Nepotism

Larger listed companies should consider recruiting offshore-based directors whose governance skills are better aligned with their organisation’s international growth strategy.

So says Dr Ulysses Chioatto, an Adjunct Associate Professor in Law at Western Sydney University who has examined the alignment of board skills and composition with company strategy.

Chioatto believes board composition is not keeping pace with the growing internationalisation of Australian business. By appointing mostly local directors, companies are overlooking a larger pool of candidates offshore – and missing an opportunity to strengthen boardroom diversity.

“All too often, we see the same faces on ASX 200 boards,” says Chioatto. “Diversity initiatives are driving some much-needed change, but the ‘gene pool’ of directors is still too small. Part of the answer is looking overseas for directors and boards having an international mindset.”

Chioatto, a former head of Research for Australia and New Zealand for proxy adviser Institutional Shareholder Services (ISS), makes the point that ASX-listed companies are driving a renewed push to expand overseas, but their boards still consist mostly of Australia-based directors, many of whom do not have extensive professional experience overseas.

That’s not to say Australian directors lack international skills, but having offshore-based directors can add a different skillset and perspective, provided boards can overcome the logistical challenges of having directors in different countries, he argues.

A new breed of information technology and financial technology (fintech) companies on ASX are being “born global” – that is, targeting international markets from the start.

Australian healthcare, medical devices, funds management and tourism companies, for example, continue to expand successfully overseas. Many of the market’s top performers this decade have been mid- or small-cap companies (ASX 100 to 500) that are growing overseas.

Chioatto’s analysis of skill matrices in annual reports of large listed companies has led him to conclude that board skills are insufficiently aligned with strategy.

Here is an edited extract of Chioatto’s interview with the Governance Leadership Centre:

Governance Leadership Centre: Ulysses, you argue that the current pool of directors in Australia is too small. Why do we still see a high rate of ASX 200 directors with multiple directorships?

Dr Ulysses Chioatto: People talk about the need for fresh faces on boards and the benefits of diversity, but the pool of suitably qualified people who can govern large, complex listed companies is small. ASX 300 companies still mostly look to the domestic CEO pool for future directors.

In a market such as Australia, there are not a lot of CEOs for boards to choose from. They tend to be exceptionally well paid and may have less interest in future board roles if compliance risks and board workloads increase. Why would a CEO who is paid a multi-million-dollar salary consider a portfolio of directorships that offers a fraction of his or her current pay?

GLC: What are the benefits of sourcing overseas-based directors?

UC: The obvious one is Australian companies can choose from a director pool many times larger and more diverse than ours. There are lots of ex-CEOs overseas, male and female, who have skills well suited to Australian boards.

Industry and market specialisation is another benefit. An Australian tech company, for example, can look for offshore-based directors who have spent decades in the US tech space. A company looking to enter the United Kingdom can recruit a director who is based there and understands the regulatory framework and competition in that market. A company that wants to expand in Asia could add a director who works in the region.

GLC: We talk about the “Asian Century” and the opportunities for Australian companies. Should more of our companies recruit China-based directors?

UC: Yes. Our most critical trade point is China, yet there are hardly any Chinese-heritage directors on our boards. A third of our exports go to China and direct Chinese investment in Australia was 54 per cent of all foreign-investment proposals in FY17.

Australian boards must understand that China is not a market economy based on the rule of law but a party-corporate conglomerate ruled by the Communist Party. China's strategy is its ‘One Belt, One Road’ global objective: this has included the purchase of energy and port companies in Australia. We need directors on boards who deeply understand China’s economy, industry and government.

GLC: Why have Australian companies been reluctant to recruit overseas-based directors?

Boards tend to recruit directors who are like other directors, and people they know in this market. It’s more of a risk recruiting an offshore-based director who is not well known in this market or has not worked with other directors here.

UC: To be fair, I suspect many ASX 300 companies consider offshore-based directors during their board-search processes. Yet the appointment is nearly always an Australian director.

Boards tend to recruit directors who are like other directors, and people they know in this market. It’s more of a risk recruiting an offshore-based director who is not well known in this market or has not worked with other directors here.

GLC: What are the logistical and cultural challenges of having offshore-based directors?

UC: That’s a fair question for boards and one that can be overcome with smart planning of board meetings and technology. It’s true that having directors mostly based in Australia makes it easier for them to meet and adds to boardroom collegiality. Requiring offshore-based directors to fly to Australia for board meetings is an issue.

Still, if Australian companies are serious about expanding internationally, it makes sense to hold more board meetings overseas. That gives Australian directors an opportunity to better understand those markets by visiting the company’s sites there and meeting key staff.

It makes no sense for companies growing overseas to have only Australia-based directors and to hold most boards meeting here, because it’s easier. As Australian companies ‘internationalise’, our board composition and governance structures must adapt.

GLC: You nominate biopharmaceutical company CSL as an exemplar of an Australian company with international governance practices. Why does CSL stand out?

UC: CSL continues to expand rapidly overseas and has several directors based in the United States and the UK. In my view, CSL is an excellent example of a board that has skills aligned with organisation strategy. The board has a strong mix of industry specialists, innovation experts with offshore experience and governance generalists.

It’s no surprise that CSL has consistently been one of the best performers on ASX for a long period. (CSL’s annualised total return is 22 per cent over 10 years). The company has what I call a ‘growth-focused’ board. Westfield Corporation (before its takeover this year by Unibail-Rodamco) was another with a growth-focused, international board. Westfield, too, delivered excellent long-term performance.

In contrast, too many Australian companies have ‘compliance-focused boards’ that have a heavier weighting of lawyers and accountants. Banks, for example, will be locked into more compliance monitoring after the Financial Services Royal Commission.

GLC: In your view there is a misalignment of skills disclosed in annual reports of large listed companies with corporate strategies. How significant is this issue?

UC: My review of this reporting shows that companies are stuck in a 'bygone white-picket-fence world' of directors with predominantly legal and accounting skills. These companies are not matching strategy and director skill sets. (The Third Edition of the ASX Corporate Governance Principles & Recommendations says listed entities should report on board skills in their annual report.)

Unfortunately, published skills matrices offer such limited, wafer-thin disclosure that it’s hard to truly assess if the company’s board has a skillset aligned to strategy. I don’t see many companies that have an international strategy also having a genuinely international board.

There needs to be greater focus on skills-based composition (aligned with strategy), and a move away from the ‘boys club’ and having an average board size that remains around eight.

Companies with large boards (over 10 directors) risk looking like dinosaurs that do not have a clear focus on the board’s role and the value it adds to their company.