Questioning by Counsel at the Hayne Royal Commission of Board Chairmen, CEOs and accountable executives has revealed the market’s expectation of the level of stewardship and scrutiny which shareholders and customers in particular might anticipate rests with the Board or the CEO in communicating strategy, financial results and breaches of company policy.
APRA’s Review of CBA’s governance highlighted the need for more rigorous Board oversight of non-financial risk (in particular operational, compliance and conduct risks) and the importance of a Board’s impact on risk culture.
APRA’s findings in relation to the role of the CBA Board identified core deficiencies, including:
- Insufficient rigour and attitude of urgency
- Diminished trust and elevated complacency
- Insufficient challenge from Board to executive management
- Weakness in reporting
- A lack of accountability which led to an inability to identify who is accountable when things go wrong.
The Review extended its comments in relation to “insufficient rigour and urgency” and “weakness in reporting” to the Board Audit Committee and Board Risk Committee revealing that,
“most global financial institutions, in the light of experience, have developed a sense of ‘chronic unease’ about the potential threats to their financial and reputational standing from non-financial risks, and their risk culture and risk management frameworks have evolved in line. In contrast, the review observed that CBA, led by their Board Risk Committee exhibited an inappropriate level of comfort for too long.”
APRA also indicated that other shortcomings included the CBA Board’s reliance on key individuals (i.e. Chief Risk Officer), inadequate communication between Board committees, over-confidence in the operations of both committees and a lack of rigorous Board benchmarking.
Counsel’s questioning of Board members implied an expectation that a Director’s level of understanding of issues relevant to the welfare of customers and shareholders required more engagement and commitment of their time.
That being the case, is it possible that Directors serving on an ASX Top 50 Board will need to increase their time commitment to, say, double their present level? Or for the next 50, say, 1.5 times their current commitment? And for the next 100, say, a 25% to 50% uplift?
What are the implications, then, for the number of Boards on which Directors may serve and the number of leading ASX Boards which Directors may Chair?
To what extent do current revelations reveal the necessity for the Board to have an Office of the Board, reporting to the Chair, independent of management, undertaking detailed investigations internally on matters considered important by the Board?
This would not lead to a situation where management are not accountable to the Board or do not report fully and transparently to the Board. Rather, the Board could have an independent office, separated from the internal auditor and the external auditor, investigating matters of specific interest primarily addressing issues relevant to shareholders, the customer, the organisation’s culture, its reputation and the broad parameters of risk and management reporting.
In reviewing Board Charters of the top 50 ASX listed companies, the vast majority set out the core obligations of the Board and formal Committees together with the accountability of the CEO and key management. The latter generally indicate that authority is delegated to the CEO and the organisation’s leadership team to:
- implement the approved strategy;
- meet Board-approved financial plans and report regularly on progress toward the achievement of those plans;
- oversee the implementation of Board-approved policies and the management of relationships with customers, suppliers, shareholders and other stakeholders including regulators in a manner which upholds the organisation’s code of conduct and the delivery of its products and services in accordance with specifications and understandings presented in formal company documents to the relevant stakeholders.
In the context of most statements of Board accountabilities, the language predominantly reflects an overview of what the Board is responsible for overseeing and what management have delegated authority to implement and accountability to achieve.
Without dwelling on the potential of semantics, management is seen as accountable and the Board are perceived as having clear responsibilities to review and approve a significant array of policies and practices with clear delegations to management.
It is evident from the language that the Board review, consider and approve policies, products and services, operational parameters, the strategic plan, the organisation structure, acquisition and divestment initiatives, and capital management and have a prime obligation to set performance criteria in order to appropriately evaluate the effectiveness of the CEO’s stewardship of the organisation.
The Board have oversight of risk management and approval of the organisation’s risk appetite. They delegate accountability to management to deal with regulators, though generally reveal their availability to meet with regulators at their request. Their role is primarily to review and approve and then monitor management’s performance.
In order to meet their responsibilities as defined, the Board have significant dependence upon the integrity and knowledge of the CEO and the leadership team and in that context will potentially define their relationship with the CEO and the CEO’s reporting to the Board as one of ensuring that the CEO reports systematically with openness on the progress being made by the company towards achieving its corporate purpose.
Depending on the nature of the enterprise, there will be variable degrees of emphasis on the customer, the supplier, the management of risk incorporating the nature and diversity of risk, the resourcing of the organisation with capable individuals, their oversight of health, safety and the environment and their impact on the organisation’s reputation and compliance with relevant regulation. Boards almost universally rely upon management to keep them informed of any breaches, challenges, changes to the regulatory environment, changes to the commercial environment which may lead to modification to their financial plans, their capital management, their acquisitive or divestment initiatives and their risk appetite.
The Corporations Act (s184) provides context to the decision-making power and accountability of Boards and executives. The Act stipulates criminal offences if a director or other officer of a corporation fails to exercise their powers and discharge their duties in good faith in the best interests of the corporation; or if they directly or indirectly gain an advantage for themselves, or someone else, or cause detriment to the corporation. Although the Act provides the definition of accountability, the assessment requires interpretation of the decisions made by the Board or executive from a retrospective perspective (that is, did the Board make the right decision based on the outcome).
In recent years, remuneration has become an area of focus. Shareholders could consider and vote against a company’s Remuneration Report, potentially leading to a Board spill. There has been a closer engagement required of Boards to receive independent guidance and advice, though they retain authority to approve the executive remuneration framework, reward policy and outcomes, in relation to senior management including the CEO.
We also observe a more detailed focus on performance management frameworks and variable remuneration programs including employee equity programs and superannuation, with larger companies having oversight of the implementation of these programs in multiple jurisdictions.
Notwithstanding the criticality of this Remuneration Committee review role, a significant proportion of Australia’s leading companies acknowledge that they do not seek or receive recommendations. Therefore, by implication, Boards assume the principal accountability for the authorisation of remuneration levels and incentive payments involving cash and equity.
The Hayne Royal Commission identified some shortcomings in this area in relation to the Board’s depth of knowledge of remuneration programs throughout the organisations over which they have stewardship and a reliance upon management recommendations.
Arising from the findings of the Royal Commission to be published in February 2019, we anticipate that Board Charters might require amendment revealing that Board obligations will extend beyond reviewing, approving and monitoring the organisation’s operations and financial stewardship for the purpose of ensuring that management meet their obligations in every respect for which Directors are accountable under the law.
Given the identification of shortcomings in either the information and the depth and quality of information provided by management, or the level of investigation by Directors, it would be our expectation (though we do not believe this will initially be well accepted) that a Board may need a small cadre of highly skilled individuals who are independent of management and have the authority of the Board to investigate all matters, assuring the Board that
- their approvals are being followed in every respect at all levels of the organisation;
- the nature and quality of reporting from the base of the organisation through the various layers of management provide the Board with the essential information to assure shareholders, customers, suppliers and regulators that the organisation is fully compliant;
- remuneration outcomes take full account of adherence to approved policies;
- and those employees who behave in a manner which is in breach of approved policies and practices are terminated, this process applying from the base of the organisation through to the level of CEO.
It would be a matter for further consideration to determine if such an outcome might be a step too far.
The Hayne Royal Commission has shattered the old adage that “all publicity is good publicity”. Let Egan Associates help make your Board the best it can be. We can advise on your Board’s composition, evaluate its effectiveness, benchmark governance and compliance, assist with succession planning and provide strategies to achieve your organisations objectives. Call John Egan on (02) 9225 3225 or email [email protected] for a confidential discussion.