Book extract, pp. 11-14
There has been a long tradition of portraying boards of directors as ineffectual bodies beholden to management. Indeed, boards were regularly portrayed as “rubber stamps”1 for management or even more colourfully as “ornaments on the corporate Christmas tree”2 and “parsley on the fish”.3 However, current legal, market and societal pressures on directors have seen this negative view of boards fade.
Compliance pressures on boards are well documented and tend to dominate governance discussion. Changes to the Corporations Act 2001 (Cth) or ASX Principles, for example, will generate a plethora of guidance and articles about the implications of the changes for boards and individual directors and how they can comply. However, boards also face growing pressure to ensure organisational performance and are increasingly held accountable for corporate failures and the poor performance of the companies they govern. It seems that every week the business press exposes another board failure. For example, in April 2017, US hedge fund Elliot Management launched an aggressive campaign against Australian mining giant BHP Billiton Ltd over its board composition and poor decision-making including share buybacks and the company’s losses in shale oil, which amounted to $US25 billion.4 This led to changes to the board and the decision by the BHP board to offload its US shale assets.5 These changes were welcomed by the market.6
Performance pressures have simultaneously risen for a number of reasons. First, with the rising expectations that boards be held accountable for corporate performance, boards themselves have in turn become more involved in the leadership of the organisations they govern. Effective leadership is described in the management literature as involving a range of activities: establishing the tone of a corporation (i.e. its culture and values), formulating a corporate mission and objectives, developing a strategic direction and guiding change. In short, leadership is seen as a key determinant of many things for which boards are increasingly accountable. For instance, boards are responsible for the culture of the organisation, for ensuring an appropriate strategic direction, ensuring appropriate use of resources and the establishment of corporate goals and purpose.7 It is not surprising that boards are responding to these pressures by seeking greater input into the leadership of the organisations they oversee.
Second, there has been a dramatic rise in shareholder activism over the past three decades. The reason for this is the increase in power and involvement of large institutional investors and activist investor firms, who are far more demanding of boards and companies due to limited investment opportunities. For instance, with more than 50 per cent of Australia’s market capitalisation concentrated in the top 50 companies,8 there is little opportunity for institutional investors dissatisfied with corporate performance to practice the ‘Wall Street walk’ (i.e. sell the stock). Instead, institutional investors are exerting pressure on their representatives, the directors, to address their concerns. This trend is seen internationally with large pension funds in the US (such as the California Public Employees Retirement System (CalPERS)) being vocal advocates for governance reform. More recently, activist investor firms such as the Australian investment company Sandor Capital, which has launched successful campaigns against companies such as BlueScope Steel Limited and Fleetwood Corporation Limited,9 have been investing in publicly listed companies with the intention of pushing for a variety of outcomes including seats on the board, removal of the CEO, changes in strategy, a push for mergers, and unlocking value for shareholders.
Shareholder activism has gained in momentum due to the growth in a different but related group, proxy advisory firms such as the Australian Council of Superannuation Investors (ACSI) and Institutional Shareholder Services (ISS). These advisers analyse company information and issue voting recommendations to their clients, who are usually institutional investors and fund managers. In doing so, they are able to put pressure on companies to conform their governance practices to good practice standards established by these advisory firms including the appointment of directors (especially independent directors), the appointment of auditors, executive remuneration and major corporate transactions. As such, these firms provide a valuable service to investors who may not have the resources to conduct the research necessary to evaluate every proxy proposal prior to casting their proxy vote. The growth in influence of these advisory firms on major investors has reached the point where there have been calls to regulate the proxy advisory industry.10 For example, a US study found that a negative ISS recommendation on a remuneration proposal leads to a 25 per cent reduction in voting support, which suggests proxy advisers have a strong influence over shareholder votes, especially on topics such as remuneration.11
A third force for change is the ever-increasing media and community scrutiny of all aspects of corporate life. Names such as James Hardie and 7-Eleven in Australia, Wells Fargo and Turing Pharmaceuticals in the US along with Toshiba in Japan and Volkswagen internationally have come to symbolise a breakdown in corporate ethics with boards firmly placed in the firing line. Additionally, coverage of poor corporate decision-making (such as Woolworths’ strategy to enter home improvement via Masters) and systems failures (such as Ardent Leisure’s mishandling of the company’s response to four deaths at its theme park Dreamworld in 2016)12 have been laid directly at the feet of the board. This trend in media coverage looks likely to continue and only serves to intensify community expectations that boards need to be brought to account for the performance of the organisations they govern.
Thus, despite mixed findings on the empirical links between organisational performance and corporate governance, there is a belief in the investment and general community that good governance will improve corporate outcomes. Institutional investors perceive that the board can directly enhance shareholder value by intervening in the case of corporate crises, providing strategic guidance and selecting and monitoring the CEO. As a result, more than 80 per cent of European and US institutional investors say they will pay more for companies with good governance.13
In light of the pressures boards face, we now turn to outline how board evaluations can help the board address these pressures. An effective board evaluation provides evidence on the extent to which a board is meeting its compliance responsibilities, performing well or poorly, and demonstrates a commitment to continuous improvement. As well as outlining these advantages, we also consider the barriers some boards face when instituting regular board evaluations and provide responses to remove those barriers.
This extract is from the recently released book published by the AICD and written by the team at Effective Governance ‘Reviewing Your Board - A guide to board and director evaluation’. To purchase a copy head to the AICD website or to purchase a Kindle version head to Amazon.
Aimed at helping boards to conduct evaluations that add value, ‘Reviewing Your Board’ is written by experts with more than 25 years’ experience working with boards and conducting over 1,000 board reviews. ‘Reviewing Your Board’ is authored by Geoffrey Kiel, Gavin Nicholson, Jennifer Tunny and James Beck.
1. M L G Mace, 1971, Directors: Myth and Reality, Division of Research Graduate School of Business Administration Harvard University, Boston, p 14.
2. Ibid, p 90.
3. Irving Olds, former chair of Bethlehem Steel, quoted in R Leblanc and J Gillies, 2003, “The Coming Revolution in Corporate Governance”, Ivey Business Journal, Vol 68, No 1, September/October, p 1.
4. J Kehoe, 2017, “Onset of Activists”, The Australian Financial Review, 18 April, p 36; J Thomson, 2017, "How BHP Has Won Back Its Investors: Resources", The Australian Financial Review, 28 August, p 30.
5. J Whyte, 2017, “Exacting a High Price: Hitting Back”, The Australian Financial Review, 26 August, p 15.
6. Thomson, 2017, op cit.
7. G Kiel, G Nicholson, J A Tunny, and J Beck, 2012, Directors at Work: A Practical Guide for Boards, Thomson Reuters, Sydney.
8. S&P Dow Jones Indices, 2017, “S&P/ASX 50”, http://au.spindices.com/indices/equity/sp-asx-50 (accessed 10 July 2017).
9. V Sprothen, 2016, “Activist investors start making wave in Australia”, The Wall Street Journal Online, 21 November, https://www.wsj.com/articles/activist-investors-start-making-waves-in-australia-1479625457 (accessed 12 September 2017).
10. P Durkin, 2017, “Boards pressure ASIC for mandatory code to regulate proxy firms”, The Australian Financial Review, 10 September, http://www.afr.com/leadership/boards-pressure-asic-for-mandatory-code-to-regulate-proxy-firms-20170908-gydgga (accessed 20 November 2017).
11. N Malenko and Y Shen, 2016, “The Role of Proxy Advisory Firms: Evidence from a Regression-Discontinuity Design”, Review of Financial Studies, Vol 29, No 12, December, pp 3394–3427.
12. P Durkin, 2016, “Dreamworld Lessons: Prepare for Crisis”, The Australian Financial Review, 1 November, p 34.
13. P Coombes and M Watson, 2000, “Three Surveys on Corporate Governance”, McKinsey Quarterly, No 4, pp 74–77.