Corporate Governance Disclosure in Australia: the State of Play

ELIZABETH CARSON

CORPORATE GOVERNANCE DISCLOSURE IN AUSTRALIA:

THE STATE OF PLAY

he zeal with which corporate governance has been embraced can be seen as a reac- T tion to the experience of the 1980s which

“left deep residual concerns about standards of corporate governance, the reality of legal enforcement and the integrity of company disclosure” (Hoare Panel 1994). Higher standards of corporate governance have been proposed as a means of increasing the accountability of users of funds to suppliers of funds. As a response to these concerns, in September 1994 the Australian Stock Exchange (ASX) gave advance notice of a new listing rule - 3C(3)(j) - to apply from 30 June 1996. This study looks at the level of corporate governance disclosure by publicly listed companies as at 30 June 1995 by reviewing the annual reports of all ASX-listed industrial companies with 30 June year-ends.

An Australian Society of CPAs (1995) study which examined 100 of the Top 150 companies by market capitalisation has significantly influenced the existing body of knowledge about corporate governance disclosure. Our knowledge, however, is skewed towards the behaviour of our largest listed companies, with little or no explanation of the reasons behind disclosure or non-disclosure of corporate governance issues. This study builds on the ASCPA study in two ways:

by widening the scope of companies examined so as to include companies with market capitali- sations of $1 million as well as those of $23.8 billion; and by developing a rationale as to why companies do or do not disclose corporate governance information. Potential influences on corporate governance dis-

closure may be size (larger companies may be exposed to more media attention, and Coles Myer is an example of this), auditor type (Sig Six auditors and smaller auditors may influence their clients dif- ferently) and overseas listing (companies facing multiple disclosure requirements are likely to give more

Corporate governance has been proposed as a general prescription to remedy the excesses of the 1980s.

The Australian Stock Exchange has embraced this view and has imposed a new listing rule, applying from 30 June 1996. This study examines the current level of corporate governance disclosure in light of advance warning of this listing rule in September 1994 and international best practice. Factors which influence levels of voluntary corporate governance disclosure, such as size, auditor and overseas listing, are also examined.

AUSTRALIAN ACCOUNTING REVIEW VOL. 6 No. 2 1996 3

information than is required by each jurisdiction). The term “corporate governance” is used in this

paper to describe monitoring and control mechanisms used by companies with the objective of increasing shareholder value (ASX 1994). Much emphasis is placed on the importance of an independent chairman, a majority of independent directors and the presence of an audit committee. However, the presence of these mechanisms is unlikely, in itself, to prevent misuse of shareholder funds. Of far greater importance is the so-called “tone at the top” which involves the creation of a corporate culture resistant to unethical behaviour. Unfortunately, this is a ddficult concept to capture in a wide-ranging study of this kind.

The new listing rule requires listed companies to set out in their annual reports “ . . . for reporting peri- ods ending on or after 30 June 1996, a statement of the main corporate governance practices that the company had in place during the reporting period. Where the statement identities a corporate governance practice that has been in place for only part of the reporting period, the part of the period for which it has been in place must be disclosed”.

While 3C(3)(j) applies to year-ends after 30 June 1996, an ASX discussion paper stated that compliance would be encouraged in the intervening period (ASX 1994). The ASX did not stipulate required practices, noting that “particular governance mechanisms may not be appropriate for all companies and in some cases may impose unwarranted costs on listed companies” (ASX 1994). As a result of this, the ASX has listed, as Appendix 33 of the ASX Listing Rules, matters on which companies may choose to comment. Appendix 33 is indicative of corporate governance matters that companies should comply with to satis@ the new rule, including the key issues of appointment of directors, compensation arrangements, appointment of external auditors and the strategies to monitor and manage risk. (See Appendix A)

There has been criticism from commentators of the ASX’s “softly, softly” approach (Korporaal 1995). The ASX does not appear able to impose sanctions on companies which, after July 1996, do not disclose their corporate governance practices. It would appear, therefore, to have “more bark than bite” (Cleveland 1994) and to be relying on peer pressure to ensure compliance with 3C(3) Q). The adoption of the stance taken by the ASX on corporate governance best practice would demonstrate to the market a healthy concern for these matters. The degree of compliance with these measures is also likely to influ-

4 AUSTRALIAN ACCOUNTING REVIEW

ence any future move for stronger sanctions and regulation through the Corporations Law.

The Australian Investment Managers’ Association (AIMA) published in June 1995 A Guide for Investment Managers and a Statement of Recommended Corporate Practice (Appendix B summarises the guide). The guidelines are designed to assist the 56 investment management iirms which are members of AIMA and which hold about 45% of the available capital of companies listed on the ASX (Matheson 1995). If followed by the members of AIMA, the guidelines can be expected to be extreme- ly influential on Australian corporate practice. The statement of recommended corporate practice “is designed to build on the requirements of any listing rule or other regulation which may be introduced. It is therefore recognised that this standard may go fur- ther than any listing rule or regulation” (AIMA 1995). The AIMA statement, like the ASX listing rule, is not so much interested in prescribing a set of rules as in encouraging the board of each listed company to “consciously address the governance issue and that the annual report explains the company’s approach to governance that the investment community is in a position to understand (AIMA 1995).

Clearly the fund managers who form AIMA are in a good position to influence the boards of companies, given their voting strength and influence. This was demonstrated in the Coles Myer situation, where a coalition of fund managers ousted the executive chairman from his position and organised for the appointment of a majority of independent directors. This type of action by fund managers is a recent p h e nomenon in Australia, although it has been a power- ful force in the governance of companies in the United States and, to a lesser extent, the UK. It has been said that Australia is now seeing the emergence of “superannuation fund capitalism” (Lampe 1995) in which investment decisions are dominated by the concerns of trustees with fiduciary duties on one hand and the myopia of investment managers on the other. As noted by Henry Bosch, former head of the National Companies and Securities Commission, “we are now seeing the emergence of institutional share holders as a force in corporate governance as they begin to act l i e owners rather than speculators” (Cummins 1996).

Higher standards of corporate governance have been seen as a solution to the “gap of trust” (MacDonald 1995a) born of the business misde meanours of the 1980s. An alternative view of the increased interest in corporate governance issues is as a response to increased competitive pressure. Ira Millstein, a New York corporate lawyer, attributes the growing interest in corporate governance issues partially to “prodding from institutional shareholders - primarily large pension funds - and evolving judicial interpretations of directors’ duties, it has largely resulted from economic forces; the need to reinvent

the corporate enterprise so as efficiently to meet newly emerging global competition” (Callick, 1995). It is important for the Australian business community to note what is occurring overseas as “we are also seeing a convergence of national corporate governance practices as a result of financial markets and investment practices becoming more international” (Callick 1995). Clearly, “corporate governance standards which are familiar and acceptable to international investors can only make our market more attractive to them and enhance the potential equity raising capacity of Australian enterprises” (MacDonald 1995b).

Corporate governance is an issue in many jurisdic- tions. The London Stock Exchange requires companies, as a condition of listing, to state in their annual reports whether they comply with the Cadbury Code and, if not, reasons for non-compliance. The Cadbury Code (released in December 1992) sets out the basis for best corporate governance practice. Similar requirements are present for both the Johannesburg and Toronto stock exchanges. In the US, listing rules require the appointment of an audit committee but there is no formal requirement to report on corporate governance practices. The quasi-legislative approaches to corporate governance generally undertaken in the western world are in direct contrast to the approaches under taken in Japan, Germany and France (International Capital Markets Group 1995). The approach taken by the ASX is similar to that of the United Kingdom.

ANALYSIS OF DISCLOSURES IN ANNUAL REPORTS

This study determined that 594 industrial companies with 30 June 1995 year-ends were listed on the ASX. Annual reports of 68 of the companies were unavail- able and 32 property trusts were excluded as they are subject to different reporting requirements; most property trusts did not disclose any of the information required by the ASX listing rule or by AIMA. This left 494 companies whose annual reports were reviewed page by page to determine compliance with the listing rule requirements.

1. Executive/non-executive directors This disclosure item appears to be fundamental to the various international corporate governance codes. Clearly, it is important for shareholders to know whether the directors in general and the chairman in particular are independent of the company. The companies in this sample did not perform well in this aspect. Forty-one per cent (204 companies) did not disclose explicitly whether directors were executive or non-executive. Some gave no information about the directors, or information that was too vague to be useful. This result compares poorly with the ASCPA finding that 31% of Top 150 companies did not explicitly disclose executive or non-executive composition.

Interestingly, 49% (244 companies) disclosed that they had independent chairmen whereas 77% of the large companies examined by the ASCPA had independent chairmen. Forty-four per cent (218) of companies had a majority of independent directors (as per the AIMA definition’) whereas the ASCPA study found that 76% of companies were in this category. This difference is likely to be a result of a more strin- gent definition of independent directors.

2. Board membership. The Cadbury Report does not require the establishment of nomination committees but regards them as “good practice”. International recommendations range from the nomination committee having at least a majority of non-executive directors (Cadbury, CISCO, ATMA) to being composed solely of non- executive directors eoronto). Ten per cent (50 companies) disclosed information in accordance with this rule. All of the companies which disclosed this information had a nomination committee which was either a sub-committee of the board (generally comprising a majority of non-executive directors) or the entire board. This is consistent with the ASCPA findings of 14% of larger companies disclosing in accordance with this rule.

3. Non-executive directors The Cadbury Code suggests that non-executive directors should be appointed for a set period and that reappointment should not be automatic. CISCO recommends that the period of appointment for non- executive directors in smaller companies should be longer than in larger companies, given the time and effort required to locate a replacement and the loss of accumulated knowledge. CISCO also recommends that resigning non-executive directors should be given the opportunity to communicate to shareholders, at company expense, the reasons for their resig- nation. Seventeen per cent (85 companies) disclosed information in accordance with this rule, consistent with the 19% found by the ASCPA However, the information disclosed was limited in nature in that it rarely went beyond stating the number of years for which a non-executive director could be appointed and provisions for the non-executive director on retirement.

4. Independent advice provisions The Cadbury Code, Toronto Report, Hong Kong Code and AIMA Guidelines are in agreement that non-executive directors should be entitled to seek professional advice at the expense of the company in order to perform their duties adequately. Eighteen per cent (92 companies) disclosed information in accordance with this rule, consistent with the 19% found in the ASCPA survey. Generally this consisted of the ability to seek professional advice with the per- mission of the chairman “which will not be unreason- ably withheld”.

AUSTRALIAN ACCOUNTING REVIEW 5

5. Compensation arrangements for management and non-executive directors International best practice concerning remuneration appears to combine a remuneration committee, made up mainly of non-executive directors, with disclosure of remuneration levels, including the components of remuneration (shares, options, etc). The Bosch Working Committee also recommends that the remuneration committee should review related-party transactions. Remuneration committees were the next most popular committee after audit committees, ranking before nomination committees. Eight per cent (41 companies) partially complied with this pro- vision, some addressing only the remuneration of non-executives or of management, but not both. Twenty-two per cent fully complied with this rule, addressing both aspects of the question, consistent with the 25% disclosure level found by the ASCPA. Some service contracts with management were disclosed; however, whether all existing service contracts were disclosed is not known. This was often in the Contingent Liabilities note to the accounts. Very few companies noted the operating mechanism for directors’ option and share plans, other than the number held and occasionally an expiry date or exercise price. The remuneration of directors and top management is generally disclosed as per AASB 1028 by way of note.

6. Auditors and audit committees Eighty-three per cent (409 companies) partially complied with this rule by simply disclosing the existence or non-existence of an audit committee. However, this is already required under Listing Rule 3C(3) (i). An additional 14% fully complied with this rule, over and above the requirement in 3C(3) (i), compared with 28% in the ASCPA study. Clearly the existing rule has had a large impact on compliance with the new rule. Surprisingly, 3% (16 companies) appear not to comply with the existing listing rule. The findings of this study are somewhat different from those of ASCPA, which found that 90% (of our 150’Iargest companies) had an audit committee whereas 65% (320) in this study had an audit committee. It was interesting to note that five companies who explicitly supported corporate practices and conduct did not have an audit committee.

7. Risks and risk management The Cadbury, Toronto and AIMA guidelines all per- ceive one of the key roles of the board as identifying and managing risk. However, no prescription is proposed other than an effective system of internal con- trols. Twelve per cent (61 companies) noted that they had complied with this rule, compared with the 27% found in the ASCPA survey. Compliance appears to be associated with size (ie, larger firms) and industry (ie, financial sector).


8. Ethical standards Nine per cent (46 companies) stated that they had complied with certain ethical standards. One company mentioned compliance with the Australian Institute of Directors’ code of conduct. One company (also listed in the UK) mentioned compliance with the Cadbury Code. One company explicitly supported the principles laid down in Michael Lavarch’s Corporate Practices paper. Si percent (30 companies) supported Bosch’s Corporate Practices and Conduct paper. This is significantly lower than the ASCPA findings of 21% of companies explicitly having a corporate code of conduct.

OTHER ITEMS OF INTEREST Twenty companies mentioned restricted trading in the firm’s shares by directors and management. This was often in the form of restricted trading before and after an announcement by the company, restrictions on short-term trading and advance notice to the board before selling shares in the company.

Twelve companies (2%) fully complied with all aspects of the ASX listing rule. Only 11% complied with more than half of the rule fie, four items or more). It was surprising that 33% (161 companies) did not comply with any aspect of the new rules, other than that required by 3C (3) (i) . This is significantly different from the ASCPA findings that 8% made no disclosure of corporate governance practices.

Only one company fully complied with the AIMA requirements. It is interesting that this company is one of our largest publicly listed companies and has been the target of litigation and a significant fall in share price. Sixteen per cent (80 companies) complied with more than half of AIMA’s requirements. A similar figure of 15% (75 companies) did not comply at all other than for the already mandated compensation requirements. The median of the sample was three disclosure items.

DATA ANALYSIS To develop a rationale as to why firms did or did not disclose in accordance with the new listing rule, the study tested the effect of some selected independent variables on the disclosure score obtained in the review of annual reports. Size, overseas listing and auditor type have been commonly suggested as determinants of disclosure in the voluntary discle sure literature.

The data were tested by regression analysis.The ordinary least square (OLS) regression model was fitted to the data in order to assess the effect of each variable on voluntary disclosure levels. Regression analysis allows the researcher to determine the impact of the additional effect of any one item on the dependent variable while controlling for the other independent variables.

Variables Auditor Size Overseas listing

Auditor 1.00 Size 0.262*** 1.000 Overseas listing 0.186*** 0.393*** 1.000

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Table 2 presents a summary of the results. This analysis was performed on 447 companies for which complete data could be obtained. The multiple regression model is highly significant (p < 0.001). The adjusted coefficient of determination (r9 indi- cates that 17.5% of the variation in the dependent variable is explained by variations in the independent variable$. The coefficients for size and overseas listing were significant; however, auditor type was not significant. It appears that firms which also have an overseas listing are more likely to voluntarily disclose information than those listed only on the ASX. However, the key finding of this research is that disclosure appears to be largely size-driven. The absence of a significant result for auditor type is also interesting. This finding may indicate that smaller auditing firms (particularly in the second tier) do not differentially prepare financial statements and that the source of difference between Big Six and non-Big Six firms may be located elsewhere. Chi-squared tests of proportions were carried out. Sue and overseas listing were found to be significant at the 1% level while auditor was not found to be significant.

CONCLUSION In light of the work above, it appears that Australian listed companies in general fall signscantly short of international best practice. Considering that this is now required Australian practice, companies need to do a considerable amount of work to comply with the new rule, especially smaller listed companies. This is a disappointing result, given the public expectation that companies will have adequate corporate governance mechanisms. It is possible that directors and management were largely unaware of the imminence of the new listing rule and of the AIMA requirements, despite the publicity generated by both the ASX and AIMA. No doubt, both management and directors have relied on their auditors to bring the issue to their attention as part of their role in the audit of financial statements. Auditors appear to have failed to fulfil the role that their clients (and the public at large) expect of them.

Elizabeth Carson is a senior accountant with Price Waterhouse and is in the School of Accounting, University of New South Wales

AUSTRALIAN ACCOUNTING REVIEW 7 ** Sigdicant at 0.05 *** Significant at 0.001

I Auditor I + I 0.017635 I 0.394 I 0.6935 I Sue + 0.358907 7.511*** 0.0000

Overseas listing + 0.117773 2.509** 0.0125

Adjusted r2 = 17.48%, F = 32.557, p < 0.001

AUSTRALIAN ACCOUNTING REVIEW 7 ** Sigdicant at 0.05 *** Significant at 0.001

NOTES 1 “An independent director is a director who is not a member of management (a non-executive director) and who:

is not a substantial shareholder of the company or an officer of or otherwise associated directly or indirectly with a substantial shareholder of the company; has not been employed within the last three years in any executive capacity by the company or any other group member; is not retained as a professional adviser to the company or any other group member or a principal of a firm or company so retained; is not a significant supplier or customer of the company or any other group member or an officer of or otherwise associated directly or indirectly with a significant supplier or customer; has no significant contractual relationship with the company or any other group member other than as a director of the company; and is otherwise free from any interest and any business or other relationship which could, or could reasonably be perceived to, materially interfere with the director’s ability to act with a view to the best interests of the company.”

- AIMA definition, 1995. In order to determine the independence (or otherwise) of non-executive directors, related parties notes, remuneration disclosures, loans disclosures, economic dependence disclosures, shareholder list- ings and directors’ experience were reviewed. 2 A logistic regression was also performed, using disclosure as a (0,l) variable (as opposed to a contin- uous variable). The results were consistent with those reported for the linear regression.

REFERENCES Australian Investment Managers’ Association, 1995, Corporate Governance: A Guide for Investment Managers and A Statement of Recommended Corporate Practice, Australian Investment Managers’ Association.

Australian Society of CPAs, 1995, Corporate Governance Disclosure - How do Australia’s Top Companies Rate?, Australian Society of CPAs.

ASX Discussion Paper, 1994, Disclosure of Corporate Governance Practices By Listed Companies, Australian Stock Exchange Limited.

Bosch, H., 1995, Corporate Practices and Conduct, 3rd edition, Pitman Publishing.

Cadbury Report, 1992, The Financial Aspects of Corporate Governance, report by the Committee on the


Financial Aspects of Corporate Governance, London Stock Exchange.

Callick, R., 1995, “Australia: Directors Can’t Hide from ‘Investor Consumerism”’, Australian Financial Review, 9 June (Ira Millstein quoted).

CISCO, The Financial Aspects of Corporate Governance: Guidance for Smaller Companies, report by the City Group for Smaller Companies.

Cleveland, D., 1994, “ASX Treads Lightly on Corporate Governance Code of Practice”, Australian Financial Review, 2 June.

Cummins, C., 1996, “AICD Hopes Shareholders Will Run Firms by the Book, Sydney Morning Herald, 9 February, p. 33.

Hoare Panel, 1994, Report to the Attorney-General, April.

Hong Kong Code, 1995, “Code of Best Practice”, included in the Guide for Directors of Listed Com#anies, Stock Exchange of Hong Kong Li i ted.

International Capital Markets Group, 1995, International Corporate Governance: who Holds the Reins?, ICMG, London.

Korporaal, G., 1995, “Softly, Softly is the ASX’s Way”, Sydney Morning Herald, 18 September, p. 23.

Lampe, A, 1995, “Australia: Super Funds to Get Tougher”, Sydney Morning Herald, 2 November.

Matheson, I., 1995, “Agenda for Good Governance”, Australian Financial Review, 27 July, p. 15.

MacDonald, J., 1995a, “Australia: Public Proxy Fights Not the Way to Go”, Sydney Morning Herald, 9 June.

MacDonald, J., 1995b, “Australia: US Funds Put New Pressure on Boards”, Sydney Morning Herald, 30 June.

Toronto Report, 1994, Where were the Directors? Guidelines for Improved Corporate Governance in Canada, Report of The Toronto Stock Exchange Committee on Corporate Governance in Canada.

APPENDIX A Appendix 33, ASX Listing Rules Below is an indicative list of corporate governance matters. A company may take them into account when making the statement in its annual report under Listing Rule 3C (3) 6). 1. Executive/non-executive directors Whether individual directors, including the chairman, are executive or non-executive directors. 2. Board membership The main procedures the company has in place for:

devising the criteria for board membership; reviewing the membership of the board; and

nominating directors. If any of these procedures involve a nomination

committee, a summary of the main responsibilities of the committee, and the names of committee members. If one or more members are not directors of the company, their positions in the company. 3. Non-executive directors The company’s policies on the terms and conditions relating to the appointment and retirement of non- executive directors. 4. Independent advice provisions The main procedure(s), if any, by which directors in the furtherance of their duties can seek independent professional advice at the company’s expense. 5. Compensation arrangements for management and non-executive directors The main procedures for establishing and reviewing the compensation arrangements for:

the chief executive officer and other senior executives; and non-executive members of the board. If these procedures involve a remuneration

committee, a summary of the main responsibilities and core rights of the committee, and the names of committee members. If one or more members are not directors of the company, their positions in the company. 6. Auditors and audit committees The main procedures that the company has in place for:

the nomination of external auditors, and reviewing the adequacy of existing external audit arrangements, with particular emphasis on the scope and quality of the audit. If any of these procedures involves an audit com-

mittee, a summary of the main responsibilities and core rights of the committee, and the names of committee members. If one or more members are not directors of the company, their positions in the company. (Refer also to Listing Rule 3C (3) (i) .) 7. Risks and risk management The board’s approach to identifying areas of significant business risk and putting arrangements in place to manage those risks. 8. Ethical standards The company’s policy on the establishment and main- tenance of appropriate ethical standards.

APPENDIX B Australian Investment Managers Association - Recommended Corporate Practice 1. It is recommended that every listed company should prominently and clearly disclose in a separate section of its annual report its approach to corporate governance, including the standards with which it complies. 2. It is recommended that the board of directors of

every listed company should be constituted with a majority of individuals who qualii as independent directors as defined in these guidelines. The board should annually review its required mix of skills, experience and other qualities. 3. It is recommended that the chairperson should be an independent director, or if the chairperson is not an independent director, that the independent directors should appoint one of their number to be lead director and to monitor and report to them on issues falling within the normal purview of a non-executive chairperson. 4. It is recommended that committees of the board of directors should:

a. Generally be constituted with a majority who are non-executive directors; b. Be entitled to obtain independent professional or other advice at the cost of the company, and; c. Be entitled to obtain such resources and information from the company, including direct access to employees of advisers to the company, as they may require.

5. It is recommended that the board should appoint an audit committee, a nomination committee and a remuneration committee as defined in these guidelines. 6. It is recommended that the terms of a non-executive director’s appointment should be contained in a letter of appointment exchanged between the director/proposed director and the company and dealing with the matters outlined in these guidelines. 7. It is recommended that the non-executive directors should meet on their own at least once annually to review the performance of the board, the company and the management and to discuss any other items raised by any of them. Other directors and/or management may be invited to attend part of the meeting but the business of the meeting should be decided in the absence of such persons. 8. It is recommended that the board should establish a policy to encourage non-executive directors to own shares in the company. 9. It is recommended that the board should at least annually review the allocation of work of the company between the board and management. 10. It is recommended that the board should annually review, and disclose in the annual report, its policies for remuneration, including incentives, of the board and senior executives. The justification for these policies and their relationship to the performance of the company should be similarly reviewed and disclosed. 11. It is recommended that the quantum and components of the remuneration of each director and each of the five highest-paid executives should clearly be disclosed in one section of the annual report. This should include the existence and length of any service contracts for the CEO. 12. It is recommended that separate issues should

AUSTRALIAN ACCOUNTING REVIEW 9

not be combined and presented for a single vote by shareholders. 13. It is recommended that major corporate changes which in substance or effect may erode share owner- ship rights should be submitted to a vote of shareholders. Ample time and clear and sufficient information should be given to shareholders to enable them to review and make informed judgments on these resolutions. 14. It is recommended that every listed company should have a company code of ethics that is adopted by the board and all employees and is available to shareholders on request.


Documents

Corporate Governance Disclosure in Australia: the State of Play