Directors need skin in the game, not an ASX straitjacket

Originally from the Australian Financial Review

By John Wylie

David Murray is right to criticise the ASX’s proposed Corporate Governance Principles but his focus on the role of board committees and the board-CEO relationship underplays a larger point.

The most important thing needed in Australian boardrooms today is for directors to think like owners of their businesses. The ASX’s proposed principles drive them in the opposite direction, encouraging a mindset of risk management, independence, best practice compliance and corporate virtue-signalling.

Owners aim to grow businesses and create shareholder wealth while prudently managing risk. They try to manage their company in a holistic way that balances the interests of shareholders with customers, employees, the public and regulators. They know what’s going on in their businesses without having to follow a corporate manual.

They do these things because it’s common sense, in their self-interest and because their livelihood and reputation depend on it; not because a regulator with a serious case of mission creep mandates it for them.

They don’t always get it right, but you know they’re in there trying, with the greatest natural interest in achieving the right balance.

The ASX has lost sight of its core role in our nation’s economy, which is to provide the infrastructure to enable investors to stake the equity investment and risk capital needed to grow Australia’s economy and create jobs.

In 55 pages of prescriptive values and rules for Australian public companies, it’s a remarkable achievement for our national securities exchange not to mention, even once, the words “grow shareholder wealth” as a core goal.

Nowhere is the topic even raised as to whether non-executive directors (NEDs) should own shares in the companies they represent, to align interests with shareholders and promote an ownership mentality in the boardroom. One comment is made that “it is generally acceptable for NEDs to receive securities as part of their remuneration” – the unstated inference being it may be better for NEDs not to own shares. This may be beneficial in small companies where entrepreneurs may tend to push boundaries, but the reverse applies in large companies. We need NEDs to think and act more like owners.

Australia’s large companies have a chronic problem with NEDs owning too little equity in their companies. The emphasis is on independence and stewardship, not an ownership mentality. NEDs in large companies should own at least two years’ worth of their fees in shares; they’ve been successful in their business careers otherwise they wouldn’t have been appointed to the board in the first place, so they can afford it.

As Warren Buffett says, the best NEDs are the ones who don’t need the directors’ fees, so feel at liberty to speak their minds.

The ASX index has underperformed many other world markets over the past decade, directly reducing the savings of ordinary Australians. Despite our much-heralded 27 years of continuous economic growth, we’ve underperformed both the UK and Japanese markets, which is pretty remarkable given Britain’s Brexit own goal and Japan’s demographic time bomb and 20-year deflation trap.

Time to encourage greater risk

The model of stay-close-to-home, minimise risk and punch out steady franked dividends to mums and dads is not working. A greater risk appetite is needed.

It would be a stretch to argue that NEDs owning more shares will inexorably lead to better corporate performance, but it may not be entirely a coincidence that the only major resource company not to have a significant write-off at the end of the commodities boom was Fortescue, 33 per cent owned by its chairman, Andrew Forrest. At the same time it grew its market cap from $3 billion to more than $13 billion. Clearly in owner-driven companies it’s possible to grow and manage risk well at the same time, and also have a strong social conscience as Fortescue continues to prove.

If we’re going to take the shackles off our country’s NEDs and give a better deal to shareholders, many things need to change. Not just directors’ willingness to have equity skin in the game personally and the ASX’s proposed corporate governance straitjacket.

Shareholders need to cut boards more slack about long term growth bets, especially ones in the nature of venture capital plays. Wesfarmers’ execution of its Bunnings UK play was poor, but the company had earned the right to bet $700 million of risk capital originally after creating circa $20 billion of value in the Bunnings franchise over the previous 20 years.

The rent seekers seeking to profit from corporate misfortune need to be put back in their box, specifically the class action industry that now routinely brings lawsuits for unexpected earnings downgrades, a lucrative and growing form of ambulance chasing. Few realise how extreme the Australian scene is now in the world context due to the combination of our tight continuous disclosure laws and litigant-friendly class action regime. It’s become one third of all class actions in this country.

How does it encourage directors to invest and take risks, particularly in unfamiliar offshore markets, if they face the prospect of a lawsuit if things don’t go to plan?

Capital allocation processes in the boardroom need to be tightened and more attention paid to alignment of interests with shareholders’. Corporate advisors’ fees heavily weighted to the fact of a deal happening – rather than how it turns out for shareholders – should be disclosed so incentives at play in the boardroom are transparent to the shareholders taking the economic risk on the deal.

The ASX needs to get back to the basics of its role in Australia’s economy and concentrate on light touch ways it can help grow our national wealth. Some recent events notwithstanding, Australia has a long-standing reputation for good corporate governance and low sovereign risk for a reason.

The new challenge is to encourage sensible risk-taking within an ownership culture in the boardroom, not to become a corporate nanny state. In the long run, this matters a great deal more to Australia’s economic returns and international investment reputation than a few percentage points in our company tax rate.

John Wylie is principal of advisory and investment firm Tanarra Group.