Parliamentary Joint Committee report on corporate responsibility
What are the implications for directors’ duties?
The Parliamentary Joint Committee on Corporations and Financial Services (Committee) published its report on Corporate Responsibility: Managing Risk and creating value in June 2006.
The report provides valuable guidance in assessing the likely regulatory and policy measures that may be implemented by the Australian Government in response to the growing focus on ‘corporate social responsibility’ (CSR) within the business community and the public at large. The growing interest in CSR stems both from widely-held concerns regarding sustainability in the era of globalisation, as well as the increased focus on corporate governance generally, itself prompted by a series of high-profile corporate collapses and scandals in Australia and elsewhere.
In particular, the Committee has concluded that the existing legislative framework of directors’ duties is satisfactory and that no amendments to the Corporations Act 2001 (Cth) (Act) are required. The Committee favoured what it terms the ‘enlightened self-interest’ interpretation of directors’ duties, namely that the existing legislative framework already permits directors to take into account the interests of non-shareholder stakeholders in corporate decision-making, to the extent that those interests are relevant to their company.
Background to the report
The Committee’s report was prepared in response to terms of reference dated 23 June 2005 concerning ‘Corporate responsibility and Triple-Bottom-Line reporting’. This update focuses on only one aspect of those terms of reference, namely the extent to which organisational decision-makers do, and should, have regard for the interests of non-shareholder stakeholders and the broader community, and the extent to which the current legal framework governing directors’ duties encourages or discourages this.
The PJC inquiry received approximately 146 submissions from a broad range of respondents, including mining companies, banks, large non-listed companies, academics and researchers, professional advisors, professional bodies and not-for-profit entities. Many subsequently appeared before the Committee to summarise their submissions and answer questions.
This inquiry was held concurrently with the inquiry into directors’ duties and CSR held by the Corporations and Markets Advisory Committee (CAMAC) under terms of reference dated March 2005. The inquiries made reference to each other and in many cases received identical submissions. CAMAC’s final report is expected before year-end.
Does the existing legislative framework encourage or inhibit CSR?
The Committee began by reviewing the drivers and principles of what it terms ‘corporate responsibility’, noting that the concept of corporate responsibility is multi-faceted and a ‘one size fits all’ approach is not appropriate in light of the diverse range of corporate entities, corporate activities and stakeholder interests in Australia today.
The Committee then reviewed the existing legislative framework (being the duties imposed on directors and in some cases other officers under Part 2D.1 of the Act), and assessed its impact. In particular, the Committee identified four general approaches to this framework, being:
- The directors’ restrictive interpretation, which considers that the directors’ obligation to act in the best interests of their company is paramount and will generally preclude acts of corporate responsibility unless they are clearly incidental to profit generation or legal compliance by the company (the ‘James Hardie’ argument).
- The shareholders’ restrictive interpretation, which objects to acts of corporate philanthropy and other forms of CSR that are not clearly incidental to profit generation or legal compliance on the basis that corporate funds are the shareholders’ property and should be distributed to them for use as they see fit (including philanthropic acts).
- The short term interests interpretation, which holds that investment in CSR is permissible under the current framework provided such activities can demonstrate the same ‘return on investment’ (eg enhanced reputation and market share) as purely financial investments.
- The enlightened self-interest interpretation, which considers that careful and appropriate corporate responsibility is generally in the company’s interests and is therefore permitted under the current legislative framework.
The Committee rejected the first two interpretations as overstating the impact of the Act’s requirements, and identified a number of problems with the third model. The Committee strongly favoured the enlightened self-interest approach, noting that the adoption of this approach by directors is likely to foster their company’s long-term growth (contrary to the claims raised by many opponents of CSR).
Should the existing legislative framework be changed?
Having formed this view, the Committee then considered a number of options for legislative change. These included proposals that the Act be amended to make corporate responsibility compulsory, or to clarify that it is permissible to engage in corporate responsibility, along with arguments that no amendments are required to support the enlightened self-interest interpretation and that a whole-of-law approach is necessary, as corporate regulation is achieved under numerous pieces of state and federal legislation.
The Committee concluded that there was no compelling case for change, and that the proposed ‘mandatory’ and ‘permissive’ amendments to the Act were clearly inappropriate. It argued that the broad range of statutes currently regulating the social and environmental performance of corporations gives further support to its view that no amendments to the Act are required.
It is noteworthy that the Committee soundly rejected the proposed ‘duty to promote the success of the company’, a directive provision contained in the UK Company Law Reform Bill 2005. The Committee considered this to be an inappropriate means of entrenching the enlightened self-interest approach, as it is likely to give rise to considerable uncertainty for directors as well as a ‘compliance culture’ (rather than a true commitment to CSR) within corporations.
The Committee also rejected a proposed ‘ethical judgment rule’, which would offer a ‘safe harbour’ for directors who make decisions based on bona fide and well-founded ethical considerations, even if those decisions have a detrimental effect on their company or its shareholders. The Committee considered that the existing ‘business judgment rule’ contained in the Act is satisfactory, and that the proposed rule may also offer a ‘defence of last resort’ to directors who have in fact behaved improperly.
The Labor members of the Committee agreed in principle that no changes to the directors’ duties provisions in the Act are required, but recommended that this be reconsidered by the Australian Government if any legal barriers to the consideration of legitimate social and environmental issues by directors are subsequently raised.
Other recommendations of interest
In brief, the Committee also recommended that:
- The influence of 'short-termism' on corporate behaviour could be countered by structuring the remuneration packages of directors, executive officers and managers to include longer-term (ie greater than a 3 to 5 years) and CSR performance measures. It will be interesting to see whether the business community shares this view and makes any significant changes to existing remuneration models.
- Not-for-profit entities should strive to meet the same corporate responsibility standards as the for-profit sector is expected to meet. Representatives of the NFP sector had submitted to the Committee that NFP's may require greater time and assistance to comply with those requirements than other companies might.
- The ASX Corporate Governance Council, as part of its review of the Principles of Good Corporate Governance and Best Practice Recommendations, consult with industry to provide companies with further guidance regarding non-financial reporting. In particular, the ASX Guidance Note should promote the disclosure by companies of their top five sustainability risks and the strategies implemented to manage those risks.
- Sustainability reporting remain voluntary. The Committee considered it premature to adopt the Global Reporting Initiative Framework as the basis, or a starting point, for voluntary sustainability reporting, but recommended that the Australian Government monitor the national and international uptake of the GRI Framework and provide the business community with guidance on how to apply it. The Committee also recommended that company auditors annually review the extent to which companies make non-financial disclosures in their Operating and Financial Reviews, and advise boards on the adequacy of such disclosure in light of the evolving needs of shareholders and the market in order to evaluate material non-financial performance, risk profile and risk management strategies.
- The Australian Government play a key role in encouraging and facilitating corporate responsibility through a range of policy initiatives involving education, consultation, promotion of CSR initiatives globally, provision of seed funding and a review of possible regulatory initiatives to encourage CSR. In particular, the Committee recommended that the Australian Government encourage Australian companies to become signatories to the UN Global Compact (where appropriate for them), and should itself show leadership by implementing voluntary sustainability reporting targets and 'green' procurement targets for government agencies, with each agency to report on its targets and performance in its annual report.
Key implications for directors
The Committee’s recommendations may be unpalatable to those who consider that directors require urgent clarification of the scope of their duties and powers - eg clarifying precisely when causing their company to engage in corporate philanthropy (which can involve a broad range of activities, from anonymous donations to long-term sponsorships and community partnerships) will result in them breaching their duties. Activists seeking regulatory change to make CSR a mandatory and explicit component of corporate decision-making may also be disappointed.
However, the Committee’s recommendations, and the existence of the PJC inquiry itself, are a victory for proponents of CSR generally. They legitimise the claims that ‘corporate responsibility’ is a multi-faceted but meaningful concept, and that companies are likely to benefit if they integrate CSR into their core business and strategy - and are likely to suffer if they do not.
Importantly, the Committee stated that: ‘In many cases, it will be clear that corporate responsibility enhances shareholder value. At the very least, it is clear that rampant corporate irresponsibility certainly decreases shareholder value ... Progressive, innovative directors, in seeking to add value for their shareholders, will engage with and take account of the interests of stakeholders other than shareholders.’ (at paragraph 4.59)
The Committee’s report provides valuable guidance as to the Federal Parliament’s likely response to the CSR debate. The response of the public and the business community to the Committee’s report, along with CAMAC’s final report, will also be interesting to monitor.
What should directors do now?
Prior to CAMAC releasing its final report and the Australian Government formally responding to both reports, directors should consider the following:
- Who are the key non-shareholder stakeholders of my company? What level of dialogue currently exists between my company and these stakeholders? What form does it take?
- To what extent does my company engage in acts of 'corporate responsibility' above and beyond strict legal compliance? Who or what determines the nature of these activities, and their scope? Is there a unitary 'CSR' and sustainability strategy which is understood and supported by the board, management, staff and non-shareholder stakeholders? Are any systems in place to monitor the impact of these activities on the company's performance (in dollar terms or otherwise)?
- To what extent does my company currently report on the sustainability of its operations and its key sustainability risks? What framework or guidelines are used? Does the reporting extend to the activities of entities which are owned or controlled by my company? Is there any independent assessment of such reports? If my company does not currently engage in such reporting, what strategies are in place to implement an appropriate reporting framework if required in response to regulatory change or market expectations?
- What opportunities does the growing interest in CSR offer my company? How could these opportunities be best identified and captured?
Prudent companies will have systems in place to monitor and promote legal compliance. But companies that show leadership by looking beyond strict legal compliance to focus on issues such as internal and supply chain environmental and social sustainability, zero waste, water and energy efficiency, climate change and social justice and equity issues may stand to benefit over the medium to long term, if not also the short term.
Companies and government agencies that wish to develop or refine a CSR or sustainability strategy should begin by engaging with internal and external stakeholders to identify areas for improvement. Phillips Fox has assisted numerous clients with this process. We are trained in stakeholder engagement by AccountAbility in London. AccountAbility has developed internationally accepted Stakeholder Engagement Guidelines and a practical manual which we can guide you through to develop in-house and specific stakeholder engagement policies and solutions.
This publication is intended as a first point of reference and should not be relied on as a substitute for professional advice. Specialist legal advice should always be sought in relation to any particular circumstances and no liability will be accepted for any losses incurred by those relying solely on this publication.