Corporate governance time bomb

Tuesday, 01 April 2003


    There is a new corporate governance game in town which some see as a beacon of enlightenment — while others believe it to be a ticking bomb that will sacrifice company performance to the need for compliance. One thing is certain; for company directors the landscape will never be the same again.

    The boss of the company walks into the staff room and says that from tomorrow he is introducing new company behaviour guidelines that he would like everyone to take onboard. He stresses however that these new guidelines are not mandatory and no one will be fired if they do not conform. All he wants is for those people not conforming to tell him why not.

    This is the ticking time bomb that some directors fear is hidden in the new ASX corporate governance guidelines.

    Just as any employee would find it difficult to front the boss and tell him that his guidelines do not fit their circumstance, there is an assumption, not altogether unrealistic, that boards will be reluctant to deviate from the guidelines for fear of censure and that the guidelines will then become defacto law.

    While this scenario has still to be played out in practice, it does raise the question of whether boards have the courage of their conviction.

    The principle underpinning the new guidelines is that if a company believes that some of the guidelines are inappropriate to their circumstance then they must explain it to the ASX and to their shareholders.

    Sounds simple enough, so why all the angst?

    The problem with corporate governance is that one size does not fit all and it is crucial that the public, via the media, understands this. Moreover the assumption that all corporate governance is good and that anyone deviating however slightly from the excepted mantra is bad is a risky proposition.

    The heart of the matter is what happens if a board tells the ASX it is taking a different path.

    ASX managing director and chief executive officer, Richard Humphry says that the ASX will be satisfied with the why not explanation the majority of the time. It is only when they believe that flagrant breaches are occurring that they will refer the matter to ASIC.

    Senator Ian Campbell, the parliamentary secretary responsible for the Corporations Law says the ASX guidelines are not meant to have teeth. He says corporate governance is a cultural issue not a legal issue.

    What is really at issue and what, for some boards is most difficult, is the need for a better communication process between them and the shareholders.

    Speaking at a Sydney lunch on April 3, former NSW premier, Nick Greiner said the missing link in the corporate governance debate was the poor communication flow between shareholders and boards.

    It is a view echoed by Richard Humphry.

    He says the fundamental purpose leading to the development of the corporate governance guidelines was the need to increase the communication between shareholders and companies.

    "The tradition of reporting through annual reports is fine but in a sense it is anachronistic. With the current technology there is no reason that information cannot be kept up to date on the web. We want to go ahead on that in the longer term," says Humphry.

    "It is imperative that we did this. The secondary objective was that this was achieved by way of guidelines rather than legislation. We knew that following the passage of the Sarbanes-Oxley Act in the US that unless the ASX acted there was a real danger that legislative action would be brought in.

    "There is no doubt that this is being driven by community concern regarding the recent corporate failures. It is also obvious that there is inadequate communication between corporations and their shareholders. It is why I react to a certain smugness among some people that they know what they are doing when they don't."

    Humphry may be right, but there is genuine concern among the Australian director community that the self-regulation governance guidelines devised by the ASX Corporate Governance Council are flawed.

    But what is really at stake?

    Are the new guidelines a political placebo to placate the Government and the community that something is being done as a result of the corporate failures? Is it a necessary step in rebuilding investor confidence in an equity market in which the ASX has a vested interest? Will the new guidelines improve corporate governance? Will compliance come at the sacrifice of company performance? Will the new rules governing independent directors be made at the sacrifice of experienced directors? Is executive remuneration set to go even higher as the envy factor through complete remuneration disclosure kicks in? And will adherence to the new rules bring financial benefits to individual companies in terms of investor confidence?

    There are no easy answers to any of these questions. But the reality is that the legislative Sword of Damocles hangs over the current debate and the Government will almost certainly be forced to act if the industry does not put its own house in order.

    In terms of executive remuneration, the recent mammoth payout to departing executives is creating concern that executive remuneration contracts and the various perks and dismissal provisions contained therein should be made public knowledge.

    The corporate governance guidelines address this issue but it may not be enough to forestall legislative action by the Government.

    One of the fundamental concerns with the new guidelines is that no one knows how they will work in practice. The theory is that companies should adopt the new guidelines and if they deviate from them, the onus is on the company to provide the ASX with an explanation .

    For instance, the guidelines (see page 15) recommend that companies should have independent chairmen. But Harvey Norman executive Gerry Harvey, Kerry Packer or Frank Lowy are not independent chairmen so what is the effect on this type of situation?

    In an interview with the Australian Financial Review, Harvey said there was "absolutely no way" he would consider stepping aside for an independent chair arguing that independent boards were not necessarily competent boards.

    "The best-run companies are always those run by people with a substantial interest in the company because their blood spills all over the path; when (shareholders) go broke, you go broke," says Harvey.

    It is here that the uncertainty and concern arises. Moreover, careful distinction needs to be made as to the document's recommendations and its guidance notes.

    The recommendations require an "if not, why not" response while the guidance notes are no more than commentary. Under the new rules guidance is given as to what amounts to "independence".

    An independent director is a non-executive director (ie. is not a member of management) and:

    1. is not a substantial shareholder of the company or an officer of, or otherwise associated directly with, a substantial shareholder of the company

    2. within the last three years has not been employed in an executive capacity by the company or another group member, or been a director after ceasing to hold any such employment

    3. within the last three years has not been a principal of a material professional adviser or consultant to the company or another group member, or an employee materially associated with the service provided

    4. is not a material supplier or customer of the company or other group member, or an officer of or otherwise associated directly or indirectly with a material supplier or customer

    5. has no material contractual relationship with the company or another group member other than as a director of the company

    6. has not served on the board for a period which could, or could reasonably be perceived to, materially interfere with the director's ability to act in the best interests of the company

    7. is free from any interest and any business or other relationship which could, or could reasonably be perceived to, materially interfere with the director's ability to act in the best interests of the company.

    The guidelines recommend that the chairman is an independent director. The board should state in its annual report which directors it considers to be independent. The board should also state its reasons if it considers a director to be independent notwithstanding the existence of the criteria of points 1 to 7.

    What the new guidelines propose is that a company merely has to tell the ASX why it is not complying and the assumption is that this will be adequate. But what if the explanation isn't adequate. What happens then?

    "Look, the fundamental principle behind the new guidelines is disclosure. We want the shareholders empowered to make a decision. If you don't comply you must tell your shareholders why not," says Humphry.

    "There will undoubtedly be situations where, because of a company's size, it is just impractical for them to comply, but as long as they tell shareholders the reason, we will be satisfied. Whether the shareholders will be satisfied is another thing.

    "We will monitor companies and if they do not comply or explain why we will be referring them to ASIC - and ASIC has indicated to us that it is quite appropriate that sanctions be built into legislation.

    "ASIC chairman David Knott has written to me about this and they are perfectly happy to have people say they comply or say why they didn't. But he believes that there should be sanctions available to those companies that don't comply or say why they didn't."

    And what happens if the ASX doesn't like the explanation that is given. It is this same uncertainty that is present in the disclosure rules pertaining to media rumours. According to Humphry, he gets more questions on that issue then anything else.

    "It may seem a burden to comply with the media rumour disclosure regime but if you examine it from the public interest point of view then it is absolutely critical that companies answer these queries," says Humphry.

    "If the market is in an uninformed state it is neither in their interest or the market's interest. I have found very few people who understand this social obligation to the community at large - and that is a disappointment."

    What companies fear is that their reputation and that of their directors rests on the assessment of a middle management ASX employee. This may be unrealistic but it is a risk management issue that needs to be addressed.

    "It is true that this would be a judgment exercise by the ASX, but at the end of the day it is about giving information to the shareholder/owners of the business. If companies do not want to communicate with their owners then we get interested in that company.

    "Our compliance people will form a close relationship with the relevant company officers. Quite often they will seek out our advice on issues. It is an iterative process of communication. It also throws an enormous responsibility on us to act fairly and we are conscious of that."

    Humphry is also quick to point out that the new guidelines are flexible in that there is no need for smaller listed companies to have an audit committee much less an audit committee comprising independent directors as is currently proposed.

    "There are some companies whose total capitalisation is less than the price of a reasonable house in Sydney or Melbourne and we have to consider how we nurture these companies," Humphry says. "I think even the smallest company will be able to look at this and be able to say we haven't adopted A, B or C because this would be to the detriment of shareholders because the cost would outweigh the benefits.

    "Many of the conditions are just common sense and I would expect them to be complied with. It is about informing shareholders. It is the same reason we introduced cash reporting for small companies so that the burn rate of cash was adequately relayed to shareholders."

    What also upsets directors is that all listed companies are being punished because of the actions of a few. They feel aggrieved because most boards have acted to implement visible and verifiable changes in board composition and structure.

    While there is some truth in this it is wise to remember that US companies such as Tyco International were viewed as models of corporate governance until misdeeds surfaced and shareholders lost money.

    A recent corporate governance paper from consulting firm Booz Allen Hamilton in New York says the corporate governance fixes firms are rushing to institutionalise may be "naively counter-productive".

    "The drive to more tightly regulate the membership and functions of corporate boards is already encouraging companies to view governance as a legal challenge rather than as a way to improve performance," says the paper.

    "Moreover evidence exists that such externally imposed governance requirements may compromise long-term performance."

    According to Booz Allen Hamilton more than 50 studies have been devoted to the question of whether board composition - specifically, measures of board independence - correlates strongly with financial performance.

    "In sum, the quantitative research done to date is inconclusive at best, suggesting that a board's performance should be measured by the merits: the quality of the dialogue, the insights of individual directors, the overall tone set by the CEO."

    It is a proposition that wouldn't meet any criticism from BHP Billiton chairman Don Argus who gave an insightful talk on corporate governance at a recent fund managers conference.

    "The issue of corporate governance has attracted the business world's full attention following a spate of scandals and failures that have undermined investor confidence in systems of governance and contributed to falls in stock markets," says Argus.

    "As with all complex problems there is a demand for a simple answer ... and as you know there are simple answers to complex problems and they are usually wrong. So we have had a tidal wave of rules, regulations and laws. There is no shortage of remedies for failures of governance.

    "Most of these remedies are, however, structured. They are concerned with rules, procedures, composition of committees and the like, and together they are supposed to produce vigilant involved boards."

    "I am not discounting these issues because they are important, particularly with regard to maintaining confidence that the directors of a company can be trusted to manage the business in the interests of the investors.

    "However, it does leave corporate governance detached from the day-to-day business operations. In focussing on the details and procedures of governance, the market has, in my view, failed to debate what I believe to be the central question of what do we want good corporate governance to achieve?" "In my view, corporate governance is there to ensure that the board of directors develops, implements and explains policies that

    • Increase shareholder value
    • Lowers the cost of capital
    • Reduces financial, business and operational risk
    • Ensure there is a real depth of management talent
    • Addresses reasonable shareholder concerns

    "This is of course a much broader definition of corporate governance than usual and positions it in the heart of business operations. In other words a great audit committee won't make a company great - but a great company will have a strong audit committee.

    "Any framework for corporate governance must nurture a perspective that looks beyond quick fixes, to the permanent need for the private sector to deliver continuing prosperity in a responsible manner."


    The purpose of this database is to provide a full-text record of all articles that have appeared in the CDJ since February 1997. It is aimed to assist in the research and reference process. The database has a full-text index and will enable articles to be easily retrieved.It should be noted that information contained in this database is in pre-publication format only - IT IS NOT THE FINAL PRINTED VERSION OF THE CDJ - therefore there might be slight discrepancies between the contents of this database and the printed CDJ.

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