Governance research

How boards view shareholders and stakeholders

Analysis of a company’s business objectives indicates which grouping is favoured

Who do boards serve? That question is central to a growing governance debate on whether boards only serve the interests of shareholders or have a broader remit to serve shareholders and stakeholders.

Professor Ian Ramsay, of the Melbourne Law School, and Belinda Sandonato, a Research Assistant at the School and lawyer at the Australian Securities and Investments Commission, have added to this discussion through an analysis and comparison of business objectives of the largest listed companies in Australia, the UK and the US. The Corporate and Securities Law Journal published their paper in June 2018.

The authors analysed how the business objectives of large companies accounted for stakeholder interests. The goal: to determine if companies prioritised the interests of shareholders; those of shareholders and stakeholders; or those of stakeholders, in their published business objectives.

The authors note that boards approve their company’s business objectives, so understanding the focus on shareholders and stakeholders is useful in determining how boards view this issue.

In Australia, 68 companies in the S&P/ASX 100 index publish a statement of business objectives in their annual report. Eighteen publish it in their Board Charter and nine in the Corporate Governance Statement. In the UK, most companies (89) publish the business objectives statement in their annual report.

The research found that 48 of the top 100 listed Australian companies, by market capitalisation, prioritised shareholder interests in their business objectives, with low or no reference to the interests of other stakeholders. Another 35 companies prioritised shareholder interests and included a reference to named or unnamed stakeholders in business objectives.

“Viewed in combination, 83 out of 100 companies … identified the interests of shareholders as their top priority in their business objectives,” the authors wrote. “This highlights a clear trend among Australian companies to prioritise shareholders above other stakeholders.”

In contrast, only 17 of the top 100 UK companies considered shareholder interests at the exclusion of other stakeholder groups. Most UK companies still prioritised shareholder interests in their business objectives, but considered other, named stakeholders.

US companies were broadly on par with Australian companies in prioritising shareholder interests over other stakeholders in their business objectives.

“FSTE companies (in the UK) appear far more willing to name their stakeholders in setting business objectives, and less inclined to prioritise only shareholder interests,” the authors wrote.

That may be partly because of differences in companies law in the UK and Australia; The Companies Act 2006 (UK) instructs directors (Section 172 (1)) to have regard to a wide range of stakeholders when promoting the success of the company for the benefit of its shareholders. The Australian Corporations Act (2001) has no similar provision.

Legal uncertainty around dealing with cyber-security risks

Boards obliged to take all possible measures to protect their company

Rapid escalation in data breaches has made cyber-security risks a high priority on many board agendas. Boards are under market scrutiny to ensure they have considered their organisation’s cyber risks and that appropriate safeguards exist to protect data and other technology assets.

However, a lack of case law in Australia on directors’ duties in relation to cyber risks has created uncertainty for boards. Some governance observers say cyber risks should be on the agenda of every board given most organisations rely on technology to function. Others say this view imposes an unreasonable burden on corporates that hold only limited, sensitive data.

James Duffy, a Senior Associate at Gilchrist Connell, has written an insightful paper on this issue in the latest edition of the Australian Business Law Review (Vol 46, No.2). He looked to overseas developments on cyber risks and boards, and general statements in Australian law for guidance.

Duffy says Australian boards, in discharging their duty of care as it relates to cyber risks, should:

  • Assess their organisation’s cyber-security risks;
  • Act to prevent loss from the breach of cyber security;
  • Ensure the business can respond effectively to a cyber breach;
  • Mitigate loss by taking cyber insurance.

Duffy says: “The cyber-risk landscape is bound to undergo constant change in the near future. Directors of corporations exposed to cyber threats are likely to take on board as much guidance as possible from governmental, industrial and professional organisations to avoid personal liability and the threat of mandatory measures being legislated.”

He adds: “Directors can take advice from their peers and learn lessons from cyber risks that materialise in their industry and globally; however, directors must tailor their approach when considering a cyber-security regime, including cyber-insurance policies, that is suitable for their corporation.

Duffy says that given the complexity of cyber-security dialogue and the limited resources available in Australia to assist corporations with their cyber exposures, “it is likely that the best way for corporations and directors to escape liability for cyber breaches is to follow and implement relevant parts of the voluntary guidance that is widely available, where necessary and where reasonably practicable for that corporation”.

AGMs in the digital era

Hybrid model gains support as shareholder attendances wane

A long-running debate over the value of Annual General Meetings is likely to intensify in the October/November 2018 AGM season for companies with a June 30 year-end.

AGM attendances have steadily fallen this decade. Less than 1 per cent of shareholders attend company meetings, a 2016 Computershare survey revealed. AGMs for large companies can cost up to $1 million – a big expense for a meeting that might only attract 100 retail investors.

Falling attendances create questions on whether AGMs are still worthwhile in the digital era and if other formats are needed. A small group of Australian and New Zealand companies in the past few years have adopted a hybrid model that includes a shorter, traditional AGM, supplemented by online technology.

Purely virtual AGMs, used in the US, may not be possible in Australia without legislative change and, at best, still seem several years away. It is possible that a cohort of retail investors who value traditional AGMs for the opportunity to view management and the board, and meet other shareholders, would resist a move to online-only AGMs.

The Best Practices Committee for Shareholder Participation in Virtual AGMs in late May outlined a range of issues that companies should consider when holding hybrid or virtual AGMs. The Harvard Law School Forum on Corporate Governance and Financial Regulation published its views.

The committee outlined several best practices when using technology for AGMs:

  • Determine the meeting before the proxy is published. The board should be aware of prospective investor reactions to voting and decide which meeting format is most appropriate.
  • Consider items to be discussed at the meeting. An AGM that consists of mostly routine, procedural matters may be well suited to a hybrid AGM. Another that faces a significant “no” vote on an issue may require a traditional in-person AGM.
  • Evaluate constantly changing technology and processes. Boards should be involved in evaluation of new technology for AGMs and ensure any technology used is reviewed so that they can determine if shareholders valued the change.
  • Ensure equal access: Boards must ensure all shareholders have equal access to the meeting and are able to participate in voting and in question-and-answer sessions after the AGM’s official business has concluded.
  • Create formal rules of conduct: Boards should consider if hybrid AGMs require different rules on participation of shareowners. Rules of conduct should be available to in-person and online attendees well before the meeting and promote fairness throughout the meeting.
  • Establish rules when questions are out of order: Clear rules are needed for questions, posted online or provided in person, that are ruled out of order. Rules that might require shareholders to wait until others have had a turn to speak, before making a second comment, may be needed, particularly in hybrid AGMs.
  • Post questions received online during the meeting: Companies that have an online component at their AGM, or solicit questions in advance, should post all appropriate questions on the investor page of their website after the AGM.
  • Ensure shareholders have access to board members: Like an in-person AGM, shareholders who participate through an online component of an AGM should have fair access to see, hear and ask questions of board members.
  • Have a technical support-line. Companies should provide technical support, if needed, for shareowners who use the online component of the meeting.
  • Archive shareowner meetings for future viewing: Companies should archive the webcasting of the AGM on their website for a reasonable time (at least a year) after the meeting.

Focus on sub-committees

How boards should go about assessing them

Board committees have become a bigger part of the governance landscape this decade as tasks, such as audit or remuneration, are allocated to specialist groups.

Anecdotally, committees have taken on more responsibility and work as boards face increasingly complex challenges in oversight of risk, strategy and organisation culture.

However, the risk is sub-committees becoming “mini-boards” as the main board delegates more tasks, and directors losing sight of issues examined in sub-committees they are not members of.

The EY Centre for Board Matters in July reported a study on how S&P 500 companies in the US (over 2013 to 2018) are using board sub-committees. They found board committee structures had barely changed over the six years, despite rapid changes in the business landscape.

This raises questions as to whether board committee structures for large organisations are becoming outdated and if there are ways to make committees more effective.

EY found the largest 500 companies in the US, across industries, primarily relied on three key committees, as required by US stock exchanges: audit, compensation, and nomination and governance. Large banks had a fourth committee on risk, as required in the US.

Few S&P 500 companies introduced additional committees. Only 7 per cent of S&P 500 companies have technology or public policy and regulatory affairs committees; 6 per cent had corporate responsibility and sustainability committees.

Boards of large US companies, it seems, have resisted the temptation to add committees that focus on emerging risks, such as cyber security or digital disruption.

But as EY notes: “Board agendas have become increasingly packed with complex and evolving oversight topics, and key committee responsibilities have stretched beyond their core purview. Challenging the committee structure as part of the board assessment process may help the board determine the most effective oversight approach based on the company’s unique circumstances.”

EY suggests six questions boards should consider with sub-committees:

  • Is the board’s committee structure appropriate to forward-looking board priorities and company-specific needs?
  • Is the board size and composition adaptable to changing committee responsibilities as needed, based on the company’s evolving oversight needs?
  • Is the board familiar with how peer companies are addressing board oversight responsibilities?
  • Do assessments of board effectiveness reveal possible pressure points that might be resolved with changes in committee structure?
  • As committees assess their own effectiveness and performance, are their capacity, workload and areas of expertise part of that assessment?
  • As new directors join the board and bring new areas of expertise, does the board consider whether the current committee structure fully leverages those new director skills?

PhDs and R&D

Having a scientist director aboard an innovative move

Governance of innovation has become a bigger board topic this decade as organisations strive to introduce new ideas for product development, business models or production processes. Less considered is which directors are best placed to monitor a firm’s innovation efforts.

Dr Tim Swift, from St Joseph’s University in Philadelphia, has studied the impact PhD scientists have on the R&D-based innovative performance of firms conducting hard science. The Journal of Strategy and Management published his paper on this topic in its latest issue.

Swift makes an important contribution. It can be hard for directors to monitor a firm’s R&D performance because innovation can be difficult to observe and R&D managers may not disclose a research project’s true long-term prospects to the board.

Also, boards may not have sufficient data – or skill – to evaluate or refute executive claims about the merits of a costly piece of R&D.

Swift’s study examined all publicly traded chemicals firms in the United States from 1996 to 2005. He found that companies that had board members holding a PhD in chemistry, biology or biochemistry generated more patented knowledge – and were also superior monitors of the firm’s R&D function and performance.

“(There is) clear evidence that PhD scientist directors are particularly effective at enhancing the firm’s innovative performance when the search for external sources of knowledge is important,” wrote Swift. “When these PhD scientist directors serve on the boards of other chemicals companies, they have the opportunity to serve as boundary spanners between the firms on whose board they serve.”

Although Swift focused on the chemicals industry, his research raises questions about the benefits of directors with PhDs serving on boards, across industry.

He wrote: “Team decision-making research suggests directors with advanced academic credentials that are strongly linked to the type of innovation underway in the firm can be important influencers of firm innovation performance.”

Swift says board directors with advanced academic training can span the gap between academia and business, a recurring problem in Australia that is reflected in our low OECD ranking for university and industry collaboration. Board directors with PhDs tend to know experts in their field and may be better placed to challenge management on the firm’s innovation performance because of their subject knowledge in a field.

Academia has not been a large source of board directors for listed companies in Australia, possibly because some experts with advanced academic credentials lack general management experience. But as Swift shows, there are benefits of having directors who have PhDs on boards, where the firm has an emphasis on R&D and innovation.