Governance – Increasing Complexity and Scope

The 2017 and 2018 reporting periods have seen increased shareholder activism, changes in emphasis and priorities expressed by institutional investors and proxy advisors, and a sense of urgency in addressing issues arising from the Hayne Royal Commission which are clearly observed as extending beyond the Financial Services Sector.

Recent activity including comment by Chairmen in addressing shareholders and by proxy advisors commenting on research, together with certain activist initiatives, have revealed the need for Boards in many industries across enterprises of varying scale to involve themselves in a diversity of issues previously considered the primary, if not sole, accountability of management.

Recent revelations have indicated that senior management have delegated substantial authority in relation to the interaction of their staff with customers in the supply of products and services, both domestically and international.

The findings of the Hayne Royal Commission note the occurrence of widespread breaches of codes of conduct which all employees are required to operate, however have received little or no management oversight. The fallout from the Commission has led a number of financial institutions to compensate customers through payments of millions of dollars, due to breaches by staff in the conduct of their relationship with customers.

Revelations from the Commission have also highlighted that many Boards need to have a direct involvement in the specification and execution of internal audits. This has also led to internal auditors raising questions as to their scope of work and the level of depth of their investigations in meeting their statutory and service obligations.

While not directly, and certainly not universally, revealing their limited engagement to protect management’s interest, they have revealed that Board awareness of staff conduct across all levels and the application of bonus or related commission payments have not been aligned with Corporate Policy or in contractual arrangements.

These initiatives have brought reputation and organisation culture to a position of pre-eminence. Though also potentially revealed that the management and measurement of culture has fallen short of providing information of increasing relevance to Boards and indeed senior management.

It also highlighted in many organisations the need for increased training of management and supervisors with oversight of staff and internal communications. Such training would reinforce the criticality and adherence to an organisation’s values, ethics and core corporate policies, which are fundamental in developing and maintaining an organisation’s reputation.

The emergence of this focus on culture referencing the knowledge and behaviour of employees and adherence to policy, and prior reporting by companies of exemplary employee engagement and high net promoter scores, may bring into question the utility of these measures as currently constructed. Recent revelations might similarly bring into question whether positive improvement in these scores should lead to the payment of an incentive, or if these measures should act as gateways or modifiers under incentive programs.

In parallel with this increasing focus and demand on Board engagement in the stewardship of compliance with corporate policy, there is increasing noise in the market place which may lead to ESG becoming another core ingredient (ESG Shaping Future of Governance Model). Reflecting the effectiveness of governance, and new demands on Boards and management to develop appropriate policies and assessment protocols to monitor their environmental, social and governance stewardship across what is becoming an increasingly complex set of shareholder, society and Government expectations.

Within the parameters of ESG there will be an increasing focus on climate policy and conflicts of perspectives which will need to be addressed in relation to the Paris Accord, the policies and compliance of other developed countries and the increasing engagement of corporates and Governments in addressing climate financial risk. While not representing new issues in relation to the conduct of a corporation, the above reflects a changing perspective of society, shareholders and Government which is likely to lead to policy transformation, increased transparency in reporting, and questioning of many traditional approaches where financial metrics represent either a significant dominance or a single criterion in the determination of executive pay at risk.

While employees who are paid to conduct themselves in accordance with corporate policy, the incidence of non-conformance could become a significant modifier in the way in which management are rewarded rather than being a foundation for additional reward.

The demands upon management and the engagement of Boards in determining an organisation’s priorities to ensure their short-term prosperity and long-term sustainability is changing significantly. Boundaries are extending well beyond revenue and profit growth, return on investment and innovation to include the application of technology, the organisation’s engagement in social media, cyber security, quality assurance and multi-jurisdictional compliance embracing a much broader footprint of key strategic and operational activities. Mutual trust between the Board, management, the organisation, its customers, and the organisation and its shareholders will be critical.

Recent research, undertaken by King & Wood Mallesons, offers more detailed insight into these issues – Directions 2018 – The Rise of Intangibles & a new Recipe for Trust.

If you require further information on this topic, please call  John Egan on (02) 9225 3225.