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Adams, Michael --- "Corporate Governance - What is the best model and why?" [2003] ALRS 1

Last Updated: 5 July 2009

CORPORATE GOVERNANCE —

WHAT IS THE BEST MODEL & WHY?[1]

PROFESSOR MICHAEL A ADAMS
Professor of Corporate Law, Faculty of Law, University of Technology, Sydney
Assistant Director, UTS Centre for Corporate Governance
Consultant to Blake Dawson Waldron Lawyers

INTRODUCTION

Renewed emphasis has been thrown upon corporate governance in more recent years following the high profile collapses of HIH Insurance Ltd, One.Tel Ltd, Pasminco Ltd, Enron, Andersen and the list goes on. The somewhat paradoxical consequence has been that corporate governance has become a buzzword, yet it possesses a certain mysterious, mercurial quality, which has allowed it to defy attempts to definitively characterise what is really is.

Thus, corporate governance presents a challenge at the most fundamental of levels; however, the challenge does not end there. Indeed, if corporate governance was not so important and trying an area, the focus of the 2003 ASIC Summer School may well have been altogether different!

This paper has been produced as an aide-mémoire of the key areas covered by the Discussion Panel at the 2003 ASIC Summer School on Tuesday 11 March 2003. For this reason, it should not be seen as an attempt to cover the following topics in exhaustive detail:


  1. Selection of Board
  2. Role of Auditor
  3. Role of Underwriter/Analyst/Broker
  4. Role of Shareholders
  5. Role of Institutional Investors
  6. Remuneration for Senior Management

I have endeavoured to deal with the above areas in as contemporary a fashion as possible, avoiding over-use of legal jargon and presenting the fundamentals in a manner designed to be digestible by lawyers and non-lawyers alike.

I SELECTION OF BOARD

In this new millennium, the boards of all corporations are expected to be operating within the corporate governance dicta that have emerged both internationally and in Australia in response to some of the experiences in the 1980s. A range of bodies, from both public and private sectors, have issued reporting and behavioural guidelines, and organisations such as the Australian Institute of Company Directors and Chartered Secretaries Australia have played a prominent role in reinforcing the standards and expectations of behaviour and performance from all directors and officers. In addition, the federal government’s Corporate Law Economic Reform Program (CLERP) is continuing to have an impact on the sphere of governance, with the final outcomes from CLERP9 keenly awaited. Much is also expected from the Australian Stock Exchange Corporate Governance Council, which is formulating best practice corporate governance recommendations as an alternative to the more proscriptive approach taken by the United States in the Sarbanes-Oxley Act 2002.

All of these guidelines, recommendations, codes of best practice, rules and legislation will influence the operation of the variety of boards and board members in Australia. However, it can be argued that all good boards are the same: the directors challenge and confront because they devote the time necessary for preparation and participation and bring with them a rich body of business experience to assist management.

But, unlike Tolstoy’s unhappy families, who were said to be unhappy in their own particular way, all poorly functioning boards are also the same. They are fraught with conflicts, have members who fail to attend meetings and are ill prepared, have an atmosphere of cronyism, and lack of independence. They are unwilling to challenge decisions and information. They fail to ask the questions necessary to get to the heart of corporate issues.

As a result, reforms that shift power from one party to another will not by themselves create more smoothly-run, profitable organisations. This is because they do not address the fundamental problems in corporate governance, which stem not from power imbalances but from failures in the corporate decision-making process. Corporate failures usually result from a few well-intentioned but flawed management decisions that are not challenged in an efficient, effective manner. The Royal Commission into the collapse of HIH Insurance has highlighted the inherent risk associated with boards that fail to challenge decisions of senior management or other board members.

In fairness, it can be said that being an officer is one of the most challenging tasks in the modern corporate world. Directors need to have the ability to look outwards, beyond the company, seeing the business in its competitive commercial context. Equally, directors are called upon to look inwards at the component parts of the enterprise at the same time. Moreover, perhaps one of the most difficult things all directors have to manage is the focus on both medium and long-term issues, as well as concentrating on the company’s present position. Many directors argue that striking this necessary balance is made particularly difficult by major stakeholders being focussed almost solely on short-term measurements of corporate success, such as share price and price-earnings ratios.

Indeed, times have changed from the image (and possible reality) of a sinecure position, where directors merely attended the odd meeting, followed by a lunch and a nice fee. The company secretary, for example, was described in 1887 by the United Kingdom Court of Appeal as being a ‘mere servant’,[2] yet by 1971 that same Court had readdressed the position, describing to the company secretary as being the ‘chief administrative officer’.[3]

Focus of late has certainly shifted away from the managers of large corporations and towards the board of directors. Partially, this can be explained by the fact that regulatory controls are not so much aimed at the actual mechanics of running corporate entities, but rather the way in which an entity is being run. This is one of the key differences between the nature and role of the management of the corporation and its board of directors.

A. Non-Executive Directors

While Australian law does not distinguish between the duties of non-executive directors (NEDs) and executive directors (EDs),[4] of late much has been made of board composition and structure, with particular attention being given to the role of independent non-executive directors. Several US studies have produced indirect evidence of a positive relationship between the proportion of NEDs and shareholder wealth; other US evidence suggests that independent directors are more effective in small rather than large companies.

Yet there is strong argument that independent NEDs are important for reasons other than corporate performance; in particular because they have a role to play in situations where there is a potential for conflict between the interests of the executive management and those of the shareholder body.

UK companies traditionally had boards comprising about one-third NEDs, but there was a reluctance to allow as many as half because it was felt those running the business should be in control. However, one of the recommendations from the 1992 Cadbury Report on the financial aspects of corporate governance was an increase in emphasis of independent NEDs for British public companies. In recent years this has been approaching 50% and even higher. Most recently (January 2003), a major report was conducted in the United Kingdom by Derek Higgs on behalf of the Department of Trade and Industry entitled ‘Review of the role and effectiveness of non-executive directors’. The Higgs Report, the findings of which now apply to all companies listed on the London exchanges, recommended (amongst other things) that at least half the board members be independent non-executive directors.

The leading public companies in the US and Australia have tended adopt the practice of boards with a majority of NEDs. Indeed, this has become a legal requirement in the United States, following the reforms arising out of the collapse of Enron as instituted by the Sarbanes-Oxley Act. It remains to be seen whether the recommendations of the ASX Corporate Governance Council will follow the international movement towards a majority of independent non-executive directors or develop a path of Australia’s own. Media speculation on leaked draft recommendations has strongly suggested that the ASX Council will follow suit, requiring boards to comprise a majority of independent non-executive directors or be able to provide a plausible reason as to why they cannot meet this requirement.[5]

The uncertainty surrounding the role and effectiveness of non-executive directors is understandable when considering the board structure of those entities involved in the major corporate collapses of recent years relative to those companies who have been acknowledged for their sound corporate governance practices.[6] (In the interests of accuracy, however, it should be noted that while Harris Scarfe Holdings is included in the list of collapsed companies, it was bought out of receivership by a consortium of shareholders led by the current CEO Robert Atkins and is now trading confidently. Harris Scarfe returned a net profit of $19.3 million for the eight months to August 2002 and is expected to achieve annual sales exceeding $300 million.)[7]


Corporation
NED
ED
Board
NED:ED
Lend Lease Corporation
9
3
12
3.00
Foodland Associated Ltd
6
1
7
6.00
Goldfields Ltd
3
1
4
3.00
Wespac Banking Corporation
12
2
14
6.00
Wesfarmers Ltd
11
2
13
5.50
Rio Tinto Ltd
9
6
15
1.50
General Property Trust
8
1
9
8.00
CSR Ltd
10
4
14
2.50
Average
8.5
2.5
11
4.44
One.Tel Ltd
5
4
9
1.25
HIH Insurance Ltd
5
2
7
2.50
Pasminco Ltd
6
1
7
6.00
Harris Scarfe Holdings
5
1
6
5.00
Enron
12
6
18
2.00
WorldCom
8
3
11
2.67
Average
6.83
2.83
9.67
3.24

Table 1: Non-Executive Directors and Corporate Collapse

While the British Prime Minister, Benjamin Disraeli, may have had a point when he mused that there were only three types of lies — lies, damned lies, and statistics — certain tentative conclusions can be drawn from the comparative analysis contained in Table One. In fact, three palpable points can be made about board composition in those companies that have enjoyed a reputation for sound corporate governance as against those entities that have been recent victims of collapse.

Firstly, it can be seen that the average board size of a successful company is larger than the average board size of a collapsed company, by approximately 1.5 board members. Secondly, the board of a successful company on average will have nearly two more non-executive directors than the average board of a collapsed company. Thirdly, the ratio of non-executive directors to executive directors of the successful companies tends to be higher than that of the collapsed companies.

From these three observations an optimist might conclude that the key to successful corporate governance, in terms of board composition, is to ensure that you have a large board with a non-executive director gearing ratio greater than four. However, this is clearly an overly simplistic viewpoint to take, which ignores an infinite number of further necessary considerations vis-à-vis the governance of corporate entities.

Moreover, to accept such a viewpoint is to ignore one glaring paradox. All of the collapsed companies’ boards were inline with internationally accepted corporate governance best practice in relation to board composition — all had a majority of non-executive directors. Enron, the world’s largest corporate collapse and catalyst for the Sarbanes-Oxley Act, had 12 non-executive directors out of a board of 18. Such a paradox underlines two key issues in corporate governance.

The first is that non-executive directors are not a failsafe for boards per se. Non-executive directors who lack independence contribute little to the checks and balances required in the boardroom. They key to the success of NEDs is independence; a point made abundantly clear in the UK’s recent Higgs Review, which requires the boards of publicly listed companies to have at least half of its members as independent non-executive directors. The Higgs Review proposes a definition of independence that requires boards to be satisfied that their directors are ‘independent in character and judgement’ and provides a list of relationship or circumstances that would affect such independence.[8]

According to the Review, a director may not pass the test of independence where the director:

w is a former employee of the company or group until five years after employment (or any other material connection) has ended;

w has, or has had within the last three years, a material business relationship with the company either directly, or as a partner, shareholder, director or senior employee of a body that has such a relationship with the company;

w has received or receives additional remuneration from the company apart from a director’s fee, participates in the company’s share option or a performance-related pay scheme, or is a member of the company’s pension scheme;

w has close family ties with any of the company’s advisers, directors or senior employees;

w holds cross-directorships or has significant links with other directors through involvement in other companies or bodies;

w represents a significant shareholder; or

w has served on the board for more than ten years.

The Investment and Financial Services Association (IFSA) released its Blue Book on Corporate Governance — A Guide for Fund Managers and Corporations in December 2002, which includes similar independence requirements in relation to directors. However, the independence checklist contained within the IFSA guide is not as exhaustive as that of the Higgs Review. It remains to be seen what final stance on independence will be taken by the ASX Corporate Governance Council in late March 2003.

The second key issue that arises from the paradoxical presence of a majority of non-executive directors on the boards of collapsed corporations goes to the heart of the ongoing to debate as to whether a prescriptive or proscriptive approach should be taken to regulating corporate governance. It is argued that a prescriptive approach, such as best practice guidelines, allow for flexibility in regulation and governance that cannot be provided by strict statutory requirements. Furthermore, ‘box ticking’ is the customary, undesirable corollary of a proscriptive (statutory) approach to corporate governance. This symptom is made worse by the so-called boilerplate approach, encouraged by the large accounting and law firms. That is, strict legislation regulating corporate governance leads corporations to concentrate their efforts on compliance with the letter, rather than the spirit, of the law. This very fate, it may be argued, has befallen the audit committee in Australia.


Year
Total No. Companies
Proprietary Companies
Public Companies
ASX Listed Companies
1991
892,749
871,648
10,402
1,096
1995
933,652
915,437
7,712
1,186
1999
1,111,214
1,092,436
7,441
1,222
2003
1,232,151
1,213,399
7,993
1,484

Table 2: Australian Company Classification Statistics 1991-2003 (Source: ASIC)

When ASX Listing Rule 4.10.2 was introduced on 1 July 1996, mandating audit committees as a condition precedent for all public companies seeking ASX listing in Australia, virtually 100 per cent compliance was achieved. Corporations listed, or seeking to be listed, on the ASX put an audit committee into place, ticked the box, and moved on; they had complied with the law. The fact that, in the majority of cases, the audit committee consisted of several members of the board of directors meant that the board of directors effectively audited itself. It meant, as can be seen from Table Two, that whilst companies listed on the ASX make up less than one per cent of all companies registered in Australia, there were over 1,000 completely meaningless audit committees following the introduction of Listing Rule 4.10.2. Thus, thousands of corporations complied with the letter of the law, but the spirit of the law was lost (or ignored).[9]

The United Kingdom has continued its ‘comply or explain’ approach to corporate governance following the Higgs Review’s preference for maintaining the status quo, rather than issuing statutory governance requirements. On the contrary, the United States has taken a far more forceful approach with the passing of the Sarbanes-Oxley Act, in requiring higher standards of transparency, direct accountability on the part of the chief executive officer, and a greater degree of independence in the boardroom. The United-States approach has faced stiff criticism from supporters of principles-based corporate governance regulation, such as Europe and the United Kingdom. The Chief Executive Officer of Nestlé, Peter Brabeck-Letmathe, was quoted in The Australian Financial Review condemning the regulations introduced by the Sarbanes-Oxley Act, saying:

‘These latest SEC regulations, there are 3,000 pages of them...I can spend 95 per cent of the board meeting filling out forms and consulting lawyers and lose time to oversee the business. We have completely lost the balance. Rules can never act as a substitute for personal integrity.’[10]

Australia is clearly going to continue to follow a principles-based scheme for regulating corporate governance, with no immediate plans to follow the United States down the legislative path. It is also likely that Australia (through the ASX Corporate Governance Council) will adopt best practice guidelines closely analogous to those presented by the Higgs Review in the United Kingdom, with the focus being on the independence of non-executive directors, audit committees and the chairperson. What is actually adopted by the ASX Corporate Governance Council is expected to be announced in late March 2003.

B. Role of the Chair

Enormous interest in the legal community has arisen concerning the role of the chairman of the board in the light of the Higgs Review in the United Kingdom, the pending outcomes of the ASX Corporate Governance Council, APRA’s investigation into Mr Bernie Fraser’s position as chairman of Members Equity,[11] and most particularly a recent decision of the New South Wales Supreme Court.[12] In short, debate has centred on whether:

w the chairman should be independent;

w the role of chairman and CEO should be separated; and

w the law should expect a higher standard of care and diligence to that expected of other non-executive directors.

An important caveat with which I should begin is the usage of the term ‘chairman’ and principally its masculine leaning. Historically, one would imagine, the term grew from the simple fact that the large majority of people who chaired meetings were men. Hence, ‘chairman’. However, in today’s society and business community, this is no longer the case, nor necessarily appropriate. Many women hold board positions and there are many women who hold the title of chair of the board both in Australian and around the world. Names such as Jill Ker Conway (Lend Lease), Patricia Russo (Lucent Technologies), Sandra Yates AO (Saatchi & Saatchi, Australia) and Rowena Danzinger (Opera Australia) immediately spring to mind.

In Australia, the Acts Interpretation Act 1901 (Cth) recognises that outdated gender references in Commonwealth legislation need correction, with s 23 directing that ‘[i]n any Act...words importing a gender include every other gender.’ It is also worthy of note that s 18B of the Acts Interpretation Act 1901 deals specifically with the position of chair, stating that:

Where an Act establishes an office of Chair of a body, the Chair may be referred to as Chair, Chairperson, Chairman, Chairwoman, or by any other such term as the person occupying the office so chooses.

So, too, in this paper, wherever possible I have endeavoured to refer to the position in as gender-neutral a fashion as possible, using the expression ‘Chair’.

There can be little doubt of the importance of the chair of the board, with the Higgs Review describing the chair as being:

‘pivotal in creating the conditions for overall board and individual non-executive director effectiveness, both inside and outside the boardroom...The Chairman has the responsibility of leading the board in setting the values and standards of the company and of maintaining a relationship of trust with and between the executive and non-executive members.’[13]

It is on this basis that the Higgs Review recommended that, upon appointment, the chair must be able to pass the same test of independence as that laid down for non-executive directors (see p 5, above).[14] The ASX Corporate Governance Council is expected to make a similar recommendation when it releases its final guidelines and principles of best practice in late March 2003.[15]

The second issue of contention is whether the role of chair and CEO should be held by the same person or separated. The Higgs Review claims that approximately 90 per cent of companies listed on the London Stock Exchange split these roles.[16] A similar statistic might be expected in Australia, yet there remain a few standout exceptions, such as Rupert Murdoch being Chairman and Chief Executive of The News Corporation Ltd. The overwhelming weight of opinion,[17] however, suggests that these two roles should ordinarily be separated. Once again, the ASX Corporate Governance Council is expected to follow suit, requiring separate CEO and chair roles or a reasonable excuse as to why this is not possible.[18]

Moreover, the Higgs Review arrived at an understandable corollary from its stance on the need for an independent and separate chair; recommending that a chief executive should not later become chair of the same company.[19] One would assume further discussion on this recommendation will surface given that no guidance as to timeframe was given by the Higgs Review. That is, should there be a period of time, the passing of which would allow a former CEO to take on the position of chair? Surely the intention of the Higgs Review was not to permanently preclude former CEOs from returning as chair at a later date?

Predominately, discussion concerning the chair of the board has revolved around issues of independence, with less attention being given to legal responsibilities and accountabilities. However, these critical concerns came to the fore on 24 February 2003 in the decision of Austin J in the New South Wales Supreme Court in ASIC v Rich.[20] The case involved four former directors of failed telecommunications company One.Tel Ltd; viz Jodee Rich, Bradley Keeling, John Greaves, and Mark Silbermann. One.Tel also had three other non-executive directors, Lachlan Murdoch, James Packer, and Rodney Adler. Mr Greaves was the only other non-executive director and was also chairman of the board.

ASIC’s case was that each of the four defendants contravened s 180(1) of the Corporations Law (now Corporations Act 2001 (Cth)), which holds that:

A director or other officer of a corporation must exercise their powers and discharge their duties with the degree of care and diligence that a reasonable person would exercise if they:

(a) were a director or officer of a corporation in the corporation’s circumstances; and

(b) occupied the office held by, and had the same responsibilities within the corporation as, the director or officer. (emphasis added)

ASIC was seeking to prove that Mr Greaves had:

‘special responsibilities beyond those of the other non-executive directors, by reason of his positions as chairman of the board and the Finance and Audit Committee, and also by reason of his high qualifications, experience and expertise relative to the other directors.’[21]

Therefore, ASIC submitted that, as ‘responsibilities’ for the purposes of s 180(1), those special responsibilities as a chairman led to a higher standard of requisite care and diligence, which Mr Greaves failed to meet. ASIC outlined the alleged responsibilities in some depth, stating that, as chairman, Mr Greaves was required:


(a) to take reasonable steps to ensure that he and the other members of the Board monitored management of the One.Tel Group, properly assessed One.Tel's financial position and performance, and properly and promptly detected and assessed any material adverse development affecting its financial position or performance;
(b) to take reasonable steps to ensure that he and the other members of the Board were informed of all material financial information concerning the One.Tel Group which was necessary to enable the Board to monitor management, to properly assess its financial position and performance, and to properly and promptly detect and assess any material adverse development affecting its financial position or performance;
(c) to take reasonable steps to ensure that the material financial information referred to in (b) above included information which revealed:
(d) to take reasonable steps to ensure, in conjunction with the Joint Managing Directors, that systems were established, maintained and monitored which resulted in the material financial information referred to in (b) above:
(e) to take reasonable steps to ensure that the One.Tel Group employed a Finance Director with the financial qualifications, skills and experience reasonably appropriate for a person holding that position and having the responsibilities set out in paragraph 10 below;
(f) to take reasonable steps to ensure that public statements made on behalf of the company did not mislead the ASX or the investing public;
(g) to take reasonable steps to ensure that One.Tel:
(h) to take reasonable steps to ensure that if the One.Tel Group was to continue its existing operations the cash reserves within the Group were maintained at a level which ensured that the companies within the Group were able to pay their debts as and when they fell due; and
(i) to make recommendations to the Board as to the prudent management of the One.Tel Group, including as to its funding requirements, cessation of its business and/or appointment of an administrator.[22]

Thus, according to ASIC, the statutory duty of care and diligence (s 180(1)) led to the imposition upon Mr Greaves, given the circumstances, of a series of more specific duties, each of which he failed to discharge. It was argued by ASIC that the specific duties arose because a reasonable person, in the corporation’s circumstances, occupying Mr Greaves’ positions and having the same responsibilities (listed above) as he had within the corporation, would have acted with a far greater degree of care and diligence. In accordance with the law, because the reasonable person contemplated by s 180(1) would have acted with such a degree of care and diligence, Mr Greaves had specific duties to do likewise.[23]

Mr Greaves’ argument to the contrary was that he had no such responsibilities, rather:

‘he was a non-executive director, in essentially the same position as the three other non-executive directors who have not been sued by the Commission, notwithstanding that he was chairman of the board and of the Finance and Audit Committee.’[24]

In finding for ASIC, Austin J felt comfortable with the fact that, whilst there was no precedent that directly attributed to the chairman wider non-procedural functions or responsibilities, the precedents do not deny the possibility that wider responsibilities might exist.[25] Austin J felt that ASIC has a ‘reasonably arguable case for the view that Mr Greaves had the responsibilities pleaded’,[26] adding that the United Kingdom Higgs Review (released after ASIC’s submissions were completed) contained ‘emphatic statements which appear to reinforce the Commission’s evidence.’[27]

Interestingly, in justifying his decision to allow the duties of the chairman to be widened, Austin J concurred with some of the first instance observations of Rogers J in AWA Ltd v Daniels,[28] namely that ‘the chairman is responsible to a greater extent than any other director for the performance of the board as a whole and each member of it.’[29] It is well known that the decision of Rogers J in AWA Ltd v Daniels was overturned on appeal, but Austin J claimed that ‘nothing said by the Court of Appeal on appeal from Rogers J’s judgment (Daniels v Anderson (1995) 37 NSWLR 438) calls these observations into questions.’[30]

In closing what is a fairly controversial decision, Austin J defended his acceptance of ASIC’s reliance upon non-legal, corporate practice material as evidence, and noted:

‘It may appear, at first blush, to be unduly harsh on a person in Mr Greaves’ position that evidence of this kind might be relied upon to establish that in 2001 he was subject to responsibilities and, ultimately, legal duties never before set out in a statute or by judicial decision. It should be remembered, however, that the Court’s role, in determining the liability of a defendant for his conduct as company chairman, is to articulate and apply a standard of care that reflects contemporary community expectations. It is now commonplace to observe that the standard of care expected of company directors, both by the common law...and under statutory provisions, has been raised over the last century or so. One might correspondingly expect that the standard for company chairmen has also been raised.’

Indeed, Austin J has most certainly achieved just that. It is a decision that appears to open the door for all chairmen to have their legal obligations judicially increased. Austin J has implicitly approved of the list of responsibilities submitted by ASIC as belonging to Mr Greaves as chairman of the board of One.Tel. It remains to be seen whether such a level of responsibility will be applied across the board (no pun intended) to all chairmen. However, one would imagine that this decision will go on appeal, which undoubtedly will be watched carefully by every board in Australia.

II ROLE OF AUDITOR

I should state from the outset that auditing is not my area of expertise and, as such, I will not make more than a few passing comments. Mr Wayne Lonergan, the Australian representative to the Standards Interpretation Committee of the International Accounting Standards Board, is a fellow member of the Discussion Panel at the 2003 ASIC Summer School and I would refer you to his better qualified comments.

Much has been made of the role of auditors in corporate governance, particularly since the collapse of both HIH Insurance and Enron and the subsequent demise of the audit firm Andersen. Indeed, Professor Ian Ramsay’s in-depth report[31] (the Ramsay Report) into the independence of auditors in Australia was a bi-product of the public and governmental foofaraw in 2001. Once again, just as the independence of non-executive directors is viewed as a key component in sound corporate governance, it is the independence of auditors that has been the focal point of government, the regulators and the media. The inadequacies of the audit provisions contained within Part 2M.4 of the Corporations Act 2001 were highlighted by the Ramsay Report, particularly with regard to their inability to ensure the independence of auditors. These provisions, it was revealed, have not been updated in over forty years; it is inevitable, therefore, that Australia has fallen behind the rest of the world in relation to auditor independence

It cannot be doubted that auditors must be made subject to comparable requirements to those imposed upon directors and officers of corporations vis-à-vis conflicts of interest in order to avoid relationships that can lead to a less than objective audit. The federal government has sought to achieve this through the adoption of many of Professor Ramsay’s recommendations into the ninth stage of its Corporate Law Economic Reform Program (CLERP9), which seeks to amend the Corporations Act 2001. Legislation, however, cannot be the only answer. The major accounting bodies, such as the Institute of Chartered Accountants in Australia, also have a key role in ensuring auditors understand the importance of maintain independence from their clients through ongoing training programs and developing viable and adept codes of conduct.

Finally, attention must be drawn to the plight of the regulators of corporate governance, and particularly that of ASIC. What follows is neither an attempt to ingratiate myself to, nor be unjustly critical of, ASIC; rather, what I proffer are just practical observations. In Australia, much media finger pointing and blame apportionment initially followed the collapse of HIH Insurance, with auditors suffering greatly as a result of this. Fortunately, in time, the systemic problems of corporate governance came to the fore, which allowed for a more holistic view to be taken of the regulatory sphere in which auditors operate.

It is worth noting, in the interests of presenting a balanced argument, that auditors may not have missed as many problems as the media suggested shortly after the collapse of HIH Insurance. It is often the case that many breaches of the law are reported to ASIC by auditors, but no action is taken by the regulator. ASIC keeps annual records on how many complaints it receives from external administrators (such as auditors, liquidators, administrators, etc.) about suspected breaches of the law and how it deals with each of these complaints.

According to the last three ASIC Annual Reports, ASIC has consistently been unable to take any action on 94 per cent of complaints it received from auditors/liquidators during the course of each financial year. What this means is that of the 9,567 complaints ASIC received during the financial years 1999/2000, 2000/2001, 2001/2002, 8,993 of these were merely recorded with no further action taken. In view of these statistics, it has quite rightly been suggested that ‘it is unacceptable for a regulator to be placed in a position where it is unable to appropriately act upon the complaints it receives.’[32]

Thus, whilst the importance of auditors remaining independent of their clients cannot be understated, there may well be other forces at play which allow for corporate indiscretions to fall through the cracks. Factors such as under funded regulators cannot be ignored; the best regulatory system is futile if it cannot be enforced.

III ROLE OF UNDERWRITER/ANALYST/BROKER

Private briefings of financial analysts by publicly listed companies and unequal disclosure generally have received considerable coverage in the media in the last few years. Much was made of the ASIC investigation into the private briefing of a Credit Suisse First Boston analyst by Brambles Industries Ltd in November 2000. More recently, on 26 February 2003, ASIC commenced civil penalty proceedings against Southcorp Ltd, alleging an email sent to selected analysts was tantamount to a breach of the continuous disclosure provisions contained within Chapter 6CA of the Corporations Act 2001 and the ASX Listing Rules.[33] Private briefings are nothing new and, depending on your viewpoint, are either a necessary evil, necessary, or just plain evil.

It would appear however, that the balance of power may be shifting in terms of the timing of disclosure to the market. As a result, financial analysts may find themselves enjoying a new position of power when it comes to the level and timing of disclosure of information by those companies listed on the ASX. How this position may arise is by virtue of the enhanced disclosure reforms of the ASX Listing Rules, which took effect from 1 January 2003.

Most relevant is the new ‘False Market’ Listing Rule 3.1B, which has become colloquially known as the ‘Hugh Morgan Rule’ because it grew out of WMCs refusal to respond to a report in The Australian Financial Review of a WMC break-up proposal in 2001.[34] Lawyers for WMC claimed that the ASX had no right to force companies to respond to media speculation, which prompted the ASX to insert Listing Rule 3.1B, which states that:

‘If ASX considers that there is or is likely to be a false market in an entity’s securities and asks the entity to give it information to correct or prevent a false market, the entity must give ASX the information needed to correct or prevent the false market.’

It is not until one observes the circumstances in which the ASX would consider there to be a false market that the shift of power becomes clear. The Notes to Listing Rule 3.1B provide that the ASX has authority to seek clarification in the form of disclosure from a company where:

‘There is a reasonably specific rumour or media comment in relation to the entity that has not been confirmed or clarified by announcement by the entity to the market.’

Whilst significant public debate has ensued regarding the potential it creates for ‘knee-jerk reaction to every bit of media scuttlebutt’,[35] little has been said of the position in which it places analysts. Through private briefings, analysts are often privy to greater levels of (or at least earlier) disclosure than the rest of the market, which places them in a position of great responsibility. Listing Rule 3.1B now potentially offers analysts greater leverage in drawing information from companies, by using knowledge gained in private briefings to create ‘reasonably specific rumours’. This is a different position to that of the media, who are generally not party to private briefings and therefore are more likely to comment or produce rumours based on speculation and lack of information than evidence disclosed by the companies.

Thus, by virtue of Listing Rule 3.1B, analysts may find themselves in a position to produce credible, specific rumours in relation to particular activities or transactions involving ASX listed companies. Such a powerful position of influence over listed companies’ disclosure policies effectively brings analysts into the corporate governance realm. The outcome of this perhaps unexpected shift in the balance of power over corporate disclosure will hopefully be to open up greater dialogue between companies and analysts and increase transparency across the entire market. Whilst I am I no way suggesting that analysts would misuse their new position, it is hoped that such influence will be acknowledge and used appropriately.

IV ROLE OF SHAREHOLDERS

The role of shareholders, particularly minority shareholders, in corporate governance has traditionally been quite limited. The courts have long recognised that the majority shareholders may make decisions binding the minority shareholders, enforcing the concept of majority rule.[36] Over time, several common law exceptions to the majority rule were acknowledged in order to protect minority shareholders from certain types of behaviour, such as equitable fraud,[37] and allow such shareholders to sue in the name of the company.

These various exceptions to the rule in Foss v Harbottle were effectively abolished in March 2000, by virtue of the introduction of the statutory derivative action (SDA) now contained within s 236 Corporations Act 2001. A legal action is ‘derivative’ when the person who brings the action relies upon a cause of action belonging to the company, rather than a cause of action which belongs to them personally.[38] Thus, put simply, s 236 permits almost any past, present or future shareholder to bring proceedings in the name of the company where it is probable that the company will not bring the proceedings itself, provided there is a serious question to be tried and the shareholder is acting in good faith in the best interests of the corporation.

The requirements for the applicant to bring a derivative action both in good faith and in the best interests of the corporation are integral in avoiding vexatious claims and greenmailing. Importantly, these criteria recognise that a company may have perfectly sound business reasons for not pursuing a legal action open to it and that its directors might legitimately decide that the best interest of the company would not be served by taking legal action.[39] Sections 236 and 237 seek to strike a difficult balance between protecting minority shareholder rights and safeguarding companies from unnecessary litigation.

Perhaps one of the best publicised and most obvious example of unnecessary (in my opinion) minority shareholder litigation is the case of Gambotto v WCP Limited,[40] which revolved around the compulsory acquisition of shares belonging to a minority shareholder. Whilst Gambotto’s Case was not a derivative action, the result was to further entrench minority shareholder rights, which may now be ‘protected’ by s 236. My opposition to the decision in Gambotto’s Case runs beyond the discussion of the case necessary for this paper; however, in my view, it is arguable that the best thing to come out of Gambotto’s Case was a blueprint for the acclaimed Australian film ‘The Castle’!

In addition to the provisions regulating an applicant’s standing to seek leave for an action under s 236, s 240 is designed to further protect corporations from greenmail. Section 240 prevents the parties to a statutory derivative action from settling the claim without the supervision of the Court. The rationale being that a shareholder may make a claim against the company for $40 million in the derivative action, but agree mid-way through the case to withdraw the action and settle the claim for $5 million paid to the shareholder personally. Effectively, this would entitle the shareholder to a personal windfall of $5 million, notwithstanding the merits of the case and the fact that it should be the company that is compensated in the event of a finding of a contravention of the law.


Year
All Corporate Law Cases
Applications under s 237
Granted
Refused
2000
7,397
1
1
0
2001
8,002
6
3
3
2002
8,071
6
2
4
Totals
23,470
13
6
7

Table 3 Applications under s 237 for leave to bring a Statutory Derivative Action under s 236 (Source: Prof M A Adams, 2003; derived from Lexis-Nexis Butterworths & Timebase Databases)

The consequence of these stringent standing requirements and protection provisions is clearly evident in Table Three above. Since the introduction of the statutory derivative action on 13 March 2000, only 13 applications for leave to commence an SDA have been lodged in the superior courts in Australia. Of those applications, only six (ie 46 per cent) have been granted leave to proceed. It may be concluded that the SDA, whilst promising theoretical preservation of shareholders’ rights, in practice offers little recourse.

V ROLE OF INSTITUTIONAL INVESTORS

There can be little doubt that institutional investors, such as superannuation fund managers, have, by virtue of the sheer size of their shareholdings, the potential to play a leading role in the corporate governance of the companies in which they invest. Indeed, it is reasonable to surmise that institutional investors have a vested interest in establishing and maintaining sound corporate governance of these companies. It is easy to imagine that a fund manager with possibly hundreds of millions of dollars invested in a particular public company would be most concerned with how well its investment was being managed by the corporation.

However, there is an alternate scenario worthy of consideration. Where it becomes apparent to an institutional investor that a company in which it has invested has poor corporate governance structures in place, the investor is essentially faced with two choices. Option one is for the investor to use the power it enjoys as a result of being a large shareholder to influence the board to rectify the problems and aid in the implementation of healthy corporate governance practices. However, whilst this may help to ensure the future integrity of the institutional investor’s investment, it will also require the investor to expend time, money and resources in helping the company to get back on the straight and narrow.

The question, which is inherently linked with the investor’s second option, arises: ‘why should an institutional investor go to this much effort and expense?’ This is a perfectly valid question, especially when considering that the alternative to an investor aiding the company to right the error of its ways is for it to simply ‘do the Wall Street walk’ — to sell its holdings in the company and move on to another investment. To liquidate its holdings and reinvest in another, more stable company would cost the institutional investor significantly less than it would to help a company with poor governance.

After all, institutional investors are not the regulators, are they?

It depends upon your point of view. Many fund managers would argue that their allegiance lies with their investors; a fund manager’s role is to soundly invest the assets under management in a manner to best achieve a positive return for the fund and its unitholders. Thus, if a fund manager becomes aware that they have made a poor choice of investment, they are expected to exit that investment and reinvest somewhere else.

However, IFSA would argue otherwise. In its Blue Book, IFSA suggests that:

‘[e]ffective corporate governance depends heavily on the willingness of the owners of a company to exercise their rights of ownership, to express their views to boards of directors and to exercise their voting rights if they do not received a satisfactory response.

The relative size of their shareholdings provides fund managers with a particular responsibility and capacity to exercise that shareholder influence and franchise.’[41]

Ideally, all fund managers would acknowledge that with power comes responsibility. They have the power to ensure their interests are represented at board level and with that comes an indirect duty to all the shareholders of that company. Thus, whilst it may be unreasonable to make institutional investors accountable to other shareholders of companies in which both parties invest, institutional investors should be prepared to accept their role in the corporate governance of those companies.

VI REMUNERATION FOR SENIOR MANAGEMENT

Putting to one side the ubiquitous tabloid sensationalism about executive remuneration,[42] there are some genuine areas of concern in relation to the disclosure and transparency of payments to senior managers, particularly those of publicly listed corporations. Having said that, the recent media attention given to payments made by the Commonwealth Bank to a former senior executive has only served to draw awareness to this important area of reform.

Section 300A of the Corporations Act 2001 requires listed public companies to disclose in the annual directors’ report:

w board policy for determining the nature and amount of emoluments of board members and senior executives of the company; and

w the relationship between such policy and the company’s performance; and

w details of the nature and amount of each element of the emolument of each director and each of the five named officers of the company receiving the highest emolument.

Much criticism has been levied at the brevity of s 300A and its inability to achieve true, accurate and understandable disclosure of executive remuneration in Australian publicly listed companies. However, s 300A is not necessarily the last bastion of executive disclosure; s 334 allows for the Australian Accounting Standards Board (AASB) to make accounting standards for the purposes of the Corporations Act 2001. Condemnation of the capabilities of s 300A saw the AASB release an exposure draft in May 2002 to promote discussion on appropriate reforms in order to achieve greater transparency of directors’ financial entitlements.

Exposure Draft 106, Director, Executive and Related Party Disclosures, proposed a new accounting standard entitled ‘Director and Executive Disclosures by Disclosing Entities’. ED106 suggested that its mandate arose from the fact that:

‘[d]irectors and executives who are entrusted with the governance of an entity hold positions of responsibility within that entity. Accordingly, there is a need for a high level of accountability through disclosure in the financial report of their transactions with the entity and the benefits they gain as a result of positions held within the entity.’[43]

ED106 proposed significant increases in transparency, requiring all directors and executives to disclose their total remuneration for the reporting period and the aggregate value of each component part thereof. Components of remuneration were to be divided into four categories:

w primary benefits (cash salary, fees, commission, compensated absences, bonuses, and non-monetary benefits);

w post-employment benefits (pension and superannuation benefits);

w equity compensation (shares, units, options, and rights); and

w other compensation (termination benefits).

It can be seen that what ED106 projected was a considerable expansion of the transparency and disclosure regime to that found under s 300A. However, the public consultation period vis-à-vis ED106 closed on 30 September 2002, and, as of February 2003, no further progress has been made in terms of introducing these suggested reforms into law.

It may be that the AASB is awaiting the principles of good corporate governance and best practice recommendations of the ASX Corporate Governance Council before launching accounting standards requiring greater (or less) disclosure than that taken by the ASX. The recommendations of the ASX Council are not due until the end of March, yet The Australian Financial Review claims to have obtained a confidential copy of the draft guidelines, which include a new executive remuneration disclosure policy.[44] It is claimed that the draft contains some 100 recommendations and 10 principles of good corporate governance, however, only a few ‘key recommendations’ have been released by the newspaper.

What has been revealed in terms of remuneration transparency is that the ASX Corporate Governance Council recommends that companies should disclose:

w key executive employment contracts;

w the existence and terms of any retirement schemes for non-executive directors; and

w require shareholder approval for equity-based remuneration.

Understandably, the AASB proposed accounting standard goes considerably further than the newspaper reports of the thoughts of the ASX Council. The final recommendations and principles of the ASX Corporate Governance Council are eagerly anticipated, although it is unlikely that they will provide any surprises nor stray beyond the boundaries of the respective approaches taken by the United Kingdom and United States. Regardless of the outcome of the ASX, the stance adopted by the AASB should be encouraged and ideally put into practice.

VII CONCLUSION

The question posed by ASIC as the theme for the Discussion Panel (and therefore this paper) is a difficult one. Corporate governance truly is a delicate balancing act between the laissez-faire ideals of self-regulation and government or legislative intervention.[45] Business, economic, political and social climates all impact upon what is appropriate in terms of governance in individual countries, which results in corporate governance best practice really being viewed as a ‘horses for courses’ matter. Changes in government, academic thought, and management theory all go towards ensuring that corporate governance remains dynamic, rather than static; which, in turn makes pinning down the ‘best’ model of corporate governance nearly impossible.

In terms of corporate governance thinking, in a post-Enron world times have certainly changed. It was not that long ago that discussion revolved around international convergence of corporate governance; the Organisation for Economic Co-operation and Development (OECD), the Commonwealth Association for Corporate Governance (CACG), the Pacific Economic Co-operation Council (PECC), are just a few of the international bodies that all released similar best practice guidelines in the 1990s. However, since the collapse of Enron in the United States, the concept of international convergence appears a little fragile. Whereas once the United States, United Kingdom and Australia could have been grouped together in terms of corporate governance thinking, post-Enron all three nations appear to be taking divergent approaches in reforming their corporate regulatory environments.

As a result, there is clearly no single corporate governance model that is appropriate in a global sense. However, there are certain common factors that can be used in benchmarking sound corporate governance practices and those have been canvassed at the 2003 ASIC Summer School and in this paper. Australia’s position appears set to continue along the road to reform, with the government keen to instil investor confidence and faith in the corporate regulatory structure. It is hoped that a realistic approach to this challenging question is adopted and that business and entrepreneurial flair does not fall victim to an unreasonably protectionist stance.

Lastly, it is worth remembering that corporate governance in its most rudimentary form comes down to two factors: doing the right things and doing things right.[46]


[1] It must be disclosed from the very beginning that certain parts of this paper draw upon an article written for Chartered Secretaries Australia entitled ‘The Convergence of International Corporate Governance Systems — Where is Australia Heading?’, which was published in three parts in the February, March and April 2002 editions of Keeping Good Companies. I would direct the reader’s attention to this article for full referencing of the resources upon which reliance was made.
[2] Barnett, Hoares & Co v South London Tramways Company (1887) 18 QBD 816 (per Lord Esher MR).
[3] Panorama Developments (Guildford) Ltd v Fidelis Furnishing Fabrics Ltd [1971] 2 QB 711.
[4] Daniels t/as Deloitte Haskins & Sells v AWA Ltd (1995) 37 NSWLR 438.
[5] Fiona Buffini, ‘Tougher Board Rules Likely’, The Australian Financial Review, 21 February 2003, 11; Fiona Buffini, ‘Draft Stirs Winds of Change’, The Australian Financial Review, 21 February 2003, 11.
[6] The companies in the top half of Table One have been recipients of either the Australasian Reporting Award for Corporate Governance or the Investor Relations Magazine award for Corporate Governance.
[7] Ben Hooper, ‘Harris Scarfe’s back — so are the smiles’, The Adelaide Advertiser, 4 February 2003, 9.
[8] Derek Higgs, United Kingdom Department of Trade and Industry, Review of the Role and Effectiveness of Non-Executive Directors, (January 2003) [9.11].
[9] It should be noted that Listing Rule 4.10.2 was deleted on 1 January 2003, and a similar requirement was inserted in Condition 13 of Listing Rule 1.1. The key difference, which overcomes the problem of corporations ignoring the spirit of the law while complying with its letter, is the requirement that the audit committee comply with best practice recommendations to be prescribed by the ASX Corporate Governance Council.
[10] Lenore Taylor, ‘Can we regulate against risk?’, The Australian Financial Review, 30 January 2003, 53.
[11] Stewart Oldfield, ‘APRA disputes Fraser independence as bank chair’, The Australian Financial Review, 17 February 2003, 3.
[12] ASIC v Rich [2003] NSWSC 85.
[13] Higgs, above n 8, [5.1]–[5.2].
[14] Ibid, [5.8].
[15] Buffini, above n 5.
[16] Higgs, above n 8, [5.3].
[17] See, eg, Higgs Review at [5.3]; IFSA Blue Book at [11.5]; Bosch Committee, Corporate Practices and Conduct, (3rd edn) 1995.
[18] Buffini, above n 5.
[19] Higgs, above n 8, [5.7].
[20] [2003] NSWSC 85.
[21] Ibid at [4].
[22] Ibid at [14].
[23] Ibid at [27]–[29].
[24] Ibid at [5].
[25] Ibid at [56].
[26] Ibid at [70].
[27] Ibid at [69].
[28] (1992) 7 ACSR 759; 10 ACLC 933.
[29] Ibid at 867.
[30] [2003] NSWSC 85, [59].
[31] Ian Ramsay, Independence of Australian Company Auditors — Review of Australian Requirements and Proposals for Reform, Department of the Treasury, October 2001.
[32] Chartered Secretaries Australia, The Need for a Corporations Panel, Discussion Paper (September 2002) [2.14].
[33] Australian Securities and Investments Commission, ASIC Files Proceedings Against Southcorp, Media Release, No 03-070 (26 February 2003).
[34] Tony Boyd, ‘ASX Muddle Over When a Rumour is not a Rumour’, The Australian Financial Review, 29 January 2003, 44.
[35] Damon Kitney and Fiona Buffini, ‘CEOs Warn — ASX Crackdown Threatens Deals’, The Australian Financial Review, 24 February 2003, 1, quoting Mr Graham Bradley, Chief Executive Officer of Perpetual Investments.
[36] Foss v Harbottle [1843] EngR 478; (1843) 2 Hare 461.
[37] Cook v Deeks [1916] UKPC 10; [1916] 1 AC 554.
[38] Robert Baxt, Ian Ramsay and Geof Stapledon, ‘Corporate Governance in Australia: The Evolving Legal Framework and Empirical Evidence’ in Low Chee Keong (ed), Corporate Governance — An Asia-Pacific Critique (2002) 195.
[39] Ibid, 197.
[40] [1995] HCA 12; (1995) 182 CLR 432.
[41] Investment and Financial Services Association Ltd, Blue Book on Corporate Governance — A Guide for Fund Managers and Corporations, Guidance Note (December 2002) [10].
[42] Fiona Buffini, ‘Golden Handshakes Exposed’, The Australian Financial Review, 28 February 2003, 10.
[43] Australian Accounting Standards Board, Director, Executive and Related Party Disclosures, Exposure Draft 106 (May 2002) [3.1.1] 15.
[44] Fiona Buffini, ‘Reforms set on board table’, The Australian Financial Review, 20 February 2003, 7.
[45] See, eg, Michael Adams and Mark Freeman, ‘The Securities Market in Australia’ in Gordon Walker and Brent Fisse (eds), Securities Regulations in Australia and New Zealand (1994) 127.
[46] Lutgart van den Berghe and Liesbeth de Ridder, International Standardisation of Good Corporate Governance: Best Practices for the Board of Directors (1999).


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