Enhancing accountability: a closer look at the ‘Two-Strike Rule’

Remuneration plays a pivotal role in the corporate landscape, influencing not only the retention, motivation and performance of executives, but also shaping the overall governance framework of companies.

The recent Companies Amendment Bill [B27B-2023](Bill), a legislative initiative aimed at, inter alia, promoting equity between directors and senior management on the one hand, and shareholders and workers on the other, introduces significant changes to the remuneration disclosure requirements for public and state-owned companies. One such notable reform is the introduction of the ‘Two-Strike Rule’, as defined and discussed below.

Understanding the ‘Two-Strike Rule’ and its alignment with global practices

The ‘Two-Strike Rule’ aims to enhance transparency and accountability in executive remuneration. Arguably, the rule alters the dynamics of remuneration governance, particularly for non-executive directors (NEDs) serving on remuneration committees (RemCom).

The move to implement the ‘Two-Strike Rule’ brings South African legislation in line with global peers, particularly Australia, which previously adopted a similar rule. There are, however, some noteworthy distinctions between the Australian and proposed new South African rules.

In Australia, the ‘Two-Strike Rule’ entails that board members of a company will be required to stand for re-election if the company’s remuneration report (Rem Report) receives a ‘no’ vote of 25% or more at two successive annual general meetings (AGM). The first strike is triggered when the company’s Rem Report receives a ‘no’ vote of 25% or more at an AGM. The company’s subsequent Rem Report in the following year must explain how the shareholders’ concerns have been taken into account. The second strike occurs should the company’s subsequent Rem Report receive a ‘no’ vote of 25% or more at the next AGM (Second AGM), resulting in a ‘spill resolution’ to be put to shareholders at the Second AGM. A successful ‘spill resolution’¹ would initiate a ‘spill meeting’, in which the company’s directors (except the managing director, who may continue to hold office indefinitely) would need to stand for re-election.

In South Africa, the Bill proposes that, if the Rem Report (including the background statement, remuneration policy and implementation report) is not approved by ordinary resolution (more than 50% of votes cast by shareholders) at a company’s AGM, the RemCom must, at the Second AGM, present an explanation on the manner in which the shareholders’ concerns have been taken into account. NEDs serving on the RemCom must stand for re-election as members of the RemCom at this Second AGM, at which the explanation is presented. If, at this Second AGM, the Rem Report in respect of the previous financial year is also not approved by ordinary resolution, the NEDs on the RemCom may continue to serve on the board as NEDs, provided that they successfully stand for re-election at the Second AGM. However, there is a crucial caveat – these NEDs will not be eligible to serve on the RemCom for a period of two years thereafter (Suspension Period). The abovementioned provisions do not apply to members of the RemCom who have served for a period of less than 12 months in the year under review.

Legislative perspectives and amendments

Following representations by the business community, Trade, Industry and Competition Minister Ebrahim Patel, who is responsible for overseeing the Companies Act, provided a concession by reducing the Suspension Period from three years to two. Despite this, the introduction of the new re-election requirement to the board adds a layer of complexity, making it a more rigorous provision, compared to the Bill’s predecessor [B27 – 2023].

A necessary addition or an undesirable imposition on governance

The ‘Two-Strike Rule’ introduced in the context of executive remuneration has several key benefits. Firstly, it empowers shareholders by allowing them to express their views on the remuneration structure of executives, ensuring that their interests are actively considered. Secondly, the ‘Two-Strike Rule’ promotes accountability by encouraging companies to tie executive pay to performance, with the prospect of a vote against the Rem Report incentivising directors to align their decisions with the company’s long-term success, and shareholder value. Lastly, the ‘Two-Strike Rule’ contributes to improved transparency through comprehensive disclosure of remuneration policies and practices. This heightened transparency enables shareholders to make well-informed decisions, and holds companies accountable for their remuneration choices.

However, the ‘Two-Strike Rule’ also poses some potential drawbacks. Firstly, there is apprehension about the ‘Two-Strike Rule’ fostering a short-term focus on immediate results to secure shareholder approval, rather than incentivising the pursuit of long-term strategic goals. Secondly, the compliance requirements of the ‘Two-Strike Rule’ pose a significant administrative burden for companies, involving extensive time and resources for comprehensive disclosure and adjustments to Rem Reports. Lastly, the requirement for certain NEDs to stand for re-election to the board raises concern about the overall attractiveness of directorship roles, potentially impacting the pool of candidates willing to take on such positions.

Remuneration is a multifaceted area that undergoes continuous evolution, influenced by market dynamics. By placing greater emphasis on shareholder involvement and detailed reporting, the Bill seeks to address concerns related to executive remuneration practices. While the ‘Two-Strike Rule’ aligns South African legislation more closely with international peers, its nuanced provisions and potential implications warrant close attention. The coming months will likely see robust discussions and adjustments as stakeholders navigate this new terrain, in pursuit of a more transparent and accountable corporate environment.

1.The term “spill” refers to the effect of the ‘Two-Strike Rule’; that is, to have board members stand for re-election

Sources:

Companies Amendment Bill [B 27B—2023], https://www.gov.za/sites/default/files/gcis_document/202312/bill-b27b-2023.pdf

Explanatory Memorandum on the Corporations Amendment (Improving Accountability on Director and Executive Remuneration) Bill 2011, https://treasury.gov.au/sites/default/files/2019-10/explanatory_memorandum.pdf

Corporations Amendment (Improving Accountability on Director and Executive Remuneration) Act, No. 42, 2011, https://www.legislation.gov.au/C2011A00042/latest/text

https://www.businesslive.co.za/fm/features/2024-02-01-new-pay-rule-to-squeeze-boards/

Jaynisha Chibabhai is a Corporate Financier | PSG Capital.

This article first appeared in DealMakers, SA’s quarterly M&A publication.

DealMakers is SA’s M&A publication.
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