This article appeared in The Australian Financial Review on 16 August 2018 (subscription may be required).
Non-executive directors play a crucial role in Australia's corporate governance framework, but the nature of their role is increasingly misunderstood. Recent discussions among policy makers and commentators reveal an emerging view that non-executive directors should be so intimately involved in day-to-day operations that they are able to ensure that nothing ever goes wrong.
Such a view is not only unrealistic given the size and complexity of many modern companies, but also fundamentally misunderstands the role of non-executive directors, the duties they have under law, and their place in our corporate governance framework.
While I, too, have been confronted and disappointed by governance failings in financial services, the reaction from some stakeholders has served to further fuel misunderstandings of the role of non-executive directors and stoke calls for further regulatory intervention.
But it would be wrong, as a response to these failures, to undermine the foundations of what has made Australia's corporate governance model globally respected.
Australia has a deserved reputation for sound corporate governance. The World Economic Forum 2017-18 Global Competitiveness report ranks Australia as eighth out of 137 nations for "efficacy of corporate boards". The Asian Corporate Governance Association also ranked Australia first in corporate governance practices in its 2017 review of Asian jurisdictions.
One of the hallmarks of this world-respected governance model is the distinction between the role of the board and that of management. This separation supports the board's important oversight role in holding management to account and protecting the interests of shareholders.
This is not to say the role of a non-executive director, or the board for that matter, is to abdicate all responsibility to management and accept whatever the CEO puts forward. The Australian Prudential Regulation Authority report into the Commonwealth Bank reinforced what we already know about the importance of the board's role. As the Centro case highlighted, directors simply cannot rely on the advice of management as a substitute for their own attention and critical eye.
But it is true to say that non-executive directors work on the business, not in it. In order to align to a perspective where directors can prevent any instance of wrongdoing (if such a thing were possible), they would have to become, in effect, prescient full-time employees. This would fundamentally undermine the non-executive director's ability to act as an independent and inquiring mind. Non-executive directors must be close to, but independent from, management to do their job well.
As APRA noted in their report into CBA, "One of the challenges facing all boards is ensuring strong oversight of senior management while still preserving an appropriate separation from managerial responsibilities." This clearly isn't possible if you push directors into a quasi-management realm. Blurring the line between non-executive director and executive management means boards would no longer be able to challenge management statements and assumptions, because they would have helped form them.
Lack of knowledge
Despite this, there are still moves towards blurring the boundary between board and management. In the original draft of the Banking Executive Accountability Regime, a regime which the government flagged last week it wishes to roll out to other industries, it was clear that the regime sought to impose managerial or quasi-managerial expectations on non-executive directors. This issue was fixed during the consultation phase, but its original inclusion revealed a lack of knowledge from policy makers regarding the governance function of boards. It served as yet another reminder that the devil is always in the detail.
While it would be nice to think that we could regulate our way to a world where no employee of any company ever acted unethically, the truth is corporate governance is too complex a matter for all factors and eventualities to be foreseen and proscribed by regulation.
The Australian corporate governance framework, including the ASX Principles which have caused so much recent debate, is well respected both regionally and globally. Of course that doesn't mean that they are the panacea for the current trust deficit within the financial services sector, and the broader business community.
Non-executive directors in businesses of all types should reflect on the learnings from and recommendations that will emerge from the current royal commission. Directors and management need to take accountability for misconduct in their organisations and be transparent about their actions in response. Importantly, however, regulators must enforce the laws already available to them. And before legislators rush to legislate, they need to understand the underlying strengths of the corporate governance system we already have.