(August-2002) Protection and profit

Over the past forty years, the nature of share-ownership has undergone a significant shift. What used to be a large number of individuals owning a small amount of shares each has now become fewer entities owning a much larger amount each. As a natural consequence, institutions that invest money in shares, either directly or indirectly, on behalf of their clients or members, are facing up to higher levels of responsibility in monitoring the actions of corporate Australia. As the value of funds invested through Australian super funds increases, trustees are taking their fiduciary duties more seriously by implementing various corporate governance strategies to positively effect corporate outcomes for their shareholder members.

“Trustees are reflecting the growing community concern over corporate standards and the need for improved regulatory, ethical, and transparent behaviour on behalf of the business community. Most Australians now have a direct financial stake in the operations of our major companies,” notes Michael O’Sullivan, president of the Australian Council of Superannuation Investors (ACSI).

Exemplifying the growing interest in corporate governance, the ACSI, formed in 2001 by several super funds and industry bodies to provide independent information on corporate governance issues, recently held its inaugural conference in Melbourne for superannuation trustees to explore this area.

Corporate governance in Australia

Historically, Australia has been a very different from other markets around the world, says Sandy Easterbrook, principal of Corporate Governance International (CGI). But he says: “The corporate governance ball was first picked up by fund managers, rather than the large superannuation funds, as was the case in the US and UK.”

When the Australian Investment Management Association (AIMA) was initially formed, its main plank was corporate governance. “It used to be the case that fund managers led the way in corporate governance, but this is no longer the case,” says Easterbrook.

Over the past decade or so, changes in the industry have taken place which have meant that corporate governance is not as high on the agenda as some people believe it should be.

One of the major changes in recent times is the increasing number of public floats and amalgamations of fund managers, which has meant a rise in large, multifaceted companies. This is leading to an acceleration in conflict between the funds management arm and the corporate finance arm of firms. “This is quite a sea change since the mid-90’s,” says Easterbrook.

What’s a trustee to do?

“Up until now, superannuation trustees have not taken corporate governance very seriously, but because of the recent corporate disasters, such as Enron in the United States, and One.tel and HIH in Australia, trustees are realising that they need to know that companies are being properly run,” says Susan Ryan, president of the Australian Institute of Superannuation Trustees (AIST),

However, says Easterbrook, trustees are in a difficult position. “There is a lot of pressure placed on fund managers in regard to the fees that they charge, so what ends up happening is that corporate governance supervision ends up coming out of the fund managers’ pocket.”

“Trustees need to be told that corporate governance is their responsibility. If trustees don’t do it, no one else will,” he adds. And, it will be the shareholders who stand to lose out.

Corporate governance activism could be an important part of a fund’s strategy on managing its investment risks, says Phillip Spathis, executive officer of ACSI.

While good corporate governance in a listed company on it own does not guarantee against poor performance, having effective tools that apply additional scrutiny will enable the trustee to better form an opinion on the level of risk it is prepared to tolerate, he adds.

“This is consistent with a trustee’s prudential and fiduciary obligations, to protect and advance the financial interests of members of the fund.”

There are several ways in which trustees can become active in corporate governance issues. While the most visible way to take action is through proxy voting, Anne-Marie Corboy, CEO of HESTA, adds that trustees should take care not to take a “one size fits all” approach.

Various factors, such as fund size and investment strategy, can help determine what approach a fund should take to corporate governance issues.

An alternative to voting, says Spathis, is for a fund to adopt formal or informal engagement with a company.

“The trustee or their representatives, enter into dialogue with the companies they invest in on corporate governance issues,” he says. “The object of engagement is to ensure that company directors and management are aware of specific concerns of the trustees through a means of constructive dialogue.”

Divesting from an investment, or not investing at all, is also an option.

Issues such as auditing regulations, independence and fees, CEO pay patterns, and board composition are attracting a great deal of interest amongst trustees who are concerned about effects these issues may have on the operation and performance of a firm.

With an increasing trend towards outsourcing, trustees have less knowledge about a growing area of detail in regard to investments. Trustees need to monitor fund managers to make sure corporate governance issues are being appropriately and adequately addressed.

If much of the responsibility for corporate governance is given to fund managers, then it is important to carry out two steps, says Don McLay, managing director of the Australian Focus Fund.

Firstly, funds need to have a strategy. Secondly, they need to vote.

In delegating corporate governance to a fund manager, you have to check that the fund manager is actually doing something. Trustees should make their expectations clear in terms of how they want to manage corporate governance issues. They can request a record of how the fund manager has voted, or why they voted a particular way. They can also stipulate a default voting position, such as voting in accordance with the CGI recommendation.

Tools of the trade

Over the past 12 months several tools have become available to help trustees navigate through the territory of corporate governance.

A new governance rating system released by CGI, which aims to help trustees and fund managers identify and react to governance issues in major listed companies, was launched at the end of 2001. The governance assessment takes into account various factors including a company’s board structure, its policy on disclosure and its remuneration practices.

In addition, CGI is currently speaking to super funds about a new product it is marketing. The product will give funds “selective snippets” and useful reports on a number of companies to help trustees understand what issues they need to be aware of. CGI hopes that this products will also help educate trustees about what corporate governance is all about and give them the tools to hold fund managers to account.

AIST is also planning a series of workshops at the end of the year for trustees, to discuss what they can do in this area and the steps they can take.

At the same, time several custodians have introduced services which help trustees keep tabs on how their managers are embracing corporate governance and voting proxies.

In a first for Australia, the Australian Focus Fund, which is still in the fundraising stage of development, is another tool for trustees. The fund focuses on poorly performing companies and aims to improve their corporate governance. The fund will be managed by Vertex Capital Management and advised by CGI.

“Australia is well behind in terms of Western world involvement in corporate governance issues,” says Don McLay. US pension funds have been very active for a number of years as have UK funds.

Recent research has shown that there is a clear correlation between a firm’s corporate governance profile and its share price. Two recent examples are Mayne Nickless (on the negative side) and Orica (on the positive side).

“People are prepared to pay a premium on a company that has good corporate governance,” adds McLay. And, this premium ranges from 18 per cent in the Western world to 28 per cent in emerging markets.

“People are starting to see that corporate governance is not just about doing the ‘right thing’, but that there are real bottom line outcomes.”

Where to from here?

The signs are very encouraging. Trustees are demonstrating a very strong willingness to learn and understand. And, many of them are on a very fast learning track. But they want examples of what other funds are doing in the corporate governance arena.

One of the significant issues is the education of trustees. Trustees have a lot of power that they have never exercised before, says McLay.

In the past, shareholders have been treated like mushrooms, he adds. But if the trend continues, superannuation fund trustees will ensure that their members are no longer kept in the dark.