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.

The Heightened Market for Risk & What Directors Should Do About it

“In a bull market, be a bull” – sage advice given to me by one of Western Australia’s leading brokers 24 months ago. Of course this approach works fine up until the point that it doesn’t work, and this broker to his credit picked up on nervousness in the market which led to more conservative thinking.

Those that picked the calamity to follow were considered naysayers by many – but the extent of the crash caught so many by surprise. Australia is in relatively good shape – thanks to a rigorous process of debt reduction achieved by the Liberal government, and the stronger regime that we have had in place to regulate the banking sector in comparison to other markets.

If you are a director of a company then the savage effect of removing the wind from the companies that were heavily geared and sails sheeted full into the wind is cause for concern everywhere. Recent news reports indicate a great likelihood of class actions, insolvency practitioners are struggling to cope with demand, and there is a domino effect from companies that fail.

For those that have had portfolios halved in value, the obvious target is boards of companies.

Smart companies already have comprehensive programs in place – policies, reporting, delegations and systems – to cover risk. In addition, smart boardroom practice is to have a structured approach to decision making. It serves two purposes – firstly to ensure that factors are considered rigorously, and secondly, it provides a record for how the decision was arrived at, which factors were considered important at the time. Decisions of the past are often judged on the facts of today. A documented framework allows insight into how the decision was arrived at – and a defense in case of litigation (in the absense of anything else).

For those members of the AICD, the Feb 2009 issue of The Boardroom Report includes “10 ways to bolster risk management”. which covers board composition, governance structure, risk as a standing agenda item, the issue of compensation, and most important of all, setting the tone from the top – the appetite for risk.

AICD Company Directors Course

Perth Old Boys School

Home to Chatham House

Having completed the Australian Company Directors Course, I run the risk of sounding like a paid advertisement… BUT if you have contemplated doing this course, don’t hesitate, just do it. The quality of presenters and the work that has gone into preparing the course material is utterly first rate. I must say I have also learned a great deal from the participants who are all business leaders in a wide range of fields, and it is the interaction with the other participants as well as the lecturer that is the most valuable.  As in any learning, you only get out what you put in. There is a lot of reading material and preparation for every week. The case study material is really strong and gives you a very good grounding for all facets of directorship.

Since completing the course, I have been invited twice to speak to potential participants about the course and what they should expect. I completed the 10 week course, but many people undertake the 5 day intensive, and the residential is considered by AICD to be the best option to take – but it is the most expensive.

Make no mistake there is a lot of reading. You receive two comprehensive manuals. I read the manuals in full twice prior to starting the course, then read each chapter and undertook the prep work before each weekly session, then read it twice at the end to ensure I prepared well for the assignment and exam. As I paid for the course myself, I wanted to make sure I really knew the material. When you are in a boardroom situation, you must come prepared and you should treat this no differently.

I liked the weekly sessions as it enabled some contemplation and digestion time for the content, and I would recommend that approach. That said, many others have said to me that the 5 days is a really good way to complete it as well (particularly if you travel frequently).

There are a couple of issues I found with the course: the online examination created a number of problems for people in our group. As a proponent of internet technologies, I’m sure this will be ironed out, and AICD have enabled the web exams to cater for scenarios where coming to a location to undertake an exam isn’t realistic.

The other issue I had was the complete lack of a mark from the exam and assignment. A very small percentage of the national graduates are awarded a distinction, however there is no feedback at all. I believe AICD will do something about this in the future.

Some of the participants have agreed to continue to meet monthly, so we have created a group we called Chatham House, based on the application Chatham House rule. If you are after the original Chatham House group here which is home of the Royal Institute of International Affairs, is a world-leading institute for the debate and analysis of international issues.

In summary, an outstanding course and I highly recommend it to anyone that is either a director already or contemplating becoming one. Interestingly around one third of the participants in the course decided never to become a director due to the current liabilities that exist in those roles. This is an area that needs significant attention in our legal frameworks.