The Problem with Good Governance
‘Good Governance’ is a phrase you will often hear throughout your board career (once you get your head around what governance actually is – that may take a few years once you begin your board career).
Corporate governance has a couple of commonly-used definitions that have remained in use since the early 1990s and early 2000s:
‘Corporate governance is the system by which companies are directed and controlled. Boards of directors are responsible for the governance of their companies. The shareholders’ role in governance is to appoint the directors and the auditors and to satisfy themselves that an appropriate governance structure is in place. The responsibilities of the board include setting the company’s strategic aims, providing the leadership to put them into effect, supervising the management of the business and reporting to shareholders on their stewardship. The board’s actions are subject to laws, regulations and the shareholders in general meeting.’ Lord Cadbury, 1992
Corporate governance describes ‘The framework of rules, relationships, systems and processes within and by which authority is exercised and controlled within corporations. It encompasses the mechanisms by which companies, and those in control, are held to account.’ Justice Owen, 2003 (this definition is used in the ASX Corporate Governance Principles and Recommendations, fourth edition).
Good corporate governance, therefore, must mean boards’ adherence to these governance frameworks and practices. In Australia, we can tell if the boards of listed entities are adhering to the ASX’s version of corporate governance through their annual corporate governance statements. But, does adherence to particular principles and recommendations mean good governance? Does it guarantee good governance? Or do we believe that good governance guarantees good corporate outcomes?
Why do we need ‘good governance’?
According to the ASX Corporate Governance Principles and Recommendations, ‘Good corporate governance promotes investor confidence, which is crucial to the ability of entities listed on the ASX to compete for capital.’
The OECD takes a wider lens on what good corporate governance why good governance is necessary:
‘Good corporate governance helps to build an environment of trust, transparency and accountability necessary for fostering long-term investment, financial stability and business integrity, thereby supporting stronger growth and more inclusive societies.’
If good governance equals investor confidence, positive financial performance, and business continuity (vis-à-vis continued dividend distribution to shareholders), does the inverse apply? Does investor confidence, positive financial performance, and business continuity (vis-à-vis continued dividend distribution to shareholders) mean that there is good corporate governance within the board and organisation?
Evidence of ‘Good Corporate Governance’
Even when boards and organisations are ticking the boxes of good governance practices, it does not necessarily mean that the organisation is governed well. We cannot point to tangible or objective artefacts (like the current share price or the lack of organisational crises) to reassure ourselves that good governance exists.
HIH was an example of a board who approached their corporate governance model as a set-and-forget exercise. The HIH Royal Commission found that: ‘HIH had failed to review the model to assess its suitability for changing circumstances in the insurance industry.’ 1
Having a majority of independent board members2 (a common attribute of good governance practices) did not prove beneficial to Australia’s major banks, leading to a series of negative customer outcomes and spurring the Banking Misconduct Royal Commission in 2017.3 In short, it found that, despite being subject to the ASX corporate governance principles and recommendations, customer interests were subordinated to those of the employee and the corporation, leading to poor customer outcomes; remuneration and profit became the primary aims for employees and the board; compliance with the law and proper standards were not incentivised; and the balance of power between customer and the entity further contributed to poor customer outcomes.4 Consequently, penalties and fines in the billions were issued to some of the banks. Nonetheless, the share price of the major banks has remained high.
Governance as Corporate Stewardship
At the end of the day, individuals and their collective temperament and attitude towards corporate governance (AKA board culture) make up the board (surprisingly, this is often left out of considerations of corporate governance principles and recommendations). The Board Members must play a stewardship role.
Part of this stewardship role involves constantly evolving (or responding to external factors) the corporate governance practices of the board and organisation to ensure it is always fit-for-purpose. Not just reviewing what’s not working, but also looking toward the future and asking what we can do that we’re not doing and what can we do better than how we’ve been doing it, given our advanced knowledge and understanding of what’s happened and happening in the organisation, industry, and broader economy, and our best assessment of what’s coming in the future. Tempered with the understanding that ‘No system of corporate governance can prevent mistakes or shield companies and their stakeholders from the consequences of error. Corporate failures will occur.’5
The Limitations of Good Corporate Governance Practices
Good governance practices and frameworks seem to only tilt the odds in favour of continued corporate operation and likelihood of success. To go so far as to see it as guaranteeing success or immunity from crisis or failure is perhaps a bridge too far. Consider the impact that COVID had on company share prices (initially and subsequently). No matter how well (or poorly) an organisation was governed, it was impossible to avoid COVID-driven impact on share price and operations (both negatively and positively).
The problem, therefore, with Corporate Governance is what makes it good (or not) is very context specific. It is also transient; what is considered good at one point in time or in one context, is considered bad in other moments. For your corporate governance frameworks, principles, and practices lead to positive outcomes two things need to happen (regularly, not just once):
- The board must define what it is working towards; what it wants the organisation to achieve financially and beyond, and how it wants to achieve that goal.
- Then, it can determine what good corporate governance practices are necessary to support the what and the how desired corporate outcomes are achieved. This is where corporate governance practices can become “good”.
Answering these two questions requires looking backwards and looking forwards. What adjustments do we need based on the not-so-desirable outcomes that are being realised, and what do we need going forward to evolve good corporate governance beyond the basics to ensure the realisation of corporate outcomes.