All above board
all above board
great governance for the government sector – second edition
Julie Garland McLellan
Julie Garland McLellan
Government sector organisations are important. They provide many of the
essential goods and services that underpin society, and allow industry and
commerce to function efficiently. They are diverse and span almost every sector of
industry from agriculture to zoo-keeping. The directors who serve on government
sector boards play a vital role in the success of the nation. Until the publication of
All Above Board there was no comprehensive guide to assist in developing and
applying governance skills specifically for the government sector. Now in its
second edition, All Above Board will help directors, and those who work with
them, to develop the skills required for great governance and great outcomes.
Second Edition
Second Edition
all above board
great governance for the government sector
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All Above Board
The Australian Institute of Company Directors is a member institute for directors dedicated to having
a positive influence on the economy and society by promoting professional directorship and
good governance. Company Directors delivers director development programs, information and
advocacy to enrich the capabilities of directors, influence the corporate governance environment
in Australia and promote understanding of and respect for the role of directors. With offices in each
state of Australia and more than 27,000 members, Company Directors represents a diverse range
of organisations from the top ASX 200 publicly listed companies to not-for-profits, public sector
entities and private companies.
Disclaimer
The material in this publication does not constitute legal, accounting or other professional advice.
While reasonable care has been taken in its preparation, Company Directors does not make any
express or implied representations or warranties as to the completeness, reliability or accuracy of
the material in this publication. This publication should not be used or relied upon as a substitute
for professional advice or as a basis for formulating business decisions. To the extent permitted by
law, Company Directors excludes all liability for any loss or damage arising out of the use of the
material in the publication.
Any links to third party websites are provided for convenience only and do not represent endorsement,
sponsorship or approval of those third parties, any products and services offered by third parties,
or as to the accuracy or currency, of the information included in third party websites.
Copyright
Copyright strictly reserved. The text, graphics and layout of this guide are protected by Australian
copyright law and the comparable law of other countries. The copyright of this material is vested
in Company Directors. No part of this material can be reproduced or transmitted in any form, or
by any means electronic or mechanical, including photocopying, recording or by any information
storage and retrieval systems without the written permission of the Australian Institute of Company
Directors.
Published in October 2011 by:
The Australian Institute of Company Directors
Level 2, 255 George Street
Sydney NSW 2000
T: 61 2 8248 6600
F: 61 2 8248 6633
E:publications@companydirectors.com.au
W:www.companydirectors.com.au
© 2011 Australian Institute of Company Directors.
Design by Kirk Palmer Design
Printed by Ligare Pty Ltd
National Library of Australia Cataloguing-in-Publication entry
Title: All Above Board: Great governance for the government sector
ISBN 978-0-9871901-4-7
Subjects:Corporate governance
Government boards
Public sector governance
Contents
Acknowledgmentsix
xi
Foreword to the second edition
Introductionxiii
Chapter 1 Corporate Governance in Context
What is governance?
Governance structures and definitions
What constitutes good governance?
The value of good corporate governance
A brief history of governance The development of corporate governance in the government-owned sector
The current governance status quo
The difference between boards and committees
Chapter 2 Government Operations
The Australian government framework
Federal government
The federal government law-making process
The Australian Constitution
Council of Australian Governments
State and federal governments
Local governments
Government departments
State and federal treasuries
Portfolio departments
Liabilities and rights of elected officials and staff
Importance of the public sector
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Classification of public sector organisations
Legislation and regulation
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Chapter 3 Key Governance Roles in Government
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The role of elected representatives
Fiduciary duties
Profitable organisations or community benefits
Community service obligations
The role of parliament
The role of the government as shareholder
Key ministerial roles
The portfolio minister
The shareholder minister
Local government shareholder roles
Chapter 4 Board Operations
General governance functions
Reporting and accountability functions
The integrity and value of reports
The annual general meeting
Performance audits and reporting
Board meeting agendas
Board papers
Board meetings
Technology in the boardroom
Minutes and recording decisions
Workshops and seminars
Board tours and site visits
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Contents
Board performance reviews
Board composition and recruitment
Composition
Recruitment
Board committees
Audit committee
Remuneration committee
Other board committees
Chapter 5 Key Governance Roles in Corporations
The chairman
Individual board members
Nominee directors
Moving from government to boards
Right to information
Confidentiality
Conflicts of interest
Directors’ skills
Personal risks of directorships
Gaining financial and legal knowledge
Indemnity
Deeds of access
Insurance
The chief executive
The difference between chief executive and managing director
Key governance roles of senior executives
The company secretary
The chief financial officer
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The general or corporate counsel
The risk manager
The prosecuting officer
External advisers
The difference between consultants and contractors
How to manage consultants
Developing selection criteria
Conflicts of interest when appointing consultants
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Chapter 6 Policy, Strategy and Planning
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The role of public policy
Who develops public policy?
The effects of policy changes
The role of the government in policy
How policy is developed
The role of the board in strategy
Strategy retreats
Key planning documents
Statement of corporate intent
Corporate plan
Business plan
Succession plans
Gaining familiarity with the plans
Practical tools for planning
SWOT analysis Scenario planning Industry competitive forces Core competence agenda Contents
The firm value chain The balanced business scorecard and strategy maps The regulatory diamond Chapter 7 Risk Management, Finance and Reporting
The role of the board in risk management
Risk processes and structures
The Australian and New Zealand standard on risk management
Establishing a context
Identifying risks
Analysing risks
Evaluating risks
Treating risks
Reporting risk
Financial requirements and disclosure
Continuous disclosure
Government observers
The annual general meeting
Triple bottom line reporting
Diverse stakeholders
National tax equivalent regime
Dividends and other payments to the shareholder
Ring-fencing requirements
Public monies
Purchasing and tendering
Grants
Private-sector funding
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Chapter 8 Ethics and its Place in Business Life
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What is ethics?
The business case for ethics
The role of the board in creating an ethical organisation
The effect of changes in the environment
Common ethical issues in government-owned organisations
Remuneration levels
Dedicating resources to training
Downsizing and related issues
Conflict between taxpayers and public interest
Receiving gifts and entertainment
Displays of religious, political or cultural significance
Conflicts between personal agendas and current policy
The legislative context
The current Public Service Act
The current values
Criminal acts
Bribery
Manslaughter
Statutory duties
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Likely Future Developments
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Appendices
1 List of acronyms and abbreviations
2 Governance codes
3 Bibliography
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Acknowledgments
I would like to pay tribute to everyone who helped with this book, especially the
staff in the various government departments I have interacted with, and the board
members who have so graciously shared their knowledge. Heartfelt thanks are due
to my current and former boardroom colleagues: they have taught me practically
everything that is in these pages.
Particular recognition is due to my family, David and Andrew McLellan, for
their patience, tolerance, love and support while I have been busy completing the
text.
Finally, I would like to thank the team at the Australian Institute of Company
Directors for their role in bringing this book to publication.
Julie Garland McLellan FAICD
About the author:
Julie Garland McLellan is a professional non-executive director with experience on a range of
boards and committees including Federal, State and Local government-owned organisations.
Her experience on listed and not-for-profit boards allows her to identify and communicate the
differences that make government sector boards uniquely challenging and ultimately rewarding.
Julie understands how different communities, external stakeholders, customers, suppliers, staff,
investors, regulators, policy makers, management and boards influence a company. She is a
former Australian Institute of Company Directors Councillor and has developed and facilitated
Australian Institute of Company Directors’ courses. She is the author of The Director’s Dilemma,
a newsletter with subscribers in 36 countries, and also of two internationally acclaimed books
Dilemmas, Dilemmas: Practical Case Studies for Company Directors and Presenting to Boards.
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Foreword
“A board is not a board is not a board.”
W
hen I introduced the State Owned Corporations Act in 1989 in
New South Wales, indeed when I first joined the boards of QBE
and Stockland in 1992, the expression “corporate governance” was
barely known, much less studied and the focus of massive political, regulatory and
media attention.
These days, to paraphrase Paul Keating, every galah in every pet shop is talking
about corporate governance.
Clearly, the origin of this focus in the last two decades lies in the many listed
company failures and scandals that occurred in most western economies, and to
which Australia was certainly not immune.
Governments and communities moved to develop and enforce new standards,
structural and behavioural, to help protect the interests of shareholders and all
stakeholders.
Groups representing investors and directors, among others, developed their
own views and interpretations of best practice to go with a range of legislative and
regulatory initiatives.
Naturally this has led to attention on governance practices at private companies,
not-for-profit non-government organisations (NGOs), and of course, the public
sector with its huge variety of institutional forms that often have boards.
This second edition of All Above Board provides a readable and accessible
approach to understanding the governance of single shareholder entities – large
and small, corporate and advisory – operating at the complex interface of politics,
public service and the community.
With the use of many practical examples, it clarifies both for new directors
starting their careers in this sector, a common and successful route for many, and
for experienced private sector directors, the similarities and differences, formal and
informal, between government boards and others.
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The temptation to simply take the private listed company template and slavishly
apply it is resisted but the many applicable aspects are articulated.
This book will help public sector directors answer simple but crucial questions.
Why are we here? How do we reconcile our role with expectations of shareholder,
ministers, portfolio ministers and myriad stakeholder groups? What are our legal
powers and responsibilities? To whom are we accountable? How do notions of
best practice apply to the particular board on which I am invited to serve?
The backgrounds of government directors reflect far greater diversity in every
sense than in, say, the ASX 200. As such, All Above Board provides an effective
means of creating a common understanding of governance as it is now. It is of
course a living, breathing practice which changes with changing community
standards and expectations.
Dare I say, it should also be compulsory reading for politicians who find
themselves responsible for appointing and dealing with boards, often with little
or no relevant experience of their own.
At the end, however, no matter how comprehensive and useful a guide this
book is, directors will understand that it can only be an aid to their individual
application of values, views and common sense, which led to their selection.
Hon Nick Greiner AC FAICD (Life)
Sydney, Australia
September, 2011
Introduction
The role of a company director is complex and multifaceted. At times it provides
a control function; at other times, a motivating one. At all times it is a vigilant
and prudent risk-taking role. Experts around the world agree that directorship is
a blend of art and skill and that it requires people of good judgment, high integrity,
deep experience, ability to work in a team, and advanced leadership skills.
In the government sector the aims of the organisation can be far more complex
than those of commercial-sector corporations, and the range of experiences,
qualifications and personalities that govern the sector make it an exciting and
unpredictable place to be.
This book highlights the practical issues for anyone embarking on a career as
a director in the government-owned sector. No single issue takes precedence except,
perhaps, the duty to act in good faith and for a proper purpose. All events are
important at the time they affect the organisation. The hallmark of a good board
is to help keep the organisation ahead of the game, so that issues are managed
before they trigger an adverse event and correct priorities are maintained as the
organisation progresses towards its strategic objectives.
The government sector is diverse: it contains many different sizes and types of
organisations governed by company directors whose only similarity is their duty
towards, and frequent passion for, the organisation and its mission. The challenges
are as varied as the directors who successfully guide these organisations.
Sections of this book will be important for different organisations at different
times. Selecting the time to tackle each issue and bring it all together to create a
high-performance organisation is a balancing act that each director will address
in his or her own way.
This book has been written as a practical guide for people who are serving on,
aspiring to serve on boards, or working in an organisation that has an interface
with a government sector board. It is not a basic guide to directorship but will
provide a useful reference for people who are familiar with directorship and
governance in the commercial or not-for-profit sectors, so they may effectively
transfer their skills to the government sector.
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Although the book is written from an Australian perspective, the information
it contains is not jurisdiction-specific and, with a little effort, can help directors
in other countries. Indeed feedback about the first edition from international
readers has been used to enhance the rationale for the development of government
sector governance practices in Australia. The book contains a short guide to some
of the international governance codes and explains the principles, which will allow
the reader to apply these in their own context and understand how international
influences affect governance at National, State and Local levels.
Many different organisations operate under government ownership. These
organisations generally have two things in common:
1.They are owned by a single shareholder, which paves the way for the
board and management to develop a close relationship.
2.They have a specific objective to achieve. This is frequently, but not
always, more important than generating a high financial return on the
shareholder’s funds.
This book aims to help the reader develop a good relationship with the
shareholder and achieve the organisation’s strategic objectives.
A range of names is used for incorporated bodies within the government sector
– entities, enterprises, companies, corporations, authorities, commissions, and
probably a few that even the author has not yet encountered. What they have in
common is a separate incorporation. To avoid confusion, this book refers to all of
the different classes of incorporated bodies as “organisations”.
The government sector uses many acronyms to abbreviate the names and functions
of organisations, processes and institutions. Where possible, this book has avoided
acronyms in favour of the complete word. Some are unavoidable, and where an
acronym is in current and frequent widespread use it has been used in the text.
Australia has a three-level government structure with a federation, or
commonwealth, uniting and serving the State and Territory governments as well
as providing assistance to the Local government sector within each State. This
gives rise to a complex matrix of rules, laws, guidelines and regulations that affect
organisations in the sector. This book has not attempted to reproduce, or even
reference, all the applicable legal instruments. Instead, it has selected legislative
introduction
instruments from all three levels and from different States and Territories to illustrate
the points. The reader is advised to find comparable instruments in their own
jurisdiction and to compare and contrast them with the examples in this book.
Understanding your own legal environment and how it differs from others is one
of the hallmarks of an experienced director.
To assist in understanding the law, this book makes use of practical examples
of organisations that demonstrate legal principles. Australian government sector
organisations operate under a combination of precedent and statute law. Legal
precedent operates in a specific way: the older cases establish the rules that are
applied to newer cases. In Australian law courts it is quite usual for cases to refer
back to cases that happened many years before. As a result, where a case has
established an important precedent that is still relevant to boards today, the book
will refer to that case and not to more recent examples that demonstrate the
precedent. The original judgments tend to contain more exposition of reasoning
than cases where precedent is applied, even if those cases are more recent.
Understanding how government sector organisations have evolved and the
theory of how they may best be governed, requires a grounding in general governance,
as well as an understanding of how the government sector is different from other
sectors of the economy.
Although most corporate governance and boardroom theory has been developed
in regards to the commercial sector, the government sector is different. Government
sector organisations often operate in very sensitive environments, and concern for
stakeholders and the environment is an appropriate preoccupation for a board
member. Board members are often recruited because they have strong ties to
stakeholder groups or a passion for a local region, industry or environment that
will provide insight for the board when developing a strategy that is sensitive to
stakeholder concerns. As a board member, there is a difference between ensuring
that the activities are undertaken, with correct regard to the potential side effects,
and being there to thwart the aims of the organisation. Board members have an
over-riding duty to the organisation they govern.
Government organisations typically exist in areas of the economy or society
where free-market mechanisms would fail. Often there is an inability to translate
the value of the product or service into a price that can be borne by the consumers.
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At other times there is a monopoly that requires removal of the profit motive or
redistribution of the dividend stream back into the general government sector
budget to make the price of the products and services socially or politically
acceptable. There are also cases where the government operates sound commercial
businesses and derives from that activity a profit stream that funds other areas of
government endeavour and boosts government resources.
As a result of this complex array of organisation types, precedent and rationale
for government ownership, a plethora of regulations are developed to keep pace
with society, technology and economic developments. The changing regulatory
environment is a stimulus that draws many directors to choose government-owned
boards over public listed and private company boards. The satisfaction of influencing,
or of precipitating regulatory change, can be a potent motivator for serving on
government-owned boards.
Effective directors need to understand the policy framework and how to
influence it. They also need the confidence and skills to develop organisational
strategy within the government context and within the constraints provided by
the policy framework of the government of the day.
There are some risks, however, that counterbalance the thrill of doing a necessary
and fulfilling job in a stimulating and changing environment. Examples are the
State Bank of South Australia and the National Safety Council where a nonexecutive, and unpaid, chairman was found personally liable for over $97 million
when the company was found to have been trading whilst insolvent.1 It is important
to note that while fulfilling your dream of helping build a better tomorrow, you
are running some risks that could, if not properly managed, cost you your house,
your life savings and your reputation. In cases of extreme misconduct courts may
impose a banning order that can effectively end a director’s career. Some of these
risks are the same as those facing the directors of listed and privately owned
companies; others are far greater because of the nature of the sector in which the
organisation operates, the complexity of the regulations or the higher expectations
that the government, as shareholder, has of its directors.
1
Insolvent trading is defined as trading when debts or obligations are taken on that cannot be discharged as and when
they fall due. Under these circumstances the directors may be held responsible for the debts and obligations incurred
by the company.
introduction
In general, a government-owned company is governed in a similar way to one
in the private or listed sector. In a few areas there are some very different practices.
Probably the most notable difference are in:
• strategic and operational planning
• the recruitment and resignation of directors, and
• the appointment of the auditor.
In these areas the government-owned organisation lacks the ambiguity of the
“corporations law company”, as the shareholder is identifiable, is approachable
and is usually willing and able to take up its responsibilities and have meaningful
input into the processes and their outcomes.
As with any other directorship, governance in the government sector is about
making decisions and managing the outcomes. The board and directors are
responsible and have to decide on a case-by-case basis how to treat each item that
comes their way. This book should provide a wider set of factors to consider in
board and individual directors’ decision-making
Ethics and values drive much of the observable behaviour in government sector
boardrooms. An understanding of the ethical framework is imperative for success
in governing in the sector, and many directors, even those with many years of
experience on commercial boards, are unfamiliar with the public sector ethics acts
and legislation, and how these can subtly alter boardroom processes.
Most directors have a positive motive for the decision to stand for board
membership, whether a general desire to serve the community or an affinity with
the sector or objectives of the organisation. There is nothing wrong with having
a personal stance on issues as long as it is managed in an appropriate fashion and
in accordance with achieving the shareholder’s aspirations for the organisation.
The government sector has complex stakeholder relationships and it is quite
common for board members to have personal interests in the matter on which
their boards must decide. Appropriate management of these potential (and often
actual) conflicts is an important task for government sector directors.
Serving on a government-sector board is a life-enriching experience and will
have a positive effect on the lives of others in the community.
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Chapter One
Corporate Governance
in Context
This chapter gives a brief history of governance and
discusses the reasons governments have boards that
govern the organisations that they own. It provides
an introduction to the government-owned organisation
and its benefits to the Australian economy.
What is governance?
The Australian Securities Exchange (ASX)2 defines corporate governance as “the
framework of rules, relationships, systems and processes within and by which
authority is exercised and controlled in corporations”. Although this book is
concerned with governance in the government sector, many organisations in the
sector aspire to the highest and most recent standards, typically those of the listed
sector where shareholder activism and regulatory pressure demand continuous
improvement. It is not uncommon to find companies in the government sector
2
ASX Corporate Governance Council, Principles of Good Corporate Governance and Best Practice Recommendations,
June 2007. Available at www.asx.ice4.interactiveinvestor.com.au.
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aspiring to and reporting against private-sector standards as well as their own
guidelines.
Governance is the way things get done, rather than the things that are done.
Main Roads Western Australia defines governance in its 2010 annual report as:
“how we direct and manage business activities to optimise performance, achieve
regulatory compliance and deliver value”.3
Like many of its peers, Main Roads Western Australia uses modified ASX
guidelines as well as guidelines specific to the public sector when designing and
evaluating its governance processes and structures, explaining that:
To further underpin the strength of our governance practices we have assessed our
performance against the Guidelines established by the Western Australian Office of
Public Sector Standards Commissioner. This checklist is based on the nine Corporate
Governance principles developed by the Australian Stock Exchange and modified for
the State public sector.
In his 2002 Review of the Corporate Governance of Statutory Authorities and
Office Holders, John Uhrig, AC, defined governance as:
… the arrangements, by which the power of those who implement the strategy and
direction of an organisation is both delegated and limited to ensure the organisation’s
success, taking into account the environment in which the organisation is operating.4
In the Commonwealth sector the Uhrig definitions and principles are applied
to a range of organisations using governance structures of both board and direct
administrative control. The process involves ongoing review and refinement and
updates are published so that stakeholders may view the progress.5
Brendan Butler, SC, defined governance very succinctly: “If management is
about running a business, governance is about seeing it is run properly”.6
The concept of a “proper” adherence to an acceptable and independently
3
4
5
6
Available at www.mainroads.wa.gov.au.
Review of the Corporate Governance of Statutory Authorities and Office Holders, John Uhrig, AC, June 2003. Available
at www.finance.gov.au.
Available at www.finance.gov.au.
B. Butler, “Corporate Governance in the Public Sector”, Fourth Annual Public Sector Symposium, Brisbane, June 1999.
CORPORATE GOVERNANCE IN CONTEXT
established standard is pervasive in government sector governance. The elegance
of Butler’s definition is that “run properly” is a concept that will evolve with
circumstances and differing societal expectations.
Generally, whenever people are discussing governance they are discussing how
the organisation is controlled and the processes, systems and procedures that ensure
control is effective and is exercised in an appropriate manner.
Governance structures and definitions
Before starting to examine how corporate governance is delivered in the government
sector, it is worth establishing the basic concepts of board governance that apply
across all structures.
A corporation is governed by three groups of people:
• shareholders, who own the corporation and provide the capital,
• management and staff, who do the day-to-day work, and
• directors, who are elected by the shareholders to govern the company on
their behalf.
These groups are not always rigidly separate. It is possible for a shareholder to
be a director and also a staff member.
Directors who are also managers or staff members are known as “executive
directors”. They are more familiar with the business than directors who are not
involved in running it. In small businesses with few shareholders it is possible for
the shareholders to come together and take the big decisions about the business.
As businesses get bigger and bigger, shareholders become more numerous and less
connected with the business; it becomes more and more difficult for shareholders
to get together often enough to make the decisions that are required. To prevent
the management from operating unsupervised, shareholders will elect non-executive
directors, who are not part of management, to independently review management’s
performance and make the necessary decisions to guide sustainable development
of the organisation.
Agency theory suggests that management, if left unsupervised, will eventually
tend to run the business to suit themselves rather than to meet the legitimate
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needs of shareholders. Symptoms of this include paying excessive salaries,
granting themselves perks and perquisites that are unjustified, taking excessive
or insufficient risks, etc. Shareholders elect representatives to oversee the actions
of management to ensure that the interests of the shareholders are adequately
safeguarded.
Non-executive directors have no part in the day-to-day running of the
organisation. However, they are expected to be familiar enough with the business
to be able to spot any tendencies towards subverting the shareholders’ interests
and prevent them from occurring. It is important that the non-executive directors
have the skill and that they invest sufficient time and effort to do this. It is also
important that they do not become too closely aligned with management so that
they can be independent in their supervisory role. Sometimes independence is
sacrificed to gain better familiarity or vice versa.
Some non-executive directors who have not recently worked for the corporation,
are not associated with any large suppliers or customers and have no significant
emotional or pecuniary relationships with management are considered to be
“independent” of management.
In Australia every organisation has a constitution. This document sets out the
company’s name, its aims (or objectives) and the rules for how it will operate.
Companies may write their own constitution, adopt the standard constitution
contained in the Corporations Act or use a combination of both. Shareholders can
enforce the constitution the same way they would enforce a contract. It can be
difficult and time consuming both for the shareholders to enforce and for management
to implement changes to the constitution that shareholders require of them. Companies
can amend (or update) their constitution by passing a special resolution of their
shareholders. Ideas about what is a “good” constitution change, and it is a good
policy for companies to keep their constitutions up to date and aligned to current
ideas of good practice.
What constitutes good governance?
Just as there is no agreed standard definition of corporate governance, there is also
no single “right” set of procedures, structures or measures that would ensure good
CORPORATE GOVERNANCE IN CONTEXT
governance. Boards and shareholders work out what is most appropriate for their
organisation at that particular time.
Some general principles exist. These are often contained in mandatory codes
of practice. However, over time, codes evolve or are redesigned to suit the current
circumstances.
In the government sector there are many codes, guidelines and statements of
principle that may be applied to the governance of organisations. Some are legislated;
others are options that organisations may choose to adopt. Different jurisdictions
have decided to highlight different principles in their governance codes, a reflection
of their different cultures, histories, social structures and aspirations. Although the
codes are different they are not inconsistent with each other.
Some of the better-known governance codes are discussed in Appendix 2.
EXAMPLE 1: QUEENSLAND CORPORATE GOVERNANCE GUIDELINES
FOR GOVERNMENT-OWNED CORPORATIONS
The Treasury of the State of Queensland has drafted a set of corporate governance
guidelines for State-owned companies. These guidelines set out the expectations of
shareholding ministers in relation to the corporate governance of all Queensland
government-owned corporations established under the Government Owned Corporations
Act 1993 (GOC Act). They are intended to provide a framework for government-owned
corporations to develop, implement, review and report on their corporate governance
arrangements.
The guidelines have been drafted with regard to:
–ASX Corporate Governance Council Principles of Good Corporate Governance and Best
Practice Recommendations (ASX principles)
–Auditor-General’s Report No.2 2002-2003 – Review of Corporate Governance and Risk
Management at Government-Owned Corporations
–Auditor-General’s Report No.10 2002-2003 – Review of Management’s Assessment of
Fraud Control Risks and Associated Plans and Procedures
–OECD Principles of Corporate Governance.
Opportunity for reflection
What guidelines apply in the jurisdiction of your organisation that would influence your
corporate governance practices? What processes does your organisation use to ensure
that any changes are brought to the attention of the board and acted on in a timely
manner?
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The value of good corporate governance
Christopher Søren Shann Turnbull defined good governance as the ability of
corporations to efficaciously achieve their purpose while minimising the involvement
of the law or regulators in protecting and furthering the interests of corporate
stakeholders and society in general.7 This definition is particularly relevant to the
government sector, where the need for regulatory attention to be focused on a
government-owned organisation is often accompanied by political sensitivity.
Many experienced directors in the sector will use phrases such as “remain under
the radar” or “keep your head below the parapet” in describing how their governance
attempts to minimise the level and frequency of intervention required.
Good governance is positively correlated with value creation. A McKinsey study
found that investors were willing to pay a premium of up to 30 per cent for shares
in companies with good corporate governance.8 While there is no share price
premium for government-owned organisations to aspire to, the creation of value
is still a key consideration for the board.
Value for money is embodied in the Australian Public Service Values9 and in
most of the State and Territory values or ethics legislation. Value for money may be
embedded in intangibles, such as reputation, performance levels, community
satisfaction or the ease of attracting good staff, or may be measured in financial terms.
A brief history of governance
Corporate governance became an issue when the modern corporation was invented.
Modern corporations are characterised by a separation between owners and other
capital providers on the one hand and business operators or managers on the other.
There are records of Phoenician sailing and trading businesses dating back 4000
years and records of mining businesses in India that date back more than 7000
years. Somehow these businesses needed to develop systems and processes that
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C S S Turnbull, “What’s Wrong With Corporate Governance Best Practices?”, in Corporate Governance, A synthesis
of theory, research and practice, edited by H Kent Baker and Ronald Anderson, 2010, John Wiley and Sons, Hoboken.
Roberto Newell and Gregory Wilson, “A Premium for Good Governance”, The McKinsey Quarterly, No.3, 2002.
The APS Values are discussed in Chapter 8 Ethics and its Place in Business Life.
CORPORATE GOVERNANCE IN CONTEXT
would engender trust, so that the needed capital could be provided and the returns
shared with the providers of capital. In short, they needed corporate governance.
These early enterprises did not have the concept of limited liability, and if the
business failed the owners were held personally responsible for all debts incurred.
In some instances they could be held to more than just financial responsibility
and penalties. The code of laws of Hammurabi established that:
If a builder build a house for someone and does not construct it properly, and the
house which he built fall in and kill its owner, then that builder shall be put to death.
If it kill the son of the owner, the son of that builder shall be put to death.10
Under those circumstances, owners and providers of capital in early enterprises
were closely involved in monitoring how the business was conducted. This was the
only way they could manage the high personal risks attached to being in business.
As a result, those businesses were generally small. Owners of capital would only invest
in businesses that they personally understood and could devote their time and
attention to managing. This need for close involvement and personal knowledge
limited the available supply of capital to businesses and inhibited their rate of growth.
Modern corporations have adopted the principle of separate identity, whereby
the business is considered to be a being separate and distinct from its owners.
The first documented systems of modern corporate governance sprang from
medieval Europe when businesses, mainly trading corporations, local service providers
and monasteries, were granted licences, or royal charters, to undertake activities.
These licences recognised the business as a legal entity in its own right, in some
instances, and limited the liability of the owners and/or operators for the potential
losses of the corporation. Businesses became “synthetic persons” or “incorporated”
as entities apart from their managers or their capital investors. Thus the inhibition
on growth was removed (or loosened) and those businesses could develop at a faster
rate and to a greater ultimate size than businesses where the liability was absolute.
At about that time in Britain, some local government boroughs were among
the first businesses to be awarded this status so that they could apply pooled
community resources for the common good. The elected (or hereditary)
10 Hammurabi’s Code of Laws, estimated first published circa 1780 BCE, translated by L W King.
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community representatives became the equivalent of modern local councils and
governments.
The competitive economy was not, at that time, believed to be an efficient
model and many of the early organisations were granted monopoly status to
guarantee that they would be efficient generators of wealth for their owners. Those
monopolies were often granted with a limit on the activities that could be undertaken.
The concept of the articles of association and of acting ultra vires by exceeding
these limits had been invented.
At about the same time other corporate forms were being tried; mostly
partnerships and sole traders, which still exist today, and unlimited liability
companies often operating under trust or guarantee. In many of these corporate
forms the liability of the owners was absolute, so they were not as popular as the
limited liability companies. Standard forms of enterprise emerged and had the
benefit of allowing investors to learn the basic corporate structure and powers once
and then apply that knowledge to several businesses in which they might invest,
rather than having to become familiar with the intricacies of myriad forms of
enterprise. Enterprises that conformed to a standard type were preferred as
investment vehicles over those that were specific (or special-purpose vehicles).
Eventually, the exercise of these preferences created disparate growth rates, and
pressure from investors and the business community led to the development of
ever increasing numbers of limited liability companies.
International trading organisations in the 18th century took full advantage of
their monopolies and developed into enormous international businesses that
generated significant shareholder wealth and national prestige. This development
accelerated as the industrial revolution brought the need for ever greater sums to
be invested in new and, frequently, capital-intensive industries.
As businesses grew more complex, control became more and more difficult
and codes, standards and laws were developed to regulate the activities of the
companies and the claims they could make when raising money from shareholders.
The numbers of shareholders in certain companies also grew, so that it became
cumbersome for management to report to each shareholder individually. Standardformat reports, reporting time frames, report content and a secondary share market
developed. Shareholders elected boards to represent their interests and to provide
CORPORATE GOVERNANCE IN CONTEXT
a trusted intermediary between themselves and the professional managers of the
business.
There were cases of fraud where funds were raised for business ventures that
did not exist, or where businesses were allowed to spend sums on items that
benefited the management rather than generating a return for the owners of the
business. In addition, some businesses, such as railways and other infrastructure
companies and large associations of commodity producers, extracted high returns
from their monopoly status and this led, in some instances, to cases of price
collusion and anticompetitive behaviour. Legislation was drafted to counteract
those two trends. Perhaps the most far-reaching of these was in 1890, when the
Sherman Antitrust Act in the US declared that it was illegal to restrain trade or to
attain or to preserve monopoly power through anticompetitive acts. A raft of
legislation in many countries limited the powers of boards and management and
set out basic requirements for provision of information to shareholders and for
using funds for the purposes for which they had been obtained. This was the
beginning of the corporate governance movement.
The development of corporate governance in
the government-owned sector
According to current economic theory, there is no rationale for governments to
own businesses unless they provide “public goods” or are regulatory bodies that
serve to prevent abuse of power by other organisations. A public good could be
defined as something that, once available, cannot be withheld from any who need
it, regardless of their ability to pay. This inability to withhold is as often based on
technical considerations as it is on any basic moral or ethical right.11
Clean air, water supply and sewerage, street lighting and national defence are
common examples of public goods in the developed world.
Another definition of public good is provided by the concept of “non-rivalry”.
Under this definition, any good that is available equally to all, regardless of use by
some, is a public good. For example, if I enjoy the use of the street lights when
11 A full discussion of ethics is contained in Chapter 8 Ethics in its Place in Business Life.
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driving at night on my suburban road, it does not make the lights any less bright
or any less available for my neighbours. The lack of access to telecommunications
infrastructure for some regional areas is an example of a service that has become
considered as a public good but that is not equally available to all and from which
it is very simple to exclude users that are not economically viable for the company.
For example, businesses may wish not to extend mobile phone coverage or reticulated
gas networks to remote areas with few inhabitants.
EXAMPLE 2: The State Bank of New South Wales
When the State government of New South Wales proposed to privatise the State Bank,
Stan Neilly, member of parliament for Cessnock, had the following comments:
I oppose the bill, but not for any of the reasons enunciated by opposition members. To
me, philosophically, the sale of the State Bank goes against the grain. The government
has a fiscal responsibility to the electorate as well as a social responsibility. I believe that
a well-managed State Bank would avert many of the difficulties with which some people
in our community become confronted. I recall an occasion in the mid-1980s, when the
State Bank of New South Wales tried to influence home lending rates. It did so only for
limited time, but at least it took the lead. I recall also when the State Bank was a friend
to the farmer—the man on the land. During the past two years, the State Bank has been
primed the sale [sic] and, in conjunction with that priming, there has been a review of the
loan portfolio. Some hard decisions have been made, and those decisions have had sorry
ramifications the [sic] property owners.
Opportunity for reflection
Is there a role for State governments to own banks, or are banking services best provided
by the private sector? If the government is going to own banks, should these banks play
a social, or a purely commercial role in society?
Traditional market mechanisms are not always effective or efficient in providing
public goods to an acceptable service standard. Frequently, “natural monopolies”,
systems that would be too costly for a rival to build, are used to provide the service.
A good example of this is the electricity supply network. Rival electricity vendors
would not want to supply a second wire connection to every customer: it would
be a waste of resources and would be unprofitable. Also, in many cases, the good
or service is not sold at a price that would enable a privately owned company to
make a commercial return on its investment, especially given the risks associated
with the supply of the service to certain customers.
CORPORATE GOVERNANCE IN CONTEXT
Modern technology enables the provision of services via infrastructure to be
separated from the ownership and maintenance of that infrastructure. This has
resulted in the creation of separate businesses that can compete in a normal
commercial manner, using infrastructure provided by a “natural” monopoly supplier.
As this phenomenon has developed, industry boundaries have changed and
governments have retreated from businesses that used to be seen as key areas for
government activity but are now seen as commercial markets. The process is referred
to as “privatisation” because businesses are removed from government, or public,
ownership and placed into the ownership of privately owned commercial businesses.12
The population holds government responsible for providing an acceptable level
of service at an acceptable price to a majority of the electorate. Failure to do so
would result, usually, in the government being voted out of office in favour of a
new government that promised a service more closely aligned with the needs of
the population.
What is defined as acceptable levels of service and the acceptable price can
change over time, and governments need to pay strict attention to this process.
As the demand for services changes, so do perceptions of how large a role the
government should play in their provision. As the level of service and the number
of services demanded by society have increased, so has the complexity and variety
of methods used to provide them.
Government involvement in industry and the economy has varied, depending
on myriad circumstances, including commercial markets, external impacts such
as war and changing political climates. Its involvement has included developing
regulatory bodies or authorities that establish terms and conditions for trade and,
supported by the union movements, employment in many industries.
Today many governments around the world use corporations to provide goods
and services for their populations. Many of these are governed by boards. In freemarket economies the focus of governance thinking is currently on board
12 The reverse of this process, “nationalisation”, occurs when the government decides an industry (or a service in an
industry) is too important to the nation to be allowed to stay in private-sector ownership. The government then enters
the market to take the activity into government ownership. This happened with many services, such as health care,
rail and electricity supply, in the years after World War II. Some of those industries are still in government ownership,
while others have been privatised and are once again in the private sector.
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independence and diversity. The government sector is following this debate and
increasingly composing boards of independent and diverse directors.
The desired level of government intervention in markets and ownership of
businesses differs around the world. In some countries, such as France, government
is required to play a comparatively large role; in others, such as the US, government
plays a comparatively small role. The role of government in industry will change
according to the prevailing social, economic and political environment. This is a
natural process but can be very unsettling for directors of businesses in the sector
as governments change their ideas about what activities they will, or will not,
undertake.
As the extent of government involvement changes so, too, does the structure
of the organisations under government ownership.
Government, unlike commercial shareholders, is a single entity and does not
need elected board members to manage the flow of information between the
government body and the organisations that it owns. Straightforward executive
control is possible. Also, government can employ specialist managers to manage
each business and professional accountants to check up on the management and
ensure that all is being done effectively and efficiently. In spite of these two factors,
governments all around the world continue to place boards between themselves
and many of their organisations. They have good reasons for doing this:
1.Corporate structures are too complex and the number of organisations is
too high for politicians to manage by direct personal involvement.
2.There is a need for services to continue to be provided immediately
before, during and immediately after elections: an independent board
with sufficient tenure can ensure that business continues to deliver while
the political landscape is changing. Executives who report directly to the
politicians on a daily basis are often considered less likely to continue to
operate independently, regardless of the political agendas, and in many
countries it is common for a change in the governing political party to
involve a large change in the leadership of government-owned
businesses.
3.Boards typically include experienced people from the private sector who
may bring the latest ideas and efficiencies into the government businesses.
CORPORATE GOVERNANCE IN CONTEXT
4.Legislation has evolved to enable risk to be transferred to the board, rather
than to remain with the elected government.
Although the extent of government involvement in commercial areas has
changed over the years and will continue to change in the future, these reasons
remain relatively constant and explain much of the government sector board
governance that we currently take for granted.
The current governance status quo
Australia has a wide range of government-owned businesses comprising every type
of organisation, from large government departments to small quasi-independent
entities. Within the Commonwealth sector13 as at 1 October 200914 there were
932 separately identified government bodies. This does not include bodies associated
with and/or belonging to state and local governments.
The following criteria determine whether an organisation should be classified
as “government sector”:
• whether the organisation is established or given statutory recognition in
a Commonwealth act, regulation or other legislative instrument
• if a minister, secretary (of a department of state) or agency chief executive
is involved in governing the organisation, either as a member (such as
a shareholder) or a director, or has the capacity to direct the organisation
• if the board or executive are appointed by a minister, secretary (of a
department of state) or agency chief executive
• if a minister, secretary (of a department of state) or agency chief executive
has some influence or authority over board appointments or a right to
make a proportion of board appointments,
13 See Chapter 2 Government Operations for an explanation of Commonwealth, State and Local governments.
14 The date of the most recent list of Australian government bodies available at the time of publication. More up-to-date
lists will be published from time to time and details can be accessed at www.finance.gov.au The list of 932 public
sector organisations includes bodies where the government is involved in their governance, but does not include bodies
where the government’s involvement is for investment purposes: that is, to achieve a profit, is purely in the form of
providing finance through loans or grants, or through other contractual arrangements that do not impose a governance
responsibility on the government.
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• if the Commonwealth or one of its bodies acts as a trustee
• if the Commonwealth or one of its bodies has a proportion (or all)
of the shares
• if the Commonwealth, through any minister, secretary, agency
chief executive or their delegate, agency or authority or statutory
body or Commonwealth company is a member of a company
(whether as a shareholder or guarantor), partnership, association, joint
venture or trust.
Directors need to understand the governance arrangements applying to their
organisation and also understand how their organisation is expected to coexist
with other government- and non-government sector organisations. Before accepting
an appointment to a government-owned board it is important to check the exact
nature of the appointment and the status of the organisation. The differences
between one organisation and another can be indicative of differences in the legal
environment that create risks which, if not understood and managed, can be career
or organisation threatening.
For most government sector boards, directors are appointed by the shareholder
and serve for a predefined term of office. Unlike public-listed companies, where
the directors elect a chairman15 from among their number, the government, as
shareholder, usually directly appoints the chairman. The chair is also appointed
for a predefined term of office.
Independence and skill are particularly valued in directors, as they allow the
board to provide the organisation with a wider variety of qualifications, experience
and knowledge than it would be possible to find in a single executive manager.
This aids decision making and effective oversight of large and complex organisations.
The size of the board is designed to ensure access to an appropriate range of skills
and experiences without overstretching the budget of some of the smaller
organisations. Boards range in size from 3 to 21 members with most boards having
between five and seven members.
15 The term chairman has meaning associated with service, serving and presiding. It is not indicative of the gender of
the person in the role.
CORPORATE GOVERNANCE IN CONTEXT
There is a trade-off between giving boards time to develop a team to work
effectively together and preventing the team from falling prey to “group think”.
Governments select a length of tenure carefully so that an effective team can achieve
a reasonable amount of progress, but so an ineffective team does not have time to
damage the entire organisation. Within the sector, board members’ terms of office
range from very brief appointments to oversee specific projects or activities to
seven-year terms. Most directors are appointed to serve between three and five years
and the current practice16 is that appointments are renewed only once, or twice if
the director is promoted to chairman. More information on appointments and
board operations is contained in the Section on Board Composition and Recruitment.
The difference between boards and committees
There are important differences between boards and committees:
• A board acts as a team; the key aim is to maximise performance. A good
board will be willing to upset certain stakeholders if the long-term value
created by a course of action is greater than that of other potential courses.
A board has a statutory duty to further only the interests of the
shareholders as a whole and no such duty to further the interests of any
other stakeholder. Where a board member has been nominated by a
shareholder or stakeholder, that board member still owes his or her duty
to the shareholders as a whole and never to their nominator(s). When the
interests of a shareholder conflict with those of other shareholders, the
directors must do their best to impartially assess the best course of action
for the company as a whole and not for any one group.
• A committee is a decision-making body that looks and, to some extent
acts, like a board but it is made up of representatives. The key aim of a
committee is to ensure that no outcomes will be unacceptable for any one
of the stakeholder groups represented. This is very different from the aim
of a board, which is to maximise performance. A committee is more
16 The preference is observable as a pattern emerging from the drafting of terms of reference and tenure for many boards
over recent years. It is rarely expressed as a preference with proponents often preferring to call it “best practice” rather
than just the prevailing notion of good practice.
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focused on minimising the chance of an unacceptable outcome. For the
public sector the use of committees made up of representative members is
crucial for good governance in difficult areas where free markets would
not provide good governance outcomes.
Another important difference is that board members carry a personal liability
for the actions of the organisation that the board governs. This liability extends
beyond the decisions made by the board members in board meetings to myriad
events including, but not limited to, workplace health and safety, trade practices,
solvency, bullying and harassment. Committee members are usually held to account
by their nominators but rarely have responsibility for actions outside their sphere
of direct control. It is, perhaps, this liability that underlies the general practices of
remunerating committee members using sitting fees and remunerating board
members using an annual fee similar to a salary.