Corporate Governance and Control

Corporate governance is part of a complex process involving regulations, guidelines and industry practices designed to monitor and manage the operations of organisations.

It affords a sense of control and predictability to a range of stakeholders, being governments, investors, management, consumers, clients or the community at large.

However, current governance or control mechanisms in isolation essentially only provide a thin veil of control in a highly complex operating environment.

There are a large number of organisations globally that have managed to maintain apparently robust governance structures, right up to the precipice of their own destruction.

Whilst the need for strong corporate governance is recognised by regulators worldwide, there is a growing view that corporate governance practice is not simply about a battle between contending stakeholders, greedy management and ineffectual boards of directors; but extends to the ethos of the organisation and culture of the company and its board.

This emerging view puts as much focus on the performance of the board in terms of culture and character as the traditional reliance on conformance involving governance and control measures.

Corporate governance and control mechanisms tend to focus on the relationship between the owners of capital and the operators of that capital; essentially shareholders and managers, although other stakeholders can also be highly influential.

For governments, corporate governance is about monitoring and managing the relationship between a more complex set of stakeholders in terms of clients, the general community, various government agencies and interest groups. Similarly, Not-for-Profit organisations have a broad constituency of stakeholders including sponsors, the community and clients.

The other important point to note about most governance, compliance or control structures is that they are historical and based on static data recorded at a point in time and thus, are therefore more analogous to driving a car by reference to the rear vision mirror.

Governance sets minimum standards of behaviour that stakeholders would expect should they become involved with an organisation.

The traditional view is that corporate governance arises due to the separation of ownership and control that often occurs in companies, organisations and governments.

Fundamentally, corporate governance is about ensuring the owners of a company – the investors / shareholders – are protected from the potential opportunistic behaviour of managers that can erode the owner’s wealth or deviate from the organisation’s stated purpose.

Governance and control mechanisms are also about maintaining the trust of stakeholders. If stakeholders perceive there to be a robust control structure, they may offer more support and are less inclined to intervene in the operations of the firm.

Apart from the regulatory requirements pertaining to Corporate Governance, an organisation can benefit from a strong foundation via the fostering of a resilient organisational culture, enhancement of a corporation’s public image and via a dramatic reduction in the costs of capital for the business.

The world is littered with public sector and corporate examples where governance structures have failed dramatically.

A recent US study on the impact of Sarbanes Oxley, arguably the world’s most stringent and costly governance regime, concluded that of 400 accounting scandals in the US in 2002, every single firm was Sarbanes Oxley compliant.

This point can be further illustrated by questioning whether firms like Enron, HIH, Babcock and Brown, Lehman Brothers and Bear Stearns had compliant programs, audited operations and accounts and risk management structures. They did and these systems ultimately did not protect them.

Clearly, a world without governance and control structures would not bear thinking about, but a total reliance on their ability to provide comfort over organisational operations is simplistic and perilous.

Governance and control structures are necessary and beneficial when applied properly. However, they are essentially only one part of an overall solution.

Corporate Governance, within the developed world, has come to be recognised as an important component of business, and regulators within Australia, the US, Canada and the UK have all developed standards, regulations and best practice guides.

Whilst some jurisdictions, such as the US, have favoured a legislative approach; within Australia regulatory bodies have favoured a principles-based, comply or explain approach. Whilst specifics vary between countries, and for different organisational forms (e.g. Public vs. Private companies), the fundamental recommendations of each body are essentially the same.

The following are a collection of principles of good corporate governance and associated practices, as outlined by the Australian Stock Exchange (ASX), which constitute a practical guide to meet many of the recommendations and principles outlined by regulators, with the aim of enhancing investor confidence in a firm’s governance practices.

The following 8 ASX principles are also reflected in a host of legislation, guidelines and practices throughout the developed world and serve as a guide to current best practice. Moreover, while these principles relate specifically to listed firms, the general thinking is and should be reflected in government departments and Not-for-Profit organisations.

Principle 1: Lay solid foundations for management and oversight

Companies should establish and disclose the respective roles and responsibilities of board and management.

• Recommendation 1.1: Companies should establish the functions reserved to the board and those delegated to senior executives and disclose those functions.
• Recommendation 1.2: Companies should disclose the process for evaluating the performance of senior executives.
• Recommendation 1.3: Companies should provide the information indicated in the Guide to reporting on Principle 1.

Principle 2 – Structure the board to add value

Companies should have a board of an effective composition, size and commitment to adequately discharge its responsibilities and duties.

• Recommendation 2.1: A majority of the board should be independent directors.
• Recommendation 2.2: The chairperson should be an independent director.
• Recommendation 2.3: The roles of chair and chief executive officer should not be exercised by the same individual.
• Recommendation 2.4: The board should establish a Nominations Committee.
• Recommendation 2.5: Companies should disclose the process for evaluating the performance of the board, its committees and individual directors.
• Recommendation 2.6: Companies should provide the information indicated in the Guide to reporting on Principle 2.

Principle 3 – Promote ethical and responsible decision-making

Companies should actively promote ethical and responsible decision-making.

• Recommendation 3.1: Companies should establish a code of conduct and disclose the code or a summary of the code as to:
  • the practices necessary to maintain confidence in the company’s integrity
  • the practices necessary to take into account their legal obligations and the reasonable expectations of their stakeholders
  • the responsibility and accountability of individuals for reporting and investigating reports of unethical practices.
• Recommendation 3.2: Companies should establish a policy concerning diversity and disclose the policy or a summary of that policy. The policy should include requirements for the board to establish measurable objectives for achieving gender diversity, in order for the board to assess annually both the objectives and progress in achieving them.
• Recommendation 3.3: Companies should disclose in each annual report, the measurable objectives for achieving gender diversity set by the board in accordance with the diversity policy and progress towards achieving them.
• Recommendation 3.4: Companies should disclose in each annual report the proportion of women employees in the whole organisation, women in senior executive positions and women on the board.
• Recommendation 3.5: Companies should provide the information indicated in the Guide to reporting on Principle 3.

Principle 4 – Safeguard integrity in financial reporting

Companies should have a structure to independently verify and safeguard the integrity of their financial reporting.

• Recommendation 4.1: The board should establish an audit committee.
• Recommendation 4.2: The audit committee should be structured so that it:
  • consists only of non-executive directors
  • consists of a majority of independent directors
  • is chaired by an independent chair, who is not the chair of the board and has at least three members.
• Recommendation 4.3: The audit committee should have a formal charter.
• Recommendation 4.4: Companies should provide the information indicated in the Guide to reporting on Principle 4.

Principle 5 – Make timely and balanced disclosure

Companies should promote timely and balanced disclosure of all material matters concerning the company.

• Recommendation 5.1: Companies should establish written policies designed to ensure compliance with ASX Listing Rule disclosure requirements and to ensure accountability at a senior executive level for that compliance; and disclose those policies or a summary of those policies.
• Recommendation 5.2: Companies should provide the information indicated in the Guide to reporting on Principle 5.

Principle 6 – Respect the rights of shareholders

Companies should respect the rights of shareholders and facilitate the effective exercise of those rights.

• Recommendation 6.1: Companies should design a communications policy for promoting effective communication with shareholders and encouraging their participation at general meetings; and disclose their policy or a summary of that policy.
• Recommendation 6.2: Companies should provide the information indicated in the Guide to reporting on Principle 6.

Principle 7- Recognise and manage risk

Companies should establish a sound system of risk oversight and management and internal control.

• Recommendation 7.1: Companies should establish policies for the oversight and management of material business risks; and disclose a summary of those policies.
• Recommendation 7.2: The board should require management to design and implement the risk management and internal control system to manage the company’s material business risks and report as to whether those risks are being managed effectively. The board should disclose that management has reported as to the effectiveness of the company’s management of its material business risks.
• Recommendation 7.3: The board should disclose whether it has received assurance from the Chief Executive Officer (or equivalent) and the Chief Financial Officer (or equivalent), that the declaration provided in accordance with section 295A of the Corporations Act is founded on a sound system of risk management and internal control; and that the system is operating effectively in all material respects in relation to financial reporting risks.
• Recommendation 7.4: Companies should provide the information indicated in the Guide to reporting on Principle 7.

Principle 8- Remunerate fairly and responsibly

Companies should ensure that the level and composition of remuneration is sufficient and reasonable, and that its relationship to performance is clear.

• Recommendation 8.1: The board should establish a remuneration committee.
• Recommendation 8.2: The remuneration committee should be structured so that it:
  • consists of a majority of independent directors
  • is chaired by an independent chair that has at least three members.
• Recommendation 8.3: Companies should clearly distinguish the structure of non-executive directors’ remuneration from that of executive directors and senior executives.
• Recommendation 8.4: Companies should provide the information indicated in the Guide to reporting on Principle 8.

It would it be difficult for any group to argue against the principles and what they are seeking to achieve. However, the ability to comply with these principles and the direct correlation with an ethical well managed firm is tenuous.

Whilst the need for strong corporate governance is recognised by regulators worldwide, many now believe corporate governance practice is not simply about a battle between contending stakeholders, greedy management and ineffectual boards of directors; but extends to the ethos of the organisation, the culture of the company and its board.

This emerging view puts as much focus on the performance of the board in terms of culture and character as the traditional reliance on conformance, involving governance and control measures.