CORPORATE & COMMERCIAL NEWS, JULY 2009

The value of good governance and best practice

Various reports have now been written about the corporate practices (or lack of) that have contributed to the global credit crisis. For example, the OECD published a report in February this year entitled The Corporate Governance Lessons from the Financial Crisis. The UK Treasury also published a report on the banking crisis in May this year entitled Banking Crisis: reforming corporate governance and pay in the City. The current financial crisis highlights the importance of good corporate governance. What are the fundamentals of good governance?

Although the finance sector has come under the closest scrutiny, many of the findings are equally applicable to companies operating in other sectors. For example, consider the following findings:

• Directors have either been misled by management, or have not taken the time to fully assess management recommendations or practices, or become fully acquainted with the company’s products and services, especially non executive directors;
• There has been Board make-up imbalance, with necessary skills lacking, and a recurring theme of one or more dominant directors who effectively derail any good governance initiatives;
• No (or ineffective) corporate risk committees; and
• Passive shareholders.

The reports focus largely on corporate governance and risk management issues. Many readers might say – “that’s all very well but we are presently just trying to stay in business”. The wider issue for businesses now looking beyond the real economic recovery when it arrives, is how these issues flow over into building and maximising the value of your business. This is especially true if you are planning an exit strategy some time within the next 5 years.

Corporate Governance, risk management, and “best practice” issues generally are at the core of building and retaining real corporate value. Companies need to have effective working practices in these areas, not only to avoid costly litigation, but also to:

• build brand and shareholder value; and
• to make it easier for a would-be purchaser to see the value of the business and therefore to be willing to pay your asking price when selling.

The point here is that these governance best practice issues are not just for compliance sake, they should form part of your company’s wider succession planning.

What was the value of some of the worlds largest companies before it was discovered they were deficient in these key areas? The answer is “far higher than afterwards”. The perceived value behind good or even modest corporate financial statements can be quickly undone if these best practice measures are not in place, and cannot be shown to have been in place as effective working structures.

What should businesses do?

Below are some suggestions:

• Gather and assess more information about these best practice issues. For example, you might approach the NZ Institute of Directors for further information, or obtain information from say the Securities Commission website.
• Re-assess the make up of your Board of Directors. Do the right skills currently exist within your Board to effectively address these issues in the context of your business?
• Re-assess Board and management practices. Do they foster awareness and education of, and adherence to, best practice?
• Form a Risk Committee if one does not exist, and have it chaired by the most suitable company director. Make sure that the right people with the right skills form part of that committee. For example, a good lawyer and a good accountant should be mandatory inclusions, even if external to your business.
• Present some initial Terms of Reference and related deliverables for the Risk Committee to work to. Initially, those may relate to fact finding, initial assessment and related reporting to the Board.

When the Risk Committee moves beyond its initial start up phase, it should be working effectively with the Board and the managers in your business on an interactive and constructive basis, not only to sure up on corporate governance, risk management, and “best practice” issues, but also to assess other risks facing your business (both internally and externally). The Committee should have continual input into your overall strategic plan.

 The Risk Committee will no doubt identify legal, financial, management and other matters that need to be addressed. They will be graded ‘Urgent – Priority 1’ through to ‘nice to have and will need before any sale’. Much will come down to the Terms of Reference for the Committee.

Essentially, the decision faced by Boards is to do nothing, risk the consequences, and potentially lose out on the enhanced value such measures would bring, or seize the alternative and constructively progress towards maximising the value of your business and the ongoing retention of that value.

For advice on governance contact Sean Lynch, Partner, DDI +64 9 375 8722, or email sean.lynch@heskethhenry.co.nz