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Corporate Governance in New Zealand

Principles and Guidelines

Issue Three: Board Committees

Q: What are the benefits and/or drawbacks of board committees in the New Zealand environment?

The majority of respondents saw the benefits of board committees outweighing the drawbacks.

Respondents noted that benefits of committees include:

• bringing a focus and appropriate expertise to the consideration of board issues;
• enhancing board efficiency and effectiveness;
• enabling issues to be studied in-depth;
• allowing for a better division of workload;
• allowing for specialisation; and
• giving board members specific areas of responsibility.

Committees were viewed as more beneficial for larger or listed companies and companies with large boards. Several respondents considered that audit and remuneration committees have a particular place. Some noted that committees are beneficial for improving governance.

"Sub-committees do have a role in large organisations. They are also useful in the monitoring of specific projects. They should not be used to denigrate the Board's collective responsibility or to isolate some members from the decision making process."

Drawbacks were seen in delegating responsibility to committees when whole boards should be responsible and accountable. Some respondents thought that full reporting by committees to boards was also desirable, with confirmation of committee decisions retained at board level. Some said that certain matters should not be referred to committees. Others considered that committees should only have delegated powers of recommendation back to full boards. Some noted as drawbacks the practicalities of having committees when board size is limited, and the small size of most (New Zealand) organisations. Several noted that committees are not necessary for smaller boards.

Some supported committees being optional and kept to a minimum. Several said that a committee should only be established where it improves the board's effectiveness. Some were concerned that directors may not have a complete understanding of issues if there are too many committees. Others considered it important that committees not duplicate the work of boards. Some respondents emphasised the need for committees to have clear and transparent terms of reference, powers and membership.

Q: Is it appropriate in the New Zealand environment for public companies to establish board audit committees with formal responsibilities for appointing and overseeing external auditors?

There was close to unanimous support for audit committees with responsibilities for appointing and overseeing external auditors.

Qualified support was based on the size and legal status of the entity (with the strongest support being for listed companies having audit committees). Some respondents noted that it would be appropriate for larger companies and for companies with wide public ownership. Others agreed that it was appropriate, but noted that for smaller boards the appointment and oversight of external auditors could be done by the board as a whole. The view was expressed that an audit committee should not be mandatory and is a matter for the board to decide.

Several respondents did not consider board audit committees to be appropriate in a New Zealand context. Some noted that boards as a whole could perform this function.

Q: Is it appropriate in the New Zealand context for audit committees to include a majority of independent directors and an independent chairperson?

There was strong support for requiring audit committees to include a majority of independent directors and an independent chair. One respondent said:

"In New Zealand an audit committee should comprise wholly or substantially independent non-executive directors. The chair of the committee should be an independent non-executive director. Except in the case of companies having a small number of directors where it can give rise to practical difficulties, the chair of the board should not also be chair of the audit committee."

Several respondents who gave qualified support suggested that the chair of the audit committee should not be the chair of the board, and that the committee need not comprise a majority of independent directors. Several considered that a majority of independent directors would be desirable but that an independent chair may not be necessary. Some respondents said it was important that the audit committee be made up only of independent directors and an independent chair. Others supported the practice but considered it should not be mandatory.

A minority disagreed with the requirement for a majority of independent directors and an independent chair. Of these, some considered it should not be mandatory and that it was the board's decision. Some considered that the board members with the most appropriate skills should be used, although obvious conflicts should be avoided. Others suggested, in relation to listed companies, that it should not be a requirement but that the basis of a decision to vary from majority independence should be communicated to shareholders.

Some respondents (both those who agreed and who disagreed with the need for independence) commented on the definition of "independent director". Some noted in relation to supplier directors of co-operative companies that although directors may be impartial, they are not likely to be "independent" because they may trade with the co-operatives. A distinction was drawn by some respondents between "independent directors" and "non-executive directors", with the view that audit committees should not include executive directors.

Q: It is often a requirement for audit committees to have at least one member with financial expertise. What other capabilities or credentials ought to be reflected within the membership of an audit committee?

There was strong support for audit committees having at least one member with financial expertise.

Other skills seen as important included legal knowledge, risk management expertise, industry knowledge, experience, "a questioning mind", independence, integrity, knowledge of the company, knowledge of operational and strategic risks, and an understanding of the audit process. Good judgment and commonsense were seen by some respondents as important attributes.

Some respondents considered a formal accounting qualification necessary. Others noted the need to have sufficient time to devote to the role. A small number said that the attributes that made someone eligible to be a director should be sufficient to qualify them for sitting on an audit committee.

Q: Is it appropriate in New Zealand for boards above a certain size to delegate responsibility for director and executive remuneration to a board remuneration committee?

There was strong support for the proposition that boards above a certain size have a remuneration committee. Some respondents said this was a matter that should be left to boards to decide.

"Director and executive remuneration will always be of interest to shareholders. .... Establishing a remuneration committee that has a formal and disclosed charter clearly indicates that a company has a methodical way to set ... remuneration. Companies with large boards may be more efficient if they delegate setting these policies to a remuneration committee however ... such decisions are fundamentally the role of the board."

Of those who gave qualified support for the proposition, many said that the matter could be delegated to committees to consider and make recommendations, but it was for boards to make determinations on remuneration. Some said it should not be mandatory. Others noted that it would depend on the type of entity, the size and legal status of the company, the complexity of the company and the size of the board. Generally it was seen as more appropriate for larger or listed companies and companies with larger boards.

Some who disagreed did not consider it necessary given the size of most New Zealand companies. Some respondents considered that shareholder input to the process is important. Others said it was not relevant to district health boards and not appropriate for local government.

With or without a dedicated committee, a clear and transparent remuneration policy was seen as important.

Q: Is the establishment of appointment committees with delegated responsibility for recruitment and the appointment of new directors and executives appropriate in New Zealand?

Opinion was divided on the need to establish appointment committees.

Company size and board size were seen as determinants of the need for an appointment committee. Generally it was seen as more appropriate for larger companies and companies with larger boards. Some respondents considered that the decision on whether to have an appointment and nomination committee should be optional and at the discretion of the board. Some thought that an appointment committee might be established on an ad-hoc basis rather than as a standing committee.

Several respondents who provided qualified support suggested that, while it may be appropriate to have an appointment committee, it should not have delegated responsibility for making appointment decisions. Some thought the role of the appointment committee should be to consider and make recommendations to the board, with the board to make any determination and accept responsibility for the decision.

"Appointment committees are appropriate, and suitable for making recommendations, however the full board should retain final responsibility."

Some respondents who disagreed considered it to be a matter for the full board, or considered it unnecessary or inappropriate. Some queried whether there was any merit in establishing such committees and noted the small size of the New Zealand market.

Informed decision making and a transparent process were seen as important, whether or not an appointment committee was used.

The question was not seen as relevant for appointments to district health boards and public sector entities. For some roles, appointments were made externally and based on different criteria.

Q: Should independent directors make up the majority on remuneration and appointment committees?

Although opinion was divided on the need for boards as a whole to include a majority of independent directors, there was strong support for remuneration and appointment committees to be made up of a majority of independent directors.

"Yes, this would encourage independence and objectivity in these sensitive areas."

Where agreement was qualified, respondents noted the size of the company, the size of the board and whether it would be feasible to achieve this. Some said it was more important that the majority were non-executive directors, and others qualified their support according to the definition of "independence" used.

Some respondents disagreed. Several said that the people with the best skills should be used. Others disagreed because it would be too restrictive for some organisations. Some noted that "independence" does not enable directors to better fulfil the functions of the committee. Others considered it was a matter for the full board to decide.

Some respondents considered these committees should comprise only independent directors.

Q: Do you agree or disagree with the view that audit and remuneration committees should comprise different people (ie that no director should sit on both)?

A majority of respondents disagreed that audit and remuneration committees should be composed of different people. A typical comment was:

"Disagree. The committees should comprise the best skills from around the board table. Obvious conflicts should be avoided."

Some considered that the best person for the job should be appointed. Others commented that board size might constrain this and that it may not be feasible or practical in a New Zealand context. Some respondents did not see any particular conflict with a director sitting on both committees, and several said that a person should not be disqualified from sitting on another committee. However, some people thought there should be a material difference in committee composition, and others supported having an independent chairperson.

A small number noted that factors such as board size, experience, expertise and the need to spread the composition and workload of committees should be considered.

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

There was a strong view that although committees may be useful for dealing with matters in detail, full boards must retain responsibility, particularly for policy and governance decisions. It was suggested that committees should report to boards, that minutes of committee meetings be circulated to boards, and that committees should not be able to decide policy or commit boards on major decisions.

Some people said that committees should be used as appropriate to the particular organisation and should not be mandatory. Others thought that committee terms of reference, composition and procedures should be clearly defined and regularly reviewed by the board. Some noted the need to avoid conflicts of interest when appointing committee members, and queried whether the chairperson of a board should chair any board committees.

Specific comments about audit committees included that

• audit committees should be independent of management and should receive the reports of both internal and external auditors; and
• audit committees should report directly to shareholders.

A few respondents suggested that committees should be able to use external advisers. It was also suggested they should be able to co-opt members who were not directors.

Views by type of entity

While a number of issues were raised in relation to the role and composition of board committees, no discernable trends or themes emerged when analysed by type of entity.

Issue Four: Reporting and Disclosure

Q: Continuous disclosure has been a requirement for publicly listed companies in New Zealand since December 2002. In relation to good corporate governance, are there any areas or matters on which additional disclosure should be encouraged?

A majority of respondents said there were no other areas or matters in which they considered additional disclosure should be encouraged. Some of these people added comments including

• Zealand's continuous disclosure regime is sufficient in relation to disclosure of company information;
• this was a matter for shareholders to determine via boards; and
• existing statutory requirements provide adequate protection of rights.

Some respondents said commercial sensitivity is an issue and it would be difficult to prescribe what is appropriate for the public arena.

A minority of respondents suggested that a greater level of disclosure in relation to the principles of good governance be encouraged. These people sought more disclosure of the matters covered in the questionnaire, including:

• related party dealings;
• codes of ethics;
• share trading by directors and executives;
• remuneration;
• minutes of shareholder meetings;
• NZX compliance;
• board composition and performance; and
• risk management processes.

Other comments were that it is too early to tell whether the continuous disclosure regime is "sufficient", and that good corporate governance is poorly defined and too easy to manipulate.

Q: Do you believe there is a need for greater emphasis on timely, accurate and complete disclosure by unlisted companies?

Opinion was divided on the need for unlisted companies to adopt a higher level of disclosure.

Among those who supported greater disclosure, there was a view that the level of public interest in the unlisted entity should determine whether a higher lever of disclosure was needed.

"... the benefits of information disclosure go beyond the maintenance of an informed securities market, and there would be benefits for stakeholders .... of unlisted companies in enhanced disclosure. ... Continuous disclosure is also important for unlisted entities with an element of wide or public ownership however.... it is appropriate that entities be able to adopt and justify different positions."

There was support for a greater emphasis on timely, accurate and complete disclosure in unlisted companies that are widely held, and when there is public money at stake.

Of those respondents who did not consider that a higher level of disclosure is required, a number suggested it was important that the public understands the risks involved in investing in the unlisted market. Others said the requirements of the Companies Act 1993 were sufficient.

Q: Do you believe that listed companies in New Zealand should report quarterly?

A majority of respondents disagreed with the proposition that listed companies should be required to report on a quarterly basis. Of those who disagreed, many said that continuous disclosure is sufficient. Others noted compliance costs, and the risk that quarterly reporting would encourage entities to focus on managing short-term results.

Some respondents who supported quarterly reporting said that listed companies should be able to meet the extra costs involved, and that as companies prepare monthly accounts there should be no problem generating quarterly results. One representative of a large international entity said that quarterly reporting encouraged the highest standards of investor disclosure. Some welcomed the idea of quarterly reporting, but said it should be voluntary and not mandated.

Q: Do you think it is appropriate in New Zealand for CEOs and CFOs to publicly certify the accuracy and completeness of financial statements?

A great majority supported the proposition that company CEOs and CFOs should publicly certify the accuracy and completeness of financial statements. Several respondents went as far as saying this should be a fundamental requirement.

"Absolutely essential for proper accountability, it would put the emphasis where it should sit, that is, where the detailed knowledge resides."

Other comments included that CEO and CFO certification is essential to proper accountability, and that there should be a penalty for those making an untrue certification. A small number said that certifying the accuracy and completeness of accounts to boards should be required but that it was not necessary to extend this to public certification.

Of those who did not support the proposition, some argued that it is the auditor's responsibility. Others said that directors should remain primarily responsible to the public because the CFO and CEO are employees and should only certify the accuracy and completeness of financial statements to the board if the board required it. For example:

"Not necessary. The board reports and should be getting its certificates - part of internal procedure."

Q: What other safeguards are needed for ensuring integrity in reporting practices and outcomes?

A majority of respondents suggested that additional safeguards would be useful. Most comments focused on strengthening audit committees and independent auditors. Some suggested that stronger enforcement and penalties are required.

Some respondents commented on boards being equipped with financial knowledge, certification of financial statements by directors, and good quality financial reporting. Comments also included the importance of robust whistleblower policies.

Q: Should companies report on their performance against the accepted principles of good corporate governance or explain why they haven't?

There was strong support for the proposition that companies should report on their performance against accepted principles of good governance.

Some said this should not be overly prescriptive. Some respondents qualified their support by saying that reporting should be kept simple, and others said that a balance needs to be struck between hard rules and best practice.

There was strong support for "if not, why not" reporting for listed companies. For unlisted companies some respondents thought this was a matter for boards. Some suggested a template might be useful (particularly for smaller companies), but others warned against the ease with which people can conform to a check list. There was a strong view that reporting should not become a "tick-in-the-box" exercise. Some suggested that reporting should involve describing compliance as much as non-compliance.

Of those who disagreed, many said this would be a waste of time and would not add to shareholder value. Others said it is difficult to report on the "performance" of principles. A few said it depended on what the principles were.

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

The most significant other issue identified was the need for company reporting to be easily understandable to shareholders. The roles of analysts and the financial media in this were questioned and it was commented that more investor education could help. Suggestions were made about enforcement, including protection for whistleblowers. The comment was made that regulating disclosure will not help overcome fraudulent behaviour.

Views by type of entity

Representatives of associations and professional firms tended to have more to suggest in relation to additional areas for disclosure.

The majority of company representatives said current requirements were sufficient.

On the issue of whether there should be a greater level of financial disclosure from unlisted companies, support was spread across all entity representatives, including those from unlisted companies.

People from professional firms were less likely to support the CEO and CFO certifying the accuracy of financial reports.