Who Should Be A Director?

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dreamstime_s_51900283Directors are critical to organisations’ long-term success. Regulators and other stakeholders are also increasingly looking to directors to provide ethical corporate leadership as well as strategic oversight. But how do organisations – or potential directors – decide who should fill this role?

A recent report by Mr Patrick Gallagher (FCPA) and Prof. Nonna Martinov-Bennie – Who Should Be A Director? – addresses this question. The report is the first in a new series of thought-leadership papers by IGAP and CPA Australia on contemporary national and international governance issues.

The report is a primarily a guide to, and discussion of, the 3rd edition of the Australian Security Exchange’s (ASX) Corporate Governance Principles and Recommendations (ASXPR) (2014). The report covers three main areas:

  1. The main principles of ASXPR2014, with a comparison to international governance standards;
  2. The skills and characteristics directors and boards need, including character, knowledge and formal ‘independence’ requirements; and,
  3. The benefits of board diversity.

Understanding ASXPR (2014).

ASXPR 2014 applies to all listed entities in Australia. It has eight principles and 29 more specific recommendations, with additional explanation and recommendations in accompanying commentaries.

According to Gallagher and Martinov-Bennie, the most important ‘foundational rules’ about should be a director are contained in ASXPR Principle 2, which emphasises that:

a listed Entity should have a board of an appropriate size, composition, skills and commitment to enable it to discharge its duties effectively.

This principle requires that all directors bring skills, character and insight that enable the board to meet its responsibilities.

Director skills and characteristics

While any person can legally be a Director, Gallagher and Martinov-Bennie emphasise that good corporate governance requires close attention to the skills of both individual directors and the board as a whole.

ASXPR Principle 1 provides further insight into these skills. Gallagher and Martinov-Bennie highlight the value of the commentary to Principle 1, which ‘effectively states a range of expected functions that directors must fulfil’.

This commentary indicates attributes a Director must bring, which include leadership, strategic understanding and financial knowledge, and also the personal skills and character to challenge powerful individuals or interests when required.

Gallagher and Martinov-Bennie also outline important formal requirements for directors to be ‘independent’. However, they stress that – in itself – being independent is not enough to be a good director: Directors must also bring the right mix of skills, knowledge and capabilities.

Benefits of board diversity

ASXPR2014 (1.5) recommends that boards should have a diversity policy, disclose this policy and report on their performance in encouraging diversity.

Gallagher and Martinov-Bennie state that the wording of this recommendation implies that ‘gender diversity is at the heart of ambitions for new corporate governance thinking within Australia’.

While some may view diversity as an imposition, Gallagher and Martinov-Bennie highlight key benefits of greater gender diversity that have emerged from extensive research. These benefits can include:

  • Improved board performance;
  • A better mix of leadership skills; and
  • Access to a wider talent pool.

Final thoughts: Setting the tone

So ‘Who should be a Director?

ASXPR2014 sets out key principles that ASX-listed boards must understand and apply. But Gallagher and Martinov-Bennie also observe that ‘every corporation is different and faces different circumstances from time to time’.

Hence, they argue, the good director not only understands the fundamental principles of good corporate governance, but is also attentive to the ‘needs of the corporation, its shareholders and other stakeholders’.

For Gallagher and Martinov-Bennie, two key principles encapsulate the approach that directors and boards should be able to enact:

  1. The board must set the tone for the whole corporation; and
  2. The tone needs to ensure an ethical and responsible organisation.

Prospective directors need to ensure they have the skills and knowledge to meet these challenges.

Learning the Lessons: Alan Cameron on Audit Committees at the joint IGAP & CPA Australia Annual Forum.

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Camerron photoAlan Cameron AO used his address to the IGAP and CPA Australia Annual Forum in 2014 on ‘The evolving role of audit committees’ to draw lessons from the HIH and Centro cases for contemporary audit committees.

Cameron is current Chair of the ASX Corporate Governance Council and several large public companies, and also a former Deputy Chancellor of the University of Sydney.

He addressed the IGAP and CPA Australia Annual Forum in his personal capacity, drawing on his extensive experience to provide insights into what the Centro and HIH judgements reveal about good audit committee practice.

Cameron’s keynote address emphasised directors’ role in addressing governance issues early, rather than becoming ‘gatekeepers’ after the fact:

‘To me gatekeepers are auditors and regulators and other people who look at the results afterwards. I think directors are rather earlier in the line than gatekeepers’.

Looking back over the Centro and HIH cases, Cameron highlighted three key lessons for how boards and audit committees can best execute their functions.

  1. Keeping the board and audit committee separate

The HIH judgement underscored how audit committees need to meet separately from the board if the accounts are to be examined rigorously. In Cameron’s words:

‘If the whole board is involved in the work of the audit committee, the audit committee is not doing its job. Its job is to have a first detailed look and if the whole board is there all the time as a matter of routine that isn’t going to happen’.

‘To me a troubling aspect of the processes of the HIH audit committee was its practice of meeting before and effectively in the presence of the board. As a result of that practice it operated as little more than an extension of the board… I see that now all over the place’.

  1. Making time to review financial reports properly

Another impediment to rigorously examining the accounts is not allowing the audit committee and the board time to consider the financials properly. Among other issues, the HIH judgement criticised ‘the practice of the six monthly financial reports being considered by the audit committee, approved by the board and announced all on the same day’.

Not only do directors need time between meetings to adequately review the financial reports, they also need time to access the right people:

‘The audit committee should meet auditors in the absence of management before or in the course of each meeting or at least from time to time. The material should be distributed well in advance of a committee meeting’

  1. A clear audit committee charter

Cameron’s analysis of the HIH judgement also highlighted the absence of a clear role for the audit committee in that company. By contrast, a clear and detailed charter can help define and clarify the audit committee’s role:

‘The [HIH] charter is short and the terms of reference are couched in general language. They do not clearly define and establish the role and responsibilities of the committee and its relationship to the board. There is no evidence that the terms were reviewed annually to see that the committee in its role remained relevant to the needs of HIH. So I think the clear message from that is short might be dangerous. You do need to review it every year’.

Learning the Lessons

Although Cameron’s address focused on audit-committee practice, he also reminded participants of the whole board’s responsibilities under law:

‘Whilst an audit committee has an important role of monitoring oversight that is not to the exclusion of the role of a director to consider the financial accounts for him or herself’.

Cameron concluded by highlighting several practices that directors might adopt, including:

  • Insisting on reviewing paper copies of the reports;
  • Checking organisations’ systems for dealing with whistle-blowers; and
  • Paying attention to internal audit.

Ultimately though, Cameron stressed that there is no substitute for directors using their limited time to investigate the right issues:

‘We can set up all these structures, but if people don’t ask the right questions, and be appropriately sceptical, then you will still have these problems’