Australia’s ‘Two Strikes’ Rule Succeeds at Reining in Executive Pay

Australia’s ‘Two Strikes’ Rule Succeeds at Reining in Executive Pay

The compensation of chief executives is a matter of constant controversy, with debates over how much CEOs should earn, what form their compensation should take, how their pay should be determined, and who should have a voice in setting it. One way critics of massive CEO pay packages seek to control them is by giving shareholders “say on pay”—i.e., more power to reject the executive compensation plans drawn up by boards of directors.

To that end, in 2001, Australia’s government enacted a law known as “two strikes”, which stipulates that if at least 25 percent of a company’s investors vote against approving its remuneration report at two consecutive annual shareholder meetings, that automatically triggers a vote on whether to force the entire board, except the managing director, to stand for re-election within 90 days. The idea behind the rule is to give shareholders more power over executive pay and boards a reason to act on controlling it. And so far, Graham Kenny observes at the Harvard Business Review, it seems to be working:

The country has witnessed numerous first strikes with boards quickly backtracking to save their skin. Among the crowd are some of the nation’s largest companies – CSL, Woodside Petroleum, AGL Energy, Boral, and Goodman Group. The mere threat of a first strike has had boards treading carefully. It’s clear that boards are starting to get the message from the national government, shareholders, the public, and the media that excessive executive packages are unacceptable.

More than that, smart businesses are stepping forward to proactively embrace the changing culture.

One business which typifies the change is Wesfarmers. The company is Australia’s eighth largest by market capitalization and an opinion leader in business circles. Highly diversified across food retailing, hardware, office supplies, department stores and industrial products, its current CEO, Richard Goyder, is stepping down to be replaced by an internal appointee, Rob Scott. Scott will earn up to $4 million less than his predecessor agreeing to a $1 million cut to fixed pay and a $3 million cut to bonuses.

The issue of executive pay has also got the attention of policymakers in the US and the UK. In the US, where CEO pay at large companies rose by an average of 6.1 percent last year, the Securities and Exchange Commission adopted a rule in 2015 requiring public companies to disclose the ratio between their CEO’s pay and that of the median employee starting this year. The Trump administration has expressed criticism of the rule, but activist investors have pressured the administration not to delay its implementation, and it now appears likely to go into effect as scheduled.

Notably, a study last year found that most US employees who know their CEO’s salary are comfortable with it; the bigger challenge for companies required to comply with this rule may be in disclosing the pay of the median employee, which will instantly lead to half the workforce discovering that they are earning a below-average salary for their company.

In the UK, meanwhile, the government revealed plans last November to not only force the publication of CEO-employee pay ratios, but also subject executive compensation to annual binding shareholder votes at both public and privately-held companies, in addition to giving employees some form of representation on boards—though the plan was a bit vague as to what that would entail. The ruling Conservative party’s weak showing in June’s special election, however, has cast doubt on how much of its agenda the government will actually be able to implement.