Agenda

A round-up of the latest news for directors.

Risk-management committees

Remuneration and governance consulting firm Egan Associates believes boards are still not adequately recognising risk management in director or executive accountability, or sufficiently incorporating it in role descriptions or performance rewards.

Egan’s The KMP Report:The Rise and Rise of Risk makes an important, timely contribution to a growing governance debate on how best to handle risk. Various surveys show risk management is becoming a much bigger issue for large organisations

That will surprise few boards. Heightened global, economic and political uncertainty, shareholder activism and cyber attacks are just some of a long list of threats facing organisations. So how should boards deal with these and other risks?

The latest version of the ASX Corporate Governance Council’s Corporate Governance Principles and Recommendations suggests organisations take a formal approach to risk. Its updated principle 7 says the board of a listed entity should have a committee to oversee risk, chaired by an independent director. If it does not, the board should explain its processes for overseeing the risk-management framework.

The third edition of the principles, effective from July 2014, will be measured and reported on for the 2014 – 15 financial year, meaning listed companies with a 30 June balance will disclose whether they have established a risk-management committee in their next annual report.

Egan notes several pros and cons from a separate risk-management committee. The main advantage is that a risk committee can formalise the process for addressing risk and provide dedicated oversight of risks as board workloads increase.

A risk committee can also have experts who can translate risk metrics for the main board’s consideration, and it can be easier for a standalone risk committee to bring focus to, and articulate, detailed discussions on risk management. The committee can also be the point of contact for executives on risk issues.

The main disadvantages are the small size of most risk sub-committees, and difficulties if the wrong directors are on it. A bigger threat is boards believing their work on risk oversight is done because it has been outsourced to a specialist committee, even though the principles clearly state risk management is a crucial board task.

Another downside is extra resources required for a separate risk committee. Done well, it could lead to a substantial increase in workloads for directors on the committee, meaning extra fees may be required. A separate risk committee could lead to some boards asking shareholders for an increase in the fee pool during the next round of annual meetings.

Skills diversity in focus

The latest Australian Institute of Company Directors’ Director Sentiment Index shows efforts to increase board diversity are continuing.

Forty-seven per cent of directors surveyed said their organisation is actively trying to increase gender diversity, a slightly higher finding than the previous survey.

More than 65 per cent of directors said their board was actively trying to improve skills diversity. That will please governance observers who argue the diversity debate must extend beyond gender, to also include skills, culture, age and other diversity indicators.

The push for greater skills diversity might reflect a growing recognition that boards, generally, need deeper technology skills, to oversee and advise management on issues such as the digitisation of business models, big data, and social media. On page 56 of this issue of Company Director we report on the rising demand for directors with technology skills.

Boards are less concerned about age. Only 28 per cent of respondents said their board is trying to improve age diversity. This is surprising given the average age of non-executive directors in Australia is among the world’s highest and has crept higher in the past seven years.

Cultural diversity is also a low priority. Only 22 per cent of respondents said their board is actively trying to improve ethnicity diversity. Another 43 per cent said the issue is not relevant for them and 35 per cent said their board was not active in this area.

As more Australian organisations focus on the coming boom in middle-class Asian consumers, a lack of cultural diversity on boards might become a bigger governance issue in coming years.

Another interesting survey finding was expectations for sharply higher environment, social and corporate governance reporting in the next two years. Just over half of survey respondents expect an increase in climate change regulation, 49 per cent perceive greater regulation on workplace health and occupational safety, and 42 per cent expect higher industrial relations regulation.

Much to gain from enhanced public sector digitisation

Digitisation of business models is not only an issue for large listed companies that worry about technology-driven disruption to their industry. It is potentially a trillion-dollar issue for the public sector worldwide and a rising issue for public sector boards.

Recent McKinsey & Company analysis suggests the full potential of government digitisation could free up to US$1 trillion annually in economic value worldwide through improved cost and operational performance as federal, state and local governments put more information online.

As pressure on government budgets intensifies, public sector digitisation that facilitates shared services, greater collaboration, improved fraud management, productivity enhancements and improved efficiencies is vital, argues McKinsey. But it says most governments are far from capturing the full benefits of public sector digitisation.

This trend has implications for boards of government enterprises. High-performing boards might ask how the organisation is responding to the risks and threats of digitisation and whether a bigger transition to e-commerce could improve the organisation’s performance.

This is a particularly important issue for local councils. Although it has vastly improved the dissemination of information online and bill paying through e-commerce, the local government sector has much to gain from a transformation to digitised services.

The big question

Question
A private company is a wholly owned subsidiary of another private company. In order to change the constitution of the subsidiary company, is it necessary to pass a resolution of the members of the holding company or is it adequate to simply prepare a written resolution of the sole shareholder holding company?

Answer:
It would appear that, a written resolution of the subsidiary company’s sole shareholder (i.e. its holding company) is all that is required to alter the company’s constitution. A company may modify or repeal its constitution, or a provision there of, by special resolution (section 136(2) of the Corporations Act 2001 (Cth)(the Act)). Also, the company’s constitution may provide that the special resolution does not have any effect unless a further requirement stated in the constitution relating to that modification or repeal has been complied with (section 136(3) of the Act).

A special resolution is a resolution of which notice (section 249L(c) of the Act) has been given and that has been passed by at least 75 per cent of the votes cast by “members” entitled to vote on the resolution (section 9 of the Act). The term “member” is defined by reference to any “person” who is a member of the company (section 231 of the Act). As ordinarily understood the term person includes not only natural persons, but also companies (see section 9 of the Act and section 22(1)(a) of the Act Interpretation Act 1901 (Cth)). Therefore, it would appear to be sufficient if the special resolution is passed by the holding company rather than the actual shareholders of the holding company.

Mixed response to continuous disclosure proposals

Proposed changes to the ASX listing rules Guidance Note 8 on continuous disclosure have received a mixed response. Although BHP Billiton and other large organisations broadly support the thrust of the changes, the Australasian Investor Relations Association (AIRA) is concerned the changes could make it harder for smaller listed enterprises to provide earnings guidance.

Listing rules guidance for analyst and investor briefings, analyst forecasts, consensus estimates and earnings surprises are significant issues for boards of listed entities. Newcrest Mining’s fine in 2014 for continuous disclosure breaches, centred on selective discourse of information to the investment community, highlighted the risks to boards. Disclosure of earnings surprises has become more problematic for listed entities since the global financial crisis. High sharemarket volatility and fewer stockbroking analysts, which affects the robustness of consensus estimates, has made it harder for some organisations to know when to disclose information to the market, and how to communicate with the market on analyst reports and briefings.

ASX’s proposed changes go some way to reducing these problems. It suggests adding a statement to section 7.1 of Guidance Note 8 that “it is perfectly acceptable for an entity to have a policy of not providing earnings guidance to the market.” It says an entity that does not provide guidance needs to be careful that it preserves internal budgets and projections. On “earnings surprises”, ASX distinguishes between a “market sensitive” surprise, where earnings differ so significantly from market expectations that it needs to be disclosed, to lesser situations where earnings differ from expectations but would not be expected to be disclosed. These wording changes are vitally important to boards of ASX-listed entities. Breaches of continuous disclosure rules are a key source of shareholder class actions and a significant problem for directors if their company is deemed to have breached disclosure obligations.

Boards of large and small listed companies could ask the executive team if the organisation is across these proposed listing rules changes and if its investor relations (IR) function is sufficiently resourced and abreast of latest IR developments. Boards need to know they are signing off on market releases that meet the latest listing rules requirements.

The changes are expected to take effect from 1 July 2015 after ASX reviews submissions from a consultation process earlier this year, in conjunction with ASIC.

Managing the global environment: An interview with Dr Eileen Doyle

Here is a short excerpt from an interview with Dr Eileen Doyle, deputy chairman at CSIRO.

CD: The impact of global megatrends is often long-term and uncertain (e.g. climate change, ageing population). How can companies manage this in an investor/market context which often emphasises near-term economic performance?

ED: It’s not easy. Boards are there for long-term shareholder value – for the notional long-term shareholder. We don’t always have that in our register. I think we just have to keep improving our communication with all shareholders about our companies’ strengths and long-term objectives. Of course we still do everything we can in our control to lift short-term results.

CD: In your experience, where have businesses not been responsive enough to changes in the global context?

ED: They haven’t understood their competitive structure, such as the merger of customers to change buying power. They haven’t realised the impacts of new technology such as laser measurement of online clothes purchases; or 3D printers on distributed manufacturing. They don’t understand their supply chain, e.g. a new raw material can totally change the production process.

CD: What things can organisations and their boards do to better respond to changes in the global context?

ED: It’s important to track trends and technology with the best indicators you can develop, use this tracking and input to your strategic planning process, and pick business options that build on your core competencies.