Is the Executive Remuneration debate clouding all judgement on director liability?

I attended a briefing held by the Australian Institute of Company Directors (AICD) called Directing Tomorrow Today: The Essential Director’s Update. For me this is a must attend event, as there is a wealth of quality information provided on current issues relating to the essential process of quality company directorship.

There is an enormous amount of work that AICD undertakes on the members’ behalf to advocate for appropriate legal frameworks and legislation changes. One particular area of the debate which has taken an extraordinary turn for the worse is the expectations around personal liability for company directors.

Let us not forget why the formation of limited liability companies were created in the first place – to limit liability to shareholders in order to raise capital to grow. However the overwhelming and I think highly disturbing trend is that the liability is certainly transferred away from shareholders and directly and personally placed onto the shoulders of company directors. A recent survey conducted by Australian Federal Treasury has clearly shown that it is affecting decisions to take on directorships. Here are a couple of key points quoted from that survey by Gabrielle Upton, Legal Counsel AICD,  in the February issue of Company Director magazine:

  • 71 per cent of respondents had declined the offer of a company directorship because fo the risk of personal liability
  • 62 per cent of respondents believed their boards had lost a potential or suitable board member because of that person’s concern about the risk of personal liability
  • 87 per cent knew of other people who had declined an offer of company directorship because of the risk of personal liability; and
  • 75 per cent knew of other people who had resigned from a company directorship because of the risk of personal liability

Why is this occurring?

The fallout from the Global Financial Crisis, some large scale corporate collapses created a real change in regime and compliance activities.

In addition the continued greedy behavior by a small number of directors in top companies has led to rewards for this small percentage completely out of alignment with corporate performance. In short pay has gone up, performance has gone down. In addition, the pay packets for these individuals are way out of kilter with the expectations of most of the population. Those people who act in the interest of personal greed, instead of the interests of the shareholders, deserve every bit of the criticism they get.

Unintended Ramifications of this Activity

There is a high calibre of corporate governance in Australia. Part of this is due to the separation of the powers of the Chairman of the Board, and the CEO that applies in Australia. Another big part is the emphasis on non executive directors being part of boards.

However the risk / reward trade-off has become so significant that mighty steps need to be taken in order to ensure that the director pool continues to grow AND that directors don’t become obsessed with risk to the detriment of company performance. You could understand this too if your career and everything you own and have worked for was at stake too.

Yet, the issue of the greed of a few is desensitizing those involved to the potential plight of the genuine director – and they receive little sympathy.

There are more than 660 state and territory laws that impose personal liability on individual directors and officers.

660 laws that impose personal liability on the people that are directing a company. That is outrageous. The most damning thing is that some of these laws come from a context of providing proof of innocence rather than proof of guilt. Imagine that being applied in any other setting? I don’t know the details of the bill of human rights, however the right of innocence until proven guilty is something we all take for granted.

The counter argument is that we must have suitable deterrents for those earning the big dollars that are a sufficient penalty. I have no issue with that. Let’s however be clear on the principal at play: the director that has acted honestly, in the best interests of the shareholders, that has sought advice when appropriate, has inspected and checked that risk is being managed effectively and making reasonable decisions based upon the facts presented SHOULD be protected by law. Those that act dishonestly deserve to be punished mightily.

The Unintended Affected

It is vital to understand that the liabilities and responsibilities of being a director remain the same (other than specific rules applying to listed companies, such as continuous disclosure) if someone is working in a small company, or contributing their time as a director for a not for profit board.

There is a huge amount to consider as a company director to discharge responsibilities properly and effectively. The reward should be commensurate with the risk. If the risk is inordinate, then rewards to match will be demanded – and many of the best and brightest minds will pursue other opportunities.

Put this in comparison with the standards expected and the respective pay packets of Australian Rules Football players, many of whom earn many multiples of the salary of the prime minister of our country.

As with the global financial crisis… never in the field of business governance should so many be angry at so few.

5 thoughts on “Is the Executive Remuneration debate clouding all judgement on director liability?”

  1. Great post, and points well made.

    What you’ve brought into focus is a fundamental question on whether there is / should be a higher duty of care for certain circumstances.

    Many of the onerous regulations relate to employee safety and environmental damage. The premise of these is fairly simple – companies should do everything reasonably possible to provide a safe working environment, and also not to degrade public necessities such as drinking water and the like.

    This sounds fine on the face of it, however as these laws are set and enforced at the state and territory level, the requirements can vary between locations, hence contributing to the AICD’s stats and their argument on this matter. Of course some states including my home state of WA are resisting getting these laws onto a common footing for various reasons, including some that you’ve raised in your article.

    There’s a presumption in these that companies will not take sufficient action unless there’s personal responsibility for directors on these. Unfortunately, I suspect this has actually proven itself to be correct which is a sad reflection on institutional leadership. (My latest speech talks about this and should be up on Youtube soon).

    Another case for heightened duty of care is for listed entities, particularly the likes of the ASX 300 which are held by the majority of mums and dads through their superannuation funds, even if they don’t like the company or know that it’s got roguish behavior. In fact, the only way to avoid these companies tends to be to start a self managed super fund and do your own research (very hard to do for most) or not invest in shares at all (not really an option).

    Within this context, I have doubts about whether the if-not, why-not (comply or explain) approach is appropriate for certain things – particularly risk management.

    I suspect that even more rules or enforcement are around the corner, and if that means listed directors are being even more diligent and cautious then this is a good thing – particularly considering that directors of large companies have been awarded significant pay rises in the past few years, and their justification was due to the additional work required to deal with these matters.

    For what its worth, my advice for directors would be to make sure the executives are also on the hook for all of this, and tie it into their remuneration and KPIs.

  2. Thanks for your comment, some great points there.

    I do think the key point you make is right – that community expects a heightened standard for those directors of the largest companies. Yet legally the standard is the same, and this is where the greedy have done a disservice to the many. We may get to such a point that non executive directorship becomes a full time role to discharge the responsibilities and ensure that compliance is met. This will further diminish the talent pool.

    Look forward to more on this debate and to your presentation. Could you post the link here for reference for those interested, thanks.

    Justin

  3. Great post and very important points raised.

    I have just resigned from a NFP School Board (after 3.5 years of 30+ hours a month service) for many of the reasons cited. The OH+S liability alone for a Director of a private school is scary. Added to that the possibility that this school may become insolvent and it made no sense to continue to put my family’s assets at risk.

    The Government needs to become more aware of the unintended consequences happening in this area.

  4. Thanks Steven for the comment and your example exactly illustrates the key issue – if the aim is good governance of all organisations with a board, then a legal framework that is too punitive will discourage the people that are able to make a quality contribution. The NFP sector is exactly the area that will suffer the most. The director that honestly goes about their role with due care and diligence should have a right to have no concern about the assets that they have spent a lifetime accumulating.

    It really is a case where those earning the very high directors fees draw fire that applies to all, and I’m sure that the legislation was developed with this small group in mind. However it is the wider group that is equally affected by the changes in laws.

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