountingahead.com.au

Board diversity and executive

remuneration

MODULE 4 | PART A.3 | STUDENT COMPANION

Why diversity matters

Reason What it means for the board

Fairness Discrimination on grounds such as race, sex, sexual orientation or religion is unlawful, and

larger employers report on gender equality to a national agency.

Performance Directors with different experiences notice different risks, ask different questions and bring

wider networks. A diverse board also helps attract talent from every background.

Legislated quota

A fixed minimum, backed by penalties

Moves numbers fast, but can face legal

and fairness challenges. Example:

California's 2018 law for public

companies, struck down by a Los Angeles

court in 2022.

Targets and disclosure

Measurable objectives, reported publicly

Australia's main approach. ASX

recommendations: a diversity policy with

measurable objectives; ASX 300 boards

aim for at least 30% of each gender within

a set period.

Voluntary campaigns

Business-led commitments and peer

pressure

Flexible and fast to start, but progress

depends on willingness and leadership.

Culture makes any approach work

Diverse shortlists for senior roles | sponsoring promising people early | checking equal pay for equivalent roles | making flexible work and

returning from parental leave normal

Executive remuneration: the design rules

Non-executive director

Paid for time and responsibility

Fixed fee

Superannuation and expenses

May own shares, bought like any investor

No performance incentives: protects

independence

Shareholders approve the total fee pool

Executive

Fixed pay plus pay at risk

Fixed pay: Salary and superannuation

Short-term incentive: Yearly, mostly cash, against key performance

indicators

Long-term incentive: Three to four years, delivered in shares, options or

rights

Guard rails: Caps, deferral, non-financial measures, malus and clawback

ETHICS & GOVERNANCE | M4 PART A.3 | STUDENT COMPANION

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Accounting Ahead | Original study resource | accountingahead.com.au

Design rule Why

No incentives for non-executive directors A bonus tied to targets would compromise their independent

judgement.

Balance short-term and long-term pay Rewards that only look at this year encourage short-termism.

Include non-financial measures Safety, customers and risk management matter as much as profit.

Cap incentive plans and keep board

discretion

Uncapped plans can pay out far more than anyone intended.

Defer part of variable pay Problems can surface before the money is locked in.

Nobody decides their own pay An independent remuneration committee designs packages.

Controls on pay: malus, clawback and transparency

Award granted Deferral or vesting

period Vests or is paid After payment

Malus

Reduce or cancel an award before it is received

Clawback

Recover pay that has already been received

Misconduct found while shares are

still deferred

Malus: cancel the unvested shares

Accounts restated two years after

a cash bonus was paid

Clawback: recover the bonus

ASX recommendations

Disclose policies on deferral, reduction,

cancellation and clawback

Control How it works

Remuneration report Listed companies publish a detailed report each year, and shareholders vote on

it.

Two-strikes rule 25% or more against at two AGMs in a row triggers a spill vote (see Part A.2.4).

Termination payments Since late 2009, payments above one year's average base salary need

shareholder approval.

Pay ratio (United States) Listed companies disclose chief executive pay as a ratio of median employee

pay.

Financial sector (Australia) The prudential standard requires direct board oversight, balanced measures and

multi-year deferral of senior executives' variable pay.

ETHICS & GOVERNANCE | M4 PART A.3 | STUDENT COMPANION

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Accounting Ahead | Original study resource | accountingahead.com.au

Real examples. Persimmon (UK): an uncapped 2012 incentive plan led to a chief executive award of about

GBP 75 million after reductions; the chair and remuneration committee chair resigned in December 2017.

Wells Fargo (US): after unauthorised customer accounts were exposed in 2016, the board stripped a

further US$75 million from two former executives in April 2017, on top of earlier forfeitures.

Key terms

Term Meaning in plain words

Goal congruence Pay designed so that an executive's self-interest points the same way as the

shareholders' interests.

Fixed pay Salary and superannuation, paid regardless of performance.

At-risk pay Pay that is reduced or not paid at all if targets are missed.

Key performance indicator A measurable target used to judge performance, financial or non-financial.

Deferral Holding back part of a reward for several years before the executive receives it.

Malus Reducing or cancelling an award before it is received.

Clawback Recovering pay that has already been received.

Ratchet effect Pay creeping upwards because no remuneration committee wants to pay below

the market average.

Sources: Persimmon plc announcements, December 2017 and November 2018; Wells Fargo board sales practices investigation report,

10 April 2017; California SB 826 and Crest v Padilla (Los Angeles Superior Court, 13 May 2022).

ETHICS & GOVERNANCE | M4 PART A.3 | STUDENT COMPANION

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Accounting Ahead | Original study resource | accountingahead.com.au

Practice questions

MODULE 4 | PART A.3 | TRY THESE BEFORE THE WORKED ANSWERS

Question 1 - redesign the Tidewater Energy pay package

Imagine Tidewater Energy Ltd, a listed company. Its chief executive receives a fixed salary of $1.2 million and

a short-term bonus of up to 150% of that salary, paid entirely in cash and based only on this year's profit.

Long-term shares vest after one year if the share price has risen, with no cap. The non-executive directors

receive a bonus when the profit target is hit. The chief executive's contract promises 18 months' base salary on

termination. Identify five problems and recommend a fix for each.

ETHICS & GOVERNANCE | M4 PART A.3 | STUDENT COMPANION

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Question 2 - malus or clawback?

Decide whether malus or clawback is the relevant tool, and explain why. (a) Two years after a cash bonus was

paid, the accounts it was based on are restated for a material error. (b) Serious misconduct is discovered while a

manager's deferred shares are still due to vest next year. (c) An unvested long-term award relates to a period in

which the company badly breached its risk appetite.

ETHICS & GOVERNANCE | M4 PART A.3 | STUDENT COMPANION

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Accounting Ahead | Original study resource | accountingahead.com.au

Worked answers

MODULE 4 | PART A.3 | WORKED ANSWERS - ATTEMPT THE QUESTIONS FIRST

Question 1 - Tidewater Energy

Problem Fix

Short-term bonus depends only on this year's

profit

Add non-financial measures (safety, customers, risk) and defer

part of it.

Bonus paid entirely in cash Pay part in deferred shares so value depends on longer-term

performance.

Long-term shares vest after one year Measure over three to four years, with service conditions.

No cap on the long-term award Cap the award and keep board discretion to adjust outcomes.

Directors' profit bonus Remove it: non-executive directors should receive fixed fees only.

18 months' base salary on termination Above one year's average base salary, so shareholder approval is

needed; better to limit it to 12 months or less.

No malus or clawback Add both, linked to misconduct and material misstatement.

Question 2 - malus or clawback

(a) Clawback. The bonus has already been paid, so the company must recover it.

(b) Malus. The shares haven't vested, so the board can reduce or cancel them before they're received.

(c) Malus. The award is unvested, so it can be reduced to reflect the risk breach.

Common slip: thinking clawback and malus are the same. The dividing line is whether the executive has

already received the pay.

ETHICS & GOVERNANCE | M4 PART A.3 | WORKED ANSWERS

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