Agenda

Recent news for directors.

Ethnic diversity improves corporate governance

The diversity debate has focused mostly on gender and skills. Less considered are the benefits of ethnic or racial diversity in executive and board ranks, and how it affects organisation performance.

That will become a bigger issue for Australian boards. Only 1.9 per cent of executives or leaders in S&P/ASX 200 companies have Asian cultural origins, according to Diversity Council Australia research conducted last year. Few of Australia’s top 200 listed-company boards have Asian-born directors.

A new paper, by Utah State University’s Alison Cook and Christy Glass, examined the effect of racial/ethnic minority CEOs and diverse boards on corporate governance and product development. The authors studied Fortune 500 companies in the US from 2001 to 2010. The study, Do minority leaders affect corporate practice? Analysing the effect of leadership composition on governance and product development was published in Volume 13, Issue 2 of the journal, Strategic Organization, and makes an important contribution on the effect of leadership diversity in organisations on a range of firm-level practices, including governance.

The authors found no evidence that a CEO from an ethnic minority group significantly affected corporate governance or product development in an organisation. However, the presence of board members from minority groups was associated with improvements in corporate governance and product development.

Cook and Glass also said board diversity improved governance, especially in firms led by white, male CEOs. “The presence of ethnic diversity on the governing body only advances strong corporate governance. One possible explanation is that diverse boards are more likely to select CEOs – regardless of race/ethnicity – who support their ideas and priorities.

“The presence of minority (race) board members significantly improves both corporate governance strengths and product innovation under a white CEO. Firms with white CEOs and diverse boards are more likely than other firms, including firms led by minority CEOs, to pursue strong governance mechanisms and enjoy strong product innovation. These findings underscore the importance to firms of having diverse boards irrespective of the race/ethnicity of the CEO.”

AICD unveils integrity management course

The Australian Institute of Company Directors (AICD) has launched an Integrity Management for the Local Government course, which has been designed specifically for senior leaders in local government organisations and executives who are responsible for reporting on integrity and governance to councils, state government and other oversight bodies.

The course, which is initially being rolled out in New South Wales, aims to increase the understanding of good governance in local government; identify the role, liabilities and key duties of councillors and recognise the links between risk management, risk culture and effective leadership.

The initiative is being championed by Statewide Mutual to promote integrity management amongst its member base and the local councils across NSW. Statewide is also sponsoring the mayor and general manager of each council to attend the course.

Bill Warne, chair of Statewide Mutual said the course was a reactive response to an increase in councillors’ and officers’ claims. “The development of the program arose from observations that councils were having issues with referrals to the department, lack of understanding of respective roles by both elected officials and staff, code of conduct complaints, disputes between elected officials and senior management and in some cases, referral to ICAC,” he said.

Warne added that such “tensions” were time consuming, detrimental to morale and added to council costs.“It was considered that if we could promote better governance practices across our industry and promote a clearer understanding of roles and responsibilities, that this would be a positive risk management initiative,” he added.

The one-day course will be delivered at 15 different regional centres across NSW over an 18-month period. Arrangements will be made with each region to determine the most suitable dates for the course delivery.

Announcing the launch, Peter Achterstraat AM FAICD, NSW president, said: “Councillors and council officers have an important responsibility to drive organisational outcomes that benefit communities.”

Time to review hurdle rate

When evaluating investment opportunities, boards might consider the expected rate of return or the time to recoup the investment. But do assumptions about the hurdle rate of return and the payback period need to change in an era of record-low interest rates?

This is a critical question for boards. As the cost of capital falls, more executive teams will ask their board to approve capital-expenditure proposals for new projects, or to buy other companies, so that the firm can maintain growth through acquisitions. It is also an important question for the economy.

The Reserve Bank of Australia (RBA) in June tried to answer this question in the paper Firms’ investment decisions and interest rates, which was authored by Kevin Lane and Tom Rosewall of the RBA’s economic analysis department, and published in the RBA’s June Quarter 2015 Bulletin, and provide another explanation for the subdued investment intentions of Australian companies.

The RBA 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. It said Australian firms “tend to require expected return on capital expenditure to exceed high hurdle rates of return that are often well above the cost of capital and do not change very often.” In addition, many firms require the investment outlay to be recouped within a few years, requiring an
even greater implied rate of return.

Nearly 90 per cent of Australian corporations surveyed last year by Deloitte use hurdle rates exceeding 10 per cent and, in some instances, had not altered this rate for years, despite falling interest rates and a lower cost of capital.

As the RBA notes: “In many instances, it appears that firms are using hurdle rates that have not changed in a long time, set at a time when nominal long-term interest rates were far higher than they are today. Whether explicit or not, such behaviour is consistent with a reduced appetite for risk or the possibility that risks have increased.”

Companies have good reason to maintain a required rate of return on new projects, even as the cost of capital falls. Lower interest rates can be temporary, boards are typically asked to approve projects that run for years, and a lower hurdle rate can send the wrong message to the executive team about the type of projects that will be approved.

Nevertheless, the RBA research provides a useful takeout for boards: review the assumptions behind the required hurdle rate and payback period for new projects, and test if they still stand in a period of sustained low interest rates. The risk is some boards reject opportunities based on outdated criteria and damage their organisation’s long-term growth prospects.

The big question

Question
We are looking for the rule of rotation for non-executive directors in a unlisted company. Is it the same as for listed companies i.e. limited to three years? Is there a limit to the number of three-year terms, assuming the director is duly re-elected?

Answer
Lifetime tenure, as was common in earlier times, has definitely gone out of favour (whether for listed or unlisted companies).
Now most directors are appointed, as a matter of good practice, for a period of three years, renewable. If the individual is performing well, naturally, their term can be renewed, at the company’s discretion.

It is a matter for each company to assess the position with respect to company directors’ appointments (irrespective of whether they are executive or non-executive directors; listed or unlisted). The position is not prescribed by law. However, the matter may be specified in the company’s constitution to make it binding on the company, its members and directors alike.

Queen’s Birthday Honours 2015

Special congratulations to former Australian Institute of Company Directors (AICD) chairmen John Story AO FAICD and Rick Lee AM FAICD for their recent Queen’s Birthday Honours.

Chairman from 2007 to 2009, John Story AO FAICDLife, was named an Officer of the Order of Australia for distinguished service to business and commerce through a range of corporate governance roles, as an industry leader and mentor in the public and private sectors, to the law, and to professional organisations.

Chairman from 2010 to 2013, Rick Lee AM FAICD, was named a Member of the Order of Australia for significant service to business and commerce through a range of executive roles, and to sporting and charitable groups.

Further congratulations to the following members who appeared on the Queen’s Birthday Honours list this year.

Clive Austin AO FAICD
David Eiszele AO FAICD
Lauren Elizabeth Jackson AO MAICD
The Hon Gary Roy Nairn AO GAICD
Professor Ross Milbourne AO FAICD
Rupert Myer AO FAICD
Karen Simmer AO FAICD

Professor David Arthur Battersby AM MAICD
Barry Buffier AM FAICD
Brett Chandler AM MAICD
Samuel Stuart Clark AM  FAICD
Dianne Margaret Davidson AM MAICD
Andrew Edwin Fairley AM FAICD
Ronald Finlay AM MAICD
Dr Keith Garner AM MAICD
Ronald Graham AM FAICD
Rhonda Hawkins AM FAICD
Air Vice-Marshal William Francis Henman AM MAICD
Mark Jones AM MAICD
Brigadier Darren Scott Naumann AM MAICD
Sabina Jane Shugg AM GAICD
Anthony Jona Tate AM GAICD
Russell Charles Taylor AM MAICD
Bruce Turner AM MAICD
The Hon John Watkins AM MAICD

Dr Philip Stephen Bachelor OAM FAICD
Catherine Mary Birrell OAM GAICD
Mark Brandon OAM MAICD
Dr Philip Godden OAM FAICD
Anne Robyn Lord OAM GAICD
Alan Newing OAM FAICD
Joseph Rizk OAM MAICD
Michael Floyd Williams OAM FAICD

Susan Margaret Christophers PSM GAICD
Matthew Richard Hall PSM MAICD
Toni Rosina Moate PSM GAICD

Detective Superintendent Cameron Ian Harsley APM MAICD

Brigadier Michael Mahy DSC GAICD – Commendation for Distinguished Service
Commodore Philip Spedding DSC AM RANR MAICD – Commendation for Distinguished Service

Lieutenant Colonel Jason Stuart Groat CSC GAICD

Commodore Peter Leavy CSM GAICD

KEY
Officer of the Order of Australia – AO
Member of the Order of Australia – AM
Public Service Medal – PSM
Medal of the Order of Australia – OAM
Australian Police Medal – APM
Conspicuous Service Cross – CSC
Conspicuous Service Medal – CSM

Note: While much care is taken to ensure that we include all members honoured, we apologise in advance to anyone who may have been overlooked.

Effective scenario planning in uncertain times

Governing in conditions of high uncertainty is a recurring theme among boards. As economic, industry and geopolitical risks rise, boards must consider a wider range of scenarios for their organisation and how it would respond.

But what makes effective scenario planning at board level and how can directors ensure the organisation has sufficient skill in this function in executive ranks?

Management consulting firm McKinsey & Company says scenario planning often under-delivers in organisations because of insufficient experience with this tool, a lack of “corporate memory”, too much delegation, cognitive biases, or excessive focus on detail. McKinsey provides five tips for effective scenario planning:
 
1. Fight the urge to make decisions based on what you already know: Review all trends that could affect the organisation, but avoid relying on readily accessible information or evaluating trends only in the same industry or geographic context.

2. Beware of giving too much weight to unlikely events: Evaluate trends using qualitative then quantitative approaches and avoid too much focus on numbers early in the process.

3. Do not assume the future will look like the past: Build scenarios around critical uncertainties and engage senior management; avoid outsourcing scenario creation to more junior team members.

4. Combat overconfidence and excessive optimism: Assess the effect of each scenario and develop strategic alternatives; avoid planning for the most likely scenario, to the exclusion of all others.

5. Encourage open debate: Instil the discipline of scenario-based thinking with systems, processes and capabilities to sustain it; do not treat scenario planning as a one-off exercise and consider the risks of “groupthink”. As with all critical risk management processes, boards should test their organisations’ systems and capabilities for sustained scenario planning from time to time. In a volatile business environment, it is not enough for boards to consider a range of possible outcomes and the best response. Directors must ensure the processes behind board and executive-team scenario planning are robust.