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.

Economic Inequality: Where are the accountants?

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dreamstime_s_53174060Dr Dale Tweedie and Dr James Hazelton

Rising inequality in income and wealth is one of the biggest contemporary social and economic concerns, but accountants have been surprisingly quiet on this issue.

Concerns over economic inequality

The growth of economic inequality is increasingly a topic of public debate in countries like the United Kingdom, the United States and Australia.

Numerous influential – and typically conservative – economic institutions have now identified growing income inequality as a critical economic and social issue. The World Economic Forum listed deepening income inequality as number one on its top ten trends of 2015, and describes growing inequality as a threat to global economic growth, social cohesion and sustainability. The International Monetary Fund has reported that inequality in developed nations is at its highest level in decades, with ‘significant implications for growth and macroeconomic stability.’ There is also growing evidence of serious and widespread social harms from economic inequality, with economic inequality being linked to social ills ranging from poor physical and mental health to drug addiction to rates of violent crime.

Public debates over inequality have created an all too-rare cross-over between academic research and public concerns. French economist Thomas Piketty’s 685 page treatise on economic inequality was a surprise hit of 2014, reaching the top of the New York Times’ best-seller list. While Piketty’s analysis of the causes of economic inequality is hotly disputed, there is little challenge to his finding that income inequality has sharply risen in most developed nations since the 1970s. For example, in the United States, Piketty reports that the top decile’s share of national income grew from just under 35% in 1970 to almost half by 2010.

A role for accountants?

Despite growing evidence of the economic and social costs of inequality, accountants have had little involvement in either public or academic debates. However, as we observe in a recent article (50 free e-copies here), there are key contributions that accountants could make to public discussions

First, as Piketty and others have argued, both public deliberation and informed public policy about economic inequality requires greater global transparency about who owns economic wealth and receives economic income. Whatever else it may be, accounting is a vehicle – albeit imperfect – for understanding and promoting transparency. Accountants might therefore add their voice to calls to improve public access to economic information, such as in the recent debate over whether taxes paid by resource companies to governments should be disclosed.

Second, key debates about the equity of income distribution, such as ongoing critiques of the pay of executives (especially CEOs), are closely connected to corporate governance. While economists have proposed macro level policies like a progressive tax on capital (Piketty) and a minimum basic income, seriously addressing inequality will invariably need to address how resources are managed and distributed within corporations. Accountants have the expertise to evaluate existing corporate accountability mechanisms and propose workable alternatives. These proposals could complement the broader macroeconomic agenda that economists like Piketty put forward.

What do you think?

Is there is a role for accountants on economic inequality? And if so, what do accountants – or accounting – have to say?

Accounting for inequality will be the subject of a special session of the Australasian Centre for Social and Environmental Accounting Research (CSEAR) Conference, which will be held at Macquarie University, Sydney in 2015, and also a special section of the Accounting, Auditing and Accountability Journal.

What does the market expect of audit committees? Michael Coleman at the joint IGAP & CPA Australia Annual Forum.

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MC picWhat does the market expect of audit committees? Increasingly, ‘everything’, Michael Coleman told the Annual Forum, held in October, 2014.

The joint IGAP and CPA Australia Annual Forum gathers leaders from industry, the accounting profession and academia to address key issues in contemporary governance and performance.

This year’s topic – ‘The  evolving role of audit committees’ – explored how audit committees are responding to rapidly evolving risks, liability, technological advancements and complexity in reporting, among a myriad of other challenges.

Coleman was Chair of the Financial Reporting Council (FRC), sits on a number of prestigious boards and has also had 30 years as an audit partner. He used his keynote address to highlight a potential expectations gap between what markets expect of audit committees and what directors can reasonably deliver.

Coleman highlighted several key challenges that audit committees are facing:

  • Changing expectations of regulators and the market; for example, that audit committees should be satisfied that auditors are doing their job or commenting on financial reviews;
  • A greater focus on risk; and
  • The proliferation of reports (e.g. Integrated Reporting).

A particular difficulty Coleman highlighted is the expectations for audit committees to form a judgement on audit quality:

“So whether it’s a good audit or not a good audit is a tough one and this is something that as audit committees we’re probably going to have to take a reasonable amount of time to consider.”

“We need to question amongst other things whether or not the auditor has been sufficiently sceptical. Now, how does an auditor demonstrate to the board that they’ve been sceptical?”

Coleman also highlighted how Australia has to some extent followed the United States trend of increasing the responsibilities of audit committees:

“In particular in my experience it’s become common for audit committees to approve fees over a certain level in relation to non-audit services provided by the auditor and audit committees have taken on a far more extensive role in relation to overseeing the financials.”

However, unlike in the United States, Australia still sees the audit committee as a sub-committee of the board:

“It’s not a separate creature, it’s not a separate animal and so therefore, and especially following Centro, we have the situation where boards, very, very rigorously in my experience, are actually as a whole considering the financials.

“The audit committee might look at the detail, but then the board as a whole still wishes to satisfy itself that it’s actually doing the right thing.”

Finally, Coleman observed how the expectations on audit committees would continue to evolve in the future with the release of a new auditing reporting standard in June 2016, which “will require the auditor’s report to include commentary on their key audit matters”. The new standards are likely to some interesting discussions, and to some changes to the dynamic of the relationship between the auditor and audit committee.

Why governance can’t ignore safety

A recent Four Corner’s report (screened 3/2/2014) on road safety and the heavy vehicle transport industry in Australia revealed the human toll of work-related accidents: 242 people killed in truck-related accidents, and many more injured, in just one year. According to Four Corners, safer work practices might have avoided many of these tragic events.

The Four Corners exposé highlights, in two interrelated ways, the fundamental importance of work health and safety (WHS) to all businesses.

truck_givewayphot1. Effective business governance includes effective governance of WHS.

The new WHS Act (enacted in all States but WA and VIC) requires all officers of a business or undertaking (PCBU) to exercise due diligence so as to ensure the health and safety of workers. The Act explicitly requires all businesses to provide safe systems of work – including safe equipment, safe processes and work methods (such as appropriate rosters, supervision, instruction etc.).

The Four Corners program drew particular attention to the potential health and safety implications of deferred maintenance. This is especially relevant to accountants, given their role in allocating budgets for maintenance programs. Moreover, recent research suggests that accountants are less likely than operational personnel such as engineers to perceive maintenance as even having been ‘deferred’.

2. Health and safety risks requirement management along the entire supply chain.

The Four Corners program also documented how a fatal incident on Sydney’s North Shore in October 2013 prompted an external safety investigation into the Cootes transport fleet. Impacting along the supply chain, this incident resulted in retail fuel shortages along the east coast while road safety checks were carried out on hundreds of Cootes vehicles. For example:

Frustrated Melbourne motorists again faced empty bowsers for some types of fuel or complete service station shutdowns today because of disrupted deliveries, with about 25 Caltex, 30 per cent of BP and a number of Shell ­outlets affected. BP spokesman Jamie Jardine said the company would have difficulty maintaining fuel supplies until all of the [Cootes] trucks were back on the road. (Herald Sun, October 10, 2013)

The vehicle checks identified more than 200 defects, many being major defects in safety critical systems such as brakes, steering and suspension. Three months on, the transport company has this week announced the loss of a major contract with Shell to distribute its fuel. The potential for safety issues to pose a risk to the well-being of workers’ and bystanders is clear. These events further demonstrate the potential for poor safety to also impact on the financial performance of both suppliers and purchasers.

Safety and Corporate Responsibility: Systemic Issues

Concerns over the role of payments, subcontracting, incentives and safety are not new. Similar issues raised by the NSW Staysafe Inquiry into Road Safety almost a decade ago, formed the basis of a research note published in the Accounting, Auditing and Accountability Journal in 2007 by IGAP researcher Dr Sharron O’Neill.

The pervasive nature of this problem raises serious questions, explored by Four Corners, about the sustainability of heavy transport business model and the corporate responsibility of business practices. Low wage rates for contractors and drivers coupled with increasing fuel and other transport costs were reported to still be providing incentives for long hours and excessive speed.

Four corners identified two factors motivating these unsafe behaviours.

1. Some drivers reported being directed by transport managers to meet “impossible deadlines”. Importantly, prosecutions and fines for subsequent speeding and log book infringements were falling on the drivers rather than those employers and companies who direct the systems of work. This alludes to a critical disconnect in enforcement processes that appears at odds with the legislated accountability of PCBUs under both the WHS Act (as outlined above) and the chain of responsibility legislation introduced by the National Heavy Vehicle Regulator. The latter suggests,

All parties in the road transport supply chain can be held responsible for their actions (or inactions) relating to breaches of the road transport, fatigue, speed, mass, dimension and load restraint laws.

If you consign, pack, load or receive goods as part of your business, you could be held legally liable for breaches of road transport laws even though you have no direct role in driving or operating a heavy vehicle.

2. Four Corners reported that unsustainably low wage rates lead drivers to work long hours to make a reasonable income. The Road Safety Remuneration Tribunal, established under the previous federal government in 2012, had proposed to examine pay and conditions and ensure ‘safe rates’ for heavy vehicle drivers. However, the future of ‘safe’ remuneration is already in doubt following a Federal Government review of the Tribunal which is due to be handed down by April 2014.

All in all, heavy vehicle safety is a complex problem with significant accounting and corporate social responsibility implications. We now wait to see the outcome of the government’s inquiry, and the response by the retail and transport industries to the Four Corners report. One would hope appropriate changes can be implemented before more lives are lost.

– Dr S O’Neill and Dr D Tweedie.

Internal Audit ‘After the Crisis’

In the aftermath of prominent corporate scandals and the global financial crisis, corporate governance has received close attention from regulators and the public. Regulatory responses have focused on increasing governance requirements and disclosures and this has, in turn, driven increased awareness and demand for internal assurance within organisations. Internal audit is integral to corporate governance, and is well placed to provide this assurance. In a recent article, Dominic Soh and Nonna Martinov-Bennie used interviews with audit committee chairs and chief audit executives to investigate internal audit functions in the Australian context, and to consider how their effectiveness might be improved.

 KEY FINDINGS ??????????????????????????????????????????????????????????????????????????????????????????????

1. The scope of the internal audit function has expanded and refocused in recent years. Internal audit is increasingly involved in risk management rather than traditional “tick and flick” financial audits. There is also greater engagement in operational areas, and increased focus on performing a value-adding role, such as identifying how businesses can increase their efficiency and effectiveness. There is a clear expectation that in addition to its assurance role, this ‘value-added’ emphasis will continue.

2. The changing role of internal audit is largely due to regulatory reforms. Increased sensitivity to directors’ liabilities, particularly of those directors on the audit committee, has meant increased acceptance of the importance and value of the internal audit function as the ‘eyes and ears’ of the organisation. Some audit committee chairs described the assurance and comfort from internal audit as greater, and perhaps more valued, than from external audit.

3. The effectiveness of internal audit depends on its structure, resourcing and organisational status.

  • There was a clear preference for an in-house function (or at least an internal chief audit executive), on the basis that intimate business knowledge contributes to an effective audit function and makes it better equipped to meet the audit committee’s assurance needs.
  • Interviewees highlighted the importance of key competencies (audit, finance, operational, technological, and legal), but especially the capacity of the chief audit executive to ‘command the confidence and respect of the people out in the field so as to be able to gain access and cooperation’.
  • Good relationships with, and support from, the audit committee and senior management were seen as critical to an effective internal audit function. For example, it is imperative that the audit committee supports and protects the status and visibility of the function e.g. by providing a platform for internal auditors to present their findings at audit committee meetings, ensuring the chief audit executive is present in operations meetings, and ensuring that management undertakes appropriate remedial action in response to audit recommendations.

4. Performance metrics have not evolved in line with internal audit’s role. Common measures of effectiveness related to the annual audit work plan and to measures of acceptance and adoption of audit recommendations. Since these measures were similar to prior surveys, it is clear that performance evaluation mechanisms have not evolved alongside the expansion and refocus of the internal audit function.

IMPLICATIONS:

1. Internal audit cannot be evaluated in isolation. The quality and effectiveness of the internal audit function is largely dependent on other parties within the organisation, especially the audit committee and senior managers. Consequently, an ineffective internal audit function might indicate that there are broader issues in the organisation’s corporate governance.

2. Whether internal audit meets stakeholder expectations is unclear. The misalignment between the current and evolving role of internal audit and static performance measures makes it difficult to assess whether internal audit is meeting stakeholders’ expectations. Given that the internal audit function serves different stakeholders (who at times have divergent interests) within the organisation, more diverse metrics are required to measure whether internal audit is meeting the potentially different needs of stakeholders. For example, while audit committee chairs emphasised the value of assurance, chief audit executives emphasised ‘value added’ from the organisation’s perspective.

3. New performance metrics may be required. Given the increasing emphasis on the consulting and value adding role of the internal audit function, alternative metrics such as value tracking by cost savings or value creation may better measure the performance and effectiveness of the function. There is however a potential risk that such metrics would impair internal auditor’s independence and objectivity, with implications for the external auditor’s evaluation and reliance on the internal audit function.

4. The chief audit executive skills need careful assessment. The increasing involvement of internal auditors in consulting and operational areas requires staff with industry knowledge and experience. In addition to strength of character and an inquiring mind, the chief audit executive needs strong communication skills to build bridges with all business areas, and to confidently report to higher organisational levels. Developing these competencies is no mean feat, and would take considerable time. Organisations therefore need to consider how limited tenure or rotation of this role could work, if it is required or even tenable.  These also have implications for what the career path of a chief audit executive would ultimately look like.

See: Dominic Soh’s and Nonna Martinov-Bennie’s article and abstract: