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Focus: Corporate Governance – July 2008

Report on shareholder participation in corporate governance

In brief: The Parliamentary Joint Committee on Corporations and Financial Services has inquired into the engagement and participation of shareholders in the corporate governance of companies in its report titled Better Shareholders – Better Company: Shareholder Engagement and Participation in Australia. Partner David Robb (view CV) and Lawyer Jessica Choong report.

• Committee's terms of reference
• Overview of report
• Corporate governance framework
• Improving information flows
• Improving corporate accountability mechanisms
• Conclusion

Committee's terms of reference

The terms of reference of the Parliamentary Joint Committee on Corporations and Financial Services (the committee)¹ were to 'inquire and report on the engagement and participation of shareholders in the corporate governance of the companies in which they are part-owners', with particular reference to:

• barriers to the effective engagement of all shareholders in the governance of companies;
• whether institutional shareholders are adequately engaged, or able to participate, in the relevant corporate affairs of the companies in which they invest;
• best practice in corporate governance mechanisms, including the election of directors, voting arrangements and the conduct of annual general meetings;
• the effectiveness of existing mechanisms for communicating and getting feedback from shareholders;
• the particular needs of shareholders who may have limited knowledge of corporate and financial matters; and
• the need for any legislative or regulatory change.

The committee received 45 submissions, including from ASX Limited and industry bodies such as the Business Council of Australia, the Australian Institute of Company Directors, the Australian Council of Super Investors and Chartered Secretaries Australia.

Overview of report

The committee published its report on 23 June 2008 and made 21 recommendations for improving the flow of information between companies and shareholders and improving corporate accountability mechanisms. In light of the report's broad scope, the remainder of this article focuses on the committee's views and recommendations in the following key areas:

• the corporate governance framework in which shareholder engagement and participation occurs;
• engaging with companies on environmental, social and governance issues ('responsible investment');
• simplifying company information for retail investors;
• the value of annual general meetings;
• disclosing material information equitably;
• company meetings informing shareholder voting; and
• voting on directors and directors' remuneration.

Corporate governance framework

As background to the views and recommendations expressed in its report, the committee noted that shareholder engagement and participation occurs within the delegated authority model of corporate governance. Under this model, directors are responsible for managing companies and they are held accountable for their decisions by shareholders, who are entitled to appoint and remove the directors.

The committee considered that the 'critical nexus' between these decision-making and accountability functions is informed and effective engagement between shareholders and the company board, two key features of which are information flows and corporate accountability mechanisms.

Submissions received by the committee suggested that deficiencies in shareholder engagement and participation stem principally from companies and investors not adopting the best practices allowed within the current regulatory framework, rather than being hampered by that framework. As such, the committee considered that it would be more appropriate for legislative reform in this area to remove impediments that currently prevent companies from engaging with shareholders in line with best practice, rather than to impose minimum standards of engagement.

In light of this background, we now consider some of the views expressed and recommendations made by the committee in its report.

Improving information flows

Institutional investor issues

Responsible investment

The Committee noted that institutional investors are increasingly concerned with 'responsible investment', that is, taking an active approach to engaging with companies on environmental, social and governance (ESG) issues. This approach recognises that ESG issues are important to long-term sustainability and, therefore, to minimising long-term investment risks.

The Committee considered that it would not be appropriate at this stage to seek to regulate ESG reporting. However, given investors' demand for reporting on ESG issues, the Committee encouraged companies to provide ESG reporting on a voluntary basis.

In light of some submissions which suggested that companies may be concerned about liability for making disclosures on ESG issues, the Committee considered that companies should be able to engage and report on ESG issues without fear of contravening continuous disclosure obligations. Accordingly, the Committee recommended that ASX should clarify the scope of continuous disclosure requirements (under Listing Rule 3.1) as they apply to engagement on ESG issues.²

In relation to this recommendation, we note that, on 30 June 2008, the ASX Corporate Governance Council released a Revised Supplementary Guidance to Principle 7 ('Recognise and manage risk') of the Corporate Governance Principles and Recommendations. The Revised Supplementary Guidance to Principle 7 emphasises that when companies are considering issues relating to material business risks, they should be mindful of their disclosure obligations under ASX Listing Rule 3.1.

Retail investor issues

Simplifying company information for retail investors

Submissions received by the Committee suggested that, despite recent reforms to the Corporations Act 2001 (Cth), company information (as primarily contained in annual financial reports) remains inaccessible to retail investors and hinders shareholders from being capable or willing to engage with companies.

Although the requirement for companies to provide a concise report was intended to overcome some of these problems, the Committee considered that they have declined in relevance as shareholders are increasingly able to access company reports electronically. Rather, the Committee considered that the absence of information which outlines company performance and objectives in plain English is a more significant impediment to shareholder engagement.

As a result, the Committee recommended that section 314 of the Corporations Act should be amended to remove the requirement to produce a concise financial year company report.³ It intends that this recommendation may encourage companies to provide a report on company performance and objectives that is comprehensible to shareholders. Further, the Committee recommended that ASIC should establish best practice guidelines for clear and concise company reporting.⁴

The value of annual general meetings

The Committee heard claims that AGMs are becoming less relevant to shareholders. The declining trend in AGM attendances can be attributed to their informative purpose effectively being replaced by continuous disclosure and their deliberative purpose being settled by proxy before the meeting.

The Committee considered that AGMs remain an important forum for shareholders to engage directly with company boards, particularly for retail investors who are not afforded the opportunity to attend the private briefings given to institutional investors. However, it noted that companies may need to reconsider their attitudes to AGMs in order to reignite the relevance of AGMs to modern shareholders.

Accordingly, the Committee recommended that ASIC should establish best practice guidelines for companies holding annual general meetings.⁵ It suggested that these guidelines should address issues such as ways of maximising attendance and improving shareholder participation in questions and discussion at the meetings.

Disclosing material information equitably

The Committee heard concerns that retail investors are being disadvantaged by not having timely access to information being presented by companies in private briefings to institutional shareholders. Further, it heard concerns that such information is not being reflected in the market disclosures made by companies under ASX Listing Rule 3.1.

The Committee supported the practice of companies privately briefing institutional investors, where they are doing so in accordance with the obligation to disclose material information under the ASX Listing Rules. Accordingly, the Committee recommended that ASIC should selectively or periodically monitor and enforce company information disclosed in private briefings to institutional shareholders to ensure compliance with continuous disclosure obligations.⁶ In order to provide the most equitable access to such information, the Committee also suggested that companies should make the information available on their website at the time of the briefing and provide advance notice to shareholders that the information will be available.

Improving corporate accountability mechanisms

Exercising voting entitlements

Company meetings informing shareholder voting

The declining trend in attendances at AGMs (as considered above), has also led to concerns that shareholders' voting decisions are not being based on the information conveyed at AGMs.

Chartered Secretaries Australia proposed that, in order to allow investors a reasonable opportunity to consider their voting position, the informative and deliberative functions of AGMs should be separated by opening voting on resolutions at the AGM and allowing shareholders to vote for some time after the AGM had closed.

The Committee agreed that shareholders would be better placed to make informed voting decisions by allowing them to vote in this manner. Accordingly, the Committee recommended that the government should consult with industry on the implementation of postponed voting after the close of company AGMs.⁷ Adopting the suggestions made by Chartered Secretaries Australia, the Committee considered that postponed voting could be mandated through provisions in the Corporations Act or, alternatively, included in the ASX Corporate Governance Council's Corporate Governance Principles and Recommendations (ASX Corporate Governance Principles and Recommendations) on an 'if not, why not' basis.

Voting on directors

As noted above, directors' accountability to shareholders is an important aspect of shareholder engagement. However, submissions received by the Committee suggested that significant impediments to shareholders enforcing this accountability are director entrenchment and a lack of information being provided on director candidates.

Having noted that the ASX Corporate Governance Principles and Recommendations state that board renewal 'is critical to performance', the Committee considered that the dominance of entrenched directors on company boards is contrary to good corporate governance and shareholders' interests. The Committee also agreed with submissions which suggested that shareholders' voting on directors should be informed by proper information about candidates' qualifications and experience.

Overall, the Committee considered that the process for nominating and electing directors in many companies could be substantially improved to ensure that better quality candidates are appointed. Accordingly, the Committee recommended that ASIC should develop a best practice guide to company constitutional recommendations and practices governing the nomination and election of directors.⁸

Voting on remuneration

As a result of the CLERP 9 reforms to the Corporations Act, shareholders can now engage with directors on their remuneration by participating in a non-binding vote on the directors' remuneration report.⁹ The main concern heard by the Committee was that this initiative may be undermined by shareholder directors being able to vote on their own remuneration, particularly where they have substantial holdings. Accordingly, the Committee recommended that the government should amend the Corporations Act to exclude shareholder directors from voting on their own remuneration packages either directly or by directing proxies.¹⁰

The Committee also heard concerns regarding:

• the October 2005 amendment to ASX Listing Rule 10.14, which allows companies to grant shares as part of a director's remuneration package without shareholder approval if the shares are purchased on market; and
• the lack of transparency regarding external management agreements.

In relation to ASX Listing Rule 10.14, the Committee noted that the on market exemption is reasonable having regard to the rule's objective to prevent shareholder value being diluted by share issues to directors. However, the Committee recognised the potential for the exemption to be used improperly.

In relation to external management agreements, the Committee noted the absence of disclosure regarding the terms of the agreements, such as the remuneration paid or voting entitlements issued to external managers. The Committee recommended that these issues should be addressed by the government examining the on-market exemption to Listing Rule 10.14 and the disclosure requirements pertaining to external management agreements as part of its green paper review of corporate governance regulations.¹¹

Conclusion

The wide range of recommendations made by the Committee recognise that, while standards of corporate governance in Australia are relatively high, there remains scope for improving the role of shareholder engagement and participation in corporate governance. The Committee not only encourages the government, regulators and industry bodies to continually develop regulation and best practice guidance in this area, but also encourages companies to consider whether they can adopt practices to better facilitate shareholder engagement and participation within the existing corporate governance framework.

Footnotes

1. The Parliamentary Joint Committee on Corporations and Financial Services is a Commonwealth Parliament committee comprising 10 members who are divided equally between the House of Representatives and the Senate.
2. Recommendation 2.
3. Recommendation 4.
4. Recommendation 6.
5. Recommendation 5.
6. Recommendation 8.
7. Recommendation 18.
8. Recommendation 19.
9. Under section 250R(2) of the Corporations Act 2001 (Cth).
10. Recommendation 20.
11. Recommendation 21.

For further information, please contact:

• David RobbPartner, Sydney
  Ph: +61 2 9230 4389
  David.Robb@aar.com.au
• Jon WebsterPartner, Melbourne
  Ph: +61 3 9613 8832
  Jon.Webster@aar.com.au
• Ewen CrouchPartner, Sydney
  Ph: +61 2 9230 4958
  Ewen.Crouch@aar.com.au
• Andrew KnoxPartner, Brisbane
  Ph: +61 7 3334 3356
  Andrew.Knox@aar.com.au
• Andrew PascoePartner, Perth
  Ph: +61 8 9488 3741
  Andrew.Pascoe@aar.com.au
• Matthew BarnardInternational Partner, Hong Kong
  Ph: +852 2903 6212
  Matthew.Barnard@aar.com.au

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