Governance disclosures provide insights into board performance

Governance reporting is often seen as mostly about conformance. But high-quality disclosures provide insights into how boards are structuring themselves to govern for performance and meet the challenges of a volatile global business climate.

ASX Corporate Governance Council: Adoption of Third Edition Corporate Governance Principles and Recommendations
KPMG, May 2016

KPMG’s recent review of disclosures by ASX-listed companies shows boards are thinking more about their skills and diversity, director induction and training, and how their organisation manages and reports on key material risks. Boards are also providing greater disclosure on internal audit controls, sub-committees and the organisation’s investor relations efforts.

These are important developments. Institutional investors are paying greater attention to whether boards have the right skills and are sufficiently cognisant of their organisation’s key material risks. As shareholder activism worldwide grows, the ability to disclose governance structures and use this reporting to improve conversations with investors is critical.

KPMG found many companies have adopted new governance recommendations, but reporting depth and quality varied.

Areas for improvement include disclosing more detail in the board skill matrix; outlining director development programs; and much clearer interpretation of key material risks and how they are determined. The lack of consistency on material risk disclosure was perhaps the biggest concern identified in KPMG’s comprehensive analysis.

To recap, the ASX Corporate Governance Council issued the Third Edition of Corporate Governance Principles and Recommendations in March 2014 and the changes took effect in July that year. The Principles set out recommended corporate governance practices for listed entities that are likely to achieve good governance outcomes and meet investor expectations.

The Principles work on the “if not, why not” basis: boards decide whether their organisation adopts a particular recommendation and, if not, must explain why. This approach provides flexibility for companies, particularly smaller entities that lack resources to adopt all governance recommendations or believe some do not suit them.

KPMG examined the disclosures of 600 randomly selected ASX-listed entities across ASX 200 companies (by market capitalisation), ASX 201-500 and ASX 501+. ASX’s Education and Research Program funded KPMG’s research, which was released in late May.

Board skill matrices

Recommendation 2.2 of the Principles says a listed entity should have and disclose a board skill matrix setting out the mix of skills and diversity the board currently has or is looking to achieve in its membership.

KPMG found 74 per cent of entities surveyed adopted the recommendation; nearly all ASX 200 companies included a board skill matrix.

Although most companies followed the spirit of this recommendation, there was wide variation in disclosure quality, KPMG found. Some entities disclosed that a board skill matrix has been established but did not outline the specific skills required.

The level of explanation for each skill varied. While some entities described the attributes required for directors to possess a skill, others only noted key words in the matrix and provided no further explanation of the skill required.

Finance, legal and accounting were the most identified skills in matrices, but the majority of entities did not consider director “people skills” or geographic experience, KPMG found. That surprised, given many ASX 200 companies have overseas operations and large employee bases.

Technology and digital skills were also infrequently disclosed. “With technology transforming the rules of business and reshaping industry in every sector, we expected technology and digital expertise to feature in the majority of board skill matrices,” wrote KPMG.

Director induction and development

Recommendation 2.6 says a listed entities should have a program for inducting new directors and provide appropriate professional development opportunities for directors to develop and maintain the skills and knowledge required to perform their role as directors effectively.

KPMG found a high level of disclosure on director induction and development. However, many organisations only disclosed that they provided information for new directors to familiarise themselves on the organisation through induction programs.

Fewer entities outlined their programs and policies to enable directors to maintain and develop their skills. Several said a director development program was in progress; that suggests opportunities for ASX-listed entities to provide more director development opportunities.

Organisations with fuller disclosures typically said their induction programs offered directors access to board papers, strategic policies and plans, meetings with executives, and site inspections. Director development programs included AICD membership and courses, opportunities to learn about the organisation through site visits, and conference attendance.

Material risks

Recommendation 7.4 says a listed entity should disclose whether it has any material exposure to economic, environmental and sustainability risks and, if it does, how it manages or intends to manage those risks.

KPMG identified significant variations in the quantity and quality of material risk disclosure – a potential concern for investors who need to know boards are abreast of their organisation’s key risks and have a process to identify them.

Only 32 per cent of ASX 200 companies adopted the recommendation, although more than half surveyed cross-referenced to other information the organisation provides on material risks in their sustainability report. More than a third of ASX 201-500 companies and almost half of ASX 501+ companies did not address the adoption of recommendation 7.4.

Those that disclosed material risks paid far greater attention to economic than environmental or sustainability material risks.

KPMG identified instances of organisations in the same industry disclosing very different risk profiles. Some organisations disclosed several material risks while their nearest competitor stated it had no material risks, despite operating in the same industry and facing the same broad risks.

“We also consider it unlikely that over 20 per cent of companies did not have any material economic, environmental or sustainability risks,” wrote KPMG.

Many entities provided little or no explanation of their process to determine key material risks and there seemed to be different interpretations of “material risk”. KPMG said a consistent interpretation of material risk and a clear explanation of the process boards use to determine those risks would provide improve disclosures for investors.

Internal audit function

Recommendation 7.3 says an entity should disclose if it has an internal audit function, how the function is structured, and what role it performs. If it does not have an internal audit function, the entity should disclose that fact, and the processes it employs for evaluating and continually improving the effectiveness of its risk management and other internal control procedures.

The majority of entitles across all categories adopted this recommendation or provided a reason why not. About 78 per cent of ASX 200 companies disclosed an internal audit function, as did 36 per cent of ASX 201-500 companies. Smaller entities tended to disclose an alternative process for internal audit, such as relaying the board’s audit and risk committee and/or management.

However, the depth of disclosure varied. Some entities said they had established an internal audit function but gave no detail on its structure or accountabilities.

Board sub-committees

Recommendation 2.1 says the board of a listed entity should have a nomination committee that has at least three members (the majority of whom are independent), and an independent chair, and disclose the committee’s charting, membership and meeting/attendance levels.

Recommendation 4.1 says the board should have an audit committee, with broadly similar stipulations to those required for the nomination committee.

Recommendations 7.1 and 8.1 say boards should have risk-management and remuneration committees with similar requirements to those in nominations and audit.

KPMG found high compliance with all four recommendations, particularly ASX 200 companies, as expected. Again, the detail of disclosure varied: fewer entities disclosed whether the committee chair was independent, the number of directors on the committee, and the number of meetings held each year.

Shareholder communications

Several new recommendations in the Principles were designed to improve investor relations (Recommendations 4.3, 6.1, 6.2, and 6.4).

They included ensuring the external auditor attends the annual general meeting; providing information on the organisation and its governance on the website; implementing an investor relations program to facilitate two-way communication with investors; and providing an option for investors to receive and send communications from/to the entity electronically.

KPMG found a high level of compliance across all four recommendations and noted that entities were embracing digital technologies to communication with investors. Access to corporate governance website disclosures was an area for improvement.