What constitutes good governance?

ASX Corporate Governance Council chair Elizabeth Johnstone gives her view on draft fourth edition of the Corporate Governance Principals and Recommendations.

Culture and values

The draft fourth edition was released in May, the day after the Australian Prudential Regulation Authority (APRA) independent inquiry panel released its report into Commonwealth Bank (CBA), highlighting the importance of companies looking beyond strict legal requirements (can we do it?) and incorporating standards of integrity and ethical behaviour into their decision making (should we do it?).

Given the barrage of press on the APRA report and the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, it might be tempting to think that poor culture and values are mainly issues within the financial services industry. They are not. In recent times, we have seen examples in other sectors, including exploitative and unsustainable franchise models, systemic wages frauds (particularly in the casual retail sector) and a number of investigations into alleged bribery and corruption overseas.

While much has been said about the responsibility of boards for setting the right culture in their companies, what has not been made clear is how a group of individuals who typically meet every month or two for half- or full-day board meetings with crammed agendas can practically fulfil this responsibility.

The council has sought to bring this clarity by substantially redrafting principle 3 to read: “[a] listed entity should instil and continually reinforce a culture across the organisation of acting lawfully, ethically and in a socially responsible manner”. Revised principle 3 is proposed to be supported by three new recommendations:

1. Recommendation 3.1: A listed entity should articulate and disclose its core values.
2. Recommendation 3.3: A listed entity should:
   • have and disclose a whistleblower policy that encourages employees to come forward with concerns that the entity is not acting lawfully, ethically or in a socially responsible manner and provides suitable protections if they do
   • ensure that the board is informed of any material concerns raised under that policy that call into question the culture of the organisation.
3. Recommendation 3.4: A listed entity should:
   • have and disclose an anti-bribery and corruption policy
   • ensure the board is informed of any material breaches of that policy.

It is also proposed to be supported by important amendments to the commentary to existing recommendation 1.1 (role of board and management) to add to the list of the usual responsibilities of the board:

• defining the entity’s purpose
• approving the entity’s statement of core values and code of conduct to underpin the desired culture within the entity
• overseeing management in its implementation of the entity’s business model, achievement of the entity’s strategic objectives, instilling of the entity’s values and performance generally
• ensuring that the entity’s remuneration framework is aligned with the entity’s purpose, values, strategic objectives and risk appetite.

And to clarify that the information provided to the board by the senior executive team should not be limited to information about the financial performance of the entity, but also its compliance with material legal and regulatory requirements and any material misconduct that is inconsistent with the values or code of conduct of the entity.

In addition, proposed changes to existing recommendation 3.1 (codes of conduct) — to become recommendation 3.2 in the fourth edition — will recommend that the board is informed of any material breaches of a listed entity’s code of conduct by a director or senior manager and of any other material breaches of the code that call into question the culture of the organisation.

These new and amended recommendations are intended to assist a listed company to set “the tone from the top” and to ensure that the board is provided with the information it needs to monitor the culture of the organisation.

Social licence to operate

Closely allied to culture and values is the notion of “social licence to operate”. The proposed commentary to principle 3 acknowledges:

“A listed entity’s ‘social licence to operate’ is one of its most valuable assets. That licence can be lost or seriously damaged if the entity or its officers or employees are perceived to have acted unlawfully, unethically or in a socially irresponsible manner.

Preserving an entity’s social licence to operate requires the board and management of a listed entity to have regard to the views and interests of a broader range of stakeholders than just its security holders, including employees, customers, suppliers, creditors, regulators, consumers, taxpayers and the local communities in which it operates. Long-term and sustainable value creation is founded on the trust a listed entity has earned from these different stakeholders. Security holders understand this and expect boards and management to engage with these stakeholders and to be, and be seen to be, “good corporate citizens”.

This may include:

• respecting the human rights of its employees, including by paying a “living wage” to employees and not employing bonded, forced or compulsory labour or young children, even in jurisdictions where that may be lawful
• maintaining a safe and non-discriminatory workplace
• offering employment to people with a disability or from socially disadvantaged groups in society
• dealing honestly and fairly with customers and suppliers
• not engaging in aggressive tax-minimisation strategies
• not dealing with those involved in, or who finance crime, corruption, human conflict or terrorism
• acting responsibly towards the environment
• only dealing with business partners who demonstrate similar lawful, ethical and socially responsible business practices.

Interestingly, the way in which “social risks” is proposed to be defined in the draft fourth edition references similar concepts. “Social risks” are defined as: “the potential negative consequences to a listed entity arising from its impact or perceived impact on social groups (including employees, customers, suppliers and local communities) or from it being seen to operate outside ‘accepted community standards’. It includes the risks that can lead to the loss of an entity’s ‘social licence to operate’ mentioned in the commentary to principle 3”.

Some people will debate this, say it is too vague, that it will change over time, that it is socialism prevailing over capitalism. But this is the new paradigm, as amply demonstrated by the APRA report and the banking Royal Commission.

Gender diversity

The council is proposing a number of changes to recommendation 1.5 and the related commentary in the draft fourth edition to enhance gender diversity outcomes. Most notably, it is recommending that a listed company in the S&P/ASX 300 set a measurable objective to have not less than 30 per cent of its directors of each gender on its board, within a specified period.

It is also recommending that the board or a board committee charge management with designing, implementing and maintaining programs and initiatives to help achieve the company’s measurable gender objectives and undertake an annual review with management of the company’s progress towards achieving those objectives and of the adequacy of the company’s programs and initiatives in that regard. The company will be expected to disclose in relation to each reporting period whether that review has taken place.

Within a few days of the release of the draft fourth edition, the female chairman and all three of the female non-executive directors on the board of AMP had agreed to stand down, following revelations from the banking Royal Commission. Perhaps predictably, this sparked media debate whether the push for gender diversity on Australian boards had gone too far and whether boards had been “forced” to pick directors based on gender rather than on ability.

The issues with AMP had nothing to do with the gender of the directors who stood down. Gender diversity on boards is not an ethical or moral issue. It is the right thing to do from a business perspective. Women constitute half the Australian workforce and more than half of those graduating from Australian universities. Research has shown that better gender balance on boards and in senior management is associated with better financial performance. The promotion of gender diversity can broaden the pool for recruitment of employees, enhance employee retention, foster a closer connection with and better understanding of customers, and improve corporate image and reputation. For these reasons, I am hopeful companies in the ASX 300 will support the proposed changes to recommendation 1.5.

Conclusion

In my view, corporate governance in Australia is not “broken”. In its 2016 survey, the Asian Corporate Governance Association ranked Australia first of 12 jurisdictions in Asia in terms of corporate governance practices. There is, however, a need to rebuild the public’s trust in corporate Australia, damaged by the revelations of the Royal Commission and other government inquiries. The proposals in this draft edition are intended to achieve this objective.

To read further coverage on the fourth round of hearings of the Royal Commission, click here.

ASX Principles consultation — an AICD perspective

The Australian Institute of Company Directors has been an active and engaged member of the ASX Corporate Governance Council since its inception in 2002, supporting the development of the Corporate Governance Principles and Recommendations under the “if not, why not?” reporting model.

We support the council’s view that now is the right time to update the Principles and consider where improvements can and should be made, including the important considerations outlined by council chair Elizabeth Johnstone FAICD. In the AICD’s view, it is also important we continue to build on the strengths of the Principles and the “if not, why not?” model.

At their core, the Principles should guide, rather than dictate, to companies what good governance might look like. As the consultation draft correctly states, “which governance practices a listed entity chooses to adopt is fundamentally a matter for its board of directors”.

As the AICD noted in the June edition of Company Director, the changes proposed to the Principles are substantial. Like other council members, the AICD is reviewing the proposals and providing a submission as part of the process.

The AICD’s overarching concern is that the Principles remain principles-based, with sufficient clarity and flexibility for listed entities to apply the recommendations to their own governance needs and circumstances (supported by the “if not, why not?” model), with widespread support by listed entities, directors and stakeholders.

The AICD sees opportunity for improvements to the draft. First, there is a risk that the Principles, in adding recommendations and more detailed commentary, may be moving too far towards prescription, and so detract from a focus on the most material issues and risk less meaningful engagement on the Principles.

The consultation draft also introduces concepts such as “social licence to operate” and acting in a “socially responsible manner”. While these are important considerations for boards, the terms are inherently subjective and will be interpreted differently by different stakeholders. AICD members have concerns that this could risk muddying the waters for directors on their duties and obligations to act in the interests of the company as a whole. In a welcome move, the draft proposes extending the existing recommendation on diversity disclosures. If introduced, the recommendation would help ensure the momentum towards more gender-balanced boards continues.

The AICD will work with the council towards finalising a Principles that has broad stakeholder support and continues to fulfil its critical purpose. Members will be kept informed on progress.