Advisory Boards

The Rise of advisory boards

Overview

A relatively inexpensive and effective way to strengthen an organisation is by establishing an Advisory Board.

Performance orientated organisations, including large conglomerates, statutory authorities, not-for-profits and public companies, establish advisory boards to provide management with an inexpensive and flexible sounding board of expertise and advice.

The reasoning for establishing advisory boards will differ between each organisation, but required in each case is a need for a set of senior leaders with relevant expertise who can look at opportunities and issues and provide strategic insight.

Key Findings

Advisory Boards can:
• Provide strategic input and advice to management.
• Have relatively reduced liability compared to statutory boards.
• Be less costly to maintain than statutory boards.
• Help deal with specific objectives such as expertise in a new market or new regulations.
• Help the organisation benefit from leveraging the experience and credibility of the Advisory Board members to access new capital, clients and expertise.

What is an Advisory Board?

An advisory board is a committee of individuals selected by relevant stakeholders (the owner in the case of private companies and the statutory board for public companies), to provide defined advice and information to the owners, board and management.

Advisory boards counsel, guide and recommend in terms of routine activities and have no power of decision making.

Importantly, they are not a substitute for a statutory board of directors.

The purpose and composition of an advisory board differs for each organisation and will be dependent upon the life cycle of the organisation, its strategy or specific need for expertise.

Differences of an Advisory Board?

An advisory board is different to a statutory board.

The following are differences found in advisory boards:

• No fiduciary responsibility. Unlike a statutory board of directors, advisory board members are not governed by legislation or listing requirements.
• No powers of management. Advisory Board members counsel and have no powers to veto management decisions.
• Do not represent shareholders.
• Report directly to Management and provide advice and support to the CEO. Statutory boards report to the shareholders and then to management.
• Less formal than a statutory board of directors
• Appointed by the managing director (usually) and not by shareholders.

Responsibilities of an Advisory Board

The following are responsibilities typically undertaken by Advisory Board members.

• Provide industry perspectives and expertise.
• Provide independent guidance and counsel.
• Further strengthen financial and strategic advisory credentials.
• Enhance domestic and international reach by leveraging the networks of advisory board members.
• Network with other members of the board, management and owners for the benefit of clients, regulators and other stakeholders.
• Advise on new strategic objectives.

Benefits of an Advisory Board

Reduced Liability

A Statutory Board of directors has a fiduciary responsibility to the company. However, Advisory Board members do not have the same implied fiduciary responsibilities. Notwithstanding, there can be a fine line between Advisory and Statutory Board membership, as there is legal precedent in Australia that if a person is ‘seen’ to be acting as a Director of a company, then that person is considered to be a Director of the company in question. For this reason, the charter of an Advisory Board and the responsibilities of its members must be clear and not encroach upon Statutory Board activities.

Reduced Cost

Since, Advisory Board members are not burdened with the same fiduciary responsibilities as a Statutory Board, their compensation is lower and thus the organisation reduces its costs whilst benefiting from their expertise and oversight.

Expertise

An Advisory Board member’s experience and association related to a specific industry, market or knowledge of growing a business is used as a sounding board to support decision making.

Reputation

Advisory Board members are typically very experienced or high-profile executives who can therefore provide management with corporate credibility and reputation enhancement through association

Networks

Organisations can grow faster and improve their performance by leveraging the networks Advisory Boards possess. For example, former politicians and bureaucrats are popular appointments to conglomerates to leverage key foreign contacts or greater access and understanding to new regulations.

Independence

Advisory Board members are not appointed by shareholders and thus do not owe interest groups or specific shareholders any duty. They are hired on the basis of providing expertise and guidance on a specific needs basis. Moreover, Advisory Board members are not typically hired from within the firm and can therefore usually provide an independent perspective.

Board Performance

From Conformance to Performance

Overview

Contemporary boardrooms are significantly different environments from those prior to the GFC, and boards that do not keep pace with both regulatory and stakeholder expectations do so at their own peril.

Boards are expected to be more engaged, more knowledgeable and more effective than in the past.

In doing so, boards cannot continue to drive the board evaluation process simply from a technical focus on compliance factors and ignore the critical issue of the behavioural performance of individual directors and the culture of the board as a team.

Key Findings

• The board evaluation process is an important tool for monitoring the performance of boards of directors.

• Board evaluations that emphasize conformance and do not properly account for the behavioural contribution of directors are not adequate.

• An effective board assessment should combine both technical factors (conformance oriented) with behavioural considerations (performance oriented).

Introduction

Regular evaluation of a board’s performance is now considered an integral part of an organisation’s corporate governance structure. Regulators, shareholders, corporate litigators and other major stakeholders have long attributed the failure of organisations during the Global Financial Crisis to the oversight failure of their boards.

What is less understood in the board evaluation process is the type of evaluations required to provide stakeholders of organisations with sufficient information about the performance of their boards.

An effective board evaluation must combine regulatory responsibilities (conformance) with performance based evaluations.

What is Conformance?

Most board evaluation frameworks tend to examine board performance from a compliance perspective. Inadequate board performance is often explained from the perspective of non-compliance with established regulatory frameworks.

In Australia, compliance frameworks include the Australian Prudential Regulation Authority (APRA), the Australian Corporations Act 2001 and the ASX Corporate Governance Principles for Publicly listed companies.

ASX Corporate Governance Council Governance Principles

Recommendation 2.5 of the ASX CGC Principles and Recommendations states that ‘Companies should disclose the process for elevating the performance of the board, its committees and individual directors’.

Australian Prudential Regulatory Authority

The APRA Prudential Standards APS 510 – Governance, states that the board ‘of a regulated institution must have procedures for assessing, at least annually, the board’s performance relative to its objectives’.

Corporations Act 2001

The Corporations Act 2001 of Australia regulates directors’ duties and the fiduciary responsibilities they have to their shareholders.

What is Performance?

The performance of any board is a function of the character of the board members and the effectiveness of the culture of the board as a team.

Crucially, board performance is derived from the quality of the human interactions within the boardroom.

Thus, boards intending to increase performance must begin by evaluating their own performance and how they function as a team.

It is only when boards objectively, intellectually and effectively evaluate their own performance can they grow and improve.

This leads to better performance through stronger leadership, resilience and cohesiveness.

Improving Board Assessment

A board assessment framework that incorporates both conformance and performance factors is essential for effective board evaluation.

However, current approaches to board performance evaluations are heavily focused upon compliance without regard to specific behavioural factors, such as the culture within the boardroom.

This includes the character of the team and the relationship between the chairperson and the chief executive.

The characteristics of individual members of the board will also provide an assessment of the board’s overall quality.

Conclusion

An increasingly prescriptive oversight regime by regulators has had a major impact on the focus of board evaluations.

Consequently, compliance to standards and regulations is the prevailing theme in terms of board evaluations.

There is little regard for assessing the issue of behavioural factors in the context of broader board performance.

Traditional reliance on board control processes (conformance) is only part of the solution.

The incorporation of specific behavioural factors when evaluating board performance, namely the culture of the board as a team and the characteristics of the individual directors are also critical considerations.

Director Skills

Director Skills

Overview

The skills and experience of directors is a topic of critical importance to fellow board members and shareholders. There is continual debate regarding the optimum skill-set for a director, ranging from the need for financial literacy, the logical advantage of compliance experience, the added benefit of IT expertise and the utility of various entrepreneurial and strategy related factors.

Ultimately, the skills of a board’s directors need to align with the strategy and needs of the organisation, and not solely with a generic set of criteria.

What is right for one organisation may not be optimum for another, even one from the same market and industry.

To this end, organisations should seek to appoint directors that complement the particular strategy of the company in question rather than a standard list of skills.

Whilst many directors are often hired for technical skill or their ability to open doors, it is arguable that the most admired directors are recognised and remembered for the behaviour and decision making abilities.

Regulatory Framework

The Corporations Act of Australia requires every director to exercise reasonable care, diligence and skill. It is therefore necessary for directors to have the appropriate knowledge, skill and experience to comply with their fiduciary duties to all shareholders.

Every board and its directors should have the collective and individual knowledge, skills and experience to make decisions that add value to the organisation as a whole.

The ASX Principles of Good Corporate Governance and Best Practice Recommendations state that:

‘Corporate performance is enhanced when there is a board with the appropriate competencies to enable it to discharge its mandate effectively. An evaluation of the range of skills, experience and expertise on the board is therefore beneficial before a candidate is recommended for appointment. Such an evaluation enables identification of the particular skills, experience and expertise that will best complement board effectiveness.’

Other guides within the industry, such as the APRA prudential standards APS 510, GPS 510 and LPS 510; require boards to assess their performance and that of individual directors at least on an annual basis.

Directors are appointed to the board because their specific skills, knowledge and experience will fill particular gaps in relevant competencies. It is important to acknowledge that not all directors will possess all necessary skills, but the board as a whole must possess them.

The skills which are crucial to a board’s success should encompass both generic skills and those specific to the industry of the organisation.

Key Generic Skills

Senior Management Experience

Directors must have experience as a senior manager, given they have responsibilities as a communicator, decision maker, leader, manager and executor.

Moreover, the relationship between the CEO and the board of directors is vital to every organisation. Consequently, previous experience on the part of directors in a major decision-making role regarding policy and strategy will provide efficacy within the boardroom.

The additional benefit usually ascribed to directors with senior management experience is the ability to manage and navigate through organisational complexity, with greater ease than those who have not managed complex structures.

Listed Experience

Listed companies must adhere to ASX listing requirements and are subject to greater regulation within the Corporations Act. For example, directors have higher disclosure requirements under Section 191 of the Corporations Act. ASX listing rule 3.1 requires listed companies to disclose certain price-sensitive information to the market as it occurs.

Chair Experience

The Chair should be an independent director, responsible for leadership of the board and for the efficient organisation and conduct of the board’s functioning. The Chair should also facilitate the effective contribution of all directors and promote constructive and respectful relations between directors and between the board and management.

Audit Experience

All directors should have at least a basic understanding of financial statements. Audit experience gives directors the ability to critically analyse financial statements, thus contributing to the effectiveness and efficiency of their decision making.

Financial Literacy

Organisations have a language which usually centres on the ability to read and review financial or business presentations. An inability to read and interrogate financial information is a liability for a director in any organisation.

Risk Experience

Directors must have the ability to assess risk when making key decisions. This goes beyond risk mitigation and includes the ability to take considered risks for the long term benefit of the organisation, which align with the organisation’s long term goals.

Compliance Experience

Directors must understand the company’s governance responsibilities, such as compliance with local laws and regulations, as well as social responsibilities.

Strategy Experience

Directors are expected to have the ability to see the macro perspective of an organisation based on patterns, trends and cause/effect relations, so as to determine the raison d’être of the organisation. This requires sensitivity to, awareness for, and an understanding of the business and market environment, in addition to a practical grasp of the firm’s core competencies.

Relationship and Origination

Directors should be engaged in the business and have the ability to introduce and develop opportunities or use their knowledge and networks for the benefit of the organisation’s long-term strategy.

Investor Relations

Directors must be aware of current and upcoming issues which the organisation may face, particularly those that relate to their fiduciary duty.

This skill is central in enabling effective communication between the organisation and the financial community. Boards should be able to respond to inquiries from shareholders and investors, as well as others who might be interested in the organisation’s stock or financial stability.

The critical flaw many boards make is to either hire directors based purely on technical skills or seek the same skill set from each director.

The skills required should be viewed as a matrix. Provided the necessary skills are covered in the matrix, the board is then able to broaden the hiring requirements and build genuine diversity, which in turn leads to richer thinking and better decision making.

The major issue in hiring solely based upon technical skills is that skills erode over time. For example, a retired audit partner may be hired for skills that are potentially obsolete.

Key Attributes

Beyond these generic skills, directors should also possess certain attributes as a member of a board.
These include the following.

  • Communication and Contribution
    Directors must be able to effectively communicate their ideas to the board. Directors are required to contribute their skills, knowledge and expertise to their board in order to be an effective member of that board. Good directors have a voice and are prepared to use it constructively.
  • Collegiality
    Cooperative interaction amongst board members is critical. Working with a team of fellow directors requires tact, sensitivity, the ability to engender trust and respect, and an awareness of different perspectives, interests and the values of others.
  • Continual Development
    Any director needs to understand the business they are overseeing, either through previous experience or building on that knowledge. This is particularly the case in complex or specialists industries. The ability to learn and continually develop is beneficial to a director’s longevity and contribution.

Boardroom Quotas

Quotas in the Boardroom

Overview

Establishing quotas within the boardroom is at the forefront of conversations surrounding improvements to board diversity.

While there have been a number studies linking enhancement of boardroom diversity with greater boardroom performance, there has been no agreed approach to achieve a diverse boardroom.

Different countries have adopted varying approaches. Europe continues to pursue regulatory change and introduce mandated board quotas whilst other countries, including Australia, have used principles or recommendations to elicit voluntary change.

Key Findings

• There is growing pressure from interest groups to introduce mandated board quotas, to improve diversity.
• Quotas increase diversity, but do not necessarily address the drivers of board performance.
• ASX Corporate Governance principles require listed entities to disclose diversity policies within annual reports.
• Board performance is a function of skills, experience and values that are aligned with organisational strategy and needs.
• A combination of appropriate board diversity and the existence of relevant skills and behavioural characteristics of directors can provide the best enhancement to board performance.

Introduction

Does the increased presence of women or other groups influence board performance? In boardrooms across Europe, the US and Australia, directors, regulators and key stakeholders have long debated the introduction of mandated boards via quotas.

Diversity can be defined in many ways to include gender, race or cultural background. In Australia, the Commonwealth Government released its much anticipated white paper “Australia in the Asian Century”, leading to calls from chairpersons and directors against ‘Asian Board’ quotas.

Contemporary research suggests that boards with more diverse gender representations outperform firms dominated by male-only boards. Enhanced return on equity amongst more diverse boards are just some of the long argued benefits towards greater boardroom diversity.

What is fuelling the debate to introduce quotas?

Supporters for regulatory change point to low representation numbers amongst females at board level. As of 2010, women represented only 13% of the directors of listed Australian companies.

This contrasts with the female participation rate, which comprises nearly half of the overall labour force. Overseas, the numbers are similar.

Only 16.1% of board seats of US Fortune 500 companies are occupied by women, with this figure even lower in the UK where 15% of seats are occupied by women.

Contemporary approaches to improving gender diversity

Europe:
The European Union (EU) is trying to introduce legislation to ensure gender equalisation within the boardrooms of European organisations. This initiative, led by European Union Justice Commissioner Viviane Reding, would oblige company boards to allocate 40% of their seats to women by 2020 or face EU fines.

Finland:
Recommendation 9 of the Finnish Corporate Governance Code for Listed Companies states that both genders shall be represented on an organisation’s board. This recommendation came into force in 2010. If a company does not comply with the recommendation, it must account for and explain its divergence from the Code.

United States:
There is no legislation that mandates fixed percentages of female representation on boards of listed entities. However, the Securities and Exchange Commission (SEC) has a rule that requires companies to disclose whether and how a nominating committee considers diversity.

Australia:
Since 2001, the Australian Stock Exchange (ASX) requires its member companies to set and report targets for gender diversity at the board and senior executive levels. Included in these targets is the provision to develop strategies for increasing the pool of female candidates, to improve diversity amongst listed entities.

The ASX Corporate Governance Council’s Corporate Governance (ASXGC) Principles and Recommendations, encourage entities to establish diversity policies for their boards, set measurable objectives for achieving their diversity goals and disclose the involvement of women in its workforce and board.

Setting Quotas: The Advantages

There is growing pressure by regulators and other stakeholders for Australia to consider gender or cultural-based quotas.

The reasons against quotas include.

• Quotas mean tokenism. Quotas help increase the minimum number of female seats in the boardroom but only as a token gesture.

• Qualification into a boardroom must be determined by meritocratic means and quotas would only exacerbate the problem of a gender divide. Instead, both male and female directors must be considered as equals, without regard to one’s gender, age, racial or cultural background.

• Quotas target the symptom but not the cause. Organisations with inherent biases will continue to suffer from the same cultural problems, regardless of quotas. Such organisations will seek the same biases, education, and experiences in the selection of mandated directors.

• Quotas encourage mediocrity and de-emphasise skills. Employment by way of a quota leads to a reduction in skilled directors as the emphasis on gender, race or culture forces organisations to consider a lower pool of qualified candidates. Instead, the key considerations should be the skills and value alignment required of a director that are necessary to add value to the organisation.

• Quotas only prescribe minimum standards. Cultural change within an organisation cannot be achieved through prescriptive regulatory measures.

• Regulation serves only to create minimum standards or floors and does not acknowledge the pertinent issue of matching skills with the strategy of the organisation, which is crucial in improving board performance.

Conclusion

If a board is genuinely performance oriented, it should shift its focus from simply who is on the board to why they occupy seats; by focusing on the specific skill sets and individual characteristics that align with the organisation’s strategy.

Voluntarily diversifying its composition to mirror the demographics, perceptions and profiles of society can provide a catalyst for enhanced diversity of thought and leadership within the boardroom.

However, this does not necessarily address the crucial issue pertinent to shareholders- what drives better performance?

Stronger board performance can be achieved through a combination of appropriate diversity and the relevant skills and characteristics of the directors in question.

Board Culture

Board Culture

Overview

Corporate culture is enacted and continuously created by every member of an organisation through their day-to-day participation. It provides employees with (largely unspoken) rules for how they should behave to gain and maintain social ‘membership’ in the organisation.

The board is the ultimate custodian of corporate culture in an organisation and has a responsibility to set the appropriate tone from the top.

Consequently, the team culture within the board itself is just as important as the culture throughout the organisation. Despite this, many boards continue to focus the majority of their time on process and governance related issues whilst ignoring or diminishing the ongoing effort required to cultivate an effective standard of board culture.

Governance and control structures are necessary and beneficial when applied properly. However, these factors are only part of an effective board performance program.

The board also needs to achieve a constructive means of interacting and performing as a team of peers, guided and facilitated by the Chairperson. This represents the quality of the team culture within the boardroom.

In this context, the best way to ensure optimum board performance is to combine comprehensive compliance measures with behavioural factors that enhance the performance of the board as a team and the value of each director’s individual contribution.

Introduction

A performance culture emanating from the board is the critical determinant of its own effectiveness and the effectiveness of the organisation it oversees.

Whilst there may be exceptions where boards “float with the rising tide” or enjoy structural or technological advantages embedded within the organisation, boards that fail to address their own performance culture are ultimately failing their shareholders and stakeholders.

What is Board Culture?

Whilst the term culture is often misused and overcommercialised, a good performance culture at board level imbues the organisation with greater reliance and flexibility than an organisation that focuses solely on the minimum corporate governance requirements.

In this context, culture refers to the team orientation of the board and its ability to collaborate and constructively challenge each other whilst still maintaining board cohesion and collegiality.

It also includes the role of the Chairperson as a team manager; a pivotal responsibility in terms of enhancing team effectiveness in balancing the skills, talents and ambitions of other board members, the relationship with management generally and with the CEO specifically.

Whilst the relationship and level of communication between the CEO and Chairperson are important, the power relationship is also critical.

There are countless examples of the CEO undermining the authority of the Chair, which effectively undermines the entire governance structure.

Current research would suggest without the right cultural dynamics within the board room, the performance and effectiveness of the board will be severely impaired.

A performance culture within the board enhances decision making and leads to more informed and effective outcomes.

Why is Board Culture important?

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, accounts and risk management structures. They did and these systems did not ultimately 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 only one part of an overall solution.

Board Culture is tangible

Boards can become fatigued with surveys and questionnaires and banal benchmarking exercises, which many describe as a search for mediocrity.

Often the process of evaluating board culture is inadvertently overlooked as either too hard and confrontational, or too vague and esoteric in nature.

However, those boards that enjoy a good culture often link that culture to the character of the individual directors, and most importantly to the character and competence of the Chair, whom draws out the experiences of each director to add to the richness of boardroom decision making and debate.

Board Performance Priorities

Intuitively, nearly all directors rated culture as the number one determinant of organisational and board effectiveness in a recent study of 88% of the ASX boards by market capitalisation.

The key message from the table below is that whilst directors spend time on the compliance structures, they clearly believe the character of the directors and the culture of the board as a team is far more important than a sole focus on the prevailing regulatory regime.

A concern many directors raised was the situation that some board members view the regulatory standard as the maximum standard of behaviour, whereas it is the minimum and conforming to the minimum regulatory standards discharges or acts as a proxy for moral or ethical behaviour.

What is Good Board Culture?

Whilst the controls, skills and composition of the board may be assessed through a large variety of historical reporting; culture must be uncovered through extensive dialogue with a large range of stakeholders from a variety of perspectives, to discern myth from reality.

A board with a bad culture appears obvious to many directors. The factors and behaviours that determine a good culture are less obvious. Some of those trace behaviours are:

  • The relationship between the board and management.
  • The power relationship between the individual directors. One director may monopolise air time or not endure dissent.
  • The ability to engage in open, frank and critical debate that supports the strategic goals of the organisation.
  • The ability to listen to arguments and change their minds on issues.
  • The relationship between the CEO and Chair and the inherent power struggle/ balance that needs to be managed and maintained.
  • The level of trust, respect and support for the organisation’s strategic direction.

The above is a guide to some of the critical markers which are used to assess board culture.

The culture of the board and the characteristics of the individual directors speak to their ability as a team to meet future challenges, strategic goals, unplanned risks and stressful events.

In this sense, their culture may be seen as a leading indicator of board effectiveness; whereas the control and composition categories relate to lagging or historical markers, which an organisation has previously experienced.

Corporate Governance

Corporate Governance and Control

Overview

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.

What is Corporate Governance?

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.

Why is it necessary?

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.

Does it work?

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.

Best Practice Approaches

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.

Future Direction

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.

Directorship Tenure

The Length of Board Directorships

Overview

There was a time when a directorship was akin to a life peerage, where tenure was perpetual until the director became physically incapable of attending meetings.

Today, the issue of board tenure is much more complex and framed by the director’s usefulness or appropriate contribution to the organisation. How this departure point is canvassed and ultimately agreed upon is not always obvious or effortless.

Key Findings

• There is no direct correlation between board terms and board performance.

• There is a recent trend by organisations to limit directorship to three year terms.

• Board Performance evaluations are beginning to incorporate a consideration of director tenure, in addition to composition.

• Organisations typically use three approaches to tenure:

  • ­Fixed Terms: Where a director’s term or number of re-elections is limited.
  • Fixed Term plus Hurdles: Where the maximum term is set at two three-year terms.
  • Performance Process or Hurdles: Where there is a review of the performance of directors against stated goals.
Introduction

“I would hate to see mandatory tenures for directors. It is the contribution that needs to be counted and not the age or length of tenure”
– Chairman, ASX/50

For a director, the decision to call it a day is a critical component of the board composition debate and speaks to issues of performance, cronyism, diversity, corporate memory and quality decision making.

Whilst in the past, lack of attention on the part of directors attending meetings may have been tolerated, the current performance of directors is demanding consideration of not only who sits on the board but how long they sit there. For instances where board terms are specified, most terms are usually set at three years

Setting Term Limits: Advantages and Disadvantages

Many boards find that setting term limits can be beneficial.

The advantages of setting term limits include:

• Incoming directors know that their contribution and commitment has to be measured within a limited time frame.
• Managing diversity is made easier through regeneration of the board whilst the gene pool can be continuously replenished.
• The board has a built-in balance of continuity and turnover.
• Passive, ineffective, or troublesome board members can be more easily rotated off.
• Board members experience a better rotation of committee assignments.
• A regular infusion of fresh ideas and new perspectives is brought onto the board.
• The board pays attention to, and gains a regular awareness of the changing group dynamics.
• Eliminates the sense of entitlement for those that wish to retire into a directorship.

The disadvantages of setting term limits include:
• There are some industries where it is important to have an experienced director with a good corporate memory, who has witnessed recurrent trends or cycles over time.
• There is a risk that large portions of expertise or corporate memory is lost at one time if board succession planning is not managed effectively.
• Extra attention and effort needs to be focused on managing the pipeline of potential directors.

“Length of service is not the issue. What needs addressing is performance and the sense of entitlement that can develop amongst long serving directors”
– Former Non-Executive Director, Listed Australian Bank

Issues with not Setting Term Limits

Boards without a term limit policy can experience:
• Stagnation, if no change occurs among the board members.
• Perpetual concentration of power within a small group.
• Group think and diminishing debate/ discussion over critical issues.
• Alienation and intimidation of the occasional new member.
• Tiredness, boredom and loss of commitment by the board.
• Loss of connection to dynamic changes in demographics, strategy or environmental factors.

Approaches to Setting Term Limits

Fixed Terms:
Under this structure, a director’s term or number of re-elections is limited in advance.

Commonly, the term is set at three years with mandatory retirement after two or three, three year teams.

For example, Singapore Airlines mandates a 6 year maximum term for directors as do some super funds.

Fixed Term plus Hurdles:
This is where the maximum term is mandated, for example, two three year terms.

If a director wishes to seek re-election for a third term of three years, then a significant majority of other directors or two-thirds of the board must also sanction the reappointment.

Should a fourth term be sought, then all directors must unanimously agree to the reappointment.

In addition to director sponsorship, the process could be supplemented with a shareholder or stakeholder engagement process.

Performance Process or Hurdles:
This process involves the review of the performance of directors against stated goals or their general contribution to strategic development of the organisation and board.

This process needs to be transparent and independent amongst the directors, but the results confined to the board, chair and head of the nominations committee.

The simplistic survey approaches currently employed are insufficient to effectively evaluate a director’s contribution, and hierarchical line management performance models are usually not appropriate to the peer and matrix structures found in boards.

Conclusion

“I was on one board for more than twenty years and resigned due to the perception that my tenure was too long, but had much more to give. I was on another board for about three years and felt I had made my contribution. Every situation is different”
– Former-Chairman, ASX/20

Adopting limits for directorship terms can provide a release valve for under-performing directors. However, it does not directly address the issue of board performance.

Director Characteristics

Director Characteristics

Overview

Boards are spending a significant amount of time focusing on the technical process related to board procedures and responsibilities, and the control structures of the board.

Whilst these factors are critical and necessary, many boards are beginning to recognise that the character of the individual directors and the culture of the board as a team are just as important.

Moreover, there is a significant difference between the skills of a director and the characteristics (behaviour) that make that director an effective contributor to the board’s performance.

It is the right combination of appropriate and relevant skills and the desirable type of characteristics that will ultimately determine the value of a director’s contribution to the organisation.

Whilst a person’s true character is often revealed under duress, there are definable and measureable characteristics that distinguish high performing directors.

Introduction

Whilst the control structures that surround a board and the composition and skills of board members are critical to success, the ability to leverage individual talents is determined by the behaviour and characteristics of the directors whom compose the board.

What are the Characteristics?

Characteristics refers to the individual directors’ behavioural traits, the sum of which provides the raw ingredients for a higher performing board.

Similarly, the team culture in the boardroom provides the recipe through which to combine those characteristics to the benefit of the board as a whole.

Some directors may exhibit passive characteristics, where their contribution is measured by their attendance at board meetings only.

Other directors may be more proactive and engage in a range of activities beyond mere attendance or compliance requirements, including mentoring management, and opening their contacts or networks of influence for the betterment of the firm.

Directors may be highly independent and not sway or deviate from standards or beliefs when under pressure or bullying by other directors, the CEO or even the chairperson.

Characteristics are very different to director’s skills. For example, there may be a director with 30 years audit or investment banking experience.

However, if he/she does not properly read the board papers or does not have a voice for expressing a constructive opinion at board meetings, that director can become a liability despite his/her obvious skills and experience.

Conversely, despite having a relatively lower level of corporate experience, some directors may be excellent communicators and ambassadors of the firm, which can enhance their overall contribution.

Some directors may be more financially literate, while others have great strategic insights, and some may have critical but infrequently required bear market or credit crunch skills.

Having the right compliance and composition is of little value if individual directors are not prepared to step up to new challenges and be counted when and where it makes a difference to the performance of the organisation, and in the execution of its strategic plan.

Director skills remain critically important, but it is the combination of skills and characteristics (behaviour) that determines the ultimate value and contribution of a director to the board.

Consequently, the skills of a director and their contribution to the board and strategic development of the firm are not the same.

The right combination of character and skills of individual directors can have a profound impact on the effectiveness of the board, if managed successfully by the chairperson.

Desirable Characteristics

Whilst some directors may baulk at a conversation about indiviudal characteristics, absence of such a discussion is an obvious precursor to serious organisational issues.

Whilst a person’s true character is often revealed under duress, there are characteristics that distinguish high performing directors. These include:

• They are thought of by other directors as open, honest and ethical in all their business dealings and command the trust and respect of their peers.

• They are engaged and prepared in their dealings with the board.

• They are advocates and ambassadors of the organisation, provided it is aligned with the board strategy and protocol.

• They are open and generous with their contacts and networks of influence.

• They are respectful and thoughtful of other directors and management, especially in allowing other directors a voice for opinion on issues that vary from their own.

• They are independently minded, yet pragmatic with an enduring desire and ability to learn about the business.

Characteristics Assessments

Many of the compliance and process issues concerning board performance can be obtained from online or paper based questionnaires.

However, the behaviour of individual directors can only be genuinely revealed by conservation and personal interviews with the person in question, his/her peers and other relevant stakeholders (such as senior management).

Moreover, the calibre of the people asking the questions is important, as it is critical to know who and what to ask and undertake such discussion in a consistent and impartial manner.

This allows structure and substance to guide the discussion and not personality or persuasion.

Board Composition

Board Composition

Overview

Board composition is a critical issue that should concern the quality of board decision making, and not only a single selection criteria such as gender or age balance.
Gender diversity is a critical element of the board diversity debate. However, the guiding principle of board member selection is to achieve better decision making, through the application of relevant individual skills and experiences to a common problem in order to produce better overall outcomes for the organisation.

The issue many Chairpersons constantly struggle with is balancing the tensions, skills, perspectives and contribution of individual board members for the betterment of their firm.

There can tend to be an innate selection bias towards other directors whom are known to the Chairperson or board, and have similar values and backgrounds to those currently serving on the board.

This can result in better diversity of gender or age, but if all directors share a homogenous outlook, their collective decision making may produce suboptimal outcomes.

What is Board Composition?

Board composition refers to the way in which the board of directors of a company is structured and the characteristics of individual board members; in terms of their age, experience, gender, tenure, outside interests and ethnicity to mention a few.

Diversity initiatives are commonplace in today’s corporate environment and range from mere tokenism to a genuine search for individuals of diverse backgrounds by merit.

Large, successful firms frequently tout their commitment to diversity, sometimes appointing women and racial minorities to their board. Why would a profit-minded firm go out of its way to do this?

Firms may wish to send a particular signal about their values in the form of a willingness to invest in a diverse workforce, in order to enhance their attractiveness to potential employees, customers and investors.

In Australia, listed firms are required to disclose their policy and progress towards achieving gender diversity, whilst in Europe debate continues on a proposal to codify a 40% female board quota.

A survey of senior industry directors indicates support for measures to enhance the transparency of corporate recruitment activities, but not for mandatory regulations, such as quota to achieve gender balance on boards. Furthermore, many senior female directors tend to oppose quotas while aspiring female directors are more supportive.

The simplistic tokenism surrounding the diversity debate undermines a wealth of research, which supports the commercial value of embracing diversity as a competitive advantage.

This discussion will introduce the many other benefits of boardroom diversity, as verified through academic research, in addition to the importance of incorporating the findings of this contemporary industry research within ones own boardroom.

Is Board Diversity necessary?

Many corporate directors would agree that an increase in boardroom diversity is an important goal worth pursuing, yet most of these directors would not understand or be able to articulate why it matters. The easiest justification is the concept of fairness – that an active involvement in diversifying boards is the morally correct outcome.

However, due to the criticism and social stigma surrounding this sensitive issue, some boards have been reluctant to make the necessary changes due to the belief the impact of board diversity on corporate performance is neutral (or even negative), and may ultimately entail costs to shareholder wealth.

This straightforward but ill-informed view makes the normative case for “doing the right thing” more difficult to justify. Boards ask, “Why should shareholders incur the costs of providing a public good in the form of greater board diversity?

The common argument against boardroom diversity is the talent pool doesn’t exist, which may or may not be the case. But if the goal is better decision making and not technical skill, at least 50% of the population might disagree.

Does board diversity work?

There are a range of proven advantages in pursuing greater boardroom diversity and/or focusing on the composition of the board (e.g. in terms of size) in general, which would ultimately direct the company towards measures positively impacting financial performance, institutional investment and share price.

Some of the researched benefits of board diversity include:

  • The “groupthink” phenomenon is likely to be less prevalent. It will therefore be easier to critically analyse management decisions.
  • Accessing an untapped talent pool which research has proven, includes more attention-forcing directors whom add perspective to the critical decision making processes.
  • Female and minority board members reduce agency costs (costs which are incurred from the separation of ownership from control). By being ‘outsiders’, they may be less likely to defer to management or the status quo, thus reducing the risk of self-serving behaviour by managers or even other board members.
  • Possessing more and better information. A diverse group of people will engage in a richer discussion, by contributing multiple perspectives to a given problem.
  • Operating differently from traditional orthodoxy. A more diversified board may be more likely to engage in ‘constructive dissent’, whilst female members question decisions in a different manner to male members.
  • Enhance corporate reputation by conveying a credible signal to external stakeholders of corporate behaviour.
  • Positive signalling. Board changes may provide important signals to investors indicating the potential for improved reputation and financial performance.
  • Improving Corporate Social Responsibility ratings. Enhancing critical board processes.

Other changes in Board composition, aside from increasing gender and ethnicity diversity, which may be just as financially rewarding include:

  • Appointing external and/or foreign directors is associated with better performance compared to boards which have a majority of insider executives and affiliated non-executive directors. In disparately owned companies, a higher proportion of outsiders reduces underinvestment and agency problems, which has significant economic implications
  • Innovativeness of a company is found to have a positive relationship with the size of a firm’s board, especially in SMEs.
Conclusion

While these points may appear easy to adopt, they must be implemented in the correct manner for a firm to thrive and succeed.

For instance, while there is a positive relationship between innovativeness and the size of a firm’s board, studies have also shown that board size may have a significant negative influence on the performance of the board.

This indicates information asymmetries between directors, which thereby suggests a need for a review of the individual characteristics (i.e. personality) of each director.

Risk Appetite

Risk Appetite

Overview

Formulating a risk management program without defining your Risk Appetite is like designing a bridge without knowing which river it needs to span. The bridge will be too long or too short, too high or too low, and certainly not the best structure to cross the river in question.

Risk Appetite Definition

The term ‘Risk Appetite’ is becoming increasingly used in the corporate environment. Despite its growing profile, many organisations are still grappling with the concept. The best starting point is to adopt a simple definition of Risk Appetite:

“How much risk does an organisation need to take in order to achieve its objectives?”

For example, at what point does a company start to feel uncomfortable if a large percentage of its annual revenue is derived from a concentrated source that keeps increasing?

An organisation’s Risk Appetite is derived from its strategy and objectives. It enables the organisation to properly understand:

  • What risks will the business accept?
  • What risks will the business not accept?
  • What risk will the business treat on a case-by-case basis?
  • What risks will the business escalate for further consideration?

A properly articulated and implemented Risk Appetite helps the organisation achieve its objectives in the safest and most effective manner.

Risk Appetite Statement Characteristics

A well defined Risk Appetite Statement should have the following characteristics:

  • Reflective of corporate strategy, including organisational objectives, business plans and stakeholder expectations;
  • Reflective of all key aspects of the business operations;
  • Recognises that certain risks need to be controlled within defined parameters or avoided altogether;
  • Acknowledges a willingness and capacity to take on acceptable risk to grow the business;
  • Is documented in a formal manner and available to relevant stakeholders;
  • Considers the skills, resources and technology required to manage and monitor risk exposures in the context of Risk Appetite;
  • Is periodically reviewed and reconsidered with reference to evolving industry and market conditions; and
  • Has been approved by the Board.
Risk Appetite Considerations

The following factors impact upon the Board, Management and the organisation as a whole:

Board

  • Risk Appetite is ultimately the responsibility of the Board
  • It enables the Board to set and monitor the risk taking by the organisation
  • It enables the Board to make better strategic decisions

Management

  • Risk Appetite enables Management to better understand their risk responsibilities
  • It needs to be built into business operations and actively monitored by management

Organisation

  • Risk Appetite is the foundation of sound risk management
  • It is both a Governance and a Management tool
  • It is as much about ‘enabling’ responsible risk taking as ‘constraining’ adverse risks
  • It is both a Governance and a Management tool
Advantages

A properly developed and implemented Risk Appetite framework is the foundation of an effective risk management program within the organisation. It provides the following benefits:

Linking Board Expectations to Management Behaviour: Risk Appetite Statements facilitate top-down direction from the Board with ongoing monitoring and control in a language that is understandable by everyone. Conversely, they provide bottom-up information and insight from the business via the calibration of risk limits and triggers, as well as reporting on risk profile vs Risk Appetite.
Linking Business Decision to Business Strategy: Understanding Risk Appetite helps boards and management to make better decisions. It reduces the likelihood of unpleasant surprises.
Encouraging Consistent Behaviour: Internal communication of Risk Appetite provides the business with a clear mandate for the amount and type of risk to accept and manage and the risks to avoid. External communication of Risk Appetite assists in shaping realistic stakeholder expectations.
Enhanced Clarity over Risk: Articulation of Risk Appetite provides greater clarity over the risks the organisation is prepared to accept and those it deems undesirable that need to be controlled or avoided.
Increasing the Capacity to Take Risk: Understanding Risk Appetite helps an organisation in the efficient allocation of risk management resources. It enables the pursuit of business opportunities that, without an understanding of Risk Appetite, would otherwise be rejected.
Improved Risk Reporting: Reporting frameworks are more sensitive to risk tolerance levels allowing more meaningful early warning indicators and risk limits. It also makes risk assessment tools more effective as they need to take into consideration the ‘bigger picture’.

Conclusion

Risk appetite is an integral link between company objectives and its overall risk management profile. When clearly articulated to all levels of a company, Risk Appetite can create a positive culture of risk awareness and accountability.

Risk appetite requires ongoing maintenance and monitoring according to current markets and future business objectives in order to fully appreciate its benefits.