Corporate Governance (Australia)

By- Praveen Moolchandani

With recent collapses of many large conglomerates around the world, it has become clear that little was being done to regulate or control the way managers managed the organizations.

The concept of corporate governance that had lost its focus in the past, regained its importance as one of the most important aspects in the domestic and international business arena. In simple words, Corporate Governance is comprised of a set of guidelines and rules that companies must abide so that their actions result in the best possible results for all the stakeholders of the company.

These rules and guidelines are written down in the white papers and books maintained by the regulatory bodies in different countries. The report highlights the concept of corporate governance literature; evidencing its importance and relevance through the HIH insurance case in Australia.

The analysis of the case helps in identifying the possible reforms that are needed to improve the system and the role of government towards these reforms. The report finally concludes with the recommendation that companies should involve themselves in self-governance to be able to create a better corporate image in the business arena.

Introduction
When managers of a company are given authority, it becomes their duty to act for the welfare of the stakeholders. Unfortunately, this does not happen in many cases and this is where the issue of corporate governance comes into light. Corporate Governance can be defined as the economic, legal, and institutional framework in which corporate control and cash flow rights are distributed among shareholders, managers, and other stakeholders of the company (Eun.S & Resnick.B 2004:1). In the recent years, investors have seen many large corporations like Enron, HIH insurance, WorldCom, Daewoo etc. fail; due to the prioritization of self-interests by

managers over the interests of the investors. This has raised arguments against the efficiency of corporate government policies set out by the respective countries around the world. Although after large failures, some countries have raised their corporate governance standards or in some way issued new guidelines, this has not helped in reducing the diffidence of the investors. In July 2004, a public poll was conducted by CNN asking viewers whether they trusted the way big organizations do business and 90% of the results revealed a NO with only 10% saying a YES. This essay lays down some aspects surrounding the issue of corporate governance and discusses the failure of HIH Insurance, which was believed to be the biggest business failure in Australia.

Corporate Governance Literature

Many theories have supported the study and understanding of corporate governance:

1. Agency Theory If the investors and managers of a company get into an agreement in advance; upon the interests of each other and how managers would react to a future circumstance, there would be no room for conflict of interests. However, future transactions are uncertain and deciding upon uncertain circumstances is not possible. This directly puts control in the hands of the managers who may react in self-interests. Funds may be misused in many ways. A manager may set-up his own company and sell the main companys products at a lower price. He/She may even use the companys money for luxury purchases for personal use. Agency theory is the prime cause for the failure of corporate governance policies that the managers must abide.

2. Stakeholder Theory The stakeholder theory states that a company is an arrangement formed of its stakeholders which functions in an environment bestowed by the host country. In simple words, the theory states that management should work for the betterment of the stakeholders of the firm. This initiative to look after the interests of the shareholders should not come by isolating the stakeholders from the decision-making of the directors. According to Michael Porter (2004:2), this is possible only when a firm maintains long-term board members, employees and supplier contracts. This

will improve the competitive position of the firm.

3. Political Theory According to the political theory by Pound .J (1993:3), the active investors of a company try to change or alter the corporate policies by building voting support from the discrete investors, rather than buying that support. This simply means that if a company is not performing well, the shareholders or the investors should appoint a capable director by means of peaceful voting. The political theory is better than and contrasts with the acquisition theory which states that an underperforming firm should be acquired by means of takeover at market price plus premium or tender offer.

Corporate Governance & Law

Every country around the world may follow any one the four laws namely English Common Law, French Common Law, German Civil Law and Scandinavian Civil Law. In Australia, which is a former British colony, English Common Law is followed to protect the investors. The Australian Stock Exchange (ASX) Corporate Governance Council regularly issues best practices guidelines to be used as a framework by companies, when they form their disclosure policies. The council requires all companies to include in their annual reports, the extent to which they have followed the guidelines or principles. If the companies ignore few guidelines according to the nature of their business, a separate note on why the guidelines were ignored should be made. The main principles or guidelines issued by the ASX Corporate Governance Council include: 1 The annual reports of the companies should include the roles assigned to the members of the board of committees and the management executives. 2 The council requires the company to have an adequate management or a board structure, which brings flexibility at work and adds value to the business. 3 Make ethics the way of doing business and indulge in responsible decision-making. 4 The layout of the financial reporting should be such that verifies the

details disclosed; which maintains the honesty in reporting. 5 The financial reports should reveal accurate, timely and detailed information about all the transactions and events of the company for a particular period. 6 The management must reverence the rights of the shareholders and act in a manner, which leads to fulfillment of those rights. 7 The management should have the foresightedness for any sort of risk; both internal and external and ability to control it. 8 The past and present decisions or policies set by the board and management must be evaluated and good decision-making should be encouraged. 9 The remuneration system should be checked for fairness and must be according to the performance of the company and the individuals. 10 The management must always remember their responsibilities towards all the stakeholders of the company.

Every year, ASX Corporate Governance Council issues amendments to these principles according to the changing international business environment and the emergence of new issues that need to be addressed. The council also recognizes and classifies some companies who follow best practices of these principles. The body that monitors and regulates the companies for the application of these principles is called The Australian Securities & Exchange Commission. The commission scrutinizes the corporate failures and conducts prosecutions against the company directors.

The Failure of HIH Insurance, Australia

HIH Insurance was began its operations in 1968 when Ray Williams & Michael Payne inaugurated NW Payney Underwriting Agency Private Limited. The company was recognized as Health International Holding Insurance in 1999. (See Appendix 1). HIH Insurance with $940 million in assets and 217 subsidiaries across different countries was the second largest insurance company in Australia.

In mid-march of 2004, liquidators from KPMG were appointed who initially

estimated the asset losses for the company to be $300 million. The firm went to a provisional liquidation on the same day and after few days; the estimated loses numbered $5 billion. After a series of enquiries by the KPMG auditors and the Royal Commission; Rodney Alder, the former director of HIH Insurance was sentenced to four and a half years for the following charges (Dunphy.B & Hay.A :4): Section 180 - failed to carry on the duty of caring for shareholders. Section 181 - that Alder did not conduct his duty by acting in the good faith of the company. Section 182 - that the director misused his status and position for self-interest Section 183 - that Alder did not communicate accurate information and mislead the stakeholders.

Arguments against HIH Insurance

According to the liquidators, HIH followed an aggressive expansion policy without setting aside enough funds in cases loses occurred. The company acquired FAI insurance in 1998 by paying a price much above the market estimate. Moreover, it was known later that FAI was a company founded by Rodney Alder's father, was insolvent when it was acquired and that HIH was supposed to bear $400 million in loses. In a few weeks, Standards & Poors lowered the credit rating of HIH to BBB minus from an initial A plus.

The company also involved itself in a series of film financing arrangements in London. HIH granted loans to many small banks for film financing purposes which was considered a risky investment at that time. HIH had to face millions in losses when it was unable to claim the reinsurance money from the banks it had granted loans to. This was poor decision-making on the board's part. Further, the Australian Securities & Exchange Commission investigated the issue and revealed that Alder illegally purchased 3,250,000 HIH Insurance shares through Eagle Pacific Equity, a company owned by Alder himself.

This shows that Rodney Alder manipulated the stock market for his personal interests. Moreover, a further investigation disclosed that Alder had invested an additional five hundred thousand dollars of company's funds in Business Thinking Systems, in which HIH has invested another two million dollars. Therefore, Alder breached the law by not disclosing this vital information about his personal financial interests.

Argument against Australian Prudential Regulation Authority (APRA)

In an interview with Elizabeth Fry from the CFO Magazine (2004:5); Jeff Simpson, former HIH Deputy General Manager revealed that after he resigned from his job in 1999, he went to the APRA and expressed his trepidation regarding the way things were done at HIH. He also believed that there was a possibility that the company may go insolvent. However, the authorities ignored his concerns and thought of him as an unhappy or dissatisfied former employee. This raised questions over the ignorance of authorities; which could have saved or at least alerted the Australian Securities & Exchange Commission. Necessary steps could have been taken to prevent the damage.

Concluding Remarks on HIH Case

It is evident that HIH Insurance did not abide by many of the principles issued by the ASX Corporate Governance Council. These include dishonestly in reporting, inaccurate and misleading information in the financial statements, acting in selfinterests rather than the interests of the shareholders and stockholders and inadequate appraisal of the management's and board's decisions and policies. Soon after the collapse the government of New South Wales provided a rescue package of $50 million, Victoria government offered $35 million of help and the Federal Government offered $500 million for the stakeholders. HIH Insurance case created history as one of the biggest business failures in Australia. However, the real loses were born only by the shareholders and other interested stakeholders of the company. Right after the HIH case, the ASX Corporate Governance Council raised its corporate governance standards and regularly assists companies with different governance issues that they face by issuing new amendments.

Corporate Governance Reform Proposals

HIH Insurance case has not only awakened Australian Corporate Law bodies but has also alerted the regulatory bodies in every country around the world. The following issues related to corporate governance should be looked after:

1. Corruption Corruption can take many forms at the board level. For example, directors may themselves decide upon their remuneration schemes, they may sell shares to another director(s) at a lower price, use the resources of the company for their personal benefits or luxury, influencing the auditors to report false information to the shareholders etc. The Australian Securities & Exchange Commission jointly with the ASX Corporate Governance Council should issue new guidelines to control this vicious issue of corruption.

2. Evaluation of Board Performance The performance of the board is hardly appraised whereas every other unit or department of the company is assessed every quarter, half-yearly or annually. Therefore, the performance of the board in terms of operational decision-making, asset management, profits and growth should be done by the government authorities from time to time.

3. Distinct CEO & Chairman Roles It is studies that still many companies in Australia have one person as the CEO and also the Chairman of the company. This allows one person to decide the recruiting procedures including who is to be recruited and also gives him/her the authority to decide the remuneration schemes for himself. This results in corrupt practices and fraud. Therefore, the chairmans role should be separated from CEOs role in the company.

4. Participative Board This is a serious issue in many companies where the members of the board do not provide their input in the decision-making and the influential member or the director makes decisions according to his interests. This may be due to cultural beliefs that the superior person or the director will make the best decision or it may be due to communication gaps.

5. Auditor Independence The auditor is many companies is selected by the director and not by the majority members of the board. This may result in the appointment of an auditor who may prepare reports according to the directors wish and may not provide his/her independent judgment and analysis. This would result in misleading of shareholders and other stakeholders.

6. Non-Executive Directors The Australian board members are always hesitant to appoint non-executive directors in the board to advice independently on the main issues and monitor the performance of the board and the company as a whole. The appointment of non-executive directors is considered vital. These directors do not come up with plans and strategies or make decisions, but they just advise and this board culture is not accepted by many top-management people.

7. Role of Banks - Philosophers like Diamond.D (1984:6) argue that there has been little discussion for the role banks can play in corporate governance. According to him, banks while providing the necessary finances for investing purposes, should evaluate the company and its operations and the current plan of investing. This is considered yet another vital issue.

Recommendations Given & Actions Taken By the Regulatory Bodies

a) Annual reports now to be assessed or evaluated by the New South Wales (NSW) government for accuracy, transparency, detailing of factual data and analysis of the effectiveness of those facts. Moreover, a decision was taken to allow the presentation of annual reports in a summarized format for those shareholders who preferred ease of reading them. Others who preferred detail reports should be provided at no cost. This practice was to be allowed in every city throughout Australia.

b) Federal Government also stressed down a conception from section fifty two of the Trade Practices Act; calling for all the companies to present the detailed

information to shareholders in a way that is understood by the shareholders. The report should not be confusing and must be easily understood by any rational investor.

c) The Australian Reserve Bank has made it compulsory that non-executive directors should make up most of the board members. This is applied to those companies that are regulated by the bank through its banking license. Moreover, it was suggested that non-executive directors should not hold any shares in the company.

d) Corporate Law Economic Reform Program (CLERP review 9) According to this paper, a suggestion to reform the auditing practices is laid down. It is proposed that the auditor should not only prepare statements according to the basic compliance requirements of the companies. He/She must present the independent analysis, views and recommendations and report them to the stakeholders of the company in an understandable manner.

e) The Australian Institute of Company Directors recommended that the directors should voluntarily resign after a period of two or three years. If the board decides upon the director to continue his period with the company, reasons for the same should be given in the annual reports to the shareholders. For the non-executive directors, the term with the company should not exceed more than nine-ten years in any case.

Conclusion & Recommendations

It is evident from the literatures and the real life example that corporate governance has gained much importance in the recent years. For those managers who distort the ethical system of reporting and act in the best interests of shareholders, laws have become strict and greater importance has been given to the investors confidence. The HIH insurance case created history with its collapse. Despite the actions taken by the regulatory authorities and the compensations offered; many stakeholders sill lost a lot

of money with the company.

This leads to the another growing importance of the reforms that have been proposed by many governmental, non-governmental and independent professionals. There is no doubt that the state and national governments have taken important steps to limit the breach of corporate law and that, some vital steps are indeed required for the betterment of the same.

However, it is equally relevant that the companies should involve themselves in selfgovernance i.e. follow the guidelines laid down by Australian Securities and Exchange Commission and the ASX Corporate Governance Council. This would not only reduce the burden on the regulatory authorities who inspect hundreds of companies every year. Moreover, if all the companies do self-governance, they will be able to prove themselves as good corporate citizens of the country and create a golden image in the marketplace.

References
1. Eun, S. & Resnick, B. 2004, International Financial Management, 3rd edition, Tata McGraw-Hill, India 2. Porter, M.E. 1992, Capital Choices: Changing the Way America Invests in Industry, A Research Report Presented to The Council on Competitiveness and Co sponsored by The Harvard Business School, Boston. 3. Pound, J. 1993, 'The Rise of the Political Model of Corporate Governance and Corporate Control', New York University Law Review, 68:5, November, pp.100371. 4. Dunphy.B & Hay.A, Corporate Governance - Liability issues arising out of directors responsibilities Available: http://www.claytonutz.com/downloads/DunphyHay.pdf [Accessed: 2 March 2006] 5. Fre, E. 2004 HIH insider goes public: life of a whistleblower has given Jeff Simpson unique insights into private and public sector governance CFO, may 1, 2004 6. Diamond, D. 1984, Financial intermediation and delegated monitoring, Review of Economic Studies, 5 I, pp. 393-4 14. 7. Parliament of Australia, 2001 HIH Insurance Group Collapse, Available: http://aph.gov.ae/index.html [Accessed 26 February, 2006]

8. AllBusiness, 2005, Is it time for radical reform of corporate law in Australia? [Online], Available: http://www.allbusiness.com/periodicals/issue/72574-1-2.html [Accessed 27 February 2006] 9. Dellaportas, G. 2004, New standards improve transparency, Australian CPA [Online]. Available: Proquest 5000, [Accessed 3 March 2006] 10. Greg, J. 1995, Legal reforms to affect annual reports, Australian Accountant [Online]. Available: Proquest 5000, [Accessed 4 march 2006] Websites: Australian Securities & Exchange Commission http://www.asic.gov.au/asic/asic_polprac.nsf/byheadline/Financial+reporting?openDo cument Australian Stock Exchange http://www.asx.com.au/supervision/governance/index.htm