Five ways to improve how the board and executive interact

Time management is rarely high on the list

When asked about the strengths of high-performing boards, directors often point to technical or interpersonal skills – the ability to grasp a range of issues, constructively challenge management and work collegially, for example. Time management is rarely high on the list.

Yet the most effective directors spend twice as many days a year on board activities as others do, according to global consulting firm McKinsey & Company. Some directors are more committed to their role, others simply work harder, but the best ones use their time effectively.

“Boosting [director] effectiveness isn’t just about spending more time [on board duties],” notes McKinsey. “It’s also about changing the nature of engagement between directors and the executive teams they work with.”

McKinsey outlined five ways to improve board/executive engagement in its April 2015 article Changing the nature of board engagement. They are:

1. Engage between meetings
High-performing boards find ways to keep directors engaged and informed between board meetings. That minimises time on background issues and helps directors focus on key matters in the main board meeting.

2. Engage with strategy as it forms
Good boards work with the executive team to guide and shape strategy as it forms, not review a near-complete strategy in which they have had low involvement. That saves considerable time in the approval stages as the board is familiar and comfortable with the process that has delivered the strategy.

3. Engage on talent
The board moves from simply observing the organisation’s top talent, as part of normal succession-planning duties, to cultivating it. Directors might tap their networks to find candidates for executive roles, or mentor the organisation’s up-and-comers.

4. Engage the field
Directors are assigned specific operational areas to examine, for example, cyber-security risks or long-term growth trends in Asia. The director might lead a working committee that includes executives.

5. Engage on the tough questions
Should every board or a large listed company have at least one director whose responsibility is to think like an activist and challenge the group view? Being able to challenge management on complex strategic issues is a critical skill that strengthens board/executive engagement, notes McKinsey.

CEO fixed pay and board fees alignment improves

Much has been made of the alignment between executive pay and organisation performance since the global financial crisis. Less considered is the relationship between chief executive officer (CEO) fixed pay and total non-executive director (NED) fees in listed companies.

Remuneration and board specialist Guerdon Associates examined this relationship for companies in the S&P/ASX 200 index. It also focused on changes between CEO and NED fees for ASX 20 companies over 2012-14, and in relation to CEO tenure.

Guerdon found the ratio of CEO pay to NED fees in the top 20 listed companies by market capitalisation fell in the past three years. In calendar year 2012, the average CEO’s fixed pay as a ratio of total NED fees was 102 per cent. In 2014, the ratio was 93 per cent.

Total NED fees for top 20 companies grew 4.4 per cent over 2012–2014, while CEOs had a slight decrease in fixed pay, Guerdon found.

Another trend was boards awarding significantly lower fixed pay to new CEOs compared with their predecessors. The fixed pay of CEOs with tenure of one year was about 80 per cent of total NED fees in the organisation. At 10 years’ tenure, the CEO’s fixed pay was on average about 110 per cent of total NED fees.

This analysis suggests boards are improving the alignment between CEO fixed pay and board fees as director workloads increase, and keeping a tighter rein on fixed pay for incoming CEOs.

Comparing CEO fixed pay with NED fees is an interesting way to gauge executive remuneration. Some governance observers believe a chairman of a large listed company should earn about half the CEO’s fixed pay, or that total board fees should be in line with CEO fixed pay.

Guerdon’s report, Can you set CEO fixed pay based on total non-executive director fees? appeared in its April newsletter.

Tackling shareholder activism

It is widely believed that shareholder activism is growing in Australia. A recent newsletter from law firm Clayton Utz states “Australian companies need to plan for the possibility of an activist attack”. The note considers recent tactics against Antares Energy, Karoon Gas and Molopo Energy and observes that Australian companies “can no longer be quarantined from US-style activism”.

Sue Decker, former president and CFO of Yahoo, believes that boards should proactively take steps to handle shareholder activism. In a recent article she states, “As insiders, we are in a better position to act on our fiduciary responsibility to represent the interests of shareholders than is an independent party and we have more tools and power at our disposal to do so”.

Decker outlines what public company boards can do to better align with their core responsibility to shareholders:

(i) Facilitate direct engagement between the board and shareholders. Boards typically hear about shareholder concerns indirectly and often not attributed to any specific shareholder. Decker states: “If a designated director or a designated third party representing the board were to reach out to shareholders from time to time, both sides would learn and benefit”.

(ii) Establish a mechanism to attract new directors with some of the skill sets of long-term shareholders, and a board rotation mechanism to create room for new ideas and more diversity. For example, Decker suggests a system where each new board member agrees to hand in their resignation every six to eight years. Some directors will be asked to serve multiple terms if they are continuing to help the company build value, but many will move on after that time-frame.

(iii) Call on management to “analyse strategic choices as an activist would: by looking at alternatives to the strategies the CEO is recommending”. Decker notes that this is not typical; more commonly, the CEO will consider options and present only one to the board. She states: “The road not taken is the one the activist will surface so the board must have analysed these alternatives”.

Stay Informed

This is one of many articles featured in the Australian Institute of Company Directors’ Centre for Governance Excellence and Innovation (CGEI). The CGEI is a resource centre dedicated to governance issues.

Other recent highlights include an opinion piece by Steven Cole FAICD which queries whether the Australian economy and society would benefit from a reallocation of resources from the compliance aspects of governance towards initiatives designed to enhance the performance of the nation’s organisations and their directors and officers.

The big question

Question
When should a private company be audited and what are the parameters of private company audits?

Answer:
Small proprietary companies may need to have their financial statements audited if required to do so by members holding five per cent of the shares or if required to do so by the Australian Securities and Investments Commission. Alternatively, if the private company is controlled by an overseas company and the overseas company has not been required to have its accounts audited, the private company may also be required to have its accounts audited.Otherwise, only private companies which fall within the definition of “large proprietary company” need to be audited.

A proprietary company is a large proprietary company for a financial year if it satisfies at least two of the following conditions:

• The consolidated revenue for the financial year of the company and the entities it controls (if any) is $25 million or more.
• The value of the consolidated gross assets at the end of the financial year of the company and the entities it controls (if any) is $12.5 million or more.
• The company and the entities it controls (if any) have 50 or more employees at the end of the financial year (s45A of the Corporations Act 2001).

If the proprietary company satisfies at least two of the above conditions, the company will need to be audited. Public companies usually need to have their accounts audited (s292 of the Corporations Act 2001).

This Q&A is taken from Director Assist, a complimentary member service operated in partnership with IFX. Answers are provided by a network of specialist practitioners.

Value of human capital comes under institutional investor spotlight

High-performing boards keep close tabs on organisation culture for good reason: an engaged workforce contributes to stronger financial performance and helps minimise risks. Yet the investment community mostly ignores the value of “human capital” in assessing companies.

That is changing. Institutional investors, such as industry superannuation funds, are increasingly considering a broader range of metrics to assess organisation performance. It is part of a global push for companies to provide greater detail on non-financial information.

Macquarie Research’s pioneering work on employee engagement shows a clear link between workforce satisfaction and motivation, and performance. Organisations with an engaged workforce consistently out-performed the “laggards” on total shareholder return over eight years, Macquarie notes.

Its model focuses on a range of employee-engagement metrics outlined in the organisation’s environmental, social and corporate governance (ESG) reporting. They include staff turnover, absenteeism, pay and productivity, workplace diversity, industrial disputes and safety.

Macquarie found workplace diversity – the ability to attract and keep female staff – is a strong indicator of an organisation’s broader human-capital management. Low reported absenteeism was typically associated with positive trends in staff morale and productivity. Low voluntary staff turnover, where employees decide to leave, was another healthy sign.

None of this should surprise boards. Over the years, many strategies have failed because an organisation’s culture resisted them or there was weak alignment between the two.  In its Employee Engagement 2015 Survey, published in mid-April, Macquarie notes that an organisation’s human capital is often more valuable than its physical capital.

A bigger surprise is how the investment community is starting to pore over ESG data, find corporate leaders and laggards on employee engagement and factor it into investment decisions.

For boards, that means ensuring there is robust reporting on workforce metrics through internal “climate surveys”, understanding how the results drive long-term organisation performance and testing whether executives are sufficiently incentivised to deliver higher employee-engagement scores through reward structures.

Future of AGMs

The role and relevance of the annual general meeting (AGM) continues to be a focus for directors, according to a survey by law firm King & Wood Mallesons, with numerous respondents indicating that the AGM is “no longer an effective way of communicating with stakeholders” and “a waste of time and money because so few shareholders turn up”.

The King & Wood Mallesons report says: “these sentiments are consistent with the results from previous surveys and reflect concerns that the AGM, in its current form, is no longer filling its intended role as a forum for shareholders to ask questions, raise concerns and engage with directors and management.

“Institutional shareholders typically have greater opportunities to engage with directors and management outside the AGM, given the size of their holdings, their
resources and connections, and their perceived influence (including in relation to whether there is a ‘strike’ recorded against a company’s remuneration report).”

Tips for joining a government board

The abrupt axing of some government boards as part of the Federal Government’s smaller government reform agenda, coupled with a volatile political arena, means greater due diligence is needed. Tony Featherstone provides some tips for directors looking to join a government board:

1. Know what you are getting into
Understand the main differences between governing on a government board and a commercial or not-for-profit one. Are you suited to that style of governance?

2. Why me?
Ask why the board wants you to join. Is your skill-set aligned with the board’s needs and does it add to board composition? Are you passionate about the organisation?

3. Public policy
Effective directors on government boards typically have a strong interest in public policy and serving the community. They don’t see a government board as a stepping stone to a commercial board or mostly as a training ground to learn new skills.

4. Politics
Can you leave your politics at the boardroom door and govern objectively, regardless of who is in power? Are you confident the board’s work will continue if there is a change of government?

5. Clarity
No aspect of due diligence is more important than clearly understanding the government board’s role and responsibility. Why was it established, what is its charter and how much decision-making power does it have?

6. Reporting lines
Understand who hires and fires the chief executive officer (CEO), how director appointments are made and how much say the board has in its composition.

7. Reputation
Assess other directors, the chairman, CEO and responsible minister. Are you happy to stake your reputation on the board?

8. In practice
Talk to directors on the board or others who report to the minister. Is he or she willing to take frank and fearless advice and what is their history of acting on it? Can the board deliver clear outcomes?