The fallout from the Financial Services Royal Commission reinforces the need for investors to assess boards when buying stocks. Boards that allow poor organisation cultures to form, are too influenced by executives or asleep on risk management, destroy wealth.
Consider AMP. Former chair, Catherine Brenner, resigned after damning evidence of misconduct by AMP staff emerged at the Royal Commission. Three other directors announced this week they will leave the board in 2018.
AMP’s debacle again highlights how the market overlooks boards in company assessment. For all the tough talk, through institutional investors voting on executive pay and director appointments, underperforming boards are tolerated for too long.
AMP has a strong incoming chairman in David Murray, the former Commonwealth Bank CEO and former Future Fund Chairman. There will be board renewal and probably a lift in AMP’s governance and performance, in time, under Murray’s watch.
But is worrisome that major board changes only occur when there is a crisis and the share price is in free fall.
Investors too often ignore the signs of dysfunctional boards and incompetent directors. Worse, they focus research efforts on assessing company management and forget about directors, even though choosing and incentivising the right CEO – and monitoring his or her behaviour – is the board’s top job. A strong board makes a huge difference to investors.
I have written extensively about boards for over a decade and interviewed many chairpersons and non-executive directors. Governance has improved greatly during that time and Australia has many capable directors. But too many weak boards still exist.
My concern is that current market trends are counter to what the market wants. The governance community has pushed for greater board diversity and independence. Yet fund managers I talk to want boards stacked with industry experience and directors who have real “skin in the game” through equity ownership (that is, less independence).
Here are my seven top criteria for assessing boards. Several of them are somewhat counter to current board trends and may not please governance purists. But they’ll help investors identify boards that have their back; and boards with their snouts in the governance trough.
When reading director bios in the annual report, consider the length and seniority of director experience in the organisation’s industry. Take care if too many directors are from outside the industry. It is harder to hold management to account, approve capital-allocation decisions and strategy, and understand risks if you don’t come from the industry.
Director diversity is important but beware boards that appoint directors to tick boxes on gender, race or other diversity metrics. Extensive industry experience is the foundation of good boards: diversity of skills and experience is another layer on top.
Board independence is valuable – to a point. Academic studies have shown that too many independent directors on boards affects firm performance over time. Yet the governance community has generally pushed for higher levels of board independence.
Professor Alex Frino, deputy vice-chancellor (global strategy) at the University of Wollongong, found that the largest 200 ASX-listed companies with balanced boards (between independent and non-independent directors) outperformed in terms of market-adjusted stock-price returns. Companies with boards that had 40-60% independent directors performed best.
The takeout for investors: look for boards with a mix of independent and non-independent directors. Executive directors, founders or others with real “skin the game” can make a big difference to governance and firm performance because they have more to lose.
The market does not pay nearly enough attention to director busyness, particularly in the financial-services sector. Catherine Brenner, for example, was also a non-executive director of Coca-Cola Amatil and Boral: a challenging workload given AMP’s size and complexity.
The market tends to frown on directors who have more than two chair roles of ASX-listed companies and non-executive directors who have more than four roles. That is too generous. How can directors be expected to govern effectively if their time is spread across several demanding governance roles in the for-profit and not-for-profit sectors? Some board directors even have consultancies on top of numerous directorships.
When assessing company boards, beware those that have too many “professional company directors” with a portfolio of multiple directorships.
Yes, directors benefit from diverse industry insight and a larger network when on several boards. In truth, though, having lots of board roles is often about earning extra director fees – and spending less time on each role.
No chairpersons should earn $600,000 of shareholder funds in fees if they spread their time over several other roles, including some that also provide six-figure annual income.
I get why institutional investors frown on directors who serve more than three terms on a listed-company board. Too many boards in years past had directors who stayed on the gravy train for too long. Board renewal and refreshment is important.
But every case should be treated on its merits. Some directors I know who have served multiple terms on a board make a valuable contribution. They know the firm, its industry and people well. They are passionate about the firm and understand its boardroom dynamics.
When assessing boards, do not discount the value of directors with long experience in the role (more than six years). Do not fall for the hype that younger directors are needed to help boards understand technology and disruption. Beware boards with too many new or young directors.
Governance intuition and wisdom – and the ability to hold the CEO to account – come with experience. Younger directors can add value, but take care with those who have specialist skills and limited managerial experience. Good directors can govern across multiple issues.
I like listed-company boards that have a director who can take on the CEO role at short notice. The AMP board at least had the foresight to have Mike Wilkins (pictured), a former CEO of insurance group IAG, as a director. Wilkins stepped in as acting CEO after Craig Meller resigned.
Having directors who can lead the organisation does three things. First, it provides a ready-made replacement in crises and much-needed stability. Second, it provides better monitoring of the current CEO because a former CEO (of a competitor, or of the company after a stint away from it) is on the board. Third, it provides better mentoring for the current CEO.
Take care if the organisation’s former CEO joins the board too soon after leaving his or her executive role. That can create conflict with the new CEO. But it’s invariably a good sign when an ex-CEO from the firm’s industry is on the board within a reasonable period away from an executive role.
Nothing says more about board quality than executive pay. Boards that are “captured” by management approve overly generous remuneration schemes. There is misalignment between executive pay and performance and bad CEOs walk away with too much shareholder money.
Look at the firm’s record on executive pay and performance. How does the pay compare to the firm’s nearest peers in Australia and overseas? Has the board taken tough action on underperformance through forfeiture of executive bonuses or other incentives?
What is the market’s view? Have there been strikes recorded against the firm’s executive-remuneration report? Has there been media controversy over the scale of executive pay?
After executive pay, succession planning says much about the board. Great boards orchestrate planned succession events among executives and directors. Typically, the departing CEO is replaced by an internally sourced candidate who is well known to the board.
There’s usually a link between dysfunctional boards, high executive turnover and a reliance on company outsiders to fill the CEO role.
Also, watch for resignations from C-level executives; they are best placed to monitor the CEO and will leave if they lose confidence. Take extra care if the company’s c-suite has a revolving door: sudden resignations by the chief financial officer or other key executive talent are rarely a good endorsement of the CEO.
Good governance is fundamentally about stability. When boards work well, we should not hear too much about them because of a smooth transition between outgoing and incoming CEOs and directors. The focus is on the business and management.
Granted, succession planning is among the hardest board tasks to get right; even the best-laid plans sometimes go awry when CEOs resign suddenly. But the best boards have a knack of finding the right CEO and keeping him or her in the job longer. This management and board continuity drives firm outperformance and sustainability over time.
Tony Featherstone is a former managing editor of BRW, Shares and Personal Investor. This article first appeared on www.switzersuperreport.com.au.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.
Click here to take a free 21-day trial to the Switzer Report, a leading investment newsletter and website for self-directed investors.