14 November 2011

'Lining Up Community Expectations and Corporate Practice in the Social and Governance Arena', Address to Macquarie Securities Annual ESG Conference, Sydney


Thank you for that kind welcome and thank you for the invitation to speak to you today.

I would like to congratulate Macquarie Securities for hosting this conference and exploring the rationale behind why companies choose to report on environmental, social and governance issues.

The more cynical members of the community might argue that ESG reporting is just another invention of the corporate and public relations practitioner.

However, the cynical view of ESG fails to acknowledge some of the changing perceptions of 'value' emerging throughout the investment community.

These days fewer and fewer investors are content with judging the value of the stocks they invest in solely by reference to whether the companies in which they have invested are making money.

While a company's profitability will always be a key consideration, more and more investors are demanding to know that their company's profits are being made ethically and in a way that does not impact negatively on the environment or the broader community of which we are all a part.

A company at odds with the local, regional or global community with which it interacts will always carry risk. Reputational risk and, over time, regulatory risk.

Savvy investors know that healthy profits can never be immune from the damage that could be inflicted by a tidal wave of community objection and opposition.

Against this backdrop, the growing appetite of investors to be reassured of the ethical practices of the companies they invest in means that it is in the best interests of companies to be good corporate citizens and ensure that they report and measure their performance against meaningful metrics and indicators in this regard.

ESG reporting is not only an important means of measuring performance but is also an important tool for improving long-term value. It helps to identify shareholders' priorities and can be used to attract capital.

ESG and the rise of the retail investor

Some ask why companies should seek to align themselves with community expectations. After all, under the law a board is accountable to its shareholders, not the community at large.

One of the reasons why companies should care about community expectations lies in the penetration of mainstream Australia into the equities market.

A mere three decades ago, fewer than 10 per cent of adult Australians directly owned shares.

By 2010, that proportion was up to 43 per cent.

Add to this the indirect ownership of equities through compulsory superannuation – which is proposed to increase from 9 per cent of a worker's salary to 12 per cent - and you can see the extent to which the interests of shareholders and the interests of the broader community start to significantly overlap.

An increase in share ownership means that more and more Australians are taking an ownership interest in corporate Australia.

As more and more so-called 'mum and dad' investors pay attention to financial markets, it is becoming more common for the discussions around the kitchen table to influence those around the boardroom table.

Many of today's retail investors made their first foray into equities through mass-marketed floats of former state-owned entities like the Commonwealth Bank, Qantas and Telstra.

These were national institutions that carried out duties of national significance. Shareholders in these companies were just as likely to also be regular customers and they not only expected a return on their capital but also an appreciation of the company's heritage, a commitment to Australian jobs and a focus on high standards of service delivery.


I think much of the debate that has occurred around the Qantas dispute in recent weeks can only be properly understood when viewed through the prism of the company's history.

As one of those former state-owned institutions, there is still much affection for our national airline and equally an expectation that it shares the sensibilities of the flying Australian public, many of whom are also shareholders in the company.

Indeed, Qantas prides itself on its alignment with the needs of its customers and its engagement and support of its employees. It has gone to great lengths to report on its activities in this space, even winning an award for best ESG disclosure by an Australasian company at the 2010 Australasian Investor Relations Association.

That is why the past few months of industrial tension and the dramatic decision to ground the entire airline and strand tens of thousands of passengers has come as a shock to many. This is particularly so when the grounding of the airline came just days after the company's AGM.

Events like these raise questions about whether a company has a genuine commitment to good corporate citizenship or whether its ESG reporting is simply paying lip service to the notion.

The very fact that a company chooses to report on these matters suggests that they understand the value that investors place on them and they realise that there is a competitive advantage to be obtained from making transparent disclosures around ESG.

However, just as investors would bring a company to account for any discrepancies in its reporting of financial matters, so too will investors bring a company to account for divergences between the ESG principles that are espoused and those that are put in practice.

ESG and social media

Any differences between a company's commitment to reporting against ESG principles and its corporate practices will be scrutinised.

The rise of the new media has only emphasised the importance of companies behaving responsibly to protect their good corporate reputation.

Indeed social media has changed the rules of the game. The rapid take up of social media like Facebook and Twitter have meant that 'news' both good and bad now has the capacity to travel further and faster than ever before.

For the most part, I believe that those people charged with responsibility for building and protecting the reputations of their companies understand just how challenging an environment this has created.

Take for example, the backlash faced by Gerry Harvey on Twitter at the start of this year, when consumers decided to fight back against his campaign to have the GST treatment of low value imports altered to combat the rapid increase in online retailing. Mr Harvey saw first-hand just how significantly social media has changed the rules of the game.

As he announced that he was pulling his support for the campaign in response to, what he described as, the "vicious and hateful" social media attacks he said:

"you might have got a nasty phone call or a letter back in the old days but now anything slightly controversial, these people, whoever they might be, they go for you zealously and with hatred all over Twitter".

While I make no comment on the ethics or otherwise of Mr Harvey's involvement in this campaign, I think this example shows that under the new rules of the game, bad news can travel incredibly fast.

In the face of a virulent Twitter-led attack on a company's reputation, even a well funded and experienced corporate and public relations team still has its work cut out for it.

Against this backdrop, the growing appetite of investors to be reassured of the ethical practices of the companies they invest in means that it is in the best interests of companies to be good corporate citizens and ensure that they report and measure their performance against meaningful metrics and indicators in this regard.

ESG and executive remuneration

Calls for better ESG reporting and greater accountability have been renewed in the wake of the global financial crisis.

The fallout of the GFC left many shareholders, governments, regulators and the millions of suddenly unemployed searching for answers as to how some of the world's largest and most well known corporations had been involved in practices that had taken the global economy to the precipice.

One of the questions that was asked early in the GFC was how the pay of some executives was allowed to increase while the value of their companies plummeted.

Underpinning this concern was the view that some remuneration structures actively encouraged the kind of risk-taking that had literally destroyed companies. But there was also a deep-seated fear that corporate values and behaviour had drifted away from the expectations held by the community.

While Australia did not experience the levels of corporate excess of some other major economies, there was still much concern that executive pay levels had become disconnected from the performance of companies.

As a result, in 2009, the Government asked the Productivity Commission, one of Australia's most respected economic institutions, to examine the framework governing executive pay in Australia.

Informed by hundreds of written and oral submissions, the Productivity Commission concluded that our framework was highly-ranked internationally but made recommendations for a range of sensible improvements.

The Productivity Commission's recommendations were based on the principles of better aligning executive pay with the interests of shareholders, improving the capacities of boards, and reducing conflicts of interest. These recommendations formed the basis of the Government's reforms that were passed by the Parliament in June of this year.

The new laws strike a balance between strengthening our framework and maintaining the principle that the level and composition of executive remuneration should remain a matter for boards to determine.

Our guiding belief is that executives who bring value to a company should continue to be appropriately remunerated for their work, but boards should be made to account for this remuneration to shareholders.

We want to see these new laws change the boardroom culture, encouraging directors to engage with shareholders and be more responsive to their concerns about executive pay.

A key mechanism in this accountability is the two-strikes test.

As you would be aware, under the two strikes test shareholders can vote to spill a board and force fresh elections if there have been 'no' votes of 25 per cent or more recorded against the remuneration report at two consecutive annual general meetings.

The two strikes test does not provide shareholders with the power to determine remuneration. Rather, it places a responsibility on the board to explain and justify the remuneration packages being provided to executives.

In this way, boards that provide a satisfactory explanation to shareholders about executive remuneration would not expect strikes to be triggered over two consecutive years.

As a major reform to the non-binding vote, the two strikes test attracted a great deal of attention when it was first proposed.

It has also been the subject of debate during the first AGM season in which the new laws have operated.

There have been a relatively small number of strikes recorded against companies in 2011.

For the most part, the boards that have recorded a strike have indicated their preparedness to engage with investors around the areas of concern, and I welcome them embracing the spirit of our reforms.

This shareholder engagement is consistent with the principles that drive ESG reporting.

A company's approach to executive remuneration and shareholder communication helps define the perceptions of how they operate as a company and the culture that they foster.

Communicating with shareholders on remuneration and beyond, should be seen as an important part of a board's activities because of its inherent impact on company value.

Some companies, like Transurban, that had previously recorded large no votes against their remuneration report and were widely tipped to be among the first to receive a strike actually won endorsement for their pay structures.

Transurban Chairman Lindsay Maxsted said that the board had taken the no votes seriously, "acknowledged further work was to be done, and undertook that work".

These comments were in stark contrast to the response of some others, who seem to be demonstrating a yearning for a return to the corporate dark ages.

This resistance is to be expected. The non-binding vote received similar resistance. I have no doubt that, in spite of the bluster and bravado of some of the comments being made by some directors, those companies who have received a 'first strike' on their remuneration report will be working hard to engage their shareholders over the coming 12 months to avoid a second strike and possible board spill. This will, in my view, be a good thing and a clearly intended consequence of the legislation.

The Integrated reporting agenda

The market is demonstrating that it is capable of demanding that corporate Australia be more responsive to ESG matters.

Increasingly, institutional investors are also making ESG a priority when deciding on where to invest their capital. There is a growing market for 'ethical' and 'sustainable' superannuation funds, and there is equally no shortage of advisors who are well-equipped and actively helping investors identify ESG-savvy investment targets.

Of course, helping to drive the disclosure agenda domestically and internationally is the work being done on the integrated reporting framework.

The International Integrated Reporting Committee, launched in 2010, has agreed to a program of work and is engaging G20 countries on ways to better integrate mainstream financial reporting with transparent disclosures about governance, remuneration, business models, and environmental and social issues.

In Australia, the Financial Reporting Council (FRC) is considering the issue of integrated reporting and intends to respond to the Committee's proposals.

Stakeholders have raised questions about the practicalities of integrated reporting and the effective presentation of critical information that is consistent with reporting requirements globally – particularly the existing, crucial, financial reporting requirements.

These are important developments that indicate the strong growth of ESG reporting into the future and will provide guidance for companies looking to respond to the increasing demand for transparency from the market.


Achieving a better alignment between corporate practices and the expectations of the broader community will play an important role in improving the international competitiveness and increasing the long-term value of Australian businesses and, in turn, the future prosperity of Australia more broadly.

I look forward to seeing more Australian companies move beyond the threshold of simply delivering profits and towards the objective of adding value for their investors by demonstrating their ability to operate responsibly and sustainably.

Thank you.