Remuneration

Non-Executive Director remuneration

Director fees
Retirement allowances
Superannuation

Employee remuneration

Framework for remuneration
Annual cash-based incentive scheme
Long term incentive schemes
CEO remuneration

Non-Executive Director remuneration

Directors' fees

The total remuneration available to non-executive directors is fixed by shareholders at the annual meeting. The current annual fee pool limit is $1,500,000 and was approved by shareholders at the Annual Meeting in October 2003.

The Human Resources and Compensation Committee annually reviews director remuneration taking into account the responsibilities, skills, performance and experience of the directors and then makes appropriate recommendations to the board. The committee takes advice from independent consultants to ensure that remuneration is in line with other comparable companies in New Zealand and Australia.

During the year ended 30 June 2009, the fees paid to non-executive directors were as follows:

For the Chairman NZ$435,000;
For each non-executive director NZ$145,000;
For the chairman of each of the Audit and Risk Management Committee and Human Resources and Compensation Committee, and Nominations and Corporate Governance Committee (if a different person than the chairman of the board) NZ$30,000; and
For each member of a board committee NZ$15,000 (excluding the chairman and those persons who chair a committee).*
For the Telecom board representative appointed to the Independent Oversight Group NZ$30,000.

*No more than one amount for membership of a Board Committee will be paid where a director is a member of more than one Committee.

No director (excluding the CEO) receives compensation in the form of stock options or restricted shares or participates in bonus or profit-sharing plan.

Information on the total remuneration paid to Directors and values of other benefits received by the Directors of Telecom, during the previous financial year can be viewed in the Remuneration at Telecom section of the latest Annual Report (PDF 2.7MB).

Retirement allowances

The retirement allowances of all non-executive directors in office at 1 May 2004 were grandfathered and the remaining retirement allowances were frozen as at 30 June 2007. On the eventual retirement (or death during office) of any such non-executive director, an allowance will be paid to that director. An accrual has been maintained for the current amount of retirement allowances owing to directors appointed prior to 1 May 2004. The accrued amount was frozen at 30 June 2007.

No director (excluding the CEO) has a service contract with any member of the Telecom group that provides for benefits or remuneration in the event that the service of any such director within the Telecom group is terminated. For details of benefits or remuneration to be paid to the CEO in the event that his or her service is terminated, see CEO Remuneration below.

Superannuation

No superannuation was paid to any director for the financial year ended 30 June 2009.

Employee remuneration

Framework for remuneration

The Human Resources and Compensation Committee is responsible for reviewing Telecom's remuneration and human resources strategy, structure, policy and practices. It seeks external expert advice on best practice remuneration structures and market trends to ensure that the remuneration strategy for Telecom contributes to effective performance and value creation.

The Human Resources and Compensation Committee recognises the vital role people play in the achievement of Telecom's short-term and long-term objectives as a key source of competitive advantage. To grow and be successful, Telecom must be able to attract, retain and motivate capable employees.

The key principles determined by the Human Resources and Compensation Committee that underpin Telecom's remuneration policies are:

rewards are market-competitive to attract and retain talented people;
remuneration is linked to performance so that high levels of performance attract higher rewards;
the overall cost of remuneration is managed and linked to the ability of the company to pay; and
rewards to senior management are aligned to those of shareholders.

Rewards are market-competitive to attract and retain talented people

The overall remuneration structure is designed to deliver rewards that are competitive in the labour markets in which Telecom competes for people. All Telecom's senior management positions are job sized using an internationally recognised job evaluation methodology. Job evaluation assesses the comparative importance of each position in terms of its impact and accountability and ensures internal equity between positions. It also facilitates comparisons of remuneration data between Telecom positions and those in other companies that are meaningful and accurate. All senior manager position evaluations are confirmed by an independent expert in job evaluation methodology.

All other positions are allocated to job bands that are defined by job evaluation ranges. A sample of positions is formally evaluated with others allocated to job bands through a matching process. Telecom accesses market remuneration information by sourcing a number of New Zealand and Australasian remuneration surveys and seeking independent specialist remuneration advice. This provides comprehensive market information such as remuneration trends and data, performance-based reward structures and pay levels including benefits and incentive components for different positions in various industries. These are used to ascertain Telecom's competitive stance and ensure that the Telecom rewards are sufficiently competitive.

The Human Resource and Compensation Committee decides Telecom's position within a comparative market and this determines remuneration ranges. Individual remuneration is set within these ranges taking amount of a number of factors including individual performance and capability, specific business needs, the criticality to Telecom of a specific position or individual, market shortages of specific skills, regional differences and economic climate. Remuneration ranges are reviewed annually to reflect movement in market remuneration.

Remuneration is linked to performance so that higher levels of performance attract higher rewards.

Telecom has a comprehensive performance management process. Overall business strategy shapes Telecom's corporate plan. It cascades to business groups and is reflected in business plans and finally in individual performance plans. Individual performance plans, established each year, clarify performance expectations against which individual achievement is assessed.

Individual performance is a key input into the annual remuneration review decisions along with current market relativity of that individual's remuneration package. Individuals receive remuneration increases based on performance.

The variable remuneration component is at-risk and entirely performance based. This component includes specifically designed sales incentives, annual cash-based incentives and equity-based or longer-term incentives. Each scheme links desired performance outcomes with appropriate reward.

Sales incentives, specific to sales positions, are designed to drive achievement of sales, customer value and service targets. The annual cash-based incentives, issued via either the senior short-term incentive scheme or the short-term incentive scheme, drives company, business and individual performance and links individual reward to shareholder value. An annual incentive scheme applies at all levels in the organisation with the specific structure and amount of incentive based on position level - senior managers participate in the senior short-term incentive scheme while others participate in a general short-term incentive scheme. In line with market practice, equity-based incentives apply only to senior management positions. These incentives link rewards of those individuals that directly impact on business performance with improvements in shareholder value.

The overall cost of remuneration is managed and linked to the ability of the company to pay.

Telecom has a significant financial investment in its people. Effective growth is dependent on the quality, commitment, innovation and drive of these employees. Telecom aims, in a competitive market, to achieve the appropriate balance between managing overall remuneration costs and investing in people.

Telecom sets a conservative position for its fixed remuneration and only pays remuneration at a higher market level when performance objectives are achieved. The overall remuneration cost is therefore linked to Telecom's performance and ability to pay. The total funding available for annual remuneration increases is based on market movement and is approved by the Human Resource and Compensation Committee prior to the remuneration review. The Human Resource and Compensation Committee monitors remuneration costs and practices to ensure that they are in line with policy.

Rewards to senior management are aligned to those of shareholders

The Human Resource and Compensation Committee makes recommendations to the board on senior management incentive remuneration plans, share option and share ownership plans. Senior management remuneration packages comprise a fixed portion and an at-risk portion that is generally only paid when performance objectives are met. Typically Telecom's executives have approximately 50% of their remuneration package paid as a fixed component. The remaining 50% is at-risk, with generally 30% in an annual cash-based incentive and 20% in an equity-based scheme.

Annual Cash-based Incentive Scheme

The annual cash-based incentive scheme is an integral part of Telecom's overall approach to competitive performance-based remuneration. It aims to reward individuals for meeting or exceeding individual, business group and company goals that are aligned to Telecom's strategic direction. Telecom performance is based on key financial measures set by the board.

The Board determines Telecom's strategy and measures of success and agrees a Corporate plan with reference to external performance benchmarks. Based on this agreed plan, targets are set at the beginning of the year with the Board assessing performance against these following the completion of the financial year. Similarly business group targets are set and assessed. Corporate and business group plans cascade down the company to form the basis of individual performance plans. These plans translate high level corporate and business group strategies and targets into individual objectives that are specific, measurable, achievable, realistic and time bound. Objectives define, manage and measure individual performance throughout the year.

The incentive design balances business performance and individual performance so that above target performance in both results in above target payments, while below target performance in either results in lower incentive payments.

Long-term incentive schemes

Telecom also operates both equity and cash-based long-term incentive (LTI) schemes. These are designed to ensure there is an appropriate balance between short, medium and longer-term performance objectives and to align senior management with shareholder interests where possible. Approximately 520 senior managers currently participate in equity-based incentive schemes. In the last two years Telecom's LTI programme has been delivered in restricted shares or share rights. Due to Undertakings restrictions, Chorus long-term incentives are delivered via a cash-based scheme.

The total number of shares, share rights and share options on issue under Telecom's LTI scheme comprised less than 1% of the total shares on issue at 30 June 2009. See note 22 to the financial statements for more details.

Telecom Share Option Scheme

The Telecom share option scheme has operated since 1994.

No options have been issued under the share option scheme since September 2005 and in 2008 the board decided that this scheme would be discontinued. The ability to exercise the options that remain on issue is subject to meeting prescribed performance hurdles. A cost of equity performance hurdle applies to all options issued under the share option scheme since September 2003. For these options to be exercised, Telecom's share price must exceed the option exercise price escalated by the cost of equity less dividends paid, within the applicable period. Until exercised, share rights have no voting rights.

Telecom Restricted Share Schemes

In September 2001 restricted shares were introduced as a component of remuneration for selected senior people. Restricted shares are now the primary equity-based mechanism for LTI participants. They are intended to align employee incentives with shareholder value without the dilutionary impact of widespread use of share options.

Restricted shares are delivered via two different mechanisms that provide the same incentive and reward outcomes. These are the Telecom restricted share scheme and the Telecom share rights scheme. The restricted share scheme is only used in New Zealand and the share rights scheme is used in Australia and for New Zealand-based executives. The restricted share scheme and share rights scheme are structured to deliver an equivalent benefit to all participants.

Under the restricted share scheme, shares in Telecom are issued to Telecom Trustee Limited, a Telecom subsidiary. Participants purchase shares from Telecom Trustee Limited with funds lent to them by Telecom and which are held on their behalf by Telecom Trustee Limited. Telecom Trustee Limited cannot exercise any voting rights attached to the share. Once vested the shares have the same voting rights as ordinary shares. Generally the shares vest after a three-year period although a reduced period may be used in some cases. If the individual is still employed by Telecom at the end of the specified period the employee is given a cash bonus which must be used to repay the loan and the shares are then transferred to the individual. Under special circumstances individuals who cease employment prior to the end of the restricted period can receive a partial award under the restricted share scheme. Restricted share issued on or after September 2007 may be eligible for dividends.

Under the share rights scheme, participants are granted rights to purchase Telecom shares at a nil cost strike price. Share rights have no voting rights until exercised and generally cannot be exercised for a three-year period. The rights will be exercisable at the end of the restricted period only if the individual is still employed by Telecom, except in special circumstances. The share rights granted to the majority of executives in the 2008 and 2009 financial years carry the same performance hurdle as that applied to the grant of the CEO performance rights scheme made in the 2008 financial year (as details under CEO remuneration).

Participants in Telecom's incentive schemes are prohibited from creating any interest (including any security, legal or equitable interest) in the underlying security, which means participants can not limit the economic risk of participating in unvested entitlements under Telecom's incentive schemes.

Chorus long-term incentive scheme

The Undertakings specify Chorus staff cannot be granted Telecom equity or receive incentives linked to Telecom performance. The Chorus long-term incentive is therefore cashbased. The duration of the cash grants is generally three years with performance criteria determined by the Board and specific to Chorus.

CEO Remuneration

Employment agreement

Dr Reynolds, Telecom's CEO, has an employment agreement that commenced on 27 September 2007. The agreement is not a fixed term contract. The conditions of employment under the agreement reflect customary conditions that are appropriate to a senior executive operating within the Australasian business community.

Termination benefits under employment agreement

The employment agreement may be terminated by the Board on three months' notice.

If the board gives notice of termination within the first three years of employment (Initial Period), Telecom will pay Dr Reynolds an amount equal to the greater of (a) 12 months' base remuneration or (b) base remuneration for the period from the end of the notice period to the end of the Initial Period and, in either case, a payment equal to 12 months of the annual performance incentive. Where the board gives notice of termination after the Initial Period, the termination payment shall be an amount equal to 12 months' base remuneration. In addition to the above entitlements, the board also retains sole discretion to determine any entitlements under the CEO's performance incentive scheme, performance rights scheme and performance entitlements scheme, subject to the rules of these schemes.

The agreement may be terminated by the CEO on three months' notice if there is a fundamental changes that results in Dr Reynolds no longer being the CEO of a publicly listed company. If such a fundamental change occurs, the CEO is entitled to receive a payment as if the board had terminated his employment.

The CEO may also, at any time, terminate the agreement on six months' notice, during which time period he will continue to receive all remuneration and other entitlements under the agreement.

The board may elect to pay the CEO an amount based on his base remuneration in lieu of all or part of any termination notice period.

In the event that Dr Reynolds is prevented from carrying out his duties by personal accident, death or ill health, the board may in certain circumstances terminate the agreement immediately and make a payment equal to 12 months' base remuneration to Dr Reynolds.

If the agreement is terminated by the board for serious misconduct or bankruptcy, Dr Reynolds shall be entitled only to the base remuneration and accrued statutory holiday pay to the date of termination. All other entitlements shall be forfeited.

There is no redundancy payment provision contained in the employment contract of the CEO.

Remuneration

The CEO's remuneration package has been set to reflect the scope and complexity of the role; to closely align the package to the interests of shareholders; enhance his long-term commitment to Telecom; and to be performance based so that the package is directly linked to performance outcomes. The remuneration package includes a fixed cash component amount, an incentive award to be paid under the Performance Incentive Scheme, and an allocation of share rights under the Performance Rights Scheme. The performance incentive scheme and a long term incentive. In previous years, the CEO's long-term incentive has comprised an allocation of share rights under the performance rights scheme. For the 2009 financial year, it is intended that his long-term incentive be delivered through a combination of share rights granted under the performance rights scheme and entitlements granted under the performance entitlements scheme.

CEO performance incentive scheme

The performance incentive scheme is designed to reward the CEO for achieving pre-specified target levels of performance. The target value of the incentive award is set annually by the board and paid at target value if target performance is achieved in the relevant year. This amount can be adjusted up or down in line with assessed under-or over-performance, subject to the maximum target value stated below.

The measures used in determining the amount of the incentive award are set annually by the board. These are likely to include overall financial targets such as EBITDA and specific performance objectives, that may include financial criteria based on Telecom's business and strategic plans, and other criteria relating to corporate governance, reputation, effective leadership and management. The performance incentive scheme is delivered in two parts, 60% cash payment and 40% by fully paid ordinary Telecom shares subject to restrictive conditions. The annual target value of the incentive award is NZ$1,750,000 per annum. The maximum target of the incentive award is 175%. At the board's discretion, 100% of the award may be delivered in cash.

The shares issued to (or purchased by) the CEO under the performance incentive scheme are not able to be sold or otherwise disposed of for a three year period following issue. The shares have equivalent rights to shares held by all other Telecom shareholders. If the CEO's employment is terminated for cause then any shares issued or purchased under the performance incentive scheme within the previous three years will be forfeited. If employment is terminated on notice or terminated by the CEO following a fundamental change in employment then the restrictions on disposal will cease to apply. If employment otherwise ceases then the board retains the discretion to remove the restrictions on disposal.

CEO performance rights scheme

The performance rights scheme is designed to link part of the CEO's remuneration with the long-term performance of Telecom. A grant of share rights equivalent to NZ$2,100,000 under the performance rights scheme were issued to Dr Reynolds on 16 September 2008. Each performance right is granted for no cash consideration, generally with a three year vesting period, and provides the right to purchase one ordinary share in Telecom at a nil exercise price.

The 2008 and 2009 grants will only be able to be exercised if Telecom's total shareholder return (TSR) meets or exceeds a specific performance hurdle. The performance hurdle has a relative return component, which compares Telecom's TSR to 20 global integrated telecommunications companies. It also has an absolute return component, which compares Telecom's TSR to targets set by the board based on independent external advice.

Both the relative and absolute TSR targets have a minimum performance threshold (represented by the 50th percentile performance target) and a stretch performance target corresponding to the maximum vesting outcome (represented by the 75th percentile performance target). Vesting outcomes are structured as follows:

if only one of the targets is achieved at the 50th percentile level or higher then 25% of the share rights are exercisable at the 50th percentile performance target level, increasing on a straight-line basis such that 50% of the share rights would be exercisable at the 75th percentile performance target

if the 50th percentile performance target is achieved on both the relative and absolute targets then half of the share rights become exercisable

if at least the 50th percentile performance target is achieved on both the absolute and relative targets then the number of share rights able to be exercised is determined by the performance target for which the achievement is highest, with 50% of the share rights being exercisable at the 50th percentile performance target level, increasing on a straightline basis such that 100% of the share rights would be exercisable at the 75th percentile performance target

if the 75th percentile performance target is achieved on either or both the relative and absolute targets then all of the share rights become exercisable.

Testing to determine whether the performance hurdle was achieved will occur at the end of the vesting period of the grant, and again 12 months later. If the 50th percentile performance target is not met on either the relative or the absolute target on the initial test date then a maximum of 50% of the share rights can be exercised if the 50th percentile target is met or exceeded on the re-test. If the number of shares that would be exercisable on the re-test is greater than the number that were exercised on the initial date then those additional share rights will become exercisable.

Shares issued on the exercise of share rights will be fully paid ordinary shares and will rank equally in all respects with all other ordinary Telecom shares at the date of issue of the shares.

If the CEO's employment is terminated by the board without notice, any non-vested share rights issued under the performance rights scheme will be forfeited. If employment ceases due to either termination by the board on notice or termination by the CEO following a fundamental change in employment then those grants of share rights that have not reached the initial exercise date and that are more than halfway through the period from commencement to initial exercise date will vest on a pro-rata basis (calculated as the ratio of the period from the commencement date to the termination date divided by the period from the commencement date to the initial exercise date of the grant). If employment ceases for any other reason then any entitlement to vesting of the share rights shall be solely at the board's discretion.

CEO performance entitlements scheme

The CEO's long-term incentive for the 2009 financial year is to be delivered through a combination of share rights issued under the performance rights scheme and an issue of entitlements under a performance entitlements scheme. The CEO will receive the same value from the combined issue of entitlements and share rights as he would have received had his long-term incentive been issued solely in the form of share rights.

The performance entitlements scheme has been established due to a shortfall between the number of share rights that Telecom has undertaken to grant the CEO for the 2009 financial year and the number of share rights that were authorised to be issued by shareholders at Telecom's 2007 annual meeting. The shortfall has arisen due to a number of environmental factors, including the significant decline in world markets since 2007, resulting in a decline in Telecom's share price. Despite the shortfall, Telecom considers it critical that Telecom honours the contractually agreed levels of remuneration in the CEO's employment agreement and that the existing levels of the CEO's remuneration, directly linked to Telecom's long-term share price, are maintained. It also considers that it is not an appropriate time to materially alter the CEO's incentive arrangements given the current economic climate and the review of executive remuneration currently being conducted by the Australian and other overseas governments.

The performance entitlements scheme will have substantially the same terms as the performance rights scheme and as such links a portion of the CEO's remuneration with the long-term performance of Telecom. However, instead of issuing equity securities to the CEO on the vesting of his entitlements, a cash payment equivalent to the market value of the ordinary shares the CEO would have received, had he exercised an equivalent number of share rights under the performance rights scheme, will be made.

The entitlements issued for the 2009 financial year will have a three year vesting period and be subject to the same performance hurdles as the 2009 grant of share rights under the performance rights scheme (as detailed above). The CEO will be granted one entitlement for each share right that he would have been entitled to be granted in excess of the remaining 678,910 share rights authorised by shareholders.

Upon vesting of the entitlements, a cash payment will be determined by multiplying the market price of the Telecom shares at the time the entitlements are exercised by the number of entitlements being exercised. The cash payment will therefore be substantially the same as the market value of the ordinary shares the CEO would have received had he exercised share rights under the performance rights scheme.

Upon termination of the CEO's employment contract, the entitlements will be treated in the same way as any share rights held by the CEO.

For more information on CEO remuneration please see pages 124-126 of the Annual Report.

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