February this year marks 12 months since the release of the final report of the banking Royal Commission. The central conclusion by Commissioner Kenneth Hayne AC QC — that “failings of organisational culture, governance arrangements and remuneration systems lie at the heart of much of the misconduct examined in the commission” — set the tone for a year in which scrutiny of board practice and governance reached new heights.
Last year also saw the start of both the aged care and disability Royal Commissions, and an Australian Law Reform Commission (ALRC) inquiry into corporate criminal responsibility; the CEOs and chairs of two of Australia’s major banks stepped down; and for the first time, a second strike was recorded against the remuneration report of one of Australia’s largest companies, Westpac.
So what can boards learn from an environment where expectations of boards are rising, and community and stakeholder tolerance for misconduct has reached a new low?
Front and centre for boards should be trying to understand, respond to, and ultimately shape, stakeholder and community expectations. As Hayne commented, the evidence before the Royal Commission showed entities too often put the pursuit of profit above all else, including the interests of customers and compliance with the law.
The task now for boards and the organisations they govern is to credibly and publicly demonstrate how they are taking into account other stakeholder interests in their decisions. Boards should be asking themselves how they intend to bring the stakeholder voice to the board table, and what steps they can take to better understand community expectations.
In an environment where debate rages on the purpose of the corporation and calls to reshape directors’ duties — particularly to act in the best interests of the corporation — remain, it will be incumbent on organisations to show how they produce shared value for stakeholders and the broader community.
Perhaps the most significant shift of the year has been an increasing expectation that the senior leaders of organisations take personal responsibility for corporate misconduct and loss of trust. Former NAB chair Dr Ken Henry and CEO Andrew Thorburn stepped down after Hayne cast doubts in his final report on their ability to lead their organisations. In November, Westpac CEO Brian Hartzer left his position in the wake of the AUSTRAC civil proceedings, and both chair Lindsay Maxsted FAICD and risk and compliance committee chair Ewen Crouch AM FAICD announced they would be leaving the board sooner than planned.
The question for directors is: when should they be held responsible for misconduct that occurs on their watch? While directors can stress the importance of the line between board and management, ultimately organisations must be able to demonstrate personal accountability when things go wrong. The fallout from the Royal Commission has shown that the size and complexity of an organisation, and relative distance of NEDs from the day-to-day running of the company, will not quash calls for board-level accountability.
At the same time, the question of accountability has raised the related issue of liability. Should directors and officers who are held publicly accountable for breaches of the law, also be personally liable? That question will be the subject of ongoing debate in 2020, with the ALRC to hand down its report on corporate criminal responsibility by the end of April.
Board oversight of culture
Boards are increasingly focused on how they can provide effective oversight of organisational culture. Setting the tone from the top is crucial, however modelling the right behaviour is just one aspect. The challenge for boards is how to provide ongoing cultural stewardship while retaining the distinction between the board and management, and recognising that NEDs are necessarily distant from day-to-day operations. This challenge is particularly acute for large, complex organisations. Boards are struggling with two related challenges: devising tailored metrics, and consistently but constructively testing the trust they must place in the CEO and other senior executives.
Multiple Royal Commissions have also demonstrated the need to consider the myriad ethical considerations that impact on board decision-making — and why boards must ask not only “can we” but “should we”?
In 2019, the AICD released two new resources (see above) for boards on governance of organisational culture and ethical decision-making, which provide some guidance for directors.
At the heart of the problem for boards is agreeing with management the kinds of indicators, particularly leading, that point to areas of weakness.
Governance of remuneration
The Royal Commission and its aftermath have forced a rethink on remuneration and whether current structures remain fit for purpose. Commissioner Hayne observed that in almost every case, the conduct at issue was driven in part by individuals’ pursuit of gain, whether in the form of remuneration for the individual or profit for the business. The link between misconduct and remuneration has broad implications and is relevant well beyond financial services.
Boards are taking steps to strengthen their approaches to remuneration governance and must test that remuneration structures are operating as intended, and aligned to the desired strategy and culture. Questions of what the organisation values — and whether staff are properly rewarded for “doing the right thing” — accountability and the appropriateness of metrics used to measure performance are being debated. Boards are also increasingly considering whether they require a greater oversight of remuneration practices — and the behaviours they drive — throughout their organisation, that is, beyond the traditional domain of senior executive pay.
Executive bonuses continue to make the headlines and it is clear that shareholders, regulators and the community expect bonuses will be reduced — to zero where appropriate — to demonstrate accountability for conduct failings. For listed companies, investors want to see that incentives are genuinely at risk, rather than essentially fixed pay in another guise.
Oversight of non-financial risk
More specifically, boards across all sectors are attempting to grapple with the question of non-financial risk — a fluid concept, but generally understood as meaning operational risk, compliance risk and conduct risk.
The Australian Securities and Investments Commission Corporate Governance Taskforce report on director and officer oversight of the area within seven financial services entities was the first time the regulator had explicitly set out views on better governance practice. While the report, coming on the back of the Australian Prudential Regulation Authority CBA report and entities’ self-assessments, contained few surprises, it nonetheless highlighted that practice in this area needs to improve.
The taskforce will also release its report on variable remuneration this year.
At the heart of the problem for boards is agreeing with management the kinds of indicators, particularly leading, that point to areas of weakness. Unlike financial risk, which has been well understood for decades, maturity in this area remains relatively low. Gaining a better handle of non-financial risk should be a core priority for all boards in 2020, and will take a clear and sustained focus. Failure to do so may well see 2019 repeated.