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Corporate Governance & Board Structure

Ismail Bin Ahmed April, 2007

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Corporate Governance & Board Structure

1.1 Introduction

Quoting Sir Adrian Cadbury from The Company Chairman (1990): "The classical theory of the board is that the shareholders elect the directors and authorize them to run the company on their behalf. The board in its turn sets the aims of the enterprise and appoints managers to carry out those aims. The managers thus carry the authority of the board and the board that of the shareholders."

The Cadbury Report has done much to restore the supremacy of the board's ultimate power and accountability, as well as its integrity. It helped generate a "corporate governance movement," especially in Commonwealth countries such as Australia, Canada, New Zealand, and South Africa, plus the Netherlands, with the US tagging along behind. (Garrat, 2003)

The Organisation for Economic Co-operation and Development (OECD) public governance principles guidelines in 1999 and revised in 2004 amply illustrate the points which governments and their departments should aim for in terms of a governance framework: (Cowan, 2004)

Accountability - willingness and openness in relating the decisions made

to clearly defined and agreed objectives. Transparency - decisions and actions open to scrutiny by appropriate

bodies, institutions and individuals.

Efficient and Effective - outputs from government activity are achieved at best cost for the agreed level of quality.

Responsiveness - capacity to respond rapidly and with flexibility to societal changes and to the need for critical re-examination of policies by the general public.

Forward Vision - ability to anticipate future problems based on current and takes into account the cost of future demographic, economic and other change.

Rule of Law - transparency of laws, regulations and codes and their enforcement.

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These are aspirations represents not just good governance but a practical approach for the public sector in any country. Corporate governance necessary to monitor whether outcomes are in accordance with plans and to motivate the organisation to be more fully informed in order to maintain or alter organisational activity.

Corporate collapses, misinformation, fraud and the failure of many watchdog institutions, from auditors to investment analysts, have driven the need for change beyond the self-policing business arena and into the realm of politics - as had happened to Enron and Worldcom - as well as lesser corporate debacles, such as Adelphia Communications, AOL, Arthur Andersen, Global Crossing, Tyco, created an atmosphere of doubt and among the investing public. Practical applications of corporate governance in the US now mean compliance with the law - not just compliance with a "softly" enforceable voluntary code.

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2.1 Australian Corporations Law Australian corporate law originated since The Crown granted charters of

incorporation such as on some early Acts passed in the United Kingdom in 1834 and 1837, and then in 1844 as "an Act for the Registration, Incorporation and Regulation of Joint Stock Companies". This United Kingdom Act was followed by enactments in the several Australian colonies, which legislation was repealed and replaced over time until each Australian State came to have its own modern Companies Act. (Yorston, Fortescue & Turner, 2004)

2.2 Model Birth and Growth of a Board Initially the membership of a board may be limited to a small group of

founders of a business, or the founder and one or more friends or members of the family. Their meetings may be informal conversations. As business expands, more individuals may be invited to join the board. The board has executive directors but the company is dominated by the entrepreneur owner.

Some of executive directors may be employees. Others may be non-executive directors. As business flourish, it is necessary for the company to call and hold proper annual general meetings of the members.

Appointment of one or more independent directors follows to ensure the interests of the minority shareholders. The board has to decide whether a dividend is appropriate, instead of ploughing all the profits back into financing further growth of the business.

The appointment of a non-executive director to the board, at best, probably a widely experienced professional chartered accountant could give the board a lot of expert advice. He could also be seen by the minority shareholder as a non-executive director who would bring some balance to the board. Regular, properly convened and minuted board meetings became a norm.

When the business significantly takes off and the rate of expansion could not be funded from ploughed-back profits, additional finance became a necessity.

The board may agree that a merchant bank, which offers to provide venture capital, be invited to provide funds. The merchant bank provides a convertible loan, secured on the company's assets and holds a significant equity stake in the company. The merchant bank is given a seat on the board as part of the package.

The board now had more executive directors, including the Chairperson and CEO, and non-executive directors, one of whom represented the interests of the merchant bank.

The company continues to thrive and it may opt to become an incorporated company by offering shares to the public, with the entrepreneur remaining as Chief Executive who acquires majority equity of the company but continues to serve as a director.

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3.1 Directors and the Board: Legal Duties Owner-directors as had been described above need to be kept aware of

the fact that an incorporated business is a legal entity in its own right. In return for the privilege of limited liability certain legal obligations must be assumed. The company's assets are not their private property.

The board of directors of a company, regardless whether they are owner-directors or not, have a duty of care and skill to supervise the policy and management of the company's activities.

As agents for the company, the directors have the powers and duties of carrying on the whole of its business, subject to the restrictions imposed by the memorandum or articles and any statutory provisions contained in the Corporations Law.

Whilst little may be expected historically from company directors in relation to care and skill, this duty has been interpreted in a way that places a very modest burden upon the shoulders of directors based on a leading case, Re City Equitable Fire and Insurance Co Ltd (1925). (Routledge-Cavendish Lawcards, 2006)

The directors are also under a fiduciary duty towards the company and improper actions may entail liability either through a breach of the Corporations Law, the company's memorandum and articles, or the general law. Much is expected in terms of honesty and integrity from the directors, since a director is considered to be a type of trustee of the company's property [Keech v Sandford (1726)]. (Routledge-Cavendish Lawcards: Company Lawcards, 2006)

Much of this law has been developed by the cases, but there is some modification of the judge-made law by statutory provisions.

Directors must act bona fide in the interests of the company; exercise their powers for the purposes for which they have been conferred; not place themselves in a position in which there is a conflict between their duties to the company and their personal interests; and must not make a secret profit.

3.2 Directors and the Board: Types of Directors (Adapted and improvised from Tricker, 1994)

An executive director is both a member of the board of directors and an executive in the company. He or she is appointed by the shareholders and is responsible like all directors under company law besides being an employee of the company under a contract of employment.

A non-executive director is one who does not also hold a management position in the company on whose board he or she serves.

A nominee director is a director who has an agency agreement to promote the interests of a principal; for example, the interests of a major shareholder or a merchant bank with a significant stake in the company. Their nominee

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commitment does not prevent them from acting like every other director, in the best interests of the company as a whole.

Representative directors quite similar to nominee directors. But they are appointed to the board to represent the interests of a stakeholder group, such as the city council, employees, consumers, or other vested interests. They must also for the good of the company as a whole.

An alternate director can be appointed, in line with the company's charter, to attend board meetings whenever the person for whom he or she is the named alternate cannot be present. When acting in this situation, the alternate director acquires all the rights and duties of other directors.

A shadow director is someone who, though not formally a member of the board, plays in the background and exercises power over board decisions. In some jurisdictions, where it can be shown that a board is acting under such influence, the shadow director can be held responsible like other board members.

Many people who have the title of director do not, in fact, serve on a board. The reasons might be to reward performance with recognition and status, or to give prestige to an executive who is required to represent the company with major clients, customers, government and so on. Others differentiate their director's titles with qualifications, such as non-executive director or executive director, in ways not recognized by company law. Whilst a few, who do not bear the title of director at all, could find themselves held responsible as if they were.

3.3 Directors and the Board: Institutionalisation of the Corporate Governance

All directors, who have been properly appointed by the shareholders, are equally responsible to safeguard and enhance stakeholder investment by effective oversight of management activities.

Their activities include reviewing the development and execution of strategies; selecting and reviewing the performance and compensation of the chief executive and senior management; and ensuring transparency of communication and disclosure of financial and non-financial information, including establishing an effective audit process. (Ernst & Young - Effective Governance Model)

In addition to undertaking all of these activities an over-arching challenge for the board is to create a sound culture that allows the principles of good governance to thrive. No matter what processes and activities are in place, at the core of good governance is culture. (Ernst & Young - Effective Governance Model)

According to ASX Corporate Governance Guidelines Principle 2, "Ultimately the directors are elected by the shareholders. However the board and its delegates play an important role in the selection of candidates for shareholder vote."

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4.1 Board Structure and Corporate Governance According to the ASX Corporate Governance Council Principle 2 of Good

Corporate Governance and Best Practice Recommendations, a company should "Structure the Board to Add Value" – This principle "seeks to ensure the board has an effective composition, size and commitment to adequately discharge its responsibilities and duties. The recommendations include that the chairperson should be an independent director, the role of the chairperson and CEO should be performed by separate individuals, a majority of the board should be independent and the board should establish a nominations committee". (Ernst & Young: Effective Governance Model - An Operating Framework)

Certainly, board structure is a foundation for an effective board. It focuses on the background interests, affiliations and position of its members. It is deals with the balances of power and is at the centre of board performance and accountability.

4.1.1 Board Size ASX Corporate Governance Guidelines Principle 2 on Composition and

Commitment states that "It is important that the board be of a size and composition that is conducive to making decisions expediently, with the benefit of a variety of perspectives and skills, and in the best interests of the company as a whole rather than of individual shareholders or interest groups. The size of the board should be limited so as to encourage efficient decision-making".

It is obvious that there is no prescribed size for a company's Board or for its composition. A company is at liberty to decide for itself the best fit for the purpose it has been established. Companies should, therefore, consider first and foremost why the Board is being set up and what it is hoping to achieve. (Cowan, 2004)

The minimum and maximum numbers of members of a company's board are usually laid down in the company's Articles of Association or charter which can only be changed by a special resolution of the members.

According to a UK survey by Coulson-Thomas and Alan Wakelam, there is little evidence that there is an ideal or `standard best' size for a board. (Coulsin-Thomas, 1993)

The impact of company size upon the nature and operation of a board, and the subject-matter with which it is concerned, will vary. Market sector, the complexity of a process or technology, whether there are international operations, company structure and many other considerations will influence these factors. (Coulsin-Thomas, 1993)

The optimum size of the board depends, as has been suggested, upon the circumstances of the company, the qualities of the directors and how the business of the board is conducted. A board which is `too small' may be deficient in certain areas of expertise, and might lack breadth and balance. One that is `too

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big' may inhibit close interpersonal relationships, causing board processes to be more formal. Schisms can more easily arise while a strong may CEO feel inclined to view the big board as his or her 'audience'.

In the UK, John Harvey-Jones of ICI PLC streamlined the governance of the divisional companies that reported to the main board by reducing the board sizes significantly. Proposals for increasing board numbers are frequently put to boards; suggestions for reducing the board size are far more unusual (Tricker, 1994).

4.1.2 Board Composition

ASX Corporate Governance Guidelines Principle 2 on Director Competencies states that "Corporate performance is enhanced when there is a board with the appropriate competencies to enable it to discharge its mandate effectively. An evaluation of the range of skills, experience and expertise on the board is therefore beneficial before a candidate is recommended for appointment. Such an evaluation enables identification of the particular skills, experience and expertise that will best complement board effectiveness".

Good governance means good people. A board's power is a function of its directors and how they are chosen. Former Coca-Cola director Charles Duncan says, "Be very careful in recruitment. All other things are dependent on the right individuals. Do your due diligence. You can have any kind of processes and controls," but without the right people, it doesn't matter.(Shultz, 2001)

Someone who has been successful in leading a company does not mean her or she is effective in the boardroom. A decisive, action-oriented CEO or entrepreneur may not easily become a collaborative team member who sits quietly, be a good listener, a good advisor, and a consensus builder. Perspective of a CEO is narrow because he or she worked in the business of a single company. A balance of consultants and professionals who have broad perspec-tives and insight is the key.

Include some directors with prior board experience. Their ability to mentor new board members and the governance knowledge they bring. Proven directors may be deemed capable -but they may or may not be the best for another company. Someone who serves on a board does not mean that he or she is a good board member. It is necessary to visualize who will be at the board table and how they will interact with each other and how they will complement the strengths and weaknesses of each other and management.

Avoid a majority of investors. Companies will only limit their ability to recruit proactively to their strategic needs by overloading their boards with investors. Fast growth companies are especially vulnerable, because board seats are swapped for investments. Ideally, a core board must be recruited before a company seeks significant funding.

Ensure diversity. The most successful and competitive companies have

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active and diversified boards which is characterised by its breadth of perspective, background, knowledge and experience from outside the organization brought to its leadership.

There should be relevant level of financial competencies and understanding of relevant law at the board table, though that does not necessarily mean practicing accountants and lawyers should be directors. The board responsibilities of these profesionals are the same as for all other directors.

4.2 Director Independence 4.2.1 Director Independence: Non-executive Directors

The aim of Principle 2 of the ASX Corporate Governance Guidelines is to achieve an appropriate balance between achieving a desirable level of board independence and maintaining sufficient relevant experience and competence for the board to fulfil its objectives (Independent Review Group Report March 31, 2004: http://www.asx.com.au/about/pdf/IRG_report_web_tool.pdf)

The principal argument for the inclusion of non-executive directors on a board is for the independent and objective perspective they can bring to board deliberations. Non-executive director can make a vital contribution as part of the checks and balance mechanisms to ensure that executive directors do not treat the company as their private possession. (Tricker, 1994)

Lack of independence is a major reason for ineffective governance in every type of organization. For the board to perform at the highest level it must have a wider perspective for strategy development and decision making than is available within the organization.

The independent governance role and function should focus on bringing a number of key benefits to the leadership, management and governance of the organization. Directors with an independent perspective are more likely to constructively challenge proposals and decisions before the board, other directors and management.

The board should consider providing more fulsome disclosure in relation to the skills, experience and abilities of its directors and how the company benefits from this. (Appendix 2: Ernst & Young: Effective Governance Model - An Operating Framewok) Disclosure may include the risk profile of the company and the impact this has on desirable board membership. For example, the board may wish to discuss the entrepreneurial nature of the business, to demonstrate the relevance of a board-member selection.

The CLERP 9 Act contains a number of important reforms to the existing corporate governance provisions in the Corporations Act, including continuous disclosure. Changes to continuous disclosure offence provisions includes the controversial power given to ASIC to issue infringement notices for breaches.

(AAR: Corporate governance site: CLERP 9: Overview: www.aar.com.au/corpgov/clerp)

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4.2.2 Director Independence: Relationships ASX Corporate Governance Guidelines Principle 2 states that "Family ties

and cross-directorships may be relevant in considering interests and relationships which may compromise independence, and should be disclosed by directors to the board:.

Independence of mind means the integrity of the individual and his freedom from any conflict of interest that could affect the exercise of independent judgment.

The bottom line question is; does the director have any relationship that could be construed to influence his/her ability to exercise independent judgment as a director of the organization? (Matheson, 2004)

Independence, in practice, also means the directors do not benefit personally from the decisions of the board. A director must be free from the influence of employees (including management) protecting their personal position, status, career or financial position. In the extreme, this would exclude employees, and their immediate families, the organization's legal advisors, bankers, consultants, suppliers and customers from being directors.

A non-executive director is deemed as independent if, he or she satisfies the description in Box 2.1 of the Principle 2 of the ASX Corporate Governance Guidelines (Appendix 1).

Prospective Board-Members should be assessed and made to answer the list of Questionnaire in Appendix 2. Even seasoned directors should be interviewed in the context of the board. They need to understand the company charter and what is expected of them.

4.3 Chairperson 4.3.1 Role of the Chairperson

ASX Corporate Governance Guidelines Principle 2 - Recommendation 2.2 on Commentary and Guidance states: The chairperson should be an independent director that:

The chairperson is responsible for leadership of the board, for the efficient organisation and conduct of the board’s function, and for the briefing of all directors in relation to issues arising at board meetings.

It is important that the chairperson facilitate the effective contribution of all directors and promote constructive and respectful relations between board members and between board and management.

Where the chairperson is not an independent director, it may be beneficial to consider the appointment of a lead independent director.

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It is vital that the chairperson commit the time necessary to discharge that role effectively. In that context the number of other positions, and time commitment associated with them, should be taken into account.

A strong Chairperson is an important factor to success. An overbearing Chairperson may how ever lead to disaster for all concerned. Some or all of the following reasons may indicate a Chairperson who is bent on keeping personal control: (Cowan, 2004)

Setting highly controlled Board meeting agendas to which other directors are denied input

Creating a Board environment which makes it difficult for other directors to participate in general debate Curtailing discussion of important and/or strategic matters Creating an "inner group" of intimate directors which sets Board direction Minimising the input and impact of reports from important Board Committees Limiting the availability of important data to independent directors.

4.3.2 Separation between Chairperson and Chief Executive

ASX Corporate Governance Guidelines Principle 2 Recommendation 2.3 states: The roles of chairperson and chief executive officer should not be exercised by the same individual.

An all-powerful Chairperson influence may be exacerbated when there is no division between the role of Chairperson and CEO. This concentration of power can often simply be seen by the other directors as too much to overcome and is often cited as the main contributor to pursuance of poor company strategies long after they have seen to be failing. (Tricker, 1994)

The roles of chief executive and Chairperson of the board must be separated to enhance checks and balances at board level and reduce the risk of domination by a powerful chief executive. Howe ever, while separation of roles can enhance conformity, having one person as the Chairperson/chief executive may encourage performance because often, a company needs single-minded leadership in competitive conditions.

The CEO and the directors must treat each other as equals in the operation and governance of the company. They must trust and respect each other. Collegiality and cooperation must be preserved to ensure that the important responsibilities of the board are properly discharged even while current

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trends are leading to a reduction of the CEO's dominance in the boardroom, especially as the new rules of corporate governance are implemented. Therefore: (Brountas, 2004)

The CEO and the directors must cooperate and work together to create an open board environment where disagreement doesn't create disruptive tension or animosity.

Directors must be aware of the CEO's need for attentive and committed directors who are willing to devote the time necessary to acquire and maintain solid knowledge about the company's business, finances, competitors, and risks.

Directors need to concentrate during board meetings and remember what the CEO and management tells them about achievements, problems, plans, and future strategies. There is nothing more frustrating to a CEO than a director who asks for a discussion or explanation of a matter, a future strategy, or a compensation program that was exhaustively presented and discussed at a recent prior meeting.

Directors need to assist the CEO in planning the agendas for the board meetings, thereby allowing the CEO to conduct meetings that are relevant, informative, productive, and beneficial to both management and the direc-tors.

The CEO wants and needs honest feedback from the directors, including advice designed to improve board meetings and enhance director knowledge, as well as frank and helpful criticism when required and encouragement and praise when earned.

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5.1 Disclosure of Corporate Governance Practices In reality, the ASX Corporate Governance Recommendations are not

prescriptive. They are guidelines, designed to produce an efficiency, quality or integrity outcome.

The two main platforms for companies to disclose their corporate governance practices are the annual report and their website. The annual report is to summarise a company's corporate governance practices and where they do not conform with the best practice principles, to explain why a particular approach has been taken. (CLERP 9 Discussion Paper: Annual Reporting Meeting: http://www.aar.com.au/corpgov/iss/ann/index.htm)

1) The Recommendations provide a framework to help companies provide meaningful and comparable disclosure about their governance practices. The Recommendations are inspirational statements, but will not represent best practice for all companies in all situations.

3) Companies should not adopt the Recommendations without first considering what constitutes best practice in its own particular circumstances.

4) Best practice evolves over time. Companies must seek to improve their governance practices, having regard to changing market needs and changing circumstances.

5) A company's only obligation is to disclose to what extent it has not followed the Recommendations and why.

6) If it chooses to implement alternative governance practices, it is encouraged to disclose how these practices embody the spirit and intent of the overarching Principle.

Mr. Justice Owen, in his first recommendation in the HIH Royal Commission report, recommended to the Government that:

'...the disclosure and other requirements of the Corporations Act 2001 (Cth), the relevant accounting standards and the Australian Stock Exchange Listing Rules that relate to directors' remuneration be reviewed as a matter of priority, to ensure that together they achieve clear and comprehensive disclosure of all remuneration or other benefits paid to directors in whatever form.' (CLERP 9 Remuneration- http://www.aar.com.au/corpgov/iss/rem.htm)

The Australian Government has addressed this recommendation in the CLERP 9 Discussion Paper process. The discussion paper proposed the

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Corporate Governance, in consultation with ASIC, prepared guidelines for the use of webcasting.

The Corporate Governance recommendations provide that companies should:

establish a communications strategy to promote effective communication with its shareholders, including a policy on electronic communication;

consider webcasting or teleconferencing general meetings; and

consider allowing shareholders to lodge proxies electronically, subject to the adoption of satisfactory authentication procedures.

However, the CLERP 9 Act does not contain any provisions that are directly aimed at addressing the impediments to introducing webcasting as a substitute for physical attendance at the general meeting. (CLERP 9 Discussion Paper: Shareholder Participation – Access to Meeting: http://www.aar.com.au/corpgov/iss/share.htm#acc#acc)

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6.1 The Significance of Structure - Governance and Management Distinguished

Board structure distinguishes between those directors who hold management positions in the company and those who do not. In Australia and countries influenced by the development of British practice, those with management positions are referred to as executive directors and those without are called non-executive directors. In Australia, the boards of public companies tend to have a majority of non-executive directors.

Another distinction can be drawn between non-executive directors who are genuinely independent of the company's affairs, other than holding their board appointment, and those who, although they are not executives of the business, nevertheless hold positions which might bring their objectivity and independence into question. Howe ever in practice, some members may have charismatic power to influence their fellow directors, whilst others may be allowed to dominate, but there is no official hierarchy.

Corporate governance is increasingly used to refer to the specific work of directors and boards, as they interact with top management, shareholders, auditors and other external parties, contrasting with management's work in running the business.

A useful way of depicting the interaction between management and board is to present the board as a circle which is superimposed on the hierarchical `triangle of management' (Figure 1). Board structures can be distinguished and their strengths and weaknesses can be assessed using this model.

Figure 1: The Board and Management Differentiated (Adapted from Tricker, Robert. I. International Corporate Governance: Text, Readings and Cases, Singapore: Prentice Hall, 1994. pg. 44)

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7.1 Conclusion

A survey in respect of corporate governance practices in the Asia-Pacific region published by the Association of Chartered Certified Accountants in Australia (November 2002) revealed that:

"...Australia does have a high standard of corporate governance and clearly must do much more to promote this internationally rather than just in Australia. Positioning Australia in this way will help encourage capital inflows into the country. If we fail to do this, we risk losing investment capital to other countries in the Asia Pacific region." (Cowan, 2004)

Paul Gompers of Harvard and Andrew Metrick of the University of Pennsylvania’s Wharton School found that "firms with stronger shareholder rights had higher firm value, higher profits, higher sales growth, lower capital expenditures, and fewer corporate acquisitions." http://www.larsonallen.com/effect/spring05/psg.pdf

Most directors desperately need educating to be able to cope with the complex and dynamic external demands on their business. Lack of knowledge is a major cause of boards' strategic incompetence. It takes time to change both the mindset and behavior of a board so that its members become comfortable with their strategic roles and tasks and with regular and open review of their performance.

Notwithstanding their exemplary experience and qualifications, directors who do not come to board meetings fully prepared to discuss and act on the meeting agenda should either resign voluntarily or be removed by their fellow members. In an era when bad corporate governance is under attack and directors are being sued for failing to perform their fiduciary duties, a director who comes to board meetings unprepared should be told that his or her presence is no longer required and be invited to leave.

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Appendices

Appendix 1 ASX Corporate Governance Council - Good CG and Best Practice Recommendations http://www.shareholder.com/shared/dynamicdoc/ASX/364/ASXRecommendations.pdf Principle 2: Structure the board to add value Have a board of an effective composition, size and commitment to adequately discharge its responsibilities and duties. An effective board is one that facilitates the efficient discharge of the duties imposed by law on the directors and adds value in the context of the particular company’s circumstances. This requires that the board be structured in such a way that it: • has a proper understanding of, and competence to deal with, the current and emerging issues of the business • can effectively review and challenge the performance of management and exercise independent judgement. Ultimately the directors are elected by the shareholders. However the board and its delegates play an important role in the selection of candidates for shareholder vote.

How to achieve best practice Recommendation 2.1: A majority of the board should be independent directors3. Commentary and guidance Assessment of independence

An independent director is independent of management and free of any business or other relationship that could materially interfere with – or could reasonably be perceived to materially interfere with – the exercise of their unfettered and independent judgement. Disclosure of independence

The board should regularly assess the independence of each director in light of interests disclosed by them. So that it can do this, each independent director should provide to the board all relevant information.

Directors considered by the board to be independent should be identified as such in the corporate governance section of the annual report. The board should state its reasons if it considers a director to be independent notwithstanding the existence of relationships listed in Box 2.1. In this context, it is important for the board to consider materiality thresholds from the perspective of both the company and its directors, and to disclose these.

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The tenure of each director is important to an assessment of independence. The board should disclose the period of office of each director in the corporate governance section of the annual report. Where the independent status of a director is lost, this should be immediately disclosed to the market. Independent decision-making

All directors should bring an independent judgement to bear in decision making.

To facilitate this, there should be a procedure agreed by the board for directors to take independent professional advice if necessary, at the company’s expense.

Non-executive directors should consider the benefits of conferring regularly at scheduled sessions without management present. Their discussions can be facilitated by the chairperson or lead independent director.

Family ties and cross-directorships may be relevant in considering interests and relationships which may compromise independence, and should be disclosed by directors to the board.

Box 2.1: Assessing the independence of directors

An independent director is a non-executive director (ie is not a member of management) and:

1. is not a substantial shareholder of the company or an officer of, or otherwise associated directly with, a substantial shareholder of the company

2. within the last three years has not been employed in an executive capacity by the company or another group member, or been a director after ceasing to hold any such employment

3. within the last three years has not been a principal of a material professional adviser or a material consultant to the company or another group member, or an employee materially associated with the service provided

4. is not a material supplier or customer of the company or other group member, or an officer of or otherwise associated directly or indirectly with a material supplier or customer

5. has no material contractual relationship with the company or another group member other than as a director of the company

6. has not served on the board for a period which could, or could reasonably be perceived to, materially interfere with the director’s ability to act in the best interests of the company

7. is free from any interest and any business or other relationship which could, or could reasonably be perceived to, materially interfere with the director’s ability to act in the best interests of the company. The UK Higgs report nominates 10 years in relation to director tenure considerations, but has not yet been adopted in the UK. The Council will continue to monitor developments in other jurisdictions in this area.

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Recommendation 2.2: The chairperson should be an independent director. Commentary and guidance Role of chairperson

The chairperson is responsible for leadership of the board, for the efficient organisation and conduct of the board’s function, and for the briefing of all directors in relation to issues arising at board meetings.

It is important that the chairperson facilitate the effective contribution of all directors and promote constructive and respectful relations between board members and between board and management.

Where the chairperson is not an independent director, it may be beneficial to consider the appointment of a lead independent director.

It is vital that the chairperson commit the time necessary to discharge that role effectively. In that context the number of other positions, and time commitment associated with them, should be taken into account. Recommendation 2.3: The roles of chairperson and chief executive officer should not be exercised by the same individual. Commentary and guidance

There needs to be a clear division of responsibility at the head of the company.

The division of responsibilities between the chairperson and the chief executive officer should be agreed by the board and set out in a statement of position authority.

The chief executive officer should not go on to become chairperson of the same company. Recommendation 2.4: The board should establish a nomination committee. Commentary and guidance Purpose of the nomination committee

Particularly in larger companies, a nomination committee can be a more efficient mechanism for the detailed examination of selection and appointment practices meeting the needs of the company.

The existence of a nomination committee should not be seen as implying a fragmentation or diminution of the responsibilities of the board as a whole.

It is recognised that for smaller boards, the same efficiencies may not be apparent from a formal committee structure.

Composition of nomination committee

The nomination committee should: • consist of a minimum of three members, the majority being independent directors • be chaired by the chairperson of the board or an independent director.

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Charter

The nomination committee should have a charter that clearly sets out its role and responsibilities, composition, structure and membership requirements. Responsibilities

Responsibilities of the committee should include: • assessment of the necessary and desirable competencies of board members • review of board succession plans • evaluation of the board’s performance • recommendations for the appointment and removal of directors. Selection process

A formal and transparent procedure for the selection and appointment of new directors to the board helps promote investor understanding and confidence in that process. Director competencies

Corporate performance is enhanced when there is a board with the appropriate competencies to enable it to discharge its mandate effectively. An evaluation of the range of skills, experience and expertise on the board is therefore beneficial before a candidate is recommended for appointment. Such an evaluation enables identification of the particular skills, experience and expertise that will best complement board effectiveness.

The nomination committee should consider developing and implementing a plan for identifying, assessing and enhancing director competencies.

The nomination committee should also consider whether succession plans are in place to maintain an appropriate balance of skills, experience and expertise on the board. Composition and commitment

It is important that the board be of a size and composition that is conducive to making decisions expediently, with the benefit of a variety of perspectives and skills, and in the best interests of the company as a whole rather than of individual shareholders or interest groups. The size of the board should be limited so as to encourage efficient decision-making.

It is also important that individual board members devote the necessary time to the important tasks entrusted to them. In this context, all directors should consider the number and nature of their directorships and calls on their time from other commitments.

In support of their candidature for directorship, non-executive directors should provide the nomination committee with details of other commitments and an indication of time involved. Non-executive directors should specifically acknowledge to the company prior to appointment or being submitted for election that they will have sufficient time to meet what is expected of them.

The nomination committee should regularly review the time required from a non-executive director, and whether directors are meeting this. A non-executive director should inform the chairperson and the nomination committee before accepting any new appointments. Election of directors

The guidelines in Attachment A concerning notices of meeting are designed to facilitate better communication with shareholders. They contain guidance about how to frame resolutions for the election of directors.

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The names of candidates submitted for election as director should be accompanied by the following information to enable shareholders to make an informed decision on their election: • biographical details, including competencies and qualifications and information sufficient to enable an assessment of the independence of the candidate • details of relationships between:

- the candidate and the company - the candidate and directors of the company

• directorships held8 • particulars of other positions which involve significant time commitments • the term of office currently served by any directors subject to re-election • any other particulars required by law. Term of directorship

Non-executive directors should be appointed for specific terms subject to re-election and to the ASX Listing Rules and Corporations Act provisions concerning removal of a director.

Re-appointment of directors should not be automatic. Recommendation 2.5: Provide the information indicated in Guide to reporting on Principle 2.

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Guide to reporting on Principle 2 The following material should be included in the corporate governance section of the annual report: • the skills, experience and expertise relevant to the position of director held by each director in office at the date of the annual report • the names of the directors considered by the board to constitute independent directors and the company’s materiality thresholds • a statement as to whether there is a procedure agreed by the board for directors to take independent professional advice at the expense of the company • the term of office held by each director in office at the date of the annual report • the names of members of the nomination committee and their attendance at meetings of the committee • an explanation of any departures from best practice recommendations 2.1, 2.2, 2.3, 2.4 or 2.5.

The following material should be made publicly available, ideally by posting it to the company’s website in a clearly marked corporate governance section: • a description of the procedure for the selection and appointment of new directors to the board • the charter of the nomination committee or a summary of the role, rights, responsibilities and membership requirements for that committee • the nomination committee’s policy for the appointment of directors. Application of Principle 2 in relation to trusts

References to “board” and “directors” should be applied as references to the board and directors of the responsible entity of the trust.

There may be technical conflict in implementing the recommendations that the chairperson be an independent director or a lead independent director, where the responsible entity is a wholly-owned subsidiary of a fund manager and all the directors are employees of the parent. This should be discussed and clarified in any explanation of departure from the best practice recommendations included in the corporate governance section of the annual report.

Refer also to section 601JA(2) of the Corporations Act, which sets out the criteria for independence of a director of a responsible entity.

Note also that Part 5C.5 of the Corporations Act in relation to compliance committees for trusts provides under section 601JA(1) that a responsible entity must establish a compliance committee if less than half the directors of the responsible entity are external directors.

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Appendix 2 Adapted from Shultz S. F. The Board Book: Making Your Corporate Board a Strategic Force in Your Company's Success. New York: AMACOM, 2001, pg.53.

Questions to Ask Prospective Board Members

Why do you want to serve?

What is your opinion of our company? (Does she have some knowledge of how you compete, how you market, who the competition is, who your customers are, what your employee profile is, how you use your board and what your critical issues are?)

How will you contribute? Examples.

What are your specific areas of expertise? How will those add value to the board?

What is your financial acumen? Each director does not need to be an accountant. She must, however, have the ability to monitor and steward resources.

How many other boards do you sit on? For profit and not for profit. What role do you play on those boards?

What is your view of the role of a board and corporate governance?

Do boards add value? How?

What are the downsides?

How do you use your board? (If applicable.)

What is your most rewarding experience on a board?

How specifically have you added value? Examples.

What is your most difficult experience as a director?

Are you willing to commit to the level of participation and support that we need?

What committees would you like to sit on? Why?

Do you prefer to be compensated in stock or cash? (Nell Minow says if directors don't think that your company is the best investment they could possibly make, they should not be on the board. This includes being willing to buy stock in a turnaround situation. If they don't have enough confidence in the company to buy stock, how can they add value as a board member?)

Are your goals and values compatible with those of our organization? Describe.

What are your concerns?

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Appendix 3 (Ernst & Young: Effective Governance Model - An Operating Framewok) http://www.ey.com/global/content.nsf/Australia/AABS_-_Effective_Governance_Model

The following information must be disclosed in the corporate governance section of the annual report. This information is in addition to any disclosures, which may be made in order to explain departures from best practice Recommendations.

1. The skills, experience and expertise relevant to the position of director held by each director in office at the date of the annual report.

2. The names of the directors considered by the board to constitute independent directors and the company’s materiality thresholds.

3. A statement as to whether there is a procedure agreed by the board for directors to take independent professional advice at the expense of the company.

4. The term of office held by each director in office at the date of the annual report.

5. The names of members of the nomination committee and their attendance at meetings of the committee.

6. Details of the names and qualifications of those appointed to the audit committee, or, where an audit committee has not been formed, those who fulfill the functions of an audit committee.

7. The number of meetings of the audit committee and the names of the attendees.

8. Whether a performance evaluation for the board and its members has taken place in the reporting period and how it was conducted.

9. Disclosure of the company’s remuneration policies including the costs and benefits of the policy and the link between performance and remuneration.

10. The names of the members of the remuneration committee and their attendance at meetings of the committee.

11. The existence and terms of any schemes for retirement benefits, other than statutory superannuation, for non-executive directors.

In addition to the mandatory disclosure, the CGC provides guidance on how to report on each Principle. In all cases a departure from a recommendation must be adequately explained.

Finally, the CGC also requires that various information be made publicly

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available, ideally on the company’s website in a clearly marked “corporate governance section”.

The following information must be made publicly available. Where a company does not have a website, this information must be made available by other means. For example, a company may provide the information on request by email, facsimile or post.

The statement of matters reserved for the board or a summary of the board charter or the statement of delegated authority to management.

A description of the procedure for the selection and appointment of new directors to the board

A copy of the charter of the nomination committee or a summary of the role, rights, responsibilities and membership requirements for that committee

A copy of the nomination committee’s policy for the appointment of directors.

The company’s code of conduct or a summary of its main provisions.

The company’s policy regarding trading in the company’s securities by directors, officers and employees.

Information about the procedures the company has for selecting and appointing the external auditor, and for the rotation of the audit engagement partners.

A summary of the policies and procedures the company has in place to ensure compliance with listing rule disclosure requirements.

A description of the arrangements the company has to promote communication with shareholders.

A description of the company’s risk management policy and internal compliance and control system.

A description of the process for performance evaluation of the board, its committees and individual directors and key executives.

A copy of the charter of the remuneration committee or a summary of the role, rights, responsibilities and membership requirements for that committee.