Corporate governance: substance over form

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UNSW Law Journal Volume 25(2)




These are certainly interesting times to be commenting on corporate governance. The corporate collapses of the past 18 months, both in Australia and overseas, have raised inevitable questions about the state of corporate governance, and the role of directors and officers in discharging their responsibilities and duties to shareholders and the wider community. With greater direct and indirect share ownership, the whole community is affected by corporate governance; thus it is understandable that regulators and governments will be especially concerned to address this issue.

Debates about corporate governance and the possibility of introducing new provisions in the law to ‘improve governance’ surface in parallel to downturns in the economic cycle and resulting corporate failures. However, the best governed of companies can still succumb to competitive and economic forces. Therefore, corporate failure does not necessarily imply poor standards of corporate governance. Nevertheless, it is important not to be complacent about governance. Good corporate governance relies on the existence of effective checks and balances, and effective governance is not a static concept. Publicly available material about recent collapses has already revealed key governance weaknesses, and it seems inevitable that further lessons will be revealed in due course as regulatory investigations and inquiries are completed.

The challenge at a moment such as this is to understand which aspects of corporate governance can be strengthened by a regulatory or legislative approach, which necessarily focuses on form and disclosure. Regardless of the changes introduced, regulation and legislative prescription can only seek to avoid certain behaviours. The business community needs to develop a culture of valuing good corporate behaviour and its contribution to company performance and shareholder value in order for it to operate effectively. This requires a commitment from all market participants, including professional advisers, to improving the substance of governance.

Enhancing the substance of governance will necessarily involve not only the support of changes to deliver improved audit efficacy and independence and the entrenchment of better disclosure practices, but the empowerment of non-executive directors. The latter is perhaps the most significant challenge. It will require strengthening the framework in which independent directors operate, through better communication of corporate information; willingness on the part of non-executive directors to spend more time on each board membership, including an acceptance that they should be properly remunerated for so doing; encouraging an atmosphere of constructive questioning in the boardroom; improving practices relating to board selection, performance and succession; and boards developing a strong focus on business ethics.

A recent survey of the top 200 listed companies on the Australian Stock Exchange (‘ASX’) by Chartered Secretaries Australia has found that in response to recent collapses and governance concerns, 83 per cent of the companies have reviewed and changed some governance related procedures.1 The focus for change has been on executive option plans, audit and compliance committee charters, rotating audit partners and reconsidering other work from audit firms. The speed of this response is a reflection of a desire on the part of many that there not be an overreaction by regulators and government.

While a corporate regulator can play an important role in reinforcing the importance of the element of governance through enforcement, discussion and education, ultimately, a focus by directors on culture, values and ethics, and an appreciation of the importance of the substance of governance, is needed.


The concept of corporate governance is not a precise one — its content is affected by different cultural variables.2 Consequently, it is not surprising that various definitions and interpretations have emerged over time.

Early debate about corporate governance generally revolved around issues relating to board structures and systems. Corporate governance has, for example, been defined as the system by which organisations are directed and controlled.3

Corporate governance generally tends to gain public attention when performance problems are apparent. Thus, the initial focus on corporate governance arose as a result of the corporate collapses of the late 1980s and early 1990s.4 In addition, globalisation and the growth of the world’s capital markets, the growth of shareholder activism and market expectations in general have added to the focus and debate on governance.

In light of this increasing interest, aspects of corporate governance have been extensively examined over the past two decades by a number of publicly appointed committees. Australia had the Bosch committee5 and the Hilmer committee.6 In the United Kingdom, there were the Cadbury committee,7 the Greenbury committee8 and the Hampel committee.9 The United States saw the development of the General Motors’ Board Guidelines on Significant Corporate Governance Issues (‘GM Guidelines’), and internationally we witnessed the development of the OECD Principles on Corporate Governance (‘OECD Principles’).10

The report of the Bosch committee was the first significant Australian attempt to set out corporate governance standards of best practice. It considered the function of the public company board, its structure, the role of company accountants and auditors, the conduct of directors, the role of shareholders and codes of ethics. Its main recommendations were that:

  1. the roles of chairman and chief executive officer (‘CEO’) should be separate;11

  2. the boards of public companies should include a majority of non-executive directors who have an appropriate mix of skills and experience, and whose abilities are appropriate to the needs of the company;

  3. each public company board should appoint an audit committee with at least a majority of non-executive directors; and

  4. public companies should develop, publish and enforce a code of ethics.12

The Bosch report also proposed that the annual reports of all public companies should include a statement by the directors that the company supports and has adhered to the principles set out in Corporate Practices and Conduct. It was recommended that any departure from the principles should be noted and the reasons for them given.13

In September 1994, the ASX issued a discussion paper,14 which noted that a large proportion of listed companies did not adhere to the Bosch committee’s principles. This was a source of concern because local and overseas investor confidence in Australian equity markets could be adversely affected if there was a perception that appropriate corporate governance practices were not generally followed. The ASX also noted that several major overseas stock exchanges had introduced rules relating to corporate governance practices of listed companies.

In 1996, the ASX introduced Listing Rule 4.10.3, requiring a listed entity to include in its annual report a statement of the main corporate governance practices that the entity had in place during the reporting period. An indicative list of corporate governance matters is provided in Guidance Note 9.15

General thinking about corporate governance at the time was also greatly influenced by the Cadbury, Greenbury and (shortly thereafter) Hampel committee reports in the UK, which contained many similar recommendations. Broadly, these include the desirability of independent non-executive directors of sufficient calibre and number to improve board decisions; the establishment of audit committees, nomination committees, remuneration committees and other aspects of internal control; and the separation of the role of chairman from CEO.

Thus, by the mid to late 1 990s, there were a number of different descriptions of ‘good governance’, both within Australia and overseas. Although the definitions differed in some respects, these differences, with one exception, were not really substantial and the essential ‘structures’ of good governance were largely agreed upon. The difference of substance related to the acceptance in the US of the combined role of chairman of the board and CEO; two roles which, in Australia and the UK, it was thought most important to separate.

The work of these committees added not only to the literature on governance, but to its development. Their largely structural approach underlay the Australian practice of governance — a practice which has been seen as ‘institutionalised and compliance focused, more driven by process and liability management for corporate officers, than by notions of shareholder protection and wealth creation’.16 Generally, the ‘substance’ was subsumed by the focus on ‘form’. Corporate governance lost momentum and potential as an effective program for corporate risk management; instead it became a formula for boards to implement.

Some individuals, of course, appreciated that this focus on systems and structures should really be a focus on performance. The Hilmer committee in 1993, for example, emphasised that ‘governance is about “performance” as well as “conformance”’.17 The committee concluded that three elements were at the heart of poor performance and hence should be a focus for corporate governance:

  1. confusion over the role of the board, in particular, a failure to balance its interest in performance with its duty to oversee conformance with the relevant rules and regulations;

  2. weak director selection processes; and

  3. a lack of processes to keep performance at the centre of the board’s agenda.

However, until recently, there has been very little discussion on how to overcome these obstacles and start focusing on substance and defective processes rather than on structures. In the current environment, regulators, legislators and the business community face the challenge of revitalising the essence, or substance, of governance.

Shareholders, too, are asking the more general question of how effective a board really is. The ‘new shareholder’ has evolved and corporate governance is high on their agenda when choosing between various investment options. Media commentators have noted that ‘even before the collapse of Enron, HIH and One.Tel, shareholders and anti-globalisation coalitions were demanding better risk management by boards and senior management across a number of areas’.18 Similarly, the demands on board performance have increased and ‘in a world of active shareholder and fund manager interest, aggressive capital markets and carefully measured corporate performance, the requirements are much higher’.19

This growing concern about the performance aspect of governance, albeit in non-specific terms, was being expressed by a number of business leaders before recent collapses. A prominent director, the chairman of several leading companies, commented well before the recent flurry of interest in the subject:

We need a fresh approach to how we think about boards and the real drivers of

board performance, rather than the emphasis that we see today, which is focused on

the formalised edicts of the corporate governance debate.20

Another director admitted that ‘many boards are struggling and failing to make the transition from a reactive, compliance-oriented model to a new strategic, performance focused approach’.21

Therefore, the key challenge facing legislation, regulators and business, is how to respond to this latest crisis of governance, or at least, crisis of confidence in existing governance.

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