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Corporate Governance in New Zealand

Principles and Guidelines

2.

Board composition and performance

Principle

There should be a balance of independence, skills, knowledge, experience, and perspectives among directors so that the board works effectively.

Guidelines

2.1.

Every issuer's board should have an appropriate balance of executive and non-executive directors, and should include directors who meet formal criteria for "independent directors".

2.2.

All directors should, except as permitted by law and disclosed to shareholders, act in the best interests of the entity, ahead of other interests.

2.3.

Every board should have a formal charter that sets out the responsibilities and roles of the board and directors, including any formal delegations to management.

2.4.

The chairperson should be formally responsible for fostering a constructive governance culture and applying appropriate governance principles among directors and with management.

2.5.

The chairperson of a publicly owned entity should be independent. No director of a publicly owned entity should simultaneously hold the roles of board chairperson and chief executive (or equivalent). Only in exceptional circumstances should the chief executive go on to become the chairperson.

2.6.

Directors should be selected and appointed through rigorous, formal processes designed to give the board a range of relevant skills and experience.

2.7.

Directors should be selected and appointed only when the board is satisfied that they will commit the time needed to be fully effective in their role.

2.8.

The board should set out in writing its specific expectations of non-executive directors (including those who are independent).

2.9.

The board should allocate time and resources to encouraging directors to acquire and retain a sound understanding of their responsibilities, and this should include appropriate induction training for new appointees.

2.10.

The board should have rigorous, formal processes for evaluating its performance, along with that of board committees and individual directors. The chairperson should be responsible to lead these processes.

2.11.

Annual reports of all entities should include information about each director, identify which directors are independent, and include information on the board's appointment, training and evaluation processes.

Key findings from consultation

• An independent director has no relationship with the company that could compromise his or her ability to exercise unfettered judgment.
• An independent director should not be a substantial shareholder in, a material customer of, or a material supplier or professional adviser to, the company.
• Opinion was divided on whether independent directors should make up the majority of boards.
• Boards should have members who bring the skills and experience needed for the governance of the particular entity.
• Board size should be determined by factors including the size and complexity of the company and the skills and experience needed to govern it.
• The CEO should not be the chairperson nor go on to be the chairperson.
• Boards should review their performance yearly.
• Boards should review the performance of individual directors.
• More could be done to enable shareholders to assess board performance.
• Opinion was divided on whether directors should be certified or accredited.
• Entities should have recruitment and induction programmes for directors.

Securities Commission view

The board must guide the strategic direction of the entity, and direct and oversee management. Each director must have skills, knowledge and experience relevant to the affairs of the entity. Individual directors may bring particular attributes that complement those of other directors. An effective board requires a range and balance of relevant attributes among its members. Each director must be able and willing to commit the time and effort needed for the position.

Independence of mind is a basic requirement for directors. Each should endeavour to have an independent perspective when making judgements and decisions on matters before the board. This means a director puts the interests of the entity ahead of all other interests, including any separate management interests and those of individual shareholders (except as permitted by law). Directors with an independent perspective are more likely to constructively challenge each other and executives-and thereby increase the board's effectiveness.

Non-executive directors, with no other interests to hinder their judgement in the interests of the entity, can contribute a particularly independent perspective to board decisions. Increasingly, international practice has been to establish criteria for defining some independent directors of listed entities, and to require or encourage a majority of such directors on the board. Recent studies indicate, however, that board effectiveness is not always enhanced by directors' formal independence if this is given too much weight in contrast to the independence of mind, and the skills, knowledge, experience, and time that a director can contribute to the entity. Independent representation is an important contributor to board effectiveness, but only when considered along with the other attributes sought in a non-executive director.

As reflected in the consultation, there may be practical constraints in New Zealand if too high a level of formal independence is required of boards. With New Zealand's relatively small pool of qualified and experienced directors there is a risk that seeking independence at the cost of all else will lead to missed opportunities to appoint directors who can contribute to the success of entities. We consider the underlying issues relating to director independence can be addressed by:

• Directors having an independent perspective in their decision making;
• A non-executive director being formally classified as independent only where he or she does not represent a substantial shareholder and where the board is satisfied that he or she has no other direct or indirect interest or relationship that could reasonably influence their judgement and decision making as a director;
• The chairperson of a publicly owned entity being independent.
• In every issuer, the board including independent director representation.
• Boards of publicly owned entities comprising
  • a majority of non-executive directors; and
  • a minimum one third of independent directors.

• Boards taking care to meet all disclosure obligations concerning directors and their interests, include information about the directors, and identify which directors are independent.

It is important to recognise the contribution of executives: the skills and perspectives they have provide a sound basis for challenge by non-executive directors. Strong executive representation at board meetings or on boards promotes a constructive exchange between directors and executives that is necessary for boards to be effective. To maintain proper balance between executive and non-executive directors, it can be useful for the latter to meet regularly to share views and information without executives present.

Efficiency and accountability are improved if the respective roles of the board and executives are well understood by all. This can be assisted by the adoption of a board charter that sets out the responsibilities of the board and its directors and that includes details of any delegations given by the board to management.

Directors are entitled to seek independent advice. This may be necessary to fully inform themselves about an issue before the board, and to effectively contribute to board decisions.

The chairperson is critical in director-executive relations. The chairperson's role includes promoting co-operation, mediating between perspectives, and leading informed debate and decision making by the board. The chairperson also has a pivotal role between the CEO and the board. Balance in the relationship between management and the board is particularly important in entities with public shareholders. This balance is facilitated if the roles of chairperson and chief executive (or equivalent) are clearly separated and if the chairperson is an independent director. We agree with respondents to the consultation that in general, the chief executive should not move on to become chairperson. Only in special circumstances should the roles be combined, e.g. where an individual has skills, knowledge and experience not otherwise available to the entity (and where these circumstances are fully explained to investors).

The optimum number of directors for any entity will depend on its size and the nature and complexity of its activities, as well as its requirement for independent directors. If a board is too large, decision making becomes unwieldy; if too small, it may not achieve the necessary balance of skills, knowledge and experience needed by the entity. This balance is most important for issuers.

The need to achieve the right mix, and to choose directors who can make an appropriate contribution, make director selection and nomination vitally important. Rigorous selection, nomination and appointment processes are needed to achieve this. A separate nomination committee can help to focus resources on this task, and also on succession planning.

Non-executive directors often do not have the advantage of prior knowledge of an entity. This makes it important that they clearly understand their expected roles within the entity. It will be of value for a new director if the board sets out its expectations of his or her role.

To be individually effective, directors need to make themselves familiar with both the activities of the entity and their responsibilities as a director. Induction training and opportunities to attend directors' professional education can greatly assist this process.

Effectiveness can also be enhanced if the board and directors regularly assess their own performance and that of their individual members against pre-determined measures of the efficiency and effectiveness of board processes, and on the contributions of individual directors. The Commission would like to see each board develop its own review and report processes as an integral element of its focus on good governance.

3.

Board Committees

Principle

The board should use committees where this would enhance its effectiveness in key areas while retaining board responsibility.

Guidelines

3.1

Every board committee should have a clear, formal charter that sets out its role and delegated responsibilities while safeguarding the ultimate decision making authority of the board as a whole.

3.2

Where issuers have board committees, the charter and membership of each should be published for investors.

3.3

Proceedings of committees should be reported back to the board to allow other directors to question committee members.

3.4

Each publicly owned company should establish an audit committee of the board with responsibilities to: recommend the appointment of external auditors; to oversee all aspects of the entity-audit firm relationship; and to promote integrity in financial reporting. The audit committee should comprise:

• all non-executive directors, a majority of whom are independent;
• at least one director who is a chartered accountant or has another recognised form of financial expertise; and
• a chairperson who is independent and who is not the chairperson of the board.

Key findings from consultation

• Board committees set up for specific purposes can improve effectiveness, however boards should retain responsibility for policy and governance.
• Public companies should have audit committees to appoint and oversee external auditors.
• Audit committees should have an independent chairperson and a majority of independent directors.
• Audit committees should have at least one member with financial expertise.
• Large boards should have a remuneration committee.
• Opinion was divided on the need for appointment committees.
• Remuneration and appointment committees should have a majority of independent directors.
• A person should be able to sit on both the remuneration committee and the audit committee.

Securities Commission view

Board committees can significantly enhance the effectiveness of the board through closer scrutiny of issues and more efficient decision making in key areas of board responsibility. Committees enable the board to make maximum use of particular skills, knowledge and experience of directors. In addition, they can be a means of fairly apportioning board workload among directors.

A committee must have an effective relationship with the board as a whole. Committee members must clearly understand the committee's purpose and role and the extent of any formal delegations from the board. A clear, formal committee charter agreed by the board is an efficient way to achieve this. Disclosing the charter and information on the composition and work of committees will assist investors and stakeholders to assess the effectiveness of board committees.

The accountability of the board as a whole must be maintained, including in relation to work undertaken by committees. The board must be well informed about decisions for which it retains ultimate responsibility. For this reason it is important that the proceedings of committees are reported back to the board, and time is given for any director who is not on the board to comment on or seek an explanation of the business of the committee.

Financial reporting and audit processes are a key area of board responsibility. It is increasingly common practice in New Zealand and internationally for entities to use audit committees. We believe they are an important tool for all publicly owned entities, and we would encourage their use by all issuers.

As with other committees, the role of the audit committee needs to be clearly established. This can be achieved by a formal charter, including responsibility for recommending the appointment of external and internal auditors; overseeing the entity-auditor relationship; and promoting the integrity of the entity's financial reporting.

The structure of the audit committee is important, both in terms of independence and the skills needed. To ensure effectiveness, it should comprise:

• only non-executive directors;
• a majority of independent directors;
• at least one director who is a chartered accountant or has another recognised form of financial expertise; and
• a chairperson who is an independent and is not the chairperson of the board.

Other areas of board performance could also be improved by the use of committees. Remuneration and nomination committees are increasingly being used in New Zealand and overseas. It is vital that boards give proper time and attention to both matters. All entities, particularly those with large boards, should carefully consider whether the use of committees could enhance their effectiveness in these key areas.