Talk about whine and moan. You would have thought it was the end of capitalism the way the market carried on when the Australian Stock Exchange (ASX) announced it was preparing the snappily titled Principles of Good Corporate Governance and Best Practice Recommendations late last year.
From the outset the doomsday merchants were critical of almost every aspect of the new code. The Australian Institute of Company Directors (AICD), which was involved in its development, initially refused to put its imprimatur on it. The code was accused of being too prescriptive, not prescriptive enough, too hard for smaller companies to implement, a toothless tiger. You name it, every insult was slung at the guidelines.
Thankfully, however, the market has warmed to the code and now, more than six months after its official release, the dust has started to settle and Aussies are finally getting their heads around the new regime. While it’s likely to be some years before the market will be able to fully appreciate the effect of the new principles – and judge whether corporate governance in Australia has actually improved – companies’ efforts to meet the requirements set out in the code, and the market’s reaction to these efforts, are becoming more positive.
But it wasn’t always this way. Eighteen months ago responsibility for the regulation of corporate governance in Australia was a hot potato. The ASX didn’t want it. The Australian Securities and Investments Commission (Asic) didn’t want it. Even Senator Ian Campbell, who has been in charge of a review of Australia’s corporate law, didn’t want to touch it. Then suddenly the ASX announced it was establishing a committee that would set benchmarks for best practice corporate governance for Australian companies.
‘We suspect there was a call from Canberra that led to the ASX seeking to grab the governance ground,’ says Sandy Easterbrook, a principal of Corporate Governance International, who acted as the unofficial coach for the buy side during the guidelines’ development.
What happened next was a scramble to put together a committee representing the vested interests in the Australian market. The end result was the 21-member ASX Corporate Governance Council, comprising representatives from most of Australia’s largest business groups, including the AICD, the Australasian Investor Relations Association (Aira) and the Business Council of Australia in addition to buy-side organizations like the Australian Institute of Superannuation Trustees and the Australian Council of Superannuation Investors.
Once the council was announced, it was a race against time to put together the principles and resolve the concerns of both the market and companies. ‘Because the ASX did all the drafting, that side of the river accepted [the draft guidelines],’ comments Easterbrook, who reports there was a fair bit of compromise by both the sell side and the buy side before agreement was reached on the final outcome.
Squawking & hawking
Despite the relatively rigorous consultation process used in developing the guidelines, their official release sent the market into something of a spin. At issue was the ‘comply or explain’ principle. While there was barely a whisper about the guidelines themselves, the market worked itself into a frenzy about the comply or explain mechanism, which allows companies that don’t meet a particular principle to remain non-compliant as long as they tell the market why not.
It was this self-guidance philosophy that prompted the toothless tiger accusations. ‘A company can avoid the guidelines by simply saying that it does not comply and giving a stock-standard explanation,’ charged Labor Party Senator Steven Conroy when the principles were first released. ‘Without any real enforcement mechanism it’s business as usual,’ he complained.
While this reading of the comply or explain mechanism may be understandable, it is not what the council intended. Although certain sections of the market have regarded the mechanism as a loophole that allows companies to shirk their corporate governance obligations, it was actually intended to provide listed entities with scope to develop corporate governance practices that were appropriate to their individual requirements. This scope is needed because there is such a huge difference in the corporate governance needs of a company capitalized in the billions and, say, a micro-cap stock capitalized under A$5 mn.
‘There seems to be widespread misunderstanding about comply or explain,’ says Ian Ramsay, a Melbourne University professor and corporate governance expert. He argues that ‘it’s perfectly appropriate for a company, particularly a smaller company, to say it doesn’t need 50 percent independent directors [one of the code’s guidelines] provided it provides transparent reasons why the recommendation is not appropriate.’
Unfortunately, the market’s initial reluctance to accept the comply or explain principle has left smaller companies skittish about the guidelines. ‘There is a concern among smaller companies that if they explain, will that explanation be accepted? Everyone has to work towards acceptance that it’s okay to be different,’ says John Hall, CEO of the AICD. ‘There needs to be more widespread acceptance that explanation is compliance.’
Figuring out implementation
Six months on, how are companies coping with the new principles, which actually only come into force for the 2004 financial year? Many companies are still deliberating at board level the best way to implement them. Those for which good corporate governance has always been a priority are already reporting according to the terms of the principles. ‘Others haven’t started and are overwhelmed,’ says Carolyn Kerr, chair of Aira.
The first company out of the starting gates was the big winner of the IR Magazine Australia Awards 2002, James Hardie. The building materials giant is already in compliance with each of the guidelines’ ten principles, as well as almost every one of the recommendations that sit underneath the principles. Greg Baxter, executive vice president and head of investor relations for James Hardie, says the company now issues ‘more information on corporate governance than you’ll ever want to see.’
Baxter says it was an easy decision to be one of the first to adopt the new code as James Hardie has long used corporate governance to differentiate itself from its peers. ‘Good corporate governance and disclosure is just how we run the business,’ he says. ‘It underpins everything.’ And, while the company has its roots in Australia, it also has a US listing, which means it’s had to cope with the requirements of the Sarbanes-Oxley Act, which is much more prescriptive than Australia’s new code.
According to Baxter the company’s ‘Australian heritage served us well’ when it was preparing to comply with Sarbanes-Oxley. It already had separate chairman and CEO roles (common in Australia and a recommendation of both Sarbanes-Oxley rules and the ASX’s new guidelines) and had already implemented an independent audit committee (again a requirement of both sets of rules). ‘Even though the US situation is more prescriptive, the guidelines are similar,’ says Baxter. ‘We haven’t had an issue with any of the reforms.’
Another company with a listing in both the Australian and US markets, and which has also been an early adopter of the ASX’s new governance code, is one of James Hardie’s closest competitors, CSR. The former sugar giant turned building services company also has a long history of good corporate governance, thanks to an historic requirement to be transparent as the former sole statutory marketer of Australia’s sugar crop.
‘Although the guidelines are helpful, we would argue that we have most of the principles in place anyway, and it’s been that way for years,’ says Graham Hughes, CSR’s company secretary.
CSR has been an SEC registrant since 1993 and Hughes says good corporate governance is ‘a culture thing’ for the company: ‘We take some effort to document our practices. It’s just a question of doing things properly.’ Indeed, CSR was already rotating its audit partners, had adequate numbers of independent directors and had implemented CEO/CFO sign-off on financial accounts ‘many years ago’.
What about the small fry?
Although larger companies appear to be coping quite well with the guidelines, it’s the smaller companies that are struggling. ‘For smaller companies compliance is a bigger burden,’ posits Baxter. ‘They just wouldn’t need the systems and procedures [that the guidelines outline]; and wouldn’t see that they need them.’
But while it’s true that most companies will utilize significant resources this year drafting policies and procedures to ensure they meet the guidelines, once they have these documents in place, updating them each year should be relatively easy. What will be considerably more difficult is changing the company culture so that good corporate governance is a given not a luxury. For smaller companies under less public pressure than bigger ones to reform governance practices, this is the real challenge.
There is widespread acknowledgement of the problems smaller companies will face in implementing the new guidelines. To help work through some of these issues, the ASX has formed an Implementation Review Group (IRG), which is charged with working with companies to ascertain some of the problems in implementing the code and making recommendations for how the guidelines might be amended to work more effectively. ‘It will look at particularly disadvantaged groups and a potential carve out for smaller companies,’ says Easterbrook.
Resolving issues
Aside from problems which are specific to smaller companies, the new code has also unleashed a range of other problems on the Australian corporate environment. The code’s recommendation that a majority of the board should be independent potentially strains the talent pool of directors in Australia and could prompt Australian companies to reshuffle directors like a pack of cards. This argument has been proffered in the UK and elsewhere as well. However, John Hall disputes this claim, countering that the number of qualified directors is increasing every year. ‘Over 1,700 people undertook our director qualification course last year,’ he says. ‘There’s no evidence that skills are lacking.’
Another issue the market is facing is monitoring compliance with the new code. While the ASX has significant monitoring resources, most of these are directed at compliance with listing rules and any serious attempt to monitor compliance of the corporate governance principles surely means the ASX needs more funding in this area. The disciplining of companies in breach of the code is also an area that has yet to be properly addressed.
Susan Bray, the ASX’s national coordinator for market integrity, says that as companies aren’t obliged to report according to the guidelines until 2004, the ASX will be reviewing ‘annual reports generally this year, to feed back into IRG.’ How exactly compliance will be monitored into the future remains to be seen.
The final reading
Much of the criticism directed at the guidelines seems to suggest sections of the market are expecting too much. It’s important to acknowledge that the existence of the guidelines cannot prevent breaches of corporate governance altogether; there will always be rogues keen to make a fast buck at the expense of shareholders.
In the end, the success of the code hangs on the way companies apply it to their individual corporate governance policies. It also depends on investors actively using companies’ published corporate governance policies when making investment decisions; the onus is now on investors to check the ASX’s guidelines against corporate governance information published in annual reports and on company web sites.
In practice, the guidelines merely help facilitate the market mechanism by ensuring that a company’s corporate governance practices are in the public domain. Beyond that, it’s up to the market to decide whether those practices are appropriate or not.
The ASX’s 10 corporate governance principles
A company should…
Lay solid foundations for management and oversight
Structure the board to add value
Promote ethical and responsible decision-making
Safeguard integrity in financial reporting
Make timely and balanced disclosure
Respect the rights of shareholders
Recognize and manage risk
Encourage enhanced performance
Remunerate fairly and responsibly
Recognize the legitimate interests of stakeholders
