Executives received some good news and some bad news yesterday.

The bad news for CEOs was that the Federal Government has finally acted to correct the loophole which allowed boards to pay golden handshakes of up to seven times their total remuneration (the new limit will be 12 months base salary). The good news for executives however was that instead of acting to restrict short and long term bonus payments and cash remuneration, the Rudd Government has established another review, this time by the Productivity Commission, to “examine the framework” in relation to executive remuneration.

By acting on the easily solvable issue of termination payments (which can be rectified with a simple amendment of the Corporations Act), but avoiding dealing directly with executive remuneration generally, the Federal Government has deftly sidestepped offending its newfound friends in the business community. The Productivity Commission review will be presented in nine months alongside other non-binding reports already being prepared by the Treasury and APRA. Meanwhile, last month, the Australian Institute of Company Directors released a set of completely useless optional guidelines for members.

While Kevin Rudd and Nick Sherry order reviews, one body has prepared what appears to be a set of well-researched and workable remuneration reforms. Regnan (a corporate governance advisory firm owned by various institutional investors such as BT Investment Management, Hesta Super and VicSuper) last week released their Remuneration Reform Proposal which, while not flawless, represents a significant improvement on the existing mechanisms that govern executive remuneration.

Regnan’s proposals revolve around the creation of a board determined cash threshold which can be paid to executives — any remuneration which is above this threshold level must then be paid by way of “common equity vesting over a period of five to ten years following the grant date regardless of continued employment, with any dividends paid on common equity during escrow to be reinvested in more common equity”, rather than cash or other equity instruments.

Source: Regnan Remuneration Reform Proposal

The idea of “locking up” equity rewards differs from the current system of remuneration which allows for boards to provide a hefty, short-term “bonus” payment in cash, based on a set of (usually confidential) metrics. (For example, former Babcock & Brown CEO, Phil Green, received more than $30 million in non-recoverable cash payments in the years prior to the group’s collapse). Even so-called “long-term” incentives will generally vest over no more than five years, with the majority of long-term incentives being paid to executives three years or less.

The Regnan proposal removes the ability for a board to make cash bonus payments above the pre-determined (and clearly stated) “threshold” level. As the report notes:

The proposed remuneration reform ensures listed companies are able to offer competitive salaries in the form of common equity to attract executive candidates. If a candidate believes that through their contribution they can build and/or progress a sustainable business model with sound risk management, which will drive long-term sustainable growth, then rewards will be provided as common equity vests.

If a candidate does not have the conviction that equity payments vesting over five to ten years will provide them with economic reward, then it is open to question whether they believe they have something to offer the company in terms of a lasting outcome through their tenure.

The Regnan proposal serves to far better align executives and shareholders as both parties will hold the same instrument (being shares). By contrast, by issuing options or performance rights which can be exercised within three years, executives enjoy the upside but do not face the same downside risks as shareholders.

The other key area of proposed reform relates to termination payments, While this is one area which the Federal Government appears to be acting to rectify, Regnan’s proposals suggested a further improvement: any termination payments which exceed the 12 months base salary threshold must take the form of common equity vesting over a period of five to ten years following the performance period. This requirement would be in addition to shareholder approval.

Regnan’s proposals are not without flaws. The notion that the board may choose its own ‘threshold’ level upon which cash payments can be made gives rise to the potential for misuse. For instance, if one large company were to increase the threshold figure, rivals may soon follow suit. However, the threshold amount is clear and easily understood, providing shareholders with a simple figure upon which cash remuneration can be paid to executives.

The global financial crisis has provided the Federal Government has a unique opportunity to improve executive pay structures, in a similar manner to those outlined by Regnan. Sadly, Nick Sherry and Kevin Rudd appear to be more interested in reviewing, than in reforming.