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Chapter Two - Background on corporate governance
2.1
This chapter outlines Australia's corporate governance framework and its
relevance to shareholder engagement, based on the delegated authority model in
which company directors make decisions in the company's interest, subject to
shareholder oversight. As background for the following two chapters, the
committee describes the importance of effective channels of communication
between companies and their shareholders, as well as efficient and transparent
voting mechanisms to enable shareholders to enforce board accountability.
Finally, the committee notes inquiry participants' preference for a
non-regulatory approach to improving shareholder engagement in Australia.
Corporate governance model
2.2
The participation and engagement of shareholders in the companies in
which they invest occurs within the parameters of the delegated authority model
of corporate governance. This operates on the basis that company directors are
responsible for overseeing the direction and management of the company, which
they have a fiduciary duty to undertake in the best interests of the company in
accordance with section 181 of the Corporations Act 2001 (Corporations Act).
Although the Corporations Act provides for shareholders to engage in direct
decision-making in limited circumstances, such as amending the company
constitution (section 136) or reducing share capital (section 256C), this
control over setting the direction and overseeing management of the company
rests with the Chairman and the board and implemented by company management
under the guidance of the Chief Executive.
2.3
In discharging their duties, directors are held accountable for their
decisions by shareholders with the legal entitlement to remove and appoint
directors under section 203D of the Corporations Act. This governance model
recognises that management by shareholders would be impractical, but ensures
that those responsible for the company's performance and direction are
accountable to the owners of the company for the decisions they make on their
behalf.
2.4
The Institute of Chartered Accountants described the accountability of
the board as the mechanism for offsetting the concentration of decision-making
control they possess.[1]
Similarly, the Australian Institute of Company Directors (AICD) told the
committee that this corporate governance model struck an appropriate balance
between control and accountability:
...shareholder participation in business decisions would dilute
board accountability and make it impossible for companies with large numbers of
shareholders to operate effectively in a modern economy.[2]
2.5
They also advised that it best manages the conflicts associated with a
diverse mix of shareholders with both long- and short-term imperatives.[3]
2.6
ASX Limited commented that this framework provides good value to
companies and shareholders via improved corporate governance:
Shareholder involvement in corporate governance primarily
consists of monitoring the performance of the board of directors and the
company as a whole. The agency costs associated with this model, such as
continuous disclosure compliance and other forms of shareholder monitoring and
company communication, are outweighed by the efficiencies which flow from this
model.[4]
Shareholder engagement and effective governance
2.7
The critical nexus between these decision-making and accountability
functions is engagement between shareholders and the company board that is
informed, meaningful and effective. Evidence received by the committee
suggested that participation and engagement with company boards is an important
means by which shareholders are able to improve the value of their share
ownership and minimise risk.[5]
Treasury submitted that ineffectual shareholder engagement brought increased
investment risk:
Shareholders must retain effective mechanisms to examine the
affairs of the company and voice concerns to the company and its managers.
Shareholder participation is vital in ensuring accountability of the company’s
board and management. Without effective monitoring of directors and management
by shareholders, there is an increased risk of directors and managers
underperforming.[6]
2.8
To provide an example of its benefits, Australasian Investor Relations
Association cited a recent US survey of fund managers claiming that a potential
ten per cent share price premium could be attached to companies with 'superb'
investor relations.[7]
2.9
Shareholder engagement and participation that contributes to good
corporate governance has two main features:
- Shareholders
being well informed about the companies in which they invest through effective
communication; that is, transparent reporting of company information and
meaningful dialogue between shareholders and company boards; and
- Shareholders
being able to perform their accountability role by exercising their voting
entitlements effectively.
2.10
These elements of shareholder engagement are summarised below and the
issues raised during the inquiry that relate to them are examined in further
detail in chapters three and four respectively.
Communication between shareholders and company boards
2.11
Access to relevant information and the opportunity to engage directly
with the board on matters of corporate governance are critical to enabling
shareholders to exercise their accountability in a way that benefits the
company. The various methods, both mandatory and voluntary, that companies use
for communicating information to shareholders include:
- Mandatory company reporting as stipulated by the provisions
contained in Chapter 2M of the Corporations Act;
- Regular disclosure of information that might have a material
effect on the share price as mandated by ASX Listing Rule 3.1;
- Reporting performance at company meetings, which must be
conducted in accordance with the provisions contained in Chapter 2G of the Corporations
Act;
- Informal briefings to investors, usually major institutional
shareholders.
2.12
In its submission, Treasury outlined the importance of shareholders
being able to make an informed assessment of the companies they invest in:
A key objective of Australia’s financial reporting framework is
to provide existing and potential shareholders, as well as a range of other
stakeholders, with full and reliable information about a company. These
disclosures enable users to make informed investment decisions, actively
participate at AGMs, influence management and hold it accountable for the
company’s operations. The financial reporting framework therefore provides an
important platform to enable shareholders to participate and engage with a
company.[8]
2.13
An important consideration during the inquiry was the need for companies
to tailor, and shareholders demand, methods of communication that best suited
the requirements of diverse classes of investors. In particular, there is a
clear distinction between the type of communication with company boards that is
suitable to large, well resourced institutional investors, and the most
appropriate way for companies to engage with individual retail investors. The
next chapter, Chapter Three, addresses the problems associated with
communication between companies and shareholders in the context of these two
separate investor classes.
2.14
What ought to be noted here, though, is the increasing significance of
institutional investors that has occurred in recent times. According to the ASX,
institutional shareholders comprise a growing segment of the equities market,
largely due to the increasing value of superannuation funds under management.
Their submission stated that, from June 1988 to March 2007, institutional
investment rose from 23.1 per cent to 40.4 per cent of total investments. They
added that 'a significant proportion' of the 32.5 per cent of securities held
by investors outside Australia (in March 2007) would be institutional
investment. During the same period household (retail) investment declined from
36.1 per cent to 23.7 per cent as a proportion of total investment in the
Australian stock market.[9]
2.15
Treasury also commented on the 'de-retailisation' trend, emphasising the
need for the corporate governance framework to be flexible enough to adapt to
the 'differing requirements of different types of shareholders and their
relative prominence in the market at any one time'.[10]
Accountability through shareholder voting
2.16
The voting rights attached to share ownership provide investors with an
important mechanism by which to maintain the accountability of a company board.
The principal regulatory provisions that apply to voting on company
resolutions, including the election of directors, are contained in Part 2G.2
and part 2D.3 of the Corporations Act. The ASX Listing Rules, which are
enforceable under sections 793C and 1101B of the Corporations Act, also
regulate company voting procedures. ASX Listing Rule 14.2 sets out the
requirement for companies to provide for proxy voting. The Listing Rules also
establish the process for electing company directors. The relevant provisions
are as follows:
- Listing Rule 14.3 stipulates the time frames within which
director nominations must be accepted (35 business days, subject to the company
constitution);
- Listing Rule 14.4 limits tenure of directors to three years
(after which time they must be re-elected); and
- Listing Rule 14.5 requires director elections to be held
annually.[11]
2.17
Chapter Four reviews evidence to the committee on problems associated
with the mechanisms used to lodge and record votes and the capacity of
shareholders to exercise their vote effectively.
Preferred approach to reform
2.18
As described by the committee intermittently in the following chapters,
the basis for any deficiencies in the participation and engagement of
shareholders on corporate governance matters is frequently company or
shareholder inertia or apathy, or companies' cultural resistance to
acknowledging the views of investors. In other words, investors and companies
are not always choosing best practice currently permitted by the current
regulatory framework, rather than being hampered by it, or being permitted to
abuse an overly relaxed system to the detriment of shareholders. Consequently,
the majority of contributors suggested that additional regulation may not be
effective or warranted in facilitating engagement.
2.19
Although the committee received a number of recommendations on
regulatory means to improve shareholder engagement, contributors did not mostly
express the opinion that the current regulatory framework for corporate
governance was fundamentally responsible for obstructing engagement between
shareholders and companies. For example, AICD said: 'there is always the
opportunity for incremental improvement, but we do not by any means believe
that the system is inherently wrong or that there is any systemic problem with
it'.[12]
They added that, from their experience, shareholders are not expressing concern
that they are insufficiently engaged.[13]
The Law Council of Australia submitted that the current system allowed
sufficient shareholder participation and did not require legislative or
regulatory change.[14]
2.20
Chartered Secretaries Australia (CSA) noted the importance of
maintaining a balance between engagement with shareholders and the efficient
management of companies. They asserted that there are:
...areas where further discussion and communication by relevant
parties could engender improvements, but we stress that any additional
regulation at this point is more likely to create regulatory and administrative
burdens on companies than facilitate the effective engagement of shareholders.[15]
2.21
The Institute of Chartered Accountants concurred, stating that
shortcomings in company governance 'are best overcome by proactive voluntary
corporate governance action rather than prescriptive regulation'.[16]
CSA contended that black-letter-law approaches tended to produce 'the wrong
outcomes'.[17]
The Business Council of Australia maintained that 'flexibility' within the
regulatory framework best facilitated engagement.[18]
Regnan commented that regulatory change must be preceded by investor demand:
...the driver for change now has to be very strong investor demand
and institutional demand. That will probably lead to requests from companies and
investors for a regulatory regime to give force to what they agree in the
market on engagement.[19]
2.22
ASX Limited stated that any further regulatory diversion from the
delegated authority model would be unwarranted:
Starting ... from the basis that the current governance framework
works well, and contributes to market efficiency, any exception to the default
position that shareholders appoint directors as their agents to act on their
behalf needs to be supported by an identifiable and justifiable principle. An
example of such a principle is regulation providing for a direct shareholder
vote in circumstances where a conflict of interest between shareholders and
directors cannot be managed by any other means. In our view, current
regulations give adequate effect to this principle.[20]
Committee view
2.23
Shareholders own their companies, so engagement with company boards is
their right, but there is a benefit beyond the exercising of that right.
Shareholder engagement through dialogue, disclosure and voting ensures the accountability
of company boards and management, providing an important check on their power
that serves to improve corporate governance standards. This works in much the
same way as the central tenets of democracy improve the standards of political
governance via the accountability of elected representatives. In the political
sphere this occurs through best practice elections, checks and balances on
institutional power, selection on merit and transparency. Maintaining political
accountability includes equally vital institutional and participatory elements;
the right structures need to be in place to enable democratic participation to
be as effective as possible. Similarly, the willingness and capacity of
shareholders to engage, question, form opinions and vote on company matters is
essential to bringing these democratic principles to bear in the corporate
realm.
2.24
However, the notion that those granted responsibility for running
publicly listed companies should be accountable in this way is sometimes met
with resistance from elements within the corporate sector. Some company boards
prefer instead to use the delegated authority model of corporate governance as
an opportunity to operate autonomously, with minimal shareholder-based
accountability. This attitude is clearly detrimental to the objective of best
practice corporate governance.
2.25
The committee recognises that Australia's standards of corporate
governance are relatively high. But there is certainly room for improvement; Australia's
companies and boards are not perfect. Companies that have failed to adequately
facilitate shareholder engagement and participation need to be pressed harder
to do so. Regulators such as the Australian Securities and Investments
Commission and the ASX, as well as industry bodies such as the Investment and
Financial Services Association, have developed very effective best practice
methodology and principles. These organisations should be encouraged to
continually adapt their corporate governance guidance to account for shareholder
engagement objectives and to explore ways of ensuring they are adopted by
companies not giving them sufficient credence. Rather than imposing minimum
standards of engagement on companies, legislative reform is best suited to
removing impediments currently preventing companies from engaging with
shareholders in line with best practice guidance.
2.26
It is in this context that the committee discusses the more contentious
shareholder participation and engagement issues and makes its recommendations.
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