In the months since the release of the proposed fourth edition of the ASX Principles and Recommendations, there has been vigorous debate over the merits of introducing even more stringent reporting requirements for ASX listed companies.
Our initial view was that these changes have the potential to import the most fundamental change in the approach to corporate governance of listed entities in many years, circumventing changes which would typically be expected to occur through legislation and decisions of the courts.
That view has not fundamentally changed, but it has deepened since we published our initial paper in August. The proposed Principles have generated wide commentary and discussion, and as a consequence, we believe a broader analysis of the role that the ASX Principles and Recommendations should play in relation to corporate governance in Australia is required – specifically, what the proposed Principles and Recommendations can (and cannot) be expected to provide, and to understand the potential implications of the Principles. These implications include a potential conflict between statutory duties of directors and their obligations arising under the Principles, and how implementation of the Principles does not ensure compliance. Resolving those conflicts, and changing the nature of corporate governance in Australia, are tasks that most properly sit with the Federal Parliament.
The purpose of the Principles
The Principles were first introduced by the ASX Corporate Governance Council in 2003. The Council itself was formed in 2002 in response to the introduction of the Sarbanes-Oxley legislation, highly proscriptive legislation in the United States that was enacted as a consequence of the Enron collapse and other widely publicised corporate failures. The US legislation aimed to protect investors by enforcing the accuracy and reliability of corporate disclosure.
The Council introduced the Principles as voluntary recommendations to apply to ASX listed entities, with the intent that they operate on an "if not, why not" basis. The Principles are designed to produce an efficiency, quality and integrity outcome for Australian corporations,[1] and there is a growing expectation in the market that companies should treat the Principles as requirements that they must comply with. It is seen in the proposed 4th edition of the Principles that the Council has taken these market expectations and transformed them into a checklist of requirements that corporations need to tick off. Notwithstanding this, the Council has stated that the proposed Principles have never been intended to be proscriptive since their introduction and that the "if not, why not" approach should continue.
The Council is therefore going beyond the original spirit of the Principles by increasing the amount of obligations that directors have, with little evidence that the Principles themselves are an effective mechanism for achieving good corporate governance, and despite existing legislation that already regulates these obligations. As a result, the Board may be burdened with unnecessary paperwork, and detracted from its focus on strategy to tasks outside the scope of its role.
From shareholder primacy to social licence to operate
Australia has long held the view that the primary purpose of a corporation is to best serve the interests of the shareholders. In their analysis of Australian business objectives, Ian Ramsay and Belinda Sandonato found that the largest companies by market capitalisation were primarily focused on the interests of their shareholders; in fact, 83 companies of the ASX 100 identified the interests of their shareholders as their top priority.[2]
There are criticisms of shareholder primacy: it's said to encourage short-term thinking and shareholder activist attacks, depress wages, and reduce long-term sustainable investments.[3] As a result, the interests of other stakeholders are neglected. For this reason, the Council has proposed that a corporation should explicitly state what its purpose is. The Council is implying that corporations should have a broader purpose than merely fulfilling the best interests of the shareholders, and should instead emphasise a corporation's social licence to operate.
What could a corporation's "social licence" look like? BlackRock founder Laurence D. Fink has stated that "to prosper over time, every company must not only deliver financial performance, but also show how it makes a positive contribution to society". This sentiment and the concept of the corporate social licence to operate are evident in the proposed Principles. While this is regarded as best practice in the mining sector, it is not necessarily one that translates well to the broader corporate world. This is largely because a mining project has a fairly clear set of stakeholders and interests based in the local community, from which it draws its social licence. Compare this with a corporation operating across Australia – who gives it its social licence? Which sector or sectors of the community? The potential for uncertainty and confusion, rather than good governance, is obvious. This is not to downplay the importance of corporate social responsibility – a more limited concept which should be emphasised in the Principles and Recommendations – but a social licence to operate should not be the central underpinning for all corporate governance. Even if the argument above is rejected, we maintain that introducing it into the Principles and Recommendations is a step better suited to proper legislative deliberation.
Finally, the proposed Principles will potentially conflict with the statutory obligations of directors. The proposed Principles proscribe that directors "must have regard" to the interests of other stakeholders, while section 181 of the Corporations Act states that directors must act in the best interests of the company. The inconsistency between the Principles and the legislation may lead to confusion amongst directors, and may blur the lines of management accountability. If management and the directors need to spend more time addressing the requirements outlined in the proposed Principles, then this may disadvantage their companies when competing with private equity enterprises who are not accountable to the Principles. While the Principles, unlike the Act, are not binding, there are still reputational repercussions for companies if the Principles are not complied with. Therefore, the ASX Corporate Governance Council should reformulate the wording of this proposed Principle to prevent the conflict.
A corporation's values and culture
Moreover, the proscriptive nature of the proposed Principles is also seen in relation to the values of a corporation. For example, instead of recommending that companies should have a non-discriminatory employment policy, the proposed Principles and Recommendations go further and mandate that companies should specifically embrace 'gender identity', 'physical abilities' and 'cultural background'. We support these principles.
The current view is that if a corporation acts upon values such as diversity, then it should make full disclosure in relation to these, thereby allowing stakeholders to make decisions regarding whether they want to become involved with a corporation. Anything beyond transparency is proscriptive, and should be a matter left to Parliament rather than the Council.
The proposed Principles also provide that a Board must define the "core values" of the corporation, which in turn defines what type of organisation it aspires to be, and what it requires from its directors, senior executives and employees to achieve that aspiration. It can be seen from the APRA review of the Commonwealth Bank of Australia that a "good" corporate culture may play a role in ensuring good corporate governance, but this does not mean that the Council is capable of regulating the culture of a corporation through implementing proscriptive principles.
Another issue gaining a lot of traction in the wider community is Environment, Social and Governance (ESG). There is more pressure on corporations to actively mitigate these environmental concerns, particularly in relation to climate change. The proposed Principles articulate that corporations should evaluate long-term risks, such as environmental risks. Corporations are already incentivised to do this for reputational purposes, with it increasingly becoming more common in the market to publish a corporation's strategy for addressing ESG issues. However, yet again, the Council is taking on the role of quasi-legislators, and should allow ESG concerns to remain implicit in the Principles.
Increasing the efficacy of the Principles
There is a difference between having a transparent corporate governance policy, and being open about how that policy is implemented. ASIC recently reviewed the proposed Principle and made a submission in response, which criticised the current rule requiring companies only to disclose the existence of a corporate governance policy, which it says has led to boilerplate disclosure in corporate governance statements that barely change each year. And as can be seen from recent events, having the Principles does not ensure compliance.
ASIC has suggested that each year, corporate governance statements be accompanied by a standalone document about how the Principles have been implemented in practice for the last year. This, accompanied by monitoring of disclosures made under the Principles, would increase the likelihood that the original purpose of the Principles is met.
From recommendation to proscription
It is clear that the Council is attempting to shift a corporation's purpose away from shareholder primacy to one of social responsibility, and in doing so, is creating a highly proscriptive checklist of requirements, rather than recommendations as was originally intended. This may go on to create conflict with the existing legislative obligations of directors, and the proper role of the Board.
No doubt the Council should carefully consider the discussions which the 4th Edition have generated, but it needs to remember the original fundamental policy upon which the Principles were based when they were created.
[1] ASX Corporate Governance Council, Principles of Good Corporate Governance and Best Practice Recommendations (March 2003) Page 8.Back to article
[2] Ian Ramsay and Belinda Sandonato 'Corporate Governance and Corporate Social Responsibility: An analysis of the business objectives of the largest listed companies in Australia, the United Kingdom and the United States' (2018) 36 Company and Securities Law Journal 98.Back to article
[3] Martin Lipton, 'The Purpose of the Corporation' Back to article
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