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Corporate Governance in New Zealand

Principles and Guidelines

THE FINDINGS FROM RESPONDENTS

Issue One: Ethical Conduct

Q: There is a view that companies should have formal codes of ethics or conduct to guide the actions of board and management, as well as other staff? To what extent do you agree with this?

The great majority of respondents supported this. A typical response was that a code of ethics:

"should be considered best practice ..."

Some qualified their support by commenting it should not be mandatory to have such codes. Others considered that codes may be appropriate only for listed companies, and may be unworkable for smaller, privately owned companies.

Some respondents suggested that codes be kept simple and should offer guidelines rather than rules, although several respondents stated a preference for more prescriptive codes. There was a view that it is not possible to legislate for ethical behaviour.

Some stated that an entity's culture, with management leading by example, is more important than a set of written principles. Some emphasised the need for careful selection of directors. Several considered that a code sets the tone of an organisation and raises awareness of ethical issues. Some people stressed that implementing a code of ethics is more important than the existence of a code. There was some support for individual entities preparing their own codes, while others supported a "standard" code which could meet the needs of a variety of entities.

Of those who disagreed, some noted that the Companies Act 1993 contains basic ethical obligations in the form of directors' duties, and that these should suffice. It was also suggested that a board charter is a more useful document, defining the governance responsibilities of the board and the demarcation of responsibilities between the board and management.

Q: Should a code of ethics or conduct be published?

A majority of respondents supported publishing codes, although there was a strong view that this should be at the discretion of the entities concerned. One respondent's comment summed this up saying:

"Publication internally in an organisation is useful in assisting consistent communication of a Code of Ethics or Conduct. Publication can also be useful to shareholders so they can gain an understanding of the ethics of their company. Each company needs to consider whether the circumstances of its business mean that is worthwhile providing a published version of a code..."

Some people commented that it may be appropriate to publish codes, or summaries of them (with full copies available on request), in annual reports and/or websites. This was considered more important for listed companies, state-owned enterprises and public sector bodies. Others considered that internal distribution would be sufficient.

The small number who disagreed with publishing codes said it was of limited meaning or value.

Q: Codes of ethics may address various issues including integrity, the use of company assets, conflicts of interest and confidentiality. What issues do you think it is most important for such codes to include?

A majority thought that codes of ethics should address issues of integrity, conflicts of interest, confidentiality and the use of an entity's assets and resources (including information).

Some respondents said it was appropriate to set out in codes the consequences of breaching them. Several considered that codes should include provisions relating to legal compliance, disclosure, good faith, transparency, trading in company securities, whistleblowing, responsibility to stakeholders, honesty in dealings with third parties, and the health and safety of employees and the wider community.

Some respondents stated that codes should include policies on the giving and receiving of gifts and political donations and others thought that codes should include a "no personal gain" policy. Several commented that, to be effective, codes should be kept simple and short. It was also suggested that each code's content be tailored to the particular company. Some respondents gave examples of codes on which a model could be based, including the Code of the Institute of Directors in New Zealand Inc and the NZX Corporate Governance Principles.

Q: What do you consider the most appropriate responses - both internal and external to the company - where such a code has been breached?

There was strong support for having policies and procedures for dealing with breaches. Some people commented that these should be transparent and applied consistently.

" One policy for all, and transparently so.".

The majority view was that the way breaches are handled, and the extent to which they are communicated externally and/or internally, should depend on the severity of the breach. Some respondents considered breaches should be dealt with internally, unless the law required external reporting and action. Suggested sanctions included fines, censure and dismissal.

Some people specified different responses for directors and employees. Some considered that codes should be enshrined in employees' contracts and breaches dealt with in the same way as breaches of any other company policy, with serious breaches resulting in dismissal. For directors, several respondents commented that failure to comply with codes should result in their resignation.

Some commented that breaches by senior management, directors and CEOs should be dealt with by the board, whereas breaches by staff can largely be dealt with by management. Several respondents thought that companies should decide the appropriate responses to breaches. Several considered that disclosure at some level may be appropriate.

The majority supported internal resolutions of breaches, but several respondents favoured the enforcement of codes of ethics by external bodies, such as NZX, the courts, or a regulatory agency. In the case of public sector bodies it was suggested that enforcement be handled by the Auditor-General.

Q: Do you have any other comments on this issue?

The view of several who made further comments was reflected in one comment that:

"ethical conduct is the basis of governance - it sets the tone of an organisation and a behavioural standard against which to measure corporate actions".

Some respondents commented that they already had codes of conduct or ethics. Some referred to the NZX Corporate Governance Principles and others to the Institute of Directors in New Zealand Inc's Code of Ethics, existing company law or professional body obligations as being sufficient.

Several respondents noted the importance of entities monitoring compliance with codes. Some commented that codes can provide stakeholders with a benchmark against which to measure an entity's performance. Some respondents were concerned about the risk of over-regulation and excessive compliance costs. Several commented on the difficulty of reaching consensus on what should be included in a code of ethics. Some concern was expressed that any agreed principles may be too general to be useful.

Several stated the view that it is not useful to attempt to codify ethics. It was also suggested that there is no need for ethical standards beyond those already imposed by law.

Views by type of entity

Views on ethical conduct appear to be based on personal or institutional philosophies. There was no apparent underlying trend by type of entity that suggested different entities, be they listed or unlisted companies, private or public sector, hold different positions on the issues surrounding ethical conduct, the need for codes of ethics or how to handle breaches.

ISSUE TWO: Board Composition and Performance

Definition of independent director

Q: Are the elements included in the following definition appropriate for the New Zealand environment?

"Someone who is not an executive and who has no business or other relationship that could compromise - or could reasonably be seen to compromise - the ability to exercise their unfettered judgement. Such business or other relationships include being a substantial shareholder (or its representative), a material customer, supplier or professional adviser to the company."

Responses indicated strong support for the elements in this definition of an independent director, particularly for larger and/or listed companies. Although the criteria were generally supported, some respondents questioned one or more of them. Several also suggested further criteria.

Some respondents argued that directors representing substantial shareholders should not necessarily be seen as contravening the definition of independence. Issues were raised about relationships with material customers or suppliers, with a number of people disagreeing with the notion that they could not be considered "independent". Some respondents queried the threshold at which a director with a perceived vested interest should be considered not independent.

In relation to professional advisers, some respondents noted that given the size of some professional partnerships, the definition may exclude people not actively involved in providing services to the entity in question.

Additional criteria that were suggested included the exclusion of:

• former executives or employees as persons unlikely to be considered independent (although some respondents suggested a "stand-down" period); and
• people who have personal or family relationships with people involved with the entity.

Some questioned whether long-term service on a board could jeopardise independence, although views on this point were mixed.

Generally contributors noted the limited pool of potential directors in New Zealand, and that this should be borne in mind when considering whether a person is sufficiently independent to serve on a board. On a related note, some contributors stressed that rules on independence should not be considered exhaustive, and should be interpreted in the context of the size and nature of each organisation.

Some stressed the importance of transparency of criteria for appointment, and of rules for dealing with possible conflicts of interest. Some suggested that disclosing directors' interests and board procedures for dealing with conflicts would address issues of independence.

Several suggested that definitions of independence should not distract attention from the responsibility of all directors, whether classed as independent or not, to act in the best interests of the company.

Q: Should independent directors make up the majority of a board? In which situations might it be appropriate not to have a majority of independent directors?

Opinion was divided on whether independent directors should make up the majority of a board. One respondent who supported a majority of independent directors said:

"This is best practice. The interface between board and management to be robust needs a majority of independent directors."

Some of those who supported the concept suggested that while this might be appropriate for listed companies, it may not be appropriate for smaller, privately owned companies or larger or wholly owned subsidiaries. There were also comments on the representation of the interests of majority shareholders. It was suggested that some more specialised types of entities may not suit having a majority of independent directors, for example, co-operative companies have a majority of supplier shareholders.

Many who disagreed with the suggestion that independent directors should be a majority of the board, did agree that there is a need for some independent directors. Some respondents who disagreed with the suggestion cited the need for directors with relevant specialist or industry knowledge, and suggested that, where necessary, this was a more important criterion for board membership than independence.

Some respondents said that the question of independent directors was a matter for individual boards and their shareholders to consider, and that a blanket rule was inappropriate. Others noted that if interests are disclosed and directors act in accordance with established protocols relating to conflicts, the issue of their independence or otherwise should be irrelevant.

"Too great an insistence on independence may lead to organisations missing out on the best people for boards and at times it may be appropriate to recognise that the technical lack of independence of a director may not necessarily translate to an actual lack of independence."

Q: To what extent do you agree that the chair and CEO should not be the same person? What is your view on the suggestion that a CEO should not go on to become chair?

There was strong support for the chairperson and CEO not being the same person.

"This is fundamental. How can the same person provide an interface. The chairperson is the key person to monitor management. You cannot monitor yourself."

Some respondents suggested that while this principle should generally be followed, there may be exceptions such as for the founder or majority shareholder of an entity.

The majority of respondents considered a CEO should not go on to become the chairperson. Some qualified their response by saying there might be cases where an exceptional CEO is the best choice for the position.

"Generally agree, but should not be prescribed. Could be circumstances where, say due to specialist skills and attributes, this could be the best decision for the company."

Some respondents with this view suggested that in these instances a stand-down period might be appropriate. An alternative suggestion was that a majority of independent directors might provide an appropriate balance in such circumstances.

Some of those who opposed the idea suggested that the potential disadvantages of a CEO going on to become chairperson included a reluctance for the new CEO to change decisions made by a predecessor who was now the chairperson.

Q: Should a company's CEO automatically become a member of the board?

Opinion was divided on whether a CEO should be automatically appointed to a board.

Of those who disagreed with automatic appointment most said that appointment may well be appropriate, but that individual companies should be left to make their own choices. Others who disagreed suggested that CEO board membership is inappropriate in any circumstances.

There was a strong view that board members need to be kept informed by management, but also need to be able to question management decisions. To this end many of those who favoured not automatically making the CEO a member of the board suggested that attendance by the CEO at board meetings should be required. Correspondingly, some of the respondents who agreed with automatic membership suggested that boards should meet from time to time without the CEO present.

Q: What factors should be considered in determining board size, and is it feasible to define an optimum size?

Opinion was divided on the optimum board size, or whether such an optimum size could be defined. A majority of respondents suggested that "function should dictate form" and that factors such as company size and complexity, and ensuring a good balance of desired skill sets, experience, qualifications, and industry knowledge should determine board size. Effectiveness was also seen as a key determinant of board size, as was shareholder structure. In this regard, some respondents suggested that boards should be large enough to provide a range of voices and opinions, but not so large that discussion cannot be effective. Where respondents did suggest an optimum size, numbers varied from 3 to 12 people, with between 5 and 9 being the most frequently proposed range.

Q: The following questions were asked:

• How regularly should boards review their own performance?
• Should boards also review the performance of individual directors?
• Are the current mechanisms which enable shareholders to assess board and director performance adequate? If not, how would you suggest these be improved?

Opinion varied on how often boards should review their performance, and how this should be done. A great majority of respondents said boards should review their performance annually. Other suggestions included more frequent reviews (quarterly, for example) and longer intervals such as every two or three years.

The great majority agreed that boards should review the performance of their individual directors. Of those who disagreed, some questioned the value of this, suggesting that it would be difficult to implement or that a good chairperson should review the performance of individual directors on an ongoing basis. Some respondents were cautious on the subject of formal external reviews, suggesting that good board practice should provide for ongoing informal reviews, or that this was a matter for shareholders to determine.

Even where respondents supported the need for regular performance reviews, there was a strong view that the review process should not be mandatory.

Some respondents said the current mechanisms were generally acceptable for shareholders to hold boards to account. However, a majority of respondents proposed one or more additional measures to improve shareholders' ability to hold boards to account. Some said it was difficult for shareholders to assess board and management performance. A range of additional measures was suggested, generally focusing on a perceived need for greater transparency about board performance.

These included:

• better use of annual reports and other communications tools to highlight aspects of board performance;
• using external assessors to review performance;
• providing shareholder briefings by the board during the financial year, and forums for discussion between shareholders and directors;
• requiring issuers to report to shareholders against governance principles;
• using shareholder advocacy committees, reporting to the annual meeting; and
• providing records of directors' attendance at board meetings and time spent on board business.

Several respondents said that financial performance was the key gauge of a board's success. Others suggested that an increased emphasis on enforcing the remedies currently available in company legislation would be of assistance.

Q: Should certification or accreditation of directors be encouraged?

There were strong views both for and against the certification or accreditation of directors.

Some respondents supported certification or accreditation and considered that it could be useful, particularly for new directors. One commented:

"This is desirable especially for public companies, but would depend on the means and level of qualification ... it is important to refresh regularly on an ongoing basis..."

However, respondents generally opposed any mandatory requirements for directors to be certified or accredited. Some suggested that such qualifications may have value as a mark of achievement or measure of competence, but should not be required as a formal qualification to become a director.

Some opposed the concept of certification or accreditation. For example:

"Disagree. Passing a test won't guarantee any improvement in corporate governance. Experience is what counts."

Some suggested that an accreditation process would not necessarily provide the skills needed for effective board participation, and suggested that it may remove otherwise suitable people from consideration.

Q: What processes should boards have in place to recruit suitable directors and to ensure they remain fit for their role?

There was strong support for robust recruitment processes and general support for skill set requirements to be reviewed regularly.

"Rigorous analysis of the needs of the board for specific skills in the context of the business, and matching of recruitment process to identified skill requirements."

Board appointment committees and the use of disciplined recruitment processes, similar to those used for executive recruitment, were also supported.

Some stressed the need for boards to focus on the necessary skills required in new directors, and to widen the pool of potential applicants. Induction programmes were strongly supported and there was some support for professional development programmes - although this was not seen as something that should be regulated. Of those respondents who were more sceptical about the merit of these programmes, several said that this should be dealt with as an informal matter or viewed as a responsibility for directors themselves, and not as a matter for the board.

Q: Do you have any other comments on this issue?

Several respondents were strongly of the view that increasing shareholder value is the key responsibility of a board of directors and that this should be the main consideration when appointing directors and assessing their performance.

Others suggested that boards should seek to achieve the right balance of skills and experience. Personal qualities such as integrity and diligence were considered important. Diversity was also seen as important, but not at the expense of skills.

Several respondents said that a key factor in board performance is the "team relationship" or "chemistry" between members, together with strong leadership by the chairperson. Some cautioned that intangible factors such as these can be destroyed by too many prescriptive rules about board composition and procedures.

Some respondents noted that independence from management is very important. It was suggested that non-executive directors meet regularly without management, and that boards regularly review their delegations to management.

There were some comments about the appointment and retirement of directors, including a need for contested elections and/or regular re-elections, a set retirement age or fixed maximum term, and a limit on the number of directorships that may be held at one time.

Some respondents commented on the nature and amount of director remuneration, although opinion was divided on whether remuneration should generally be higher or lower than current remuneration levels, or whether share or option schemes encourage performance.

Views by type of entity

Those who replied on behalf of unlisted companies were more likely than those from other entities to maintain that there were difficulties in including "substantial shareholders" in the definition of independent director. Similarly, those replying on behalf of unlisted companies tended to argue that the limited pool of director talent available in New Zealand should be taken into account.

Of those respondents who emphasised the need for transparency in personal/supplier relationships, those responding on behalf of professional associations were more likely than others to advocate a high level of transparency.

Representatives of listed companies, professional firms and associations were more likely than those of other entities to support the majority of directors being independent directors.

Those people identifying themselves as board chairs were more likely than others to support the need to review the performance of individual directors.

On assessing the performance of boards as a whole, people from professional firms were more likely than others to suggest that current mechanisms were inadequate.

Relatively few respondents from unlisted or listed companies supported the certification or accreditation of directors. The strongest support for this came from associations and professional firms.