The Commission's recommended approach for corporate governance depends heavily on disclosure of corporate governance practices by entities. Implementing the Principles necessarily includes reporting about corporate governance practices to shareholders and other stakeholders. For most entities this can be achieved in the annual report.
Many responses to our consultation commented that a "tick-in-the-box" approach to governance reporting would not achieve anything. We agree. The Principles are formulated so that entities can report how they have achieved each Principle.
This reporting is likely to include a brief description of the structures and processes put in place by the board to help it fulfil its governance responsibilities, and how it has used them.
The guidelines are intended to help entities to think about how they can achieve each Principle. We do not expect entities to specifically report against these guidelines. Reporting should describe how an entity has achieved the Principles.
Listed issuers who have high standards of corporate governance are likely to address already all the issues covered by the Principles, both by adopting certain practices and by reporting on them. They report on these under NZX Listing Rule 10.5.3(h), which requires annual reports to include "a statement of any corporate governance policies, practices and processes, adopted or followed by the Issuer". For the many listed issuers whose governance practices and reporting are already of a high standard, adopting the Principles is unlikely to impose any new requirements or additional reporting.
However, listed issuers whose reporting under Listing Rule 10.5.3(h) does not cover all the corporate governance areas of the Principles should, we think, examine their corporate governance practices with a view to adopting and reporting on all of the Principles.
The Principles therefore do not impose a dual reporting regime.
Listed issuers have continuous disclosure obligations under Listing Rules. Proper observance of corporate governance is an important contributor to transparency and efficiency in the capital markets. Some matters relevant to corporate governance could be "material information" that must be disclosed under the Listing Rules of NZX. Nothing in this document about the content of annual reports should be taken to detract from any obligation a listed issuer has to disclose a matter under the continuous disclosure Listing Rules.
Formal corporate governance reporting may be new to some smaller unlisted entities. The Commission believes that all entities should think about their corporate governance practices; however we are aware that it may take time for some smaller entities to achieve and report against all the Principles. In the meantime we think it would be helpful for these entities to report to their investors and stakeholders on progress made towards observing and reporting on each Principle.
Disclosure is important because it makes entities more accountable to their shareholders and other stakeholders. However, there are two sides to this and the users of this disclosure have a significant role. For disclosure to be effective, shareholders, investors, and other stakeholders need to evaluate the information they are given and, on this basis, responsibly call directors and executives to account.
The Commission expects issuers to tell investors how they have achieved each Principle. There are a variety of ways in which any entity may achieve the Principles. It may or may not include adopting the guidelines in this document. The guidelines are not ends in themselves. They also may not be ideal for every entity to which we think they could apply. Therefore, where we have provided guidelines for any type of entity, it is open to that entity to take a different approach. Shareholders and other investors should give due weight to the entity's reporting of how it has achieved the relevant Principle, and take a common sense approach to deciding whether or not they accept it.
Directors should observe and foster high ethical standards.
Ethical behaviour is central to all aspects of good corporate governance. Unless directors and boards are committed to high ethical standards and behaviours, any governance structures they have put in place will not be effective.
Good governance structures can encourage high standards of ethical and responsible behaviour. A formal code of ethics will assist in this when it is understood by directors and management and applied to their governance decision making.
Codes of ethics are increasingly being adopted by listed issuers. More widespread adoption and implementation of codes of ethics will help bring New Zealand into line with international best governance practice and will promote public confidence in governance structures and behaviours generally.
Different businesses face specific ethical issues. A code of ethics needs to suit the particular circumstances and needs of the entity, and to be formulated with this in mind.
Codes of ethics can vary for different types of entity to address the circumstances of each entity's business. However, some common ethical issues arise in every entity that is accountable to shareholders, investors, and other stakeholders. It is our view that at a minimum a code of ethics should address the matters set out in the guidelines above. Depending on the entity there may be other matters that it is appropriate to include. As circumstances change, codes of ethics may need to be expanded or updated to ensure that they remain relevant.
The existence of a code of ethics will not, alone, create ethical and responsible practices. A code is a guide and reminder of expected behaviours and sets standards against which behaviours can be judged. A code is ineffective unless directors and employees actively adhere to it. The board will need systems in place to allow it to oversee implementation of the code. A code is not fully implemented unless there is monitoring to evaluate practices against the code. This could form part of the board's annual performance assessment.
There is a trend overseas for entities to have an ethics committee to assess the performance of directors against the code of ethics. Some entities go as far as seeking independent verification, on a periodic basis, of the implementation of codes of ethics. Some entities may find this appropriate. Ultimately the board is responsible for ethical behaviour within the entity.
A code of ethics will not be effective unless there are consequences for directors and employees who breach it. An effective code of ethics will set out processes for holding individuals accountable for unethical behaviour and include appropriate sanctions. Accountability for behaviour at variance to the code will depend on who has committed the breach, e.g., executives to the board and other personnel to executives.
Transparency encourages ethical behaviour by increasing the accountability of directors and other personnel. This accountability will be enhanced if entities publish their codes of ethics for investors and stakeholders, and describe in their annual reports the steps taken to implement the code and monitor compliance. We are of the view that this reporting should include, in general terms, information about any serious instances of unethical behaviour encountered within the entity, and the steps taken to deal with this.