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Corporate Governance in New Zealand

Principles and Guidelines

ISSUE SEVEN: Auditors

Q: To what extent should rotation of audit firms be considered appropriate in New Zealand?

A majority of respondents said that the rotation of audit firms is neither necessary nor appropriate, but some said that firm rotation should be a requirement.

Those opposed to audit firm rotation argued that in the New Zealand context the small pool of qualified audit firms would make this impractical.

"We believe the New Zealand market is too small with too few large chartered accountancy firms capable of undertaking large assignments, to mandate rotation of audit firms."

Some said that audit firm rotation might give less assurance to directors and shareholders because of the time it takes to become familiar with the work.

Other respondents emphasised the significant additional expense and time associated with a lack of familiarity resulting from firm rotation. Some noted that firm rotation was anti-competitive, as audit firms may get work other than as a result of good audit skill, and this may lead to a spread of clients across the few large firms with no price competition at all.

It was also noted that subsidiaries of overseas companies may need to follow the requirements of the overseas parents.

Several people who supported audit firm rotation suggested it was appropriate only for larger or listed companies. Most of the respondents who supported the rotation of audit firms said this should occur every 3 to 5 years.

Q: To what extent should there be a rotation of audit partners in New Zealand? If this is appropriate how often should audit partners be rotated?

The great majority agreed that audit partners should be rotated. The limited size of the New Zealand market was stressed, and some respondents cautioned against making partner rotation compulsory.

"Audit partner rotation is generally seen as an element in maintaining both the fact and appearance of auditor independence. ... such a situation is desirable ... auditor partner rotation was expected to contribute positively to corporate governance."

A small number of people said this was unnecessary. Some instead favoured firm rotation, questioning whether partners in the same firm are likely to challenge each other.

Opinion was divided on how often audit partners should be rotated. Views ranged from 3 to 10 years, with strong support for once every 5 years. Others said it should be at the discretion of the audit committee.

It was noted that rotating both the lead and review partners should be considered, with the rotations being staggered to effect continuity within the audit team. It was also suggested that lead and review partners then have no involvement with the client for a specified period.

Q: What types of non-audit work should be of concern in the New Zealand context (e.g. valuation services, executive recruitment)?

Opinion was divided on the extent to which audit firms should provide non-audit services to client companies.

The strong view was that audit firms should not undertake any work that could influence (or be seen to influence) their ability to produce impartial and independent audit reports.

"Audit firms should not undertake any work that could have a future impact on their independence as regards the audit ...."

Some suggested that all non-audit work should go to another company. Other respondents noted specific tasks, including valuation services, tax advice, strategic planning, risk management and business planning that should be excluded where an audit relationship exists. Major transaction work, investment advice, executive recruitment, and IT services were also mentioned.

A small number said that the issue was not the type of work, but the non-audit work fees in relation to audit fees. If the audit fee is only a small part of an accounting firm's overall fees from a company, the integrity of the audit work may be questioned.

Several referred to the rules of the Institute of Chartered Accountants in New Zealand and the International Federation of Chartered Accountants and said these were sufficient guides and there was no need to replicate them.

Q: Do you think disclosure of fees paid to audit firms should differentiate between types of non-audited work?

There was close to unanimous support for the disclosure of fees paid to audit firms to differentiate between types of non-audit work.

Q: Do you think the total of non-audit work should be limited to some proportion of all fees paid to audit firms each year and, if so, what proportion?

The majority said that restricting the amount of non-audit work to some proportion of all fees paid to an audit firm each year would have an arbitrary effect.

"... the board or governing body of an organisation and its auditor are responsible for ensuring that audit independence is not compromised. Mandating maximum levels of remuneration or non-audit work will not assist that process."

There was a view that certain types of non-audit work were not appropriate, regardless of proportion. Other respondents emphasised adequate audit committee monitoring and disclosure of fees as more important concerns, with strict proportions being overly prescriptive and difficult to implement.

Some said that a cap on fees for non-audit work should be established, but others said this should be set by boards of directors rather than being mandated, and that it should be published as part of a corporate governance section in annual reports.

Of those who suggested set caps, some said that the total allowable level of non-audit work should be 5% to 10%. Others preferred 25% to 30%, and a few 50%.

Q: Should boards and/or board audit committees develop and disclose policies for handling complaints by auditors or internal whistleblowers?

The great majority agreed unconditionally with this.

Several thought that these policies should be developed but that complaints were matters for management that should be disclosed only within the company.

It was stated that there was a need for an external channel owing to the number of cases where an employee whistleblower would be dealing with the cause of the whistleblowing.

Q: Should an independent audit oversight body be required in New Zealand?

The great majority did not think an audit oversight body is required in New Zealand.

"We do not believe there are the widespread problems that would justify the establishment of such bodies. In our view, current statutory requirements work satisfactorily and are adequate."

A small number supported an independent audit oversight body. Some gave qualified support, but commented on the potential cost. Others would support an oversight body that was properly constituted and independent. The comment was made that the terms of reference would be important, and whether the body would be auditing the auditors or setting audit standards. There was also a concern that there may be an insufficient pool of talent for the initiative as "it is all currently sitting with the auditing profession". In support, some said that it might give some comfort to overseas investors who have similar bodies in their own jurisdictions.

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

The majority of comments reflected a view that the role of auditors is an important part of corporate governance.

A small number said that there is too much attention paid to auditors, that the audit process is (or has become) a waste of time, and that it is better to improve the reporting practices of companies than to focus on audit practice.

It was noted that appropriate sanctions for wrongdoers would be a more effective response than restrictions placed on everyone. Along with enforcement, it was noted that monitoring audit practice (including by boards) was very important.

The role of the audit committee was stressed by some, both in monitoring the audit and in providing an avenue for communication with external and internal auditors.

It was suggested that the reasons for the resignation or dismissal of an auditor should be disclosed. Some company representatives noted that they have formal audit charters that are disclosed. Some respondents noted that while independence is important, the auditor's role should not be entirely that of detecting wrongdoing. The auditor should also be used as a source of constructive advice on best practice.

A few respondents said that auditors and audit practices have been unfairly targeted as a result of a few overseas failures, and that generally New Zealand practice has been of a high standard.

Others noted that the Companies Act 1993 requires that auditors be appointed at the annual meeting of a company, and that shareholders have a responsibility to question the independence and performance of auditors. However, it was also said that in practice this has had limited effect, and that most auditor appointments simply follow board recommendations, with auditors often retiring and being appointed (by the board) between annual meetings.

Views by type of entity

The strongest views opposing audit firm rotation came from representatives of professional firms and listed companies.

Those from professional firms were less likely to support the need for an audit oversight body than others. Otherwise, there were no discernable trends.

ISSUE EIGHT: Shareholder Relations

Q: How well do New Zealand companies encourage meaningful dialogue between the board, management and shareholders?

Some said that this was done "generally quite well" or "reasonably well". However it was a strong view that this was "poor" or "not well done", and that there was room for improvement in shareholder communications.

" ... companies nowadays generally acknowledge the importance of meaningful dialogue between the board, management and shareholders, and are increasingly encouraging it ... there is nevertheless always room for improvement in this area."

Some commented that under the continuous disclosure regime shareholders are now provided with more information than in the past. Some said that large and small shareholders still receive different treatment. Others said that too often communication is about past performance and there is limited opportunity for shareholders to express views on the future direction of a company.

Some raised concerns about the cost of communication and others questioned the extent to which all shareholders want more communication. Several questioned the effectiveness of annual meetings, and some said that communication was limited to the obligatory reports and the annual meeting.

Q: Should companies facilitate shareholder access to auditors?

There was strong support for facilitating shareholder access to auditors, but a majority of respondents would restrict this to specific occasions such as the annual meeting. It was noted that it is important to bear in mind the materiality and relevance of any issue to be raised with the auditor by the shareholder.

There was a strong view that shareholder concerns about audit matters may already be raised at the annual meeting through the chairperson and it may be sufficient to inform shareholders about this procedure rather than facilitating further access to auditors.

" .... There should be no additional facilitation. I cannot imagine that it would be in the interests of shareholder relations for a Chairman to refuse a question being put to the auditors by a shareholder."

Others noted that auditors are engaged by companies to which they owe certain responsibilities, and that an auditor could be in a difficult position if approached by a shareholder about matters confidential to the company.

Q: Do you support the view that institutional shareholders should always vote on shareholder resolutions?

Opinion was divided on this.

Although there was strong support for the idea, respondents who qualified their support thought institutional shareholders should be encouraged to vote, but could not or should not be compelled.

"To vote or not is the shareholder's individual choice. This extends to so called institutional shareholders."

It was noted that institutional shareholders are often in a better position than other shareholders to offer informed support or criticism. Some respondents said that institutions must consider whether they should take an active interest in the affairs of companies in light of their obligations to their own investors and stakeholders.

"Institutional shareholders have a duty to their investors to take part in the governance of major companies in which they invest.... Institutional investors need to start the process of good governance by taking part in the governance decisions and exercising their rights to speak and vote in companies in which they invest."

There was also a strong view was that all shareholders have the right to vote or abstain, and that to create a category that is obliged to vote would upset this equality.

Q: Should listed companies publish a formal policy on their relations with shareholders?

Opinion was divided on this.

Some said that it would be good practice and would help to reinforce the rights and importance of shareholders in corporate structures. Others noted that while good practice, this should not be mandatory. Others said that, while publishing would do no harm, it should be simple and brief and not "fall into platitudes".

Views against publishing a policy included

• that it could become just "another piece of paper";
• that implementation is more important than publication; and
• that these policies can be a source of competitive advantage when effectively implemented, but that such advantage could be removed if publishing was made mandatory.

Several said that if a formal policy is not published, it is important that shareholders understand where they can access information and how they can raise concerns with a company. At the least shareholders need to be aware of their legal and procedural rights.

Q: How well do you think that listed companies in New Zealand provide shareholders with comprehensive and easily understood commentary on their financial performance?

A majority said that listed companies in New Zealand are "good" to "moderately good" at providing shareholders with comprehensive and easily understood information on financial performance.

"Our experience is that, on the whole, listed companies in New Zealand are conscious of the desirability of keeping a balance in the commentaries on financial [information] between detail, which shareholders unfamiliar with financial terminology can find overwhelming, and readability."

Some people who stated that this was done well said that it was true particularly of the larger entities but that some small and medium-sized companies did not do it so well.

It was noted that financial reporting follows prescriptive rules that can challenge a company's ability to report in a way that is easily understood by the average investor. Also that there can be a conflict between comprehensive and easily understood information.

Some respondents said that the quality of reporting could vary. Others said that there was the potential for "masking" results and promoting complicating structures that could confuse people. Other comments were that the issues could get lost in the detail, that some reports were too technical, and that superfluities were being added that could cloud performance issues.

The fact that it can be difficult for companies to recognise the varied needs of shareholders was also raised. Some said that the market already treats those companies that communicate well in a favourable way and so there is an adequate incentive to report effectively, irrespective of prescriptive rules.

Q: Should other business entities - such as co-operatives, large trusts and unlisted companies - provide more comprehensive public reporting on their performance?

There was strong support for more comprehensive public reporting by these entities. However, some said that any such obligation should be triggered by specific factors, such as whether securities are issued by the entity and whether public money is involved.

"... the benefits of disclosure of trading performance and financial position go beyond the maintenance of an informed securities market. Accordingly if an appropriate platform for disclosure by unlisted entities could be established there may well be some benefits in such a proposal."

Others said that the costs and benefits of increasing reporting obligations need to be studied.

It was argued that for a non-public issuer, disclosure should be a matter for shareholders or beneficiaries to decide. It was also noted that more public reporting of the performance of co-operatives and large trusts would be desirable if the structure and liquidity of their ownership were similar to those of public issuers.

Of those who did not support more comprehensive reporting by these entities, a number said that requirements under current law are satisfactory and that if an entity's structure entitles it to "privacy within the bounds of its shareholders", nothing more should be required.

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

Several respondents commented that company analysts have an important role in accessing and conveying information about public companies. It was noted that smaller companies can have difficulty attracting research interest.

It was suggested that institutional shareholders have the potential to be influential in corporate governance, as do representative groups such as the New Zealand Shareholders' Association Inc.

Some commented on means of communication, with strong support for use of company websites to provide easy access to company information. It was noted that public conference calls following announcements of results could provide a useful opportunity to clarify information.

It was suggested that companies encourage shareholders to send in questions to be answered at the annual general meeting, and noted that some companies do this already.

Views by type of entity

People from listed companies were more likely to support the adequacy of current communications mechanisms with shareholders. Those from professional firms and those responding in a personal capacity were more likely to suggest improvements.

While acknowledging scope for improvement, people from listed companies and professional firms had typically positive views on the extent to which financial reporting by listed companies is comprehensive and easily understood.

A small number of respondents who disagreed on this matter were representatives of some associations, and some professional firms and a few responding in a personal capacity.

ISSUE NINE: Stakeholder Interests

Q: To what extent do you agree with the view that while shareholders have the primary interest in a company, there are other stakeholders whose interests should be considered in the context of corporate governance?

There was strong support for the view that companies should consider the interests of people other than shareholders. However, this support often had some proviso, for example "provided the interests of shareholders are paramount" or "should be considered but not mandated".

"We firmly agree with this view however, there needs to be the recognition of the responsibility of directors ... to act in the best interests of shareholders."

Some supported companies taking account of social and environmental issues, and also the interests of creditors, employees, suppliers and customers.

Some put forward the concept of a social "licence to operate" on the basis that large companies have a significant impact on the community and the economy and should have a broader view of accountability. Others said that the responsibility for identifying parties who have a key or material impact on company performance or code of ethics should rest with boards and not be prescribed.

It was recognised that the range of stakeholders is wider for public sector bodies than for companies. It was noted that these bodies already have a legal obligation to consider stakeholder issues.

Several said that the interests of stakeholders should not become a legal duty and that there is no need to over-regulate. It was noted that the scope of people with a "legitimate interest" is potentially very broad. Others said stakeholder interests should only be considered to the extent that doing so adds to shareholder value.

Some disagreed. Of these people, most said that boards should answer to shareholders only. The view was also expressed that stakeholder interests should only be a matter for management. Others said that stakeholder groups are protected by legislation, such as the Fair Trading Act 1986.

Q: Should the interests of other stakeholders be actively considered by New Zealand boards? If is, how should these interests be addressed?

While some people disagreed, the majority thought that boards should consider the interests of other stakeholders.

Of those who offered qualified support, some said that other stakeholders' interests should be considered but how actively this is done should be a matter for boards to decide. Reporting on performance should also be at the discretion of boards. Others commented that shareholder interests need to remain paramount.

Of those who disagreed some said that such interests are already considered and dealt with through legislation and it should not be part of a board's compulsory functions. It was suggested that stakeholder interests be considered only if there is a direct economic connection with the company.

A majority thought that companies should have formal policies or codes for dealing with stakeholder interests, although opinion was divided on whether these should be implemented at board or management level.

Some suggested that stakeholders' interests would best be addressed through disclosure, such as triple bottom line reporting or social impact statements. Others said they expected to see some reference to stakeholder interests in annual reports.

It was suggested that formal consultation is appropriate for some stakeholders, such as employees.

It was noted that stakeholder interests should be addressed by disclosure in statements of intent by public sector bodies.

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

Comments included

• that companies should have a broader accountability than can be achieved through a narrow focus on shareholders;
• that stakeholder interests are a matter of ethical conduct for a company;
• that recognition of stakeholder interests is simply a matter of good business sense, and should be addressed in the normal business planning of a company;
• that the potential range of "stakeholders" for any company is very broad; and
• that confusion would result if stakeholder interests were placed on a par with those of shareholders.

Views by type of entity

There were no underlying trends apparent relating to entity type and perspectives on addressing stakeholder interests.