Corporate governance is one of those phrases used on daily basis in the business and general media but few of the great unwashed, it seems, understand it or the central principles involved. There is strong public sense that corporate governance, whatever it is, is certainly somebody else’s problem. This, of course, begs the question as to whether regulators and others charged with managing the conduct of companies comprehend the whirlwind of change in the world of corporate governance that is already under way. If ever an event were to have real impact on management it is the full implications of the Sarbannes Oxley Act 2002, introduced in the United States in the wake of Enron, WorldCom and other corporate disasters.
Our Securities Commission commenced its governance study in June last year at the request of the then Minister of Commerce Lianne Dalziel. Neither should really be forgiven for setting out on this journey so late when virtually all other governments and stock exchanges had already moved to amend governance rules, many starting in the early ’90s. This slowness to act suggests one of two things: either the regulators believed the regime was already sufficiently robust, or that there were no significant problems to address. Both views indicate some complacency in the face of mounting governance failures such as Enron or, closer to home, HIH Insurance, or misunderstanding of the importance of raising New Zealand’s capital base.
Like it or not New Zealand is part of the so-called “global economy” with more than half (by value) of all tradeable shares held by offshore interests. If offshore regimes have orchestrated significant governance change there is merit in knowing why. Apart from the obvious need to conform, other pressures are at work. The need to raise capital is central feature of real wealth creation. The NZX barely participates. handful of new companies were brought to the market last year. Australia, by contrast, witnessed 47 flotations in 2003 and 50 are scheduled this year.
The importance of good corporate governance in raising our capital base was forcefully brought home to me last November in the boardrooms of two London investment banks. When asked why they invested so little of their clients’ money in New Zealand they made clear that they considered our governance regimes “out of step” with New York, Frankfurt, London etc. Their duty, they explained, was to invest in companies that operated in regimes able to demonstrate robust growth potential with low levels of risk and perceived management accountability. The small size (by value) of the NZX may demonstrate the cost of not being “in step” with other investment environments.
But now turning to the SC report, I note the efforts made to ensure consultative process. They tried, it seems, to garner the views of the entire management community before going to print. Everyone was invited: company directors, the professions, investor representatives, local authorities, district health boards, Maori organisations, fund managers and uncle Tom Cobley. After months of consultation, just 71 individuals felt strongly enough to attend meetings and 160 others sent written response. Is this the real measure of the importance of corporate governance in New Zealand?
I’m not really surprised that each of the Nine Principles of Corporate Governance set out in the Commission’s report published in February contained the word ‘should’. Nowhere is there suggestion that failure to adhere to the principles will involve any kind of sanction or penalty – other than, perhaps, public opprobrium. This is in stark contrast to regimes elsewhere and offers little support for the efforts of so-called shareholder activists to hold managers to account. With one notable exception, shareholder activists are absent from our capital markets, again in contrast with overseas.
Governance, according to the accountants and trade associations I discussed the report with, is like risk management; subject likely to induce sleep in the corporate world. In the words of one major practitioner: “Unlike me, commerce presumes the present regime works well enough and our small size protects us from the Parmalats, Enrons et al.” Others echo this view, suggesting that the report’s likely impact on local company directors will be zero.
Given the lack of prescriptive power contained in the report, ‘steady as she goes’ is the likely outcome. The publication of the report caused barely ripple in the media unlike, say, Hampel or Cadbury in the United Kingdom in the ’90s. Both stimulated lively debate that resulted in changed attitudes and have, according to leading commentators, returned corporate authority to owners. Shareholder accountability is very different in the UK. More than half of FTSE 100 companies recently reported receiving detailed instructions on governance requirements, which ranged from demands to remove chief executives to ensuring companies do not pay personal indemnity insurance premiums for auditors, perk which effectively compromises their independence.
Predicting governance change in New Zealand is always uncertain but some change is inevitable. The ‘safe bet’ is for voluntary change pending governance catastrophe akin to Parmalat. Speaking ‘off the record’, senior officials involved in governance share remarkably similar views and whilst not willing to be quoted (not yet anyway) express pressing desire to have regime that is in step with other free market economies. The most desirable changes are:
• The need to define ‘independent director’.
• The mandating of committees controlled by independent directors, to oversee director recruitment, audit and executive remuneration.
• Separation of CEO and chairmanship functions.
• Executive remuneration, benefits-in-kind and share options to be approved by shareholders at AGMs.
• Improved communication with shareholders including changes to proxy voting mechanisms.
Principle 7 of the SC report says that: “the board should ensure the quality and independence of the external audit process.” It is hard to believe that it has escaped negative criticism. While no one wanted to make negative observations about the quality of auditing services available, there is body of opinion that believes auditors should only be appointed by audit committees of wholly independent directors. Auditors do not, after all, report to companies, but to shareholders.
An independent director’s function is to monitor the relationship between auditor and company. There is implicit criticism that the relationship between managers and auditors is difficult to manage effectively in small business community. Rotation of auditors may assist the process. The report’s key findings in this area run contrary to international opinion and so only time will tell if our approach still fails to stimulate international investor confidence. For example, an independent audit oversight body is reportedly ‘not required’. The US and UK already have them and the EU is working on it at present.
The SC report probably does just enough to prod some reform but falls well short of establishing principles of best practice in corporate governance. Statements like: “Good governance practices will generally benefit stakeholders” were presumably written without the knowledge gained by independent research (McKinsey 1996 and University of Newcastle, NSW 2003 among others), establishing beyond doubt that the association between good governance and shareholder value is ‘causal’ and can be measured. Good governance increases shareholder value by 11 percent – worthy outcome for more prescriptive solution.
Ashley Balls is management adviser to the legal and financial services industries. Email: [email protected]
