On 6 January 2005, the Australian Shareholders’ Association (ASA) released an exposure draft outlining its key policies on matters of primary importance for monitoring in their reviews of companies. ASA invited comment on their first-pass review of key polices. The AICD's response highlighted particular aspects of the Exposure Draft, concentrating on policies affecting the behaviour of company managers and directors, aspects of financial performance which the ASA sees as a primary goal, differences between stakeholder and shareholder considerations for company directors and equity considerations for share allotments made in association with Initial Public Offers. The ASA's proposed numerical limits on multiple directorships were an area of particular interest to the AICD, with the AICD proposing board evaluation as being a better guide to effective performance than workload indicators. The remuneration of non-executive directors is another policy focus for the AICD and the ASA proposals for conduct of annual general meetings, dividend policies and shareholder approval for raising additional equity also attracted AICD comment. The ASA is currently reviewing its Exposure Draft in light of comment received from the AICD and others.
Ms Fiona Balzer
Corporate Information Officer
Australian Shareholders' Association
PO Box 519
Chatswood NSW 2057
Dear Ms Balzer
Exposure Draft Policy Statement by Australian Shareholders' Association (ASA)
You invited comment on the Shareholder Expectations Policy Statement, which was completed by the ASA Policy Committee in late 2004 and sanctioned by the ASA Board at its December 2004 meeting.
The Australian Institute of Company Directors (AICD) is the peak organisation representing the interests of company directors in Australia. Current membership is over 19,000 drawn from large and small organisations, across all industries, and from private, public and the not-for-profit sectors.
The following comments are organised around the structure of the Exposure Draft, which states the ASA position on these issues:
2.2 Behaviour of company managers and directors
It is respectfully observed that the ASA could be seen as one of the unelected pressure groups that the Policy Statement is seeking to exclude. The ASA would not be seen as representing the views of all shareholders.
Your policy on political donations states that 'it is not the role of companies to divert shareholders' funds to political purposes by the making of donations to political entities'. A broad policy statement like this might preclude company donations to assist with disaster relief efforts, such as those given for the recent Asian Tsunami. This disaster illustrated the point that selective corporate philanthropy can be acceptable and in line with public expectations (eg Virgin Blue's sending a plane or BOC's provision of free dry ice for temporary morgues). It would not be a good thing for a principle to rule out philanthropy that is in both community and corporate interests.
2.3 Financial performance is a primary goal
Generating value for shareholders over the longer term is seen by the AICD as having a higher priority over and above short term profits and cash flows that can only benefit current shareholders. A rising share price is driven by market expectations of returns above the cost of capital stretching into the future.
2.4 Stakeholders and Shareholders
The Exposure Draft acknowledges that the primary purpose of companies is to generate value for shareholders and that directors are accountable to shareholders as the ultimate owners.
There is, however, some confusion with the term 'stakeholders' where it is used in the second line of paragraph 2.4 - 'Directors are elected by shareholders to oversee the management of companies in the interests of the company itself and its stakeholders'.
Stakeholders and shareholders are not seen by the AICD as interchangeable terms, both sharing the same interests, and clarification is needed in applying these terms.
New 'social responsibility' legislation is under consideration which would bind directors to have regard to the interests of stakeholders other than shareholders. The ASA's constituents would be affected adversely by this proposal and the ASA may wish to take issue with the legislative proposals.
Directors of Australian companies are required to act in the best interests of the company and for a proper purpose. The Australian corporate community accepts that the long term 'best interests' of a corporation may only be identified in the context of its position in the community and by recognising a variety of stakeholder interests. Annual reports and corporate governance statements typically note that each director will act in the interests of shareholders of the company and of the company as a whole, and may have regard to the interests of employees and customers, and the community and environment in which the company operates.
This principle has widespread acceptance because empirical evidence suggests that companies which fail to respect the interests of stakeholders suffer in the marketplace, many to the extent of going out of business.
The AICD considers that imposing additional and generalised 'social responsibility' duties on directors is potentially very damaging and impractical. Tension can exist between the interests of shareholder and stakeholder. It would introduce the need for frequent decisions by directors that would have to trade off social outcomes for shareholder interest. Statutory intervention that provided legal status to the recognition of each of those interests would be an extraordinarily complicating factor, and would place directors in an impossible situation since there is no practical way to reconcile all such interests. It would, in fact, be counterproductive in that it would diminish accountability of boards and directors because of the grey area that would be introduced.
The community response to the James Hardie case in Australia has demonstrated that a failure to consider the interests of stakeholders is perilous to future commercial viability.
The current roles and duties of directors allow for legitimate consideration of stakeholder interests in pursuit of acting in the interests of the company as a whole. There is merit in highlighting this consideration as a prudent step for directors to take in decision making but further legislation is unwarranted and unnecessarily restrictive and, ultimately, unproductive.
On the separate issue of multiple directorships, the ASA seeks to impose an upper limit on workload as an assurance to shareholders who must elect directors on the basis of publicly-available information.
The AICD sees the issue as one of assessment of individual performance and board effectiveness which is best addressed through evaluation. Workload is an inaccurate guide to effectiveness. A director might hold only one directorship but be ineffective in that role. The rigour of the appraisal system is the key to its acceptance by shareholders.
The issue of individual capacity is one for each director to justify and for his board colleagues to accept. A higher number of board positions may be reason for shareholders to ask more questions about individual capacity but it is not a justification for making blanket restrictions. These are unfair to individuals and not in the best interests of the company, because they impose artificial restrictions on the pool of talented directors. They also fail to take account of differences in operating style and circumstances between boards and between companies.
3.1Initial public offers
The AICD is concerned that making allotments proportional to applications would be unfair to small shareholders who may get nothing out of new listings as currently drafted in the ASA Policy Statement.
3.2 Raising additional equity
The AICD supports the current law which allows 15 percent to be raised without shareholder approval. Arbitrary rules around placement are not seen as being in the best interests of shareholders over time and this is particularly true for retail shareholders.
Your paragraphs one and two of 3.2 of the ASA Policy Statement have been annotated, with the AICD's suggested changes being indicated by underlining as follows:
'Unless it would be uneconomic, existing shareholders expect that they be offered the opportunity to participate in the raising of fresh equity capital in an effort to preserve their level of equity in the company without dilution of the value of their holding. Moreover, shareholders consider that appropriate arrangements should, where possible and practical, be included in rights issues to enable them to receive the residual value of their rights, where for any reason their entitlements lapse.
Shareholders recognise that in a range of circumstances rights issues might be uneconomic or inappropriate, eg where the amount to be raised is large or small in relation to the existing level of shareholders' funds, and/or where equity needs to be raised quickly. In such circumstances placements of equity would be reasonable. In such circumstances invitations to participate in the placement should also be made to shareholders who qualify as substantial investors and have registered their names with the company for the purpose. Placements should be restricted to 15% of the existing equity in any year, unless shareholder approval is obtained for a higher level. Where a placement is made at a substantial discount to the market value shareholders should be given the opportunity to subscribe for additional shares on the same terms as the placement.'
The statement 'will be done through renounceable rights issues that allow existing shareholders' has been replaced in the first sentence of paragraph one. Also replaced are the words in the final sentence of the second paragraph - 'should be limited to the extent of the costs of a general rights issue relative to the amount such an issue would raise (a discount of 2.5% would be reasonable on this basis)'.
4.1 Remuneration of non-executive directors
The AICD believes it should be acceptable to pay directors in shares purchased on the market. A requirement for some equity in the business can be consistent with good corporate governance. There is no empirical evidence that remuneration paid in cash is a better incentive to company performance than a combination of cash and shares. Given the greater risk of stifling entrepreneurs, particularly in start-up companies, the AICD recommends a more flexible policy position on this issue. The AICD acknowledges the risk of short-term financial gain at the expense of longer term company growth but is concerned about the disincentives that may be associated with predominately cash payments.
The AICD believes that the structure of non-executive directors' remuneration should be transparent and simple. A combination of fees, shares and superannuation is the most appropriate in most situations. The Remuneration Committee should determine the policies and the Board should decide the level of remuneration for each individual director. Directors should have the freedom to determine the proportional allocation of their total remuneration between fees, shares etc, depending on their personal circumstances.
Owning of a company's shares aligns non-executive directors' interests with the interests of shareholders and the AICD encourages the purchase of shares on market price by non-executive directors on the basis of fee sacrifice. The ability to purchase shares under a company-mandated scheme in lieu of fees should also be encouraged. Schemes which ensure that shares are retained for the duration of board membership are preferred by the AICD.
In general, the AICD does not support the granting of options or of partly-paid shares to non-executive directors and their participation in incentive schemes applying to executives is not encouraged. In certain circumstances this may be defensible, for example where a start-up company uses options as a means of remuneration where the company is unable to satisfactorily remunerate directors in cash. If options are allocated as part of annual remuneration, such an allocation should be structured so that directors' and shareholders' interests are aligned. The possibility of immediate windfall gains through market price should be minimised and options allocated in this manner must be fully disclosed.
Examples like Microsoft and other Silicon Valley success stories would not have developed as businesses under the ASA's restrictions as reflected in the draft Policy Statement. Microsoft was once a start-up, paying all its employees in options. It paid no dividends for many years.
6.1 Conduct of Meetings
The ASA supports conduct in meetings that permits reasonable expression of shareholders' views on the matters to be decided and on the performance of the company. The Policy Statement could be expanded to include arguments against the current proposed amendments to ss 249D and 249N of the Corporations Act. These legislative proposals would allow resolutions to be put forward with the support of only 20 members and potentially would allow AGMs to be diverted by special interest groups.
The proposals could see a range of minor issues related to vested interests being included on agendas. This would only serve to make AGMs larger and longer, to the detriment of participants. It would grant the capacity to weigh down the agenda of an AGM with issues that are of no interest to the majority of shareholders. The potential to increase the costs of AGMs for companies is also open-ended and could be manipulated to apply pressure.
The AICD supports replacing the 100 member rule with a requirement for five percent of the votes as being an acceptable solution to the complications of calculating tiered and mathematical solutions. Requiring five percent of total voting shares to requisition a special general meeting is a reasonable balance of the rights of shareholders to have matters addressed, while allowing directors to run the company effectively. The change is also in line with overseas practice in a number of overseas markets.
7.1 Dividend Policies
The ASA's Policy Statement asserts that 'Shareholders are entitled, as ultimate owners of the company, to a presumption that profits will be fully distributed annually unless directors provide a satisfactory explanation for something less'.
The AICD is concerned that this policy is not in the best interests of all shareholders. It can shrink the capital base and favour short-term shareholders at the expense of longer term shareholders. Consistency of dividends over the longer term is associated with good company performance. Fluctuating dividend payments can adversely affect share value. Stability of returns over time gives investors more confidence and the company a better market performance.
A well-run company will have at its disposal opportunities that are likely to generate returns that are higher than its cost of capital. Whenever this is so, it can be argued that it is in shareholders' interests to reinvest earnings and not pay them out as dividends. However, many shareholders need dividends as current income or to benefit from franking, and the level of dividend paid is also a signal to the market of the company's expectation to be able to continue paying dividends, or to increase its payouts, in the future. We therefore support the system where boards determine the level of dividend, with full disclosure of their dividend policy.
The AICD welcomes the opportunity to comment on the draft policy statement and would be happy to engage in further discussion with the ASA. The meeting between the ASA and members of the Corporate Governance Committee on 2 March provided a very satisfactory dialogue on the issues raised in the Shareholders Expectations Draft Policy Statement.
Thank you for your assistance in arranging the participation of the ASA Chairman, Deputy Chairmen and Mr Somogyi so quickly and for your attendance and contributions at the meeting.