In the wake of the Hayne Royal Commission final report, the concept of shareholder primacy is now being examined. Experts and directors react to the report here and discuss how to focus on more long-term non-financial measures.

    After the findings of the Hayne Royal Commission final report, robust debate over governance will continue at the AICD’s Australian Governance Summit next month and beyond, including in Canberra at a parliamentary committee examining Australia’s major four banks.

    The banks will answer more questions before the House of Representatives Standing Committee on Economics, which will conduct public hearings on 8 and 27 March 2019. “These hearings will provide an opportunity to scrutinise the banks on the findings of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry,” says committee chair committee Tim Wilson MP, adding that the hearings provide an important mechanism to hold the four major banks to account before the Parliament.

    Shareholder primacy

    The debate over shareholder primacy has been stirred by the matters brought before the royal commission and the examples of misconduct aired. The question of whether laws should be strengthened to, for example, enshrine explicit consideration of stakeholder interests beyond shareholders - as has occurred in the UK - is part of the debate over good governance.

    In the final report of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, Hayne made observations regarding the duty of directors to act in good faith in the best interests of the corporation and for a proper purpose (section 181(1), Corporations Act), emphasising that directors’ duties are owed to the corporation. This “demands consideration of more than the financial returns that will be available to shareholders in any particular period”, he says in the report.

    “In the longer term, the interests of all stakeholders associated with the entity converge…pursuit of the best interests of a financial services entity is a more complicated task than choosing between the interests of shareholders and the interests of customers.”

    The UK picture

    In the UK, directors are explicitly required to consider the interests of various stakeholders (such as employees, customers and supplies) as well as the impact of the company’s operations on the community and the environment, in promoting the success of the company for the benefit of members as a whole.

    From 2019, the annual reports of all large companies (private as well as public) must include a statement describing how the directors have had regard to these other stakeholders and matters.

    Post-Hayne, the question of whether Australia should follow down the UK path has been publicly aired. However one top academic in the field of corporate law argues in a recent paper: Shareholder Primacy in Changing Times that law reform is not necessary in Australia.

    Jason Harris, Professor of Corporate Law at the University of Sydney Law School says directors are already legally bound to act in good faith for the best interests of the corporation under the statutory duties of the Corporations Act.

    “Hayne is saying that directors should be thinking long-term and acting in the long-term interests of the company. Then that should serve both the interests of the shareholders and customers and other stakeholders,” says Harris.

    “I think the existing law already allows them to act in the interests of the company over time and that will hopefully benefit shareholders along the way, but not necessarily in the short term.”

    In terms of the UK approach, “The wording of s172(1) makes it clear that the ‘promotion of the success of the company’ is ‘for the benefit of the members as a whole’.

    A more obvious shift that Hayne recommends is that legislation governing financial services should adhere to the concept of “fundamental norms” governing corporate behaviour, recognising that more detail may be needed as required (for example in complicated superannuation rules).

    “This could mean we see more provisions in the Corporations Act that try to express what the Parliament is trying to achieve by the particular regulatory regimes that it has put in place,” says Harris.

    Currently more detailed rules apply in legislation for takeovers and corporate insolvency, and it is a common regulatory tool, he says. “I think the reason Commissioner

    Hayne has recommended this here is because there seems to be such pervasive conduct which falls below community standards.”

    The statutory duties provide a set of minimum norms of corporate managerial behaviour and thereby serve the interests of the community at large, he says.

    Boards and accountability

    The Hayne final report also stressed that the primary responsibility for misconduct in the financial services industry lies with entities concerned and with those who manage and control them: their boards and senior management, which need to improve culture and strengthen governance processes.

    “There has to be a point of accountability and it is clear in a number of the case studies (in the Hayne final report) that there did not appear to be anyone who was accountable,” says Professor Harris, adding that in some cases this resulted in multiple significant breaches of legal requirements in many entities in some cases over many years, but no consequences.

    “I think Commissioner Hayne is highlighting as the problem that boards are entitled to demand that management is accountable to them and to tell management when something is not good enough.”

    Directors’ reactions

    Peter Duncan AO FAICD - Former Orica chair and board director for National Australia Bank, the CSIRO and Cranlana Programme Foundation

    All organisations need to change their corporate thinking from short-term profit maximisation to long-term value creation and longer-term reporting may be needed, he says.

    The greatly increased use of metrics by boards to determine monetary and non-monetary rewards is now widely agreed to have led to numerous abuses, says Mr Duncan. “Measurement has its place, but it has in many cases become a substitute for personal judgment. The latter is key to good management.” Companies need to get back to taking personal responsibility for decisions rather than seeing them as the output of a mathematical formula. He adds that the book ‘The Tyranny of Metrics’ by Jerry Z. Muller is a valuable resource for directors on this issue.

    Duncan is also in favour of changing Australian corporate laws to make it mandatory for directors to consider interests beyond just shareholders. “Traditionally, directors have been expected to act in the best interests of the company and therefore the shareholders as a whole,” Mr Duncan told Boardroom Report. “There has been debate as to whether the directors may act in the interests of stakeholders other than shareholders and it is time now to change Australian Corporate Law in line with the UK 2006 Act to provide explicitly for mandatory consideration by directors of interests other than shareholders, including employees, customers, suppliers and the environment. Boards should also require corresponding changes in reporting.”

    On remuneration, he advocates eliminating short-term incentives for senior executives. It is now time to eliminate all short-term incentives and greatly increase the proportion of fixed pay, he says. He personally regrets signing off on some remuneration packages during his many years of board service.

    “I say that as someone who has been involved in setting remuneration systems which now in retrospect I would not have done. (These were) not in any sense amoral or immoral but they were incentive systems designed to reward people for short-term results which it has been demonstrated has led in some cases to gaming of the system. And to behaviours which are really not what we want to see.”

    Peeyush Gupta FAICD - Board director Link Administration, Charter Hall, iCare, SBS and National Australia Bank

    He says while it is unrealistic for the community to expect that things will never go wrong in financial organisations, they should expect that when they do, they will be quickly identified and properly remediated. To stay on top of conduct, directors must carefully monitor customer satisfaction and Net Promoter Scores but pay close attention to the worst outcomes.

    Many of the compliance breaches exposed in the Royal Commission were the result of underinvestment by businesses in their core franchise and core systems, business infrastructure and processes. On remuneration, he adds that too many incentives are short-term, at the cost of long-return sustainability.

    Gupta says Australia’s financial services sector did exceptionally well after the global financial crisis because consumers didn’t lose money and the government didn’t have to bail out financial institutions. “But, unfortunately it possibly did breed in the decade that has followed too much focus on shareholders, profitability and those sorts of metrics – and not balanced delivery across all stakeholders of a company.”

    Kathleen Conlon FAICD - Chair of remuneration committees at Lynas Corporate, REA Group, Aristocrat Leisure and the Benevolent Society

    Kathleen says remuneration cannot on its own drive behaviour without other controls in place. Directors need to check that remuneration systems are operating in the context of processes, controls and risk management. The Hayne report demonstrated that directors need to understand all remuneration structures.

    In the wake of the Royal Commission report, all of the remuneration committees she serves now do deep dives into all frontline remuneration, not just that relating to executives. Her boards now look at all the remuneration structures and have a conversation about what they are trying to achieve, how they measure their effectiveness and how they manage for unintended consequences. “It’s asking yourself: ‘How do I know that they’re working?’ and ‘How do I test that they’re working?’,” she says.

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