11/04/2017

This week
IBU5GW
Director duties
Remuneration at the top
Governance
in a Globalising World

Week 7
Board processes

Introduction
What duties and obligations do boards have?

How do directors interact?

Board processes
The board is essentially a black box, we cannot
observe actions in the board room
Thomsen, S., Conyon, M., 2012,
Corporate Governance;
Mechanisms and Systems, But can analyzse boards from their legal duties and
McGraw Hill. codes of best practice

Who are directors? Who may not be a director

Anyone occupying the position of Director by Undischarged bankrupt

whatever name and performing the functions. Company auditor
In prison
EXCEPT! Entered into a personal insolvency agreement
Undischarged bankrupt; Already disqualified
Convicted of company offence; Convicted of dishonesty
Auditor of the company. Trading whilst insolvent

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Corporations Act 2001/2004

Directors generally required to act in best interest A classic example about directors fiduciary duties
of corporation, more specifically to:-

Act in good faith and for proper purpose;

Act with care and diligence;
Avoid improper use of information;
Avoid improper use of position;
Disclose certain interests;
Avoid conflict of interest.
Penalties range from breach $220,000,
Henry Ford, Henry Ford was an American industrialist,
compensation, account for profits and/or the founder of the Ford Motor Company,
disqualified from office. and sponsor of the development of the assembly line technique of mass production

Terms of Reference
Corporations Act 2001/2004/2010
Give account of actions
Obtain authority to act from Board
Cannot act outside delegated authority
Accountable to Board
Provide Board with all relevant information
Exercise due skill and care
Make sound financial investments
Comply with company policies
Act honestly and in companys best interests
Avoid conflicts of interest
Exercise powers for their proper purpose
Directors duties
Fiduciary duty: to act in the best interest of the
shareholders
Duty of loyalty: act in accordance with the
companys best interest
Duty of fair dealing: directors may not personally
take advantage of business opportunities
Duty of care: duty to exercise the duty of loyalty
with the care that can be expected from a prudent
person

Executive Directors Executive Directors

Employed as senior faffaafaf

managers;
Day to day
management;
Custodians of company
resources;
Monitor own
performances;
Aware of issues in the Michael Dell Sir Richard Branson
Founder/CEO/Chairman of Virgin Group
business; Founder/CEO/Chairman of Dell Inc.

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Non-Executive Directors Role of Non-Executives

Not employees of the business; Provide advice and direction on strategy;

May have been employees in the past; Monitor strategy implementation;
May be customer or supplier; Monitor ethics and legislation;
Removed from inside knowledge of the Monitor financial statements;
business; Appoint and remove directors;
Bring outside expertise as needed; Plan management succession;
Same legal requirements as executive Relationship with shareholders;
directors Evaluate Chairman.

Non-Executives Independent Directors

Commonwealth Bank: 8/9 members of BOD No previous relationship with the business;
are non-executives Not substantial shareholder;
Same legal responsibilities as all other
ANZ Bank: 9/10 members of BOD are directors;
independent non-executives ASX says majority of Board should be
independent

https://www.anz.com/about-us/our-company/executive/board-of-directors

Insider trading Insider trading

Cannot trade in shares of own business when have Simon Hannes: an Australian senior
inside information; executive at Macquarie Bank convicted
Information not generally available which, if known, of insider trading over call option
would have an effect on share price; brought prior to the takeover of TNT (to
Difficult to prove; whom Macquarie was an advisor)
However can go to prison; Qantas director made The options were bought in the name of
$346 but served 9 months detention; Mark Booth (Simons sister) and cost
about $90,000. After the takeover bid
Damage to reputation trust;
they were worth over $2 million.
Public confidence reduced.
He was jailed for 18 months in 1999 for
Simon HANNES of Macquarie Bank was jailed insider trading
for 18 months in 1999 for insider trading

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Insider trading 2010 Survey Conflicts of interest

1515 financial market participants;
only 11 per cent of respondents believed
Australian capital markets were free from
insider trading
62 per cent of respondents believed it was a
significant problem
[ASIC must get tougher on insider trading, survey finds
The Australian December 11, 2010]
Directors must avoid situations where possible conflict of interest between
directors personal interests and companys best interests.
Corporations Act prohibits:
Gaining advantage for self or other.
Causing detriment to company
Dealings between directors and company governed by statute, common law and
constitution
Disclosure to board and protect company interests.
Fully informed consent of company when take out company loans.
Not present at directors meeting or vote on matter when material personal
interest in matter.
Criminally liable if trade using info that:
Is not generally available.
Would have material effect on price of companys shares /secs.
Civil liability and compensate for damages suffered by other parties by above
mentioned actions.
Notify stock exchange of shares/securities in company or related entity

Remember HIH
What do boards do?
Those in control have a duty to act in the best Because board meetings are black boxes our
knowledge is limited
interests of the company. They must Board meeting agendas contain:
understand that those resources are not Non-decision/consent items
personal property. Committee reports
Financial status reports
Proposals
[Justice Owen 2003 Report of Royal Commission on HIH] Briefings
Other business
Empirical research report that boards play a role
primarily in the exercise of control, offering advice,
and networking
https://www.youtube.com/watch?v=nfP5N9Yc72A

Key tasks Country codes of conduct

Provide continuity
Select and appoint chief executive
Boards are expected to act in accordance
Understand the business and its environment with codes of best conduct
Understand potential of the business Codes are adopted nation wise but are
Make strategic plans
Identify and obtain resources needed highly similar
Obtain expected business performance Codes aim to facilitate effective,
Provide excellent leadership
Provide excellent management team
entrepreneurial and prudent management
Ensure good customer and supplier relationships which delivers long-term performance
ensure compliance with legislation
Keep Board properly informed
Codes deal with leadership, board
effectiveness, accountability, ownership etc.

4

Selected UK reviews
Turner Review 2009
In response to the global financial crisis;
Need for improved professionalism and independence of risk
management;
Include risk management in remuneration policy;
Need to improve skills of non-execs;
Need for shareholders to take more interest.
Turnbull Report 1999
Internal control must be included in business processes;
Identify nature and extent of risks;
Extent of risk which is acceptable;
Likelihood of risk happening;
Ability to minimise risk if it happens;
Cost/benefit of managing the risk;
Constant monitoring and evaluation;
Include in Annual Report.
Board process vs risk
Board process
There do seem to be some quite commonplace
practices including: risk registers, procedures for
budgetary control, project appraisal processes,
and formal risk reviews at senior levels. While not
underplaying the importance of such formal
practices and processes, executives and
nonexecutives suggest that effective risk
management at board level involves going beyond
these formal arrangements and processes to affect
the deeper thought processes and assumptions of
the directors
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Support Mechanisms
Nomination committee;
Remuneration committee;
Audit committee;
Risk management committee;
Shareholder committee.
Committee members in discussion at BAT
Board process
Quality and effectiveness of board meetings
Commitment/availability of non-executives
Degree of differences of opinions at board level
Use of knowledge and skills
Board process
Financial risk-taking is lower where non-executive
directors have high effort norms (as evidenced by
the conduct of board meetings, preparation for
board meetings and the frequency of dialogue
between executives and nonexecutives) and where
board processes are characterised by a healthy
degree of cognitive conflict, that is, differences of
opinion over key company issues and board tasks.
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Agency theory

The price and monitoring mechanisms of an

outcome-based contract can be used to align
Remuneration the goals of the parties and reduce the
opportunity for agents to behave
opportunistically

(Eisenhardt, 1989; De Looff, 1995 Fama & Jensen, 1983;

Jensen & Meckling, 1976).

Agency theory contd Agency theory contd

Modern corporations are configured in such a
way that the owners, who are predominantly
the shareholders of listed companies, assign
the running of the company to the company
management. It is this separation of ownership
and control which has led to the agency
problem.
Eugene FAMA and Michael JENSEN
The delegation of decision-making authority from
principal to agent is problematic:
The interests of principal and agent cannot be
perfectly aligned;
The principal cannot perfectly monitor the actions
of the agent;
The principal cannot perfectly monitor and acquire
the information available to, or possessed by, the
agent;
Directors cannot be trusted to act in the best
interests of shareholders because they are more
likely to look after their own interests.

The agency problem Resolving the agency problem (?)

Shareholders want maximum dividends, Corporate governance codes;

increasing share price; Legislation;
Share options;
Managers want high pay, job security, short Profit share;
term strategies to maximise profits, high Disqualification of director;
bonuses, high perks Market forces;
Contract terminated.

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Stewardship theory Theory Y

Stewardship is responsibility for taking good Managers are motivated to make decisions
care of resources entrusted to one; in best interests of the organisation
Shareholder interests are maximised by because:-
shared roles in management of the Pride;
business;
This produces Theory Y management and Intrinsic motivation;
self-actualisation behaviour rather than Market forces;
purely economic motivation. Image;
Sense of duty.

Lex DONALDSON

Competition and governance Directors remuneration

We should not worry about governance Directors remuneration determined by constitution or by
company resolution at shareholders meeting.
reform since, in the long run, product market Excessive remuneration can be challenged by Corporations Act.
competition would force firms to minimise Listing Rules place controls on total amount that may pay in
costs and, as a part of this cost minimisation, fees. Also must not include a commission or percentage of
to adopt rules including corporate governance operating revenue.
If listed company, must disclose in Report.
mechanisms enabling them to raise external
capital at the lowest cost competition would
take care of corporate governance.
[Shleifer A & Vishny R (1997) A Survey of Corporate Governance
Journal of Finance 52[2] June 737-783

Director remuneration
Westpac
non-
Example: Westpac 2013 executive
director
payments,
2013

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Executive pay at Westpac Concerns over remuneration

Pay gap between top and bottom widening
Is socially and economically unjust
High rewards not necessarily reflected in high
Gail KELLY, company performance
Westpac CEO
Targets too easily attainable
Category Weighting Example Measures

Return 40% Economic profit, Return on Equity

Directors in Australia earn, on average, 24 times
Growth 20% Customer growth, Wealth startegy, Asia strategy average wage
Strength 30% Sustainable funding, Employee engagement, Employee retention
[Australian Financial Review]
Productivity 10% Expense to Income ratio
Year Average ($A) Median ($A) Fixed pay as % Bonus as % Equity value as %
2010 4 982 196 4 388 073 39 28 33
Australian Top 100 CEO
remuneration (including 2009 4 932 253 4 039 748 41 27 32
long-term incentives)
Remuneration 2006-2010
2008 5 150 984 4 049 293 38 36 26

for Gail KELLY Adapted from ACSI (2011). 2007 5 532 515 4 168 554 33 36 31
2006 4 557 051 3 274 675 39 35 26

Top pay 2012 ASX Best Practice Recommendations

Executive directors should not be involved in determining
own remuneration
All payments subject to shareholder resolution but non-
binding vote
Disclose in annual report with highest five itemised
Clear link between levels of remuneration and company
performance
Remuneration Committee decides
Should be sufficient and reasonable
Remuneration policy understood by shareholders
Policy included in corporate governance section of annual
report
Insider trading
Australian Financial Review 2012

Summary Next time

Boards are more regulated that other corporate Anglo-American governance
governance mechanisms and carries the main
responsibility of the firm, still boards remain a black
box
Boards spend their time primarily on control, advice
and networking
Likely that board tasks are also handled informally,
thus, outside the board room
Important to consider what we really can expect,
given that boards have approximately a month of
work time per year devoted to a single firm