Rethinking the Corporate Governance Model


Australia is known as a large and innovative financial market with well-established financial institutions and fast growing fintech firms.

However, recent findings of both the Productivity Commission on the Australian financial system and the Royal Commission into the Financial Services Industry have shown that there are weaknesses in terms of corporate governance in the system to be addressed. The weaknesses, if not addressed, could be even more severe within firms with new business model, new risky asset classes and new market structure, putting investors’ wealth and integrity of the system at risk.

More corporate governance challenges heading to the boardroom 

In the backdrop of declining trust in big business, the UK Financial Reporting Council (FRC) released the new UK Corporate Governance Code (the new code) in July this year, leading another series of corporate governance code revision around the globe. Australia will soon follow.

‘Shorter and sharper’ as introduced, the new UK code, on a “comply or explain” approach, emphasises the responsibility of the board in establishing the company’s purpose, strategy, and corporate culture that ensure the company fulfils the expectation of shareholders and stakeholders and contributes to wider society.

The same trend is reflected in the consultation documents for the proposed fourth edition of the Corporate Governance Principles and Recommendations by the ASX Corporate Governance Council. The consultation draft introduces the concept of a “social licence to operate” (in the commentary of Principle 3 – Instil the desired culture) to highlight to the board and management of listed entities their social responsibility to act in the best interest of a broad range of stakeholders including shareholders, employees, customers, suppliers, creditors, regulators, consumers, taxpayers and the local communities.

This is the first time such terms as company’s “purpose”, “culture”, “stakeholders” and “society” have appeared in the main text of the principles and provisions of the UK Code and the ASX’s proposed fourth edition. The new code specifically asks companies to design effective mechanisms for stakeholder engagement to understand the views of the key stakeholders and report how such views and interests have been considered in board discussion and decision-making. The move of the typical Anglo-Saxon market toward recognising the importance of key stakeholders in the long-term sustainable success of the company reminds us of the once long debate between the shareholder wealth maximisation model versus the stakeholder capitalism model.

Stakeholder capitalism rise with shareholder activism

An interesting combination has also been witnessed when large investors themselves are demanding companies to think beyond delivering financial returns. Among the most influential voice was the letter that the CEO of Black Rock sent to its investee companies worldwide asking them to identify the social purpose they choose to serve.

The call for companies to care more about other stakeholders, not just shareholders, from the largest investment manager in the world with $6.3 trillion of AUM, certainly means serious change on the board agenda. Large investors in the market are adding big questions to their checklist when meeting with board of their portfolio companies. The board could be challenged about how their company’s purpose, strategy and culture incorporate the interest of all key stakeholders and the society at large. Companies that fail to answer these key questions may be perceived as lacking commitment to sustainable development, and thus, may earn less faith from investors.

Large investment managers like Black Rock and Vanguard are becoming more activist by signalling that shareholders no longer remain complacent with problems of weak governance driven by short-term opportunistic behavior. Actions speak louder. They have expanded the investment stewardship team to ensure more productive engagement with companies, even those of index funds. With publicly available data of companies’ resolutions receiving 20% or more of votes cast against the resolution, launched by the UK Investment Association in 2017, investors take their votes more seriously and also demand companies to take more explicit actions to respond to shareholders’ dissatisfaction.

Asking companies to respond to broader challenges to preserve their social licence to operate, investors are becoming more socially responsible. The latest figure of total sustainable investing, as reported by Morgan Stanley Institute for Sustainable Investing, was $9 trillion[1]. Investors themselves have become the catalyst for businesses to change by developing measures to assess companies on ESG (Environmental, Social and Governance) criteria as well as ESG performance of funds. An example is the Morningstar’s sustainability ratings, available since 2016. Companies need to understand that irrespective of it being negative screening or positive screening, these investors are proactively integrating ESG factors into the valuation exercise of the firm.

The question is that whether investors, after making such a tough call, are really committed to support companies through their quest for long-term sustainable financial returns and social returns. Of all shareholders out there, how many short-term optimisers could really transform themselves to patient capital providers?

[1] According to the Morgan Stanley Institute for Sustainable Investing (Feb, 2018)

This article was originally posted on the CFA Institute’s Asia-Pacific Research Exchange. Click here.

Nga Pham is a senior research officer at the Australian Centre for Financial Studies, Monash Business School. Nga is a consultant for the International Finance Corporation, a member of the World Bank Group, in the area of corporate governance.