Many boards still think like short-term monitors of management. Domini Stuart investigates whether thinking like an owner would enhance their performance and give them a longer-term perspective.
Would directors be more attuned to the long-term viability and health of their companies if they thought like owners? It is a question that many people believe can be answered with a definitive “yes”, but the answer is not so simple. There are multiple complexities and nuances that mean the answer might be varied for different companies, or even for individual directors.
Amanda Wilson MAICD, managing director of Regnan Governance Research & Engagement (Twitter @RegnanESG) believes that most directors are already thinking more like long-term strategic owners than short-term monitors of company performance.
“Investors can have investment horizons varying from the very short-term to the much longer term,” she says. “I think most boards work very hard to balance these differing demands while maintaining their own long-term focus.”
Many others agree with her premise.
“There’s a broad spectrum of publicly-listed companies and they operate in different ways,” says Maria Leftakis, managing director of consultancy firm Global Proxy Solicitation (Twitter @GPS_ShareEngage). “In my experience, ASX 300 boards are generally working to longer-term strategies and plans.”
Quarterly reporting should not be confused with a short-term board mindset.
“In fact, it can be quite the opposite,” Leftakis continues. “Boards are often put in the position of having to defend short-term performance to shareholders and the market while trying to get on with the job of achieving for the longer-term.”
Janine Cullen OAM FAICD, principal of communications consultancy JC - The Power of One and director of the Port Kembla Port Corporation, believes that when directors are considering strategic direction or faced with a difficult decision, they should ask themselves: ‘What would I do if I owned this company?’
“Good directors have the same passion for a company, and the same degree of personal interest in the company, as an owner would,” she says. “I think that helps them to do a better job.”
Skin in the game
Of course, many directors do have some degree of ownership in the companies they oversee.
“Generally, we work on the premise that people value what they own and take better care of it,” says Leftakis.
“That means having some skin in the game potentially serves at least two purposes. As an owner, a director has the ups and downs of the company in common with all of the other investors. And, depending on the size of the shareholding and its value relative to the director’s portfolio of assets, ‘ownership’ can enhance the quality of the decisions being made and the strategies adopted in the interests of shareholders because they also have a direct impact on the directors.”
However, if a substantial proportion of the director’s personal wealth is tied up in the company, there is a risk that he or she will take a short-term view of share price performance rather than the longer-term view that would be in the best interests of the company and other investors.
“This can be as venal as seeking a takeover at a time to suit personal circumstances rather than to maximise value for shareholders,” says Martin Kriewaldt FAICD, a non-executive director and former president of Company Directors’ Queensland Council.
Ownership also raises the question of independence.
“Many would hold that to be truly independent, a director should own no shares at all so that he or she can’t be swayed by personal gain,” says Kriewaldt.
“That view is not in favour these days, but it doesn’t mean we should go to the other extreme. If directors are required to commit a large amount of capital to shares on joining a company, even over a period of time, there is a risk of excluding good people who simply can’t afford such a commitment. Even buying shares of equal value to the annual fee over a three year period is a significant percentage of that fee.
“Personally, I prefer a situation where directors own either half of the annual fee or an amount which is close to the mean holding of shareholders, whichever is lower. This is enough to keep them in line with other shareholders but usually not enough to tempt anyone to inflate the value artificially.”
There is also the question of when directors can buy and sell shares.
“In active companies, directors can go for years without being able to purchase shares without some degree of risk that a subsequently-announced event will make their purchase look suspicious,” says Kriewaldt.
“That comes with the job. Directors need to forget about trying to make a bit of profit from trading like the rest of the world, and most would assert that they do.”
One suggestion is that directors announce their intention to buy or sell a specific number of shares as much as a month in advance. Another is that companies set up a purchase schedule.
“If the director is trying to pick the right time to buy shares, there is inherent potential for perceived insider trading,” says Kathleen Conlon FAICD, director of building products company CSR and digital advertising business REA Group, and president of Company Directors’ New South Wales Council.
“If a schedule were set so that, for example, 20 per cent of a director’s fees were sacrificed each quarter to buy shares in an appropriate window, this could be shown to be independent of undisclosed information.”
Cullen recommends that each board draws on any appropriate option to establish its own clear rules, corporate governance and protocol.
“These may include directors’ shares being escrowed, only be traded long term, sold after retirement from the board or only traded in the windows when any information that could influence the share price is publicly available,” she says.
Applying the “front page test”
Some boards argue that trading can be a matter of judgement and that the chairman should be able to approve individual transactions.
“This may be the case for some companies but it creates greater risk and uncertainty,” says Leftakis.
“For example, in the recent David Jones case, what shareholders and other stakeholders are telling us is that chairman Peter Mason’s decision to approve share purchases by directors Steve Vamos and Leigh Clapham did not meet shareholder or market expectations based on the board’s knowledge of the Myer approach and unreleased quarterly sales data.
“A clear director trading policy setting out the trading windows would have addressed this issue. Boards can also gather shareholder opinions on this matter to make sure they’re in line with reasonable expectations.”
Indeed, the Australian Securities and Investments Commission’s chairman Greg Medcraft told a senate estimates hearing in February that companies should look to the “front page test” when they are considering whether their directors should be allowed to trade shares.
“The front page test has been around in corporate matters since at least the 1970s and much longer in the professions,” says Kriewaldt.
“It’s a critical check for the whole company in all matters, not just trading shares. Apart from the consequences of reputational damage, the fallout from adverse public opinion is very distracting for management.
“It’s also a very real cost over and above those incurred by advisers, such as lawyers and media relations firms.”
As directors are already required to disclose their trades by both the Corporations Act 2001 and the Australian Securities Exchange (ASX) listing rules, Wilson isn’t sure that visibility is the missing ingredient.
“But, if the front page test triggers even brief consideration of the worst possible interpretation, it may help to avert perceptions of impropriety,” she says.
“Shareholders own the company, so their perceptions and opinions count for a lot,” adds Leftakis.
“Boards shouldn’t make decisions in a vacuum. If they do, they should be prepared to deal with the consequences.”
Most business owners play a leading role in their companies for many years and, as a result, accumulate an unmatched wealth of knowledge and experience.
But directors are discouraged from spending too long in the same job; long tenure could be perceived as another threat to their independence.
The ASX Corporate Governance Council’s Corporate Governance Principles and Recommendations previously suggested that a board should regularly assess whether a director who has served for more than 10 years has become too close to management to be considered independent.
“[This] has focused attention on this matter and encouraged discussion, but you simply cannot be prescriptive with this,” says Leftakis.
“Some directors will be able to continue contributing value for many years while others may have a shorter shelf life.
“The real need is for a periodic review of board composition where the directors’ skills and expertise are assessed in relation to strategy and the industry landscape. There should also be an active plan in place to renew the board.”
Wilson points out that investors are best served by independence of thought, which is difficult to measure from the outside. And Kriewaldt has found no research to support the idea that investors would benefit from a set tenure.
“There is an argument that a director becomes captive to management over time,” he says.
“I can’t see any logic in this because, over a nine or 10 year span, the CEO – the supposed captor – will almost invariably change.
“There’s also an argument that a board with long-standing directors will be wedded to past decisions and resist change, but a proper board assessment process will reveal whether the board or an individual director really is stale and in need of replacement.”
Cullen likens a fixed tenure to choosing a particular director for a board on the sole basis of diversity.
“Directors should be the best people for the job regardless of their age, ethnicity or gender, or how long they’ve been doing the job,” she says. “If a director is performing well and adding value around the board table, then why wouldn’t you want to keep him or her for eight, 10 or even 12 years?”
Boards with a long corporate memory can also play an important role in ensuring that past mistakes aren’t repeated. However, long corporate memories and a limited length of tenure may not be mutually exclusive.
“No company is static and, as it goes through different lifecycles and industry changes, the knowledge and expertise of directors who can make a constructive contribution is essential,” says Leftakis.
“But a fresh set of capable eyes also helps a board to navigate challenge and stress-test discussion so that the risk of groupthink is minimised. Corporate memory can be supported by robust succession planning and a means of documenting the essence and spirit of board deliberations for future generations of directors.”
As with most boardroom matters, directors must do their best to find an appropriate balance.
“Corporate memory on strategic issues and knowledge of the market and organisation are important, but after the period of six years, the question of independence, freshness of mind and enthusiasm does come into play,” says Professor Stephen Burdon FAICD, chairman of high-tech company Silex Systems and a Professor of Management at the University of Technology Sydney (Twitter @UTSEngage) and CASS Business School London (Twitter @Cassinthenews).
“As a general rule, I believe the view that an effective director should serve six to nine years is about right.”
Encouraging a longer-term focus
Cullen believes that innovation comes from long-term thinking, and that value grows out of long-term strategies crafted and executed by a strong leadership team.
“The board and management of every organisation should regularly engage in a strategic planning process,” she says.
“Depending on the organisation, this could be based on a time frame of between two and five years. They will then have a road map which identifies the goals they must work towards in order to achieve the company’s mission and realise its vision.
“After these sessions, they should establish metrics, such as key results areas, and include these on the board’s agenda once or twice a year to ensure that the targets and objectives are still appropriate and that the long-term strategies are being actioned.”
“The quality of board deliberations and decisions is not a science,” says Leftakis.
“The focus must ultimately be on making sure the company has the right strategy, with the right CEO to implement it, a remuneration structure that clearly aligns performance with strategy and ensuring that the directors can provide effective oversight to make sure all of this is achieved.”
Could an ownership mindset ever become a regulatory requirement?
“There are some signs in the UK that, in the future, boards will be required to report on initiatives for growth and dealing with the need to investigate the current business model for future effectiveness,” says Burdon.
“Already, Company Directors supports the idea that boards should spend a significant period of their time on future strategies.
“Boards certainly need to be encouraged more to focus on optimising returns for the long-term shareholder, and making statements about these issues in their annual reports would be a good first step.”
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