Stan Wallis is arguably one of the most influential directors of his generation.
Whether as chairman of Amcor, the head of the Financial Service Reform or as the current interim chairman of AMP, Wallis has a reputation as a fixer of big-ticket issues. Taciturn, some would even say dour, Wallis has traditionally been reluctant to publicly air his views. In a speech on June 29, to the Centre for Corporate Public Affairs, Wallis reveals his opinions on the state of corporate governance. The following is an edited version of his speech.
While much progress has been made there are, in my opinion, widespread misconceptions about the role of boards and about the corporate governance debate in this country.
We all agree about the role of a board - to agree strategy, to monitor performance, to approve major investments, to ensure major risks are managed, to appoint the CEO and approve succession plans and top management compensation, to ensure compliance on all fronts and to establish ethical standards for the company's operations and people. We probably all agree about the main tenets of corporate governance. There must be protection for all shareholders, including minorities. Management must be held accountable to shareholders, there must be transparency and free disclosure and, above all, we must have an active independent board that oversees management. As major corporations expanded in the 1970s and 80s on a global basis, there was a growing separation of ownership and control, the professional manager was accumulating too much power - a constraint on this concentration of power was needed.
The result is a view of governance best practice largely designed to prevent directors being influenced too much by management. As a result, in the Anglo Saxon world, we have achieved a large degree of convergence about what constitutes a so-called "best practice" board:
Contention exists in relation to the CEO/chairman role. The US is the obvious but very important example where a split role has little support - although efforts are being made for a non-executive director to be designated as the "lead director" to enable a "non-executive" view or decision to be reached on sensitive issues. Support is growing for equity-based remuneration for directors, but this was anathema to the corporate governance movement until recently. Certainly, incentive-based remuneration is off the agenda on the grounds that any issue which could cause management and directors to act in concert is an issue of potential conflict and therefore taboo, although stock options are being rapidly taken off the taboo list in the US. Issues concerning appraisals and whether they should be carried out collectively, or on an individual basis, are contentious. But there is a significant shift. Until five years ago, formal process was rare and the evaluation was typically left to the chairman to have a quiet word with an errant director. Now, probably more than half of listed companies engage in some form of group self-appraisal.
Appraisal of individual directors is still rare though. One can, however, argue that this is probably anomalous in a business world in which accountability, feedback and constant improvement are accepted as givens.
To retirement age and tenure limits These are not universally agreed. There is justified resistance to rigid formulae which could see effective directors being forced off boards, however the issue cannot be ignored. I believe that the answer lies in better feedback and tighter renomination processes. There is of course a leadership issue here. If boards don't themselves deal with performance issues they are hardly entitled to insist that management does. Notwithstanding the unresolved issues, there is a large degree of convergence about corporate governance and many of the battles against - egotistical managers, corporate excesses and compliant boards, and for diversity and equal opportunity and for free and transparent disclosure, have been won or substantially progressed. If today's standards of corporate governance and board independence had applied more generally in the past, we may not have seen the concentration and excesses of power which led to the spectacular downfall of a number of major corporations.
There can be no doubt, in this context, that we need appropriate standards of corporate governance and that they play a key role in protecting the downside. This applies to both "old" economy companies and to "new" economy companies. So what is the issue? What's the problem? The core issue is that the focus on governance and conformance is obscuring the real drivers of board performance. Let me list some of the contradictions and conflicts. The Australian model with an independent chair, independent directors and 8-10 meetings a year is very close to what the governance activists would like to see as the norm. By way of comparison, many largely successful US multinationals have vested much greater power in the chairman/CEO and senior management, and often have as few as four to six meetings a year. Presumably the directors of the 3600 Walmart stores in 10 countries have the same job description as the directors of David Jones who have 28 stores in Australia or of course Coles Myer which has 2000 stores in Australia and New Zealand.
One could postulate that in relation to corporate performance, the Walmart board, which meets only four times a year, would be in an inferior position to the boards of David Jones and Coles Myer, who meet almost monthly throughout the year. The results of course show that the Walmart board has delivered outstanding results for shareholders. This example could be replicated many times. The General Electric board meets less frequently than do most Australian boards, yet oversees a business that, in market value terms, is as large as the combined total of all companies listed on the Australian Stock Exchange. What then are we to make of a board's role? In the US, a separate chairman/CEO role cannot be countenanced yet we regard it as the norm. Around 80 percent of US companies combine the role. In the UK there are more executives on boards - in fact, more than 50 percent of directors are executive directors in the UK. In Japan and Korea, insiders prevail (with little acceptance that an outsider can add value) and in Europe, advisers and others with relationships to the company are valued as directors.
While there are surveys and surveys and there are assertions to the contrary, there is little evidence to indicate that "best practice" corporate governance delivers "best practice" outcomes for shareholders over the long run. Australia's corporate performance would not support such a hypothesis. Too much attention to corporate governance can often cloud a board's judgment. When you are surrounded by due diligence committees and numerous advisers in the boardroom you can be lulled into a sense of false security. The process becomes an end in itself and obscures the real issues which are at stake when boards have to exercise all their individual and collective skills and judgment to reach a decision on a major issue or new initiative. Smaller boards, with relevant skills around the table, focussed on core issues have a much better chance of reaching the right decision. Business progress has always been about taking risk and you can never make big moves forward and eliminate risk by excessive reliance on governance and due process.
I note with great interest that some critics of the state of corporate governance are expressing concern that boards are starting to focus on process rather than content. A director can be sued, not for a bad judgment, but rather if it can be shown that he or she didn't take care. Now while this is reasonable, it runs the real risk that boards become overly concerned about ticking off the steps of the due diligence process and spend too little time coming to grips with the business issues involved. In fact, there is an interesting tension built into our current governance approach which arguably predisposes our boards to be risk-averse at a time when bold moves are often needed. Directors have little upside. The replacement of financial capital with intellectual capital as the driving force in many new economy companies also requires a re-think of the corporate governance principles. Founders, owners and managers of the new age technology companies are the owners of this intellectual capital and their entitlements at the board table need to be recognised - this is particularly so when key employees own large stakes in companies.
Let me offer you an amazing statistic. For decades the average "market to book value" ratio across all firms was a little over 1x. The value creation game was to create value that exceeded the book investment. However, in the last few years, in the US for example, the ratio has blown out to around 6x. And this isn't just because of the bull market. It represents a fundamental change in the economy which is that intellectual capital and not financial capital is the source of value in many industries. So any view of corporate governance which says that employees - particularly employee shareholders - have no place at a board table now needs to be reviewed. The complexity of business and the speed of change generally in the global business world also requires a re-think of the traditional board models. How part-time directors can stay sufficiently informed to be able to carry out their role of offering advice and challenge is something that boards will need to worry about. We will have to find new ways of exposing directors to the business. At present, the life of a typical director is spent mostly pre-reading the board papers alone, travelling to a meeting and then participating in quite formal discussion around a heavily panelled table that is in so many ways very remote from the business that the board oversees.
In future, directors will have to spend more time, often in informal discussion, with management and employees, customers, suppliers and investors to gain a greater understanding of the business. We are now measuring the quality of governance performance by ticking the boxes in terms of attendance, committees, CEO/chairman roles, independent directors and so on. The corporate governance model is preoccupied with these aspects of board structure most probably because they can be observed from the outside. They are mostly interested in process and quality assurance and give scant attention to role, behaviour and skill base of a board, either in general terms or in terms of the particular industry or circumstance of the company. Whether boards are effective depends more on whether the directors have good judgment, are hard working and smart and also able to contribute constructively to the working of a wider team. Unfortunately, these attributes cannot be measured from the outside. The trend to measure governance performance by listing the structures and processes in the annual report is trivialising the really important issue of board performance.
One of the most telling points about boards is that there is very little in the literature on company management and success and failure on how the performance of boards is a major factor in the overall scheme of things. How do we facilitate, via board processes, better performance by this country's major corporations? We need first to recognise the duality of the role of a board. We do need appropriate rules about composition, degree of independence, committees and so on, to enable boards to carry out their due diligence and watchdog roles. We do need to have the right measure of corporate governance without letting the governance processes become an end in themselves. We do need to protect the downside. We then need to identify and pursue those processes which can enable boards to deliver on their role, to enhance shareholder value, to work with management and help guide management so that the right decisions are made on strategy, business and management development, culture and on a company's response to its broader social and political pressures including its obligations to all its stakeholders.
In my view this will require rolling back some of the accepted corporate governance norms which will not be an easy task in view of the entrenched views. At present we tend to think in terms of all directors being the same but in future we will think more of the portfolio of skills we might need around the table. For example, independence is a fundamentally important attribute of a board but does it necessarily follow that all directors, except the CEO (or any executive directors), should be independent? Independence comes at a cost which is being less informed. What is important is to have a group of directors who are able to represent effectively the "independent" attribute of a board but there may be value in having some other directors as well. In particular, this may involve recruiting some directors because of their relevant skills even if they don't pass the usual tests of independence. This may mean more executive directors and more directors who have had industry experience or involvements, notwithstanding that such directors have shareholdings or advisory relationships with the company. We need to accommodate entrepreneurs around our board tables, not suppress or eject them.
In opting for a re-weighting between generalist and specialist skills around the board table I am personally changing a view that I have held for a long time. We also need to review how we induct and keep directors updated on the specifics of the company and its industry and technology and, where appropriate, its regulatory context. For most companies this is a relatively ad hoc process. We will also need to focus board meetings more on the future - fewer high quality meetings of longer duration, often involving extensive local and overseas travel. This compares with the monthly board meeting which can often spend 80-90 percent of its time on a routine review of last month's performance and an over-emphasis with agenda items which relate to process and governance issues. Boards will find it helpful to agree the major issues that go to the heart of the success of the business over the next five to 10 years. This might be a list of no more than five to seven issues. For many old economy companies it will include topics such as where the next decade of growth will come from, which of our businesses are candidates for exit and how do we attract and keep good people? There will be the inevitable e-commerce questions as well. The board will have to keep this list in front of itself and schedule discussions on these issues throughout the year. Maybe the use of more standing committees or ad hoc committees on growth and development issues will be a feature.
In all of this we need rules of engagement, both inside and outside the boardroom. We don't want directors captured by management, nor do we want directors encroaching into management areas of authority and responsibility. This needs careful and adroit handling of meetings and contact points and chairmen and CEOs and boards need to spend a considerable amount of time agreeing the ground rules. Management must more clearly understand the board's needs and help them do their job. Directors must also understand how their demands for more information can be distracting or even viewed by management as a lack of trust. We will also need to rethink the sort of information that comes to boards. We will see less monthly financial and operating data. Instead we will focus on this type of information several times each year, perhaps quarterly. We will also need to recut our information so that we have a clearer view about where value is being created or destroyed in the business. We also need to increase the time boards spend reviewing the progress of projects in companies. Boards would be better off if we spent less time reviewing last month's results and more time reviewing the progress of major projects.
I am certainly coming more to a view that we need to introduce some more disciplined performance review processes on boards, both collectively and individually. Personally I am not in favour of a chairman-controlled review of individual director performance, but there will be a right answer. As a starter I would like to see the renomination process tightened up and the hurdle raised somewhat. It should not only be the individual's decision to stand again. The other board members should express a view as well. I also believe that the opinion of senior management should at least be known. While this should not be binding - because directors are to represent shareholders and not management - the importance of what we now call upward feedback is obvious. In my experience, if management views a director as dead wood they are generally right. An issue of increasing importance will be director remuneration - both its amount and the way it is paid. Many companies large and small, will be asking for greater involvement by their directors inside and outside the board room. Companies with increasing involvements overseas are commonly asking their directors to spend one, two, three weeks overseas visiting operations and attending board meetings.
In view of the commitments and responsibilities involved, professional directors today cannot aspire to hold too many boards. Therefore to attract the right men and women, at the right age and with the right experience, we are going to have to lift remuneration levels, notwithstanding all the hassles this will cause at AGMs and in the media and from politicians. Part of this may be paid for by moving to somewhat smaller boards but not all. We should be prepared to move towards more equity based remuneration, but recognise that many present and potential non-executive directors will need to be able to access sufficient levels of cash remuneration for their personal needs. I would be prepared to go further and introduce some component of risk based remuneration into the remuneration of directors. I endeavoured to do this in the last twelve months in relation to one of my involvements. While I had the support of my colleagues, I obtained virtually nil support or encouragement from institutional shareholders. Their argument is of course that incentive based remuneration could cause directors to act in concert with management, particularly in relation to the setting and achievement of performance hurdles.
I disagree with this as I believe it is possible to establish externally based and assessed hurdles which will align the interests of employees, management, directors and shareholders. There is nevertheless a very strong view in the corporate and governance community that equity or incentive based remuneration for non-executive directors should be avoided. But as I have indicated, this view no longer holds in the US which, whether we like it or not, is making the running on governance issues. A common view is that "Boards only add value when a company is in trouble" - I don't dispute this but would go on and say that in the good times boards need to pass the "smell test" ie they have to have the individual and collective capacity to prevail over a CEO and his or her management team who are on a high or who are starting to believe they can walk on water. Most boards fail to act early enough when a company is heading into difficulties - in other words they fail the "smell test".
Community issues In reality most modern corporations in Australia, UK and North America and in other developed countries have a clear view about their obligations on a range of issues to the broader community, notwithstanding that a legal framework incorporating stakeholder obligations is not mandated by government. Modern corporations are increasingly under attack from various stakeholders and interest groups or are being used tactically in pursuit of social or political agendas. A four-hour AGM where environmentalists or opponents of, for example, genetically modified food, or unionists seeking to use shareholdings as a platform to run their own self-interest agenda items is clear evidence of this. We are seeing in this country and overseas an increase in the proxy or shareholder initiative resolution at meetings on social and political agendas. Those issues often generate substantial media and public interest. I am not arguing for more institutionalised board committee type processes there is clearly a need for boards and management to be ahead of the game in terms of community issues rather than always being in defensive or reactive modes
I often ponder as to whether we should attempt to promote more appropriate and relevant debate at AGMs. Our major shareholders are generally not focussed on annual meetings, but nevertheless such meetings should be a more worthwhile forum than exists at present, and a stronger focus on the real business issues might help to put some of the activist agenda in its proper context. The pace of change in all respects is accelerating in this global, online and inter-connected world. This acceleration is affecting all aspects of our business and industries and involves all our various stakeholder and interest groups. Progress on these fronts in a largely self-regulated environment is the best route to deliver and enhance shareholder value, to meet the needs and expectations of other stakeholders and to obtain community support for our ongoing businesses and future development.
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