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20 lessons in 20 years – Part 16

Wednesday, February 13th, 2019
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Why corporate governance matters and how best to exercise your rights as a shareholder

By Anton Tagliaferro and Michael O’Neill |  18 December 2018

When one buys shares and invests in any company that is listed on the stockmarket, one becomes a part owner of that company. As a part owner of the business you then have a direct economic interest in the company’s financial future by having a share of all future profits earnt and dividends paid by that company.

Being a part owner of the company also entitles you to certain rights as a shareholder. In a private company that is owned by one family or shareholder, it is pretty clear who the owner of the company is and who makes all the major decisions. In a private company it is very clear that the management and employees are accountable to the owner of the company. Being the owner of all the shares in a private company, entitles the owner to make all the key decisions relating to the company such as the appointment of a CEO and CFO to run the company, the possible expansion into new products or territories, the remuneration of the company’s key employees as well as the company’s dividend policy.

In a listed company, the situation is very different. The owners of large listed companies such as BHP and CBA are the millions of shareholders who own the shares. Each of these shareholders may have a different opinion as to the future direction of the company, what executives should be paid and the company’s level of dividends. Thus, in the case of listed companies a Board of Directors is appointed by shareholders. The Board’s job is to act as the stewards of the company and to run the company on behalf of shareholders with the ultimate intention of creating long-term shareholder wealth.

How does a Board of Directors work?

By law all Boards of Directors of any company collectively have a duty to run the company in the best interests of all shareholders. While in Corporations Law it is clear that all directors and Boards should always act in the best interests of shareholders, the precise duties and functions of Boards of Directors, from a corporate governance perspective, are not defined in the law.

From a practical perspective, key Board duties include to:

Corporate governance is the term coined to cover all the structures, rules, relationships, systems and processes by which decisions are made and how the Board goes about exercising its authority in performing its duties and running the company on behalf of shareholders.

Corporate Governance – notorious failures

Over the last 30 years corporate governance has come to prominence after many instances where Boards of Directors failed in their duty of safeguarding shareholders’ interests. This has particularly been the case in instances where the company’s senior management misled shareholders as to the true financial position of the company or where the very large risks being taken were not properly recorded and reported to shareholders.

In the early 1990’s we saw the collapse of large listed companies such as Bond Corporation and Qintex which were managed by entrepreneurs such as Alan Bond and Christopher Skase who often treated the companies as their own and where large-scale fraud which had been committed was only discovered after these companies collapsed.

In 2001 we saw the collapse of HIH Insurance – at the time Australia’s largest insurance company. HIH was run by CEO Ray Williams who had founded the company in the 1960’s and who had a very large influence on the direction and running of the company. After the collapse of HIH we saw the CEO, CFO as well as other officers of the company spend time in jail when it became clear that they had not been properly disclosing the risks being taken by the insurer to HIH’s shareholders. Many dubious related party transactions entered into by certain members of HIH’s senior management team were also discovered following the company’s collapse.

The revelations which emerged after the collapses of all these companies led to many questions as to what the Boards of Directors of these companies should have and could have done at the time to prevent, discover and report the very large risk-taking or inappropriate behavior of the senior management of these companies – which ultimately destroyed billions in shareholder value.

Defining Corporate Governance

The issue as to what constitutes good corporate governance and the precise nature each Board’s members responsibilities are subject to interpretation as they are not clearly defined in the Corporations Act.

Over the last 20 years various regulators and bodies have attempted to set out corporate governance principles that all company Boards of Directors are encouraged to follow. Thus, the ASX has published a set of corporate governance principles which Australian listed companies are encouraged to adhere to and report on regularly.

The ASX’s 8 central principles include:

While having frameworks such as this may help in giving further guidance as to what constitutes good corporate governance, it is still fairly subjective: how does one effectively measure the competence of any director to act on a board? what represents ‘adequate’ remuneration to attract and retain key staff and Board members? Boards of Directors are effectively given a fairly large degree of latitude in the ways that companies are run.

It is thus up to shareholders to have their voices heard if they are not happy with certain aspects of a company’s performance or direction.

How can shareholders have their say?

As a shareholder in a listed company you are afforded certain rights under Corporations Law, for example:

But is this enough? What else can shareholders do to ensure the Boards of companies are looking after the long-term interests of shareholders?

IML’s experience over the last 20 years has shown us that corporate governance matters. We are keen to ensure that the Boards of the companies we are invested in, always act in the best interests of all shareholders.

How IML assesses Corporate Governance

Below are some of the things that we see as crucial when assessing how appropriately a company will look after shareholders’ interests going forward:

Assessing the company Chairman – the role of Chairman of any company is often underappreciated by many investors when assessing if shareholders’ interests are looked after. While a Chairman only has one vote on any Board of Directors, the Chairman is often very influential in things such as the hiring of other Board members and the appointment of the CEO of the company. The Chairman must also influence the Board on the ratification of the CEO and senior management’s long-term strategy for the company including things such as new acquisitions or the disposal of underperforming divisions. The Chairman is often a very important figure when it comes to very difficult decisions such as the replacing of a CEO if the company is not meeting the targets set to create long term shareholder wealth.

A good Chairman can go a long way to ensuring that long term shareholders’ interests are always at the forefront of a Board of Directors minds.

Assessing the capability of the Board – making sure the Board has relevant industry experience and can add value to the company’s management team is also an important aspect. We assess this by looking directors’ backgrounds and previous experience.

Looking at the Board’s independence – having a Board with a majority of independent, impartial directors is also very important. This can be crucial when a majority or dominant shareholder can effectively hold sway on all decisions.

One of the key weaknesses in many of the corporate failures of the past such as Bond Corp or HIH was when a large shareholder or a well-entrenched CEO’s effectively held sway on the direction of the company. These individuals were not effectively held to account by their Boards of Directors – with the Boards often prepared to trust this dominant character, or not having the strength of character to ask the difficult questions.

Thus, many companies listed on the ASX today such as Harvey Norman, Crown Resorts, Village Roadshow, Pact Group and Events Hospitality have a shareholder who controls a large portion of their shares. In these cases, we find it is especially important to form a view on the competence and independence the Directors on the Boards of these companies when deciding whether or not IML will invest.

How IML seeks to influence Boards of Directors

IML often takes an activist approach to influencing the Board of any company we are invested in when we believe it is being overly influenced by short term trends or investment bankers’ suggestions. In cases where we are not fully satisfied with certain circumstances, we take the opportunity to remind the Board that it is there to act in the long-term interests of shareholders, as opposed to making decisions based on populist or short-term reasons.

IML has always been active in seeking to influence the direction of Boards of companies we are invested in where we have felt that a company’s shareholder funds are being potentially put to sub-optimal use, where we have felt that corporate governance is weak, where some management decisions have seemed poor or where the company as a whole or a division of the company is more valuable in the hands of others.

As long as IML is convinced about the long-term potential or value of any company in which we are invested, rather than simply sell out or stand up at general meetings and grandstand, we tend to seek change through the writing of forthright letters. These letters are always addressed to the Chairman of the company with a request for our letter to be discussed at the next Board meeting of the company.

The table below outlines some of the issues we have addressed with companies we had large investments in – seeking to protect or enhance long term shareholder value on behalf of our investors.

The table includes specific examples of the many letters we have written to Boards of Directors in companies we have held shares in over the past 20 years.

At IML, we have always taken an active interest in the companies in which we are invested and where necessary always reminded the Board of its fiduciary duty towards shareholders. We have always agitated for change as best we can to bring our concerns to the attention of the Board and management, and to seek answers.

Conclusion: It is always important to invest in companies that display a good governance framework. As a shareholder, it is always important to use your rights to vote at company meetings or if this is not sufficient to engage directly with Boards by lobbying or writing directly to the Chairman of the company one is invested in to remind them of the fiduciary duty of the Board of Directors in looking after the long-term interests of all shareholders.

 

While the information contained in this article has been prepared with all reasonable care, Investors Mutual Limited (AFSL 229988) accepts no responsibility or liability for any errors, omissions or misstatements however caused. This information is not personal advice. This advice is general in nature and has been prepared without taking account of your objectives, financial situation or needs. The fact that shares in a particular company may have been mentioned should not be interpreted as a recommendation to buy, sell or hold that stock.