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.

¹Committee chair and member fees are not payable to the chairman of the board, and committee member fees are not payable to committee chairs. Where a director is the member or chairman of more than one board committee, the director receives the single highest applicable fee.

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.

Retirement allowances

While Telecom historically provided retirement allowances to non-executive directors, the allowances were grandfathered in 2004 and no retirement allowances were accrued as at 30 June 2011, following the payment of the final accrued retirement allowance entitlement to Mr McGeoch on his retirement on 30 September 2010.

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

Superannuation

No superannuation was paid to any Telecom director during the financial year ended 30 June 2010.

Telecom 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 help 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:

1. 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. Typically, Telecom's senior management positions are evaluated 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 typically 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 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 Telecom rewards are sufficiently competitive.

The Human Resources and Compensation Committee decides Telecom's position within a comparative market and this determines remuneration ranges. Individual remuneration is set within these ranges taking account 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.

2. 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 decision, along with current market relativity of that individual's remuneration package and the individual's skills and capabilities. The variable remuneration component is at-risk and entirely performance-based.

This component includes specifically designed sales incentives, annual cash-based incentives and long-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, granted via either the senior short-term incentive scheme or the general short-term incentive scheme, link company, business and individual performance. The annual cash-based 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, long-term incentives apply only to senior management positions. These incentives link the rewards of those individuals who most directly influence Telecom's long-term business performance to the delivery of outcomes that increase shareholder value, or for those in the Chorus business unit (due to Undertakings restrictions) the delivery of Chorus's key strategic imperatives.

3. 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 typically 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 Resources and Compensation Committee prior to the remuneration review. The Human Resources and Compensation Committee monitors remuneration costs and practices to ensure they are in line with policy.

4. Rewards to senior management are aligned to long-term performance of the Company

The Human Resources and Compensation Committee makes recommendations to the board on senior management incentive remuneration plans, including long-term incentives. 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 the form of an annual cash-based incentive and 20% in the form of a long-term incentive scheme.

Short-term incentive scheme - Annual Cash-based Incentive Scheme

The annual cash-based incentive scheme, being Telecom's short-term 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.

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 targets 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 against 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 or, in some cases, no incentive payments. Strong performance in the 2011 financial year against key customer and financial metrics resulted in above target business performance and short-term incentive outcomes in the 2011 financial year.

For the 2011 financial year, a free cash flow hurdle applied to all short-term incentive payments. In order for any incentive payments to be made, Telecom had to meet or exceed this hurdle, which it did. A free cash flow hurdle will need to be met or exceeded for any 2012 financial year short-term incentive to be paid.

Impact of demerger

Following the demerger of Telecom, the short-term incentive scheme continues, but the performance plans and targets will cover two periods (a period pre-demerger and a period post-demerger). As such, performance plans and targets have been recalibrated as appropriate to best reflect the position of New Telecom following the demerger.

Long-term incentive schemes

Telecom also operates both equity and cash-based long-term incentive schemes for members of the Executive team and senior managers. These are designed to ensure there is an appropriate balance between short, medium and longer-term performance objectives.

The Executive and senior manager at-risk long-term incentive schemes have been modified as appropriate over different financial years to maintain a high level of incentivisation in a context of significant transformation in the telecommunications sector.

• For the 2012 financial year (to be granted in September 2011), Executives and senior managers will receive a cash-based incentive which is directly linked to the share price performance of Telecom
• For the 2011 financial year (granted in September 2010), long-term incentives were structured as a cash-based performance incentive
• Before the 2011 financial year, long-term incentives were structured as grants under the share option scheme and/or one of the restricted share schemes

Further details on these schemes are set out below. In addition, as certain of the schemes will be affected by the proposed demerger of Telecom, details of the anticipated treatment of such schemes in demerger are also provided below.

Executive long-term incentives

Executive long-term incentive grants for the 2011 financial year - Executive cash-based incentive scheme

For the 2011 financial year the same cash-based performance scheme applied for the Executive team, albeit with performance being assessed against objectives appropriate to the Executives' roles for the duration of the scheme. This replaced grants of share rights to the Executive team (see Telecom restricted share schemes) for the 2011 financial year. The maximum value of the cash incentive was 100% of the long-term incentive component value for each Executive, with the amount of incentive paid determined by the board, based on achievement against the specified performance objectives. The vesting period will be two years and payment will occur at the end of the vesting period, provided that the Executive is still employed by Telecom.

Executive long-term incentive grants for the 2012 financial year - Equity link scheme

For the 2012 financial year, the Executive team will receive their long-term incentive awards through the equity link scheme. The Executive awards under this scheme will be subject to post allocation performance testing, with testing undertaken by the board. The equity link scheme provides a cash payment of an amount that is adjusted upwards or downwards based on Telecom share price movement over the specified period, ensuring that remuneration is linked to share price performance.

If the proposed demerger proceeds, the grants to any participants in the Telecom equity link scheme who become employees of New Chorus on demerger will transfer to an equivalent New Chorus scheme.

Senior manager long-term incentives

Senior manager long-term incentive grants for the 2011 financial year - Senior manager cash-based incentive scheme

For the 2011 financial year, all long-term incentives were delivered in cash and approximately 100 senior managers participated in the long-term incentive schemes. The quantum of each senior manager's incentive grant is now linked to performance in the delivery of the annual business plan as measured through their short-term incentive performance outcome achieved for the previous year ended 30 June. This is the same performance outcome that is applied to the annual cash-based incentive scheme (see Short-term incentive scheme - Annual cash-based incentive scheme) and comprises individual, business group and company goals. The amount of long-term incentive granted will therefore vary from 0 to 200% of the current long-term incentive component value specified in the relevant senior manager's employment agreement. The vesting period is three years and payment will occur at the end of the vesting period, provided that the individual is still employed by Telecom.

Senior manager long-term incentive grants for the 2012 financial year - Equity link scheme

For the 2012 financial year, senior management long term incentives will be delivered using the same pre-allocation performance measures as above, and will be granted under the equity link scheme (described above).

Senior manager long-term incentive grants for years before the 2011 financial year

The schemes under which equity-based incentives were granted to senior managers in previous years are summarised below. The total number of restricted shares, share rights and share options on issue under these schemes comprised less than 1% of the total shares on issue at 30 June 2011.

Telecom Share Option Scheme

The Telecom share option scheme was introduced in 1994.

This scheme is being discontinued, and the lapse date of the last tranche of options granted is 16 September 2011. The ability to exercise the outstanding options is subject to prescribed performance hurdles being met. A cost of equity performance hurdle applies to all options, under which, 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. All outstanding options currently would not satisfy that hurdle. Until exercised, share options have no voting rights.

Telecom Restricted Share Schemes

In September 2001 restricted shares were introduced as a component of remuneration for selected senior people. The objective of the scheme is 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: (a) the Telecom restricted share scheme and (b) the Telecom share rights scheme.

Restricted Share Scheme

Under the restricted share scheme, ordinary 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 shares. However, 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 vesting 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 vesting period can receive a partial award under the restricted share scheme. Restricted shares issued on or after September 2007 may be eligible for dividends.

Impact of demerger

Following the demerger, the trustee under the restricted share scheme received New Chorus shares in respect of any Telecom ordinary shares it held on behalf of participants in the same manner as other eligible holders of Telecom shares. The trustee allocated such New Chorus shares to participants in the restricted share scheme on a pro rata basis to the number of shares it held on behalf of each participant, and such New Chorus shares vested immediately. In addition, the Telecom shares held by the trustee on behalf of any New Chorus employees vested immediately. The trustee continues to hold Telecom shares on behalf of New Telecom employees in accordance with the scheme.

Share Rights Scheme

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 share rights will be exercisable at the end of the vesting period only if the individual is still employed by Telecom, and, in the case of executives, a total shareholder return performance hurdle has been met, except in special circumstances.

Impact of demerger

Following the demerger, participants in the share rights scheme received a different number of share rights in New Telecom to reflect changes in value of the share rights. Participants did not receive any New Chorus share rights or shares.

Chorus long-term incentive scheme

Chorus long-term incentive schemes are cash-based. For the 2012 financial year, eligible Chorus employees will receive their long-term equity grants under an equity link scheme equivalent to that described above but relating to New Chorus shares instead.

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. Dr Reynolds has committed to lead Telecom as CEO and as a board member through the demerger process and New Telecom's successful establishment as an independent company. It is expected that the New Telecom board will undertake a search process to identify a candidate for CEO of New Telecom to lead the Company during the 2012/2013 financial year and beyond.

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, Telecom must pay Dr Reynolds a termination payment equal to 12 months' base remuneration. In addition, the board retains sole discretion to determine any entitlements under the CEO's short and long-term performance incentive schemes (all outlined below) subject to the rules of these schemes.

The agreement may be terminated by the CEO on three months' notice if there is a fundamental change 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 on notice.

The CEO may also, at any time, terminate the agreement on six months' notice. During such notice period the CEO 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.

If 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 is only entitled 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 CEO's employment agreement.

Remuneration

The CEO's remuneration package reflects the scope and complexity of the role and is performance-based, so that it is directly linked to the long-term performance of the Company. The package includes: (i) a fixed cash component, (ii) an at-risk short-term incentive award (to be paid under the performance incentive scheme) and (iii) an at-risk long-term incentive award (to be paid under the applicable long-term incentive scheme).

Dr Reynolds' at-risk long-term incentive schemes have been modified as appropriate over different financial years to maintain a high level of incentivisation in a context of significant transformation in the telecommunications sector:

• For the 2012 financial year, the CEO will be granted a cash-based incentive which is directly linked to the share price performance of Telecom
• For the 2011 financial year, the CEO's long-term incentive was structured as a cash-based performance incentive
• Before the 2011 financial year, the CEO's long-term incentive comprised either share rights granted under the performance rights scheme or a combination of such share rights and entitlements granted under the performance entitlements scheme

Further details on these schemes are set out below. In addition, as certain of the schemes will be affected by the proposed demerger of Telecom, details of the anticipated treatment of such schemes on demerger are also provided below.

CEO short-term incentive scheme - 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 value stated below.

The performance targets which determine the amount of the award include overall financial targets (such as EBITDA) and specific performance objectives (such as financial criteria based on Telecom's business and strategic plans) and other criteria relating to corporate governance, reputation, effective leadership and management.

Any amount payable under the performance incentive scheme is typically delivered in two forms - 60% by a cash payment and 40% by fully paid ordinary Telecom shares subject to restrictive conditions. At the board's discretion, 100% of the award can be delivered in cash. The annual target value of the incentive award is NZ$1,750,000 per annum. The maximum amount of the incentive award is 175% of the annual target value.

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 otherwise have equivalent rights to ordinary shares held by all other Telecom shareholders, including the entitlement to receive New Chorus shares if the proposed demerger proceeds. Any New Chorus shares issued to Dr Reynolds on demerger will not be subject to any restrictions as to disposal, but the existing grants of Telecom shares will continue to be restricted in accordance with the terms of the applicable grants. The board has exercised its discretion to deliver the annual incentive for the 2011 financial year entirely in cash due to the expiry of the shareholder approval obtained in 2007, authorising the issue of shares under the performance incentive scheme.

CEO long-term incentive schemes

Long-term incentive for the 2011 financial year - CEO cash-based long-term incentive

The structure of the CEO's long-term incentive was changed for the 2011 financial year (granted in September 2010) to reflect the extraordinary level of change and transformation in the telecommunications industry. A cash incentive replaced grants of share rights or performance entitlements (described below) to more closely link the CEO's long-term incentives to deliverables that he could meaningfully influence in the period. This was consistent with the approach to company-wide long-term incentives granted in the 2011 financial year.

This cash-based performance scheme provides for the CEO to receive a cash payment at the end of a two-year vesting period (being 15 September 2010 to 15 September 2012), subject to achieving specified performance objectives. The maximum amount of the cash incentive will be 100% of the CEO's current long-term incentive component value (NZ$2.1 million), with the final amount of any payment being determined by the board based on the CEO's performance against the specified performance objectives. The performance objectives set by the board focus on maximising company value and leadership of the Company through this period of transformation and uncertainty. The cash incentive will not be subject to a re-test at a later date.

If the CEO ceases to be employed by Telecom during the two-year vesting period, the board has discretion as to the amount of any payment made to the CEO under the cash-based performance scheme, based on the date on which the CEO's employment ceases during the vesting period and the level of performance achieved against the performance objectives.

Long-term incentive for the 2012 financial year - Equity link scheme

The CEO's long-term incentive for the 2012 financial year (to be granted in September 2011) will be delivered through a cash-based equity link scheme (described under Executive long-term incentive). The CEO's grant under this scheme will have a three year vesting period and specific post-allocation performance criteria that determine whether a payment will be made and the amount of any such payment.

Long-term incentive for years before the 2011 financial year

As noted above, before the 2011 financial year the CEO's long-term incentive comprised either share rights granted under the performance rights scheme or a combination of such share rights and entitlements granted under the performance entitlements scheme.

CEO performance rights scheme

The performance rights scheme is designed to link part of the CEO's remuneration with Telecom's long-term performance. Three grants have been made under the CEO performance rights scheme (in September 2007, 2008 and 2009). Each share right was granted for no cash consideration, with the 2007 grant vesting equally over a one, two and three year period, and a three year vesting period for the 2008 and 2009 grants. Each share provides the right to purchase one ordinary share in Telecom at a nil exercise price 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) and from the 2008 grant an absolute return component (which compares Telecom's TSR to targets set by the board based on independent external advice).

Testing to determine whether the performance hurdle has been achieved will occur at the end of the vesting period of the grant, and again 12 months later. If neither the absolute nor relative TSR target is achieved to at least the 50th percentile 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 share rights 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.

Both the relative and absolute TSR targets have a minimum performance threshold (being the 50th percentile of the relevant target) and a stretch performance target (being the 75th percentile of the relevant target). Outcomes on achieving the absolute and relative TSR targets are broadly structured as follows if:

• Only one of the two targets is achieved at the 50th percentile level or higher then 25% of the share rights become exercisable at the 50th percentile performance target level, increasing on a straight-line basis such that 50% of the share rights would become exercisable at the 75th percentile performance target
• Both of the TSR targets are achieved to at least the 50th percentile, then the number of share rights able to be exercised is determined by the performance target for which the achievement is highest and 50% of the share rights become exercisable at the 50th percentile, increasing on a straight-line basis such that 100% of the share rights become exercisable at the 75th percentile; or
• Either or both of the TSR targets are achieved to the 75th percentile or higher, then all of the share rights become exercisable.

Shares issued on the exercise of share rights will be fully paid ordinary shares ranking 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 granted 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 share rights that have not reached the initial exercise date will vest on a pro-rata basis (calculated as the ratio of the period from the grant date to the termination date divided by the period from the commencement date to the initial exercise date of the grant). If employment ceases due to either termination by the CEO on notice, or the board for disability, then any entitlement to vesting of the share rights shall be solely at the board's discretion. Vested options will generally lapse three months after the date on which the CEO's employment ceases.

CEO performance entitlements scheme

In 2009 a performance entitlements was established due to a shortfall between the number of share rights that Telecom undertook to grant to the CEO for the year and the number of share rights that had historically been authorised by shareholders at Telecom's 2007 annual meeting. The performance entitlements scheme has 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, Telecom will make a specified cash payment as described below.

In September 2009, the CEO was granted 95,998 entitlements under the performance entitlements scheme. These entitlements have a three year vesting period and are subject to the same performance hurdles as the share rights that were also granted in September 2009 (detailed above). 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 agreement, the entitlements will be treated in the same way as any share rights held by the CEO.

Impact of demerger

Following the demerger, Dr Reynolds will receive a different number of share rights and performance entitlements in New Telecom to reflect changes in value of the share rights and performance entitlements.

For more information on CEO Remuneration please see pages 134-146 of the Annual Report.

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