Key Issues: Applied Corporate Governance
The demise of HIH:
corporate governance
lessons
The business decisions that led to the
collapse
The failures of management that led to
poor business decision-making
The clear causal link between corporate
governance and mismanagement
T
he collapse of the HIH group resulted in a
deficiency of up to $5.3 billion, making it
Australia’s largest corporate failure. The
ensuing Royal Commission report released in
April 2003 provides a rare detailed dissection of
a spectacular corporate implosion and a very
useful case study from which corporate
governance lessons may be learnt. This is
particularly so because HIH was not an unusual
case of major fraud or embezzlement. The
failures identified by Commissioner Owen were
by and large failures stemming from
mismanagement. Most breaches of the law were
designed to cover up the consequential
increasing financial difficulties which were
engulfing HIH.
Most of the multi-billion dollar deficit arose
because claims arising from previously insured
events were far greater than the provisions
which had been made. Payments of these
claims came out of present income and this
created an unsustainable situation. This under-
reserving was the main cause of HIH’s failure
and, according to Commissioner Owen, the
reason for this major under-reserving and
failure to properly price risks was
mismanagement and poor business decision-
making and execution. This was largely due to
poor corporate governance.
The failure of corporate governance could be
seen as part of the corporate culture which was
central to poor decision-making. In 1995 an
independent due diligence report described HIH
as a:
company which has not yet made a complete
transition from an entrepreneurially run company
JUNE 2003
By Phillip Lipton,
Associate Professor
Corporate Law, RMIT
influenced strongly by senior management and
from which senior management benefits
significantly, to that of an ASX listed company
run primarily in the interests of shareholders.
This remained true for the remainder of the
company’s life.
The fateful business disasters
Commissioner Owen identified four
disastrous business ventures which were critical
to the ultimate collapse of HIH. These instances
of poor decision-making were caused by and
reflect a poor corporate governance culture.
• The UK operations were established in 1993.
HIH board minutes did not disclose any
board consideration of whether the
establishment of operations in the UK was
compatible with the broader strategy of the
company and there was no evidence of
board participation in any business plan.
Poor quality management information and
inadequate accounting systems impaired the
Australian management’s ability to monitor
and control the UK operations effectively.
The resultant losses in the UK were
estimated at $1.7 billion.
• The acquisition of a US business was
accepted by the board without analysis of
management’s assertion that entry into the
US market would be profitable. No due
diligence was carried out and there appeared
to be a complete failure to appreciate the
level of risk involved. Losses attributable to
the US acquisition were estimated at $620
million.
• The board meeting convened to discuss the
acquisition of FAI was not called until earlier
on the very day of the meeting with five of
12 directors not present. Of the seven
directors present, four participated by video
conferencing. It was resolved at this board
meeting that the takeover should proceed.
The directors did not appear to have had the
benefit of board papers, including the report
prepared by HIH’s financial advisers. Adler,
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 Applied Corporate Governance cont.
representing FAI, refused to allow
a due diligence to be undertaken
and there was a general lack of
knowledge about FAI and its
financial position. The takeover
therefore proceeded even though
it was not possible to make a
considered assessment of FAI’s
worth. HIH relied on publicly
available information which did
not disclose considerable under-
reserving of FAI’s insurance
business. The decision to proceed
with the takeover was hastily
taken after scant consideration
and with insufficient preparatory
and investigative work. The
directors totally failed to consider
the risks posed by the takeover.
Estimated losses arising from the
FAI takeover were $590 million.
• The Allianz joint venture came
into operation in January 2001. It
involved the sale of HIH’s
profitable retail insurance
businesses acquired from FAI in
the joint venture. The result was
an immediate cash flow crisis
which hastened the end of HIH.
No one in management or on the
board analysed the likely cash
flow implications before HIH
entered into the joint venture.
The joint venture agreement
involved a major strategic change
for the company, yet the board
knew nothing of it or several
other restructuring proposals
developed by management. The
board appeared unconcerned
about this. At the board meeting
called to consider the restructure
proposal, it resolved to proceed
after a 75 minute meeting. The
information before the board
lacked any careful analysis of its
implications and effect on cash
flow. The directors were incapable
of appreciating the risks involved
and consequently could not ask
the right questions before the
agreement was entered into.
Within 10 weeks of the start of
the joint venture, HIH was placed
in provisional liquidation.
274 JUNE 2003 KEEPING GOOD COMPANIES
Beware the dominant
chief executive!
Ray Williams was chief executive
from the beginning of the business
until he resigned in October 2000.
He dominated the company and was
instrumental in bringing friends and
associates on to the board. This was
instrumental in the development of
a lack of accountability by senior
management to the board and a lack
of independence within the board.
Therefore there was no independent
assessment of performance even
while financial results deteriorated.
The approach of the board and
senior management to the CEO was
‘unduly deferential’. This lack of
‘psychological independence’ meant
that the board was highly inclined to
accept what it was told without
proper questioning and waive rules
and guidelines. As a dominant CEO,
Williams had no clearly defined
limits on his authority in areas such
as investments, donations, gifts and
payments to staff. Personal and
company funds were intermingled
and not disclosed to the board. The
board did not have a clear policy on
matters reserved to itself, rather
matters came forward at the
discretion of the chief executive.
Even after stepping aside as chief
executive, Williams continued to act
with the same authority as before.
Management was not held
accountable or subject to
questioning. An important aspect of
poor corporate governance and
mismanagement was the failure of
risk identification and risk
management. This failing is
obviously particularly critical in the
insurance industry.
The ineffective
chairman
The chairman of HIH, Geoffrey
Cohen, clearly failed in a number of
respects to carry out his role
properly. The chair has general
responsibility to oversee the
functioning of the board, for the
efficient organisation and conduct of
the board’s function and to ensure
that all appropriate matters are raised
for discussion. The board agenda
largely became pro forma and not ‘a
living tool for organising and
shaping consideration and review’.
Other board members did not
contribute to the agenda. Agenda
items almost entirely involved
matters brought forward by
management. The chair had no
major involvement in the process of
determining the information which
went to the board. This left the non-
executive directors highly dependent
on management for their
information. This indicated that the
board acted largely as a rubber stamp
with little independent involvement
in the company. The chair failed to
ensure that all important matters
were put on the agenda and it was
not controlled by management.
Usually there were four meetings
of the board per year plus an annual
budget meeting. The board received
little information apart from the
quarterly financial reviews and some
individual transactions and was
reliant on management to highlight
areas of concern. This indicates a
board that was only concerned with
past financial performance and was
not involved in discussing the path
ahead. In fact it was clear to
Commissioner Owen that the
directors had no idea what the
strategy of the company was.
The chair has an important
responsibility to identify and resolve
conflicts of interest and cannot just
rely on directors to make disclosure
and assume there is no conflict of
interest in the absence of disclosure.
The chair must take responsibility for
taking the lead in securing full
disclosure by all directors.
The failure of the chairman to
discharge his responsibilities can be
illustrated by his failing to bring the
CEO to account when he by-passed
the board in a key transaction. As
pointed out by Austin J in ASIC v

Rich [2003] NSWSC 85, the
chairman’s responsibilities include
the general performance of the board
and the flow of information to the
board on matters such as key
transactions. Concerns about
governance were raised by two non-
executive directors who expressed
concern to the chairman that the
board was not properly involved in
important strategic matters and was
dealing only with matters brought by
management. The chair did not
bring these important concerns to
the board because the CEO indicated
that he did not wish this matter to
be raised. This again reflects the
recurrent theme of a board held
captive by a dominant CEO.
The board that did not
ask questions
The Royal Commission report
clearly considered that the board did
not properly carry out its role. This is
not surprising considering the
dominant role played by Ray
Williams as CEO and the ineffective
role of the chair. There was little if
any documentation or analysis of
future direction or strategy. While
management is best able to propose
strategy, it is part of the role of the
board to understand, test and
endorse the company’s strategy. This
meant that the board was unable to
monitor management performance
and proposals by reference to
endorsed strategy. Where a board
functions properly, any deviation in
practice should be challenged and
explained. The board must regularly
test and review the strategy’s
appropriateness and monitor and
assess whether the strategy is being
achieved and, if so, to what extent.
Ray Williams as CEO never clearly
expressed to the board his plan for
dealing with a difficult competitive
commercial environment. It was a
damning indictment of the board
that the directors were unable to
identify the strategic directions of
Applied Corporate Governance cont.
the company. A long-term strategy or
plan was never formally submitted to
the board for critical analysis. This
resulted in investment decisions
being made which were
opportunistic and lacking in
direction. The failure to understand
strategy led to a failure to appreciate
the risks involved and the board
then could not ask the right
questions to ensure the strategy was
properly executed. Even if the right
questions were asked, the board
would have been unable to assess the
responses. This dysfunction led to
the major failures of operations in
the UK and US and the FAI
acquisition which were ultimately
crucial in the collapse of HIH.
Non-executive directors were
blamed for failing to understand the
The ... report clearly
considered that the
board did not properly
carry out its role.
outstanding claims provisioning.
This is crucial to the financial health
of an insurer and was the most
critical part of HIH’s financial
statements. This lack of
understanding meant the directors
were unable to identify and deal
with looming problems before it was
too late.
The crucial question of
determining the amount of reserves
was set in reliance on actuaries’
reports. However, these reports never
came before the board or audit
committee nor was an actuary
invited to a meeting to answer
questions on how the figures were
arrived at.
The board was heavily dependent
upon the recommendations of senior
management and there were few
occasions when proposals put
forward by management were
appropriately tested by the board.
JUNE 2003 KEEPING GOOD COMPANIES
Failure to grasp the
concept of conflicts of
interest
‘Avoidance of conflicts goes
directly to the integrity of the
board’s processes’.
The board did not grasp the
concept of conflicts of interest and
its critical importance in corporate
governance. Some board members
remained present even when their
private interests were at issue in a
way that might come into conflict
with the interests of the company.
Related-party transactions were
entered into where a director failed
to declare an interest in the
transaction because the director
considered the interest to be well-
known. In other cases, an interest
was disclosed but little further
information given so the board could
not properly decide whether it was
in the company’s interests for the
transaction to proceed.
The board did not have
appropriate procedures in place to
readily identify and resolve such
issues. This is primarily the
responsibility of the chairman.
However, it is a matter for the board
as a whole to recognise conflicts of
interest as a problem and install a
proper system for dealing with such
issues.
The inability of all parties
concerned to understand the concept
of conflicts of interest was illustrated
in the case of ASIC v Adler [2002]
NSWSC 171. In June 2000, a
subsidiary of HIH provided an
unsecured $10 million loan to an
entity controlled by Adler. At the
time Adler was also a non-executive
director of HIH and, through a
controlled company, a substantial
shareholder. This loan was used in
the following transactions:
• about $4 million was used to buy
HIH shares on the stock market.
This purchase of HIH shares was
designed to give the stock market
the false impression that Adler
was supporting HIH’s falling share
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 Applied Corporate Governance cont.
price by personally buying its
shares. The shares were later sold
at a $2 million loss.
• nearly $4 million was used to
purchase various unlisted shares
in technology and
communications companies from
Adler-controlled interests. These
shares were purchased at cost
even though the stock market for
such investments had collapsed
and no independent assessment
of their value was made. A total
loss was made on these
investments.
• $2 million was lent to Adler and
associated interests. These loans
were unsecured and not
documented.
These transactions were not
referred to the board or investment
committee established by the board
to oversee the HIH investment
portfolio. Adler was a member of this
committee. The investment
committee had responsibility for
making, managing and controlling
investments made or to be made by
HIH and its subsidiaries subject to
the control and direction of the
board. Its terms of reference included
considering and approving
investment guidelines, approving
investment authorities and reporting
all decisions and recommendations
to the board. One of its investment
guidelines related to unlisted
investments which were not to be
undertaken without prior approval of
the managing director or finance
director and then ratification by the
investment committee.
Ad hoc executive
remuneration
Remuneration reviews for senior
executives were ostensibly
determined by the board’s human
resources committee which met
annually. The committee’s terms of
reference required it to review the
remuneration of various officers and
senior employees. In fact, all
276 JUNE 2003 KEEPING GOOD COMPANIES
decisions about remuneration and
performance were made by Williams
who, although not a member of the
committee, attended all meetings by
invitation. The committee did not
make proposals on its own initiative
nor did it ever reject a proposal put
by Williams.
A requirement that senior officers
be reviewed against key position
objectives was removed from the
committee’s terms of reference at the
request of the CEO. With the
removal of objective benchmarks
against which performance could be
measured, performance evaluation
and determinations of remuneration
and bonuses were carried out at the
sole discretion of Williams.
Williams’ own performance
appraisal was carried out by the
chairman without proper process or
detailed review. Increases in his
salary were approved without advice
or regard to performance.
Unusual accounting
transactions
The board must be satisfied that
the accounts were derived from
systems likely to produce accurate
accounts. Internal financial controls
were inadequate because there was
consistent failure to meet budgetary
targets. This was not discussed by the
board. Budgetary control as a
strategic planning tool was therefore
ineffective.
HIH management regularly used
one-off end of year transactions that
affected profits to disguise poor
underlying performance. Whether
the use of such aggressive accounting
practices was appropriate was not
considered by the board or audit
committee.
Ineffective audit
committee
The audit committee’s terms of
reference and minutes indicated that
the audit committee was almost
entirely concerned with matters
directly concerning the accounts and
the figures. There was no concern
with risk management and internal
control. The audit committee should
be comprised of only non-executive
directors. The HIH audit committee
was regularly attended by all
directors including executive
directors. The non-executive
directors rarely met with the auditors
in the absence of management to
discuss contentious matters or areas
of concern.
It is necessary for such meetings
to take place so as to enable the
board to determine whether it can
safely rely upon what management is
telling it. Such meetings should
occur regularly so that the board can
consider the issues carefully. The
audit committee could not and did
not ask the right questions.
Compromised auditor
independence
Auditor independence and the
appearance of independence are
fundamental to an effective audit.
The independence of HIH’s auditor,
Andersens, was compromised in
several respects:
• the HIH board had three former
Andersens partners
• one Andersen partner was the
chair of the board and continued
receiving fees under a consultancy
agreement
• a partner was removed from the
audit team after meeting with
non-executive directors in the
absence of management
• Andersens derived significant fees
from non-audit work which gave
rise to a conflict of interest with
their audit obligations.
Conclusion
There is a commonly held view in
boardrooms that was widely
expressed in the aftermath of the
release of the ASX Corporate
Governance Council’s Principles of
good corporate governance and best
practice recommendations that the

current over-emphasis on corporate
governance is misconceived and
ultimately counterproductive.
According to this view, the causes of
corporate failure and mistakes are
poor strategy and flawed business
plans and not poor governance. It is
further suggested that the adoption
of the Best practice recommendations
will lead to a time-wasting and
distracting conformance and tick-
the-box mentality. I suggest that the
HIH Royal Commission report shows
this view to be based on an entirely
erroneous conception of what
constitutes corporate governance.
Commissioner Owen considered that
there was a clear causal link between
poor corporate governance and
mismanagement. Viewed in this
light, corporate governance is much
more than compliance with an arid
set of guidelines just for the sake of
appearing to comply. As stated in the
ASX Corporate Governance Council’s
Principles of good corporate governance
Applied Corporate Governance cont.
and best practice recommendations:
Corporate governance is the system by
which companies are directed and
managed. It influences how the
objectives of the company are set and
achieved, how risk is monitored and
assessed, and how performance is
optimised.
Commissioner Owen
distinguished between the adoption
of a model of corporate governance
and its practice in the following
terms:
There is a danger it [corporate
governance] will be recited as a
mantra, without regard to its real
import. If that happens, the tendency
will be for those who pay regard to it
to develop a ‘tick in the box’
mentality … the expression ‘corporate
governance’ embraces not only the
models or systems themselves but also
the practices by which that exercise
and control of authority is in fact
effected.
HIH had a corporate governance
model and it was stated in the
JUNE 2003 KEEPING GOOD COMPANIES
annual report. The problem was that
the board did not periodically assess
the effectiveness of the company’s
corporate governance practices.
There were relatively few clearly
defined and recorded policies and
guidelines. Where they did exist they
were ignored. It is evident that it is
these elements which are crucial to
good corporate governance practice.
The ASX Corporate Governance
Council’s recommendations are
numerous and detailed and will force
many boards to spend long hours in
restructuring the way they do things.
However they provide a
comprehensive template for boards
to improve their performance and
enable them to ensure that they
operate effectively and add value and
do not fall ineptly into the poor
corporate governance practices
unearthed by the HIH Royal
Commission.
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