Agenda

The latest news for Australian directors.

Making M&A work

Few tasks are more challenging for boards than approving mergers and acquisitions (M&A) proposals from management. Academic evidence shows most deals destroy value in the long run, but pressure to acquire other firms is building.

Global M&A activity in the first quarter of 2015 was the highest in eight years, according to financial software company Dealogic, and Australia ranked seventh for M&A volumes. Growth in Australian M&A, well behind that of other developed markets, is expected to rise as interest rates stay low and business confidence slowly recovers.

The result: Australian boards are under greater pressure to approve or reject acquisitions, or possibly fend off advances from hostile suitors. Having clear board processes to understand how M&A creates value is critical.

Research by Strategy + Business, reported in July, found deals that leveraged the buyer’s key capabilities or helped it acquire new ones averaged significantly better returns than local sharemarket indices, over two years.

The premium from capability-driven deals over other deals was a 14.2 per cent compound annual growth rate, according to the research, which examined 540 major global deals in nine industries between 2001 and 2012. But only six of 10 capabilities-driven deals earned a premium.

The research breaks M&A into three categories: leverage deals where an acquirer tries to leverage its capabilities into a new firm; enhancement deals where an acquirer buys capabilities it does not already have; and limited-fit deals that largely ignore capabilities.

Leverage deals, the most common type of capabilities-driven deal, perform better than enhancement and limited-fit deals.

In a leverage deal, a large company, for example, might buy a small company to leverage its products through a bigger sales force.  In an enhancement deal, the big company acquires the small firm because it has a capability that would be more valuable in its hands.

Strategy + Business found the best capabilities-driven firms know how to switch between leverage and enhancement deals: they are able to acquire other firms and quickly capture synergies (leverage) and create opportunities from acquired capabilities (enhancement).

The takeout for boards is to focus more on capabilities in proposed M&A: how the firm’s capabilities add value to the acquisition target, or how its capabilities create value for the acquirer. The best returns, on average, come when a firm rolls out its capabilities through the acquisition, giving more control and outcome certainty.

Female appointments gather pace

The number of women being appointed to S&P/ASX 200 boards continues to increase, with recent figures showing that the number of women hit 20 per cent as at 30 June 2015.

The figures, compiled by the Australian Institute of Company Directors (AICD) show that the increase in female directorships on ASX 200 boards so far this year has already surpassed last year’s figure of 19.3 per cent. In total, women have comprised 26 per cent of new appointments to listed company boards to date versus the 30% figure reached in calendar 2014. So far, figures for the year are tracking reasonably well, with 25 women having been appointed to an ASX 200 board, compared to 53 overall in 2014.

However, this is still shy of the record 68 appointments made in 2011 and 56 in 2010.

A total of 30 companies in the ASX 200 still do not have any women on the board, while this figure rises to 72 companies without any female board representation for the ASX 300.
For more information go to www.companydirectors.com.au/boarddiversity.

Business confidence highest in two years

Company directors are receiving mixed signals on the economy. As sharp falls in Chinese shares and commodity prices raise fears of an Australian recession, recent surveys suggest business sentiment is finally improving.

The closely-watched NAB Monthly Business Survey in July reported the highest level of business confidence since September 2013, and confidence across all industries except mining. The survey is regarded as one of the better predicators of the economy.

NAB wrote: “Improvements in both confidence and conditions over recent months are starting to suggest a more convincing turnaround in the non-mining sectors is under way.” Remarkably, business confidence is almost back to levels recorded just after the 2013 federal election.

Sluggish employment growth and easing conditions in the wholesale industry are the economy’s biggest hurdles, says NAB. “Nevertheless, it is encouraging to see leading indicators improve, including forward orders and capacity utilisation.”

The latest Deloitte chief financial officer (CFO) survey showed similar gains. Almost a quarter of CFOs in the second quarter of 2015 felt more optimistic than three months ago. “[It shows] the first signs of momentum emerging in confidence measures,” wrote Deloitte.

Low interest rates, a weaker Australian dollar, and this year’s more benign Federal Budget boosted optimism among CFOs, said Deloitte. The prospect of a Greek default and a savage correction in Chinese shares during the survey period did little to dent confidence.“More pressing concerns remaining in play are the slowing Chinese economy and alarmingly rapid growth in Sydney and Melbourne house prices.”

Taken together, the surveys suggest record low-interest rates and a lower Australian dollar are filtering through to the economy and helping other sectors pick up the slack from the fading mining investment boom. But the results are at odds with other surveys.

The latest Australian Institute of Company Directors’ Director Sentiment Index, released in May, showed almost 70 per cent of directors surveyed expected the domestic economy to be weak over next 12 months and almost 40 per cent were pessimistic about the general business outlook.

Board members share the load more evenly

Board fees in smaller companies are rising at a faster rate, New Zealand directors are enjoying larger fee increases than their Australian peers, and the gap between chair and director fees is narrowing as board work is shared more evenly.

These are key findings in Egan Associates’ latest KMP report on non-executive director pay in S&P/ASX 300 and NZ top-50 companies. The remuneration consulting firm examined five-year pay trends to 31 December 2014.

The results, released in late July, show significant fee restraint among the boards of Australia’s largest companies. The median chair fee for a top-50 ASX company was $524,550 in 2014. It has barely changed over three years, despite higher workloads. Non-executive directors in top-50 companies earned a median $238,029 in fees in 2014, up from $219,399 two years earlier. The gap between chair and director fees in the top 50 has slightly narrowed as board work is spread through more committees.

Fee growth was stronger outside the top 50. Chairs of ASX-listed companies ranked 201 – 300 earned $161,578 in fees in 2014, from $135,818 two years earlier – a 19 per cent increase.

Director fees rose about 10 per cent over that period. A chair of a top-50 company averaged 3.8 times more pay than their peers in a company ranked 201 – 300 in 2012. That fell to 3.2 times in 2014.

This is an important trend. As fund managers look further down the market for value and include smaller stocks in portfolios, there is stronger focus on governance.

Smaller companies appear to be responding by attracting experienced chairs, increasing pay, or ensuring fees are commensurate with rising workloads for small-company boards.

In country comparisons, chairs of top-50 New Zealand companies earned a median NZ$142,970 in 2014, up almost 11 per cent over three years.

Clawback regulation gaining traction

Should Australian remuneration committees consider the introduction of clawback policies? This is the question being asked by remuneration specialists, Guerdon Associates, following recent changes to clawback laws in both the UK and US.

Guerdon says that while the term “clawback” refers to the requirement to seek repayment of reward that has vested and been released to an executive, in Australia, the term is often incorrectly used in place of “malus”, which references cancellation or lapse of an unvested incentive opportunity for reasons such as the misstatement of financial accounts, or fraud.

Guerdon says that some Australian listed companies have been careful to ensure their policies differentiate between malus and clawback, a factor that may prove useful if the regulation for both malus and clawback that has emerged in the rest of the world influences investor expectations as part of the global convergence of governance arrangements.

Guerdon cites changes in the UK, where the Prudential Regulation Authority confirmed in July that banks would be required to introduce new malus and clawback policies from 1 January 2015. The regulation requires banks to apply malus, and recover incentives paid via clawback, for seven years from the date of the award, with an extension to 10 years in certain circumstances.

Similarly, in the US, companies are required to develop and implement policies to clawback incentive-based executive compensation that is later shown to have been awarded in error. This requirement applies to all listed companies, not just banks, but is narrower in scope than the UK rules.

While there does not currently appear to be further regulation on the Australian horizon, Guerdon says the rising bar of governance expectations, stimulated by overseas practices, may see an increase in the number of local investors expecting formal clawback policies over the next few years as a condition for supporting company remuneration reports.