SUMMARY OF KEY POINTS
- The global financial crisis has refocused attention on board renewal;
- The most recent tranche of amendments to the ASX Listing Rules nearly included an amendment dealing with board renewal however this proposed amendment was left out in the final stages of settling the detail of the new amendments;
- Board renewal is increasingly seen as fundamental for every company;
- It is the responsibility of a company's nominations' committee to drive board renewal.
- PNG law is silent on board renewal issues.
Board renewal has been the subject of increasing focus in the aftermath of the global economic downturn. There is increasing pressure on boards to continually review their own performance and composition to ensure an optimal structure.
The most recent tranche of amendments to the ASX Listing Rules that came into effect on 1 January 2010 nearly included an amendment dealing with board renewal. This amendment, however, was left out in the final stages of settling the detail of the new amendments.
In light of these developments it is appropriate to review current thinking and best practice regarding board renewal.
2. Key themes
The following broad themes emerge when reviewing current thinking and writing on board renewal:
2.1 Directors are elected by shareholders
The starting point for any consideration of board composition and board renewal is the fundamental principle that boards of public companies in Australia and PNG are elected:
- by shareholders
- to represent shareholders
There was a trend witnessed in the early part of the decade for in-coming directors to enter into agreements which provided they would resign if the majority of the directors requested them to do so. When the existence of these arrangements became public, ASIC was quick to respond:
The ASX Listing Rules provide that a director must not hold office (without re-election) past the third annual general meeting following the director's appointment or 3 years, which ever is longer (LR 14.4) and an entity which has directors must hold an election of directors each year (LR 14.5).
In its recent publication, Legal & General Investment Management, the largest institutional investor in the UK, has called for all directors to stand for re-election on an annual basis. The rationale given is that this would increase the accountability of directors to shareholders.
I do not anticipate that this will become normal or best practice in Australia.
2.2 Boards must be structured to add value
Principle 2 of the ASX Corporate Governance Council's Corporate Governance Principles and Recommendations (CGPRs) states that companies should have a board of an effective composition, size and commitment to adequately discharge its responsibilities and duties.
This Principle underpins any consideration of board renewal. The rationale for board renewal must logically be to ensure that a board evolves with the changing circumstances in which it operates, so that it continues to have an effective composition, size and commitment to adequately discharge its responsibilities and duties in the circumstance in which it finds itself.
It is noteworthy that the commentary to Principle 2 states that board renewal is critical to performance, and directors should be conscious of the duration of each director's tenure in succession planning. This supports an argument that renewal of a board is a good thing in and of itself.
Directors need to commit the time required to effectively discharge their duties to the company.
The commentary to Principle 2 of CGPRs states that an important issue when considering the selection and appointment process for the election and re-election of directors is that:
It also states:
In recent years commentators have observed that both executive and non-executive directors have been asked to commit significantly more time to their board and committee activities. Deloitte Touche Tohmatsu prepared a paper on board effectiveness in 2008 based on interviews with more than 100 directors. In the paper it notes:
Contemporary thinking in the area of board composition is clear on the point that directors can no longer expect to adequately discharge their duties to a company by simply attending monthly board meetings and the annual general meeting.
2.3 Board performance must be regularly evaluated
It is now accepted as best practice in Australia that Board performance should be evaluated regularly against appropriate measures and the process for conducting the evaluation should be disclosed.
Recommendation 2.5 of the CGPRs states that:
In the report of the HIH Royal Commission The Failure of HIH Insurance (2003), Justice Owen made the following statement:
In an article published in the Company Director magazine, Dr. Richard Leblanc states:
This is an area in which I anticipate greater emphasis and scrutiny will be placed on boards in the future, particularly by institutional shareholders and proxy advisory firms.
2.4 Boards must engage in succession planning
In an article published in the Company Director magazine, Jennifer Stafford, senior policy adviser to the Australian Institute of Company Directors for corporate governance, has stated:
The United Kingdom Financial Reporting Council's Combined Code on Corporate Governance (UK Combined Code), an advisory set of standards of good practice in relation to issues such as board composition, contains the following general principle:
The CGPRs make it clear that it is the responsibility of the nomination committee to review board succession plans. Adrian Cadbury, Chairman of the UK Committee on the Financial Aspects of Corporate Governance which published its Report and Code of Best Practice in 1992, commented that:
There has been a lot of commentary around the difficulties in properly handling succession of the chairman of the board. Adrian Cadbury commented, in the context of chairmen who also hold the role of chief executive, that:
It is clear that succession planning is an essential process of effective board renewal and is something that should appear regularly on the board agenda and the agenda of the nominations committee.
2.5 Directors tenure - an issue for independence?
Recommendation 2.1 of the CGPRs is that a majority of the board should be independent. Recommendation 2.2 of the CGPRs is that the Chairman should be independent.
The first edition of the CGPRs provided that a director should not be considered independent if he or she had served on the board for a period which could, or could reasonably be perceived to, materially interfere with the director's ability to act in the best interests of the company. No specific period was given, though reference was made to the recommendations for director's tenure in the Higgs Review (see at 2.6 below).
The UK Combined Code provides that:
The second edition of the CGPRs requires that a company should give reasons if it considers a director to be independent notwithstanding the existence of specified types of relationship. Notably the list of relationships does not include a director having served on the board for an extended period.
As a matter of best practice, it would nevertheless be prudent for a board when considering the status of a director who has been in office for three terms or more, to consider whether the director could reasonably be perceived to no longer be independent.
2.6 Directors' tenure – is there a maximum period for which directors should serve?
There are no upper limits under Australian law or UK law on the period that a director can spend in office. Nor is a limit imposed by the CGPRs.
In the UK, however, a common, but not universally accepted view, is that non-executive directors should not serve more than three terms of three years unless special circumstances exist.
In his Review, Higgs went further and stated:
The UK Combined Code states:
BHP Billiton Limited's Corporate Governance Statement provides that non-executive directors who have served on the Board for more than nine years from the date of their first election must stand for re-election annually. The re-election of non-executive directors of Rio Tinto Limited is governed by a similar requirement – Rio Tinto Limited's policy is that, unless special circumstances apply, a non-executive director would not normally serve more than three terms of three years each. These policies conform to provision A.7 of the UK Combined Code. The approaches of BHP Billiton Limited and Rio Tinto Limited appear to have been influenced by the dual listing of each company on the London Stock Exchange and the Australian Securities Exchange.
In its recent publication, Legal & General Investment Management has called for all directors to stand for re-election on an annual basis. Although this view has been echoed by other institutional investors in the UK, I doubt that it will be adopted in either the UK or in Australia in the near future.
In conclusion contemporary practice in Australia is not to automatically limit the tenure of non-executive directors to three terms of three years. However, the average tenure of non-executive directors is less than six years suggesting that only in exceptional cases will a non-executive director remain in office past a third-term. The majority of Australian commentary in this area appears to support the position that an arbitrary limit on the period a director can serve is not appropriate. It is sometimes said that "Tenure is deigned to avoid dealing with performance."
However, a director's tenure must still be considered in light of the need for board renewal.
3. PNG Law and Practice
The PNG Companies Act does not prescribe a maximum term for directors nor does it prescribe a retirement age for directors.
The constitutions of most Australian and PNG companies are silent on how many terms a director may serve and does not require directors to retire at a certain age.
There are no relevant laws or precedents in PNG dealing with maximum tenure or retirement ages for directors.
4. Effecting Board Renewal
It is not management's responsibility to promote board renewal. Indeed, it is difficult, if not impossible, for management to bring about board renewal directly without risk to themselves or the creation of long term bad feeling between the board and management.
Sometimes, shareholder initiatives are a catalyst for board renewal. It is quite clear that shareholder discontent saw the departure of Donald McGauchie as the Telstra chairman. Once the Future Fund (Telstra's largest shareholder) indicated that it believed a change of chairman was required, McGauchie's fate was sealed.
The most appropriate catalyst for board renewal, however, is action from within the board itself. As noted above, well managed boards are mindful of the need for refreshment and renewal of board skill sets, while balancing the need to retain adequate knowledge of the company.
Often the chairman of the board or the chairman of the nominations committee takes responsibility for board renewal and succession planning. This is very appropriate. Renewal and succession planning is a sensitive subject for all concerned and is generally best handled by a skilled chairman. Having said that, any director has the right to raise with the chairman or with fellow directors the issue of board renewal and request that this be an item of discussion at the next remuneration and nominations committee meeting.
Good succession planning requires careful thought and plenty of time. A board that "grasps the nettle" and starts planning in advance of pressure from shareholders, market analysts or outside commentators is always going to be well regarded and will be in a much stronger position than a board which is pressured into making sudden changes at board level by outside forces.
5. How Are Most Australian and PNG Companies Travelling?
In most public listed companies there is an annual or bi annual performance review of all directors, however this does not mean that all boards are open to engaging new talent as and when it becomes available.
In many companies the board renewal process requires greater structure and more formality than is currently being applied.
I would like to make the following suggestions about how board renewal could be handled going forward:
- Board renewal should be a regular agenda topic for Nominations Committee meetings. It should either appear on the agenda for each meeting or at least twice per year;
- The questionnaire that is sent to directors as part of the
annual/bi-annual board performance review should place greater
emphasis on whether the board and the committees are working as
effective units and how this can be improved rather than
concentrating on the performance of individual directors although
of course this is important too. It might also be beneficial to
introduce a number of new questions covering the following:
- The appropriateness or otherwise of the board supporting the re-election of those directors who are due to face re-election at the next annual meeting. This should be a question each year;
- The skills, experience and characteristics, if any, that the directors think the board needs, but does not have, at the present time;
- The board and the committees as working units; and
- Relationship with management.
- It would be advisable to undertake a formal assessment of the skills and qualifications that the current board has; and
- It would also be advisable to carry out a formal gap analysis with a view to highlighting the skills and qualifications the board should look for in any new directors that may be appointed to the board.
Board renewal is seen by some as a goal in itself, though it must be tempered with the need to ensure the right balance between turnover and retention of experienced individuals to allow for continuity. Succession planning is an essential component of this.
Determining who should be appointed and re-elected to the board is a matter for shareholders, however, shareholders cannot make decisions in a vacuum. They rely upon the board (often through the nomination committee) to properly identify the needs of the company and to provide shareholders with relevant information enabling them to make informed decisions on appointments.
Increased activism from institutional shareholders in particular means shareholders are less likely to simply rubber stamp the re-appointment of directors in the absence of clear support and reasons from the board as a whole.
There is ongoing debate over whether the tenure of non-executive directors should be a relevant factor in determining their suitability for re-election and their status as independent. My research indicates that there are no hard and fast rules on an appropriate maximum term.
1. Australian Securities and Investments Commission, "IR 04-40 Removal of Directors of Public Companies", Press Release 17 August 2004
2. "Fundamentals. Economic and Investment Commentary" June 2009, Legal & General Investment Management
3. CGPRs, Commentary to Principle 2, at page 18.
4. CGPRs, Commentary to Principle 2, at page 19.
5. Deloitte. "Board Effectiveness. The directors cut" Edition 1, 2007-2008, at page 13.
6. Section 6.2.10
7. Company Director, June 2004 "Building a better board" [cover story]
8. Company Director, Vol 24 No.11 December 08 – January 09 at page 69.
9. At A.7 Re-election.
10. "Corporate Governance and Chairmanship. A Personal View." Adrian Cadbury, at page 96.
11. "Corporate Governance and Chairmanship. A Personal View" Adrian Cadbury, at page 111.
12. At A.3.1
13. At A.7.2
14. "Fundamentals. Economic and Investment Commentary" June 2009, Legal & General Investment Management.
15. "Inside the Boardroom", Richard Leblanc and James Gillies, at page 150.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.