Brace for collisions

With the potential for new growth or a faster slowdown finely balanced, significant governance challenges await listed companies in 2016, writes Tony Featherstone.

Next year, 2016, could be the “Year of Collisions” for boards, as huge threats and opportunities that have built up since the global financial crisis (GFC) smash into the governance landscape. Their partial resolution could mark a new phase of growth – or trigger another financial crisis.

Consider the potential collision of an expected lift in US interest rates and emerging markets. If US rates rise faster than expected, capital could be withdrawn rapidly from developing economies, sparking another Asian financial crisis.

Or, the collision of technology and traditional business models. This trend, underway for several years, is quickening and becoming more widespread. Boards will have to test their capacity to govern through technology disruption, and whether their organisation has the right CEO and culture to lead through the new machine age.

Domestically, a federal election in 2016 and the prospect of the most significant policy reform in years will clash with a sluggish economy and sceptical electorate. A new wave of reform would bolster business confidence, encourage investment, and focus boards more on growth. But further stalled attempts at reform and signs of continued policy lethargy would weigh heavily on a fragile economy.

Then there are potential collisions of listed company boards and CEOs – witness the elevated rate of CEO turnover last year. Or, of the board and the investment market – observe the rise in shareholder activism and the desire of institutional investors to have a greater say in strategy and executive pay. Or, the collision of an expected increase in global regulation with the need for boards to spend more time on strategy and less on routine compliance.

Every year since the GFC, the listed space has had significant governance challenges, but next year has a different feel because the potential for a new period of growth or a faster slowdown is so finely balanced.

Here are seven governance considerations for listed company boards in 2016.

1. Federal election

Malcolm Turnbull’s elevation to Prime Minister has buoyed corporate Australia, judging by opinion polls and confidence surveys. Business hopes Turnbull can leverage his high political capital to usher in reforms across taxation, superannuation and industrial relations, and get the budget under control.

“2016 will provide the best opportunity in a long time for the Federal Government to drive policy reform and get the economy growing faster,” says Lend Lease Group and South32 chairman David Crawford AO FAICD. “But if government misses this reform opportunity, the economy could be down for a long time and boards will have to get used to governing in a slow, grinding economy where growth is harder to find.”

Crawford says the Coalition’s new leadership team is lifting business optimism. “It’s fascinating what happens when you have a Prime Minister who is talking to people, making sense, is not being browbeaten in parliament, telling it like it is, and is smarter than anybody else in the cabinet. Significant taxation and industrial relations reform will go a long way in making business more confident to invest.”

But a possible early election in 2016 will fuel business uncertainty. Election years are historically bad for investment, principally because elections and policy debate and reform encourage companies to delay spending. The good news is Turnbull’s high personal approval rating suggests the Coalition, at this stage, is likely to retain power. The more predictable the election victory, the less business investment typically falls.

2. Policy reform

Big business has welcomed the Federal Government’s renewed appetite to consider a broader range of reforms. Key industry groups have called on it to implement tax reform and deregulate workplace laws. Infrastructure investment, taxation reform and productivity growth should be the Government’s top three priorities, according to the latest Australian Institute of Company Directors (AICD) Director Sentiment Index.

The potential change, centered on taxation reform and potentially lifting the GST and/or broadening its base, would be the most significant policy reform in a decade. With union behaviour under fire from the Royal Commission into Trade Union Governance and Corruption, the Government could face weakened union opposition to policy reform.

“The findings from the Royal Commission, and the corruption being exposed, are setting the scene for deep policy reform,” says Crawford. “If the union movement has its wings clipped, the Government will have a clearer path to win support for taxation and industrial relations reform, implement it, and get the country moving.”

But, policy reform always creates winners and losers, meaning boards will need to be even more attuned to the public policy debate and regulatory landscape.

3. Technology

Nora Scheinkestel FAICD, says technology-driven transformation remains a huge issue for boards next year. “The enormous disruption that technology has already caused will be dwarfed by what is ahead. Many organisations are having to radically rethink their business model, and boards, more than ever, need to challenge longstanding assumptions and test for any decision-making bias about current or future strategy.”

Dr Scheinkestel is chairman of Macquarie Atlas Roads, a non-executive director of its stapled entity, Macquarie Atlas Roads International, and a director of Telstra Corporation and Stockland (from 1 December).

She says latest research suggests business is experiencing a step-change in machine-to-machine learning, artificial intelligence and automation – the convergence of which will have profound impacts on people and workplaces.

Responsible boards should have been thinking for years about the effect of technology on their organisation, says Scheinkestel. “But directors who truly understand technology are very much in the minority.

“We don’t need to have deep technical knowledge, but it is incumbent on all directors to ensure they have sufficient understanding about technology to have meaningful conversations with the executive team in this area – or a willingness to become more educated on technology.”

Scheinkestel recently completed a one-day program in software coding and developed a tracking app.

“It was great fun and while it clearly didn’t make me expert in the area, from a director’s perspective, the course exposed me to how software programmers think – a combination of creativity with a very rules-based methodology.

“It would be helpful for more directors to try to expand their understanding of, or develop, technology skills next year through courses, or by seeking greater exposure to technology trends and issues by bringing in-house and external experts together to interact with the board,” she says.

Stockland chairman Graham Bradley AM FAICD says more boards will visit Silicon Valley or other global technology clusters next year to learn about latest trends. “Boards are undertaking a great deal of self-reflection of their organisation’s IT capability, and their own. They want to know if their organisation is taking advantage of big data to understand markets, and using technology to find new and lower-cost ways of reaching customers.”

Bradley also chairs HSBC Bank Australia, Virgin Australia International Holdings and EnergyAustralia. He says boards will consider establishing technology committees or advisory panels, or seek presentations from leading IT futurists next year.

“If technology poses a significant threat or opportunity, it makes sense for the board to consider that issue in a more structured way, similar to remuneration or nomination committees.”

Global management consulting firm Accenture has recommended that boards of banks establish technology committees. A recent Accenture survey of more than 100 of the world’s largest banks found only 6 per cent of their non-executive directors and 3 per cent of CEOs had deep technology experience. “Many bank boards simply don’t have adequate expertise to assess [technology] issues,” wrote Accenture. (Turn to page 14 for more information on the survey.)

Accenture added that recruiting directors with technology expertise was no panacea to fix the problems. Bradley says finding directors with high-level general business experience and deep technology skills is challenging. “It’s not an easy skill set to find. Those up to date with latest technologies tend not to have broad experience needed to govern.”

Investa Office Fund chair Deborah Page AM MAICD told Company Director last month that chairs would need to consider whether their oldest directors had sufficient technology skills. “I suspect many boards are struggling with the effect of digital technology on their organisation, partly because some directors are not familiar with it.”

Queensland company director Keith De Lacy AM FAICD says directors can no longer float above the digital challenge and leave it all to the chief information officer. “It is time to engage. Few companies are immune to cyber risk, technology change, the need for innovation as a pathway to growth, disruption to the business model and so on. The examples are all around us – Uber and Airbnb, for example.”

4. Human resources

Boards will spend more time on human resources strategy in 2016 given technology’s disruptive effect on the workforce, says Scheinkestel. “All too often, the human resources executive gets a small spot at the end of a strategy session or is overlooked. But the strength and depth of our human resources goes to the fundamental capability of the organisation to execute on strategy and to deliver sustainable value. The capacity of staff to adapt and quickly acquire new skills should be integral to strategy discussions, particularly as technological transformation demands new business models.”

A 2013 study by Carl Frey and Michael Osborne of Oxford University predicted 47 per cent of all jobs in the US were at risk of being displaced by technology. Research this year by the authors, in conjunction with Citi, found up to 87 per cent of jobs in the accommodation and food services industry were at risk of automation, and that 54 per cent of jobs in financial services could be displaced within a decade or two.

The 2015 Deloitte Global Human Capital Trends report found that cognitive computing – the use of machines to read, analyse, speak and make decisions – is affecting work at all levels. “Human resources teams must think about how to redesign jobs, as we all work in cooperation with computers in almost every role,” wrote Deloitte.

Scheinkestel says directors must satisfy themselves that their organisation is working not only on radically transforming the business today, but also on identifying and developing skills needed for the next 10 years. “Directors need to ask: Will the organisation have the right skills for the strategy being formulated? Is it prepared for the increasing automation of jobs and the creation of new technology-driven roles? If we don’t have those skills now, does the organisation have the capacity to acquire or develop them?”

Boards, says Scheinkestel, will need to test if the executive team is driving a culture that encourages life-long learning. “The head of human resources – part soothsayer, organisation barometer, counsellor and pathologist – has an increasingly important role in these disruptive times. They can gauge the capability and mood of the organisation, they can counsel and advise the senior executive team and model some of these key attributes. Those that perform these myriad functions well will be an invaluable resource for the CEO and the board.”

5. M&A and growth

If business confidence keeps improving, boards will be more likely to approve plans for a new wave of capital investment or acquisitions, to take advantage of record-low interest rates and cashed-up balance sheets, and to capitalise on depressed equity prices.

After years of low activity, mergers and acquisitions (M&A) spiked in 2015 and takeovers are sure to be a bigger issue for ASX-listed companies – as predator or prey – in 2016. EY’s Australasia Capital Confidence Barometer, which measures more than 1,600 senior executives globally, found more than half of Australian companies were planning acquisitions in the next 12 months, from 44 per cent six months ago.

“One of the first challenges for boards in 2016 will be to reconsider their appetite for growth, despite ongoing global economic volatility,” says Bradley. “The mood in the business community is much more positive after the leadership change in Canberra, and we see continued good progress in the New South Wales and Victorian economies. There is greater optimism that the economy is transitioning towards non-mining investment.”

But there have been recent examples of companies curtailing offshore growth strategies or other investments to appease the market. Insurance Australia Group (IAG), for example, announced in October it was ending its expansion plans to China. “It is not clear whether investors, generally, are prepared to support long-term growth initiatives involving greater risk, given current global economic uncertainty,” says Bradley.

An extended period of historically low interest rates will force more boards to reconsider their organisation’s required rate of return on investments and lower the “hurdle rate” needed to approve projects, says Bradley. “It’s a difficult issue for boards: they must be satisfied that the risk and reward of a new project is acceptable, while questioning whether their expectations of the return needed to justify new investment should be lowered.”

The Reserve Bank of Australia this year found firms might be requiring a return that is too high, does not change often, or is not directly sensitive to low interest rates, when evaluating investment proposals. A reluctance to lower hurdle rates could explain the subdued investment intentions of Australian companies.

A Deloitte survey last year found nearly 90 per cent of Australian corporations used hurdle rates exceeding 10 per cent, and some had not altered this rate for years, despite a lower cost of capital.

Listed companies might also have to spend more time in 2016 educating investors to accept a lower rate of return, given a sluggish global economy and low interest rates.

6. CEO turnover

The ability of boards to oversee executive succession planning was in question this year after a spike in surprise CEO resignations. Although it’s too early to suggest a trend, several factors suggest boards would be more willing to change executive leadership in 2016.

Newcrest Mining and Federation Centres chairman Peter Hay FAICD, says having the courage to change a CEO who is no longer right for the organisation is a critical aspect of governance. “It’s difficult to generalise, but if the economy starts to grow faster, more boards might ask whether the organisation still has the right CEO for the next stage of the business cycle. Some CEOs are good at cutting costs; others excel in growth strategies; and some are good innovators. Ideally, a board should choose a CEO who can manage through all parts of the cycle, but that is not always the case.”

Technology could be another catalyst of CEO turnover, says Hay. “There’s a lot of talk about boards needing more technology skills, but the key question for directors is whether the organisation has executives who are abreast of technological change. If the board feels management lacks the capacity to stay ahead of disruption in its industry, that could be a catalyst for change.

“The board, of course, needs to be able to ask the right questions about technology, and this needs to be reflected in board composition. But first and foremost the board needs to know that it has a management team with the skills and experience needed to address appropriately the company’s technology risks and opportunities. The longer I work in governance, the more I realise that everything depends on choosing, mentoring and monitoring a management team that is fit for purpose.”

Bradley says the rise of Gen-Y managers could drive CEO change. “The CEO’s role is now so multi-faceted. To be successful with Gen-Y employees, CEOs need a far greater emphasis on communication, delegation and creating an environment of innovation. They also need a different level of humility and personal leadership style. As such, boards will increasingly ask whether they have the right CEO to lead this new generation of managers, particularly if the organisation is heading in a different direction.”

7. Invisible risks

In a social media-fuelled world, the potential for whistle-blowers to expose and communicate real or perceived scandals has never been greater. Directors, in turn, will spend more time in 2016 questioning whether they are receiving the right information, and if they have a sufficient handle on organisational culture and whether values are being upheld.

“Invisible risks are mostly in workplace health and safety, involving new responsibilities for companies and directors in mental health, harassment, bullying, and child protection [policies],” says De Lacy.

He says a rapid increase in shareholder class-action activity adds another dimension to the challenges. “This is being fed by the proliferation of class-action lawyers and associated litigation funders. The proponents sell it as ‘access to justice’ for ordinary people. I see it as un-Australian – when something happens, find people to blame and sue them. But it is the new paradigm, and it adds a further dimension to company risk, brand protection and director liability.”