Two strikes rule

The two strikes rule is an Australian law aimed at holding corporate directors responsible for the amount of executives' salaries and bonuses. Under the two strikes rule, a company's board members can be replaced if shareholders feel that the members are paying executives too much based on the company's performance. In essence, the two strikes rule is primarily intended to prevent executive salaries from growing out of control and to ensure that board members are held responsible for protecting the best interests of the company and its shareholders. Since it became law in 2011, the two strikes rule has had a largely positive effect on Australian businesses. It has kept executive pay in check, elevated shareholder engagement, improved corporate transparency, and increased focus on the question of whether executive pay is reasonable. Although there may be some potential drawbacks, the two strikes rule represents a concerted and mostly successful effort to ensure that executives are compensated in a fair and balanced manner.

Background

The compensation of corporate executives is often a controversial issue. In many cases, such executives are paid exorbitant salaries and rewarded with massive bonuses. Sometimes executive salaries and bonuses are so excessive that they are detrimental to the company. When this happens, shareholders, who hold stock in a company and are effectively its owners, may find that their interests and the interests of corporate executives do not align and may seek to rectify the issue.

Excessive executive pay is one of an array of problems that many countries face when it comes to large corporations' business practices. As a way of dealing with such problems, a number of countries have enacted various laws aimed at regulating the business world and the way that large corporations operate. In the late twentieth and early twenty-first centuries, Australia was one of the nations faced with concerns related to corporate business practices. In response to these concerns, the Australian government passed the Corporations Act in 2001. The Corporations Act defined the laws governing Australian business entities and regulated all corporate activities. While the Corporations Act helped to address many of the biggest concerns that Australia faced in terms of corporate business operations, it fell short of solving the problem of excessive executive compensation.

Australia was not the only country dealing with the issue of excessive executive compensation at the time. Out of control executive pay was also a serious problem in countries such as the United Kingdom and United States. In the early 2000s, a movement began in these and other countries to do something about this pressing issue. This movement quickly came to be known as the Say on Pay campaign. Originating in the United Kingdom, the Say on Pay campaign encouraged the establishment of methods through which shareholders could have a more direct influence on how corporate executives are paid. The Say on Pay campaign was particularly successful in Australia, where government officials were eventually persuaded to amend the Corporations Act. Although also signed in to legislation under the Dodd Frank Act of 2010 by the US, many shareholders remained unsatisfied with executives' exorbitant pay packages.

Overview

The Australian government's 2011 amendment to the Corporations Act was the two strikes rule. This rule aimed to alleviate the problem of out of control executive compensation by giving shareholders the ability to decide whether executives are receiving fair compensation. Specifically, the rule established a system through which shareholders could hold board directors responsible and keep the size of executives' salaries and bonuses in check.

The process of the two strikes rule begins when the members of a corporation's board of directors releases its annual remuneration report to the shareholders. The remuneration report details each executive's salary and bonuses. This allows the shareholders to see exactly how much money each executive has been paid in comparison to how the company has performed as a whole. The next stage of the process occurs at the company's annual general meeting (AGM), which brings directors and shareholders together for a company-wide review. Under the two strikes rule, the company is required to put forth a resolution to approve the remuneration report to the shareholders. If more than 25 percent of the shareholders vote against approving the remuneration report, the company receives its first strike. At the following year's AGM, the shareholders vote again on whether to approve the remuneration report. If the shareholders vote against approving the report again, the company receives a second strike and the shareholders are required to immediately vote on whether to hold a spill meeting. A spill meeting is a special assembly at which shareholders elect new directors for the company. If the shareholders vote in support of a spill meeting, all board positions, except that of the managing director, are officially declared vacant. At the subsequent spill meeting, the shareholders decide whether to fire the entire board or only certain members and elect replacements to fill any and all vacated positions.

In the first year of the rule's existence, well over one hundred Australian companies received a first strike and around ten companies eventually got a second strike. Studies conducted since that time confirmed the two strikes rule had a positive effect. Additionally, these studies revealed the two strikes rule has helped to lower executive compensation, increase corporate transparency concerning executive pay, encourage greater shareholder engagement in company business, and bring more attention to the problem.

At the same time, however, studies also showed that the two strikes rule may have also had some negative consequences. For example, if a large number of a company's shareholders choose not to vote on an AGM resolution, the smaller number of those who do may be left with undue influence over the company as a whole. A similar issue can also occur in companies in which a small number of shareholders own the majority of shares. In this instance, a small number of large shareholders can effectively overrule a large number of small shareholders because voting is based on the number of shares each person owns and not the number of shareholders. Shareholders may also use the two strikes rule abusively to levy strikes against a company as a way of making changes to the composition of a board for reasons other than those related to executive pay.

Bibliography

"Corporations Act of 2001." Laws.com, 23 Dec. 2019, corporate.laws.com/corporations-act-2001. Accessed 11 Jan. 2025.

Egan, John. "Don't Get Caught By a Second Strike." Australian Institute of Company Directors, 1 July 2014, www.aicd.com.au/organisational-culture/business-ethics/change/dont-get-caught-by-a-second-strike.html. Accessed 16 Jan. 2025.

"Five Years of the Two Strikes Rule – The Good, the Bad and the Ugly." Egan Associates, 22 Nov. 2016, eganassociates.com.au/five-years-of-the-two-strikes-rule-the-good-the-bad-and-the-ugly. Accessed 11 Jan. 2025.

Hodgson, Paul. "A Brief History of Say on Pay." Ivey Business Journal, Sept.–Oct. 2009, iveybusinessjournal.com/publication/a-brief-history-of-say-on-pay. Accessed 11 Jan. 2025.

Jolly, Peter, and Gina Bozinovski. "Two Strikes Rule – Playing by the Rules." Lexology, 30 Jan. 2013, www.lexology.com/library/detail.aspx?g=bcc534ff-c2d1-410f-a140-780837f04977. Accessed 11 Jan. 2025.

Rissman, Paul, and Paul Rissman. “Say on Sustainability Pay: An Underutilized Tone of Shareholder Voice.” The Harvard Law School Forum on Corporate Governance, 9 Mar. 2024, corpgov.law.harvard.edu/2024/03/09/say-on-sustainability-pay-an-underutilized-tone-of-shareholder-voice/. Accessed 11 Jan. 2025.

Walker, Julie. "'Two Strikes' Law for Shareholders, but Will It Curb Executive Pay?" The Conversation, 23 Oct. 2011, theconversation.com/two-strikes-law-for-shareholders-but-will-it-curb-executive-pay-3912. Accessed 11 Jan. 2025.

Wilkins, Georgia. "What Is the 'Two-Strikes' Rule?" Sydney Morning Herald, 8 Oct. 2012, www.smh.com.au/business/agm-season/what-is-the-twostrikes-rule-20121008-278us.html. Accessed 11 Jan. 2025.