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Excess baggage:

Responsibilities of directors

by Simon Longstaff

When are we going to have a deep and serious discussion about the foundations of corporate governance in Australia?

Perhaps now, prompted by a swag of corporate collapses and the wreckage of one too many scandals, we will finally turn our minds to some of the fundamental questions that we have left, ignored and unanswered, for more than a decade. Perhaps now, the time is ripe for something more than the usual fare – the triumph of form over substance.

In the past decade there has been an anxious wringing of hands over questions such as: the need for and composition of audit committees, the benefits of separating the role of chair from the CEO, how to manage the technical aspects of conflicts of interest, and so on. I accept that such questions do need to be discussed for sound, practical reasons. However, one can't help feeling that we've been arguing over who sweeps up the embers while Rome burns.

When bigger questions do break through, then too often the conversation has been peppered with mere assertions allowed to masquerade as 'truth' – simply because of the force and frequency with which they have been articulated. For example, I've lost count of the number of times I have heard it proclaimed that the principal duty of directors is to, “maximise returns to shareholders”.

Well, is this really so? Who says so? Why? More important still, if such a duty does exist, then should it? In a similar vein, it is often asserted that company directors have a duty to “act in the interests of all stakeholders”. Once again we might ask, “What makes a stakeholder a stakeholder in the first place? Why should company directors do anything for non-shareholders at all? What happens when one stakeholder's interests are at odds with another (such as shareholders) – which they often are?”

A popular view in business circles is that failures of corporate governance are produced by a few 'rotten apples' who are driven to do the wrong thing by some personal failing (for example, a susceptibility to greed, or the folly of an over-reaching ego, etc).

I am not convinced by this argument. Instead, I am inclined to think that or general approach has been weakened by two related factors. First, I think that we have put too much faith in the power of formal systems of regulation and surveillance to 'save us from ourselves'. Second, I think that the average board operates on 'automatic pilot' – simply acting in accordance with the unthinking custom and practice of the day.

How do these two factors operate in tandem to weaken the overall structure? While a certain amount of regulation and surveillance is indispensable, there are some who maintain the naive belief that it is possible to establish regulatory systems that have the capacity to prevent people from choosing to do what is ‘wrong’.

Those who support this approach fail to see that if you create a system in which people cannot choose to do what is wrong, then you also create a system in which people cannot choose to do what is right! People simply do not choose – they just tick the boxes, apply the rules, and so on. In these circumstances, people lose their capacity to make ethical choices. Relieved of any need to utilise this skill – it simply wastes away like a muscle encased in a plaster cast.

This 'withering' of the skill of ethical judgement is exacerbated in circumstances where people fall into the groove of unthinking custom and practice. You almost always know that people are in for trouble when they tell you that they do things because “everybody does it this way”, or “it's world's best practice”, or “that's just the way we do things around here”. Unfortunately, there are plenty of boards that are caught in the vice of regulatory fervour and unreflective practices.

The antidote is certainly not the abandonment of any form of prudent regulation and surveillance by people like the Australian Securities and Investment Commission and the Stock Exchange. Any solution must be based on the development of a balanced response. However, if regulation is to be set at an ideal level, then corporate Australia will have to demonstrate that its ability to engage in effective self-regulation is real – and not just a slogan designed to keep government off the backs of business. In other words, the onus is on company directors to demonstrate that they have the will and the ability to get their house in order.

If participants in 'the market' are going to convince people of their credentials in the field of corporate governance, then they are going to have to do far more than roll out a few codes of conduct. Instead, they are going to have to show that they have a mature understanding of the fundamentals on which any robust system of governance must be built.

As noted above, this will require society as a whole, and business in particular, to address some basic issues. For example, is the formal, legal duty of directors to act “in the best interests of the company as a whole” just another way of saying that directors have a duty to act in the best interest of all the shareholders? Or does the fact that the company is a separate legal person mean that directors have to bear in mind that the best interests of the company may, at times, be at odds with what the shareholders say they want (or even need)?

If the interests of the company are not identical with those of shareholders (for example when directors have to balance the competing demands of retaining earnings for re-investment in the company versus that of paying a dividend), then whose interests should prevail?

A related question concerns the timeframe within which directors' decisions must be made. In recent years, there has been mounting pressure from financial markets looking for strong quarterly performance – a reflection of the criteria governing the remuneration of analysts and fund managers.

This has fostered what many regard to be an unhealthy 'short-term' outlook in which immediate value is created by mortgaging the company's future. This approach stands in stark contrast to the alternative view that the duty of directors is to shareholders in perpetuity – a duty that led the one-time doyen of Australian company directors, Sir John Dunlop, to claim that directors must take into account the interests of employees, customers and the wider community. How we respond to the distortions caused by focusing on quarterly performance is one of the great, unresolved questions lying at the heart of our economic system.

Other questions press for a response: will society review the conditions under which it maintains the privilege of limited liability for shareholders, is there a need to extend the criminal law to cover the actions of errant corporate executives, how will the professions of law and accountancy (to name but two) recover their positions as 'gate-keepers' of the market economy rather than 'guns for hire'? The list could go on.

However, of immediate concern is the fact that a decade on from the infamous 'excesses of the '80s' there is little evidence to show that companies have done much more than pay lip-service to the idea of embedding an ethical approach to business within their cultures. Core values and principles operate as a form of 'Organisational DNA' and with a few exceptions, boards have typically given little more attention to ethics than can be encompassed in the odd rhetorical flourish included in an Annual Report.

For example, how many boards have a formal process requiring senior management to consider and report on the ethical implications of proposals included in board papers? How many directors can name the core values and principles of companies they govern – and agree to abide by them when making decisions? How many boards commission processes that will inform them of the extent to which their companies live the values and principles they espouse – right down to the messages embedded in systems of remuneration?

Ethical failures in companies are, as much as anything else, a result of Board indifference – or (as with Enron) worse.

Despite all of the evidence linking improved commercial performance to a genuine commitment to ethical conduct, Australian boards give this aspect of business scant attention.

That this should be so is genuinely perplexing. Perhaps people worry that a serious commitment to ethics would just make corporate life unduly complicated. The truth is that life does not become more complicated because of ethical reflection. Ethics just reveals the complication that is already there and that largely goes unnoticed – until it is too late and disaster strikes.

Just imagine how much better life would be for so many people if only there had been even a little more ethical reflection in the boardrooms of HIH, OneTel, Arthur Andersen, Enron, WorldCom ... ?

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