This article was first published in the Australian Financial Review on 24 May 2018
Corporate governance practice in Australia is going to change. That much is very clear.
Business scandals used to trigger the question "what did the board know"? Increasingly now the question being asked is "why didn't the board know".
Community expectations on nitty-gritty compliance at the very top of organisations have increased enormously. The structures of boards themselves may need to change to ensure these expectations can realistically be met.
Take the Banking Executive Accountability Regime "BEAR" as a bellwether for where things are going. All directors of authorised deposit-taking institutions (ADIs) – including non-executive directors – will be caught by BEAR and will have personal obligations to take reasonable steps to prevent matters that can adversely affect the ADI's prudential standing or reputation. These steps include – but won't be limited to – having appropriate governance, controls, risk management and procedures for identifying and remediating problems.
Now reconcile that with the Australian Prudential Regulation Authority's recent report into the Commonwealth Bank. APRA concluded that the board relied too heavily on management, leading to "a level of complacency and a 'dulling of the senses' within the board". You have to wonder how directors will satisfy BEAR-style obligations if relying on highly capable senior management to implement systems won't be enough. Boards meet together about 12 times a year, and these are truly enormous organisations (there are 80 countries with a GDP less than the turnover of the CBA).
Complex compliance obligations
Further, ASX corporate governance principles demand a mix of skills on the board, but how can this realistically work when all directors – not just some squares in the skills matrix – will have extremely complex compliance obligations?
Is the director best equipped to deal with prescriptive regulatory requirements likely to also have an amazing entrepreneurial skillset? If you want to bring on a new director to fill a particular gap in your operational capability, what are the chances that person also knows how to monitor the implementation of a compliance framework that stands up to the highest scrutiny.
Is a director with a brilliant commercial or industry-specific background, but limited technical compliance skills, going to even want a board role in the future?
Last year former ANZ chief executive Mike Smith said: "Regulation and corporate governance have got people into such a state that you have got public boards that are very, very risk averse because of the personal liability ... People who are comfortable with compliance governance are generally people who have a background in it: lawyers and accountants. So you find boards of directors are often taken from those disciplines rather than entrepreneurs."
Higher community standards
Given prescriptive governance expectations and higher community standards aren't going away, the next question may need to be about the structure of boards themselves. Two possibilities stand out.
First, companies embrace these new expectations by fundamentally changing board operations, embedding directors deeper into the company, arming them to the maximum extent possible with real understanding of the day-to-day. This is along the lines of Netflix's approach: a governance structure where directors observe monthly and quarterly senior management meetings – with much more granular agendas than a typical board meeting – and are given full access to enormous amounts of data through Netflix's online systems.
Netflix chief executive Reed Hastings claims this helps directors to make bolder decisions because they understand the company's commercial realities and challenges. Plugging the information gap between management and the board can help Australian directors comply with the more exacting governance expectations.
The other approach is to structure boards fundamentally differently, acknowledging that directors simply will never have a management-level of knowledge of a business, and that's not the point of boards anyway.
The German-style, two-tier structure has a management board – which can in effect be a compliance board in Australia – with genuine oversight of the business. More traditional non-executive directors – selected for their broader skillsets – then sit on an advisory board and don't have substantial compliance obligations but instead give strategic direction and play the role of "trusted adviser".
This structure can also allow companies to meet higher community expectations by having consumer or employee representatives on the advisory board, which also may go some way to fulfilling the ASX's latest demand that companies respect their social licence to operate.
There is a lot to think about in Australian corporate governance at the moment, but it seems likely that we will finish the next 12 months with a newly articulated idea of the standards we expect directors and corporations to satisfy.
Once we've cleared that up, we're going to need to think seriously about whether old structures and practices are still fit for that purpose.