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CFO Magazine 2002

CFO Magazine is Australia's leading business publication for chief financial officers and other senior executives in finance and related disciplines, including corporate governance. Ann-Maree Moodie is one of CFO's opinion columnists.

Contents

Corporate Governance Opinion Column

Cover Stories

It just doesn't add up.

In a recent conversation with a senior chairman of a major Australian organisation, the topic turned to the CLERP 9 proposal for audit committees to be mandatory for the boards of the 500 largest listed companies (by market capitalisation).

The conversation centred on the lack of independent directors with the appropriate financial qualifications to fulfil this forthcoming legislative requirement.

To overcome this predicament, the chairman said a course should be offered to teach the chairmen and the members of board audit committees appropriate financial skills.

This course, said my companion, would "tell directors how to read a balance sheet and a P&L, as well as what key financial ratios are and what they mean".

"Shouldn't your directors already know how to do that?" I asked.

"Where would they have learned it?" came the reply.

"Are you telling me that you'll accept someone on your board who can't read a balance sheet?"

"I'm telling you," the chairman replied, "that on every board on which I sit there are directors who are financially illiterate."

Members of Australian commercial boards vigorously defend the propensity to recruit former CEOs onto boards because such people "know how to run a company". By inference, they have financial acumen. But the point being made by the chairman with whom I spoke is that while some board members are apparently financially illiterate, others are only capable of understanding the financial issues of the industries in which they have worked as senior executives.

"We don't need to learn to be bookkeeper clerks," this chairman continued. "We need to be able to have financial statements speak to us; we need to know the sort of questions to ask. We need to know, for example, the six common tricks people play with debtors to make their P&L bigger or smaller. Most directors don't know this sort of thing."

The ramifications of these comments includes the fact that there are members of Australian boards - commercial and not-for-profit - who do not have the basic financial skills required of them to govern the enterprise, and therefore, they could well be in breach of their directors' duties.

That such people accept a board seat is outrageous. And that a chairman and a CEO do not ensure that a potential recruit is capable of reading financial documents is ludicrous.

How do such people survive the peer pressure that is supposedly brought to bear on directors when they are underperforming? The same peer pressure that is cited by board members as the reason why formal performance reviews are not necessary because boards self-assess?

It is no wonder, then, that board members are panicking about how they find sufficient independent directors with the financial experience and knowledge required to serve adequately on board audit committees.

Prior to the collapse of Enron, the most likely pool of potential directors for this consisted of partners of accounting firms.

But the requirement for board audit committees to be independent means that this avenue will be either closed off or, at least, curtailed.

The alternatives include people with banking backgrounds and former CFOs.

But given that the majority of people in this pool comprise white, Anglo-Celtic men aged in their 50s - exactly the demographic of boards for the past several decades - it can be argued that the ramifications of this aspect of the CLERP 9 proposals will be a blow to board diversity in Australia.

If this isn't to happen, then another option must be considered. There may not be too much wrong with hiring a talented individual who does not have financial expertise, as long as this deficiency is remedied as quickly as possible.

The new director could, for example, be required to attend a financial management course as part of a board's induction program.

It will only take one leading board to take a stand on this issue - and report the fact in the corporate governance statement - and pressure will be brought to bear by other boards, and shareholders, to follow suit.

A test case is the board of Coca-Cola Amatil. CCA's David Gonski, one of the country's most influential chairmen, has agreed to trial the recently released CCH online learning tool for company directors, called the Directors' Professional Education Package.

If Gonski thinks the CCH product is worthwhile, the chances are high that his other commercial and non-profit boards, including ANZ Bank, John Fairfax Holdings, Westfield Holdings and the Australia Council will be keen to try it, too.

As the old adage states, it's not the size of the pebble that's thrown into the pond, it's the reach of the ripples that count. So come on, David Gonki, why not include a directors' student report card in next year's CCA Annual Report?

Disclosure: Ann-Maree Moodie wrote the "corporate thriller" component of the CCH Directors' Professional Education Package

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Check your board for ticks.

Standards Australia International is in the business of setting specifications for products ranging from a baby's cot to the family car - and now it's hoping to have its "quality assured" swing tag hanging from a board near you.

A standard of "good corporate governance principles" is being drafted. Its two stated aims are:

  • To assist members of boards, chief executive officers and senior managers to develop, implement and maintain a robust governance framework that fits the particular circumstances of the organisation; and
  • To provide the mechanisms for an organisation to establish and maintain an ethical culture through a committed, self-regulatory approach.

The contents of the draft have much to be applauded. It suggests that in implementing a governance framework, boards should adopt a philosophy of continuous improvement, employ a system for recording and rectifying governance failures, and instigate ongoing training for directors.

Boards should also publicise governance procedures and practices in order to enhance the public reputation of an organisation and to engender shareholder and community confidence.

But the question should be asked as to the relevance of an organisation like Standards Australia even contemplating entering the corporate governance area. Best practice guides have been available for some time from more representative organisations such as Investment and Financial Services Association (IFSA) and the Australian Institute of Company Directors (AICD).

Board members also have the resources of well-publicised reports such as the Turnbull, Cadbury, Hampel and Greenbury reports from Britain, or the American Law Institute's principles for corporate governance best practice. US author John Carver's Boards That Make A Difference, is also popular. For local flavor, there's the Bosch report.

Will board members - and the shareholders they represent - consider it in any way valuable to be given a tick of approval by Standards Australia?

This public sector agency is not alone in wanting to get in on the corporate governance act. The headlines created by the corporate collapses here and overseas have made corporate governance a common phrase. Others see it as the new business nirvana.

Every week for the past two months, I have been approached by a variety of players who are keen to talk to me about creating new businesses in this "space".

They want to carve out niches as consultants in areas ranging from mentoring board audit committees, offering chairmen tools to better challenge the financial figures provided by management, risk management training, and new models for online learning.

These people know that a network is vital, and they regularly approach organisations with valuable databases, such as the AICD and Chartered Secretaries Australia (CSA), to short-cut their way into the market.

A joint venture can be a worthy business model, but it isn't the way of creating a successful board consultancy business.

Board members are a closed and clubby group. They are instinctively suspicious and distrustful of new people knocking at the boardroom door asking for access, and then to be paid for the privilege. A chairman must be assured that anyone who is exposed to his board is a person of integrity. Confidentiality is paramount.

Board members need to know the person by reputation, if not by previous professional associations, or by personal knowledge.

These new players may well have potential customers - and worthwhile ones at that - in the small to medium enterprise or not-for-profit sectors.

But the A-list boards will remain out of reach to any consultant without the network, reputation and track record, or a product or service a chairman considers worth buying.

The Colin Carters and the Henry Boschs of this world are hard acts to topple. This is why the consultancy business established recently by former IFSA chief executive officer, Lynn Ralph, is being watched closely.

But is there a market to chase? One player estimated to me it's worth at least $5 million. Others put the figure a lot higher, but even if $5 million is accurate, there clearly isn't enough to go around.

Once the major accounting and legal firms have taken their slice of the corporate governance pie, closely followed by executive search companies, which offer board performance review and facilitation services, there won't be much left. Market forces will sort out the winners, and Henry and Colin will see off the wannabes.

But in the spirit of creating better performance by directors, let's hope that when the dust settles, some new and useful ideas will have emerged.

Standards Australia is, after all, in the business of providing accreditation that will "reassure the manufacturer and the purchaser, reduce risk of product liability, identify product enhancements and highlight product differentiation". The synergies are obvious. Maybe a "quality approved" stamp on a board isn't such a bad idea.

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Old boys' feel the heat.

The response to the proposal made in this column last month to introduce mandated education and training for directors - and even an annual exam in corporate governance - was predictable.

It raised the hackles of some chairmen and non-executive directors, while others argued a case without letting rhetoric and emotion interfere with a good stoush.

When the spotlight of criticism is turned upon you, it is natural to be defensive. But it does nothing to advance the debate if one party or the other takes it personally.

This was the case with those who adopted the "a few bad apples doesn't mean the entire barrel is rotten" approach to whether there was a place for formalised training for board members.

"Does a CEO have to do a CEO's course before being appointed?" asked one director. It can be argued that yes, they do, and it's called an MBA.

The other half of the group understood that the issue of director education and training was simply a platform from which to advance a broader debate: whether board members should take advantage of the current focus on corporate governance to reflect on what it means to be a director.

"The lawyers and accountants will hate your column this month," was another response. "If the directors knew everything they would not spend heaps of company money with the backside coverers. Or the companies would not appoint lawyers and accountants to the board, and instead would actually recruit directors who knew something about running a business and adding value."

There is much to develop in both of these quotations, but for now let's move away from the different sides of the debate and concentrate instead on the central theme, and indeed the most interesting aspect, of the responses to last month's column.

Reading between the lines of the e-mails sent to me revealed that the overarching theme of concern was the direction the current debate on corporate governance was taking.

Board members are concerned that a "black letter" approach to corporate governance will see a return to a "tick the boxes" mentality, or as Stan Wallis once said, that there will be a revisiting of the 1980s approach of conformance over performance.

And they have a point. There are a number of influential groups, including the Federal Government and Opposition, as well as the Australian Securities and Investments Commission and the Australian Stock Exchange (ASX), which have each put forward proposals in recent weeks to redress poor practices in Australian boardrooms.

As a result, board members feel that they are being thoroughly corralled and are resentful that those who do not have board experience (and by inference, don't know what they are talking about) do not have a right to judge their performance.

The more cynical wonder if some critics are deliberately taking advantage of the current focus on corporate governance to advance their own agendas or to profit from the debate in some other way.

But grumbling behind closed doors will do nothing to change a situation in which directors feel they are losing control.

The "old boys' network", which is as much a description of board selection as it is a way of being a director, is clearly under threat, and certainly will be considered a redundant model within a decade. The question to be asked is, what will replace it? The position I took in my book, The Twenty First Century Board: Selection, Performance & Succession (AICD, 2001), was the need for diversity on Australian boards - members who represent a range of backgrounds and experience.

This is a view supported by the majority of board members - but more commonly in principle than in practice.

It's one proposal of how to move forward, but there need to be other options unless board members want to continue to react to the debate about their future rather than participate in it. Or dare it be said, to be leaders rather than followers.

Board members have a choice. If they think that provocative proposals put by others (such as the ASX's view that listed companies publicly answer media speculation which has the potential to create false markets) paint them into a corner then they should do something about it.

If not, other parties - be it government, shareholders or the public at large - will do it for them. And then they'll have no one but themselves to blame when they realise that they've fallen down the rabbit hole and into Wonderland.

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Unwillingly to school.

If you really want to "put a bit of stick about", as Francis Urquhart would say in the BBC's House of Cards series, raise the issue of mandated director education with the section of the director community most likely to resist it - the members of the boards of the top 200 Australian companies.

A non-executive director is generally appointed to a board - and accepts the position - because of his or her track record as a manager. Other factors are considered - the quality and influence of the person's network and his or her reputation as an individual.

Whether the director is male or female is also increasingly relevant in an image-conscious business world, but perhaps that is a topic for another time. Suffice to say, if you are female, with a strong operations background, have qualifications in law or finance, and have a circle of powerful male mentors, the greater your chances of a board seat invitation.

But nowhere in this list of attributes are formal qualifications. It isn't necessary to complete an introductory director's course before beginning a career as a director. Nor is there a requirement for board members to sit an annual exam that tests the basic skills and knowledge that would generally be considered necessary to be competent in the boardroom.

It's easier to become a company director in Australia than it is to be a taxi driver.

The Australian Stock Exchange listing rules can be interpreted as recommending that public companies disclose in corporate governance statements that directors annually participate in some kind of ongoing training or education. For most directors, this means reading business publications, attending industry seminars or conferences or making a site visit.

But what if it were mandatory for directors to sit an annual corporate governance exam? What would it test? Knowledge of directors' duties, and competency in financial instruments, accounting standards and corporate law would be a good place to start.

These are some of the topics covered in the company directors' course offered by the Australian Institute of Company Directors (AICD).

The course is currently oversubscribed, but not with people who sit on the top 200 Australian commercial boards. Of the 50 per cent of directors of the top 200 who are AICD members, only 16 per cent have completed the AICD course. And of these, just over a third have either sat or passed the exam.

Students are more likely to be middle to senior managers or directors of small- to medium-sized enterprises, family businesses, industry bodies and not-for-profit organisations.

So what are the members of the boards of the companies with which the majority of the shareholder community place their funds doing to maintain their currency?

Directors with industry-specific specialities apparently regularly build on this knowledge, while their colleagues in the boardroom continue to rely on their "subject matter experts". Regular readers of this column will be well-versed on the dangers of such practices.

One of the arguments raised against formal education for company directors is: who would take responsibility for running such a course or exam? To give the role to the AICD would mean a monopoly of director education. Business schools, some of which offer diploma courses in corporate governance, are more favoured because of a perceived independence.

There is also a matter of the delivery of such a course. If a public course were out of the question due to board members' vanity, some kind of in-house training would be the next option.

And then there's the rather awkward situation of what to do with those directors who fail the exam. Does this mean they are not competent to hold the position? Should they be allowed to sit the exam again? Should their failure be mentioned in the corporate governance statement?

Let's assume for a moment that such a world exists where all Australian company directors must sit and pass an annual exam in corporate governance. What then?

A formal qualification in corporate governance does not necessarily mean that the graduate will be a competent company director. Nor does it mean that the culture of individual boardrooms will allow such a group of well-educated people to use their knowledge.

The question to be asked of every company director in Australia is whether, if required to sit such an exam tomorrow, without time to prepare, they believe they'd pass.

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The dangers of consensus.

It is widely known - and indeed a matter of pride among chairmen and directors - that Australian commercial boards rarely decide issues by vote. The most commonly cited reason for this is the perception among directors that a board that votes must be dysfunctional or adversarial. Directors prefer to have a consensus view.

What happens, then, when a director finds himself or herself to be the sole dissenting voice on an issue before the board? Most chairmen try to avoid this situation because it threatens the collegiate nature of the boardroom. Collegiality is highly desired by Australian directors who wrongly equate it with an effective board.

There are several ways directors try not to rock the boat. It can be a policy of the board, for example, that directors give the chairman a "heads up" about issues of individual concern before the meeting. Other chairmen encourage the chief executive to "take the temperature" of directors before the board meeting to ensure a proposal is well explained. A director who is still dissatisfied, but is disinclined to "hold up the meeting" by digging in on an issue, may speak with the chairman or the chief executive privately afterwards.

If a board discussion has reached a stalemate, a chairman may force the issue and offer a director who has argued against a motion to have his or her name - and the nature of their opposition - formerly recorded in the minutes of the meeting. Most decline the invitation. As one director says: "If you are in the minority and six months later you're proved to be right, it's cold comfort to say 'I told you so' because at the end of the day, you were simply not compelling enough in your arguments to sway the board at the time."

If this is the way Australian boards make decisions, it begs the question as to how exposed directors are when they are required to decide on issues that are perceived to be highly risky.

There is a subset category in the academic research on group dynamics that is concerned with "group think". This is a term used to describe a mode of thinking that group members engage in when they become intent on maintaining the status quo. When this happens, the members of the group lose the ability to think critically. If a board has succumbed to group think, it is more likely to be falsely confident in its collective abilities and knowledge and therefore become more reckless when making decisions. Tolerance to risk is higher in groups than it is with individuals, because in groups responsibility is diffused. If no one person is responsible for the decision, then all will share the consequences of the outcome.

The majority model, which is used by Australian boards, is also a factor in the group being more likely to take the less conservative path. If the board operates by consensus, the group decision equals or approaches majority opinion; if consensus can't be reached, majority rule applies.

And then there's the factor of the dominant director, or the director regarded as being an expert in his or her field. These people tend to be the ones who will take the road less travelled and will probably be able to influence the other directors to come along too.

When faced with a decision that is perceived to be highly risky, Australian board members tend to do three things - they seek the counsel of any board member who is deemed to be a "subject matter expert"; they call for independent advice; and they try to defer the decision for as long as is required in order to ensure all the information is available.

In one recent case, an Australian board took six meetings to turn around a decision that at first blush all but one of the members of the board was prepared to reject. A rash of independent experts and a sole champion who was clearly compelling in his arguments won the consensus of the board - eventually. But directors won't always have the luxury of time.

Of course, risk and risk-taking are relative concepts and a group can also shift to a less risky position. This is known within the academic literature as a "cautious shift". In the extreme, a board that is exhibiting the symptoms of cautious shift can become risk-averse. The WorldCom collapse, coupled with speculation as to what will be the recommendations of the HIH Royal Commission, have some directors worrying that boards will adopt a "belts and braces" approach to corporate governance. Now is the time to resist reacting too strongly to the current environment.

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ASIC puts CFOs on the hook.

When Dominic Fodera was found to be in breach of section 180 of the Corporations Act in the Australian Securities and Investments Commission (ASIC) civil case against HIH, the decision of the NSW Supreme Court should have served as a warning to any CFO about the potential exposure of his or her position.

This section of the Corporations Act relates to the duty of directors and officers of a company - including the CFO - to exercise care and diligence.

The HIH, Ansett and One.Tel corporate collapses have focused attention on the role of company directors and the state of corporate governance in Australia. This ASIC action, however, draws company officers into the same spotlight, and should serve as a "heads up" to any CFO who does not respect or understand his or her legal and fiduciary obligations.

Chasing after company directors, especially well-known board members or those who have been especially inappropriate in their behaviour, makes for better media fodder than some backroom bean counter who doesn't have a public profile.

But it seems ASIC now wants to cast a wider net, as the regulator's deputy chairman, Jillian Segal, signaled in an address she gave recently to a Financial Executives International function.

Under the seemingly innocuous title of "the role of the CFO in corporate governance", Segal's intention was to ensure her audience understood that executive behaviour was under increasing scrutiny.

Segal said that it was easy for company officers to take comfort from the existence of governance structures but that these structures would only work if individual company officers ensure that they exert the "power of one".

CFOs, and company officers in general, would do so by ensuring accurate financial and management information is always provided to the board and auditors, and that matters of concern are raised with the board, (including independent directors), as well as with management.

This is an interesting but belated development that reflects governmental bureaucratic embarrassment, as much as public anger, over the series of major corporate collapses last year. The common cry has been: "Why weren't the right questions asked?"

Some sections of the director community, clearly reacting like a punch drunk prize fighter, have counterattacked by saying that they can only make decisions based on the quality of the information given to them by management. If this is wrong, management should be brought to account. Senior executives, meanwhile, say they can only influence the board, but not make its decisions.

ASIC's strategy is not to let either side off the hook. The law, as Segal says, means that both directors and company officers should act with care and diligence, discharge their duties in good faith and in the best interests of the company, and not improperly use their position to gain advantage.

Participating in a decision is enough to draw CFOs into murky waters. As one corporate governance lawyer says, acting on instructions to create false papers, draw cheques or take unauthorised expenses are three examples of the way in which a CFO could be acting in a way that ASIC would not take too kindly.

Transparency is the name of this game, but unfortunately, the word has become a motif for the ducking and weaving being done by directors, company officers and management in their attempt to dodge the attention being focused upon them.

An outrageous example of this could be seen in the response to a proposal, put to the Australian Institute of Company Directors national conference in May, by former NRMA chief, Eric Dodd. In Dodd's view, boards should be made to explain the trail of contacts that led to the appointment of a new director, thereby blowing open the "boys' club" that pervades board appointments in Australia.

Only the most naive of chairmen or directors would submit to a policy that requires them to admit that the latest appointment to the board was partly due to a business school alumni association. Directors tend to be more Machiavellian.

Segal argues that the role of the CFO today is more complex because it involves "corporate governance, risk management and the maintenance of effective systems of internal control" overlaid by the vagaries of operating in a globalised economy and in some cases, across multiple jurisdictions. In so saying, Segal is assuming that today's CFOs therefore are more likely than their predecessors to be breaching their duties. This is highly debatable.

The use of such rhetoric is a device to soften the message from ASIC that CFOs must be wary, and even if they are legally flexible in the way they meet accounting standard requirements, arguing this in the face of current shareholder ire can be expected to produce even more cynicism about corporate life - if that is possible.

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It's the Al and Dave Show.

There is a joke doing the rounds of the Big End of Town that the most dangerous place to be in Australian business is between Alan Fels and a television camera.

Fels has certainly used the media effectively to raise the profile of the Australian Competition & Consumer Commission, (ACCC), and it seems his corporate counterpart, David Knott of the Australian Securities and Investments Commission, (ASIC), is taking his mark.

The ASIC chairman even got a guernsey in Paul Barry's latest corporate expose, Rich Kids. Knott 'was obviously keen to get maximum publicity for the action,' writes Barry in his chapter describing ASIC's June 2001 raid on the One.Tel offices.

And a perusal of media releases on the ASIC website attests to a policy to publicise wherever possible the fact that ASIC is no gummy puppy, but rather a snarling guard dog.

There is no doubt that Knott is giving ASIC a higher media profile than did his predecessor, Alan Cameron, although his deputy, Jillian Segal, seems to have drawn the short straw for those public speaking engagements where television crews are unlikely to be in attendance.

If Knott is using Fels as his model to raise the profile of ASIC, it's clear that he is likewise skilled in feeding the media. In the case of the corporate raid on One.Tel, however, he only had to sit back and watch the show.

There is no surer headline opportunity than ASIC taking action against a high profile company director, especially when the sons of the two most powerful men in Australia are potentially caught in the net.

This is not to imply that Knott is disingenuous about taking a more aggressive role in cleaning up Australian business practices. Continuous disclosure may be his platform, but it is necessary if errant companies and their incompetent directors are to be brought into line.

In these terms, One.Tel is a gift, and is considered in board circles to be ASIC's 'one decent win so far'. But the jury is out on whether there will be any action behind Knott's rhetoric.

Some faint-hearts believe that Knott has adopted a high-risk strategy by aggressively pursuing a number of actions that may not be successful. Will Knott be as prepared to face the cameras if an ASIC investigation implodes?

There is also grumbling in board circles that the former public servant, corporate lawyer and investment banker inherited an organisation with public service habits. If this is true, would ASIC staff be as willing to work around the clock on a weekend to commence an action on Monday morning, as do their much more highly-paid counterparts in commercial law firms?

The question being asked is whether taking a leaf out of Fels' book is the right way for ASIC to proceed. It could be that the director community is simply getting used to how differently Knott approaches his task than did his predecessor. Directors argue that Alan Cameron was more consultative, warning companies that they would have a case to answer if misdemeanours were not redressed before he threw offenders to the media pack.

ASIC's enabling legislation states that its role as a regulator should be expressed as much as an educator as a policeman, and at present, directors say that Knott is wielding the baton, not the cane.

This is causing resentment among those within the scope of Knott's influence who argue that by using the media to ambush debate, he prevents other points of view to be raised, and if they are, it is well after the television crews have turned off their lights.

Knott, through a spokesperson, denies such things. The public face of the corporate regulator apparently knocks back more invitations to be interviewed than he accepts and the spokesperson was particularly sanity about the view that ASIC is using the ACCC as its media model.

'ASIC has a strong emphasis on enforcement and its enforcement activities have a strong educative role as well,' is the ASIC line. 'Part of that educative process is to show companies what happens if they don't abide by the law - and the companies have to know about it.'

And so, we return to the beginning. Unfortunately, Knott declined to be interviewed saying that he had sent his message - that ASIC has a legal responsibility to inform the wider public about the actions it takes through the publication of media statements - well enough through the ASIC spokesperson.

Only time will tell whether Knott, who is only 18-months into his five-year term, will be fronting the media to tell tales of corporate, as well as ASIC, failure.

If it is the latter, then maybe he can paraphrase Kerry Packer's second most famous quip - that you only get one One.Tel in your lifetime.

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Don't be one of the herd.

The chairman of Australia Post, Linda Nicholls, is known for asking audiences, in her regular presentations on reforming Australian corporate governance practices, why it is that boards of directors always sit in the same seat at every board meeting.

The intention of Nicholls' question is to emphasise how boards of directors behave in predictable ways. What she rarely discusses, however, is how this behaviour manifests itself in the potentially dangerous practice of group conformity, and how this impacts on directors' decision-making.

Academic research on group dynamics shows that people in groups act predictably. The members of the group are shown to interact more with those facing them than those sitting on either side. Concepts of personal space develop quickly and are fiercely defended. As a result, personal status develops as a function of the spatial positioning in groups.

When this research is applied to board members' interactions, one can predict that conformity will be a feature of Australian boards, given their homogeneity, as characterised by the similarity of age, education, sex and work experience of directors.

But it would be wrong to conclude that group conformity implies that board members necessarily yield to group pressure. It is much worse than that: in a group, members tend to agree with people whom they think are subject experts, or who are perceived to be generally competent. In the case of boards, this tendency is expressed in directors allowing themselves a false sense of security in their belief that one of their colleagues, perhaps a former partner in a law firm or an accountancy practice, is competent in all matters of law or finance.

Instead, the onus should be on every member of the board to develop relevant competence in all aspects of corporate governance rather than defer to the "pressure" of expert opinion. Intelligent enquiry requires a board culture that encourages independent opinion. But if board members bow collectively before a subject expert, it is a very short journey to deferring to authority generally. And since the chairman is the central authority figure on a board, deference to him or her is a special problem to be avoided.

Research has shown that where group members rate their nominated leader as an authority figure, they will conform more and debate less. In this way, chairmen come to be viewed as leaders and board members as followers. But this is not an attribute of a well-functioning board. In such cases, the chairman can use this authority to enhance or abuse the board process. For example, if the chairman leads a debate in which all directors feel their views have been considered, a decision will be made more quickly than if individuals act separately. Board members are likely to take riskier decisions if problems are perceived to be unimportant, and will become more cautious when the decision and its outcome are deemed to be more significant.

The more competent the group is perceived to be, the more likely it is that they will act as a single entity. In this light, the director who said that he doesn't recall taking a vote on any decision made by any of his boards in his 10-year career as a director points to a dubious but unsurprising record of boardroom behaviour If a group becomes so preoccupied with maintaining the status quo, it can easily fall victim to "group think", a term used to describe a mode of thinking that group members engage in when they become engrossed in seeking and maintaining unanimity. As a result, the ability to think critically is rendered ineffective.

US academic Irving L Janis says such groups typically:

  • Depict smug illusions of invulnerability, manifesting in a belief that the leader has a Midas touch and that the group cannot fail.
  • Develop a rationale that allows members to justify their actions and to reject or ignore contrary evidence.
  • Are stereotypical in decision-making and will apply a form of self-censorship of arguments which are critical.

In fact, group think can be so insidious that critical questioning by members of the group is discouraged, either by way of perceived collective pressure, or by using certain people to circumvent and prevent emerging criticism.

An understanding of how groups interact - and this is not to be confused with "teamwork" - should be a vital part of any chairman's set of skills, especially at a time when boards are increasingly expected to become more involved in the formulation of organisational strategy. Asking board members to move to another seat so they are sitting next to, and opposite, different colleagues will result in changes in the way the group members debate and take decisions, and will improve the overall standard of the board's performance.

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Where there's smoke ...

The collegiate nature of the board and the board's relationship with the chief executive are regarded as sacrosanct in corporate governance circles.

Board members never want to find themselves in the situation of releasing a public statement to say that it has been, in the infamous words of Lachlan Murdoch and James Packer, "profoundly misled" by its management team.

The issue of trust is, therefore, the foundation of every aspect of governing a public company. Without trust - between the board and management, and the company and its shareholders - corporate mayhem is just around the corner.

Boards are now accustomed to operating in an environment of continuous disclosure but for this to be achieved, the relationship between directors and senior executives must never be allowed to disintegrate into a Machiavellian farce.

In extreme cases, where board members selectively leak confidential information, managers quickly learn to tailor, or even deliberately withhold, the information it gives to the board, to protect the commercial and strategic interests of the company.

Managers, too, can also play a sly hand, by presenting information to the board in such a way as to encourage a decision to be made, or not made. Cynics will argue that management would do this to bolster the share price to maintain their bonuses. Regulators will cite incompetence, fraud or greed as motivations for such behaviour

Rather, the relationship between the board and management must be one of openness and trust, but there are varying degrees of both in Australian boardrooms.

There are many aspects to the issue of board transparency - auditor independence being just one - but its importance is most commonly expressed in the quality of the information given to the board by management and the ability of directors to analyse this information, ask questions and act upon it.

The main complaint of directors about the information given to the board is that there is either a lack of adequate detail and analysis - especially regarding the financials - in the board papers, or that the executive lacks decisiveness and offers the board a selection of options as to how to approach a decision. (In the latter case, management is quickly told to do its job and come back with the best alternative).

Senior executives, on the other hand, complain that the board can become too involved in the detail, which implies a lack of trust, or are simply asking questions for the sake of being overly cautious. Both parties are right to raise these concerns to establish protocols for a relationship that can operate in a state of mutual trust and respect.

Some boards achieve this because their chairmen are able to gather a team over time that evolves into a well-functioning group of directors. Other boards feel it necessary to try different ways of building relationships within its own membership, as well as with management.

The David Jones board, for example, uses a type of mentoring arrangement whereby chairman Dick Warburton links directors with specific skills to members of the senior management team to work on certain projects.

Venture capital firm, Innovation Capital, does it a different way. After the board meeting of an investee company has closed, the directors will convene what it calls an "operations meeting", when it invites senior management to join the table for forthright discussion on strategic issues. One of the benefits of this arrangement is that the board members, who are generally highly experienced business operators, can mentor the less well-trained senior executives of the new company.

Both of these examples are manifestations of what one chairman describes as "the moving dividing line", which should exist between the board and management.

A well-run board will respect the explicit division between its role and the role of management. It will recognise the times in which it will need to work closely with management because the issue at table is so complex or important, or when it is the domain of management alone.

Throughout the year, the board will play a variety of roles: observer, interventionist, mentor or team mate and, in a well operating company, the management team will respect and even encourage such a variety of relationships.

It is the role of the board to be able to smell the smoke coming under the door. But it is also the board's role to be able to tell the difference between a fire lit by management and one that it will be fighting alongside its executive team.

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It takes courage to be honest.

Chairmen and directors argue that the collegiate nature of boards renders group appraisals difficult and the assessment of individual directors' performance almost impossible.

The subtext of this spurious position is that a large proportion of the incumbent publicly-listed director community - usually men aged in their 50s to 70s - are of a generation that was not subjected to performance appraisals when they were chief executives.

These directors therefore actively resist employing standard management appraisal systems, in which performance is measured against previously established objectives, to themselves and their board.

Instead, they continue to promote a self-assessment process - in which information is collated from anonymous questionnaires - because it is less threatening to individual sensitivities and the results remain confidential to the board.

For those boards aiming to redress the inherent flaws of the self-assessment model - the lack of objectivity and the likelihood that the directors lack the skills (or the intent) to compile a questionnaire that will elicit useful information - another option deemed relatively safe is to use an external facilitator to conduct the process.

Such facilitators are often individuals who lead subsidiary practices within professional services firms, executive recruitment companies and law firms that already have established relationships with the company of the board they are assessing. This calls into question whether the assessment will be objective and independent.

To counter this potential conflict of interest, a handful of Australian chairmen employ independent board appraisal experts, such as university academics, but still prefer to choose someone of a similar ilk, at least in age and boardroom experience, if not also a man of similar background to the members of the board being assessed.

Otherwise, the person is considered to be an underling who is yet to be blooded by a board.

The more comprehensive performance appraisal model involves a 180-degree peer review or, even better, a 360-degree review allowing contributions from board members, the senior executive team, institutional shareholders and other key external stakeholders, such as suppliers and customers.

Such activities tend to engender goodwill (but sometimes scepticism and cynicism) with all the parties involved - and subsequently the media - who together then presume that the board is prepared to be accountable and responsible for its role and will act upon the results.

Unfortunately, for many boards, the appraisal process is little more than a window-dressing exercise because chairmen and directors do not know how to respond to the results, or are reluctant to implement the recommendations.

As a result, the so-called performance review is often a one-off event.

If a board was serious about the process, however, the chairman would:

  • assign the task to a board committee, such as the corporate governance committee.
  • clarify to the board that the performance appraisal process is an annual event and include it on the board's agenda as a regular item of discussion.
  • set objectives for the board - and for individual directors.
  • ensure the recommendations of the review are implemented within an agreed period of time.

The review would also probe beyond traditional subjects - adherence to corporate governance and the behaviour of directors - and instead ask more interesting questions about the role of the board and how it operates.

Few boards, for example, ask whether the agenda reflects the environment in which the company is operating, for example:

  • Does the agenda address issues concerning strategy, the impact of the growth of ethical investment or how the organisation treats its employees and its stakeholders?
  • Does the review process the specific contributions directors make to the board?
  • Does it enquire as to how the board communicates?
  • Do directors use argumentative language, in order to debate and make decisions, or do they use expressive language and, therefore, simply talk about their feelings on various issues?
  • Does the culture of the board hinder or promote its ability to fulfill duties?
  • Does the chairman abuse the power and authority of the role?

It would take a courageous board to ask itself such questions, respond honestly to the findings and recommendations and then be prepared to publish the results.

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COVER STORY: Down, Boy.

Two headline Australian companies - One.Tel and Westfield Holdings - have historically paid their CEOs well above market average, yet one is a high-profile corporate failure and the other is a stockmarket darling.

Click here for CEO Pay 1999 table
Click here for Corporate Collapses and Update CEO Pay 2001 tables

Can the level of CEO remuneration, and whether the CEO is being paid their 'worth', remain a way of predicting the future fiscal viability of a corporation?

In the wake of the $13 million payout made to former AMP boss George Trumbull following the GIO debacle, and the shareholder ire it raised, CEO remuneration has become a perennial hot button, especially during the AGM season.

But Grant Fleming, a researcher at the Australian National University in Canberra, says valuing the 'worth' of a CEO is a complex problem and that a CEO's remuneration should be founded on fair and reasonable variables rather than being calculated against what non-executive director Diane Grady calls 'a league table' of salaries paid to peers. It would be better, says Fleming, to determine CEO 'worth' by contrasting a common variable for companies - corporate governance.

A model of empirical corporate governance designed by Fleming calculates whether a CEO is being paid an 'excess' or a figure above the market rate, by comparing the company for which he or she works with other organisations using core corporate governance variables such as the tenure of the CEO, the proportion of non-executive directors on the board and whether the CEO is a member of the remuneration committee.

When Fleming ran a random sample of large Australian companies through the model, he concluded that if certain corporate governance factors were apparent, in particular whether there was a majority of non-executive directors on the board, then the level of 'excess' pay made to the CEO would be at the market rate.

Diane Grady: Non-executive directors ensure there is a sound market reason for pay levels.

Using this model, Fleming found that in 2000-2001, the companies that paid their CEOs well above average included Amcor, Coles Myer, Jupiters, PBL, Orica, One.Tel and Reece Australia, closely followed by Amrad Corporation, Brambles Industry and National Foods.

Yet three other companies that failed spectacularly during the same period, Harris Scarfe, HIH and Pasminco, paid their CEOs average market remuneration.

'Undertaking studies in empirical corporate governance is useful to understand what's going on in terms of decision-making functions in Australian firms but it doesn't give us a model to predict corporate failure,' says Fleming. 'In fact, firms on the face of it can look to be good citizens in terms of corporate governance and you can have other systems that are very poor and can lead to corporate collapse.'

How then is it possible to determine whether a company will be an HIH, a One.Tel or an Ansett, or a Qantas or a Wesfarmers?

Fleming argues that if in assessing a company the indications are that corporate governance is transparent, yet the CEO excess pay is still high, then the most likely reason for the result to be skewed is that other, company-specific factors are coming into play.

'Making an investment decision has many facets to it, and one of the facets that is important is the extent to which corporate governance factors and the corporate governance structure of the firm leads to efficient and good decision-making that maximises shareholder value,' says Fleming.

'When we look at all of the public reports about corporate governance over the past five years, what we find is that the primary objective of good corporate governance is to maximise shareholder value, [using a process of] efficient and transparent decision-making.

'So if we were to take a measure like excess pay, and look at those measures and concentrate on the firms that appear to be paying their CEOs in excess of what they're worth, then that's at least one signal that corporate governance may have to be better than it is.'

How, then, can CEO pay be best managed for the optimum interests of the organisation?

One example is Amcor, which in 2000-2001 paid its CEO $4.454 million, which on Fleming's model appears to be well above the market value - a figure greater than 4.1.

Using Fleming's assessment strategy, Amcor scores highly on most corporate governance factors: seven directors is an average size for Australian boards, according to research by Korn/Ferry, and there is a high proportion of non-executive directors. The CEO's tenure of three years - Russell Jones was appointed managing director in 1998 - is also average. The only corporate governance issue is the fact that the CEO is on the remuneration committee of the board at a time when fewer companies permit this to occur.

It is almost certain, then, that a company-specific reason is behind the CEO's pay being apparently high, and Fleming predicts that it is because Amcor, being a multinational packaging company with operations all around the world, benchmarks its CEO's remuneration against international, rather than domestic, labor markets. 'The CEO's pay would be determined by what he could otherwise get on the market [as the leader] of a multinational packaging company,' he says.

But home-grown Publishing & Broadcasting (PBL) also paid its CEO at an apparently high rate in 2000-2001, a period that covers the transition at the top from Nick Falloon to Peter Yates. While the size of the board, with 12 members, is large, the proportion of non-executive directors - 67 per cent - is healthy, and the CEO isn't on the remuneration committee.

The two most significant factors to consider, then, are that PBL is a family-owned, but international, company, and its CEO is new.

'PBL is an interesting example,' says Fleming. 'The same sorts of arguments that applied to Amcor can be made here. PBL is a company that would draw upon the international labor market for a CEO, particularly in the way in which media and newsprint is as much looking for expertise from people who might have overseas expertise as it is for people in other areas.

'But there could be another explanation that does make sense with the theory: the CEO at PBL is relatively new, and when this is the case, you usually have to encourage him or her to invest in building knowledge and an understanding of the firm. In such cases, there is often a one-year payment, or a payment for a few years, that is partly to induce the CEO to invest in knowledge about the company and to therefore be a much more valuable CEO over time.'

A good comparative example of firms in the same industry is Coles Myer and National Foods. Coles Myer pays its CEO well above the market rate for excess pay; National Foods is closer to market average. Again, Fleming looks to whether one company draws its CEOs from an international labor market.

'But if there is no good reason why the firm is paying a high level of excess pay to the CEO, then I might look in more detail at the corporate governance structures of the firm to understand how this took place, or just to satisfy myself that it's not something that is systematic in terms of a corporate governance failure in the firm,' says Fleming.

Otherwise, there could be a more aberrant reason, such as the way in which the CEO's remuneration package was designed. One.Tel is an outstanding example of this.

''In the case of One.Tel, the CEO remuneration was poorly designed because it was tied to achieving a particular outcome on the sharemarket - gaining a market capitalisation of $1 billion,' says Fleming, citing a series of US studies, which show that 'absolute benchmark' executive remuneration policies do not lead to optimum shareholder returns.

'One.Tel is also a good example of the way in which you shouldn't trust your models all the time because there's a good, company-specific reason as to why that excess pay is where it is - the design of the remuneration package. There's no other reason you'd look at - the size of the board is average, the tenure of the CEO is five years, they have a majority of NEDs (non-executive directors) on the board and the CEO doesn't have a position in the remuneration committee. And yet, in this instance, the design of the remuneration package was very poor.'

Other aberrations are often found in family-controlled companies, especially those with a dominant founder. In the case of Westfield, it is Frank Lowy, the founder and executive chairman, who has appointed two of his sons, Peter and Steven, as joint managing directors. Westfield awards the highest excess pay of any CEO considered in the ANU research.

'That's one signal that we might want to look out for,' says Fleming. 'It is a family-dominated company and I would guess that there is not the same type of rigor in analysing CEO pay as you would find in a much more market-owned company or dispersed ownership company.

'But all the other factors are solid. The directors are experienced, the CEO has been there for a long time and isn't on the remuneration committee, and the board size is nothing extravagant, but one thing that does stand out is that there's not many non-executive directors on the board.'

One of the most significant findings of the ANU research is that if there is more than 50 per cent non-executive director representation on the board, the more likely it is that the excess pay paid to the chief executive will be at market value.

'The key findings of the study are that corporate governance structures do matter when it comes to determining whether CEOs are paid in excess of what they're worth,' says Fleming. 'In short, the more non-executives you have on the board, the lower the level of excess pay that tends to get paid to CEOs in Australian firms.'

This link between good corporate governance and executive pay clearly has interest to CFOs who want to know how the pay scales are set, and how they may be influenced.

'CFOs can be reassured that executive search for good NEDs bears fruit and that their role in safeguarding shareholder value or trying to maximise shareholder value will be enhanced if the firm looks after some of the qualitative - and what are often seen as softer - governance issues associated with operating the firm,' Fleming says.

'One of the messages from this research is that having efficient, transparent governance factors, with one of those factors being the involvement of NEDs in committees and on the board, can actually add to shareholder value.'

Non-executive directors agree: 'I think NEDs can play a role in professionalising the process [of setting executive pay], by ensuring that outside advice is sought and listened to and ensuring that there is a sound market reason for any particular pay level that is set,' says Diane Grady, a non-executive director on the boards of Woolworths and Lend Lease.

Grady says Fleming's research is on the right track, as pay is probably more likely to be at market average, or at the base line, with non-executive directors looking at outside benchmarks, because executives would not necessarily do so.

The intention of the ANU research was to determine a better way to judge whether chief executives were being paid at a rate relative to their individual worth.

To do so, the research firstly acknowledged the firm-specific variables that affect the distribution of CEO pay, such as:

  • The type and size of firm - and its industry - for which the CEO works.
  • The risk environment and the competitive environment in which the firm operates.
  • The regulatory changes that the firm might be facing.
  • The internationalisation of the market in which the firm operates.

The factors specific to the individual, or 'human capital factors', for a specialised position such as the CEO were also taken into account. These include the age and experience of the CEO, particularly their experience within the industry or their experience in managing similar-sized organisations in complementary industries.

'When headline CEO pay is considered, unless we know something about firm-specific factors, and human capital factors, we are not in a good position to know whether one CEO is getting paid more or less than what they are worth compared with another CEO,' Fleming says.

In order to determine a better way of establishing CEO pay, the research introduced other criteria against which CEO compensation could be measured, which meant accepting that CEO pay (like remuneration for any other position) will be determined by labor market demand factors.

For example, the characteristics of labor supply will be different for CEOs than for other labor markets, particularly if labor supply is very tight at particular periods of time, or if labor supply refers to an international market for executives rather than being solely an internal Australian labor market.

The research then used a combination of these factors (firm-specific, individual-specific and labor-market factors) to measure CEO pay. These included the size of the firm and the tenure of the CEO.

Corporate governance factors such as the average experience of directors, the proportion of non-executive directors on the board and whether the CEO was a member of the remuneration committee were then introduced to determine whether particular corporate governance structures have an influence on the level of excess CEO pay. (The average experience of directors was determined by analysing directors' published biographical information. The researchers measured the number of years in which the director had been a member in the industry and then took an average of the number of years the person has been a member of the industry.)

A distinction was made between CEO pay and the levels of 'excess pay'. The first part of the study estimated what CEOs should get paid as if they were being paid within a relatively efficient labor market. The second part of the study considered the variations around what the CEO's pay should be and labelled this 'excess pay'. Once this was determined, the study considered whether excess pay varied according to particular corporate governance structures.

'Now, if we took a position without knowing what the distribution of the data is, and said corporate governance factors do not have an influence upon labor market outcomes, such as CEO pay levels, you would expect to see no relationship whatsoever between corporate governance factors such as the size of the board or the number of non-executive directors on the board and the variation in excess pay,' Fleming says. 'They would just be a random, or completely uncorrelated, set of data.

'But what we do find is that when we look at the variation in excess pay, there are relationships between that variation and some corporate governance factors.'

The choice of labor market, human capital and corporate governance factors were based on several criteria. 'It's a question that we answer with reference to what theoretical relationships we would expect to see. For example, one might expect to see people being rewarded more if they are operating firms that are more risky or people being rewarded more through CEO pay for operating larger firms. We might also find people being rewarded more if their human capital is of a high quality if they'd been working in the industry for longer.'

In addition, the researchers used previous theoretical and empirical research to determine the variables that should be used and concluded the size of the board, the proportion of NEDs and the CEO being on the remuneration committee were shown in the past to be important governance factors both in terms of theoretical and empirical research.

'But they are also important factors that are often looked at in some of the prescriptive reviews of corporate governance, both internationally and in Australia,' Fleming says.

'For example, the size of the board is often seen as being a determinant of CEO pay to the extent which a larger board is often much more difficult for governance to be efficient and so the CEO has more ability to get away with things compared with a smaller board that might be more efficient.

'The proportion of NEDs on the board is often seen as an important governance factor and the relationship between the number of NEDs and CEO excess pay is a negative one. We expect that better governance structures - that is, more NEDs - would lead to less excess pay being paid to the CEO.'

The key finding of the study was that the level of chief executive pay is directly proportional to the number of non-executive directors on the board. If NEDs comprise a majority of the board (50-75 per cent of directors) the lower the excess pay will be.

However, 'super majorities' of non-executive directors on the board (greater than 75 per cent of all directors) were not any more efficient at regulating or controlling the level of pay as compared with majorities.

'I think that's because there are costs to having lots of non-executive directors just as there are benefits,' Fleming says. 'One of the costs we have to bear in mind is that the more non-executive directors on the board [and by definition the fewer executive directors], the greater the loss of detailed firm-specific knowledge that comes from being an executive director or an insider in the firm.'

The study also found that the level of excess CEO pay is lower when CEOs hold shares in the company. 'This tells us that CEOs are very unlikely to pay themselves excess amounts of money if they are also shareholders. In essence, the CEO's interests are aligned when they have some of their pay in terms of shares,' says Fleming.

This is not to say, however, that paying CEOs in shares or options is necessarily the ideal remuneration structure.

'There's a large amount of research that suggests that it's very difficult to design good remuneration structures with options and, indeed, the experience in Australia, and in the United States recently, with revaluing options to realign the interests of CEOs with the firm, is a very contentious one. It's a very difficult thing to try to solve. But generally, managers as shareholders are less likely to pay themselves less money - and that's reinforcing.'

Leading non-executive director Diane Grady says the publication of market compensation rates for chief executives, and more recently the top five executives of a company, has dramatically altered the way in which a board and the executive team negotiate remuneration.

Before such 'league tables' were available, non-executive directors played a vital role in countering the arguments placed by the chief executive in negotiating his or her remuneration. Now the issue of executive pay is primarily based on the deviation from the baseline salary - the short- and long-term incentives.

'While on the one hand publication of executive compensation has resulted in better information and possibly less deviation from a base line, it has lifted the entire base line - and the reason for that is ego,' says Grady.

'There's a lot of press about CEO greed, but I don't think greed is the key issue. I think the big issue is ego; that executives can now look at published data in annual reports and say, 'Wait a minute - why is this guy getting more than me?', either within a company or across companies in similar industries. That puts pressure on the board.

'Most boards I know aim to be paying in the 75th percentile, so that means there is an automatic ratchetting-up process - and that's where the drive for significant CEO compensation has been coming from. The publication of the information has meant that executives who see compensation as a scorecard for their achievements or their perceived value are saying to boards, 'Look, if you want to keep me, you've got to deliver'.'

Boards are, therefore, under increased perceived and actual pressure to meet market rates of remuneration for CEOs and other executives. 'A board is sitting there thinking, 'This person's contract is up for renewal.

We know the competition is out there in the market looking for a chief executive and we think our guy is really good. However, we're currently paying in the bottom half of the league table. Is this a risky position to be in?''

Boards are countering this position, however, by significantly increasing the sophistication and measurability of the performance hurdles a CEO must meet in order to ensure that a higher percentage of pay is genuinely at risk than there has been in the past.

'Total shareholder return (TSR) is used in many companies for the long-term incentives, and the goals for the short-term incentives have changed from a vague set of objectives to, in most companies, over 50 per cent being clearly measurable - things like EBIT or sales or other very clear financial measures,' says Grady.

She believes that it is the non-executive directors who are primarily responsible for pushing for tougher and clearer performance hurdles to be set for CEOs and other senior executives.

Executive salary is usually fixed at a market rate, set against external benchmarks and independent advice from specialist remuneration companies. Short-term incentive plans are made annually, with the objectives negotiated between the board and the chief executive or between the chief executive and his executives each year.

'More and more boards are putting 'stretch' into those potential bonus payments,' says Grady. 'And then there's a long-term incentive plan which usually involves shares or options which have hurdles associated usually with TSR, or achieving minimum EPS growth and so on. Therefore, the board is influencing less the salary [of a CEO], which is almost always determined by market, but much more the bonus payments and the long-term incentive by the hurdles that are set.'

Directors generally assume, however, that the CEO will only achieve 75 per cent of performance measures, and therefore will only receive 75 per cent of their maximum potential bonus. 'I think most CEOs have a fair degree of confidence in their ability to achieve or they wouldn't be CEOs. Therefore, as long as they feel the hurdles are achievable, they are happy to have stretch in them.'

It is debatable whether boards have the required skills to be able to adequately set proper executive remuneration structures, but this is being achieved by boards 'learning' from other boards through the non-executive director body, which can bring to bear on the discussion its experience from serving on other boards.

'Performance-based pay systems sound easier on paper than they are to operate,' says Grady. 'Setting performance hurdles and getting that calibration right is tricky; understanding options, what types of options to set up and what strike prices [should be]. It's a little bit of a black art in some ways, in that there's many complex variables that need to be considered in setting up a compensation program that motivates executives properly, rewards them for outstanding performance and good performance but also makes sense from a shareholder's perspective.'

Although the research did not consider correlation between the cross-fertilisation of experience of non-executive directors and best practice corporate governance, there is clear anecdotal evidence to suggest that this is a factor on how CEOs are paid.

Dick Warburton, who is on the chairman of the board of two of the companies selected randomly for the survey - David Jones and Caltex - says it did not surprise him that the survey found that the two companies paid an 'average' excess pay to their CEOs in 1998-1999, and that the companies would probably record a similar result if tested today.

'What we want to do is to be in the same range as our competitors,' Warburton says. 'We're not aiming to pay more than our competitors and we're not aiming to pay less. So it wouldn't surprise me at all that we are at the average or mid-range, because that's where I would like to be.'

Warburton says his boards determine CEO pay based on data on 30-35 similar firms supplied by research firms such as Mercer Cullen Egan Dell, but that this does not necessarily satisfy his non-executive directors. 'I would venture to suggest that most non-executive directors believe that salary levels are higher than they should be for executives. Now that's for two reasons. One is when you look at the value of the company you keep thinking, 'Oh, that's a very high salary', but also, you do get a little bit of 'Boy, I wasn't paid that when I was an executive 10 years ago'. So you've got to try and filter that bit of data.

'Nevertheless, I do feel that executive pay levels have got higher than they should, but that we're very much bound by a competitive market. In other words, if we start paying less than the frame-of-reference companies that we use, we will see our turnover increase. And the trouble is, it's your best people who go, not your worst people.'

Warburton says his experience of serving on other boards, including the board of the Reserve Bank, coupled with the experiences of his colleagues, gives rigor to the debate on executive salaries. 'Non-executive directors are able to stand back at a more realistic level, and probably even resist some of the pressure for higher salaries, but ultimately recognise that [companies] have to be competitive.'

Nick Greiner, who also serves on two of the boards featured in the study (QBE Insurance Group and Stockland Trust Group), agreed that there was a danger of ratchetting up CEO pay due to competition, but that senior executive retention rates could also be maintained, as they are at QBE, due to a 'trade-off' between 'average' compensation paid to senior executives and the type of workplace environment offered by the company.

Behind The Research

Grant Fleming's research adopted a theoretical framework based on methodology developed by academic researcher Core, Holthausen and Larcker to provide a map of the way relationships exist between corporate governance practices and company performance using large samples.

The study used a sample of 150 firms selected from the top 500 publicly listed Australian companies. The companies were chosen by randomly selecting 50 companies from the top 100, 50 from the top 100-300 and 50 from the top 300-500. The list was then honed to 90 firms based on the available data.

'The relationships we found held for firms across all industry groups, across high-performing and low-performing firms, and across widely dispersed shareholding firms and family-owned firms,' Fleming says.

Fleming adds that the findings were unique in Australia because previous research has not adequately accommodated for the fact that firm-specific factors and human-capital factors can affect pay.

Key Findings

  • The level of chief executive pay is directly proportional the number of non-executive directors on the board. If NEDs comprise a majority of the board (50-75 per cent of directors), the lower the level of excess CEO pay will be.
  • The level of excess CEO pay is lower when the CEO holds shares in the company.
  • Super majorities of non-executive directors on the board (greater than 75 per cent of all directors) were not any more efficient at regulating or controlling the level of pay as compared with majorities.
  • There was no relationship between the members of the remuneration committee and the level of excess CEO pay (although theoretically, the researchers said they would expect to see a positive relationship between the CEO being on the remuneration committee and the payment of excess pay)

Excess pay for CEOs.

Excess Pay Level graph

We can determine excess pay by predicting what it should be, and comparing that with what the CEO actually got paid. If the CEO is getting paid what they are worth, the excess pay level measured here should equal 1. If they are getting paid more than labor demand and individual factors dictate, then the excess pay figure will be greater than 1. The graphic, above, illustrates that the distribution of excess pay for the random sample is relatively normal with mean equal to 1.17 and median 1.02. However, there are some CEOs are that being paid a lot more than they should.

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COVER STORY: Boardroom Revolution

Over the next five to 10 years, there will be a shake-up of Australian boardrooms as baby boomer kingmakers - former chief executive officers such as Stan Wallis, John Ralph, Charles Goode, Don Argus and John Lamble - step aside to make way for a new breed of leader: the career director.

This significant shake-up in Australian boardrooms will alter the balance in favour of chief financial officers, as boards increasingly consider CFOs as an integral part of the CEO/CFO team. Board members are keen to seek more input from the CFO, possibly elevating the CFO to the position of finance director, or considering the most outstanding CFOs as potential directors on other boards. Younger CFOs, in particular, will know more of the upcoming non-executive directors and chairmen, and this will assist with their relations with the board.

Unlike their predecessors, the new chairmen will be younger, university educated and professionally qualified, technology savvy, more worldly and will not necessarily have risen from the mailroom, although a handful, such as Lachlan Murdoch and James Packer, will have been contesting the crown since they were in nappies.
The new breed are less likely to be former CEOs, but rather will have enjoyed a diverse career, as lawyers, financiers and management consultants, and are in their mid- to late-40s.
Many have been building their board career since they were in their 30s and are now getting their run by being nominated to the board of a Top 10 or Top 20 publicly listed Australian company. Others are serving on the board of one of the major banks, the most sought-after commercial directorship in any ambitious board member's portfolio, because of its associations with power, influence and prestige.
Other pretenders to the thrones of Australian boardrooms are showing their colours by already chairing a high-profile board.
The most notable of these include 48-year-old Melburnian Margaret Jackson, the chairman of Qantas and a director of ANZ Banking Group, who began her career as a director at the age of 19, when she joined the Institute of Chartered Accountants Student Services Committee.
She is still young to be the chairman of a major Australian board, and it will be interesting to see whether Jackson rises to the heights of boardroom statesmanship as she enters her 50s now that her performance at Qantas has helped balance the criticisms levelled at her during the controversial 1990s when, as a director of BHP and Pacific Dunlop, she was associated with poor company performance and the ousting of CEOs John Prescott (BHP) and Philip Brass (Pacific Dunlop).
David Gonski, 48, leads the Sydney contingent of potential new kingmakers, his mix of commercial and arts boards including Coca-Cola Amatil, Westfield Holdings, ANZ, John Fairfax Holdings (publisher of CFO magazine) and the Australia Council. Other male chairs of stature include Australian Stock Exchange chairman Maurice Newman, AM, Gary Pemberton (former Qantas chairman and now chairman of Billabong) and Westfield's Frank Lowy. Telstra chairman, Bob Mansfield, 50, is another name in this group.
Then there is a crop of potential new leaders who are currently earning their stripes as non-executive directors on major Australian boards where they are being closely watched and judged by incumbent chairmen and their fellow directors.
In the close-knit circle of Australian boardrooms, where 70 per cent of board appointments are still made by "a tap on the shoulder", how these people perform in the next few years will make all the difference when it comes time for a chairman succession.
David Murray, who disappointed hungry board search firms when he extended his term as managing director of the Commonwealth Bank of Australia, is one of the members of this group that also features less well-known names, such as Rob Ferguson (Westfield), Diane Grady (Woolworths and Lend Lease), Meredith Hellicar (James Hardie, AurionGold), Belinda Hutchinson (QBE, Telstra) and Trevor Rowe (Queensland Investment Corporation and Telecorp Limited).
These names indicate that one of the biggest upheavals to occur in Australian boardrooms in the next few years is that the new chairman will be wearing a skirt.
Despite the fact that women make up less than 5 per cent of Australian directors (according to a report on the feminisation of Australian boards, called Talking at the Table by Jane Bridge of search firm Boardroom Partners), women lead a handful of Australia's key private and public sector boards.
Margaret Jackson is now arguably the most powerful woman in Australian business as chairman of Qantas. Another Melbourne woman, Linda Nicholls, leads the board of Australia Post. Former Cochlear CEO, Catherine Livingstone, is the new chair of the CSIRO as well as serving on the board of Telstra, and Jillian Broadbent has a seat on the Reserve Bank board.
"I think we are a group of younger people who have in the past 20 to 25 years seen a lot more than probably any generation of businesspeople before us," says David Gonski, who started his board career at Mercantile Mutual at the age of 28.
"We have more come from being consultants, reaching seniority in law or finance early, than we have from being chief executives of companies. And so, we've also arrived (in boardrooms) a bit earlier than our predecessors who have done it over a much longer period. I think in the next 20 years directors will become increasingly younger and it will be interesting to see if the younger ones of us hold on. If we do, we might be a clog to that - I hope we won't be."
The revolution is being driven by a complex combination of factors, of which one is obvious: age. Many of the incumbent kingmakers are getting close to the time when they will be required to submit to re-election every year, as is the law for any director of a public company aged over 72 years. Wallis is 63 in July, Goode and Argus both turn 64 in August, Ralph is 70.
A recent example of a baton change is John Lamble, AO, who left the chair of Perpetual last year. Lamble, 71, engenders immense respect in board circles, for his personal style as well as for the way he chaired the board of Perpetual Trustees and for his relationship with the current CEO, Graham Bradley.
"John had a finely tuned sense of what was his role as chairman and what was my role as chief executive," says Bradley. "I can only think of a couple of instances in six years where we would have even had a reason to discuss whether it was his job or my job to do something.
"John was always clear about what was my job and was very respectful of it. He made it clear that if I felt he was undermining my authority in the organisation that I was to tell him. On the other hand, I was confident to encourage John to interact with my senior executive team, one on one, and he always paid me the courtesy of telling me when he was going to do that and what came out of the discussion.
"I encourage all of the directors of the company to do that because it takes a bit of the burden off me time-wise and, second, I think boards should be very intimate with the details of the operations of the companies they direct. The only way to do that is to talk to people on the shop floor - in the call centres and in front of the screens."
Salomon Smith Barney Australia's vice- chairman, Paul Binsted, says Lamble is a powerful chairman who "because of his robust intellectual acuity and numeracy, his objective detachment and his high degree of integrity, is respected even when his fellow board members don't necessarily agree with him". The handing over of the chairmanship last year to former deputy chairman Charles Curran, AO, was so sensitive an issue that an independent facilitator was used to help the board find a replacement.
Don Argus is also considered to be an outstanding chairman. "He is right up there in the foremost ranks of Australian company directors with his superb leadership at National Australia Bank and the growth of that company and now the chairman of two Australian-founded, global companies in Brambles and BHP Billiton," says Binsted. John Uhrig is also considered to have shown great leadership on the Westpac board and for his partnerships with managing directors Bob Joss and David Morgan.
"[Chairmen like Wallis, Argus, Ralph and Lamble] are examples of all the 'gods' of Australian business and they are all people that I have no doubt that Margaret [Jackson] and myself have listened to. Some of them we have served on boards with and there are certainly parts [of their style] that we'd want to emulate," says Gonski.
Lessons learned from the old guard chairmen include how they have arranged their professional lives and how they have presided over the board, particularly how they have organised teams. "And I hope I continue to learn because there are still some fantastic older men in the position of chairman whom I watch with awe," says Gonski. "For example, I have seen one chairman, who is still very active and well-known, pick up a nuance in the board papers that indicated something was amiss and, in picking it up early, he was able to avert something that could be quite serious.
"It wasn't only great sensitivity, but I think great forward thinking, and then the way he moved around talking to people showed me another side. I would have hoped I'd picked it up, but I might have gone at it like a bull in a china shop whereas he was much more circumspect in the way he did it."
Says outgoing Wesfarmers' CFO, Erich Fraunschiel, who has experience as an executive director, a non-executive director and as a chairman: "A good chairman will take the role that is required by the circumstances. In most organisations, you will find the chairman responds to the chief executive and if the organisation works well, his role will be quite a different role to an organisation where the day-to-day management requires a lot of supervision."
But the incumbent chairmen are also the subject of criticism: "One of the most common criticisms made of the chairmen on the boards I have worked with has been that members don't feel that they have the ability to say what they think," says Deborah Smithers of KPMG's corporate governance advisery service. "This isn't something to do with age, it's to do with personality. So one of the things I think we'll see a lot more of is directors recognising that they need to have their say and to debate, and they need to be able to ask the tough questions, particularly of management."
As companies bear the increasing pressure from shareholders and the community at large to diversify the talent around the board table, it is expected that the next 10 to 20 years will see the current average age of directors drop from 55 years to below 50, and there will be greater female representation.
Increasingly, new chairmen will be sourced from outside the boardroom in order to meet the future strategic needs of the organisation. With the pool of potential CEOs considered to be getting smaller, one of the new hunting grounds for strategic thinkers is increasingly from the ranks of management consulting firms. Diane Grady (Woolworths and Lend Lease) and Patty Akopiantz (Coles Myer) are both trained by McKinsey & Company, where the current CEO, Michael Rennie, is also considered to be a name to watch in the future.
Boards sometimes signal a changing of the baton when a new director is put into the deputy chair's role, a position held by less than 20 per cent of the Top 100 Australian companies and considered mainly as a reward for good service, as a reserve bench or sometimes to boost the share price with a "name" director. A good example of this is Tommie Bergman, who was recently appointed deputy chairman of WMC and of Cochlear with expectations of his being elevated to chairman in the near future.
But there is also a view that the generational shift from a 60-something chairman to a 40-something chairman will be too great for some boards, which will opt instead for a chairman aged in his or her 50s. "If people in their late 60s are stepping down they may feel, and their boards may feel, that the trusted hands may be people in their late 50s, not those who are currently aged in their late 40s," said one director. "It's natural for leaders to leave their legacy to a safe set of hands, who are usually in their likeness."
KPMG's Deborah Smithers says she expects to see, as a result of the current corporate climate, a greater focus on what it means to be a director, particularly a non-executive, independent director.
"It may sound trite, but for a lot of years [becoming a board member] was seen as the reward at the end of a busy career, and it's no longer seen that way," says Smithers. "One of the most frequent questions I get asked by non-executive directors is 'why in the heck would I want to do this role'? It's risky, complex and we have a skewed risk-to-reward ratio in my view for non-executive directors.
"So I think with this current focus on what's happening in the boardrooms of Australia, I hope that we will see more people who are taking the job on as a career, not a retirement move. And that necessarily implies that if you are changing the focus of the type of people who come on to boards then inevitably that will change the focus of the people who chair them as well."
Trevor Rowe, the 55-year-old chairman of Salomon Smith Barney Australia's investment bank, is one of the players expected shortly to make his run on major Australian boards. He believes the role of chairman has changed significantly: "With the nature of the markets we find ourselves in, and the added regulatory responsibilities chairmen and boards have now, I think you are going to find more transparency than you saw in the past in terms of how investors obtain information so they can make judgements about the investment or otherwise.
"In the past, boards tended to be aloof, but today, driven by the rise of investor activism, boards will have to be more accessible to investors as well as other stakeholders."
If there is jostling for front-row positioning, it is being done with great subtlety, relying on personal networks to spread a reputation for intelligence, energy and hard work. But the new chairmen will still require an element of luck, and certainly timing, to get the seat at the head of the table.

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