essential director update 2018

Culture case study

Graham Bradley AM FAICD, chair of GrainCorp and non-executive chair of HSBC Bank Australia, highlighted the Australian Prudential Regulation Authority’s (APRA) 110-page report into the governance and culture of the Commonwealth Bank of Australia (CBA). “The APRA/CBA report will be the Harvard case study on corporate governance for years to come,” he said. “Regulators, investors and boards of directors across the world, and across industry sectors, will look to it in coming years as highlighting the standards expected of boards of directors of public companies and, I would suggest, private and not-for-profit companies as well.”

The report identified four interlinked cultural issues beneath the CBA’s failings: a sense of complacency; a reactive rather than proactive approach to compliance; an insular culture which meant it did not learn from its experiences and mistakes and had a “tin ear” towards community expectations about fair treatment of customers; and an overly collegial culture, which lessened self-criticism, slowed decision-making and impeded individual accountability. Bradley said the remarkable thing is this was not a post-mortem on a failed company. “CBA’s fall from grace and the resulting forensic analysis of its governance is set against a backdrop of continued financial success, prudential capital strength, absence of large loss-making disasters, and industry-leading customer satisfaction scores.”

Sharper focus

Expectations on boards have been elevated in five important ways, Bradley said, adding that these heightened expectations will extend over time to companies of all kinds, not just listed companies and financial institutions. Boards will be expected to:

  1. More clearly focus attention on how they are managing and monitoring the culture of their organisations
  2. More rigorously question and challenge management, including first-line managers, around culture and risk issues
  3. Ensure they have effective protocols for escalation of key compliance and reputational issues from management to the board, especially material communication with regulators
  4. Be vigorous and visible in setting a tone of urgency about resolution of risk issues and remediation of adverse events and of behaviours that do not align with the organisation’s stated values, particularly in relation to customers
  5. Engage more fully with feedback from customers, understanding the substance and not just the numbers of customer complaints.

Five implications for directors

  1. To focus more attention on corporate culture, boards will need to spend more time reviewing indicators of culture and must devise insightful measures to give windows into their corporate culture.
  2. Every director on a board or a committee must engage with audit and compliance reports: it is not satisfactory to rely on a well-qualified member of the committee or the board to discharge the committee’s or board’s responsibility.
  3. Remuneration committees will need to work harder to interrogate internal data before setting or recommending senior management pay and bonus incentives. Bonuses will need to be more fully justified wherever aberrant behaviour has occurred.
  4. Boards and committees will need to take fuller minutes in order to provide formal evidence of their greater engagement around culture and risk issues.
  5. All of this will lead boards to seek to recruit directors with deeper industry knowledge and relevant operational experience to enable them to quickly become informed inquisitors about the company’s operational risks and internal culture.

Seven questions directors should ask

  1. Do we set the right tone at the top?
  2. Do we have good measures of culture?
  3. Does our “cultural dial” need to move from reactive to challenging?
  4. Does the voice of the customer ring loudly at the board table?
  5. Do our remuneration policies have real sting?
  6. Do we rely too much on our committees?
  7. Do we have enough industry expertise and operational experience at the table?

Shareholder activism

The events of the past 12 months will increase the appetite of activist shareholders to take legal action and use other measures to put pressure on boards of listed companies, Bradley said. In particular, he foresees pressure being put on audit, risk and remuneration committees, as well as board chairs. This is troubling, because a fundamental pillar of our corporate governance for many decades has been the collective accountability of all directors for all board decisions.

The Royal Commission will lead to a slew of class actions to fuel an overheated “class action industry”. Bradley highlighted several problems with the current class action systems. Litigation funders are not liable for costs; multiple class actions can be based on the same set of circumstances; and the Australian Securities and Investments Commission (ASIC) and Australian Competition and Consumer Commission (ACCC) actively promote class actions by making available documents and reports that they gather under their extensive investigative powers that would not normally be available to private litigants.

NFP developments

The five-year review of the Australian Charities and Not-for-Profits Commission (ACNC) confirmed that the ACNC is fit for purpose and recommended that its coverage be extended to certain non-charity, tax-exempt NFPs such as NGO and membership associations.

It recommended revising the ACNC’s secrecy provisions to enable the Commission to disclose more about its regulatory activities, raising the reporting thresholds for charities and, significantly, abolishing the Commissioner’s current power to dismiss NFP directors.

Under new ACNC Commissioner Dr Gary Johns, the ACNC’s priorities for the year to come will focus on regulation of fraud, close examination of political activity by charities and use of charities for money laundering and terrorist financing, Bradley said.

Proposed revisions to ASX Corporate Governance Principles

The proposed recommendations by the ASX Corporate Governance Council to move from 29 to 38 recommendations could tip the balance too far into over-prescription in what is intended to be high-level, principles-based guidelines applicable to companies large and small.

Bradley highlighted the inclusion of concepts such as “social licence to operate” and changed wording such as “socially responsible behaviour” and “core values” as phrases that while useful in a general sense are fraught with ambiguity and apt to be interpreted by every person differently in the context of corporate compliance.

Summing up, he said it would “not be a terrible outcome” if the 2014 version of the Principles were retained unamended for the time being.

Improved awareness

How boards can better measure an organisation’s culture and how to respond to the increased community expectations on directors were key questions asked by the audience at the recent AICD Essential Director Update in Sydney. Asked how boards can determine the organisation has the culture they want or how they can recognise warning signs that it isn’t prevalent, AICD chief executive officer Angus Armour FAICD said it was important to look beyond the numbers on staff engagement to see the “very strong human component”.

Bradley outlined how as a board member of one company he had read all the staff comments on engagement surveys and at another he had listened to recordings of how staff dealt with customer complaints. “It’s given me the pith and marrow,” he said.

Directors need to spend non-pressured time — such as at the board dinner — to ask themselves how comfortable they are with the tone they are setting at the company and how well executives are embedding it from the top.

Bradley said there was a risk that the community would become confused about what part-time non-executive directors can and should do, and what they should be accountable for — and assume directors are actually managing the company.

He is concerned that a board’s role to delegate to responsible management while retaining some decisions could become blurred in the increased calls for accountability and for “heads to roll” in the wake of the banking Royal Commission.

Responding to a question about whether it was time to concede that many non-executive roles in complex and large companies are full-time, Bradley said there was a risk that the more directors were expected to be quasi full-time and present constantly in the operation, the more their non-executive role would become confused.

Armour said directors should limit how much they try to take on and calculate their time based on the premise of one of their organisations being in crisis at any point.