The principles and guidelines on best practice corporate governance handed down by the Securities Commission are not enforceable. Directors, therefore, must now accept responsibility for their adoption. Shareholders/owners should demand accountability.
Board disclosure of governance practices is essential to shareholder, owner and stakeholder understanding and evaluation of directors’ standard of governance in practice. Boards should evaluate and report against these principles in their annual reports and it is good to see that the Securities Commission will diligently monitor companies.
I support the principles as far as they go but, they don’t adequately recognise or reflect the fundamental responsibility governance has in influencing organisational performance. The important conformance / performance balance is missing.
Directors should, as the first principle states, observe and foster high ethical standards. But in recognising that the guidelines that were published with the principles recommend the adoption of written code of ethics, the principle itself does not require board to adopt such code of ethics and to ensure adherence to it. Directors, managers and employees should all be required to confirm they have read and understand the code by signing it as condition of appointment and employment.
Principle two states that there should be balance of independence, skills, knowledge, experience, and perspectives among directors so that the board works effectively.
This principle and most of the guidelines to it are sound, with one important exception. The guidelines assume that an executive director is independent and that is just not possible in practice.
The guidelines state: “All directors should, except as permitted by law and disclosed to shareholders, act in the best interests of the entity, ahead of other interests.” And the summary of key findings from the consultation includes: “An independent director has no relationship with the company that could compromise his or her ability to exercise unfettered judgment…” It is hard to see how any executive who gains any benefit from being member of board can be truly independent.
The justification given that “strong executive representation at board meetings or on boards promotes constructive exchange between directors and executives that is necessary for boards to be effective” does not require the executive to be director on the board. The chief executive and other executive management do not have to be directors in order to provide management perspectives on matters before the board – that is management role and responsibility.
There must be formal, robust, verifiable and auditable information flows to the board, not dependent on the chief executive or other management being on the board. The directors must be in position to ask the hard questions of management. And managers in the role of director are frequently not prepared to participate fully in board debate, particularly to express views on matters of difference or dispute with their chief executive. The report does recognise “efficiency and accountability are improved if the respective roles of the board and executives are well understood”.
The call to use committees where this would enhance (board) effectiveness in key areas while retaining board responsibility is sound principle. It makes it clear that committees should be established only where they add value to the effectiveness and functioning of the board and where they don’t take away the responsibility and accountability of all the directors on the board.
But the committee charter should clearly state that board policy decision making, or decisions for which the board is accountable, should not be delegated – these must be recommended to the board for approval.
The principle that the board should “demand integrity both in financial reporting and in the timeliness and balance of disclosures on entity affairs” is important but too narrow.
Transparency is fundamental to good governance and key board responsibility. Boards should ensure that not only do they meet all their formal communication obligations, but also inform all those with legitimate interest in the organisation. Individuals and organisations should have the information and understanding they need in order to exercise their responsibilities toward, and their rights with respect to, the organisation.
Principle five states that “the remuneration of directors and executives should be transparent, fair, and reasonable”. While this is an important principle of good governance, the linkage of the principle and the guidelines to performance is weak. Governance exists to ensure performance, so it is logical that director and executive remuneration, to the extent it influences it, should rise in good performance years and fall in poor performance years, and appropriately reflect long-term performance. Company director remuneration should align director interests with those to whom they are accountable – shareholders or owners of the company. The principle does not do that.
According to principle six boards should “regularly verify that the entity has appropriate processes that identify and manage potential and relevant risks”.
This is very important principle of good governance, but neither the principle nor the associated guidelines, acknowledge that growth and creating shareholder value inevitably means taking risk.
Risk adverse governance is not good governance. Effective management of risk increasingly is the key to success. Directors’ responsibilities and accountabilities require that every director has clear understanding of the current and potential risks the organisation may be exposed to and how the risks will be managed. The principle does not recognise the importance of balance – being too risk averse stifles innovation, creativity and striving for higher levels of performance.
Boards should, as principle seven states, “ensure the quality and independence of the external audit process”. And, as principle seven suggests, boards should “foster constructive relationships with shareholders that encourage them to engage with the entity”.
Finally, principle nine, suggests boards should “respect the interests of stakeholders within the context of the entity’s ownership type and its fundamental purpose”. The principle and guidelines are sound but they do not recognise the important balance that should exist.
In the governance and management of any organisation in the interests of shareholders, the direct interests of the customers it serves; the employees who make it work; and the suppliers of goods, services and finance must all be satisfied. Also the directors must balance those interests with the interests of other “stakeholders” including the environment, the community and society in general.
Doug Matheson FNZIM holds number of directorships including the chairmanship of Biomedical Services Ltd, Wairarapa Health Board, Standards New Zealand and the Asian Association of Management Organisations. He is the immediate past national chairman of NZIM.
