On choosing directors
Over the years, I have found the most crucial determinant of a well-governed company that consistently performs highly is the right board with the right blend of skills and experience.
In practice, this means that the board must agree, on behalf of shareholders, on the requisite skills and experience individual directors must possess, as well as the blend of skills and experience across the board as a whole and its committees.
The board must be able to debate to a conclusion, challenge management robustly and consistently make the right decisions to create value.
This is not an easy task and the right skills and experience are not easy to come by.
It can no longer be accepted that just anyone can discharge duties of a non-executive director and much care needs to be undertaken to ensure a board is populated with the right skills to be able to “smell the smoke” and engage with outcome thinking.
If the board is structured appropriately, the company will perform well over time.
This means that when shareholders come to vote on the re-election of a set of directors they are in a position to formulate their voting decisions based on an overall assessment of the board’s performance, holding the board accountable for its performance.
Many institutional shareholders refer to voting for directors as their most fundamental right – which indeed it is – and are asking for further details from chairmen and boards about how they choose their directors.
The global financial crisis has raised the level of awareness around this issue, with the Walker review of governance in UK banks ranking it among its five key themes. I wholeheartedly agree with this. I therefore see the issue as not being around remuneration, as we seem to be focused on in this country, but the right of shareholders to have a say on their representatives on the board.
At the moment in Australia, we mostly have directors coming up for re-election every two to three years. In the UK, it is mixed, although some companies have moved to annual re-election, and in the US annual re-election has been adopted in many instances.
The Financial Reporting Council report in the UK suggests either all directors be subject to annual election by shareholders or the chairman be subject to annual election. The recent Walker Review on banks in the UK also recommends the chairman stand for annual election.
As I see it, the issue of accountability is extremely important and I have a preference for annual re-election for all directors, although there is merit in the chairman, as the leader of the board, standing for annual re-election – as I did in the last three years of my tenure at BHP Billiton.
Annual re-election provides for accountability to shareholders and the ability for shareholders, in turn, to express a view about the performance of each director as their representative.
It provides incentives to nomination committees to ensure the board includes directors with the requisite skills and experience to deliver value for shareholders over the long term.
Further, more regular election gives boards an opportunity to deal with non-performing directors, who in Australia (unless they agree to resign or the board calls an extraordinary general meeting) may only be up for re-election every three years.
This is underpinned by the increased transparency in relation to director performance and the requirements for companies to report on board and director performance evaluation.
I recognise that annual re-election may be a step too far in the Australian context at the moment, but in principle I believe it is the right approach.
However, the corollary to the enhanced shareholder say on director election that I am advocating is a change to the threshold to nominate as a director candidate, noting the Productivity Commission’s (PC’s) recommendation that the board-declared cap on board size or the “no vacancy rule” be removed – a rule which incidentally does not exist at BHP Billiton.
Australian corporate practice for director nominations is out of step with international practice.
It typically allows any shareholder of a publicly listed company to nominate a person for election to the board subject only to nominations deadlines and the candidate’s consent.
There is no threshold requirement to gain any significant shareholder support to nominate someone for election (in contrast to the situation in the US and UK).
Australian director-nomination practice is also out of step with the law relating to other types of shareholder resolutions (where the Corporations Act 2001 requires a threshold of five per cent of the shares or 100 shareholders).
This appears to me quite a paradox – it is harder to get a resolution on to the meeting notice paper than it is to nominate a candidate to run for the board with no requirement to demonstrate shareholder support or indeed the requisite skills and experience to add value to the board.
If greater focus is to be placed on the balance of skills and experience on the board – which is what almost every post-financial crisis review of governance acknowledges – then the role of the board’s nomination committee to consider directors standing for election, and the rigour of its approach, becomes paramount.
Governing a company is very serious business and accountability to shareholders is enhanced by non-board nominated candidates standing for election who are supported by a reasonable number of shareholders (say 100 or those with five per cent of the issued capital) – not by a candidate nominated by a single shareholder holding a small parcel of shares.
Adopting this approach would avoid the situation where the election process could be manipulated as I suggested earlier.
In this context, I believe there is an opportunity for:
- The recalibration of the “two strikes” proposal to contemplate a regime (such as annual election) to encourage shareholders to assess board and corporate performance holistically, rather than just focusing on inappropriate remuneration structures; and
- The Government to consider balancing the removal of the “no vacancy” rule with the introduction of a reasonable threshold for shareholder-nominated director candidates.
I am not advocating change to the PC’s finding on “no vacancy”. Instead, I am suggesting an option for dealing with the unintended consequence of removing the “no vacancy” rule without addressing director-nomination thresholds.
A broader perspective on director accountability for company performance could enhance our corporate governance framework, maintain Australia’s role as a governance leader and appropriately guide directors and shareholders in navigating the changing expectations on Australian companies.
Five principles for effective boardroom functioning
Don Argus AC FAICD told the Australian Council of Superannuation Investors’ conference about the five principles he adopted back in 1999 for effective boardroom functioning. His principles are in no specific order. They have not changed but some of the challenges and applications of those principles have. They are:
- Every board owes its primary duty to the company itself. No stakeholder (shareholder, employee, customer or any other) is entitled to preferential treatment. The only exception is when a company is insolvent, at which point directors must regard creditors’ interests over other groups.
- Directors must look to the company’s short, medium and long-term interests. Short-termism (such as focusing solely on this year’s shareholder returns) leads to poor corporate governance and damages a company’s long-term health. Growth strategies executed effectively and profitably determine the ultimate value of a corporation over the long-term. A concentration on share prices does not focus on the right metrics.
- Directors must strike a complex balance between many competing interest groups (stakeholders) that play a role in the daily life of the company’s business and are affected by its actions.
- In discharging their fiduciary duty, directors should disregard their own interests. Their purpose is to safeguard the company’s inheritance, set the framework for the future well-being of its business and then drive that business forward within the law and best practice.
- The real key to effective corporate governance is a properly functioning board where mutual trust and respect lead to open, informed and timely debate on any and every aspect of a company’s affairs.