Post Royal Commission Governance - Part 2

Rising to the Post Royal Commission challenge

In the previous article in this series, we noted that the world of governance is likely to change dramatically in Australia.  In large part, this will be the natural blowback from regulators who are now motivated like never before to play tough cop.  In the past they have probably been worried about overstepping the mark and even causing system stability.  Right or wrong, this wont be their biggest concern going forward.

From past experience, we have found that even when an organisation passes through a crisis unscathed, there are still heightened demands on it to raise its standards even further.  

Before we can talk about how to position our organisations to meet the challenges ahead of us, we should first properly consider the underlying causes of the misconduct that Commissioner Hayne and APRA have made public.

 

 

Group-think

Trent Moy, Senior Consultant at The Ethics Centre puts it down to group think.  He goes on to explain that humans make decisions with their gut first and then back fill with their brain later if necessary.  Perhaps counter-intuitively, if you have a collegiate board and everything seems to be running smoothly, it’s actually hard to notice if you have group think and are missing a ticking timebomb somewhere.

...or something more complex?

While I have a lot of sympathies for the Ethics Centre’s view, there are some elements I’d like to comment on:

  • There aren’t actually laws of physics at play here. In reality people are complex.  It would be unusual for there to be just a single cause.  We are entering the world of social science (which is a set of theories that are still maturing)
  • Social science cuts across many areas. Adam Smith, was really the first polymath in social sciences.  He established economics, developed the Theory of Moral Sentiments and prepared a body of work on Juris Prudence.  We will turn to his thoughts in a moment.
  • Telling a group they have group-think doesn’t on its own offer any pragmatic solutions.

Principal-Agent problem

The various Royal Commissions across multiple sectors have made it quite clear that the management of many organisations have been taking advantage of the situations they have found themselves in.  This isn’t anything we should be surprised about.  It is merely a function of human nature that goes back at least as far as The Enlightenment.  We shouldn’t feel that human nature will always lead us into trouble however.  Hayne referred to the importance of recruitment practices for a reason.

With an eye to the future, Adam Smith introduces the principal-agent problem and notes that most investors do not worry themselves with ‘the business’ so long as they are happy with the dividends they receive.

“The trade of a joint stock company is always managed by a court of directors. This court, indeed, is frequently subject, in many respects, to the control of a general court of proprietors. But the greater part of those proprietors seldom pretend to understand anything of the business of the company, and when the spirit of faction happens not to prevail among them, give themselves no trouble about it, but receive contentedly such half-yearly or yearly dividend as the directors think proper to make them". – Adam Smith (Wealth of Nations)

How you interpret the paragraph above depends very much on how you see the role of directors.  Our pragmatic view is to see directors as genuine representatives of proprietors (shareholders) guarding against the negative effects of human nature and the principal-agent problem.

If governance is the solution, why is it so hard?

The number of topics that directors and other fiduciaries need to cover can be mind-boggling.  That’s why most governance experts try to codify the areas of focus using tools such as the popular Tricker Model (below), which covers 360 degrees from those that are forward looking, historical, outward facing as well as inward facing.

Most of our governance breakfast audience agreed with the intuitive need for directors to represent shareholders.  But paraphrasing APRA’s comments about CBA’s risk management: this approach appears to perform better on paper than in practice.  The difference of course is that it takes real people and the culture in which they operate to determine what really happens on the ground.  Policy and procedure manuals can only go so far.

Culture

Perhaps the real reason that governance frameworks operate better on paper than in practice is that the soft stuff (ie managing people and culture) actually turns out to be the hard stuff.

To properly put this hard stuff on the right footing, the governance framework we use at Due Governance starts with the Tricker Model, and builds on that to incorporate culture management, capability management and ensuring there is time available for self-reflection. 

In practice

One of the confronting outcomes of APRA and the Royal Commissions is the contempt in which regulators probably now view a ‘collegiate board’.  We all know the opposite of ‘collegiate’ is polarized, and that would create even worse outcomes.  So what are some practical ways to demonstrate to others that your board ‘gets it’, without self-harming the organisation?

You may wish to consider fine tuning the level of oversight the board provides.  While changes in this regard can be hard to demonstrate to others, there are numerous aspects which can be, for instance:

  • Accountability control. This can be work-shopped and mapped.  Accountability mapping also provides a great opportunity to tailor oversight to harness the inherent cognitive diversity that exists within your organisation
  • Capability management. Board’s and senior management can consider new ways to focus on the strategic needs of the organisation, while simultaneously promoting a desirable corporate culture.  This involves the organisation’s recruitment, incentive, retention and training programs. 
  • If you are not already, every board should include an in-camera session with no specific agenda items. HSBC Chairman, Graham Bradley, has noted how these sessions allow directors to turn their minds to issues that are burning quietly away in the background but initially are too small to raise as full-blooded agenda items. 

The Hayne Royal Commission rewarded industry superannuation providers for being able to link their governance processes in ways that benefit member outcomes.  On the other hand, financial service providers such as CBA have been singled out for governance processes that don’t properly deliver client and member outcomes.

Given my institutional investment background, what I fear most from overzealous regulators and legislators is that corporate profitability and shareholder needs become optional extras.  On the other hand, when long-term institutional investors support companies that focus on sustainable profitability, then growing demands on governance outcomes will not just make corporate entities better corporate citizens, but ultimately better investments.

- James Dick

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