The Minister for Financial Services and Regulation
21 October 1998 - 26 November 2001
The Sydney Institute
Launch of corporategovernance.com
1 May 2000
Thank you Gerard, and good evening ladies and gentlemen. It is a great pleasure to be addressing the Sydney Institute on May Day about issues directly relevant to the health and vibrancy of our capitalist democracy.
Rather than follow the lead of one of your most recent speakers, the Leader of the Opposition Kim Beazley, and talk about applying old economic philosophies like government ownership of public companies, I would like to talk about the new economy and what it means for Australian corporates.
In particular, we should reflect on the importance of good corporate governance and its vital role in the new economy.
Firstly, we should give my comments some historical context because both the new economy and globalisation are giving Australian businesses opportunities that could never have been contemplated before.
For the first time in our history, we are participating in a world no longer shackled by tradition or the tyranny of distance.
Tradition and commonly accepted practices are rightly or wrongly falling victim to the new economy.
And the tyranny of distance is also for Australia thankfully, falling victim to the new economy.
Australia has a unique opportunity to seize on its strengths during this global transition.
Our national "spirit of innovation" and our capacity to challenge and beat seemingly unassailable odds is well suited to the new economy.
However, in order to harness these skills we need a strong and vibrant domestic economy.
And whilst Australia has previously enjoyed periods of bountiful growth we have, from an historical perspective, failed to fully exploit the opportunities.
Since the arrival of Europeans we have enjoyed three golden economic phases.
The 1860's gold rush and the opening of substantial new agricultural lands represented the first golden phase. This delivered phenomenal wealth and directly led to the discovery and development of inland Australia.
Towns like Kalgoorlie, Bathurst, Bendigo and Ballarat were born and our resource wealth became the envy of many nations.
By the turn of the century Australia enjoyed one of the highest standards of living in the world. Yet, almost at the same time the new economies of the Northern Hemisphere were leaving us behind.
Supported by new industrial infrastructure, particularly railways, the industrial revolution was in full swing in Europe and America. Unfortunately we did not have the global know-how to join in the revolution.
Australia's second golden economic phase came after World War 2. Even though Australia had historically recognised the importance of trade with Asia, and in particular Japan as an emerging industrial economy, it was during the post-war rebuilding of Europe and Asia that we capitalised on our pastoral and natural resources.
Colloquially known as the era when we rode on "the sheep's back", we witnessed the delivery of immense wealth to rural and regional Australia. Again, our nation enjoyed substantial success.
On the one hand technological innovation linked to the Cold War and the recapitalisation of industry in Europe meant that sooner or later we had to compete with other emerging economies of the new world.
And on the other hand, our natural resources became replaceable with more affordable products, the international market for substitutable products grew therefore reducing prices. The result: our relative fortunes declined.
By 1975 it was clear that we were again, being left behind by the emerging global revolution.
And so we enter our third golden phase.
A phase when during the 1990's Australia enjoys its longest period of high economic growth for around 30 years.
A phase when as a nation and, in an essentially bi-partisan way, we shed the burden of antiquated industrial practices, high inflation and industry protection.
These burdens have been replaced with competition, free markets and consumer sovereignty.
Ladies and gentlemen, we are living the third golden phase in our nation's development. We are enjoying the longest economic expansion in a generation including 11 consecutive quarters of growth of more than 4% annualised.
And even though we are still to change some offshore perceptions of Australia as an old world economy, the reality is different.
In 1900 agriculture represented more than a fifth of the Australian economy and today it is 3%. Services represent 80% of the Australian economy and financial services is now more than twice the size of agriculture and one of the fastest growing sectors of the new economy.
Information technology and telecommunications was a relatively small sector a few years ago. Now IT&T is about the same size as mining and resources.
This pattern of diversification towards services is an exceptional opportunity for Australia. A large part of the new global economy is about services. The Internet has the capacity to deliver to consumers and in particular businesses better information, more quickly and in a more cost-effective way.
This opportunity is not just about productivity improvements in business to consumer commerce or more significantly in business-to-business commerce. It is about our capacity to deliver services to new markets, particularly across Asia.
If software means services, then as an economy we have the capacity to gain our greatest growth out of delivering software to the world. Tourism, education, IT&T, financial services, biotechnology and environmental research are the obvious lead contenders.
However, the new economy is not just about services. It is a new way of doing business and all parts of the Australian economy are going to be touched.
That's why the laws and practices governing Australian business must adapt.
And I can report to you that from a law reform perspective we are well on the way.
Taxation reform by the Howard Government is delivering one of the most efficient and business friendly taxation systems in the world.
Industrial relations reform by the Howard Government is delivering a more competitive and productive workforce than Australia has ever had.
Education and workplace training reform by the Howard Government is delivering a better quality workforce able to meet the ever-changing business environment.
And corporations law reform by the Howard Government is modernising the business law environment.
These reforms are recognised around the world as pathbreaking.
Add this to our economy's remarkable growth and we are well prepared for the new economy.
However business must also prepare for the challenges ahead. And good corporate governance is critical.
In a world of unprecedented capital mobility it can be the difference between long-term investment, speculative investment or no investment at all.
And in the minds of global investors governance issues do have an effect on the jurisdictional commitment by global funds.
For example, a series of poor corporate decisions in one country will create a trend perception that directly affects the level of international investment in that country.
Therefore, Governments too have a keen interest in business governance.
That Australia stood out as a safe haven for investment during the recent Asian financial crises is due in no small part to the more mature governance practices of the majority of Australian companies.
Good governance can mean different things to different people, but essentially it is an extended partnership between a company's board of directors and a range of other groups -- its shareholders, its management, its employees, the regulators, the markets and the wider community.
I see effective corporate governance as developing a tension between these sometimes-competing forces. The aim is to achieve the best outcome for the corporation, which ultimately will benefit all shareholders.
It is a tension driven by open and frank communication.
Corporate governance should be part of a company's strategy. It is preferable to have a document spelling out the company's corporate governance practices.
I remind listed companies of their obligation to do this as required by the Australian Stock Exchange listing rules.
Above all, corporate governance should be more than a yearly commitment made at the Annual General Meeting.
The key to good governance is the board of directors. They are the custodians of the shareholders' interests.
Australian company boards are overall recognised as top tier when it comes to corporate governance. The quality of directors is very good and as a class of leaders they have learnt well from the past and are generally working hard to understand the challenges of the new economy.
However, with the fairly narrow skill base which I'll come to in a moment and the vast number of new boards being formed the overall quality varies significantly.
In Australia over the last 4 months, 30,000 new companies have been formed. Right now, Australia has a total of 1.12 million companies.
In many ways this growth is linked to the development of new start-ups. And not all the principles of good corporate governance are high on their agendas.
We don't know enough about these new companies to form a firm opinion because one of the key factors shaping board performance is the level of scrutiny applied to board decisions.
Needless to say the boards of many large listed companies do enjoy high levels of public scrutiny. And this is appropriate and is reflected in the quality of the board members.
It is however, the case that of the 200,000 trading companies standards vary. And in part this is linked to the perception of the skills needed to be a successful director.
More boards should ask themselves if the traditional skill set sitting around the table is appropriate for the new economy. And this applies not just to start ups but equally to old economy companies as well.
For example 15% of Australian non-executive directors have an accounting background, 18% have a banking background and 9% have a background in the law.
Engineering and agri-business also had significant representation but by far the largest qualification for appointment to Australian boards is service as a senior executive in a company.
At a time when companies are boasting of the importance of human resource skills to their bottom line and services represent 80% of the Australian economy, is it appropriate that there is so little professional human resource or employee recruitment experience on boards?
And at a time when companies are spending vast amounts on IT&T and research, isn't it surprising that there is so little board representation from these fields?
And the same argument can and should be applied to marketing and corporate affairs.
And whilst I recognise that a board of directors is not meant to be a board of experts in selected fields, there is a burden on boards to bring wide business experience to the table.
The fairly narrow professional background of boards is reflected in the demographic make-up of directors.
For example, it is no accident that the large concentration of current and retired senior executives on boards has a direct impact on the number of women on boards.
Given that only 1.3% of Australian executive directors are women, a disappointing and fairly static statistic, its no surprise that overall only 8.3% of all Australian directors are women. This trails the United States and New Zealand.
However, Australian companies should be applauded for their preparedness to seek offshore appointments to their boards. Generally, if Australian companies earn significant revenue from offshore then, from a governance perspective, they should also take a global approach to board appointments.
One of the more significant issues facing boards is succession planning.
It is too often the case that companies rely on senior executives to plan for the future rather than taking the matter up at a board level
Again, I emphasise that a number of companies do this well and even set up succession sub-committees.
But the extended absence of a senior executive whilst a board is looking for a replacement, or the no man's land period during an extended and public executive search, can be extremely damaging for a company.
Remuneration is a key part of recruitment. And as a liberal, I recognise that applying limits to remuneration flies in the face of reality and cuts to the core of the spirit of free enterprise.
This is especially the case given that we are competing in global markets and executives outside Australia are generally very well paid.
However, boards must be held accountable for executive remuneration and it should be the boards that justify to shareholders the remuneration that they agree to.
In an era of increasing public scrutiny it is not for the Government, a shareholder or even the executive themselves to justify remuneration it is for the person signing the wage cheque using shareholders' funds.
That is inevitably the board and its chairman.
And it is the modern board that is going to have to deal with the management structures of the new economy.
Traditional management structures remunerate executives on a tiered basis. That is, the higher you are the more you earn.
This is a good model for the old economy but in the new economy directors should be asking if the most innovative person in the company should be the chief executive officer.
It's a question Bill Gates has asked himself at Microsoft and it's a question that should be asked of other companies, particularly IT start-ups.
How often do we see in the new economy the brains behind a great concept get locked into the detail of listing rules, AGMs, accounting standards, day-to-day legal processes and employee relations when much of the value of the company is locked into ideas that may occupy 30% of the key person's time.
Accordingly, the next step is for a professional class of managers to emerge ready to accept that the most valuable player in the side is not necessarily the captain of the team. What's more, the captain might not necessarily be the highest paid player.
In some cases the very close relationship between a board and its senior management precludes employee remuneration processes beyond the norm.
For example, in some services companies I question why chief executives are paid so much when it may be a creative employee rather than a senior manager who is making a bigger contribution to shareholder value.
This is a challenge that can only be resolved by the boards and not delegated to senior management.
And this leads me to the remuneration of boards.
In the new economy more pressures are put on directors than ever before. Time pressures are inevitably more significant during transitional phases as directors work to understand issues that are changing the way their business operates.
It is demanding for directors to come to grips with their obligations. In this regard I commend the Australian Institute for Company Directors for its world-first initiative in linking director education with Institute membership.
It is also the case however, that some directors spread their skills too thinly across a large number of boards.
Following the OECD's Principles of Corporate Governance, it is sage advice not to sit on too many boards. It is in the interest of directors to devote sufficient time to their responsibilities in order to fulfil their duties to each company, regardless of the level of remuneration.
Of course, shareholders should expect value for their money and remuneration levels should continue to be based on performance. Perhaps non-executive director share plans have some merit.
In this respect, the new economy is posing some unprecedented challenges.
The United States magazine Fortune recently reported on dot com start-ups doling out shares to customers, friends and families and relying on small boards packed with insiders.
It was reported that new economy companies are created, hyped and sold with less concern for attracting real customers than for lining one's pockets with investors' money.
Reports such as this send off the corporate governance alarm bells.
Whilst it may only be a report it would seem to indicate that perhaps the United States companies have gone too far in remunerating 78% of their directors with shares. This compares with just 1% for Australian directors. Somewhere in between is an appropriate level
For good governance at a board level other factors also need to be considered.
Board membership tenure varies in Australia. Forty per cent of Australia's directors have served less than three years and 20% have served more than 9 years.
These figures should be broadly applauded. New skills are important but it is also perhaps even more important that experience at the table is available.
At the same time term limits should appropriately remain the discretion of the board and shareholders.
And from an overall perspective Australian boards perform well when it comes to dealing with conflicts of interest. This is however, an area that will continue to be placed under considerable pressure.
As directors of old economy companies take up appointments to new company boards they may face ethical challenges and potential conflicts of interest.
For example, it is inevitable that some new start-ups will seek to take market share off old economy companies. In particular, much of B2B commerce is built on initial relationships and introductions.
It is very attractive for start-ups to poach directors with boardroom knowledge in the hope of new expertise, introductions or confidential links that may open previously closely guarded markets.
At times like this directors do not have the same prescriptive contractual ties that a senior executive may have, yet they may have a similar level of operational knowledge.
Directors need to ensure that they remain cognisant of potential conflicts of interest. It is important that 69% of publicly listed boards and 50% of private boards have documented codes of ethics (and public sector boards have the lowest number of codes), but it is even more important for all directors to live and breathe the principles of the codes.
Moreover, it should be a key factor for individuals to consider in determining whether to accept an appointment to a start-up company.
As I mentioned earlier, there are a number of stakeholders that have a keen interest in good corporate governance.
Of all of them, none has a keener interest than the shareholder.
These investors rightly expect an appropriate level of return on their investment. They carry the risk that is most closely related to the performance of the company.
The most convincing reasoning I have seen work at an AGM is where the directors can put their hands on their hearts and explain to shareholders that they too, as shareholders, have felt the pain of poor company performance.
However, most shareholders, particularly at an institutional level, are not properly exercising their voting rights as well as they are exercising their demand for investment return.
As a matter of best practice, the OECD Principles state that "shareholders, including institutional investors, should consider the costs and benefits of exercising their voting rights."
I accept that for smaller shareholders the logistics of attending the AGM of a number of different companies can be onerous and costly. Particularly if the AGM is held intrastate, interstate or even overseas.
And I am sure that Bob Mansfield would not thank me for encouraging more than 2 million Australians to attend the next Telstra AGM.
However, the Internet does empower small investors like never before and there is an increasing onus on companies to put in place accessible forums for shareholders to express views that may be traditionally expressed at general meetings.
Company chat rooms for shareholders to interact with board members should not be ruled out.
With Australia becoming the greatest share-owning nation on the planet with over 41% of the population directly owning shares, small shareholders now have the muscle and the means of having their voices heard.
Institutional shareholders should have resources dedicated to monitoring corporate governance issues in companies in which they hold shares.
A corporate governance officer, perhaps even employed at arms length from funds managers, could be charged with monitoring governance.
This emerging practice seems to work well in the United Kingdom and it would work well here. Because, whilst company secretaries tend to monitor corporate governance practices from within a company, some Australian institutional investors have tended to forget, or more worryingly, have ignored their obligations.
This is potentially very costly.
There is also a question as to whether some fund managers may be inadvertently holding back from challenging companies on governance issues for fear of incurring the wrath of actual or potential clients.
A separate and dedicated corporate governance officer would help to respond to these questions.
Ladies and gentlemen,
Good corporate governance should be a legacy from the old economy to the new economy, a legacy that ensures that new economy companies do not repeat the mistakes of their old economy predecessors.
I am not raising these issues in order to flag any prescriptive legislative responses. I have noted that a prescriptive response was not recommended in the UK after a fairly exhaustive review of corporate governance by Sir Ronald Hampel and his committee. A similar principle approach applies here in Australia.
However, I am looking for consideration and dialogue on these key matters. If these issues can be successfully addressed and resolved then good corporate governance can and will add value to the wealth of Australia.
This is of course the key to corporategovernance.com.
As Sir Ronald Hampel reiterated, the promotion of prosperity is "the first business of the board".
Whilst Australia and Australians are enjoying the prosperity of our third golden era and its consequent delivery of the new Australian economy, we should be mindful of our obligation to ensure that the corporate legacy we are creating will maintain the values that have served us well in the past.