Kenneth Hayne looks like reshaping the governance of Australia’s leading public companies judging from the line of questioning directed at Commonwealth Bank of Australia chairman Catherine Livingstone and chief executive Matt Comyn.
Based on the the lines of inquiry pursued by counsel assisting, Rowena Orr, QC, the Hayne governance era looks something like this: verbatim records of conversations held by board and sub-committee members, longer board meetings, more extensive board room information packs, intensive director induction programs, more robust challenging of management, and increased employment of lawyers and accountants as non-executive directors.
This would go hand-in-hand with the increased rules and regulations such as those already pushed through parliament covering bank remuneration. The new laws have given greater intervention powers to the Australian Securities and Investments Commission and the Australian Prudential Regulation Authority, both of which will need significantly expanded budgets.
Leading chairmen interviewed by Chanticleer question whether this sort of reform will actually improve the situation for corporate Australia’s customers, staff and shareholders. They wonder if the dead hand of bureaucracy will impede sensible strategic decision making by companies, which must, ultimately, take risks.
The financial services sector has been guilty of widespread misconduct, much of it egregious and much of it deliberately hidden from regulators. But there has been little distinction between honest mistakes, partly caused by system errors, and deliberate misconduct. It is impossible to have no mistakes whatsoever.
Review of governance
The Hayne inquiry was meant to be an examination of misconduct, but it is morphing into a review of governance, which is defined by the Governance Institute as “the system by which an organisation is controlled and operates, and the mechanisms by which it, and its people, are held to account”.
The last time a royal commission did a deep dive into the functioning of public companies was in the wake of the HIH Insurance collapse. Then prime minister John Howard set up the HIH royal commission run by Justice Neville Owen, who delivered his report in April 2003.
The HIH inquiry led to reform of APRA’s senior management, increased powers for APRA, the elevation of the importance on non-executive directors, and significant cuts to director level remuneration.
Some would argue that the end result of the HIH collapse was that corporate Australia ended up with a surge in generalists filling an explosion of positions for those in the non-executive director club and an increase in the power of CEOs.
The same observers would say the combination of increased power in the hands of CEOs answering to boards of generalists was not actually positive for accountability. Nevertheless, when high performing CEOs were teamed with hard edged chairman, shareholders did well.
The opposite can also be true as shown by the CBA. When a high performing CEO was teamed with a weak chairman in David Turner, shareholders did well but only as long as the widespread misconduct inside the organisation could be kept under the carpet through carefully orchestrated defensive strategies reliant on legalistic pedantry.
Hayne comes to the reform of corporate governance with a powerful mandate. Both the Treasurer, Josh Frydenberg, and the shadow treasurer, Chris Bowen, have said they will implement whatever he recommends.
As a former High Court judge, Hayne clearly is enamoured with the black letter law. It is not unreasonable that he should want companies to abide by laws designed to protect customers from powerful institutions that benefit from information asymmetry.
But there are dangers in pursuing a black letter law approach to changing the culture of organisations involved in misconduct. This approach necessarily demands much heavier involvement by regulators. It empowers the bureaucrats, who are under enormous pressure to show how tough they are by taking companies to court.
People forced to work within environments governed by black letter law will work to whatever rules are written. But this does little to encourage people to think for themselves about the right thing to do and how to act ethically and morally.
The strait jacket of regulation is like the coat of the same name used in the 19th century to restrain mental patients. The response to the person struggling was to tighten the strait jacket.
The Hayne governance era is likely to involve more disclosure, judging from questions about CBA’s remuneration.
In Turner’s last year as chairman of the CBA, the remuneration report took up 18 pages. Orr’s questioning showed that Hayne regarded this as inadequate because of the lack of detailed disclosure about the negative impact upon short-term incentives of non-financial risk failures.
Remuneration committee chairmen at banks should get ready for much longer meetings and lengthier disclosure of the drivers of incentives. The typical board room information pack for a director of CBA is about 1200 pages and that is before adding in the financial statements of 800 pages, according to someone familiar with them. In other words, directors are reading the equivalent of War and Peace each month ahead of their three day board meeting.
Livingstone was harangued at the Hayne inquiry for not demanding copies of three red-flagged audit reports about CBA’s response to the anti-money laundering and terrorist financing breaches. No wonder Livingstone says she wants board meetings to last longer.
An experienced chairman tells Chanticleer that board meetings that last beyond seven hours can stretch the concentration of the best director. The same chairman says any corporate governance reform that left less time for discussing strategic issues would be a mistake.
Another chairman worries that the Hayne inquiry will result in more lawyers and accountants joining boards to help cover the increased regulatory burden imposed by regulators.
Forcing board room conversations to be captured verbatim in board minutes is likely to result in less robust conversations, according to several chairmen. They believe it would suppress honest and direct interventions and work against the idea of challenging each other.
It seems certain the Hayne inquiry will change the face of governance in Australia just as the global financial crisis changed the shape of banking regulation in Britain and North America.
One shining example of what to expect can be seen at HSBC Holdings. Before the crisis it had 7000 people in compliance. Now it has 70,000. Australia’s reaction may not be this extreme but costs of compliance will soar, as will the obligations on directors to understand the businesses they oversee.
Increased board interrogation of management is not a bad thing. But it is not so smart to force all board conversations to be recorded in the minutes.
A well run board should always, in the first instance, meet without the CEO to discuss issues that need to be raised in relation to the performance of management and, in particular, the CEO. The chairman can then raise the issues with the CEO on a one-on-one basis later.
Boards are not there to rubber stamp the recommendations of management. But nor should they be there to go through lists of rules and laws designed to make regulators feel happier and give governments a sense of self satisfaction about protecting citizens from themselves.